Although Cambodia’s economic growth has been somewhat underpinned by strong credit growth, it is starting to worry experts as the pandemic prolongs

After years of expanding credit to the private sector which fuelled economic growth, Cambodia might have to come to terms with a burgeoning private debt, one which the World Bank warned as having “substantially increased” in the past two decades.

It does not help that the pandemic is further weighing down on it, although monetary measures have temporarily staved off risks of increased indebtedness.

As of September 30, 2020, 270,648 loan accounts valued at around $3.7 billion were restructured.

But although containment of financial risks triggered by the pandemic helped to maintain stability in the banking and microfinance sector, the World Bank found that risks accumulated by an overleveraged financial sector remained.

“Private debt has risen significantly, and vulnerabilities, including high credit concentration, related-party lending risks, lack of consolidated cross-border supervision, and gaps in the implementation of risk-based supervision, remain,” the latest economic update in November showed.

Credit to gross domestic product (GDP), which mostly encapsulates private debt, has inched up year-on-year.

National Bank of Cambodia (NBC) data revealed that credit-to-GDP came in slightly below 120 per cent as of December 31, 2019.

More worrying was the 19 per cent credit-to-GDP gap, which is above the 10 per cent threshold of the Bank of International Settlement, signalling a build-up of excessive credit.

Source: Credit Bureau Cambodia (as of September, 2020)

(The gap is an early warning indicator of a financial crisis for central banks, which can draw up macroprudential policies to stabilise the sector).

Total debt (external and domestic debts), according to the World Bank, was 148.4 per cent of GDP in 2018, from 58.3 per cent of GDP in 1997.

Source: General Department of National Treasury (NBC Financial Stability Review 2019)

Often, the private debt size is larger than public debt, the latter amounting to some $7.6 billion or 28.5 per cent of GDP as of June 2020, well below the 40 per cent buffer.

“Yes, exactly,” said economist Dr Chheng Kimlong. “Private sector debt is now larger than public sector debt.”

However, he contended that it is “in fact a general trend in many countries, including member nations of the Organisation for Economic Cooperation and Development”.

In Cambodia, the surge is bolstered by the phenomenal rise in loans given by microfinance institutions and commercial banks, and credit card applications.

The consumer credit index report for the third quarter ended September 30, 2020 (3Q20), recorded by the CBC showed an 87 per cent climb in credit card applications from the previous quarter while personal finance and mortgage grew at 52 per cent and 50 per cent, respectively, said Credit Bureau Cambodia (CBC) CEO Oeur Sothearoath.

Overall, small business loans formed the largest segment at 60 per cent, followed by mortgage and personal finance about 15 per cent each.

This growth is backed by improved credit access, lower interest rates and numerous loan products associated with housing loans and corporate loans, and growing middle class with expanding income capable of paying additional loans.

Despite high credit growth, FIs have managed to sustain low NPLs

“Added to it is the private sector demand for more capital for their investment projects, including real estate,” Kimlong said.

While synonymous with a healthy economy, growing private debt is symptomatic of fast-paced economic development and poses challenges, as is the case now with incomes and livelihoods reeling from the effects of the virus.

True to form, such detrimental disturbances can lead to redundancies, bankruptcies, loan losses, a sharp reduction in non-compulsory consumer spending, and postponement of investments, said Anthony Galliano, CEO of Cambodian Investment Management Holdings Ltd.

“Unfortunately, Cambodia is experiencing one of the greatest risks of a highly leveraged economy, and a negative economic shock,” he said.

The NBC has repeatedly flagged the issue of vulnerability of rapid credit growth, particularly in the real estate and construction sectors which have received massive foreign direct investments in recent years.

Its concern was further compounded by the presence of direct mortgage lending by real estate developers without proper supervision.

This falls under shadow banking activities that have expanded over the years, and which the NBC has limited data.

According to the World Bank, which shares a similar concern with the NBC, credit to construction, real estate activities, and mortgages grew quickly, averaging 32.1 per cent per year from 2009 to 2019.

And although the increase in outstanding domestic credit financing in those segments decelerated to 23.1 per cent year-on-year in August this year – from 39.4 per cent as at the end of 2019 – it still came up to 34.6 billion riel.

Out of that, mortgage financing was the largest at 14.2 billion riel, followed by construction financing (10.5 billion riel) and real estate (9.8 billion riel).

“There is a consensus that booms and busts in asset prices can contribute to financial sector distress and macroeconomic imbalances.

“The pandemic has constrained the ability of households to repay loans, in particular mortgage loans, which are mostly denominated in US dollars,” the bank said, noting that financial stability had been maintained so far.

Having said that, growth in private debt can impact the economy, Kimlong opined.

Indebtedness can be damaging when it passes the threshold, for instance, reaching 60 per cent or more over GDP as some businesses have been severely shattered.

“[Besides], those who took loans from microfinance institutions or commercial banks are on the brink of collapse or have closed down as a consequence,” he said.

Still, he noted that as of today, the real estate and construction sector remain relatively healthy as a big majority of the construction projects committed a year earlier or so have not been put on hold.

At the same time, many micro and small housing projects have continued to grow.

“This will perpetuate further private sector credit growth or at least maintain the momentum. However, it remains unclear as to when it will continue,” said Kimlong, who is vice president of independent think-tank Asian Vision Institute.

Note: Total credit=Banks+MFIs. This gap is computed using a one-sided GP filter with a lambda of 4000,000 Source: National Bank of Cambodia

With revenue collection impacted this year, public debt is likely to rise to fund a widening fiscal deficit, projected to be 5.6 per cent of GDP in 2020 and 6.1 per cent in 2021, on the back of the pandemic, the World Bank said.

Accordingly, 87 per cent of the total borrowing by Cambodia is mostly for public investment in physical infrastructure.

But while the risk of public debt distress stays low, it cautioned that the exchange rate comes under pressure as financing from abroad rises, seeing that Cambodia’s borrowings are in foreign currencies.

It noted that the outstanding US dollar debt accounted for 43.5 per cent of the total outstanding debt, followed by special drawing rights (25.7 per cent).

Interestingly, although China is the largest creditor with a total outstanding debt of $3.7 billion or 46.8 per cent of the total, the World Bank said, its debt denominated in Chinese yuan was less than 15 per cent of the total debt stock.

So, could increased government borrowing compound private debt? Kimlong dismissed that notion, saying that Cambodia has been “extremely prudent” when it comes to external borrowings and debt management.

He felt that despite the economic slowdown and the decline in revenue, the government had not borrowed much more as it would in the case of sustained economic growth.

Galliano said developing economies were printing money “like there is no tomorrow, borrowing trillions, with staggering governmental borrowing that far exceeds the global financial crisis”.

For example, even as the new stimulus package is being debated in Congress, the US has already spent $2.6 trillion on stimulus spending and $900 billion on tax relief.

“This is a survival game,” Galliano said, as governments realise the importance of quantitative easing in the absence of stimulus, tax holiday and emergency relief for businesses, failing which global economy could plunge into a deep and prolonged depression.

He said the Kingdom is confronted with similar challenges but has fewer options as it has yet to issue bonds. Therefore, it still relies on foreign debt and international aid to raise capital.

“Given the limitations on government borrowing avenues, [Cambodia] should accelerate its entrance in the global capital markets to diversify its borrowing options and facilitate opening corporate issuance to international investors,” he said.

But can the risk of private debts reduce, particularly as all market sectors depend on credit to expand? For now, the loan restructuring programme, which has been extended to June 2021, has yielded some positive results. It is also touted as a way to tackle private debt.

Source: National Bank of Cambodia

CBC’s Sothearoath said even during Covid-19, ongoing access to credit helped borrowers meet their financial obligations and manage their cash flows. Financial institutions (FIs) also allow for interest rate and instalment adjustments for those who continue paying their loans after the restructuring.

However, the impact on borrowers who opened a loan account just prior to restructuring will be very different than the one who is at the end of the loan tenure.

“FIs would have to assess the situation of the borrowers and regularly monitor their portfolio,” Sothearoath said.

Likewise, Galliano opined that banks are flush with liquidity. He said given the economic conditions, banks have increased prudence on lending and have a reduced credit appetite.

The credit market model is still substantially based on the collateral pledge and accredited payment capacity for loan model.

Source: National Bank of Cambodia

“I see no indication that this model will change, and given the current risk adverse climate, borrowing should be more restrictive,” he felt.

How about meeting credit demand via state-developed mechanisms such as the low interest SME co-financing scheme and Credit Guarantee Corporation?

Kimlong was frank in his reply when he said that these schemes can work to some extent only if the private sector remained resilient and is able to manage current risks.

“The NBC will use some of the monetary policy to prop up the financial industry but it is unlikely to disincentivise credit growth in the private sector.