Impact of Asia's Financial Crisis on Cambodia and the Lao PDR

• Author: Ngozi Okonjo-Iweala, Victoria Kwakwa, Andrea Beckwith, and Zafar Ahmed
• Position: Country Director, Southeast Asia/Senior Economist/Consultant/Economist, Southeast Asia and Mongolia Country Unit of the World Bank's East Asia and Pacific Region

Studies of the impact of the East Asian financial crisis on Cambodia and the Lao PDR highlight the importance of macroeconomic management, particularly in the face of serious shocks.

As the debate on East Asia's crisis moves to the issue of how the region can regain its past growth momentum, the econ omies of Indonesia, Korea, Malaysia, and Thailand continue to dominate the headlines. The impact and implications of the Asian crisis have been dramatic and well publicized, yet the fate of the region's smaller economies has gone largely unreported. Cambodia and the Lao People's Democratic Republic (Lao PDR), for example, have been affected by the crisis and remain vulnerable. Although they were insulated from some of the initial adverse effects, other effects have been aggravated unnecessarily by extremely weak economic management and unsustainable policy responses.

Economic reforms and growth

Cambodia and the Lao PDR are the poorest countries in East Asia, with estimated annual GNP per capita in 1998 of $280 and $330, respectively. Social indicators are poor (see table), and poverty rates are high, particularly in rural areas. Both economies have a small industrial base and depend heavily on subsistence agriculture, which contributes 43 percent of GDP in Cambodia and 52 percent of GDP in the Lao PDR.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Before the crisis swept through East Asia in 1997, Cambodia and the Lao PDR, like the region's larger economies, were registering commendable real growth rates. Both had made good progress in the transition toward a market economy. The Lao PDR's reforms had begun under the New Economic Mechanism in 1986, while Cambodia's reforms gathered momentum following the end of civil conflict and United Nations-sponsored elections in 1993.

In both countries, reforms supported macroeconomic stability, increased trade and investment flows, and a rebound in growth. Real growth in Cambodia averaged about 6 percent over 1993-96, and inflation, which had averaged 140 percent a year during 1990-92, was reduced to single digits during 1995-97. Per capita income is estimated to have doubled, from about $150 in 1991 to nearly $300 in 1997. Between 1992 and 1997, annual GDP growth in the Lao PDR averaged 7 percent, raising hopes that the country might graduate from the ranks of the least developed countries by 2020.

Growth and stability in Asia before the crisis supported the reform efforts of Cambodia and the Lao PDR and afforded them the opportunity to develop their economies. By the same token, however, both countries relied heavily on the region for export markets, large foreign savings, and trade tax receipts, and were therefore vulnerable to an economic downturn in the region (see chart).

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Emerging weaknesses, slowing reforms

Although the regional financial crisis triggered adverse shocks to both economies, their vulnerability to such external shocks had actually been mounting in the period leading up to the crisis. The reform momentum in both countries had slowed considerably, and as a consequence, underlying weaknesses in their economies were not addressed.

Cambodia's structural reforms lost steam with the increase in political tensions during the first half of 1997 and decelerated considerably in the second half of 1997 because of continuing political uncertainties. Governance problems exacerbated weaknesses in revenue mobilization and public expenditure management; donors began to halt disbursements because of the political...