Cambodia—Letter of Intent, Memorandum of Economic and Financial Policies
January 17, 2003

The following item is a Letter of Intent of the government of Cambodia, which describes the policies that Cambodia intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Cambodia, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

Economic performance in 2002 has been in line with program objectives and all quantitative performance criteria for end-September, 2002 and the structural performance criterion for end-October have been met. While structural benchmarks were largely met, some delays have occurred with respect to the centralization of accounting in the National Treasury, implementation of a new chart of accounts for fully licensed banks, and reducing the average tariff to below 15 percent.

On the basis of corrective actions being taken as detailed in the attached Memorandum of Economic and Financial Policies (MEFP) for 2003, we hereby request completion of the sixth review under the PRGF arrangement.

The government believes that the policies and measures described in the attached memorandum, complemented by a comprehensive Technical Cooperation Action Plan, are adequate to achieve the objectives of the program for 2003, and stands ready to take any additional measures beyond the current program that may become necessary for this purpose. During the remaining period of the current PRGF arrangement, the Government will consult with the Managing Director, at the initiative of either party, and will provide the IMF with such information as it requests on the progress made in policy implementation and the achievement of program objectives.

In continuing with our policy of transparency, we consent to the publication, including on the IMF's website, of the attached MEFP and the accompanying Executive Board documents prepared by the IMF staff. In addition, we will publish the audited accounts of the NBC for 2002, in compliance with the requirements under the IMF's Safeguards Assessment.

Sincerely yours,

/s/ Keat Chhon Senior Minister Ministry of Economy and Finance

/s/ Chea Chanto Governor National Bank of Cambodia

CAMBODIA
Memorandum of Economic and Financial Policies for 2003

January 17, 2003

1. Cambodia's medium-term economic objectives remain broadly unchanged from those described in the Letter of Intent (and related MEFP) of June 21, 2002. It aims to reduce poverty through sustainable growth. An annual growth target of 6-7 percent could be achieved in the medium term through capital deepening, upgrading of labor skills, and improving governance. Increasing fiscal revenue will be key, in addition to reorientation of spending, to provide adequate social spending and infrastructure while avoiding recourse to domestic bank financing, essential for maintaining macroeconomic stability. With decisive actions on tax and customs administration and tax policy aimed at broadening the tax base, government revenue could reach 14½ percent of GDP in 2006-07. The external current account deficit (excluding grants) is expected to marginally decline to around 10 percent of GDP, a level that is consistent with projected concessional financing and foreign direct investment, and maintaining gross international reserves at about 3-4 months of imports of goods and services.

Policies for 2003

2. Despite a weak global economic outlook, real GDP growth is expected to pick up to about 5 percent while inflation could be kept under 4 percent, underpinned by fiscal discipline. The current fiscal surplus is projected to increase to about 1 percent of GDP, and the overall deficit (excluding grants) to 6⅓ percent of GDP, financed largely by external concessional resources. The monetary targets are established on the basis of a declining money velocity in response to increased confidence in the banking system. The external current account deficit of 10½ percent of GDP and reserves equivalent to 3¼ of imports of goods and services are expected to remain broadly unchanged.

3. On the basis of the lower-than-expected revenue collected in 2002, the 2003 revenue target will likely be missed by ½ percent of GDP. Additional efforts will be made to collect tax arrears of CR 40 billion, and to improve tax and customs administration (CR 15 billion). These efforts will be built on a revenue base that include the collection of nontax arrears in 2002 consisting of: (i) collection of all outstanding forestry royalties identified in the June 2002 audit (CR 1.5 billion); and (ii) arrears from civil aviation (CR 8.5 billion). Progress will also be made in collecting arrears on leases of state assets. Together with higher-than-budgeted foreign financing, budgeted spending obligations could be met.

4. The customs and tax departments, as well as the National Treasury (NT), will upgrade information systems and strengthen enforcement measures. The internal audit function of the audit units of the customs and tax departments and the NT will be strengthened to address integrity issues within their respective agencies. Priority will be given to automation of customs administration which so far has proved to be a serious bottleneck to enhancing the capacity of the customs department. Anti-smuggling operations will be further strengthened through making units in key border provinces fully operational. Penalties for offenders will be stiffened, including through seizure of goods at customs on importation and exportation. Regarding the tax department, priority will be given to increasing staff working on collection enforcement, and audit of tax payers. To substantiate tax department's resolve to strengthen enforcement measures especially against those with tax arrears, about five to ten bank accounts will be frozen, exportation/importation of goods will be held at the customs department until outstanding amounts are paid, and licenses cancelled in collaboration with the Ministry of Commerce. Efforts will be made to put in place an operational management information system in the tax department. In addition, all contracts involving the use of state assets will now require MEF approval.

5. Expenditure management will be improved which will also help to ensure the effective reorientation of spending toward priority sectors. Spending on priority social sectors will increase to 3¾ percent of GDP, and the second phase of demobilization involving discharging 15,000 additional soldiers is expected to be completed by the third quarter of 2003. To improve accounting and budget execution procedures, the government will finalize monthly revenue flow estimates and ministries' spending plans for 2003 for notification to ministries before January 1 to enable commitments to start flowing from as close to the beginning of the year as possible. At the same time, the government will endorse and start implementing the recommendations prepared by the Working Group at the National Treasury while efforts to centralize government accounts will continue, and increased use of the banking system will be made for government financial transactions.

6. The monetary targets for 2003 are consistent with growth and inflation objectives. The government will adhere to these targets (see paragraph 10) and maintain a flexible exchange rate policy, within the intervention policy aimed at building up official reserves. It will not contract or guarantee any nonconcessional debt and make best efforts toward resolving outstanding debt issues with the Russian Federation and the United States.

7. Trade reform is moving forward and progress has been made toward joining the WTO. The conversion of the tariff classification to the ASEAN Harmonized Tariff Nomenclature (AHTN) was completed by end-2002. The government will reduce the unweighted average tariff rate under the AHTN to about 15 percent under the AHTN (or below 15 percent under the old system), while offsetting revenue measures will be introduced to contain revenue loss to below CR 1 billion.

8. The Government is maintaining the momentum of banking sector reform. The National Bank of Cambodia (NBC) will allocate adequate staff resources to (i) start on-site inspection of banks with the objective of completing at least 6 banks in 2003 and thereafter all banks once a year, except for micro-financing institutions which could be on a longer cycle, and (ii) verify and guide, if needed, the full implementation of banks of the new chart of accounts according to which each bank should submit their monthly financial statement to NBC starting in July 2003. A public notice announcing the intention to privatize the Foreign Trade Bank (FTB) was issued in December. FTB's reform committee will continue its work to make the bank commercially viable, but sell at any point of the restructuring process to a strategic investor offering an appropriate price.

9. The suspension of logging activity will remain in place, but monitoring log transportation and overall forest crimes is a challenge. Restructured concession agreements in line with sustainable practice have been delayed and are now expected to be completed by June 30, 2003. All log transportation by, or on behalf of, concessions will continue to be suspended until the management plans and agreements on restructured concessions are in place.

10. To monitor economic and financial performance during 2003, the government has set up structural and quantitative indicative targets. The structural indicative targets will focus primarily on improved revenue mobilization, budget implementation, and forestry reforms (Table 1). Quantitative indicative targets through end-December 2003 include (Table 2): (i) a ceiling on the net domestic assets of the NBC; (ii) a ceiling on net bank credit to the government; (iii) a ceiling on net domestic financing of the budget; (iv) a zero ceiling on publicly contracted or guaranteed nonconcessional foreign currency loans; (v) no accumulation of external arrears; and (vi) a floor on the net official international reserves of the NBC.

Table 1. Structural Policy Targets for 2003 Program
Indicative Policy Targets		Completion date
Collect
Tax arrears of CR 40 billion (excluding penalties and late interest)		During 2003
Remaining forestry royalties identified in the June 2002 audit of CR 1.5 billion		December 31, 2002
Outstanding transfers from civil aviation of CR 8.5 billion		December 31, 2002
Outstanding transfers from the Gateway II operation of US$4.7 million		December 31, 2002
The Fiscal Reform Working Group (to be convened by mid-December) will discuss the selection of an IT system for the customs department and possible sources of financing. On the basis of the discussion, the government will set a timetable for implementation.		December 31, 2002
Adopt the recommendations contained in the report of the working group in the National Treasury on standardized accounting procedures and methodology that was finalized in October, after incorporating IMF staff's comments, and start implementation.		February 1, 2003
Reduce unweighted average tariff under the current tariff schedule containing 6,823 tariff lines to below 15 percent (which should be equivalent to about15 percent under the ASEAN Harmonized Tariff Nomenclature), and implement offsetting revenue measures to contain revenue loss to below CR 1 billion.		June 30, 2003
Complete implementation of the new charts of accounts for all fully licensed commercial banks.		July 31, 2003
Maintain the suspension of logging activity until the management plans and agreements on restructured concessions are in place.		Countinous

Table 2. Cambodia: Quantitative Indicative Targets, 2003
	2002 End-Dec. Est.		2003
			End-Mar.		End-June		End-Sept.		End-Dec.
			Prog
			(Cumulative change from beginning of year)
Net domestic assets of the central bank    (in billions of riels)1,2	-1221		-20		-22		-24		-6
Net credit to the government from the banking    system (in billions of riels)2	-95		-20		-20		-20		0
Net domestic financing of the budget    (in billions of riels)2	-50		-40		-40		-40		-20
Contracting or guaranteeing of external    debt by the public sector3
Up to one-year maturity4	0		0		0		0		0
1-5 year's maturity	0		0		0		0		0
Medium-and long-term nonconcessional debt5	0		0		0		0		0
External payments arrears 6	0		0		0		0		0
			(Cumulative change from beginning of year)
Net official international reserves    (in millions of U.S. dollars)7	549		14		27		40		50
			(Cumulative change from beginning of year)
Memorandum items:
Foreign currency budget/BOP support    (in millions of U.S. dollars)	17		20		25		30		55
Total nonproject budget support    (in billions of riels)	185		83		126		169		289
		(Stock at end of period)
Net domestic assets of the central bank    (in billions of riels)	-1,221		-1,241		-1,243		-1,245		-1,227
Net credit to the government from    the banking system (in billions of riels)	-95		-115		-115		-115		-95
Net official international reserves    (in millions of U.S. dollars)	549		563		0		0		0
		(At end of period)
Exchange rate (riels per U.S. dollar,    end of period)	3,900		3,986		4,023		4,059		4,095
Sources: Data provided by the Cambodian authorities; and Fund staff estimates. 1Net domestic assets are defined as reserve money minus net foreign assets of the central bank, adjusted for valuation changes arising from the difference between projected and actual exchange rates. 2 The ceiling for net domestic assets, net credit to the government from the banking system, and net domestic financing of the budget will be adjusted upward (downward) by any shortfall (excess) in total nonproject budget support from the indicative targets. The adjustments for shortfalls in nonproject budget support will not exceed $10 million. 3Maturity based on original contract. 4Ceiling applies to amount outstanding. Excludes normal import-related credit and any borrowing associated with debt rescheduling. 5Excludes amounts contracted under the government loan agreement with China dated July 26, 2000 for a maximum loan amount equivalent to $12 million. 6Continuous indicative target. 7The floor on net official international reserves will be adjusted downward (upward) by any shortfalls (excess) in external nonproject budget support from the indicative targets. The adjustments for shortfalls in budget support will not exceed $10 million. Valuation effects on the stock of gold holdings are excluded, and gold holdings in 2002 and 2003 are evaluated at the end-December 2002 gold price.