1. Lao P.D.R. has made impressive progress in developing its economy and reducing poverty. Growth averaged 7 percent per annum over the last decade—among the highest in the region, with poverty incidence declining markedly. The country has also made significant progress towards achieving the Millennium Development Goals (MDGs). Macroeconomic policies have remained generally sound, with inflation within the official target, the fiscal deficit near pre-global financial crisis levels, and the exchange rate stable, but low reserve coverage and rapid credit growth amid high lending rates could be a source of vulnerability. The authorities’ development plan, which became operational in October 2011, targets growth of at least 8 percent annually and achieving the MDGs by 20151.
2. In concluding the 2011 Article IV consultation, Executive Directors agreed with staff that further fiscal and monetary tightening would be important to curb inflation and support the external position. They also agreed that the frameworks for macroeconomic and financial policies should be strengthened and that structural reforms be accelerated to diversify the economy, improve the business climate, and foster trade. The authorities have tightened policies further and taken steps to safeguard financial sector soundness, including the recapitalization of the major state-owned commercial banks (SOCBs). Structural reforms have been accelerated in the context of commitments under the ASEAN Economic Community and the prospect of World Trade Organization (WTO) accession, which have been catalysts for economic reform and transparency.
3. Against this backdrop, the discussions focused on policies to maintain macroeconomic and financial stability while building the foundations for more broad-based growth. There was broad agreement that the outlook for Lao P.D.R. is bright and that the recent improvements in economic performance and institutional capacity warranted a reclassification of the country’s debt dynamics to a moderate risk of debt distress. The authorities and staff agreed that downside risks from the global outlook are limited and that therefore policies needed to focus on maintaining financial sector soundness and on growing international reserves over time. In this regard we shared the view that monetary and fiscal policies should remain sufficiently tight. The authorities were more sanguine about financial market developments, but agreed that the quality of credit growth should be carefully monitored and recognized that oversight of the financial sector needed further improvement to stay ahead of the curve. Looking ahead, it will be important for the authorities to enhance competitiveness in the nonresource sector through continued structural reforms and to accelerate Public Financial Management (PFM) reforms, which would allow the budget to make a greater contribution to inclusive growth.
A. Growth is Strong and Macroeconomic Policies Have Been on the Right Track
4. Economic activity remained strong in 2011. Despite monetary and fiscal tightening, global uncertainty, and natural disasters in Lao P.D.R. and main trading partner Thailand, real GDP growth is estimated at 8.0 percent. Activity was buoyed by mining and hydropower investments and construction, while the expansion in the services sector was indicative of resilient domestic demand.
5. Inflation pressures have moderated, with the headline rate falling to 3.6 percent (y/y) in June 2012 from a peak of 9.8 percent (y/y) in mid-2011, reflecting moderating food and fuel price increases, policy tightening, and base effects.
6. The fiscal deficit has declined sharply and is now at the pre-global financial crisis average. The overall fiscal deficit moderated to 3.0 percent of GDP in FY2011 (October 2010-September 2011) from 4.6 percent of GDP in FY2010, due to expenditure restraint and buoyant mining and hydropower revenues, while VAT revenue exceeded the conservative budget target following the expansion in registered taxpayers. Debt service costs remain manageable given the concessional nature of official borrowing.
7. Despite fiscal tightening, monetary conditions remain accommodative. The Bank of the Lao P.D.R.’s (BoL) quasi-fiscal operations of providing loans to local governments continues, but its monetary impact was mitigated in 2011 by accelerating the sale of BoL securities in line with past staff recommendations. As a result, the growth of broad money declined substantially to 25 percent (y/y) at year end. However, growth in monetary aggregates picked up again, with the BoL continuing its quasi-fiscal lending operations while tempering its security sales. Quasi-fiscal lending and private sector credit expansion contributed to a rise in credit to the economy to close to 44½ percent (y/y) in April—the highest rate of growth since October 2010.
Contribution to GDP growth
Sources: Country authorities; and IMF staff estimates
Export Performance, 2000–2011
Sources: Country authorities; and IMF Direction of Trade Statistics.
8. Strong domestic demand, fueled by credit growth, and resource sector activities continue to create pressures on the balance of payments. Nonresource import growth outpaced export growth, with the overall current account deficit widening to US$1.7 billion in 2011 (21.4 percent of GDP), while gross international reserves declined by US$50 million to US$677 million at year-end, covering about two months of prospective nonresource imports, the lowest level in almost a decade. Foreign direct investment (FDI) increased sharply, mainly for hydropower projects, and covered about 70 percent of the headline current account deficit in 2011.
B. The Outlook is Favorable, but Domestic Risks are Elevated
9. Near-term prospects are generally favorable.
Growth is projected to accelerate in 2012 to 8.3 percent in light of the pause in policy tightening, a recovery in agricultural production, and public construction activities related to the Asia-Europe Meetings (ASEM). Over the medium term, growth is expected to slow only moderately.2
Inflation is projected to average 5.1 percent in 2012, before increasing in 2013 to 6.8 percent reflecting base effects and public wage bill pressures, which could also fuel higher private sector wage demands. Against the backdrop of still accommodative financial policies, inflation is subject to considerable uncertainty, as potential shocks to food and fuel prices could quickly translate into higher inflation.
The fiscal deficit is projected at 2.5 percent of GDP in FY2012 and FY2013, as higher revenue collections and savings from the reduction in off-budget capital spending are largely used for a significant increase in the civil service wage bill.
Growth in credit to the economy is expected to slow through end-2013 given lower financing of local governments and with loan-to-deposit ratios already near regulatory thresholds.
On the external side, the nonresource current account deficit is expected to widen in 2012 to 19.1 percent of GDP, while the level of international reserves is projected to rise to US$723 million by year-end due to a significant pickup in FDI inflows and nonresource exports, but with the cover remaining around two months of imports.
10. The outlook is subject to a number of, mostly home-grown, downside risks. The strong momentum in foreign-funded investment and the nonresource sector could increase growth relative to the staffs forecast. On balance, however, the outlook is subject to renewed global financial turbulence as well as three, arguably more important, internal vulnerabilities:
Spillovers. The global growth outlook is still sluggish and subject to significant downside risks. For Lao P.D.R., judging from the growth experience during 2009, spillovers appear small, although unprecedented policy stimulus at the time, for which there is less space now, likely contained the fallout There are a number of reasons to expect modest spillovers will prevail, given the country’s limited integration with global markets, continued supportive growth in main trading partners Thailand and China, and with most hydropower contracts contracted for the long term. The main channel of contagion from slower global growth would be through lower gold and copper export prices, while in the event of an extreme stress such as a domestic financial crisis, Lao P.D.R. would likely experience acceleration in dollarization, loss of reserves, and significant balance of payments pressures.
Financial sector risks. The rapid expansion of the financial sector in recent years raises concerns about banking sector soundness and a possible emergence of contingent fiscal liabilities down the road. Despite some slowdown in 2011, credit growth is on the rise again in 2012 putting recent stability gains at risk. Global shocks could expose these domestic vulnerabilities.
External risks. Reserve levels offer inadequate protection against external and internal risks (Box 1). The core balance of payments—defined as the current account balance net of FDI and ODA—remains in deficit at around 4 percent of GDP, leaving the external position vulnerable to terms of trade shocks, potentially volatile capital inflows, and possible concerns about banking sector soundness or shocks to inflation.
Fiscal risks. The level of public sector debt remains elevated compared to other LICs in Asia. While off-budget capital spending has declined, it remains indicative of weak spending controls that could give rise to additional contingent liabilities.
11. The authorities broadly shared the staff’s outlook and assessment of risks. They noted the key challenge was to ensure that growth remains inclusive and broad-based, consistent with their development plan. In this context, the authorities recognized top priorities were scaling up education and health care spending and diversifying the sources of growth. They agreed that the impact of spillovers were likely to be modest and that instead policies should be focused on monitoring and improving the quality of banking sector credit and replenishing the level of international reserves over time.
Maintaining Macroeconomic Stability
12. Policies will need to be sufficiently tight to avoid jeopardizing recent financial stability gains. Monetary policy and strong banking supervision are likely to be the “first line of defense” against excessive credit growth, but tighter fiscal policies will also contribute and reduce the current account deficit.
Box 1.Reserve Adequacy and Risks to External Stability
Traditional metrics indicate that, at current levels, Lao P.D.R.’s international reserves do not offer adequate protection against external shocks. Common rules of thumb suggest that reserves should cover at least three months of prospective imports or be equivalent to up to 50 percent of broad money. Lao P.D.R. falls short on both counts and has low reserves coverage compared to other low-income countries (LICs) in Asia.
Lao P.D.R.’s optimal level of reserves is estimated to be close to three months of imports. This is based on a recently developed methodology and assumes the opportunity cost of holding reserves is around 4 percent.1 In applying the model to Lao P.D.R., shock variables (terms of trade, external demand, FDI to GDP ratio, and aid to GDP ratio) were set at the lower 20 percentile of the country-specific distribution over the past ten years (2001–2010). Fundamental indicators (CPIA and fiscal balance) were set at their most recent levels. These choices capture the volatility of shocks to the economies of Lao P.D.R.’s main trading partners and to its terms of trade, which constitute important sources of risk to the external balance.
In the near term, the estimated optimal import coverage ratio should be seen as a lower bound on the adequate level of international reserves. The framework assumes risk neutrality. Moreover, the methodology does not account for the high degree of dollarization in Lao P.D.R’s economy. Previous research advocates higher foreign reserves coverage for dollarized economies, as currency substitution is easier under moderate dollarization. Higher coverage would also mitigate the risk a run on dollar deposits out of fear for expropriation, in the event of a balance of payments crisis.2 In this regard, it is also advisable that the assets of the deposit insurance fund mirror the currency composition of deposit liabilities in the banking system.
Reserves: South and East Asian LICs
Source: IMF staff estimates
Optimal Level of Reserves
Source: IMF staff estimates.
A. Monetary Policy: Supporting Sustainable Development by Slowing Credit Growth
13. Although inflation is manageable, in the context of heightened financial and external risks, further tightening is needed. Staff urged the BoL to contain the expansion in Net Domestic Assets by accelerating the exit from quasi-fiscal lending to local governments. In the meantime, BoL securities should be issued to sterilize these lending operations. An increase in the required reserve ratios would reduce excess liquidity, while an increase in policy rates would unlikely affect lending conditions due to the weak transmission mechanism. Tighter monetary policies could also reduce the moderate overvaluation of the kip (Box 2) and contribute to external stability.
14. A stabilized exchange rate remains the appropriate monetary anchor for Lao P.D.R., but there is scope to enhance the policy framework. Given the importance of Thailand as a trading partner, staff supports the authorities’ implicit objective of stabilizing the value of the kip vis-à-vis the U.S. dollar and the Thai baht in order to meet inflation objectives and to support efforts to de-dollarize3. Nevertheless, to achieve this intermediate target, it will be important to maintain appropriately tight macroeconomic policies. The current practice of expressing the official inflation target in terms of real GDP growth could give rise to pro-cyclical policy moves. Staff recommended instead that the BoL considers adopting an explicit inflation target range over the medium term. To get there, the BoL needs to improve the compilation of monetary statistics to enhance liquidity forecasting and foreign exchange cash-flow projections and to develop the interbank foreign exchange (FX) market, which at present consists of spot FX transactions only, as was noted in the 2011 Article IV consultation. Staff noted the IMF is willing to support these activities through technical assistance and training.
15. The authorities felt that current policy settings were generally appropriate. Although broadly agreeing with the staff’s recommendation to issue additional BoL securities, demand for these instruments was tepid, while the BoL saw raising the reserve requirement as a measure of last resort as this would put an additional burden on banks” liquidity position, especially the smaller ones. The authorities argued that the current policy settings struck the right balance for achieving the multiple BoL objectives. Over the medium-term, once the monetary policy framework was sufficiently strengthened, the BoL indicated it could consider adopting an explicit inflation target range. In this regard, they noted that the country was still dollarized and that this affected both the conduct and transmission of monetary policies. At the moment, foreign currency deposits consisted mainly of dollars and baht, but in the future other currencies might be added, further complicating the conduct of monetary operations.
Box 2.The Conduct of Monetary Policy in Lao P.D.R.
The conduct of monetary policy in Lao P.D.R. is still at a rudimentary stage. Monetary policy relies to a great extent on regulations-based instruments. The interbank market is rudimentary and financial intermediation is in the process of developing.
Monetary policy pursues multiple targets. While the Bank of the Lao P.D.R. (BoL) law states that one of the roles of the central bank is to promote and maintain the stability of the kip, the BoL also pursues several other objectives including targeting growth in net domestic assets, the inflation rate, and five-year plan’s GDP growth target. In addition, the BoL has a financial stability mandate. In practice, the BoL interprets the monetary policy objectives as keeping the inflation rate below the real GDP growth rate, keeping M2 growth below 25 percent, and limiting exchange rate volatility vis-à-vis the U.S. dollar and the Thai baht within +/- 5 percent band each year.
The BoL lacks full operational independence to set a more narrow monetary policy objective. Article 2, 2.2 of the BoL Decree on the Organization and Activities instructs the BoL “to study the national monetary policy-plan and submit it to the government for consideration and to implement this policy-plan effectively after approval by the National Assembly.”
In recent years, the BoL has used several instruments to implement monetary policy:
Reserve requirements: The reserve requirement has been set at 5 percent for kip deposits and 10 percent for foreign currency deposits since May 2006. In 2008, a reserve requirement for eligible certificates of deposit was introduced at 2 percent for both kip and foreign currency. Neither the required nor excess reserves are remunerated.
Standing facilities: The BoL has a noncollateralized overdraft lending facility, on which banks can draw for short-term liquidity. Overdrafts must be paid within seven days. Interest is charged at a fixed rate set by the BoL and adjusted infrequently. This rate is generally regarded as the policy rate, as it is the only central bank rate that is published.
Money market operations (OMO): the BoL utilizes net sales of BoL bonds (a short-term instrument) and auctions of treasury bills to conduct OMO. Net sales of BoL bonds have been the most active instrument in recent years, as they have been used to sterilize BoL’s quasi-fiscal operations. Treasury bills have been used much less.
Statutory liquidity requirements (SLR). Banks are required to hold a liquidity ratio of 20 to 25 percent.
The presence of dollarization constrains the BOL’s ability to serve effectively as a lender of last resort. While the extent of dollarization has declined over the past decade, it remains high. Going forward, it will be important to continue to maintain macroeconomic stability; promote financial intermediation in the kip in tandem with stronger bank supervision and accumulate international reserves to withstand any exchange rate pressure; and, over-time, build market-based monetary policy tools and the interbank market.
B. Financial Sector: Strengthening Supervision to Support Soundness
16. Rapid credit growth raises concerns about the health of the banking system. Stronger credit growth can be indicative of financial deepening, in itself a welcome development, provided that its pace is not excessive and improvements in regulatory and supervisory enforcement capacity stay ahead of the curve. Competition for deposits by an increasing number of banks in combination with high lending rates, calls in doubt whether banks can continue to benefit from high-yield projects while sustaining debt repayment and avoiding balance sheet problems over time. Although NPLs, as reported by the BoL, are low at present, this mainly reflects rapid credit growth and possibly the restructuring of loans before they become past due. Risk management capacities of banks are weak and although the capital adequacy of the three SOCBs has increased following a recapitalization, it remains below the regulatory minimum for two of them. Anecdotal evidence suggests connected lending is prevalent and that credit growth is fueling rapid real estate price increases, which are not fully captured in the CPI inflation.4
Deposits of Commercial Banks
Sources: BoL; and IMF staff estimates.
Loans of Commercial Banks
Sources: BoL; and IMF staff estimates.
Credit to the Economy
Sources: Country authorities; and IMF staff estimates
17. Aside from policy tightening, there is a need to strengthen banking supervision and enforcement and enhance the prudential toolkit. Although onsite and offsite inspections of banks take place regularly, the supervisory approach remains compliance-based and does not adequately address risks. In addition, data gaps and poor data quality hamper the ability to adequately monitor the system, while supervisory capacity is spread thinly as the number of banks is expanding rapidly. Staff encouraged the authorities to participate in the IMF-World Bank Financial Sector Assessment Program (FSAP). Careful monitoring of property sector developments and enhancing the prudential toolkit by setting exposure limits to real estate could help prevent potential asset-price bubbles. Staff indicated that SOCB recapitalization plans should be linked to memoranda of understanding that would lay out structural conditions and performance criteria for disbursing capital, while independent audits should continue. Further capital market development, including through additional listings on the stock exchange and development of the local bond market, would help to reduce the reliance on the banking system. There is a need for clear and impartial oversight of both the stock and bond markets.
18. The authorities agreed that maintaining the credit quality is essential for sustainable growth, but were more sanguine about financial sector risks. They saw current credit growth in line with the overall objectives set out in the development plan. Furthermore, it had slowed substantially from the peak of 2009 and reflected welcome financial deepening and strong deposit growth. In their view, financial sector indicators remained sound and overall leverage compared favorably to other low-income countries in the region. The authorities had also strengthened the financial operations of the SOCBs and had taken steps to safeguard financial sector soundness, including increasing the minimum capital requirement and issuing a new regulation on loan classification and provisioning requirements. The authorities said they would consider participation in the FSAP and continue to upgrade their systems in preparation for this. They also would consider requesting input from the IMF on the Anti Money Laundering/Combatting the Financing of Terrorism Law currently being drafted for submission to the National Assembly by year-end. In addition, the authorities are encouraged to address the shortcomings in their anti-money laundering and combating the financing of terrorism (AML/CFT) regime, identified in the 2011 evaluation by the Asia/Pacific Group on Money Laundering (APG).
C. External Stability: Building a Reserve Cushion for Dealing with Adverse Shocks
Stock of International Reserves in Asian LICs
Sources: Country authorities; and IMF staff estimates
19. Current reserve coverage is inadequate for dealing with shocks. There is a risk that rapid credit expansion and large capital inflows are funding private sector imports of consumption goods rather than future exports by bolstering productive investment outside the mining and hydropower sector, implying further erosion of reserve coverage in the future and leaving Lao P.D.R. vulnerable to terms of trade shocks; Staff noted that capital inflows are also potentially volatile, including FDI which for other countries was proven to be less robust during the global financial crisis than previously believed. Finally, concerns about banking sector soundness or shocks to inflation could lead to currency substitution, eroding reserves directly and through additional foreign exchange intervention to keep the kip stable.
20. Maintaining sufficiently tight macroeconomic policies and structural reforms would improve reserve coverage. Reserve coverage is low compared to most other LICs in Asia, with staff encouraging the authorities to take advantage of prospective large capital inflows to build reserves. A CGER-like assessment suggests that, on average, the kip’s overvaluation is moderate, but has declined since the last consultation (Box 3). Given the stated objective of limiting nominal exchange rate volatility, a continued reduction in the degree of overvaluation is consistent with further tightening of macroeconomic policies in order to contain inflation at or below trading-partners levels and slow down nonresource import growth. Over the medium-term strengthening the reserve cover requires productivity-enhancing in the nonresource sector.
21. The authorities felt reserve coverage was broadly adequate, but would try to take advantage of strong capital inflows to increase buffers further. They took some comfort from the fact that the country remained dollarized, but saw the prospect of strong FDI and Official Development Assistance as an opportunity to replenish coverage, while structural reforms would continue to enhance competitiveness in the nonresource sector. There was some discussion on the appropriate measurement of imports, with the level used by the IMF significantly higher (and reserve coverage correspondingly lower). They believed the current macroeconomic policy stance was sufficiently tight to reduce the kip’s overvaluation further and contribute to external stability.
D. Fiscal Policy: Creating Buffers for Future Spending
22. Maintaining prudent fiscal policies will complement monetary tightening to contain overheating pressures. Staff viewed the current fiscal stance as broadly appropriate and welcomed the plan to scale back off-budget operations that commenced at the height of the previous global financial crisis.5 The FY2013 budget deficit target is appropriate. However, staff urged that any revenue overperformance be saved and wage increases after FY2013 be more moderate to avoid undermining macroeconomic stability.6 Staff recognized the need to increase civil service wages to compensate for cost-of-living increases and maintain competitive pay with the private sector and supported the hiring of additional workers in social sectors (health care and education). However, the rapid, across-the-board increase in the civil service wage bill and allowances risks crowding out much needed, domestically-financed, public investment and could undermine macroeconomic stability, while earmarking of future revenue for this purpose should be avoided.
Box 3.Exchange Rate Assessment
Staff estimates, using Lao-specific elasticities, present a mixed picture on the direction of misalignment, but on average suggest modest overvaluation. The exchange rate assessment indicates a degree of misalignment of the kip in the range of -19.9 to 31.2 percent. This range of overvaluation is lower than that in the 2011 staff assessment (between 8 and 42 percent)1/. The equilibrium exchange rate (EER) approach indicates an undervaluation of the kip. The different results from the last staff report reflect data revisions of the estimated net foreign assets for Lao P.D.R. as well as developments of the current account balance.
These estimates should be interpreted with caution. The margin of error can be large due to data limitations. In addition, it should be noted that some of the required adjustment in the external position will come about naturally, with current resource sector investments expected to lead to a significant boost in exports (mainly hydropower) after 2016, which is beyond the CGER exercise. Hence, these approaches may overestimate the needed adjustment in the exchange rate and therefore the misalignment of the kip.
Real Effective Exchange Rate, January 2005-March 2012
Sources: Country authorities; and IMF staff estimates
|Purchasing power parity||4.6|
|Macro balance||16.2 to 31.2|
|Equilibrium exchange rate||-19.9|
|External sustainability||10.4 to 17.6|
Sources: Country authorities; and IMF staff estimates
Sources: Country authorities; and IMF staff estimates
Fiscal Balance and Government Deposits
Sources: Country authorities; and IMF staff estimates
23. For the medium term, staff noted that the government’s domestic revenue goal of 16–17 percent of GDP required an additional tax effort of 1 percent of GDP, which was viewed as achievable if the current strong revenue momentum is maintained despite declining mining revenue. However, the authorities would need to move forcefully on ongoing reforms of the tax system and avail themselves to TA, including that financed from the IMF” Management of Natural Resources Wealth Topical Trust Fund. In the event and assuming expenditure remains under control, the nonmining deficit, as the most appropriate fiscal target and anchor, would fall to below 5 percent of GDP by FY2015.7
24. The external debt sustainability analysis suggests that Lao P.D.R. now faces a moderate risk of debt distress from a high risk previously. The projected strong performance of the economy, fundamental improvements in institutional capacity, together with recent fiscal consolidation have led to an upgrade in the country’s risk rating and imply that debt indicators fall below indicative thresholds in the baseline. Staff welcomed the commitment to reduce public external debt to below 35 percent of GDP by 2015, which required appropriately tight macroeconomic policies so that inflation converges to key trading-partner levels to avoid nominal exchange rate depreciation. In this regard, it is also important to improve debt management capacity and develop a medium-term borrowing strategy for the government, including for resource sector activity, as well as to ensure greater disclosure of borrowing plans.
25. The authorities emphasized their commitment to prudent fiscal policies and intent to build buffers to deal with future shocks. They agreed that any revenue overperformance next fiscal year (as well as underspending) and a higher share of mining revenue should be saved, for which they would establish a State Accumulation Fund to be managed by the newly established State Reserve Department within the Ministry of Finance. The reserve could be used in the event of natural disasters or if the need for counter-cyclical policies arises. The authorities also saw higher wages as necessary to compensate for cost of living increases and also contribute to improving governance. They recognized that the level of debt remains high but indicated that the debt service is relatively low due to its highly concessional nature. The authorities have put a ceiling on new debt commitments for nonself-financing expenditures equal to 25 percent of revenues, while borrowing for commercial projects would only be pursued if the internal rate of return exceeded 9.5 percent. The improved debt distress rating was welcomed as this reflected the country’s strong performance and implied that the economy’s absorptive capacity had improved.
Building Broad-Based and Inclusive Growth
26. Lao P.D.R. is embarking on significant further trade integration, which should promote growth. The country will face increased competition following the phased mandatory reduction of tariffs under the ASEAN Free Trade Agreement. In addition, the government is embarking on revising relevant laws and passing implementing decrees in preparation for WTO accession.
27. Efforts to improve the business climate should be intensified. The latest World Bank Doing Business Survey (2012) suggests that Lao P.D.R. has made limited progress in streamlining business procedures and strengthening policy frameworks to boost private sector-led growth. Getting electricity, gaining access to credit, providing investor protections, and trading across borders are areas where much remains to be done. Ongoing efforts to improve the business climate and trade integration should be accelerated to support growth in the nonresource sector and achieve further poverty reduction (see Table 5 on the status of the MDGs in Lao P.D.R.).
28. Accelerating PFM reforms would contribute to achieving inclusive and sustainable growth, by improving the quality and transparency of spending and enhancing its prioritization to upgrade human and physical capital accumulation and poverty-reducing outlays. Priority reforms include improving government accounting and cash management and establishing a treasury single account, including through IMF TA.
29. Modernizing and upgrading the quality and comprehensiveness of economic data is becoming a more urgent priority as Lao P.D.R. develops. Data shortcomings hamper policy formulation, analysis, and surveillance, including the monitoring of emerging macroeconomic and financial risks and tracking progress made with achieving inclusive growth, including through poverty-reducing government expenditures.
30. The authorities noted that reforms to improve the business climate had been accelerated. Commitments under the ASEAN Free Trade Agreement and the prospect of WTO accession had led to significant revisions to laws and the regulatory regime. These included efforts to streamline business registration procedures and the preparation of the Investment Promotion Law, while trade-related legislation is expected to be approved by the National Assembly by September. The authorities also noted that entry conditions for Lao P.D.R.’s accession to the WTO could be finalized by end-2012, noting the positive effect on exports and foreign investments in the medium-term. The authorities responded that they will consider requesting TA to address data shortcomings.
31. Lao P.D.R. continues to make impressive progress in developing its economy and reducing poverty. The authorities” policy management has been on the right track and is supporting confidence. Staff expect strong GDP growth in the coming years, inflation to remain manageable, modest fiscal deficits, and favorable debt dynamics. As a result, poverty incidence should continue to decline, with the country having generally good prospects to achieve the MDGs by 2015.
32. The benign outlook is subject to elevated, mainly home-grown downside risks, in particular from the rapid expansion of the banking sector. Spillover effects from the weak and uncertain global environment should be relatively modest, with the main channel of contagion through lower commodity prices. Instead, the main risk to macroeconomic stability stems from rapid credit growth in an environment of limited external and fiscal buffers to absorb potential domestic and external shocks and weak financial sector oversight.
33. A key policy challenge for the Lao P.D.R. authorities is to maintain macroeconomic stability and build broad-based and inclusive growth. Policies and institutional reforms will need to balance the objective of supporting growth in the near term with ensuring that development is sustainable by minimizing risks to macroeconomic stability. In this regard, the authorities should focus on further tightening monetary and fiscal policies and strengthening banking supervision, regulation, and enforcement, while continuing to improve the business climate to support growth in the nonresource sector and achieve further poverty reduction.
34. Monetary conditions need to be tightened. Policy tightening in recent years helped to contain inflation pressures and contributed to maintaining exchange rate stability. The increased credibility of monetary policy has allowed the authorities to partially liberalize foreign exchange transactions. With inflation manageable, the BoL’s policies should be focused on phasing out quasi-fiscal operations and further reducing the pace of monetary expansion through stepped-up sterilization and higher reserve requirements. Tensions that result from the pursuit of multiple monetary policy objectives may have contributed to the low reserves cushion, thus ultimately undermining the main anchor (a stabilized exchange rate). Further improvements to the policy framework would include improving the compilation of monetary statistics to enhance liquidity forecasting and foreign exchange cash-flow projections. Over the medium-term, an explicit inflation target range could be adopted, which would enhance the effectiveness of monetary policy by anchoring inflation expectations, in the context of also improving the monetary transmission mechanism.
35. Banking supervision should be strengthened to maintain financial sector stability. Staff urged the authorities” continued attention to maintaining the quality of credit and to ensure that the pace of financial deepening is consistent with improvements in regulatory and supervisory enforcement capacity, while the prudential toolkit should also be strengthened.
36. Reserve levels are well below standard precautionary metrics and need to be replenished. International reserves provide a cushion against shocks, but current levels of protection are inadequate. Staff were encouraged by the authorities” intent to replenish reserve buffers in the near future by pursuing tighter macroeconomic policies to slow down import growth, and also to take advantage of the prospect of strong capital inflows in the coming years. The staff estimates the real effective exchange rate on average to be modestly overvalued compared to medium term fundamentals, but less so than in the past.
37. The fiscal stance is appropriate, but large civil service wage increases should be reconsidered. The deficit target in FY2013, under generally more efficient and transparent budget processes, is supportive of macroeconomic stability provided any revenue overperformance is saved and new off-budget spending is avoided. Medium-term fiscal goals also seem broadly appropriate, focused around reducing the nonmining deficit to below 5 percent of GDP. In this regard, staff are encouraged by the intention of the authorities to establish a reserve funded mainly by excess revenues. This will strengthen the ability of the budget to respond to future shocks, including natural disasters. However, the reorientation of expenditure towards civil servant wages could crowd out higher priority spending.
38. Staff support the authorities” intention to build broad-based and inclusive growth. The authorities efforts under the umbrella of WTO accession and the ASEAN Free Trade Agreement is paving the way for an improved business climate that will enhance the competitiveness of the nonresource sector. Accelerating PFM reforms would contribute to achieving inclusive and sustainable growth by improving the quality, transparency, and prioritization of spending.
39. The IMF stands prepared to support the government’s reform efforts through more intensive TA, focused on improving financial sector supervision, enhancing the monetary policy framework, and strengthening revenue administration, including through the recently established TA office for Lao P.D.R. and Myanmar in Bangkok.
40. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.
Figure 1.Lao P.D.R.: Real and External Sector Developments and Outlook
Sources: Country authorities; and IMF staff estimates
Figure 2.Lao P.D.R.: Monetary Developments
Sources: Country authorities, and IMF staff estiamtes
Figure 3.Lao P.D.R.: Resource Sector Developments and Outlook
Sources: Country authorities; and IMF staff estimates
Figure 4.Lao P.D.R.: Fiscal Sector Developments and Outlook
Sources: Country authorities; and IMF staff estimates
|Output and prices||(Percent change, unless otderwise indicated)|
|Real GDP (excluding resource projects)||4.7||6.7||7.2||7.5||7.4||7.4||7.5||7.5||7.5|
|Consumer prices (end-period)||3.9||5.8||7.7||5.3||6.2||4.9||4.5||4.2||4.2|
|Consumer prices (annual average)||0.0||6.0||7.6||5.1||6.8||4.8||4.7||4.3||4.2|
|GDP per capita (in U.S. dollars)||886||1,064||1,265||1,386||1,507||1,614||1,740||1,876||2,024|
|Public finances (in percent of GDP)1/|
|Tax and nontax revenue||14.9||15.7||15.9||17.5||17.7||17.7||17.7||17.7||17.5|
|Net acquisition of nonfinancial assets 2/||11.2||10.4||9.1||9.5||8.1||8.2||8.2||8.2||7.9|
|Nonmining balance 3/||-9.0||-6.4||-5.4||-5.5||-5.5||-5.2||-4.8||-4.6||-4.4|
|Balance of payments||(In millions of U.S. dollars; unless otherwise indicated)|
|Current account balance||-1,174||-1,256||-1,773||-2,026||-2,464||-2,683||-2,661||-2,196||-2,268|
|In percent of GDP||-21.0||-18.3||-21.4||-21.9||-24.0||-23.9||-21.6||-16.2||-15.3|
|Of which: Resources||912||1,500||1,884||2,018||2,020||2,120||2,217||2,607||2,685|
|In percent change||-5.5||44.4||15.2||8.2||6.0||6.6||6.2||15.6||2.5|
|Of which: Resources||5.4||64.5||25.6||7.2||0.1||5.0||4.6||17.6||3.0|
|In percent change||2.0||23.8||28.5||13.0||14.5||8.3||2.7||-0.7||3.5|
|Of which: Resources||-9.9||-18.6||100.1||16.6||27.2||3.8||-7.4||-11.9||-17.0|
|Services and income (net)||65||-49||86||200||324||385||362||237||282|
|Capital account balance||1,094||1,359||1,728||2,075||2,525||2,799||2,808||2,489||2,625|
|Of which: FDI||759||671||1,210||1,399||1,836||1,990||1,890||1,653||1,835|
|Debt and debt service|
|Public debt (in percent of GDP)||62.4||59.6||52.8||52.2||50.5||49.5||48.5||47.4||46.1|
|External debt (in percent of GDP)||102.3||87.1||82.8||87.8||94.6||102.2||102.1||97.3||92.1|
|External public debt (in percent of GDP)||56.0||50.3||44.3||43.8||43.1||42.7||42.4||41.9||41.2|
|External public debt service (in percent of exports)||4.9||4.3||3.2||4.7||4.6||4.7||4.8||4.5||4.6|
|Gross official reserves|
|In millions of U.S. dollars||633||728||677||723||780||892||1,035||1,325||1,678|
|In months of imports (excluding resource projects)||2.5||2.6||2.2||2.1||2.1||2.2||2.4||2.8||2.9|
|Nominal GDP (in billions of kip)||47,562||56,523||66,515||75,383||86,736||98,153||110,944||124,997||140,701|
|(In millions of U.S. dollars; unless otherwise indicated)|
|Merchandise trade balance||-1,372||-1,386||-2,074||-2,465||-3,052|
|Mining and hydropower||912||1,500||1,884||2,018||2,020|
|Mining and hydropower||895||728||1,457||1,698||2,161|
|Of which: Tourism||268||383||448||525||603|
|Of which: Public||-27||-41||-27||-59||-62|
|Mining and hydropower||-41||-86||-82||-81||-71|
|Dividends and profit repatriation||-322||-525||-651||-550||-507|
|Of which: Mining and hydropower||-279||-470||-596||-494||-449|
|Capital and financial account||1,094||1,359||1,728||2,075||2,525|
|Banking sector (net)||140||-26||-17||-10||-10|
|Foreign direct investment (net) 1/||759||671||1,210||1,399||1,836|
|Of which: Mining and hydropower projects||704||250||783||969||1,343|
|Of which: Mining projects||20||-37||102||94||81|
|Other private flows and errors and omissions||33||559||390||378||359|
|Core Balance (CA+FDI+ODA)||-253||-431||-465||-362||-331|
|Central bank net foreign assets||80||-102||45||-49||-61|
|Assets (increase -)||6||-95||51||-45||-58|
|Liabilities (reduction -)||74||-7||-6||-4||-4|
|Current account balance (in percent of GDP)||-21.0||-18.3||-21.4||-21.9||-24.0|
|Excluding official transfers||-22.7||-19.9||-22.9||-23.4||-25.6|
|Resource current account balance (in percent of GDP) 2/||-5.4||3.2||-3.0||-2.7||-6.4|
|Nonresource current account balance (in percent of GDP)||-15.6||-21.5||-18.3||-19.1||-17.6|
|Exports (annual percent change)||-5.5||44.4||15.2||8.2||6.0|
|Mining and hydropower||5.4||64.5||25.6||7.2||0.1|
|Imports (annual percent change)||2.0||23.8||28.5||13.0||14.5|
|Of which: Hydropower and mining related||-9.9||-18.6||100.1||16.6||27.2|
|Gross official reserves||633||728||677||723||780|
|In months of prospective imports of goods and nonfactor services||2.0||1.8||1.5||1.4||1.4|
|(Excluding imports associated with large resource projects)||2.5||2.6||2.2||2.1||2.1|
|Nominal GDP at market prices||5,597||6,855||8,302||9,269||10,270|
|(In billions of kip)|
|Of which: Resource revenue 1/||1,376||…||2,097||…||2,824||…||3,211|
|Income and profit taxes||1,587||1,961||2,136||2,503||3,023||…||3,724|
|Of which: Mining||487||783||888||…||1,365||…||1,682|
|Of which: Nonmining||638||691||705||…||980||…||1,255|
|Compensation of employees||2,525||2,947||2,940||3,450||3,450||4,677||4,677|
|Of which: External||318||427||373||432||409||611||470|
|Net acquisition of nonfinancial assets||5,646||4,553||5,808||5,385||6,951||5,601||6,772|
|Of which: Off-budget||1,823||…||1,130||…||1,100||…||400|
|Net acquisition of financial assets||53||…||302||…||759||…||8|
|Net incurrence of liabilities||2,565||…||2,328||…||2,562||…||2,139|
|Nonmining balance 2/||-3,478||…||-3,456||…||-4,035||…||-4,619|
|(In percent of GDP, unless otherwise indicated)|
|Of which: Resource revenue 1/||2.5||…||3.3||…||3.9||…||3.8|
|Income and profit taxes||2.9||3.1||3.3||3.4||4.1||…||4.4|
|Of which: Mining||0.9||1.2||1.4||…||1.9||…||2.0|
|Of which: Nonmining||1.2||1.1||1.1||…||1.3||…||1.5|
|Compensation of employees||4.7||4.6||4.6||4.7||4.7||5.6||5.6|
|Of which: External||0.6||0.7||0.6||0.6||0.6||0.7||0.6|
|Net acquisition of nonfinancial assets||10.4||7.1||9.1||7.4||9.5||6.7||8.1|
|Of which: Off-budget||3.4||…||1.8||…||1.5||…||0.5|
|Net acquisition of financial assets||0.1||…||0.5||…||1.0||…||0.0|
|Net incurrence of liabilities||4.7||…||3.6||…||3.5||…||2.5|
|Nonmining balance 2/||-6.4||…||-5.4||…||-5.5||…||-5.5|
|(In billions of kip, unless otherwise indicated)|
|Bank of Lao P.D.R. (BoL)|
|Net foreign assets||4,555||3,588||5,151||5,129||4,772||4,727||5,074||5,175||5,671|
|In millions of U.S. dollars||537||442||639||640||595||593||614||626||657|
|Net domestic assets||1,880||3,571||4,409||4,924||6,341||7,394||7,572||7,785||8,287|
|Of which: Foreign currency||-1,143||-1,022||-1,243||-932||-1,091||-618||-1,010||-976||-1,011|
|Of which: Kip||373||408||419||943||1,254||1,347||1,393||1,356||609|
|Other items (net)||-129||374||872||876||974||938||974||1,073||1,073|
|Currency in circulation||3,580||3,720||4,505||5,053||5,661||5,777||6,559||6,721||6,825|
|Bank reserves (kip)||1,211||1,583||3,013||3,574||3,788||4,594||4,311||4,418||4,759|
|Of which: Capital deposits||168||346||511||561||825||608||731||749||1,036|
|Bank reserves (foreign currency)||1,644||1,856||2,039||1,427||1,663||1,749||1,776||1,820||2,375|
|Net foreign assets||5,500||4,280||6,259||6,285||5,747||6,592||6,141||6,263||6,893|
|In millions of U.S. dollars||648||527||777||784||716||826||743||758||799|
|Of which: Commercial banks||111||85||137||144||122||234||129||132||142|
|Net domestic assets||9,678||13,560||14,856||18,281||20,623||21,823||24,842||26,785||32,925|
|Credit to the economy||11,143||14,805||16,270||19,949||22,478||24,489||27,835||29,697||34,885|
|In foreign currencies||6,948||8,659||9,611||11,396||12,729||14,000||16,422||17,521||20,582|
|Of which: Private credit||8,565||11,212||12,315||14,672||16,117||17,877||20,292||21,436||27,224|
|Other items (net)||-838||-471||-994||-376||-646||-1,703||-1,703||-1,703||-1,703|
|Currency in circulation||3,086||3,029||3,791||4,322||4,897||4,858||5,057||5,720||6,681|
|Foreign currency deposits (FCDs)||6,992||8,330||9,312||11,070||11,803||12,991||14,464||15,171||18,032|
|(Annual percent change, unless otherwise indicated)|
|Of which: Net domestic assets||130.7||77.2||53.5||34.8||38.8||48.4||35.9||29.9||22.9|
|Credit to the economy||90.7||61.7||46.0||34.7||38.2||44.8||39.5||32.1||17.5|
|Credit to the private sector||88.1||55.8||43.8||30.9||30.9||41.3||38.3||33.0||27.0|
|In kip (percent)||74.9||88.5||77.9||82.9||87.8||86.5||87.4||89.0||90.7|
|In foreign currency (percent)||71.6||69.0||71.6||71.3||76.1||77.9||84.8||88.8||90.1|
|Gross official reserves (in millions of U.S. dollars)||633||530||728||724||677||675||723||723||780|
|Net international reserves (in millions of U.S. dolla||343||213||386||462||387||373||399||406||382|
|Exchange rate, end-of-period (kip per U.S. dollar)||8,481||8,120||8,058||8,020||8,023||7,976||8,264||8,264||8,627|
|Nominal GDP (in billions of kip)||47,562||54,283||56,523||64,017||66,515||75,383||73,166||75,383||86,736|
|Dollarization rate (FCDs/broad money; in percent)||46.1||46.7||44.1||45.1||44.8||45.7||46.7||45.9||45.3|
|Gross reserve/Reserve Money||83||60||61||58||49||44||47||46||48|
|Excess reserves in kip||956||1,258||2,612||3,115||3,305||4,066||3,738||3,810||4,003|
|Excess reserves in foreign currency||945||1,023||1,108||320||483||450||330||303||572|
|1: Eradicate extreme poverty and hunger||Proportion of population below the national poverty line|
|Employment-to-population ratio||47||49||No target|
|Prevalence of underweight children under five years of age||44||37||22|
|Prevalence of stunting in children under five years of age||48||40||34|
|2: Achieve universal primary Education||Proportion of pupils starting grade 1 who reach grade 5|
|Literacy rate in the age group of 15–24 years||71||84||99|
|3: Promote gender equality and empower Women||Number of girls per 100 boys enrolled in:|
|Share of women in wage employment||38||50||No target|
|4: Reduce child mortality||Under-five mortality rate||170||98||55|
|Proportion of one-year-old children immunized against measles||41.8||40.4||90|
|5: Improve maternal Health||Proportion of births attended by skilled birth personnel||14||23||49|
|Maternity mortality rate (per 100,000 live births)||…||405||80|
|6: Combat HIV/AIDS, malaria and other diseases||HIV prevalence among general pop. (percentage)||0.006||0.1||less than 1|
|7: Ensure Environmental Sustainability||Proportion of land areas covered by forests (percentage)||70||42||65|
|CO2 emissions and consumption of ozone-depleting substances (mt)||50||18||No target|
|Captal adequacy ratio (Basel I)||25.0||20.1||21.6||…|
|State-owned commercial banks (SOCBs)||…||1.7||3.8||4.8||6.0|
|Foreign bank branches||…||26.2||34.0||37.7||…|
|State-owned commercial banks||4.2||1.7||1.3||1.5||…|
|Foreign bank branches||0.6||13.9||10.5||10.8||…|
|Return on assets (select SOCBs only) 1/||0.9||3.1|
|Banque pour le Commerce Exterieur Lao||4.7||3.6||…||3.1||3.2|
|Lao Development Bank||0.8||2.2||…|
|Agricultural Promotion Bank||-2.8||3.6||…||…||…|
|Number of banks||13||20||23||25||25|
|State-owned commercial banks||4||4||4||4||4|
|Foreign bank branches||6||9||10||11||11|
|Sectoral allocation of bank credit (in percent of total)|
|Industry and handicraft||22||19||19||19||20|
|Materials and technical supplies||8||9||8||5||4|
|Medium||Domestic systemic banking crisis||The financial sector has grown rapidly in recent years. Also, credit growth has been high, raising concerns over NPLs||High: Growth would slow down; there could be contingent liabilities for the government. The government has resorted to recapitalizing SOCBs in the past when capitalization fell below minimum statutory requirements.|
|Medium||Lack of restraint on off-budget spending||This could give rise to the BOL’s quasi-fiscal lending operations and result in an increase in credit to the economy and, thus inflation if the impact is not accompanied by sales of BOL securities.||Medium: Inflation would rise.|
|Medium||Strong intensification of the Euro Area crisis||Exports, FDI, and remittances would be affected.||Medium: Growth would slow down, especially in the nonresource sector.|
|Medium||Terms of trade shock||This could lead to a balance of payments crisis, currency substitution, and require intervention.||Medium: Balance of payments; foreign exchange reserves; dollarization; growth.|
See the Lao P.D.R. Poverty Reduction Strategy Paper (EBD/12/1) and the Joint Staff Advisory Note (EBD/11/92).
The moratorium on mining and land (for rubber plantations) concessions that will last through 2015, applies to new proposals only and does not affect mining and hydropower investment proposals that were submitted prior to the moratorium.
Recent gains to entrench macroeconomic stability, including from the increased credibility of monetary policy, has allowed the authorities to partially liberalize foreign exchange transactions, which could further contribute to supporting the usage of the kip.
Some of the weaknesses came to the fore in 2011 when one of the private banks experienced a bank run following a false rumor and the BoL had to step in and provided blanket liquidity support.
Between 2002–07, the headline deficit averaged about 3 percent of GDP. A significant stimulus was implemented in 2009 that led to an increase in the deficit to close to 7 percent of GDP. Most was provided through the BoL, which disbursed funds directly to private contractors to finance local government’s off-budget infrastructure projects. The authorities plan to issue bonds to clear about 20 percent of the stock of BoL lending (Kip 1,000 billion) and an additional Kip 200–300 billion to repay part of the SOCB recapitalization bonds.
The budget targets an across-the-board increase in wages by 37 percent and additional monthly allowances (about 0.9 percent of GDP each) with offsetting savings from phasing out off-budget capital spending and restraining other recurrent spending. The FY2013 budget was approved by the National Assembly in July 2012.
See Box 3 in the Staff Report for the 2011 Article IV Consultation.