Withdrawal Of EBA Could Spark Rating Downgrade, Experts Say

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The cancellation of the Everything But Arms (EBA) scheme would severely affect trade, investor sentiment, and the overall economy followed by a possible sovereign rating downgrade, while Cambodia’s strong ties with the EU makes it vulnerable to disruptions in trade relations, said experts.

The Kingdom’s textile sector could face trade setbacks if the European Union revokes the Everything-but-arms treaty. KT/Mai Vireak

In an interview with Khmer Times, RAM Ratings Services Bhd sovereign ratings head, Esther Lai said Cambodia’s economy could see possible downside risks due to the potential loss of European Union (EU)’s preferential scheme.

“It could be deemed credit negative and could exert a downward pressure on sovereign rating.

“A rating downgrade would dampen the confidence of future investors, and raise the cost of financing for the Cambodian government in future.

“Imposition of tariffs in addition to rising minimum wages will undermine the competitiveness of Cambodia’s exports to the EU, affecting overall growth. Lower demand would counterbalance volatilities of food and transport prices, keeping on a measured pace,” said Ms Lai via email.

However, Ms Lai said Cambodia could altogether benefit from China’s relocation of some production base to Cambodia.

“Over the medium to longer term, there could be a potential benefit of the relocation of production base from China to Cambodia though it depends on a continuous effort to bring down the overall cost of doing business here.

“But at this juncture the impact on the trade war to the nation’s fiscal deficit is uncertain.”

Late January this year, the Malaysian credit ratings agency reaffirmed Cambodia’s gB1(pi) rating with a stable outlook on a global scale, which reflects the country’s lack of development, susceptibility to shocks and poor business environment, as well as institutional quality.

Cambodia’s economy has grown 7% per annum since 2014 with $3.6 billion investment recorded in 2016.

The Council for the Development of Cambodia showed that 29.92 percent of that investment comes from China, followed by Cambodia (27.55 percent), Japan (22.78 percent) and Thailand (4.61 percent).

While the escalating trade tension between US and China causes jitters among emerging economies, Cambodia might gain from the potential trade diversion as Chinese export competitiveness gets eroded by higher tariffs.

Last year, US accounted for 21.3 percent of Cambodia’s total exports.

“In the first nine months this year, Cambodia’s exports to US surged 19 percent to $374.7 million versus the corresponding period in 2017 which may be the effect of pre-buying ahead of the imposition of tariffs by US on China as opposed to fundamental diversion of trade,” said Ms Lai.

IMF Resident Representative for Cambodia Yong Sarah Zhou said it is premature to speculate on the economic impact because there are no further details on the potential outcome of the EBA review.

However, she finds that with Cambodia’s strong ties to the EU, accounting for more than 40 percent of the former’s garment export, it is vulnerable to disruptions in trading relations.

“Loss of preferential access to key export markets could hamper exports and foreign direct investment, and dent confidence,” Ms Zhou said via email with Khmer Times.

The preferential trade status is an important element underpinning the success of the garment industry here.

As the single largest formal employer, it provides over 600,000 jobs in more than 500 export factories with production amounting to 30 percent of the gross domestic product (GDP) and over 70 percent of exports, she said. The garment sector hires eight percent of labour force.Cambodia is highly trade-driven where exports make up more than 100 percent of GDP in 2017, with EU being its largest market, Ms Lai said.

She added that over the medium to long term, the impact of EBA withdrawal is expected on investments and employment prospects.

“The risk would be exacerbated if countries like Australia and Canada also review their existing trade agreements with Cambodia in response to political and human right concern,” Ms Lai said, suggesting that export diversification is imperative for Cambodia.

In the National Assembly-approved Budget 2019, the government forecasts GDP to be $27.22 billion, expanding at 7.1 percent next year, and GDP per capita to rise to $1,706 from $1,563. It expects a 3.1 percent inflation rate.

Out of the $6.7 billion budget, operational expenditure (opex) amounts to $4.5 billion, and $2.3 billion for development expenditure. The government would raise $4.8 billion from its revenue and some $1.4 billion is made of borrowings from development partners and foreign institutions.

IMF’s end-of-mission preliminary findings on Cambodia showed optimism on its economic outlook but did not rule out downside risks, saying that bank credit was increasingly focused on real estate and construction sectors with an expected 20 percent growth this year.

“Concerns about credit quality, external funding, rising concentration in real estate and unregulated lending by the developers, and growing systemic importance of micro finance institutions continue to pose risks to financial and macroeconomic stability,” it said.

The fund said fiscal performance remains expansionary, reflecting anticipated rises in current and capital expenditure. As such, fiscal deficit is projected to expand to 2.2 percent of GDP this year.

Following expansionary policies this year, the authorities’ preliminary plans for 2019 are geared towards fiscal consolidation, it added.

Ms Zhou said recent fiscal performance has been strong with tax revenue growing at an impressive pace but going forward, with absent tax policy reforms, revenue growth is likely to slow down as past revenue mobilisation reforms mature and grants decline.

“Therefore, additional measures are needed to safeguard fiscal sustainability. Spending pressures should be contained including ensuring that public wage rises are consistent with fiscal sustainability and accompanied by further progress in public administration reforms.

“While ensuring spending efficiency, priority should be given to growth-enhancing infrastructure and development spending,” she added.

This brings to question Cambodia’s heavy reliance on borrowings and its economic effect with EBA’s departure.

But Ms Zhou plays down the influence, saying that public debt is low at 30 percent of GDP with loan composition dominance by bilateral creditors including China, and multilateral institutions like World Bank and the Asian Development Bank.

Ms Lai said further tax reforms can be expected to broaden the tax base to support the country’s development needs, countering the risk of higher cost funding as it transitions away from concessional multi-and-bilateral loans.

In a recent closed-door economic forum, Serey Chea, National Bank of Cambodia assistant governor, said local industries need to be proactive to beat the challenges while urging the private sector to invest in technology.

“Manufacturing diversity is already taking place … (moving) away from (a focus on) garment. Factories made up of microchip and mobile assets assembly lines are increasing. We are diversifying our export destinations to Japan, China and intra-Asean,” she told Khmer Times.

Ms Chea also stressed the need to upskill and re-skill the workforce as Cambodia moves up the value chain to adopt the fourth industrial revolution.

Considering the pivotal role of exports, a plausible measure to cushion the impact from the potential EBA loss would be for Cambodia to enhance its trade relationship with US and Japan where last year the share of exports to both nations was 28.9 percent of total exports, Ms Lai said.

But most importantly, she agreed that Cambodia should continue to upskill human capital to improve productivity.

“Emerging industries in electrical parts, automobile components, milled rice and rubber have been gaining traction in Cambodia. Tourists arrival growth particularly from China has been robust. Measures to boost arrivals would help grow services exports to offset risks to manufacturing exports from the withdrawal,” she added.

This article was originally published in the Khmer Times.