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Asia Frontier Capital's Country Report: Cambodia

AFC Country Report: Cambodia

2014 has been a tumultuous year for Cambodia's garment industry, a mainstay of the economy that accounts for over 80% of exports and employs over 600,000 people, 90% of whom are women. On January 3rd, government forces opened fire on striking garment workers, killing five and injuring dozens more. The heavy-handed response received international media coverage and condemnation from human rights groups and from apparel companies that rely on Cambodian garment factories for production.

The source of the unrest was a call by garment labor unions to increase the minimum wage to USD 160. The government finally settled on a new minimum wage of USD 100, which the unions have thus far not accepted. Cambodia's heavy reliance on its garment industry remains a questionable move from an economic standpoint. The garment industry flourishes on cheap wages and the industry's razor-thin margins mean that manufacturers have an incentive to move production to cheaper countries like Myanmar or Bangladesh as Cambodian wages rise. At the same time, however, the industry is a key foreign exchange earner for Cambodia and has provided income and employment for many of the country's rural residents who have traditionally been under-employed.

The January 2014 walk-out of workers cost the country's garment industry an estimated USD 300 million from the sudden halt in production, and global clothing and retail giants Levi Strauss and Target have both announced their intentions to scale back production and sourcing from Cambodia as a response to the unrest that has occurred this year. To try and dispel the notions that the industry remains in turmoil, the Cambodian government is working with the World Bank and the International Labor Organization to reach a consensus on what is a fair minimum wage for the sector. To add fuel to the fire, the strikes among garment workers have become increasingly politically-charged, citing the country's growing income inequality and building on the momentum of the political demonstrations by the opposition that occurred after the July 2013 national elections.

Despite the unrest, which began in December of last year, the garment sector grew 20% in 2013 to USD 5.5 billion, even with a 54% increase in the number of "labor days lost" in 2013 due to the December protests which continued into the New Year. Garment exports to the US were up 7.6% YoY and exports to the European Union were up 28% YoY.

Against the backdrop of growth in the garment sector and the simmering unrest, Grand Twins International (GTI), a Taiwanese-owned garment manufacturer that produces clothes for Adidas, decided to pursue an Initial Public Offering on the Cambodian Securities Exchange (NYSE:CSX) in June, becoming only the second traded stock on the exchange after Phnom Penh Water Supply Authority (PPWSA) listed in April 2012. GTI shares began trading in June, receiving a lackluster response from investors in comparison with PPWSA's successful flotation. The less-than-stellar demand from investors was attributed to the continued uncertainty of the garment sector, as many disputed issues remain unresolved. GTI sold 8 million shares (20% of the company) and raised USD 19.3 million, less than the USD 28 million the company had initially targeted. The capital raised will fund new factories and GTI's expansion plans. The IPO date was pushed back numerous times due to delays in receiving necessary regulatory approval.

The CSX has been unable to attract other companies in Cambodia to list on the exchange, and some potentially-interested businesses are reportedly waiting until the bourse increases its market capitalization and gains liquidity before they proceed with IPO plans. To encourage more companies to go public, the CSX may need to work in conjunction with the Cambodian government to offer regulatory incentives and tax advantages to spur growth in the country's capital markets. A lack of confidence in the Cambodian Securities Exchange will be a difficult problem to fix without upgrades in securities regulations and resolved technical issues. Some observers also wonder whether many of the local business groups would agree to the financial transparency that going public would entail, given that Cambodia is a country still plagued by corruption, with a large disparity between the rural poor and the business and political elite. One testament to the growing income inequality in Cambodia is that Rolls Royce, the luxury British carmaker, recently announced plans to open a showroom in Phnom Penh, despite the fact that the average income per capita in the country is only USD 950.

Tourism has been another strong contributor to the economy - in 2013, Cambodia received 4.2 million tourist arrivals, representing a 17.5% increase over the previous year. Overall revenue from the tourism sector rose to USD 2.5 billion in 2013, a 15% increase YoY. Siem Reap Airport, Cambodia's busiest and the gateway to Angkor Wat, will undergo a USD 1 billion passenger terminal upgrade beginning in August 2014 that is expected to double the airport's capacity to 15 million passengers.

The political unrest in neighboring Thailand has also affected Cambodia in recent weeks. New regulations imposed by the Thai junta aiming to crack down on illegal migrant workers in Thailand lead to the mass exodus of over 250,000 Cambodian migrant workers in late June. The influx of migrant workers into Cambodia has created significant challenges for both Cambodia and Thailand. Cambodia is trying to cope with the logistical task of handling the sudden return of more than 1.5% of its entire population. Thailand, on the other hand, will no doubt feel the effects of a shortage of manpower in its construction industry - it is estimated that more than half of construction workers in Thailand are from Myanmar and Cambodia. Thai factories and ports have also complained of the effects of a labor shortage and are anticipating delays in shipping delivery times and decreases in factory output. To address the problem, Cambodia is trying to lower passport costs and expand passport processing centers in Thailand to help many of the migrant workers return to Thailand to work legally. Many rural Cambodians depend on remittance inflows from migrant workers in Thailand, where wages are higher and employment is easier to find.

The events have complicated relations between Cambodia and Thailand. Cambodia's longstanding Prime Minister, Hun Sen, has close ties with exiled former Thai Prime Minister Thaksin Shinawatra and Cambodia was rumored to be a potential asylum base for Thaksin in the aftermath of Thailand's coup earlier this year. Hun Sen, however, was quick to play down such rumors and has not granted asylum to Thaksin.

A quick resolution to this mass exodus of Cambodian migrant workers is in the best interest of both countries. Cambodia doesn't have the economic resources to deal with a sudden influx of over 250,000 people, and Thailand's economy will certainly contract without the necessary workforce for its key labor-intensive industries such as construction, seafood, and manufacturing.

Although this year has seen its share of uncertainties with regards to the garment sector and Cambodian migrant workers in Thailand, Cambodia continues to register strong economic performance, with the Asian Development Bank expecting that GDP growth will rise from 7.2% in 2013 to 7.5% in 2014, primarily driven by an expansion in exports (primarily garments), tourism, agriculture, and construction.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.