2.1 HISTORICAL OVERVIEW OF THECAMBODIAN ECONOMY

Since its independence from France in 1953, Cambodia has had an unfortunate history of sudden regime changes that led to repeated changes in economic policies. During the Sangkum Reastr Niyum Regime (1953–70) period, the government placed importance on the agricultural sector, promoting policies to increase rice production yields by adopting innovative irrigation systems. The industrial sector benefited from foreign economic assistance from Czechoslovakia, Japan, Australia, China, France and the Soviet Union, including the production of textiles, glass, tires, rubber and sugar, while the government also expanded transportation and communication networks.

During the Khmer Republic Regime (1970–75) the economy was called the “Wartime Economy”. The war that engulfed the rest of Indochina spread to Cambodia in April 1970. Wartime conditions had a major impact on the country’s economy. Production and export of all commodities significantly dropped as insecurity spread throughout the countryside. Despite the government’s effort to liberalize the economy to save the nation from economic disaster by implementing a comprehensive program of reforms, maintaining a policy of strict political neutrality, and accepting foreign assistance, political instability has plunged the country into civil war.

During the Democratic Kampuchea Regime, more commonly known as the Khmer Rouge Regime (1975–79), the economic and financial systems were devastated. This regime overhauled the social and economic system; there was no currency, no bank or any monetary transactions, and no schools. The regime tried to build the economy on the agricultural sector is supported by local small enterprises and handicrafts. Part of its economic policy was to use revenues from agriculture to support the development of the industrial sector, which it later used to support the agricultural sector. However, this approach turned out to be a huge failure for the country, resulting in starvation and the death of millions of people.

In January 1979, the formation of the People’s Republic of Kampuchea (PRK) marked a new stage in the country’s rehabilitation and reconstruction. Cambodia employed a Soviet-style planned economy throughout the 1980s.

Cambodia has come a long way in its nation-building process following its tragic history under the horrendous collectivized management of the Khmer Rouge in the late 1970s. The rehabilitation process had to start from scratch in the 1980s. Cambodia needed to prevent the return of the Khmer Rouge regime while at the same time building the necessary physical infrastructure and human capital. After the official end of the civil war in the late 1990s, the Royal Government of Cambodia (RGC) announced full and complete peace in the whole country. Under the prudent leadership of Samdech Akka Moha Sena Padey Techo Hun Sen, Prime Minister of the Kingdom of Cambodia, and with peace as a necessary precondition, Cambodia has achieved remarkable economic growth in the past decades. Cambodia has also actively engaged in regional and international trade and has become one of the most open economies in the region.

The general election in 1993 marked a new chapter for Cambodia. In the first legislature of the National Assembly, the government adopted a comprehensive macroeconomic policy and structural reform program, which included efforts to integrate the Cambodian economy into the region and the world. Subsequently, the government achieved impressive results, especially in liberalization reforms and economic stabilization, which led to rapid economic growth with a low annual inflation rate below 5 per cent that still stands today.

As the focus was placed on macroeconomic growth and stability, measures to strengthen public financial management (PFM) remained weak. Good governance in PFM remained a major concern, both from the perspectives of revenue mobilization and expenditure efficiency. This situation underlined the need to push for more in-depth and comprehensive reform.

In 2004, the RGC launched a long-term and comprehensive PFM reform program covering both the national and subnational levels. Based on the Cambodian context and drawing on international experiences. This initiative aimed to gradually change government budgeting from an input-based and centralized budget system towards a more performance-based and decentralized budget management system. This program had four phases, the first of which, from 2005 to 2008, focused on strengthening budget credibility. The second phase ran from 2009 to 2015 and aimed at strengthening financial accountability. The third phase (2016–20), which is currently under implementation, focuses on budget-policy linkages. Finally, the fourth phase, to be implemented upon completion of the third phase, will seek to build performance accountability into the budget process.

Cambodia has achieved remarkable economic development, with an average annual GDP growth rate of 7 per cent in the past two decades. A series of reforms have been implemented to support this sustained and robust growth. Among them, public financial management (PFM) reform has played a crucial role and acted as the backbone of all reform efforts. Before the start of PFM reform in the mid-2000s, cash shortages were chronic and arrears in salary payments to civil servants and armed forces were rampant in the country. Inefficiency in budget allocation, which negatively affected the quality of public service delivery, was at a critical level.

Recognizing the need to strengthen the PFM system to improve accountability, efficiency and effectiveness, the government initiated a comprehensive reform program covering all PFM components in 2004. These included macroeconomic policy and the revenue-expenditure framework, public investment management, public debt management, state asset management, public procurement management, the public accounting system, the financial management information system and the fiduciary control system.

Since its inception, the PFM reform program has yielded many positive results. The significant increase in tax revenue, coupled with a transparent and effective revenue management system, enabled the government to allocate more resources to priority sectors, such as health and education, and increase support for other critical public sector reforms. It also spurred a significant increase in civil servants’ salaries, which are now paid in a timely manner through banking systems.

In this context, the new spirit of PFM reform is indispensable. The PFM system cannot be robust on its own or without all parties’ participation, especially the civil servants who implement it directly. However, general understanding and knowledge of PFM are limited, both among government officials and the general public, posing a challenge on the path to a robust, responsive, transparent and accountable PFM system. This situation has prompted the General Secretariat of the PFM Reform Steering Committee to make greater efforts to raise awareness and promote understanding of PFM.

The Public Financial Management: Cambodian Experiences book is one of the new initiatives to address the challenges mentioned earlier. The book starts with an overview of PFM in Cambodia, with a brief introduction to the discipline of public financial management. It goes on to discuss Cambodia’s experience implementing PFM reform in detail, including how PFM has reformed government budgeting and how reform impacts the many components of PFM.

Public financial management reform is the backbone of all reforms in the Cambodian government. To achieve policy objectives at minimal costs, the government budget must be credible, and its expenditure be efficient, at both the national and subnational levels of government. This section describes the PFM reforms by selected ministries: the Ministry of Education, Youth, and Sport (MOEYS) and the Ministry of Rural Development (MRD). It also introduces reform of the PFM system at the subnational administration level.

The four largest spending ministries in Cambodia are MOEYS, the Ministry of National Defence (MOD), the Ministry of Interior (MOI) and the Ministry of Health (MOH), accounting for 60 per cent of the total government spending. Individually, their shares of the budget in 2020 were approximately 21 per cent, 17 per cent, 13 per cent, and 11 per cent, respectively. MOEYS was selected for case studies as they are big spenders and more representative of the majority of administrative structures of the government while MRD was also selected as it more directly impacts the locals. MOI and MOD have special characteristics that separate them from mainstream line ministries, given that they are also involved in the armed forces and police spending.

6.1 PFMRP AND IMPACT ON MOEYS

MOEYS was established in 1996 with a mission to lead and develop the educational sector and programs for youth and sports. MOEYS is the highest-spending ministry, compared to others in the Cambodian government, having a budget of 21 per cent of the government’s total budget in 2020. Of this budget, 81 per cent was allocated to the salaries of teachers and staff. In the 1990s and early 2000s, when the government experienced budget shortages, MOEYS was more affected than others. Therefore, PRMRP Platform 1, which addressed this budget shortage, had a significant stabilizing effect on this ministry and the country’s education sector as a whole.

Management Support and Acceptance within MOEYS

The Minister of Education, Youth and Sport is the Chair of MOEYS’s PFMRP working group and is a champion of PFMRP as a whole. The director of MOEYS’ Department of Finance and its deputy directors are also the drivers of the Ministry’s reforms and have promoted clear and time-bounded action plans for reform.

1.1 BACKGROUND

The Royal Government of Cambodia (RGC) has achieved substantial progress in public financial management (PFM) since the inception of the reform program in 2004. PFM is the backbone of RGC reforms, but its objectives and benefits are not widely known to the public. While many components of PFM are present throughout the government, the overall system and its benefits are not widely understood or recognized. This is, in part, due to the holistic and long-term successes of PFM reform in Cambodia having never been described in one place.

This book offers a remedy to this problem by providing an overview of PFM and Cambodia’s reform experiences. This examination includes a recent history of PFM reform, a delineation of its components in the RGC, a discussion of how PFM affects planning and budgeting, case studies within the RGC, and a comparison of reform experiences of selected OECD and ASEAN countries. Finally, the book draws key lessons from reform experiences (successes and failures) in both developed and developing countries that may be useful in the Cambodian context.

1.2 WHAT IS PFM?

PFM can be explained with a simple analogy as the following. In everyday life, each household is faced with questions about earned income and spending. These questions may include:

• • What do we need with regard to food, clothes, education and entertainment?

• • Where does the money come from to pay for it?

• • Do we have enough money to cover all the expenses we need? Should we borrow money from somewhere? Are we able to pay back our borrowed loan?

• • Is everyone in the family adequately taken care of?

These questions are familiar to every household and if we do not properly address them can lead to dire consequences for the family.

A government is like a household, but larger. Every citizen is a family member of that household. The process by which the government manages its resources to meet the needs of its citizens is called Public Financial Management (PFM). In a family, parents work and get paid, and this may constitute the whole income for the household. The government gets its revenue from tax and non-tax sources domestically and from external sources, such as loans and grants from bilateral and multilateral aid agencies. The government wants to use its revenues efficiently, equitably and in a manner that provides stability and sustainability of the operation of the government.

Many tools are available for assessing and monitoring public financial management systems, including:

• • the Public Expenditure and Financial Accountability (PEFA) framework;

• • the Open Budget Survey (OBS);

• • the Public Investment Management Assessment (PIMA); and

• • the Tax Administration Diagnostic Assessment Tool (TADAT).

These tools are used by external institutions to assess projects, institutions and programs to improve the management of PFM outputs and outcomes. They can also monitor and evaluate PFM reform efforts. The application of these tools can act as an external navigation system that helps the ship safely reach its destination.

This chapter discusses each of these PFM assessment tools in detail.

5.1 PUBLIC EXPENDITURE AND FINANCIAL ACCOUNTABILITY FRAMEWORK

The Public Expenditure and Financial Accountability (PEFA) framework is a program designed to provide snapshots of PFM performance at specific points in time that can be used in successive assessments and provide a summary of changes over time. It provides a framework for assessing and reporting on the strengths and weaknesses of PFM using quantitative indicators to measure performance. The PEFA framework includes a reporting mechanism that provides an overview of the PFM system and its performance. It can create a foundation for reform planning, dialogue on strategy and priorities, and progress monitoring.

PEFA is also a critical tool that can help governments achieve sustainable improvements in PFM practices by providing a means to measure and monitor performance using a set of indicators across a range of public financial management institutions, systems, and processes. The PEFA methodology draws on international standards and good practices for PFM, as identified by experienced practitioners.

PEFA offers a common basis for examining PFM performance across national and subnational governments. PEFA scores and reports allow all users of the information to gain a quick overview of the strengths and weaknesses of a country’s PFM system. In addition to guidance for analysis and reporting, the PEFA Secretariat provides support, monitoring, and analysis of PEFA assessments. The PEFA Secretariat offers free advice on the use of PEFA as one of many sources of information for examining and improving PFM performance.

5.1.1 Scope and Coverage of the Framework

What Does PEFA Assess?

The purpose of a sound PFM system is to ensure that a government’s policies are implemented as intended and achieve its objectives.

The potential benefits of effective medium-term budgeting have been extensively documented. A well-designed and well-managed framework for medium-term budgeting contributes to better fiscal discipline and control, increased efficiency in resource allocation, and improved cost-effectiveness of service delivery by enhancing clarity in policy objectives, predictability in budget allocation, and accountability and transparency in the use of resources. For Cambodia, it starts with preparing the fiscal framework, now called the Medium-Term Macroeconomic and Public Finance Framework (MMPFF) that is aligned with global macroeconomic outlooks, RGC’s policy priorities, and revenue and expenditure trends.

The Budget System Reform Strategy (BSRS) describes three elements for forming the budget planning framework:

• 1. Medium-Term Macroeconomic and Public Finance Framework;

• 2. Medium-Term Budget Framework (MTBF); and

• 3. Budget Strategic Plans at ministries, institutions and provincial levels.

The MMPFF is currently used for the preparation of the budget law but is to be phased out and replaced by the Medium-Term Fiscal Framework (MTFF) between 2025 and 2027, starting at the commencement of the 2023 budget law preparation. The introduction of the MTFF and MTBF will strengthen medium-term budgeting in the annual budget process. These two tools will be critical for developing economic policy in Cambodia. The budget process operates on a three-year rolling basis, covering the budget for the immediate year and two years after, to ensure a truly medium-term outlook for budget planning.

3.1 MEDIUM-TERM FISCAL FRAMEWORK

The MTFF is a macroeconomic model that provides the basis to forecast growth by economic sector, inflation, interest rates, exchange rates and potential revenues and expenditures. These forecasts are based on assumptions of the sectoral interaction in the economy as well as the potential impact of shocks in the world economy. The reliability of the forecast is dependent upon the accuracy of the economic model and its assumptions, which attempt to reflect the actual status of the economy.

The MTFF will be part of a transparent planning and budget formulation process that will attempt to link government policies and priorities to resource allocation. It is designed to ensure overall fiscal discipline by setting fiscal targets and allocating the resultant resources to strategic priorities within these targets. The Rectangular Strategy (RS) and National Strategy Development Plan (NSDP) are the primary strategic policy inputs to the MTFF.

The MTFF sets out a fiscal strategy and fiscal policy stance by determining the total revenue and expenditure for the medium term.

Reciprocity beliefs represent a challenge for researchers. Chapter 4 found a puzzling and robust correlation between reciprocity beliefs, on the one hand, and liberal–authoritarian values (LAVs), on the other. Chapter 10 argues that, underpinning the correlation between reciprocity beliefs and LAVs, it is hypothesized, is a disagreement over how to best respond to social dilemmas. People with more authoritarian response patterns to LAV items have a preference for maximizing cooperation by minimizing instances in which people who free ride on the collective effort unfairly walk away unpunished. People with more liberal values have a preference for minimizing instances in which people are unfairly punished despite being cooperators. In a discursive context, rich are more concerned about moral hazard, welfare abuse, and opportunistic behavior; people with more authoritarian response patterns will be more likely to incorporate such claims into their own basket of fairness considerations; and people with more liberal response patterns will be more likely to resist them. Chapter 10 provides evidence in support of this argument.

Two groups display the highest support for generous redistribution to policies: (1) low-income beneficiaries, irrespective of their reciprocity beliefs, and (2) high-income contributors who trust that these policies benefit deserving recipients. This coalition is held together by redistribution to policies’ asymmetric economic implications. For low-income beneficiaries, redistribution to policies are high stakes, explaining high baseline support irrespective of reciprocity beliefs. In contrast, the uncertainty over the costs to high-income contributors of more generous redistribution to policies favors fairness reasoning, explaining higher than expected support within this group. Chapter 7 argues that fiscal stress, in the form of fiscal adjustment, can introduce a wedge in this pro-redistribution to coalition. Indeed, when the tax implications of generous social spending are no longer a hypothetical, it becomes much easier for people to reason from the perspective of their own pocketbook. In such a context, high-income respondents will react by choosing to concentrate financial efforts on social programs they directly benefit from, at the expense of redistribution to policies.