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Cablegate: Prime Minister Outlines Bulwarks Against

VZCZCXRO1841
PP RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHPF #0353/01 1211054
ZNR UUUUU ZZH
P 301054Z APR 08
FM AMEMBASSY PHNOM PENH
TO RUEHC/SECSTATE WASHINGTON DC PRIORITY
INFO RUCNASE/ASEAN MEMBER COLLECTIVE PRIORITY
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY 0762
RUEHC/DEPT OF LABOR WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 04 PHNOM PENH 000353

SIPDIS

SIPDIS

STATE FOR F, EAP/MLS, EAP/RSP, EEB/TPP/ABT/ATP--SPECK,
EEB/IFD/OMA, DRL/ILCSR-MITTELHAUSER
STATE PLEASE PASS TO USTR FOR DAVID BISBEE
STATE PLEASE PASS TO USAID FOR ASIA, DCHA, GH, EGAT
BANGKOK FOR FAS--MEYER AND PICKELSIMER
HANOI FOR FAS--WADE AND RALPH
AGRICULTURE FOR FAS/OCRA--RIKER
TREASURY FOR CHUN
LABOR FOR ILAB

E.O. 12958: N/A
TAGS: ECON SOCI PGOV EAGR ELAB CB
SUBJECT: PRIME MINISTER OUTLINES BULWARKS AGAINST
"INFLATION TYPHOON"

1. SUMMARY. Prime Minister Hun Sen took his economic battle
plan to the airwaves April 23, outlining the causes of
Cambodia's increasing inflation, enumerating policies the
government has enacted in recent years to create a robust
economy, and listing possible future steps to further combat
inflation and potential food shortages. Seizing the
opportunity of a nationally televised semi-annual meeting
between government officials and the private sector, the PM
abbreviated the government-private sector dialogue in favor
of a four hour speech about Cambodia's economic situation.
With an eye towards voters, he emphasized that Cambodia did
not have a rice shortage and detailed a number of past
actions and possible next steps to combat rising food prices
and other inflation. Most significant among these plans were
eliminating customs duties and VAT on food and agricultural
imports, providing additional credit to rice millers and the
state-owned rice company, ending a ban on Vietnamese pork
imports, and increased wages for garment workers and civil
servants. The PM also said that he would end a ban on rice
exports, but might impose export taxes on rice if Cambodia's
food security situation worsened dramatically. End Summary.

2. The Government-Private Sector Forum is a meeting of the
Prime Minister and his full cabinet with the representatives
of eight joint government and private sector working groups
tackling issues from agriculture to industrial relations.
The semi-annual event is nationally televised and attended by
hundreds of diplomats, officials, and business people. This
meeting, the 13th forum, was held on April 23. In the past,
each working group gave an overview of concerns in their area
and asked for specific government interventions, which the PM
usually approved or declined on the spot. This meeting was
notable in that the government-private sector dialogue was
dramatically shortened to allow for lengthy remarks about
inflation from the Prime Minister.

Finance Minister Predicts 7.2% Growth in 2008
---------------------------------------------

3. The opening speech of Keat Chhon, Minister of Economics
and Finance, was heavy in its praise for the Prime Minister,
noting that the economy has grown at an average of 11.1% per
year since the last national elections in 2004. However,
global financial events have hurt Cambodia's economic
performance and near term economic outlook, with 18.7%
inflation in January 2008 and GDP growth expected to slow to
7.2% in 2008. The Minister mentioned briefly that the Prime
Minister was keeping the "inflation typhoon" under control
through a combination of monetary and fiscal measures.
(Note: A sidebar, printed in the Minister's remarks but not
read, acknowledged the possibility that increased government
spending designed to alleviate the impact of inflation on the
poor could in fact end up spurring further inflation.
However, the note concluded, the current inflation is
"imported" rather than having primarily Cambodian causes, and
is unlikely to be worsened by Cambodian government efforts.
The document quotes Deutsche Bank executive Josef Ackerman as
denying the market's self-healing power and cites the USG's
bail out of Bear Stearns as further rationale for government
intervention. End Note.)

PM Weighs in on Private Sector Requests
---------------------------------------

4. On the substance of the Government-Private Sector Forum,
Prime Minister Hun Sen announced decisions about requests
made from the eight working groups that constitute the Forum.
He agreed to eliminate customs duties and suspend VAT on
food, agricultural inputs such as machinery and animal feed,
and several metals. He pledged to reduce customs tariffs on
organic chemicals. He declined to establish a convention
center in Phnom Penh, saying that private sector developers
already had plans to build several exhibition halls in the
capital. Plans to increase the reserve requirements at banks
will go forward despite objections from the banking industry.
Hun Sen said that he agreed in principle with proposals to
draft new laws on trade unions and the creation of a labor
court. (Comment: International Labor Organization

PHNOM PENH 00000353 002 OF 004


representative John Ritchotte told us neither of these
proposed laws were discussed in the Industrial Relations
Working Group. It is not clear what the proposed law on
trade unions would say. The existing Labor Law refers to a
not-yet-established labor court, and the embassy and the ILO
have previously been concerned about whether the creation a
labor court, in a country with a famously corrupt judiciary,
would undercut the innovative and transparent Arbitration
Council, which was created with U.S. Department of Labor and
USAID funds. End Comment.)

Global and Domestic Factors Fuel Inflation
------------------------------------------

5. Turning his attention to Cambodia's increased inflation,
the PM said that global factors and Cambodia's own economic
success lie behind the recent increases in Cambodian
inflation. Global causes include the five-fold increase in
global oil prices since 2003, increased consumer demand for
food and other goods, lower agricultural production due to
shifts from food to bio-fuel production and poor weather,
increased population, and the depreciation of the dollar.
Cambodia is particularly sensitive to the dollar's
depreciation, the PM noted, because Cambodia's economy is
dollarized and the vast majority of its exports go to the
U.S., while it imports most of its goods from other Asian
countries whose currencies are appreciating against the
dollar. Domestically, high economic growth rates,
skyrocketing real estate values, increasing numbers of
tourists, and the surge of broad money (cash plus funds in
checking and savings accounts and non-institutional money
market funds) have fueled the demand for consumer goods, Hun
Sen stated.

6. Throughout his speech, the PM was quick to assuage
potential fears of food shortages by emphasizing that
Cambodia has enough food to feed its people and is, in fact,
a net rice exporter. He noted that Cambodia had recently
shipped 6,000 tons of rice to Senegal. He also asserted that
while urban populations may feel the pinch of higher food
prices, these same dynamics lead to higher incomes for
farmers. With so many urban workers having family back in
the provinces, the economic effects of the increased rice
price may be evened out within families, he said.

Prudent Government Policies Have Kept Economy Growing
--------------------------------------------- --------

7. Highlighting Cambodia's prudent fiscal and monetary
policies, the Prime Minister enumerated actions that the
government has taken in the past--both specifically in
response to the recent increase in inflation and more
generally over the past several years--to keep the Cambodian
economy growing without overheating. In April 2008, the
government gave garment and shoe factories a three year
exemption from the 1% pre-paid tax on profits. This was part
of a deal that gave these factories the financial flexibility
to agree to give workers a USD 6 per month cost of living
adjustment to last through 2010.

8. The Prime Minister has taken several steps intended to
secure the country's food supply. He banned rice exports on
March 26, 2008, later announcing that he would lift the ban
effective May 26, 2008. (Note: After appeals from the
Commerce Minister, Hun Sen later agreed that three eastern
provinces with high rice production could export rice, mostly
to Vietnam. Consumer goods have long been smuggled into and
out of the country to avoid paying customs duties, and we
have heard reports that rice is now being smuggled out in
defiance of the ban, but we do not know on what scale this is
occurring. End Note.) Hun Sen said that he had also ordered
the state-owned rice company Green Trade to sell rice from
their stock; provided additional financing to be used as
working capital by Green Trade and the Cambodian Rice Millers
Association; and rescinded an August 2007 ban on the import
of Vietnamese pork products. (Note: While the PM claimed
credit for lifting the ban as an anti-inflationary measure,
the ban was initially imposed in response to an outbreak of

PHNOM PENH 00000353 003 OF 004


porcine respiratory and reproductive syndrome, also know as
blue ear disease. Hun Sen noted that the disease was now
present only in isolated pockets in Vietnam. End Note.)

9. Over the past several years, the Cambodian government has
increased the base salaries of government officials, military
personnel, and retirees by 10-20% per year, Hun Sen said, a
rate significantly exceeding inflation. The government
doubled the allowances given to the spouses and children of
working, retired, and disabled officials and soldiers.
(Comment: This move is largely rhetorical and symbolic as
these allowances are quite small even in a Cambodian context.
The spouse allowance increased from 63 cents per month to
USD 1.25, and the child allowance rose from 75 cents per
child per month to USD 1.50 per child per month. End
Comment.) By using lower, out-of-date prices for calculating
the taxes on gasoline for consumer use and diesel fuel for
electricity generation, the government has cut the effective
tax rate on these products. As a result, the price of gas
has risen more slowly in Cambodia than in neighboring
Thailand or Vietnam. Similarly, electricity prices are lower
than they would be otherwise, the PM stated.

Battling Inflation and Food Insecurity: The Road Ahead
--------------------------------------------- ----------

10. Cambodia's economy will face an unfavorable environment
in the medium term, the Prime Minister asserted, explaining
that many of the factors fueling inflation now would likely
continue. He noted that there were some silver linings to
this situation. For example, Cambodia will be a cheaper and
more attractive tourist destination thanks to the dollar's
decline.

11. The National Bank will adopt a cautious monetary policy,
Hun Sen said, by increasing the reserve requirement at banks
from 8% to 16%; encouraging banks with strong balance sheets
to invest some of their assets abroad; establishing
guidelines aimed at reducing lending in some high-risk
sectors, especially real estate; and slowly de-dollarizing
the economy.

12. Fiscal policies will also be carefully developed in
order to keep inflation in check and promote continued
economic growth. Hun Sen called for government spending to
remain within the parameters of the balanced 2008 budget.
The government will aim to increase revenue by reducing
smuggling, tax evasion, and tax fraud. The government will
reduce or eliminate customs tax and VAT on food and
agriculture imports, offsetting this loss of revenue with
higher taxes on luxury goods such as cars, alcohol, and
cosmetics. The Prime Minister called for better enforcement
of property and unused land taxes, and the implementation of
a capital gains tax. Finally, the government may consider
introducing export taxes on rice if a severe shortage of rice
develops within the country.

13. The Prime Minister also enumerated other government
policies which could boost agricultural production if needed.
Licensing rice storage, processing, and export firms would
help collect data about rice production and rice levels and
would impose some degree of control on the process. Finally,
the government and private sector could provide low interest
loans to the Rice Millers Association to increase its ability
to store rice for later sale for domestic consumption. The
government could encourage the creation of community-based
farmers associations and then direct financing, seeds, and
technical assistance to these organizations.

Comments
--------

14. Hun Sen clearly saw the nationally televised
Government-Private Sector Forum as a campaigning opportunity
and did his best to appeal to voters. His speech sought to
reassure voters with repeated assertions that Cambodia
produces enough rice to feed its people and has even exported
6,000 tons of rice to Senegal in recent weeks. His rants

PHNOM PENH 00000353 004 OF 004


were this time focused on populist themes, including
defending people in Kandal province from a land grab, and,
unusually, did not criticize the international community at
all. The PM also targeted the opposition, warning that this
could be the last Government-Private Sector forum if the CPP
does not win the election.

15. But for all his politicking, the PM's speech was most
notable for the overall soundness of his economic analysis,
actions, and plan. International observers consistently give
Cambodia high marks for its fiscal responsibility, trade and
investment openness, and overall economic mindset. Hun Sen
has been consistent in his economic goals, repeating in both
good times (considering how oil revenue might be spent) and
bad (the current inflation situation) that the government's
rectangular development strategy will guide its decisions.
The PM has now backed away from earlier reactionary moves,
announcing the immediate end to the ban on Vietnamese pork
imports and the May 26, 2008 expiration of the rice export
ban. With an eye toward the international community, he was
careful to note that his new proposed emergency measures to
limit rice exports--potentially imposing export taxes--fall
within WTO rules. The most dubious parts of his plan are his
monetary efforts. In Cambodia's highly dollarized and open
economy, the government has little control over money supply.
MUSSOMELI

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