Cambodia grapples with an impending inflation hike as oil price and US dollar surge amid the crisis

Ripples created by the Russia and Ukraine war are starting to wash ashore in Cambodia. A net oil importer, the Kingdom is being gripped by surging oil prices as well as the US dollar strengthening on the back of increased risk aversion, both of which are threatening to spiral inflation.

Consumer price index, a measure of inflation, has been creeping up since 2020, before coming in at 3.7 per cent on December 2021. The expansion was largely underpinned by transport, and clothing and footwear. This year, the National Bank of Cambodia (NBC) predicts headline inflation to be 2.7 per cent. But rumblings on the ground about higher living costs, particularly food and transport bear testimony to the uptrend in the price of goods.

Economist Chheng Kimlong attests to this whilst pointing out the likelihood that rising oil and gas prices will continue to prevail and pose significant impacts on the price of other commodities, causing an overall inflation hike in Cambodia and across some major regions.“The extent to which the inflation hike poses severe consequences depends on the duration and intensity of oil price situations.”

What this essentially means is that the new circumstances will necessitate extra interventions by the government and central bank in coming months, a move which would take a great deal of effort to execute.

“The NBC as well as the ministries concerned need to take necessary precautions with regards to the inflation trend being perpetuated by rising prices of fuels and associated commodities. Macroeconomically, the inflation pressure can be present and intensified by disruptions caused by sanctions and trade diversions as a consequence,” Kimlong shared.

In 2021, Cambodia imported refined oil worth $457 million, up 31 per cent year-on-year as the economy improved, whereas diesel imports gained 44 per cent to $1 billion compared to 2020.

At the time, Brent futures averaged $70 per barrel while West Texas International was $68, up by around 30 per cent from 2020.

This led to an increase (which has been inching up) of between 3,000 and 4,000 riel per litre in gasoline pump prices, and up to 2,900 riel per litre for diesel.

The government, which allocates a US four cent subsidy per litre since 2018 when gasoline pump prices hit 6,000 riel per litre, sets ceiling rates based on the Mean of Platts Singapore benchmark and taxes, consisting of customs duty, additional tax and special tax. The price cap is recalculated every 10 days.

Looking at the market prices for EA92 gasoline and diesel - two commodities controlled by the government - the subsidy has somewhat helped to contain the rates under 5,000 riel at 4,800 riel per litre for EA92 petrol and 4,500 riel per litre for diesel.

Given that the oil is refined, global crude oil prices have thus been factored in where the futures price list per barrel from Singapore between February 16 and 28 averaged $110 to $112 when oil prices were about $92 to $93 per barrel.

“We expect crude oil prices to rise more next week, so refined oil will also see an increase and we cannot avoid this as we are importers, not producers,” he said.

However, given the need to conserve resources in the current economic landscape, further subsidies or tax reliefs might not be an option, Penn Sovicheat, spokesman for the Ministry of Commerce asserted.

Furthermore, Cambodia’s open market policy limits major interventions, therefore resolutions are only possible through discussions with “concerned parties” including the private sector, which are the designated oil importers.

“We have to maintain the balance between `availability’ and `higher price’,” Sovicheat said, adding that it is better to have the product in the market with a slightly higher price than not have it at all as it would cause panic buying or result in markup pricing due to scarcity.

The last time the government reviewed the petrol subsidy was in 2018 when the special tax was revised lower, reducing petrol tax by $30 million annually.

“We cannot afford to do this now as we need tax revenue which is a main income for the government. If you cut one part, it would affect another part. For instance, we won’t be able to provide subsidies, like tax cuts for sectors such as tourism and manufacturing sector.

“We also need to prioritise tax revenue for the purpose of vaccinations, treatment of Covid-19 patients and social protection,” he told The Post.

That being said, the government is bracing for the effects of full on sanctions by the West, which could set off oil prices, possibly skyrocketing to $300 per barrel, Russian deputy prime minister Alexander Novak warned.

If that happens, a discussion to mitigate the situation using precautionary measures will be conducted with the Ministry of Mines and Energy, and Ministry of Economy and Finance. These measures could range from subsidy to profit sharing to guaranteed stockpile or other options that are practiced by oil producing and importing countries, like Vietnam but nothing has been decided yet in Cambodia. Sovicheat hopes it won’t have come to that.

In recent weeks, Brent crude and WTI, having hit multi-year highs following US sanctions on Russia and more on the way, have only unsettled global markets.

Although Russia is the third largest oil producer with seven million barrels per day output, it is the biggest oil exporter in the world, according to International Energy Agency.

“Similar to many Asian countries, Cambodia is a net oil importer, with fuels trade deficit amounting to $2.4 billion in 2019,” said economists Bernard Aw and Eve Barre of Paris-listed credit insurer Coface SA.

“Although the country does not import Russian oil, it will be affected by the rise in global crude oil prices. This would weigh on the already substantial current account deficit, estimated at 21 per cent of gross domestic product [GDP], which is currently covered by remittances, foreign direct investment, external financial aid and project financing,” they said, adding that Cambodia’s foreign exchange reserves remain adequate, covering around seven months of imports.

However, the convergence of events - the war and US Federal Reserve’s forthcoming interest rate hike - are likely to impact sectoral growth and investments, which concerned the government including Prime Minister Hun Sen who raised the alarm last week.

The Ministry of Economy and Finance did not return with comments on the impact at the time of writing.

Downside risk

Data by the Customs and Excise Department revealed that trade between Cambodia and Russia, and Ukraine has grown year-on-year. In 2021, total trade volume between Cambodia and Russia rose 48 per cent to $94.2 million from 2020 while trade volume with Ukraine was $8.6 million, up 25 per cent.

Cambodia exports garment and footwear to Russia and imports items such as helicopters, furskins, and construction services.

“Based on the figures, it isn’t much compared to the US, EU, China and intra-ASEAN. These two countries are not big markets for us right now but we hope to expand them via the Eurasian Economic Union free trade agreement which is under discussion,” Sovicheat said.

The EAEU region consists of Russia, Belarus, Armenia, Kazakhstan and Kyrgyzstan.

Meanwhile, Aw and Barre observed that Cambodia’s economic growth is set to accelerate this year, thanks to a recovering private demand and the reopening of the borders to fully vaccinated travelers in November 2021. But they cautioned that risks are tilted to the downside.

They mentioned that although Cambodia’s ties with both countries on investment and trade are very small, with only 0.3 per cent of Cambodian exports going to Russia and Ukraine in 2019, the conflict will have impacts on the country.

“The main impact will be through the price channel, with inflation likely to intensify - at least during the first half of 2022 - due to higher global food and energy prices,” they said.

The tourism sector, which amounted to 19 per cent of GDP in 2019, would not be directly affected, as Russians and Ukrainians accounted for a mere one per cent of total inbound tourists to Cambodia in 2018. Nevertheless, the rise in fuel prices could weaken airlines’ margins in a time when demand for travel is not back to pre-pandemic level.

“In addition, as the country greatly relies on exports - 60 per cent of GDP in 2019, with garment industry constituting 40 per cent of the total and represents the largest employer of the country - it also could suffer from a slowdown in global demand,” they told The Post via email.

`Likely to dry up’

Weighing in on the type of risks evident on the aviation sector in this region as a result of the war, Gary Bowerman, an Asia travel and tourism analyst and commentator, said jet fuel price in Asia Pacific is soaring and the region is a huge consumer of jet fuel, accounting for 22 per cent of the global market.

The rise in the jet fuel price, he said, was happening before the military offensive in Ukraine, though it is now escalating.

“This creates an enormous financial constraint for airlines, especially given the large financial hits they have taken over the past two years of the pandemic – especially those that did not hedge over the past two years,” Bowerman shared.

Carriers would be extremely cautious about the flight services they operate in the coming months, and destination marketers will have to demonstrate that they can build sustainable demand for travel to justify flights.

If the war continues and jet fuel prices continue to rise, jet fuel will not only become “more expensive but also more scarce”.

“This will result in more rationalisation of routes by airlines, and higher priced fares on flights that are operating. AirAsia, for example, has already announced a fuel surcharge on all its services,” he said.

This brings into context Cambodia’s tourism sector growth which remains dim, compounded by the absence of the Chinese market and now, the war .

“It is impossible for countries in Southeast Asia to overcome the absence of Chinese visitors. China accounted for 22.5 per cent of visitors to ASEAN in 2019, and 36 per cent of visitors to Cambodia.

“Some countries are marketing more aggressively in substitute markets. Thailand, for example, has seen an influx of Russian tourists in 2022, but that flow is likely to dry up now due to sanctions and the restrictions on financial services,” he said.

India comes forth as another target market for tourism boards in the region, though it would take time to build flight capacities and frequencies and develop effective campaigns – especially as travel is only now starting to return after two years.

“A vital goal for Cambodia, and other countries of ASEAN, in the early stage of the recovery is to rebuild travel connectivity with other Southeast Asian markets, and also look to Japan, South Korea and Taiwan over the coming months,” he proposed.

Uncertainty in long-haul markets is likely to remain, and until Chinese travellers return to the region, “overall visitor numbers will remain depressed”.

Therefore, tourism boards need to focus on key regional markets to build incremental growth, and forget about benchmarking against 2019 visitor volumes.

While there will be peaks and bumps in the recovery, Bowerman advised that “patience will be required as the travel bounce-back is going to take time”.

“For this reason, countries in the region should continue to support and promote domestic tourism to help the industry stay vibrant. This will also enable domestic travellers who do not feel ready, or are not financially unable, to travel abroad in the coming months to enjoy unique travel experiences in their home country,” he added.

More intervention

International sanctions imposed on Russia will contribute to a deep recession in the Russian economy this year, possibly contracting 7.5 per cent, with potential supply disruptions in key products provided by Russia, such as energy and food commodities, said Aw and Barre.

In time of geopolitical tensions, and therefore “higher risk aversion” (CBOE Volatility Index which measures level of risk and fear in the market - hit highest since October 2020), emerging markets will be less attractive and more vulnerable to capital outflows, exacerbated also by imminent US rate tightening.

This could trigger currency depreciations and affect countries’ ability to deal with their external debts.

In Cambodia’s case, Aw and Barre said its public debt is “quasi-exclusively” external and 60 per cent of its external public debt is denominated in US dollar, placing it in a specific position related to this matter. As the economy is highly dollarised, it reduces the effect of fluctuations in the foreign exchange rate against the US dollar.

The NBC regularly intervenes in the forex market to stabilise the riel against the USD. Source: NBC

However, the rise in risk aversion has pushed the value of the greenback higher, with the US Dollar Index (DXY) heading to 100.

Given the characteristic of Cambodia’s economy, a stronger dollar would tend to “weaken the nominal value of Cambodian imports – with the exception of those from the US”.

“In a context of inflationary pressures, it would limit the increase of Cambodian imports bill,” Aw and Barre said, adding that the central bank’s mission would be to ensure price stability and exchange rate.

In January, NBC launched several policies to support economic growth in 2022, including the stabilisation of the Cambodian riel. Last year, NBC injected $500 million to maintain the exchange rate at 4,099 riel to the dollar. In January this year, NBC projected that the riel would hold sway at 4,075 riel per US dollar.

But with greater risk aversion and imminent US rate hikes, the economists said the dollar will face upward pressures, therefore more market intervention will be necessary to defend the value of the riel against the US dollar, Aw and Barre said.

‘War won’t last’

Given the emerging effects, MoC’s Sovicheat expressed hope that the global oil pressure would taper on the likelihood of sanctions being lifted on oil producers, Iran and Venezuela.

“It is a hope, though not a concrete measure to respond to the sanctions on Russian oil export. No one can replace Russia’s capacity. But maybe the combined output of Iran and Venezuela might relieve some pressure from the market amid shortages,” he said.

In the long run, Sovicheat said the government is thinking of securing sufficient supply (for all industrial sectors) where a one-month stock is presently mandated, and that petrol prices are made “affordable”.

Understanding that industries are affected by the circumstances, he urged them to soldier on despite the loss of profit due to inflation because workers and consumers depend on them.

“We encourage them to keep producing so that there are products in the market. They also need to feed the workers and serve the export market to help the economy. So they cannot stop manufacturing.

“But what they can do is tighten their belts, reduce expenses and diversify their products and markets. They should take advantage of the free trade agreements we have signed,” he said, stressing that production must continue for the “survival of the business and people” because the “war will not last”.

“The world won’t let Ukraine die and disappear from the world map. I think the war will stop soon. It is a difference in ideology and security, [fuelled by] paranoia … we favour peace, like our leader said. We don’t advocate war.

“We expect the war to end soon and everything will go back to normal gradually.Russia and Ukraine are negotiating now, so the war will stop and the markets will normalise including the oil price,” he said.