The China Alternative – Cambodia

August 29, 2011 Posted by China Briefing Reading Time: 9 minutes

The China Alternative is our series covering other manufacturing destinations in emerging Asia that may start to compete with China in terms of labor costs, infrastructure and operational capacity. In this issue we look at Cambodia.

By Kaitlin Shung

Aug. 29 – Tourists to Cambodia often take similar routes, discovering the wide and stately streets of Phnomn Penh before taking a dusty six hour bus ride to Siem Reap, home of the beautiful Angkor Wat. Among the ruins of the ancient Khmer Kingdom at Angkor Wat, local Cambodian children can often be seen calling out flattering phrases, usually in Chinese and English, looking for a crisp American dollar or a few pieces of candy.

Cambodia boasts a rich and more recently, bloody, history. An underdeveloped country of roughly 14.7 million, Cambodia was set back significantly in the 1970s under the extremist rule of the Khmer Rouge. It was estimated that nearly 20 percent of the population died under the leadership of Pol Pot due to starvation, torture, and executions, and the economy was completely dismantled.

As a result of its short time under French rule, the official languages spoken are Khmer, French and English, although French appears to be scarce except among the older generations. The majority of the population is within the 15-64 age range and the country has a respectable 73.6 percent literacy rate.

Cambodia operates as a multi-party democracy under a constitutional democracy, and the long-serving prime minister has a considerable amount of power. The head of State is King Norodom Sihamoni, who was sworn in on October 29, 2004 while the prime minister is Hun Sen.

The Cambodian currency is the riel (KHR), which traded, on average, at KHR4,145 to US$1 in 2010. In addition to the riel, U.S. dollars are also commonly accepted and according to the New York Times, almost 90 percent of deposits and credits in the banking system are denominated in U.S. dollars. With a large portion of capital and savings in the greenback, the Cambodian government ultimately has less ability to influence the economy and thus less control.

Economy
Before the global financial slowdown, Cambodia was one of the strongest economic performers in Southeast Asia, posting annual growth of around 10 percent over the previous decade. Cambodia’s economy is focused in four key industries: tourism, clothing, construction and agriculture. The lack of diversification in the economy impacted on the country hard when the Global Financial Crisis hit and since then, the government has begun efforts at initiating reforms to encourage the development of emerging industries.

Within its labor force of 8.8 million, roughly 70 percent work in agriculture which constitutes roughly one-third of Cambodia’s GDP. The country’s GDP grew 6 percent year on year in 2010 to US$11.63 billion, which is comparatively about one-fiftieth the size of China’s economy. After agriculture, services account for 45.2 percent of GDP while industry contributes 21.4 percent.

Exports totaled US$3.687 billion in 2010, with primary export partners being Hong Kong, the United States and Singapore. Comparatively, imports were US$6.005 billion and primary import partners were China, Vietnam and Hong Kong. Key exports were clothing, timber, rubber, rice and fish while key imports were petroleum, cigarettes, gold and construction materials.

FDI inflows totaled US$532.5 million in 2010, with the majority of capital coming from China. Chinese investment is often preferred because it is generally unconditional, as opposed to Western investment which is usually tied to political and economic reform. In the first half of 2011 alone, Chinese investors had already put in place plans for 360 projects worth US$8 billion in Cambodia, which is nominally the equivalent of all Chinese investment in Southeast Asia in the previous year.

As previously mentioned, Cambodia has access to a number of natural resources, but the country often does not have the infrastructure in place to take advantage of those resources. For example, nearly 70 percent of the country is covered with trees, but the lumber industry falters under illegal logging, costing vast amounts of missed revenue.

Oil and natural gas were found in Cambodia in 2005, the exact amount of which has not been released, but commercial extraction is expected to begin in 2012.

Investing in Cambodia
“We welcome investments in all sectors, including banking, insurance, and telecommunications. Investors can own 100 percent of their business here, in most countries 100 percent foreign ownership is not allowed,” Cambodia’s Prime Minister Hun Sen has been quoted as saying.

Key industries for investment include agriculture (an industry which has an ample labor supply in Cambodia but lacks investment in physical infrastructure), technology to increase yields, and the country has a gaping hole where a processing and packaging industry should be. Furthermore, light industry and manufacturing are relatively underdeveloped, despite the low labor costs in the country. More information on investing in Cambodia can be found through the web site – www.investincambodia.com.

Taking the lead from China’s successful Special Economic Zones (SEZs), Cambodia has also begun to build SEZs, primarily along the country’s borders with Thailand and Vietnam. There are a total of 21 approved SEZs – of which five have already commenced operations and two are under construction. Cambodia’s SEZs offer tax and VAT benefits and strong government support has simplified importing and exporting into these areas.

Administratively, the government has set up two boards responsible for managing the country’s SEZs: the Cambodian Special Economic Zone Board and a separate trouble shooting committee. Both are headed by Prime Minister Hun Sen and if managed properly, will help bring foreign investment into the country through these economic zones.

Investing in Cambodia has certainly been helped by the country’s entry into the World Trade Organization in 2004 (Cambodia was the second least developed country to join the WTO through the full working party negotiation process). As a member of the WTO, Cambodia has taken steps to meet international trade and regulatory standards, including the implementation of a number of new legal reforms. Examples include: the Law on Commercial Enterprises (2005), the Law on Commercial Arbitration (2006) and the Law on Secured Transactions (2007).

In addition, Cambodia is also a member of ASEAN and the World Intellectual Property Organization.

The 2011 Index of Economic Freedom, a joint effort by The Heritage Foundation and The Wall Street Journal, ranked Cambodia 102 out of 179 countries or 17 out of 41 in the Asia-Pacific region. This is an improvement over the previous year’s ranking, attributed to improvements in monetary control, labor freedom and a reduction in corruption. Cambodia’s ranking suffers largely because of weak property rights and cumbersome bureaucracy.

Comparatively, the 2011 World Bank Doing Business Rankings ranked Cambodia as 147 out of 183 countries surveyed. A slight decrease from the 2010 rankings, Cambodia still has significant barriers in starting and closing a business as well as enforcing contracts.

Why invest in Cambodia?
Cambodia is an attractive investment opportunity for a few key reasons. First, the country has an income tax rate of 20 percent and because of its desire to attract foreign investment, also offers additional tax incentives. For example, eligible projects can receive tax holidays of between six and nine years from initial investment.

Unlike ownership requirements in neighboring countries like China, Cambodia allows for 100 percent foreign owned businesses. The lack of price controls on goods and services and no restrictions on repatriation of funds, free up investors in terms of downgrading investment risk.

Its status as an undeveloped country also works to the benefits of investors through tariff-free exports, which Cambodia has when trading with partners like the United States, Canada and Europe. Entrance into Cambodia is a gateway to the rest of the ASEAN market and domestically, the signs of an emerging middle class are appearing. With that comes the increased local consumption of goods and services.

Furthermore, as a part of the Greater Mekong Sub-region (GMS), Cambodia is strategically located in a hotspot for both economic and political influence. The GMS includes Yunan Province and the Guangxi Zhuang Autonomous Region in China, as well as Cambodia, Laos, Myanmar, Thailand and Vietnam. Currently, over US$10 billion has been pledged for infrastructure projects which will build economic corridors between countries in the region.

The positives aside, Cambodia’s business environment is not without problems and areas of concern. The most prevalent problem for foreign investors is corruption, which is reinforced by weak governance and a lacking legal framework.

In 2010, Transparency International ranked Cambodia 154th out of the 178 countries surveyed. Lack of transparency and abuse of power by government officials have drawn scrutiny to this Southeast Asian country. For example, a story came out this year about government action against two NGOs who were highlighting the negative effects of a US$84 million railroad investment, funded in part by the Asia Development Bank, on displaced families. Pressure on these groups opened the government to criticism and highlighted problems related to free speech in Cambodia.

High reliance on imported goods and services also do not speak well to the sustainability and strength of Cambodia’s economy.

Poor infrastructure in the country has impeded the development of local and global linkages between Cambodia and the world economy. The government has prioritized building roads, airports, telecommunication networks and has received support from foreign sources like the Asia Development Bank and the governments of Australia and China.

In 2010, the government passed the National Strategic Development Plan which focused on the country’s development from 2009 to 2013. A highlight of the plan was an estimated US$1.1 billion in development assistance, which was expected to be spent in 2010.

On a final positive note, Cambodia opened its own stock market earlier this year. At the time of its opening, there were no companies prepared to go public and this was largely indicative of Cambodia’s weak financial sector and a lack of confidence in regulatory bodies’ ability to enact and enforce corporate governance and accounting laws. However, three state-owned companies are in the process of preparing to list later this year and hopefully the establishment of its own stock market will bring stability to the Cambodian economy.

Geopolitical concerns
Cambodia’s close ties with neighboring China have proven to be unnerving for American leaders, as China attempts to expand its dominance in the area. In 2010, U.S. Secretary of State Hilary Clinton visited Cambodia and warned of an overly intense dependence on China.

“I think it is smart for Cambodia to be friends with many countries… It’s like our relationship with other countries. You look for balance. You don’t want to get too dependent on any one country,” Clinton said.

U.S. concerns aside, friendly relations between China and Cambodia are evidenced by high level meetings between government officials. Last year, powerful CCP member Wu Banguo attended the signing of a contract between Cambodia’s largest mobile phone company, CamGSM, and the Bank of China in the largest financing project to ever take place in Cambodia. Wu Banguo was quoted as referring to Cambodia as a “reliable neighbor, friend and brother.”

In 2011, Zhou Yongkang, a member of the CCP’s Standing Committee Politiburo, traveled to Cambodia to talk economic and political cooperation.

Complicated relations with neighboring Thailand have proven to be dire enough to come to arms and it is worth continuing to observe how relations improve or deteriorate in the future. The conflict stems from a border dispute which has come to repeated fighting between both sides’ armies at a contested site. Furthermore, Cambodia’s appointment of Thailand’s former prime minister (who was charged with corruption-related crimes) as an economic advisor has accelerated tensions between the two countries.

Future outlook
“In the next 20 years, I expect Cambodia will be one of the world’s best performers in terms of improved income and living standards, better infrastructure and a lifestyle on par with middle income countries,” Cambodia’s Prime Minister Hun Sen has said in an optimistic forecast.

At the 4th Cambodia Economic Forum held in February of this year, Prime Minister Hun Sen highlighted key areas the government hoped would expedite the modernization of Cambodia’s economy. The government’s strategies focused on figuring out ways to diversify the economy, reforming the nation’s SEZs, increasing investment in human capital, establishing the state’s place in industrial development and establishing the industrial sector’s position in the local and global economy.

Rising costs in China are turning eyes southward for new, inexpensive manufacturing hubs and less developed countries like Cambodia are stepping up to the plate. Cambodia is a particularly interesting investment opportunity, given benefits extended to it as a result of its development status and its simultaneous membership in the WTO. If the government can continue to effectively battle corruption and diversify its economic pillars, Cambodia could potentially rise from poverty and development aid to become a powerhouse in emerging Asia.

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