Impact Of Government Policies On Foreign Direct Investment Economics Essay

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Foreign direct investments play a key role in enhancing the development, the economic growth, and global integration. The importance of FDI provides benefit to countries with the economic growth through the increasing of income, new job creation, higher wage, expertise, greater exports, skilled management and greater productivity through new technology. Thus FDI becomes the target for the developing countries to absorb the capital inflow and new technology to develop their economy through their own policies to attract FDI to invest.

In this regard, “FDI may no longer be attracted to just the economic fundamentals of the host economy and therefore government developing countries have a greater role to play. Along with the policies that improve the fundamentals of the economy they also need to develop selective policies that aim at attracting more foreign investments (Banga, 2003).” Thus the governments need to more seriously take measures to respond the demand of the investors while the more competition of attracting FDI is taking place from other countries.

It is to be noted that government in recent years have largely lowered restrictions to investment and opened up more and more sectors to foreign direct investment (UNCTAD 2002). The policies to improve the investment climate are more paying from the governments to catch up the foreign investors through the incentives, including monetary, fiscal, and regulatory policies. Thus, there is a big question coming up to the impact of these policies on foreign investors.

In this respect, to achieve the goal of attracting FDI, Cambodia’s government works hard to improve its overall investment climate such as establishing the government-private forum to respond the demand of foreign investors, Strengthening the country’s legal framework, bolstered its institutions, liberalized the relevant regulations, providing investors with a guarantee neither to nationalize foreign-owned assets, nor to establishing price controls on goods and services rendered by investors, granting them the right to freely repatriate capital, interest and other financial obligations. However, the level of FDI inflows to Cambodia is still low, compared with other countries in the regions. There are different factors which determinate FDI inflows. One of these factors is related to the government’s policies and the second one is related to the domestic market potential. So the policies and the domestic market potential will be raised to discuss and analyze in this topic.


Foreign direct investment plays an important role in enhancing the economic growth in the developing countries. Cambodia, one of the developing countries, is working hard to attract FDI through improving the investment climate- creating incentive policies for foreign investors through fiscal, monetary, regulatory policies. Thus the purpose of this research aims at to show the outcome of the policies and improve its ability to attract FDI.

Cambodia undertakes a new policy of uniform treatment for all investors, domestic and foreign. The new law helped enhance increasing investment projects and gave wider opportunity for foreign investors to get benefit from their investment in Cambodia. The government policies make foreign investors more confident. These policies include fiscal policy exemption from taxes, monitory policy dealing with exchange rate, inflation etc. Regulatory policies concerned with the entry, ownership, exportation and repatriation, privatization and other relevant policies.

The study is divided into seven parts: First introduction, second: Outlook of Cambodia’s Macroeconomic, Third: Overall Economic Policy, Fourth: Cambodia Government Policies toward FDI, Fifth: The Role of Government Policies to Promote FDI Inflows, Sixth: Need Reform, Seventh: Conclusion.

II-Outlook of Cambodia’s Macroeconomic


Cambodia is a country in Southeastern Asia, bordering the Gulf of Thailand, between Thailand, Vietnam, and Laos. Cambodia covers 181,035 square kilometers in the southwestern part of the Indochina peninsula. It lies completely within the tropics. Much of the country’s area consists of rolling plains. Dominant features are the large, almost centrally located, Tonle Sap (Great Lake) and the Mekong River, which traverses the country from north to south. This area was largely isolated until the opening of the port of Kampong Saom(formerly called Sihanouk ville) [1] . The two major international ports in Cambodia, Sihanouk ville and Phnom Penh, are committed to provide opportunities for future public-private sector partnerships or private sector participation in port operations [2] . It has population of 14,562,008 in 2008, reflecting an average annual population growth rate of 1.6 percent from 2002 t0 2008 (World Bank, the 2008 Revision) [3] .

2.2-Economic Indicators

Cambodia has made great strides since 1991, when more than two decades of isolation and conflict ended and priorities turned to ensuring peace and security, rebuilding institutions, establishing a stable macroeconomic environment, and putting in place a liberal investment regime. From 2004 to 2007, the economy grew about 10% per year, driven largely by an expansion in the garment sector, construction, agriculture, and tourism. GDP dropped to below 7% growth in 2008 and probably contracted in 2009 as a result of the global economic slowdown. In 2009, GDP (purchasing power parity) reached US$ 28.09 billion with decreasing a little bid compared with that of US$28.34 billion in 2008 (CIA 2009).

The overall recent economic performance has been characterized by balanced contributions from agriculture, manufacturing, construction, tourism and services. Cambodian economy has and continues to make a significant transition from traditionally agrarian economy to one based on industrial and services. Nevertheless, the economic profile of Cambodia is narrow. Agriculture remains the dominant industry, accounting for 31 percent of GDP and 70 percent of employment. The rapidly expanding industrial sector has been a key driver of recent economic growth for Cambodia, increasing 15 percent of GDP in 1995 to 27 percent in 2005. This largely reflects strong growth in manufacturing, particularly in garment and textile productions. Relatively low wages as well as government’s tax concession have kept the garments competitively priced, and the Cambodia’s largest earner of foreign exchange as well as the single largest non-agricultural employees with around 230.000 employees in 2005 [4] .

Cambodia also experienced high inflation (150%) in 1991-1993, 14.7% in 1997/1998, and 5.8% in 2007. In 1993, Cambodia had national elections and distrust and printing of money to finance budget deficit. Similarly, in 1997/1998, in time of the Asian financial crises and national elections, the government borrowed money from banks to finance deficit, thus making more money circulate in the market and caused inflation. The external and internal factors cause inflation in 2007 and 2008. The external shocks were attributed to the increase in oil price from 22$ a barrel in 2003 to 120$ in March 2007, the rising price of imported goods, and the exchange rate (depreciating of dollars and appreciating of Euros), and the increasing world demand of resources, especially by China and India [5] .

As Cambodia continues to borrow abroad to meet cash limitations, proper debt management is necessary to ensure financial viability of the country. According to the IMF, total public external debt was estimated to be US$3 billion (including debt owed to the US and Russia before 1993) by 2003 and debt services was US$71 million [6] . But as Cambodia has started to pay interest on loans borrowed after 1993, more funds are needed for debt services. This will exacerbate the current scarcity of funds for development unless domestic revenue is strengthened to reach around 15 percent of GDP or more, annually [7] .

The current account deficit (including transfers) is expected to narrow in 2009 to around 5½ percent of GDP as lower import demand and fuel prices more than offset sharply smaller export and tourism receipts (garments account for 65 percent of merchandise exports). As the recovery starts to kick in, the deficit is projected to widen to more than 11 percent of GDP in 2010, owing principally to sluggish exports trailing rising imports and oil prices. Gross official reserves are expected to stay broadly stable, at around US$2.2 billion at the end of 2009. However, a modest decline is projected for 2010, to around US$2.1 billion by year end, as the widening current account deficit more than offsets an expected pick up in FDI and banking inflows. In the event of an even looser fiscal stance, further pressure could be placed on reserves if the exchange rate is not allowed to adjust [8] .

Table1. Cambodia: Selected Macroeconomic Indicators, 1998-05

(Annual percent change; unless otherwise indicated)

Source: International Monetary Fund (Update 2009)

III. Overall Economic Policy

Cambodia has made significant progress over the last decade in rebuilding its physical and social infrastructure and institutions, and is successfully emerging from its post-conflict situation. Economic growth in recent years has been high, averaging just over 11% per year between 2004 and 2007. Poverty has declined. The Government recently announced an updated Rectangular Strategy for Growth, Employment, Equity, and Efficiency, Phase II (RS2). How successful the Government is will depend in large part on further improving the capacity of Government to effectively formulate, coordinate, implement, and monitor key strategies, policies, and legislation to enhance the depth, coverage, speed, and sustainability of the reform program (ADB, 2009).

However, Cambodia remains daunting. Although poverty has declined, it remains unacceptably high, with about one third of the population living below the poverty line in 2007, including about 40% in rural areas. The recent increase in food and oil prices is likely to have increased the number of people living below the poverty line. The Government recognizes this key development challenge and has vowed to place renewed emphasis on pro-poor agricultural and rural development, in addition to extending reforms in the areas of governance, private sector development and employment generation, rehabilitation of physical infrastructure, and capacity building and human resource development (ADB, 2009).

3.1. Main Economic Sectors

Cambodia’s principal economic sectors are agriculture, manufacturing, and tourism. Other sectors including oil and gas are exploring but do not prove reserve  yet. According to hypothetical scenario of IMF, oil and gas will give revenues on‐stream around $US1.5 billion of 115 percent of GDP in 2011 and the revenue stream max at 4% of GDP in 2021. Moreover, some mining such as bauxite, iron, gold is initially exploring (World Bank, 2008) [9] .

Garment sector has played the potential of the economic growth for one last decade. But in 2009, the economic growth decreases because of the losing the buying order from the United States’ market, resulting of the global economic crises.

3.2.Agricultural Sector

Agricultural growth had shown steady improvement (although highly variable) averaging two percent annually over the decade prior to 2005, when the sector had unusually high growth of 16 percent. With workers in the sector also growing, sector value added on a per worker level was lower, achieving 19 percent growth over this same period. However, agricultural production and general rural economic growth remain far below their potential because of low productivity, high vulnerability to weather, constrained access to land, forests, fisheries and markets, and lack of adequate infrastructure (such as roads, water supply, electricity and communications networks) (World Bank 2006). 

In 2009, the estimated growth is 5-6% (by ADB) and 1.5% by IMF. The impact has been felt mainly in the form of lower prices and revenues. The agricultural production is expanding but the price is decreasing. It impacts on the family incomes of the farmers due to increased costs of agricultural commodities and materials used for farming such as fertilizers, fuels and labor, and low price of their harvested products and limited market. In addition, the industrial crops production is decreasing due to the decreasing material demand from factories [10] .

Agriculture can offset other declining sectors in the time of crisis by providing job opportunities and absorbing more labor from affected garment and construction sectors. But this sector also faces with difficulties as well. For the short term, the government with the development partners established The “Agriculture Support and Development Fund” to support small and medium enterprises by providing short term credit with low interest rate to farmers in order to increase agricultural productivity and food security. The government continues to enforce zero tariff policy on importing agricultural materials such as seeds, fertilizers, pesticide and agricultural equipments. For the long term, the government together with development partners increases their investment in agricultural infrastructure such as irrigation system and transports [11] .

3.3 Garment Sector

The garment sector is the main contributor to Cambodian economy. The sector employs mostly women which contribute a lot to poverty reduction. The sector has been strongly affected by the global economic downturn as about 90 percent of investment capital coming from overseas and the main textiles exporting markets are the United States and Europe. The garment export grew only 2 percent in 2008 and is estimated to decline much further in 2009 and 2010. According to forecasts made by Asian Development Bank (ADB) and IMF, the garments industry will fall to 5% in 2009. In the first five months of 2009, garment export dropped 27 per cent. As result of global economic crisis and lack of demand, more than 50 factories were closed. Consequently, there were approximately 60, 000 out of 400, 000 garment workers lost their job since September 2008 [12] .

Short term contract (normally less than three months) had been chosen by the factory owners and managers to deal with fluctuating and decreasing demand since the crisis took place. Such management policy adversely impacted on livelihood on the workers. The decrease of production results in less working hours and over time employment. It causes the average wage of the worker to decline further. After suspending and closing their activities, many of the factory employers were not responsible for compensation for the laid out employees [13] .

3.4. Tourism Sector

For the short term, the government encourages the private sector to reduce prices in order to attract more tourists. The government starts targeting other regional tourism market such as rising Vietnam, China and India. Hotel discount policy and cheaper entrance tickets to Angkor Park for two days visitors are just part of the overall policy to attract more tourists. For the long term, the government and private sector invest more in human resource development and infrastructure improvement. Regional integration especially road connection among countries in the Mekong Subregion will help the increase the flows of regional tourists [14] .

IV-Cambodia Government Policies toward FDI

4.1. Overview and Objectives

Cambodia has rationalized its investment laws, policies and procedures with a view to attracting more foreign direct investment. At present, Cambodia has several institutions that are in charge of investment and private sector development such as: Council for Development of Cambodia (CDC)- an institution to oversee investment policy and strategy, The Supreme National Economic Council (SNEC) is the highest-level body mandated to provide the Prime Minister of Cambodia with technical analysis, advice, and recommendations regarding policies and strategies (ADB, 2009).

With the respect with policies to attract FDI, the government has encouraged to its policies to increase the domestic demand through public expenditure and its share of investment. These policies are concentrated on the incentive and facility in order to attract FDI inflows.

Cambodia has been successful at the level of the overall economic policy and has achieved some success with regard to legislative framework, having promulgated a numbers of laws that promote FDI. However, such success will continue to have limited impact at the investment level with the existence of some obstacles (CICP, September 10, 2009).

4.2. Monetary Policy

Monetary policy was eased in 2009, but risks in the banking sector are on the minds of policymakers. Cambodia had limited direct exposure of its financial sector to the world financial markets. However the slowdown in economic activity, declining property values, and more limited access to FDI constrained credit growth. The central bank reduced reserve requirements from 16 percent to 12 percent and removed restrictions on credit ceiling to the real estate sector in January 2009. Nevertheless, the 12-month growth of credit to the private sector slowed from 55 percent at the end of 2008 to 6 percent at the end of 2009. To avoid liquidity shortages, commercial banks accumulated deposits, which rose to $3.3 billion by the end of 2009 from $2.5 billion a year earlier. This brought the lending-to-deposits-ratio down from 94 percent in the end of 2008 to 73 percent in the end of 2009 and the capital adequacy ratio up to 28 percent, well above the 15 percent requirement. Excess reserve holdings could pose macro-financial risk if banks resume lending at a fast pace to reduce its high cost of holding large volume of deposits [15] .

4.3. Fiscal Policy

Fiscal policy has supported the economy. The fiscal deficit is expected to have widened to 6 percent of GDP in 2009 from 2.8 percent in 2008 and a budget target of 4.2 percent. The increase is due to a combination of tax incentives as a response to the crisis and weak economic activity, and higher expenditures reflecting stimulus spending. In particular, the wage bill rose to 4.4 percent of GDP in 2009 from 3.4 percent in 2008. Priority expenditures (rural development and social sectors essentially) rose from 3.3 percent of GDP in 2008 to 3.8 percent in 2009. The wider deficit was financed by a combination of a drawdown from the government cash reserve of as much as 1.6 percent of GDP and foreign grants. The 2010 budget seeks to withdraw partially the fiscal stimulus to ensure fiscal sustainability, by introducing a property tax and various enforcement measures and curbing expenditure growth, especially on the wage bill. Measures on public wages include cuts in some allowances for the military, tightening up of promotion and use of contractual staff in the civil side, and reform of salary supplements. This would bring the fiscal deficit down to 5.2 percent of GDP, requiring only a small financing from budget reserves. To improve budget performance and expenditure impact, the Public Financial Management Reform Program launched in 2004 has entered its second phase focusing on financial transparency and accountability. The first phase generated several results, including a greater use of the banking system (92 percent of tax revenue was collected through banking system in 2007, up from 2 percent in 2004, and 72.5 percent of payments to creditors and government staff were made through banking system in 2007 compared with 5 percent in 2004), timely cash releases from central government, elimination of arrears, dissemination of budget information, and approval of a new Law on Public Finance System [16] .

4.4. Regulatory Policy

Government incentive has positive relationship with the performance of foreign investment in Cambodia. Government incentive is composed of three sub constructs. They are investment incentive, tax holiday, import and export exemption. The result shows that significant value of investment incentive is accepted with higher coefficient. It means that investment incentive is the important predictor for the performance of foreign direct investment in Cambodia. The result shows that the significant value of tax holiday, import and export exemptions is accepted with the coefficient. It means that, they have positive relation with the flow of FDI into Cambodia. Government policy and protectionism has relationship with the performance of foreign investment in Cambodia. Government policy and protectionism is composed of two sub constructs: investments guarantee and trade barrier. The results are rejected. It means that the investor’s perception regarding to government policy and protectionism is irrelevant to the performance of foreign investment in Cambodia. This reasons can be Cambodia seem to be careless with the protection of investors in the case of bankruptcy or any damages. Moreover, since the world move to globalization and Cambodia accessed to be the member of WTO, trade barrier seem to be less important for FDI now [17] .

4.5. Trade Policy

The trade sector in Cambodia is very significant to the contribution to the development of local commodity and service sectors. Service sectors have accounted $US 643 million in 2009, growing at 3.2 percent of GDP (IMF,2009) [18] .

Cambodia has gradual trade policy liberalization. At present, Cambodia’s MFN Tariff Trade is

9.1 percent, compared to 4.8 percent for the East Asia and Pacific (EAP) region and 11.6 percent for low-income countries. Cambodia’s trade policy reflects a system that is only somewhat more restrictive for non-agricultural imports than for agricultural imports of 9.6 and 8 percent, respectively. The simple average of the MFN applied tariff rate has decreased only slightly since 2001 to 14.2 percent in 2007. Cambodia has also decreased its maximum tariff (excluding alcohol and tobacco) to 35 percent. The trade policy space, as measured by the wedge between bound and applied tariffs (the overhang), has remained very low in the past decade and was 4.8 percent in 2007. Regarding its commitment to services trade liberalization, Cambodia ranks 25th out of 148 countries on the GATS Commitments Index. As part of joining the Association of Southeast Asian Nations (ASEAN), Cambodia has committed to a gradual reduction in tariffs to a 0 to 5 percent range for goods imported from other ASEAN members by the year 2010, and has also reduced the number of tariff lines since 2008. In response to the rise in food prices at the beginning of 2008, Cambodia reduced import duties and temporarily banned rice exports. In December 2008, the government waived tariffs on exports of apparel in order to assist the industry, which has been hurt by the global economic downturn. [19] 

4.6. Bilateral Investment Agreement

Cambodia has bilateral investment agreements having been initiated with China, Croatia, Cuba, France, Germany, Indonesia, Vietnam, Malaysia, Philippines, Republic of Korea, Singapore, and Switzerland.

The main purpose of reaching theses agreements is to promote and facilitate the follow of Foreign investment from afore-mentioned countries to Cambodia.

Table2: Bilateral Investment Agreement Concluded by Cambodia, June 20, 2010


Date of Signature

Entry into force


July 19, 1996



May 18, 2001



May 28, 2001

June 28, 2001


July 13, 2000

August 13, 2000


May 22, 2001



Mach 16, 1999

April 16, 1999





August 17, 1994



August 16, 2000

August 16, 2001

Republic of Korea

February 10, 1997



November 04, 1996

November 04, 1997


October 12, 1996



March 30, 1995

April 30, 1995




United States






Source: UNCTAD.2010: United Nation Conference on Trade and Development

V. The Role of Government Policies to Promote FDI Inflows

5.1. Trend of FDI Inflows into Cambodia

Cambodia has become the destination of foreign direct investment (FDI) after its first-ever general elections in 1993. Based on approved foreign-invested projects, the majority of Cambodia’s inward FDI came from Asian neighboring countries, in particular, Malaysia, Taiwan, and China, which together accounted for about 60% of the total. The United States is the fourth largest investor in Cambodia [20] . Cuyvers et al. (2006) provide an overview of inward FDI trends in Cambodia over the period 1994-2004.

However, the overall number of foreign direct investment in Cambodia is seen as fluctuated. According World Bank, in 2005 to 2007, FDI increased very fast from the US$ 375 million to US$ 866 million. The fast growth was because of the increasing in construction sector investment. Yet foreign investment decreased very fast from $US 866 million to $US 515 million in 2007 and 2009, respectively.

Table3: Foreign Direct Investment (Million US$)













Source: World Bank key indicator Update 2010, Vol. I

5.2. Significant Areas of Investment in Cambodia

As showing in the section 2, agricultural sector is the main one in contribution to Cambodian economy. So the policy in developing infrastructure is the most priority for government after the economic recession because of the global economic crisis. Beside this sector, other main ones are also paid serious attention from the government such as garment industry, service sector, and tourism sector, especially the oil and gas exploration and other minerals that will a great benefit for Cambodia in the future. Now I will pick up the two main sectors to show the government role in these sectors.

5.3. Agricultural Sector

The development of infrastructure and promoting the productivity in agricultural production are the priority of the government to develop national economy. Recently, there are a lot of irrigations and roads have been developed.

For the short term, the government with the development partners established The “Agriculture Support and Development Fund” to support small and medium enterprises by providing short term credit with low interest rate to farmers in order to increase agricultural productivity and food security. The government continues to enforce zero tariff policy on importing agricultural materials such as seeds, fertilizers, pesticide and agricultural equipments. For the long term, the government together with development partners increases their investment in agricultural infrastructure such as irrigation system and transports.

The Council for the Development of Cambodia (CDC) approved agricultural investment projects worth a combined $499.7 million in the first eight months of 2009, in comparison to $81.7 million worth of projects approved over the same period in 2008. For investors looking to grow growing rubber trees, cassava, jatropha and other crops and process crops, Cambodia is an ideal location with plenty of land available for agricultural concessions. Qatar and Kuwait have also signed agreements to secure long-term food supplies for their countries. The UAE is also keen to explore opportunities in rice cultivation in Cambodia.

5.4. Gas Sector

The government works hard to attract the foreign investors to invest in petroleum production in Cambodia. So the gas sector has attracted the intention of the foreign investors for last years. The potential of the natural resource will make foreign investors get much profit for their investment. Many big petroleum companies have applied the exploring project.

According to World Bank report, Cambodian reserves may be contributing annual revenues of $2 billion, several times the current level of domestic revenue and ODA (overseas development aid) combined – within perhaps five to ten years. There are some block as followings:

Block A – in 2002 Cambodia entered into a production sharing agreement with Chevron in a concession area known as Block A – the only block that has been actively explored so far. Chevron announced in 2005 that it had discovered oil in four exploration wells and gas in one well. According to Chevron, the oil discovered consists of a number of small dispersed fields rather than a large single block. Despite the find five years ago, it would appear the company has no intention of announcing plans to commence

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