ADDRESS BY

ADDRESS BY

Mr. KEAT CHHON

Sir. MINISTER

MINISTER OF ECONOMY AND FINANCE

Royal Government of Cambodia-Donor Monitoring Meeting

Phnom Penh, 16 January 2001

"ECONOMIC AND FINANCIAL MANAGEMENT: CHECIONG PERFONIRANCE AGAINST GOALS AND FUTURE ACTIONS"

1. Since we met in June 2001 in Tokyo during the CG Meeting, the Royal Government of Cambodia (RGC) has taken strides to implement its political platform and reform programs, aimed at sustaining economic growth, reducing poverty, and accelerating economic reconstruction, maintaining macroeconomic stability, strengthening the banking and financial institutions, implementing additional fiscal reform measures, ensuring a sound management of public property and increasing public investment in physical and social infrastructure and human resource development, while enhancing the implementation of the Governance Action Plan (GAP) and the Interim Poverty Reduction Strategy Paper (IPRSP). In particular, in all its actions and endeavors, the RGC has stuck to the recommendations made at the CG Meeting. Now it is time to check performance against goals.

2. Economic developments during the first three quarters of 2001 have generally been favorable, but growth declined in the fourth quarter, owing to the deterioration in the world economic environment. Garment exports and tourist arrivals increased strongly through September. The tragic events of September 11 have had negative impacts on the short-term economic outlook. The potential indirect effects of the attacks - on consumer sentiment and spending, on business confidence, and on risk aversion - are likely to be significantly more important. Less U.S. consumption means depressing exports from Asia, including Cambodia. There are at least three channels, through which the 11 September terrorist attacks will impact growth in Cambodia: (i) the performance of the tourism sector (considered as export of services); (ii) the performance of the garment industry; and (iii) the regional linkages. To cope with the aftermaths of the attacks the RGC has made considerable efforts to attract tourists, mainly from Asia. As a result, real GDP growth for 2001 is estimated at 5.3 percent compared to 6 percent previously projected, and inflation is anticipated to be 0 percent.

I Actions and Economic and Fiscal Performance in 2001

3. Fiscal performance in 2001 has broadly been good, with improved revenue mobilization and expenditure restraint. The budget execution data, however, is provisional on both the revenue and expenditure sides. The Budget System Law provides for a complementary period until end February to finalize all treasury operations. The 2001 Budget was implemented cautiously to make room for financing the commune elections and to reach the targeted fiscal balance. Moreover, increased spending on flood relief in 2000 has had a major impact on the financing situation in 2001.

4. Domestic tax revenue increased modestly compared to 2000. In nominal terms, domestic revenue increased 7 percent. Current revenue increased also 9 percent, compared to 2000, reflecting increased collection of non-tax revenue. This largely reflects a boost in domestic tax revenue from additional measures introduced in the second half of the year. The overall revenue performance, however, has been adversely affected by shortfalls in excise revenue collection, following the increase in excise rates. Though this is only a temporarily problem. The international trade tax collection has met the budgetary target. Overall expenditure has been contained below targets, thus contributing to the avoidance of domestic budget financing. Although progress has been achieved in reorienting government spending away from defense and security, social sector spending has remained short of expectations, reflecting primarily inefficient cash management procedures among line ministries at the national and provincial levels. Moreover, expenditure for 2000 and 2001 flood relief and for organizing the commune council elections have put an additional constraint on budget execution in 2001. But, the overall fiscal deficit (excluding grants) was contained at 5 percent of GDP, while the current surplus was maintained at 1½ percent of GDP.

5. Progress has been made in implementing fiscal reforms in 2001. Following are key policy actions taken by the Ministry of Economy and Finance in 2001 to enhance revenue collection and strengthen governance:

· Treat all diesel sales as final sales for VAT purposes;

· Unproved enforcement of the 10 percent tax on entertainment services;

· Implement stamp system for taxes on cigarettes;

· Establish a Large Taxpayers Unit (LTU), with the direct payment by cheek or transfer to the National Treasury accounts at the NBC for the largest taxpayers; and

· Reduce the number of tariff bands from 12 to 4 and lower the maximum tariff rate to 35 percent, with associated increase in excise rates in the context of tariff restructuring;

· Conducting a study on the viability on the expansion of the real regime to another five provinces. The real regime has been expanded in 2001 to five provinces: Sihanoukville, Battambang, Siem Reap, Kompong Cham and Koh Kong.

· Expansion of VAT coverage to include 150 additional firms.

· Preparing for implementation of government decision (by Prime Ministerial Order), which specifies the means for strengthening inter-agency cooperation to reduce smuggling, and detailing assistance requirements and practical arrangements wnong the Customs Department, the Armed Forces, the Military Police, the Police and the local authorities.

6. As part of additional revenue measures, the Ministry of Economy and Finance (MEF) has taken the following steps to recover non-tax revenue:

· Reinforce procedures to collect tax and nontax arrears, especially the arrears on telecommunications and from state assets;

· Improved collection of visa fees and introduce a sticker visa;

· Review the contract on the sale of tickets to the Angkor temple complex;

· The establishment of a taskforce between the MEF and the line ministries to provide for a monitoring mechanism for leases of state assets and increase efforts to collect arrears and payments due on leases of state assets;

· Initiate inventory of state assets;

· Prepare the assessment report with the Ministry of Post and Telecommunications in order to review the contract for the second international gateway and to ensure appropriate transfer of revenue to the budget.

7. Having taken the above revenue-enhancing measures, domestic revenue was 7 percent above last year. This was due to an improvement of current revenue collection specifically are non-tax revenue which almost 19 percent higher than the year 2000, mostly come from civil aviation (40 billion CRs compared to 25 billion CRs in the previous year), tourism income (14 billion CRs compares to only 6 billion CRs in the previous year); visa .fees (27 billion CRs compared to 20 billion CRs in the previous year), post and telecom (31 percent higher than in the previous year), casino royalties (20 billion CRs); and quota (104 billion CRs compared to 88 billion CRs in the previous year).

8. Tax revenue collection increased modestly and was only 5 percent higher than last year, mostly attributed to the payroll tax (44 percent above last year), excise (37 percent above last year), VAT (7 percent above last year) and international trade tax (a slight reduction of 4 percent). The tax shortfall was 92 billion CRs, due to the mediocre performance of excise collection. As part of the tariff restructuring, the maximum tariff rate was reduced to 35 percent and the tariff bands were streamlined from 12 to 4. To offset customs tariff reduction, the government increased the excise rates. Combined together international trade tax and excise collection increased by 5 percent, partly due to an abnormal increase in the imports of petroleum products in December 2001, in anticipation of an introduction of an additional petroleum tax in 2002. Such an increase will have an impact on the collection of international trade tax in the first quarter of 2002. It is also important to highlight the fact that with the expansion of the real regime to five provinces, domestic VAT collection increased by 17 percent. The collection of profit tax experienced a decrease of 2 percent, due to arrears recovery in the previous year. Turnover tax collection decreased by 23 percent compared to the previous year, as more companies are transferred from the estimated to the real regime.

9. On the expenditure side, the following actions have been taken to improve public expenditure management:

· Continue to remove ghost workers and ghost soldiers from civilian, defense and security payroll;

· Improve spending priorities by providing adequate funding and meet budget targets for spending on social and economic sectors, such as health, education, agriculture and rural development;

· Introduce the Priority Action Program (PAP) to increase budget disbursement to the priority sectors;

· Increase public investment in rural infrastructure;

· Repair and maintain national roads and bridges and strengthen institutional capacity;

· Strengthen budget procedures to strictly limit spending decisions outside the budget framework;

· Establish responsibility for performance at the level of spending units in parallel with the strengthening of technical, financial and managerial capacities.

· Establish proper audit/accounting system.

10. Expenditure has been contained below budgetary targets, reflecting revenue shortfalls. Current revenue has been squeezed to 87 percent of the budget. However, as the total of domestically financed investment expenditure and debt amortization was higher than the current budget surplus, it creates an additional tension for budget execution as a whole. Locally financed capital expenditure increased robustly by 9 percent. The current expenditure increased by 6 percent, due to higher civil administration expenditure. Commune election spending was the main factor contributing to the increase in civil administration expenditure. At the same time, defense and security spending experienced a further decline of 6 percent.

11. Monetary developments in 2001 have reflected the improved fiscal position. Broad money growth is estimated to grow by 22 percent in 2001, largely owing to increased foreign currency deposits, while continued fiscal restraint has provided room for private credit to increase by 10 percent. Gross international reserves are expected to reach the equivalent of about 3 months of import coverage at end-2001. The market exchange rate has been broadly stable against the U.S. dollar and in real effective terms. Despite the recent deterioration in the outlook for garment exports and tourism receipts, the current account deficit in 2001 (excluding official transfers) is expected to be smaller than previously projected (10 percent of ODP) reflecting the strong performance in the first nine months.

II. The 2002 Finance Law: Targets and Measures

12. The macroeconomic outlook for 2002 is estimated to be affected by the current deterioration in the world economic environment. Under the revised macroeconomic framework for 2002, ODP growth is projected to slow down to 4½ -5 percent, compared to 6 percent previously projected. The anticipated lower economic growth is expected to result in reduction in the growth of garment exports and tourism earnings. Inflation, however, is expected to remain below 5 percent. The current budget surplus will be maintained at about 1½ percent of GDP, while the overall fiscal deficit (excluding grants) will be contained at less than 6 percent of GDP and financed by external concessional resources and grants. The external current account deficit is projected to widen to 11 percent, as against 9¾ percent programmed before the external shock. Also taking into account the deterioration in the international environment, the increase in gross international reserves in 2002 is targeted at $55 million, which would maintain gross reserves at about 3 months of imports.

13. Rice remains a determining factor in the growth of the agricultural sector. Considerable efforts have been deployed after the 2000 and the 2001 floods so that this sector experience a growth rate of 4.6 percent, with other crops growing at 6.5 percent. There will be almost no tree cutting in 2002, as the management plans submitted by concession companies did not meet the standards allowing for sustainable practices. TO maintain growth in the primary sector the RGC has taken steps to promote the development of agriculture and agro-based industries. Industry has been one of the main engines in driving the increase in output, growing by a lower rate of 7 percent, mainly due to the slowdown in growth and investment in export-oriented industries such as garment and footwear (6.5 percent). Construction activity, which is the second largest sub-sector, will increase by 10.8 percent. Services output will expand by 8 percent, supported by an increase in trade and by a robust influx of tourists. Tourism related activities - hotels and restaurants - will continue to display a remarkable dynamism. With the "open sky policies", visitor arrivals are expected to pick up in 2002. This is one of the most promising sectors of the economy with great potential to grow in the future. It creates numerous jobs every year and is having a multiplier effect on other sectors of the economy.

14. Spending priorities for the 2002 budget will be the following: (i) holding the commune elections; (ii) implementing the full demobilization program; (iii) carrying out the Governance Action Plan (GAP); and executing the Interim Poverty Reduction Strategy Paper (IPRSP) by shifting further spending priorities from defense to social and economic sectors. The budget strategy will be geared towards further enhancing the mobilization of tax and non-tax revenues to meet the target of 13 percent of GDP through rigorous implementation of existing fiscal measures and the introduction of new tax policies.

15. Achieving the revenue target of 13 percent of GDP in 2002 is crucial for meeting expenditure needs. This target is expected to be met through a combination of new revenue measures, and the full-year impact of measures introduced in the second half of 2001. The newly created Large Taxpayer Unit (LTU) in conjunction with upgraded auditing will be instrumental in enhancing tax revenue collection in the period ahead. Following are the steps to strengthen collection enforcement:

· The LTU will identify the largest arrears, investigate relevant information concerning each of these arrears, take corrective actions to begin to collect these arrears;

· Review tax legislation to ensure that enabling authority to take appropriate collection action.

· Complete an inventory of state assets involving all ministries and assets will be confiscated from companies with arrears to the government.

· Increase the monthly casino royalty and review other aspects of the taxation of casinos,

· Collect VAT from airport departure fees and other services.

16. Strengthening the enforcement capabilities of the Customs Department is urgently needed for improving revenue collection. As a first priority, the Government has intensified anti-smuggling efforts by: (i) allocating more resources for the anti-smuggling program; (ii) implementing the government decision specifying the means for strengthening inter-agency cooperation, and directing the Customs Department, Armed Forces, Military Police, Police and the local authorities to combat smuggling; (iii) establishing anti-smuggling task forces in several key provinces; (iv) developing an anti-smuggling strategy targeting key revenue sources, high-risk items, and prime locations; and (v) expanding the inspection of selected garment factories to assess compliance with exemptions granted under the Law on Investment and prepare a preliminary report of findings. To complement the limited capabilities of the Customs Department, the government will continue to use the preshipment inspection system (PSI), and the PSI Steering Committee will address disputes between the government and the service provider to strengthen contract performance. Customs Department organization, human resources, and the information technology framework will be modernized in line with the work plan designed under the Technical Cooperation Action Plan (TCAP).

17. Following are tax measures under the 2002 budget:

A. Tax Measures

· Expand the coverage of the real regime to five additional provinces.

· Increase excise tax on beer from 10 percent to 20 percent.

· Collect VAT on airport departure fees.

· Implement 2 cents per liter excise tax on gasoline and 4 cents per liter on diesel as specified in the Financial Law.

· Conduct a joint review by the Tax Department and the Customs Department to improve collection of VAT.

B. Nontax Measures

· Intensify efforts to collect revenue from telecommunication services and leases of state assets. Contracts involving state revenue for telecommunications will be reviewed to ensure that appropriate funds are being transferred to the budget.

· Introduce increased royalty fees for casinos based on estimated turnover.

· Increase the share of garment quotas to be auctioned from 10 percent to at least 20 percent.

· Renegotiate contract with Sokha Hotel, the managing company for the Angkor monument complex, as the sales of entrance tickets to the Angkor complex increased by 28 percent to 239,091 in 2001.

C. Tax and Customs Administration Improvements

· Strengthen tax auditing strategy and capabilities.

· Improve coordination between the Customs and Tax Departments, especially regarding exchanges of information pertaining to large taxpayers.

· Strengthen inter-agency cooperation between the Customs Department, Tax Department, and CDC in monitoring duty exemptions for investment companies and apply penalties for undocumented use of duty exemptions.

· Intensify monitoring, enforcement, and collection of tax arrears for the largest taxpayers.

· Strengthen the anti-smuggling unit within the Customs Department and establish formal assistance arrangements with the Armed Forces and the Police to enforce customs regulations, especially on sensitive products and in problem areas.

· Identify the 50 largest accounts in the large taxpayers unit (LTLD that are in arrears, complete an analysis of the arrears, and establish an action plan with collection targets and reports on performance.

18. Expenditure restructuring will also remain a key objective under the 2002 budget. Defense spending will be reduced further to allow for increased priority social outlays. Fundamental reforms of expenditure and liquidity management are also included in the program for 2002. Key priorities in the expenditure program include: (i) increasing funding to key social ministries (i.e., education, health, agriculture, and rural development); (ii) completing the discharge of soldiers under the full demobilization program; (iii) continuing civil service reform; (iv) providing contingency funds to cover new priorities (commune elections, international obligations, higher debt service); and (v) increasing domestically financed capital expenditure. As a result, spending in the priority sectors is budgeted to increase to 3½ percent of GDP in 2002, compared to an estimated 3 percent in 2001. The Government has also stepped up efforts to improve the expenditure process, strengthen procurement practices, and upgrade cash management. In addition, the Government has prepared in 2002 the legal framework required for implementing administrative and financial decentralization in the future.

19. Comprehensive reform of budget and cash management will be implemented in 2002. High priority will be assigned to: (i) reducing the number of government accounts by integrating more accounts with the National Treasury single account; (ii) strengthening the budgetary accounting framework and improving regulations and reporting procedures; (iii) improving the operations of the cash management unit; (iv) improving inter-agency cooperation, especially between the National Treasury, the Customs and Excise Department, the Tax Department, the Budget and Financial Affairs Department, and the NBC; (v) reporting by the NBC to the National Treasury of transactions in government budget accounts on a daily basis and full account balances and bank statements for all government accounts on a monthly basis; (v) allowing for direct payment of taxes to the National Treasury account at the NBC by transfer or cheek, especially for the largest taxpayers; and (vii) establishing the new financial framework for communes with the national and provincial treasuries.

20. Procurement constitutes an integral part of budget execution. A major proportion of public expenditure at every level of government is incurred through the procurement of goods and services and construction activity. The performance criterion for evaluating procurement activities is economy, i.e. acquisition at the lowest price without sacrificing quality and timely delivery. In 1995, the government adopted a decree No 60 on Public Procurement, which was drafted based on international standards and best practices. However, since 1997, which witnessed domestic political turmoil and regional financial cataclysm, some of the important provisions of this governmental decree have not been fully implemented. In an effort to remedy these shortcomings, the government adopted a decision dated 28 December 2001 requiring full implementation of public procurement procedures for four priority ministries, Education, Health, Agriculture and Rural Development in the acquisition of goods, services and construction activities, except for heavy capital investment in road, bridge and sewerage construction.

ill Strengthening Economic and Financial Management

21. The Government is firmly committed to step up efforts to implement the governance and anti-corruption agenda. Broad dissemination of the Governance Action Plan (GAP) among government partners and stakeholders was launched through a series of workshops, both at the national and local levels, starting with the national conference hold on 11 December 2001. As part of the GAP, and consistent with the administrative reform framework, preparations are underway to deconcentrate and devolve decision-making and financial management to provincial and communal authorities. To reflect recent progress in GAP implementation in several areas, and the Government's emphasis on combating corruption and promoting social and economic development, an updated GAP will be prepared ahead of the next Consultative Group Meeting tentatively scheduled for mid-2002. To ensure full operations of the National Audit Authority (NAA), adequate allocations have been made in the 2002 budget.

22. Building institutional capacity is a key issue in nation building, and the government has the central responsibility for promulgating best development practices and building institutional capacity. National partnerships are a means for transferring know-how to institutions-e.g. training institutes, universities, ministries or other government bodies and the external partners. It means working together in a joint effort, with shared intellectual and financial responsibilities to build institutional capacity. This is neither a one-time affair nor is it open- ended. If capacity building is to succeed, it must be institutionalized and sustainable. In this view ownership and sustainability go hand-in-hand.

23. The Royal Government requires a substantial amount of technical assistance to meet reform objectives. To this end, the Government of Cambodia has requested the technical assistance (TA) covering principle areas of reform related to macroeconomic policy, including fiscal reform (tax administration and policy, customs administration, and budget management), banking reform, statistics, and the legal framework. For this reason, the MEF has signed with various donors, IMF, ADB, UNDP and the UK an MOU on the Strengthening Economic and Financial Management Project or otherwise know as Technical Cooperation Assistance Project (TCAP). Japan also provides technical assistance in the area of taxation and human resource development. The TCAP includes:

(i) fiscal reform, including improved budgetary management, broadening the tax base, avoiding ad hoc customs duty exemptions, and improving customs administration;

(ii) re-orienting government spending to priority programs in agriculture, rural development, health and education;

(iii) improving the quality and timeliness of economic and financial data;

(iv) improving administrative procedures to ensure that social sector spending targets are met; and

(v) improving public sector governance, transparency, accountability and adherence to the rule of law.

24. This national program represents a joint efforts funded by a number of donors, notably the IMF, the ADB, the United Kingdom, the Netherlands and UNDP to strengthen government's capacity to formulate and implement sound pro-poor macroeconomic policies in the fiscal and monetary areas and to manage public finances more effectively. This program focuses on capacity building for government ministries and departments at the service delivery level.

25. The program sub-components include strengthening tax administration and policy, customs administration, budget and treasury management, central bank operations, economic statistics, and development of legislative framework for monetary and financial sector reform, will inevitably create favorable prerequisite for the deepening of reform efforts deployed by the Royal Government of Cambodia. As part of the TCAP program, the MEF will undertake the following actions:

26. Budget Management: Budget formulation and implementation: raising the quality and effectiveness of public expenditures will involve three key improvements in budgetary management:

· improving the design of budget programs, including the introduction of relevant performance measurement concepts;

· Introducing a Medium-Term Expenditure Framework (MTEF) for Health and Education;

· integrating capital and recurrent budgets (and eventually aid budgets) not only at the aggregate and sector levels but also in terms of what each should contribute to the composition of improved programs and services; and

· aligning program expenditures with appropriate responsibilities and accountabilities-between the MEF and line ministries and between line ministries and provincial authorities.

27. Budget execution: Modernizing treasury operations is a necessary component in improving overall budget management and fiscal control. At the same time, some automation of existing functions and financial reporting is desirable to improve efficiency and maintain morale, and to help develop a culture of technological change and improvement.

28. Internal and external audits: a priority requirement is to establish the appropriate structure within the MEF and to provide it, and the Auditor General, with necessary resources and capacity. The internal audit capacity will coordinate with the budget unit to ensure consistency of approach and methodology.

29. Treasury Reform

· Document and streamline current accounting practices within the Royal Government of Cambodia;

· Establish a single operational structure of government bank accounts in the NBC under government control;

· Enhance current fiscal reporting system

· Move the Treasury away from performing banking duties;

· Clearly define the institutional role and relationship of the National and Provincial Treasuries;

· Establish a revised structure for a chart of accounts at the Treasury, in conjunction with a revised budget classification system;

· Implement revised accounting practices;

· Establish and implement a plan for basic computerization in NT and all spending agencies;

· Unify the public accounting management into a structure according to the accounting procedures and regulations, under the Treasury. In particular, all national budget operations should be recorded in local currency (MEF, NBC and NT);

· Unify and improve cash management system under the Treasury, on the basis of the Treasury single current account in NBC;

· Improve consequently reporting system for both budget performance and cash transactions.

30. Customs Reform

· The development and implementation of a revised Law on Customs and related regulations, such as the Customs Code, to provide the legislative base for reform and to meet international commitments and standards.

· Implement the tariff restructuring program resulting in an un-weighted tariff rate of less than 15% in the year 2002/2003

· The development and implementation of streamlined customs clearance procedures to enhance trade facilitation and improve effectiveness of operations.

· The development of expanded multi-lateral and bilateral relations, including accession to the World Trade Organization (WTO), membership in the World Customs Organization (WCO), ASEAN commitments, and development of bilateral trade agreements. Deriving maximum benefit from WCO, WTO, membership, ASEAN and from bilateral relations

· Development and implementation of an enforcement strategy and programs based on the principles of risk management in order to reduce smuggling and other illegal cross border activities.

· Automating Customs Systems and Procedures. All information technology (IT) opportunities will be exploited to improve business systems, operating efficiency and service to clients. The long-term goal is fully automated systems for all customs business processes.

· The implementation of a new organizational structure to better meet the needs of the Department, and the development and implementation of a comprehensive human resource plan, including training and development plans.

· Develop and implement a comprehensive and coordinated training and development program to strengthen management skills and technical expertise. The plan will include all training courses provided by donor organizations such as W, ASEAN Secretariat, WCO, and bilateral donors.

31. Tax reform

· Establish an unambiguous depreciation schedule for tax on profit based on the needs of all stakeholders;

· Revise the method of taxing dividends as it is currently unnecessary complex.

· Consideration of a thin capitalization provision as well as anti-avoidance rules;

· Review double taxation agreements and seek the first agreement with a small country.

· Widen the tax base.

· Review the exemption level of the tax on salary as it is excessively high.

· Review the VAT thresholds, with the possibility of lowering it slightly below the current threshold for goods, to an extent acceptable for Cambodia’s level of economic development and revenue performance of its tax administration.

· Pursue implementation of the real regime in five main provincial towns.

· Adopt selective methods to detect fraudulent invoices-, these methods should be supported by improvements of audit activities.

· Introduce mandatory VAT payments through the National Bank of Cambodia banks for the largest taxpayers.

· Streamline the system for controlling refunds and develop risk assessment techniques for the verification and approval of VAT refund claims.

· Establish and implement a reporting system to follow up, at HQ level, the evolution of tax arrears and monitor collection enforcement activities of tax offices. Establish salient information including ageing of account by tax, interest and penalties collected, number of accounts, dollars outstanding, budget to actual, opening to closing inventory, collection to

· Establish a modem management information system within the Audit Operation.

· Increase the number of auditors through internal reallocation of resources and organize appropriate audit training programs for auditors, if needed, seek technical assistance to prepare and develop these programs.

IV. Amendment to the Law on Investment. A Systemic Reform

32. Steps to review and consider amendments to the LOI were initiated in 1999 in a very different international investment climate than the one that prevails today. Since then, there has been a sharp decline in net flow of funds and FDI into ASEAN. According to figures in the most recent ASEAN Investment Surveillance Report, FDI flows into the group fell from US $27 billion in 1996 to US $11 billion in 1999. Furthermore, there are weak intra ASEAN flows, these having fallen from $5.4 billion in 1997 to 51.1 billion in 2000. Cambodia has been a beneficiary of intra ASEAN FDI flows and the well- documented relationship between GDP growth and FDI adds to concerns given the current global downturn.

33. The Ministry of Economy and Finance (MEF) and the Council for the Development of Cambodia (CDC) launched a series of intensive consultation with stakeholders in the private sector and donor community on the forthcoming amendment to the Law on Investment (LOI) of the Kingdom of Cambodia. The MEF is also commited to complete a review the Law on Taxation (LOT) with a view to harmonising the LOI and the LOT. The amendment stipulates an automatic progression to "accepted investor" status for all complying projects. The CDC is now preparing Positive, Restricted and Negative lists. Proposals for project types other than those on Negative List, which satisfy standard compliance conditions (operating licence, no disputed tax liability etc), will be registered as 'accepted' under the LOI without further evaluation.

34. The amendment package has been proposed to be applied to the following four elements:

First, elimination of the special 9 percent corporate tax rate for all new investment and phasing the 9 percent rate out to the standard 20 percent under the Law on Taxation for the next 5 years for existing and operational projects;

Second, elimination of the tax free reinvestment of profits and introduction of an appropriate investment allowance in the Law on Taxation at a rate to be determined, and applicable to all qualifying investment, new or expansion, irrespective of source of finance, without evaluation;

Third, repeal of the current tax holiday provisions and the introduction of a three year tax holiday, conditional on annual certification of compliance, to all qualifying new investment, without evaluation; the use of a tax holiday will deny the tax payer any benefits available under the Law on Taxation during the tax holiday including initial investment allowance as well as accelerated depreciation allowance; current tax holidays provided under the Law on Investment will be grandfathered (five years).

With the amendment, accepted investors are automatically entitled to tax holiday based on the following tentative formula:

Holiday = 3 + n years where

Tentatively,

n = 0 for all manufacturing (light industries);

n = 1 for tourism;

n = 2 for plantation-agriculture and heavy industries;

n = 3 for infrastructure projects and plantation agriculture.

Service industries other than tourism are ineligible for incentives.

The 'n' factor will be incorporated in the Finance Act, allowing review by government if needed, but without retrospectively. Trigger for tax holiday will be 'first profit' or three years after commencement of operations (business date) whichever is sooner. However, total period for activating and using tax holiday = (Trigger period) + (3+n) should not exceed 9 years. Further consultation will be conducted with the donor community and the private sector.

Fourth, elimination of the right to the tax-free repatriation of earnings and other incomes by approved enterprises. This would mean extending the existing advance tax on dividends to any tax holiday period it would typically generate a tax credit in both the home country and against future profit tax liabilities in Cambodia, with Cambodia benefiting from the bringing forward of access to tax revenues that would otherwise go to the home country.

V. Financial Sector Development

35. The Royal Government is conscious that an economy will not reach its growth potential and develop at an adequate pace, without an active contribution from the financial sector. Therefore, the MEF is committed to working closely with the NBC in strengthening the financial system. Over the recent years, the government has been enacting legislation, adopting policies, creating institutions and adapting procedures as part of the financial sector reforms in order to quicken the pace of economic growth.

36. Financial sector development is important to the speed and direction of economic growth, since a strong and well-functioning financial sector can break down the limitations of self-financing, mobilize idle financial resources for productive investment needs. To link up saving, investment and economic growth, the financial sector development must go together with private sector development and governance, forming one the three pillars to support the government policy of generating growth, which is seen as the major means to reduce people poverty, the ultimate goal of the government economic policy.

37. The MEF has worked with the NBC within the framework of the Committee on Economic and Financial Policies to strengthen the financial system and corporate governance, in order to improve the soundness and reliability of the banking system, which is crucial for confidence building. We have proceeded to restructure the state-owned Foreign Trade Bank (FTB) by issuing the recapitalization bonds. This issue will fully recapitalize the FTB to CR 50 billion. Banking supervision has been further upgraded. In the same way, we are working to strengthen the state owned insurance company CAMICO. Both of these SOEs will be privatized.

38. As far as the monetary sector is concerned, Cambodia has accepted the obligations of Article VIII of the Articles of Agreement of the International Monetary Fund with effect from January 1^st 2002. This means that our national currency, the Riel, will play the role of a currency like other currencies in the world.

39. Moreover, the MEF is committed to strengthening the financial system, as financial sector development affects the speed and direction of economic growth. In this sense, the National Bank of Cambodia (NBC) led a government team, which included representatives of the MEF, the Ministry of Commerce (MOC) and the Council for Development of Cambodia (CDC) in preparing the " Vision and Financial Sector Development Plan for 2001-2010", which was adopted by Royal Government on the 24th August 2001. The blueprint outlines a long-term vision and strategy for sequencing policy reforms to develop the financial system over three phases during ten years in order to enhance resource mobilization and sustainable economic growth. Over the next ten years, the MEF and the N'BC will strive to develop:

§ First, a competitive, integrated, and efficient banking system that is properly regulated and supervised and effectively mobilizes savings to provide financing to support the growth of the private sector, a reliable payment system and a banking safety net. To this end, the NBC will take the lead in strengthening a framework for monetary policy, enhancing supervision and building up institutional capacity.

§ Second, a viable, pro-poor and effective rural finance system for providing affordable financial services to enable the poor to enhance rural income and reduce poverty. To achieve this goal the MEF will work with the N-BC to act on: (i) implementing the policy actions specified in the Rural Credit Policy; (ii) strengthening supervision and regulation; (iii) facilitating institutional transformation of NG0s into licensed micro- finance institutions; and (iv) building sustainable institutions.

§ Third, an insurance sector that protects businesses and individuals from catastrophic events and a pension system that provides a secure retirement, both of which provide capital for long-term investment in the real sector. To tackle the current weak legal and supervisory capacity, the plan aims at establishing regulatory and supervisory framework for insurance and compulsory insurance, encouraging private sector participation, building up capacity of insurance regulators and supervisors, creating a multi-pillar pension system consisting of a mandatory public pension program, a mandatory privately managed funded pension system, and voluntary retirement savings programs.

§ Fourth, diverse non-banking financial products and institutions that create more balanced financial structure, increase the depth of financial market, and promote competition. These include leasing business, money market and capital market intermediaries, and development finance institutions. To this end, it is important to adopt specific leasing laws and regulations and provide procedures for banks to participate in the leasing business.

§ Fifth, a money market that enables an inter-bank market that provides banks, companies, and individuals with the means for effective liquidity managing.

§ Sixth, an efficient and transparent capital market with a critical mass of issuers that mobilizes funds for long-term investment.

§ Seventh, legal infrastructure and accounting systems that promotes the rule of law in commercial and financial transactions and support good governance by promoting transparency, accountability, and predictability.

VI. Conclusion

40. Cambodia has made some progress in improving tax and customs administration, expenditure management, bank restructuring, forestry reform military demobilization, civil service reform and trade liberalization. Another priority area is legal reform. Fiscal reform remains the backbone of the RGC's economic reform agenda. Cambodia has established improved environment and created conditions to move forward on the path of sustainable development and poverty reduction.

41. The year 2001 witnessed that the momentum created in 1999 has further strengthened. Cambodia continues to foster an environment conducive to reforms, expand economic activities, create employment, and reconstruct its social, economic and physical infrastructures. The major challenge is to maintain stability and share the fruits of growth equitably, prevent the ri