Moody’s Revises Cambodia’s Outlook to Negative from Stable

Widening current account deficit, alleged opaque sources of financing and slow erosion of foreign exchange reserves back Moody’s revision of Cambodia’s outlook. However, it expects GDP growth to be robust at 4.5 percent this year and 5.5 percent in 2023
A man pulls a cart of boxes on a street in Phnom Penh, September 22, 2022. Kiripost/Siv Channa
A man pulls a cart of boxes on a street in Phnom Penh, September 22, 2022. Kiripost/Siv Channa

Cambodia’s deteriorating external position, in view of its “severe” widening current account deficit has prompted Moody’s Investors Service Inc to change its outlook to negative from stable, although it reaffirmed its B2 ratings.

It expects the deficit to remain wide, albeit narrowing, over the next few years, raising financing concerns, the credit rating firm said on Tuesday.

“Although Moody's expects concessional funding to continue and foreign direct investment (FDI) to remain stable, other sources of financing remain opaque – highlighting the risk of a quicker erosion of foreign currency reserves than observed until now.”

“These risks are compounded by the lack of timely and transparent reporting, which complicates policy setting, indicating elevated credit risks stemming from weaknesses in governance,” said Moody’s.

It noted that in 2021, current account deficit deteriorated to 46.2 percent of gross domestic product (GDP) from an average of 9.5 percent in the last 10 years due to an increase in construction and fuel imports, as well as more than 500 percent of non-monetary gold imports (not held as reserve assets by the central bank).

Current account deficit remains significant this year, around 20 percent of GDP, even if monetary gold imports are not taken into consideration. It expects the deficit to be above 30 percent of GDP in the next two years despite narrowing on the back of reduced imports and higher exports.

Continued export weakness due to recession risks in Cambodia's main export markets and Moody's expectations that the tourism industry will not fully recover until at least 2025, challenge the narrowing of the deficit.

‘Opaque funding sources’

Meanwhile, Moody’s said the “lack of timely and transparent data” on funding sources and foreign exchange reserves complicate policymaking, raising risks of unpredictability and volatility with respect to external buffers.

“Historically, current account deficits have been offset by FDI inflows [more than 12 percent of GDP on average over 2012 to 20]. However in 2021, FDI was not sufficient to finance the current account deficit, which was also covered by unspecified sources of capital flows.

“The opacity of these flows highlights transparency concerns, and as a result, the funding of forecasted current account deficits appears highly uncertain. While Moody's expects concessional multilateral and bilateral funding to continue unabated, risks to FDI flows are also tilted to the downside due to slowing global growth, particularly in China,” it mentioned.

Looking at Cambodia’s foreign exchange reserves, Moody’s highlighted that they “slowly eroded” to $16.1 billion in July this year, but remain relatively high.

It expects the reserves to continue reducing to $15 billion (or 4.8 months of import cover) in 2022, and $13 billion (3.8 months) in 2023 from $17 billion (6.2 months) in 2021, as “financing sources for the large current account deficit remain unclear”.

However, Cambodia has no external commercial debt at present, so there are no additional financing risks in that sense, it said.

Ratings up and down

The B2 rating affirmation balances the government's highly-affordable, concessional debt with a weak institutional framework, and elevated domestic political and geopolitical risks.

Moody's expects real GDP growth to not return to pre-pandemic levels within the next few years due to a weakening of global growth, including in Cambodia's main export markets (US, EU) and in China, posing downside risks to the economy's recovery. However, it expects robust growth in Cambodia of 4.5 percent in 2022 and 5.5 percent in 2023, which is a “substantial increase” from the estimated three percent growth in 2021.

A ratings upgrade is not expected anytime soon, given the negative outlook, but a revision on the latter to stable is likely if pressures on the external position ease.

An upward rating could arise over time if reforms address institutional weaknesses and enhance policy effectiveness, such as control of corruption and rule of law.

In addition, the implementation of structural reforms should support competitiveness and reduce hurdles to doing business, contributing to a material increase in economic diversification and incomes. “Such an outcome would bolster the economy's resilience to shocks.”

Similarly, a downgrade is possible if larger external imbalances become structural, with increasing difficulties financing the wide current account deficit. This could be for example, due to a moderation of FDI inflows, and increasing pressure on foreign exchange reserves.