Foreword of the Governor The year 2009 has ended with an improved sentiment among policymakers and market participants over the prospects of the global economy and financial markets. The deep concerns and uncertainty caused by the turmoil in international financial markets in mid-2007, and which had major repercussions on economic activity worldwide during 2008 and in the first few months of 2009, seems to have abated. After a deep recession, global economic growth has turned positive. Decisive and wide-ranging public interventions in key advanced economies have allayed concerns about a systemic financial collapse and a global depression, while stimulative macroeconomic policies have shored up domestic demand across many other economies. Emerging and developing countries, notably in Asia, are recovering earlier than advanced economies. According to the IMF’s latest report on the global economy, global activity is forecast to expand by about 3 percent in 2010, after contracting by about 1 percent in 2009. Advanced economies are projected to expand sluggishly through much of 2010. Average annual growth in 2010 will be only modestly positive at about 1.2 percent, following a contraction of 3.5 percent during 2009. The emerging and developing economies’ real GDP growth is forecast to reach 5 percent in 2010, up from 1.7 percent in 2009. The rebound is driven by China, India, and a number of other emerging Asian countries. Economies in the ASEAN region are also expected to post solid growth of close to 4 percent in 2010, which will be helped by recovering commodity prices. As far as our own economic situation is concerned, the global financial crisis and economic contraction has taken a heavy toll on the remarkable gains Cambodia made in recent years-achieving stable and robust economic growth, reducing fiscal and external current account deficits, and lowering unemployment and poverty, as its economy is highly dependent on a sustained international trade expansion and foreign capital inflow. Three of the four main drivers of growth-exports, tourism, and construction-have registered contractions while agriculture remains on a firm footing. The current global economic crisis has indeed led to a sharp fall in exports, while the capital and investment flow was reduced heavily, which has in its turn adversely affected the investment decisions by the domestic private sector, as the private sector continued to adjust to slack external demand and weak conditions in the property market. The IMF’s GDP projection indicated that the Cambodian economy may contract by 2.7 percent in 2009, with a modest bounce back in 2010 to a positive 4.2 percent. With a prompt evaluation of the situation, the Cambodian Government initiated a rapid response and adjusted the orientation of the macroeconomic policy. On the fiscal front, i to help foster economic activities and sustain growth under the shadow of the global financial crisis and recession, the Government has acted counter-cyclically to prop up domestic demand, by introducing fiscal stimulus and expenditure rationalization with priority spending focusing toward improving social safety nets and providing alternative employment for vulnerable population segments, including those losing jobs in the affected export sectors. Priorities were also given to public investment in physical infrastructure and supporting growth in the agricultural sector. With regard to the monetary and banking sector, the NBC has tried to adjust its monetary policy in a flexible manner in order to deal with inflationary developments and to address liquidity constraints in the system. The monetary policies were promptly modified from an appropriately tight monetary policy during the period that the economy was hit by the impact of rising global food and fuel prices in 2007-2008 to a moderately easy monetary policy in early 2009, in order to ensure that some liquidity strains in the economy did not escalate into systemic pressures, while the NBC’s role as the lender of last resort has been further enhanced. In the meantime, inflation has come down rapidly since the middle of this year and stayed at 5.3 percent until the end of the year. Furthermore, we remain committed to a floating exchange rate regime by letting exchange rates adjust to external realities while maintaining a comfortable level of the international foreign reserves. It is worthwhile to recall that during the episode of strong growth and capital inflow in 2007 and the first half of 2008, the exchange rate of the local currency was strong. However, the currency depreciated by about 1.8 percent year-on-year to the USD in 2009 following pressure from the global financial crisis as foreign investors pulled out the needed cash to meet their obligations abroad. The gross international reserves continued to increase, albeit at slower pace than a year ago, to reach 2,367.3 USD million at the year-end, a level that is sufficient to cover about 4 months of imports. As far as the monetary and banking sector is concerned, the performance of the banking sector has been satisfactory, though challenging. Following an episode of stress, total banking system liquidity is gradually improving. The broad money supply (M2) has recovered to 36.8 percent year-on-year in December 2009, from a negative growth at the beginning of the year, reflecting the increase in customers’ deposits, with an annual growth rate of 38.3 percent in December 2009. Credit to the private sector remained low, mirroring banks’ prudent credit policy in the period of weak economic activity. To maintain financial stability, the NBC has also closely monitored the banking sector. It has further tightened and enhanced its banking supervision and paid particular ii attention to the banks’ solvency and liquidity conditions. Safeguarding the stability of the banking system, which is still in the early stages of development compared to many other economies, remains a priority of the NBC. The central bank has been very active in recent years in taking steps to improve banking supervision; recent efforts have included a focus on strengthening loan classification standards, improving bank licensing procedures and the formulation of bank resolution plans for troubled banks, should they be needed. The recent crisis has also prompted reform in the legal framework, in particular to provide for a better framework for sound banking operations and an effective exit policy. Thus, an amendment of the existing banking law has been prepared and submitted to the Council of Ministers for review. To promote a money and interbank market, the NBC has securitized the fixed certificate of deposits held by banks and issued a regulation supporting repo operations. Going forward, the NBC will consider any regulatory and supervisory measures aimed at strengthening risk management practices and policies at the banks to strengthen enabling institutions to better anticipate, manage and ultimately withstand adverse economic conditions and market trends. During the year, NBC also continued to actively support the expansion of microfinance services. This was done, among other ways, through facilitating MFIs’ access to voluntary deposits from the general public, enhancing the provision of credit to MFIs from domestic commercial banks, providing necessary support for MFIs’ capacity building and the inclusion of MFIs in the Credit Information Sharing System. Another project which should help banks in Cambodia play a more active role in the economy is the development of the National Payments System, which will serve as a channel of inter-sector, inter-industry and inter-company financial resource flows, thus promoting economic growth. With the support from private stakeholders and development partners, the NBC has made efforts to introduce institutional arrangements, operational mechanisms, inter-related IT infrastructure. Within the NBC itself, organizational development and improvement is ongoing. Among the ongoing activities is the effort to provide better central banks’ services through strengthening our branch network. So far the work to revive and strengthen our branches has proceeded smoothly and effectively as planned. The NBC’s internal audit and risk management capacity has also been steadily enhanced. Following a series of actions to build an institutional framework and develop rules and procedures to guide internal auditing activities, the audit process has been started in various areas, with satisfactory results so far. iii Various other measures have been also implemented in order to provide better and more efficient central bank services to banks and the Government; these include an improvement in the quality and in the supply and distribution of banknotes in circulation, a more efficient organization and development of the information system to support central bank operations, and active participation in the implementation of the second phase of the Public Financial Management Reform agenda of the Government. Besides this, actions to develop the skills of NBC staff were accelerated, with the help of external technical assistance. A special effort has been made with respect to banking supervision, which we would like to serve as a benchmark for other activities. Before concluding, I would like to stress an important lesson from the recent global crisis. While Cambodian banks have been spared the full impact of the financial crisis, in the years ahead they will be operating in an environment that is likely to have changed as a result