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Lao People’s Democratic Republic: Staff Report for the 2016 Article IV Consultation

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2017
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Context

1. Context. Lao P.D.R. is a small, landlocked economy that has experienced rapid growth based on capital intensive investments in the energy sector. Progress has been made in achieving the Millennium Development Goals, but poverty remains high, inequality has increased (Figure 1), and Laos’ growth model needs to become more inclusive, in particular by integrating the mainly agrarian population into more productive activities. The authorities have maintained macroeconomic stability by anchoring inflation to a stable exchange rate and bringing down the fiscal deficit in FY 13/14 and FY 14/15.1 However, fiscal progress was reversed in FY 15/16 and the economy has accumulated vulnerabilities in the form of high public debt, a progressively overvalued real exchange rate and pockets of weakness in the banking sector. With few buffers to address shocks, the economy remains vulnerable to a rapid deterioration in the external environment, a sustained deterioration in the fiscal position, or a rapid reversal of foreign capital flows.

Figure 1.Lao P.D.R.: Poverty Has Fallen, but Inequality Has Risen and Financial Inclusion Remains Low

Real-Time Coincident Indicator Shows Slowing Economic Activity

Source: IMF staff calculations.

The Laos coincident index is constructed using a state-space model and Kalman filter estimation (see Rafiq, S. 2016. IMF Working Paper 16/214). The coincident indicator is constructed using three high frequency indicators of economic activity:

(i) real exports to proxy for industrial production; (ii) real imports to proxy for changes in domestic private consumption; (iii) tourism growth to proxy for changes in the service sector growth. A value greater than zero indicates above trend growth, and a negative value indicates slowing economic activity.

2. Past IMF Advice. Fiscal consolidation was introduced in FY 13/14 and FY 14/15, in line with IMF advice, but was reversed in FY 15/16. The exchange rate remains tightly managed with respect to the US dollar, inhibiting the accumulation of international reserves. Meanwhile, public debt has continued to rise. The authorities have been working to improve bank supervision, assess risks and address weakness in state banks. IMF policy advice has been supported by technical assistance on macroeconomic policy, revenue and customs administration, interbank market development, and banking supervision.

Developments, Outlook, and Risks

3. Growth and inflation. Real GDP growth decelerated from 8 percent in 2014 to 7½ percent in 2015, and is expected to decline further to around 7 percent in 2016. A real-time coincident indicator of economic activity (see chart) shows that activity has been slowing in 2016.2 The economy faces headwinds from a slowdown in major trading partners, lower metals prices, and poor weather in agriculture (30 percent of the economy). Headline inflation decelerated to around 1 percent in 2015 following international oil prices, but has rebounded to around 2 percent in October 2016 on higher domestic food prices. Core inflation remains below 1 percent due to the pass-through of lower international fuel prices and a strengthening of the currency.

4. The external sector remains vulnerable. Staff’s assessment is that there continue to be significant vulnerabilities to external shocks and the external position needs strengthening (Box 4). While the current account deficit fell by 4 percentage points of GDP to 16.8 percent of GDP in 2015, mainly due to a decline in imports related to new hydropower projects, the non-resource current account deficit (excluding mining and hydropower) fell by only 1 percent of GDP and remains high at 7½ percent of GDP. Gross international reserves are low at 1½ months of imports and 34 percent of foreign currency liabilities in the banking sector. The nominal exchange rate has been maintained within a very narrow band with respect to the US dollar.3 While this has helped anchor inflation expectations, it has led to an appreciation in the real effective exchange rate (estimated at between 20 and 40 percent), as Laos’ major trading partners have allowed their currencies to depreciate against the US dollar.

5. Credit growth has slowed to a more sustainable level, and broader financial conditions have tightened, but risks related to dollar lending remain (Boxes 2 and 3). A combination of fiscal consolidation, a deterioration of bank and nonbank private sector balance sheets, and slower economic activity led to a decline in credit growth in 2014–15. In response, the authorities introduced a cap on kip deposit and lending rates in mid-2015. Credit growth recovered to around 25 percent in mid-2016, although the acceleration was mostly in foreign currency lending, raising worries about re-dollarization. The increase in dollar lending is also associated with a sharp decline in commercial bank net foreign assets (NFA), suggesting that dollar credit in Laos is being increasingly funded by non-core foreign sources.4

Financial Conditions Index Shows a Tightening

Source: IV- staff calculations.

The financial cycle index (FCI) for Laos is calculated using a dynamic time-varying factor model with time-varying loadings see Rafiq. S. 2016. IMF Working Paper 16/214). The model contains cross-border borrowing, private sector credit and deposit growth, various credit gaps, as well as asset and bond prices. The FCI controls for fluctuations in real economic activity and, therefore, represents ‘pire’ financial conditions. Positive (negative) values imply looser (tighter) financial conditions.

The Credit Gap Has Moderated

(Percent of GDP)

Source: IMF staff estimates.

The credit-to-GDP fan chart is based on a one-sided Hodrik-Prescott filter estimated using a Kalman filter, with multiple smoothing parameters to account for uncertainty regarding financial deepening.

6. Outlook. GDP growth is expected to moderate to 6.8 percent in 2017–18, and to rise to around 7 percent in the medium-term, supported by a resumption of resource-related FDI (mainly hydropower). Inflation is expected to remain moderate at around 3 percent. The baseline scenario assumes a rise in the fiscal deficit to around 6 percent of GDP in FY 15/16. Over the medium-term the deficit is expected to improve gradually to 5 percent of GDP as overall revenues recover and expenditure is contained. The current account deficit will widen slightly reflecting higher imports to support hydroelectric and railway projects, financed by private capital inflows, but will narrow in 2021 as project-related imports fall and electricity exports come on line. Gross international reserves are expected to remain low at around 1½ months of imports. Credit growth is projected to remain at around 20 percent in 2016–17, broadly supportive of growth but below a rate that, in staff’s assessment, would raise concerns about financial stability (Box 2). Under an adjustment scenario with a resumption of fiscal consolidation, greater exchange rate flexibility, bank recapitalization and structural reforms, short-term growth would be lower but the medium-term growth path would be more robust and near-term vulnerabilities would be reduced (Box 5).

Inflation Projected to Remain Moderate

(Percent)

Source: IMF staff calculations.

The inflation forecast is calculated using a Bayesian VAR with a Minnesota prior containing economic activity, inflation, the exchange rate and commodity prices at a monthly frequency.

7. The main risks to this outlook include:

  • Domestic fiscal risks. A sustained reversal in the momentum of fiscal consolidation driven largely by weak revenue growth would lead to further increases in the public debt ratio and a deterioration of the external position. This would have a negative effect on confidence and growth, given that the Debt Sustainability Analysis (DSA) puts Laos’ public and publicly guaranteed (PPG) external debt at high risk of debt distress (Debt Sustainability Analysis).

  • Banking sector risks. Risks could also materialize in the undercapitalized state-owned banks (accounting for around 45 percent of the banking system by assets), through deposit flight, and an abrupt depreciation of the exchange rate, which could further undermine solvency, impairing economic growth.

  • Dollarization and currency mismatches(Box 3). The high level of dollarization and foreign borrowing has led to balance sheet mismatches in the non-bank private sectors estimated conservatively at about 4 percent of GDP. A kip depreciation of 30 percent (on the order of the estimated current overvaluation) would add another 4 percent of GDP to bank and nonbank private sector liabilities, further exacerbating balance sheet weakness, increasing NPLs and affecting growth in a negative feedback loop (Box 3). Public sector liabilities are also vulnerable to exchange rate movements as about 60 percent of the public debt is denominated in US dollars.

Weak Banking System Is a Drag on Economic Growth

Source: IMF staff calculations.

The projection Is based on the local projection method In Jorda (200S). The simulation is based on a model containing economic activity, a financial conditions Index, and credit growth. The response is a projection of economic activity to a loosening In financial conditions.

  • Other domestic risks. Continued erosion of competitiveness from the kip’s real appreciation, coupled with weak productivity and low private investment, would damage growth prospects, particularly for nascent non-commodity exports.

  • External risks(Box 1). With a thin reserves cushion, the exchange rate remains vulnerable to a reversal in private capital flows or a rapid deterioration in the terms-of-trade. In the worst case, an abrupt depreciation of the exchange rate could undermine banking system confidence and financial stability. A sharp slowdown in China would impact commodity and agriculture exports and tourist arrivals. A disorderly unwinding of financial conditions in China or globally would be felt through lower foreign direct investment and capital flow reversals.

Lao P.D.R.: Risk Assessment Matrix
EventUp/DownsideProbabilityImpactTransmissionPolicy Recommendations
Domestic RisksFiscal consolidation is reversedMediumHighPublic debt rises further, current account deficit deteriorates, loss of confidence, capital outflows, and forced fiscal retrenchmentMaintain fiscal consolidation efforts; raise non-mining tax revenues; rationalize current expenditures; limit non-concessional external borrowing.
Capital positions for SOCBs deteriorate further due to rising NPLsHighHighSharp slowdown in credit, tightening in domestic liquidity conditions, capital outflows, putting further pressure on the exchange rate.Eliminate forbearance and ensure that all banks meet the mandatory minimum CAR to reduce possibility of external shocks being amplified by banking system failure. Introduce regulations to better account for NPLs.
External risksTerms of trade shockMediumHighCurrent account deficit deteriorates, abrupt exchange rate depreciation leads to capital flight and banking system instability, worsening the fiscal deficit, and raising public debt levels.Maintain a fiscal consolidation path, allow limited exchange rate depreciation and build up international reserves and government deposits. Expedite efforts to raise non-mineral tax revenues.
Significant China slowdownLow/MediumMediumLower exports coupled with weaker FDI and banking sector flows.Expedite structural reforms to accelerate diversification. Ensure adequate emergency liquidity.
Rebalancing In China demandHighMediumLower commodity and agriculture exports.Expedite policies to promote export diversification. Improve the business climate and accelerate compliance with WTO commitments.
Sharp asset price decline and decompression of global credit spreadsMediumMediumFX deposit outflows, foreign reserves fall.Build up foreign reserves to buffer against external shocks; allow for greater exchange rate flexibility; where appropriate release limited short-term liquidity to troubled banks; expedite work on a crisis management framework; increasing reserve requirements on foreign deposits during episodes of strong capital inflows would create a buffer that can be liberated when foreign deposits flow out in response to external shocks.
Surge in the U.S. dollar strengthHighMediumBalance sheet impact from currency mismatches, weaker exports, tourism receipts, FDI, and bank lending from other partner countriesMaintain macroeconomlc stability and develop interbank and foreign exchange markets to enhance monetary policy effectiveness and to reduce dollarization. Expedite structural reforms to boost non-price competitiveness
The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to Indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent), The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

8. The authorities broadly concurred with the near-term outlook and risks. They acknowledged the likelihood of lower growth but emphasized the importance of more inclusive and diversified growth going forward. They agreed that rising public debt posed a risk, and on the need for resuming efforts to increase fiscal revenue and consolidation. While they acknowledge weakness in public banks they pointed to the overall soundness of the system, efforts to improve supervision, and plans for restructuring. They also emphasized that external sector risks are mitigated by the large FDI inflows into the hydro and energy sectors and the fixed foreign currency price and quantity contracts for electricity exports, which are not affected by the exchange rate. While they acknowledged that the managed exchange rate had some costs, they considered that the risks to inflation and balance sheets of introducing greater flexibility warranted caution.

Policy Discussions

The key policy challenges are to safeguard macroeconomic stability and put in place the conditions for sustainable medium-term growth. To reduce risks and rebuild buffers, fiscal policy should resume the momentum for growth friendly consolidation, and weakness in the banking sector should be addressed. At the same time, reforms should focus on preparing for greater exchange rate flexibility and accumulating reserves. Gradually allowing the exchange rate to depreciate in line with market forces will support these objectives. Addressing structural constraints, integrating the population into productive activity and increasing financial inclusion will further support inclusive growth.

A. Fiscal Policy: Rebuilding Fiscal Buffers

9. The momentum of fiscal consolidation has been reversed, and the composition of spending has deteriorated. The overall deficit in FY 15/16 is expected to rise to 5.9 percent of GDP from 2.7 percent of GDP in FY 14/15, due to a large decline in tax and non-tax revenue. Tax revenue has been affected by the economic slowdown and the decline in commodity prices, while lower non-tax revenue reflects the absence of the sale of state assets, which supported revenue by about 1 percent of GDP on a one-off basis in 2015. Capital expenditure fell in line with lower externally financed investment (financed by grants), but current expenditure rose, mainly due to an increase in interest payments and transfers, leading to a deterioration in the composition of spending. Part of the deterioration thus reflects a deficit of a more structural nature which needs to be addressed.

Lao P.D.R.: Fiscal Outcome and Projections(Percent of GDP)
2013201420152016 (Proj.)
Total Revenue23.923.224.018.5
Tax15.815.715.714.3
Non-tax2.52.33.31.9
Grants5.75.35.02.3
Total Expenditure29.627.826.724.4
Current17.315.215.716.4
Capital12.312.611.08.0
Fiscal Balance−5.6−4.5−2.7−5.9

10. Public debt has risen and has become less concessional. The PPG debt ratio reached 65.8 percent of GDP at end-2015, from 62.5 percent at end-2013. The increase is mainly due to a rise in the stock of domestic treasury bills and bonds, higher borrowing from Thailand and China for investment in power generation projects, and the issuance of sovereign bonds in the Thai market (DSA Box 1). The increase in debt has been accompanied by a decline in the degree of concessionality, with 12.8 percent of the debt on commercial terms at end-2015, compared to about 3 percent at end-2013. As a result, the DSA assesses Laos at high risk of external debt distress, a deterioration from the previous DSA, where it was on the borderline between moderate and high risk (DSA). Given the high proportion of public debt denominated in foreign currencies (especially the US dollar), the DSA also highlights the vulnerability of the public balance sheet to a large exchange rate depreciation.

11. It is urgent to restore fiscal space by resuming a growth friendly fiscal consolidation and reducing the debt ratio. This will safeguard macroeconomic stability, particularly under a tightly managed exchange rate, and would build financial buffers to address real and financial shocks. Fiscal policy could be anchored to reducing the public debt ratio to 55 percent of GDP by 2021, a level that would lower the debt distress rating from high to moderate. Including the cost of public bank recapitalization, this would require maintaining an average overall fiscal deficit of around 3½ percent of GDP and a non-mining fiscal deficit not greater than 4½ percent of GDP over the next five years (Box 5).5 Achieving this goal would require strong and permanent revenue and expenditure measures so that the burden of adjustment does not fall on priority social and capital expenditures, and the fiscal adjustment is sustainable. In particular:

  • Tax policy and administration. A key reform objective is to boost the tax-to-GDP ratio to build space for priority spending and investment. Non-commodity revenues could be raised by broadening the tax base, including by reducing exemptions, and strengthening tax administration. The authorities have taken some important measures recently, improving the valuation of imported vehicles to calculate import taxes, eliminating exemptions for oil imports in public projects, revising excise taxes, and better administering the VAT. Nevertheless, further work is necessary to reach revenue targets:

    • Revise exemptions. The exemption regime in Lao P.D.R. is extensive and anecdotal evidence suggests there are important leakages. A first step in revising the regime is to conduct a tax expenditure study to understand where exemptions are concentrated. Centralizing the administration and issuance of exemptions, and ensuring regular reporting, will lead to a more transparent regime. In addition to the exemption regime, unifying the VAT rate between the Special Economic Zones (SEZs) and the rest of the economy would simplify VAT administration and improve tax efficiency.

    • Revenue Measures. Gradually increasing excise rates on automobiles and other luxury goods, and introducing a land tax or property tax on buildings, would support the revenue base.

    • Improve Tax Administration. Short-term priorities for reform include: improving compliance of large and medium taxpayers; restructuring the tax department to better reflect priority functions; establishing a full Large Taxpayer Office (LTO); and bringing district tax offices formally under the control of the Director General of the Tax Department. It will also be important to carefully manage the implementation of the government’s planned investments in information technology for the tax office. The authorities’ plan to introduce point-of-sale (POS) recording of transactions for retail businesses and to require strengthened bookkeeping for presumptive taxpayers are welcome.

  • Public financial management reforms. Focus should also be on restraining non-capital spending by accelerating civil service reform to lower the public sector wage bill; curtailing nonessential expenditures and off-budget capital spending; and eliminating fiscal arrears. To enhance the tracking of the government’s financial operations, reduce off-budget spending, and strengthen control over expenditure, the authorities should push ahead with a Treasury Single Account (TSA).

  • Medium-term fiscal and debt management framework. Developing a medium-term fiscal framework, that includes a revenue strategy for modernizing tax and customs policy, the legal framework and administration, as well as a public expenditure review to identify opportunities to improve efficiency, would support a well-planned sustainable fiscal reform that could identify and protect essential social spending and support growth. A medium-term debt strategy could also help anticipate and manage financing challenges as Laos moves towards middle-income country status.

12. Authorities’ views. The authorities agreed that the fiscal deficit should be put on a downward trend to reduce fiscal risk and contain growth in the public debt. They emphasized that future borrowing would remain mainly on concessional terms and oriented towards necessary investments. On exemptions, they plan to revise two laws (Investment Promotion and Special Economic Zones) and review the application of exemptions, particularly for vehicles and construction materials. On tax policy, they are planning to introduce a land tax in 2017 and revise some rates on existing taxes. On tax administration, they agreed that large taxpayers should be managed centrally and were planning to transfer this function from provincial offices to the central tax office. In addition, they expect that the POS recording of transactions would help improve tax compliance. Finally, they also cited the recruitment of more personnel for the tax office.

B. Ensuring a Sound Banking System

13. Lao P.D.R. has weaknesses in parts of its commercial banking system. Public banks that make up almost half the system are undercapitalized. NPLs in public banks have risen from 2 percent to 8 percent while the capital adequacy ratio (CAR) is estimated by staff to have fallen to around 3 percent. This partly reflects a lack of control over public investment spending in previous years at the state and local level, which resulted in arrears and cash-flow problems at some local firms.6 Some domestic private banks are also well below the mandated capital levels, although these are not systemic. Weak accounting standards mean the level of NPLs could be significantly understated. According to international evidence, the ROA and ROE of the banking system (at 0.2 percent and 0.6 percent respectively) could be consistent with NPLs above 10 percent. The recently mandated caps on local currency deposit and lending rates have also likely contributed to reverse progress in de-dollarization and may affect the profitability of already weak segments of the banking system.

Emerging and Developing Countries: NPLs and ROA

(Percent)

Sources: National authorities; and IMF staff calculations

Emerging and Developing Countries: NPLs and ROE

(Percent)

Sources: National authorties; and IMF staff calculations

14. The authorities have made efforts to improve banking supervision and detect risks. The Bank of Lao (BOL) is working to amend its legal framework to strengthen risk-based supervision and move toward Basel-core principles, including improvement of prudential regulations. A plan to restructure public banks starting in 2017 is underway, as well as implementing CARs to comply with BASEL II (likely in 2018). The central bank is also working on upgrading the payments system, and other information requirements for the securities markets. As credit growth resumes (Box 2) it will be important for the BOL to monitor liquidity conditions and control a further buildup of risks. In particular:

  • Address weakness in the banking sector. It is urgent to repair bank balance sheets to reduce the possibility of an external shock being amplified by the banking system. Eliminating forbearance and ensuring that all banks meet the mandatory minimum CAR of 8 percent is a first step. Introducing regulations to better account for NPLs would help clarify recapitalization estimates and restructuring options. Recapitalizing public banks should be a first priority, with potential recapitalization costs estimated at US$ 250 million (1.8 percent of 2016 GDP).

  • Continue to improve supervision. Supervisory capacity is stretched given rapid growth of the banking system and the large number of banks. In light of emerging risks, there is a need to maintain the moratorium on new bank licenses, and to quickly improve supervision, including risk-based supervision in the medium-term. Collecting corporate and household balance sheet information (with appropriate safeguards) and assessing the balance sheet risks in the banking system would improve the BOL’s ability to monitor and manage the economy’s exposure to exchange rate risks.

  • Develop the crisis management framework. This should include a contingency plan for the banking sector in the event of financial distress, including strengthening the institutional setup for crisis management with resolution authority, a sound emergency liquidity assistance framework with appropriate safeguards, a bank resolution framework, and a communications strategy.

  • Address foreign currency lending risks. The recent rapid rise in dollar lending, financed by foreign borrowing, may present additional macrofinancial risks. While there are limits on bank net open positions, and restrictions on foreign currency lending to non-foreign currency earning clients, the BOL should also consider macroprudential tools, including further raising foreign currency reserve requirements (which, at 10 percent, are already higher than kip reserve requirements), setting limits on loan-to-deposit ratios for foreign currency lending or additional unremunerated reserve requirements in foreign currency, to contain these risks.

  • Reduce dollarization. Although dollarization has fallen, Laos remains a highly dollarized economy, with 45 percent of deposits and 48 percent of private credit in foreign currencies. A market based approach to reduce dollarization would begin by removing the caps on kip lending and deposit rates, strengthening the deposit insurance arrangements for local currency deposits, and introducing measures to promote the use of kip (e.g., lower cost and convenient services for kip use, larger spread between foreign currency and kip reserve requirements). International experience also shows that gradually introducing a small measure of exchange rate flexibility helps reduce dollarization.

15. Authorities’ views. The authorities emphasized that, despite pockets of weakness, the banking system as a whole is stable and sound. In addition, public disclosure of audited statements of all banks will be enforced in 2017 to enhance transparency. In the area of accounting they are considering upgrading requirements in line with IFRS. On bank licensing the authorities have upgraded fit and proper criteria to safeguard against AML/CFT risks. The authorities are also aware of foreign currency lending risks, and are considering additional macroprudential measures. The authorities see interest rate caps as a way of broadening access to credit, but emphasized that these were temporary until a well-functioning financial market is developed.

C. Strengthening International Reserves and Exchange Rate Policy

16. Reserve coverage metrics for Lao P.D.R. are significantly lower than the level desirable for countries with a tightly managed exchange rate and a highly dollarized financial sector, according to the IMF’s standard metrics (Box 4). In light of the low level of reserves, the authorities should use the flexibility in their current regime (which allows the kip/US dollar exchange rate to move within a band of plus or minus 5 percent per year) to gradually let the kip/US dollar exchange rate depreciate in line with market forces. This, combined with tighter fiscal policy would support a gradual buildup of reserves towards a goal of at least 4 months of import cover. Low inflation provides an opportunity to let the kip depreciate gradually and accumulate reserves with a limited impact on price stability. Greater exchange rate flexibility would also better help manage volatility of fiscal revenues associated with changes in commodity prices.

17. Authorities’ views. The authorities consider the level of reserves to be adequate, although they agree that a higher level would further safeguard stability. The central bank calculates reserves at end-2015 at 6.4 months of imports due to a different estimate of trade flows and the exclusion of imports related to FDI projects.7 Using the central bank’s overall import figure, and not excluding FDI imports, puts reserve adequacy at around 2 months of imports, still well below recommended levels.

Lao P.D.R.: Reserve Adequacy Calculations(End-2015; millions of US dollars)
Bank of LaoIMF 1/
Imports c.i.f.5,2337,533
Gross International Reserves (GIR)987987
GIR in months of imports2.31.6
GIR in months of imports
adjusted for FDI-related
imports6.4
Implied FDI-related imports1,804

Using IMF - Direction of Trade Statistics (DOTS)

Using IMF - Direction of Trade Statistics (DOTS)

18. Lao P.D.R. should move quickly to put in place the preconditions for greater exchange rate flexibility. The de-jure exchange rate regime is a managed float, and moving to more flexibility would help Laos adjust to external shocks and reduce vulnerabilities. However, a successful move requires an alternative nominal anchor for price stability, as well as preparing the bank and corporate sectors to deal with greater volatility (in particular limiting their open foreign exchange positions). As these preparations will take time, the transition will need to be gradual.

The Exchange Rate Has Not Acted as a Shock Absorber

Source: IMF staff calculations.

The calculations use a standard VAR model containing economic activity, the exchange rate and the terms-of-trade. The Lao PDR responses to a terms-of-trade shock are compared with a panel of ASEAN countries with floating exchange rates (Indonesia, Philippines and Thailand). See Rafiq, S. 2011. “Sources of Economic Fluctuations in Oil-Exporting Economies: Implications for Choice of Exchange Rate Regimes,” International Journal of Finance and Economics 16:70–91.

19. The following sequence of reforms is recommended:

  • Develop the functioning of local financial markets. This includes implementing reforms that would allow for the smooth functioning of the interbank money market, the interbank foreign exchange market, and the government debt market.8

  • Actively manage liquidity and steer market interest rates. Once local financial markets are sufficiently developed, the monetary policy transmission mechanism should begin to function so that a short-term policy interest rate can be used by the BOL to transmit the desired monetary policy stance to the market. This will require removing caps on deposit rates and intermediation spreads, and using open market operations and exchange rate intervention to affect the market interest rate. Active liquidity management based on stable and low excess reserves will also support market development.

  • Develop the institutional framework for monetary policy. Upgrading the monetary policy framework will require institutional, technical and operational reforms. The basic elements include: a) a clear mandate and operational independence for the central bank to pursue price stability; b) development of the technical capacity to design and implement a transparent, forward-looking monetary strategy; c) a clear and effective framework for monetary control; and d) a framework for forecasting and managing banking system liquidity.9

  • Develop the foreign exchange market and introduce systems to manage exchange rate risk. Market participants need to develop internal risk management and information systems to measure foreign exchange risk, and an adequate prudential and supervisory framework should be in place to monitor direct and indirect exposure. Cautious development of derivatives in the foreign exchange market will support hedging instruments necessary for market development.

20. During this process, allowing some controlled and limited flexibility early on is important. Allowing for a two-way variation in the exchange rate at an early stage (e.g. by gradually allowing the exchange rate to float within the 5 percent plus or minus band) helps reduce one-way currency bets. Such variation also stimulates foreign exchange market development and provides incentives for risk management, while supporting the accumulation of international reserves

21. Authorities’ views. The authorities recognized that there are risks associated with the managed exchange rate, but they saw these as manageable. They pointed to significant benefits from stability including macroeconomic stability and trust in the currency, and they saw significant risks to introducing flexibility in the short-term. Nevertheless, they viewed the tightly managed exchange rate as a temporary arrangement, and agreed that more flexibility is desirable in the medium term. In this connection, they agreed that it is important to put in place preconditions to reach this objective.

D. Promoting Competitiveness, Diversification and Inclusion

22. Lao P.D.R. faces structural constraints that limit future growth potential, and render the economy vulnerable to shocks. A narrow export base founded on natural resources (mining and hydropower), a weak business climate and eroding competitiveness have inhibited investment and diversification. The country’s rank in comparative studies of the ease of doing business is well below its peers in ASEAN, and concerns remain regarding governance, access to finance, institutional efficiency, education and skills, and inadequate infrastructure. For Laos to take advantage of changing patterns in China’s import demand towards consumer goods, and further regional integration through the ASEAN Economic Community (AEC) will require addressing these structural constraints.10

Doing Business Indicators Cross Country Comparison 1/

(Distance to frontier score 2/)

Citation: 2017, 53; 10.5089/9781475579451.002.A001

1/ These indicators should be interpreted with caution due to a limited number of respondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability.

2/ On a scale of 0 to 100; 100 is the frontier and 0 is the furthest from the frontier.

23. Integrating a higher proportion of the population into productive economic activity would boost growth and reduce poverty. Over two-thirds of the population remains in agriculture, where productivity has consistently been the lowest in the region. A large skills gap impedes movement to manufacturing or services employment. School enrollment is high, but outcomes are low, and Lao P.D.R. has the highest rate of adult functional illiteracy in the region (33 percent urban and 66 percent rural). A lack of skilled labor has also contributed to low levels of investment in manufacturing, and the majority of labor in Special Economic Zones is foreign. Creating better economic opportunities will require investing in rural infrastructure, education and training. It is also necessary to improve basic health outcomes, including reducing malnutrition and maternal mortality, where Lao P.D.R. lags behind low-income country averages.

24. Policies that increase financial inclusion will help promote macro-financial stability and enhance growth. While Laos has experienced rapid financial deepening over the last decade, financial inclusion remains low. Access to financial institutions is limited to about one-third of the population, and Laos has the third-lowest level of financial access in ASEAN (only Cambodia and Myanmar rank lower). To enhance financial inclusion, policies should focus on: increasing the supply of financial services (access to ATMs, branches, and accounts); financial literacy programs (as used in Bangladesh and India); and the delivery of financial services and information through microfinancial institutions.11

Financial Institution Access Index

(1 = perfect access)

Source: Katsiaryna, S. (2016),’Introducing a New Broad-based Indexof Financial Development’, IMF Working Paper #WP/16/5.

Financial Development and Effects on Growth

Source: IMF staff calculations.

25. Authorities’ views. The authorities agreed that there were significant structural constraints to growth, reflected in the narrow base of production and exports, low fiscal revenue and a lack of inclusive growth. In addition to continuing to implement WTO commitments and enhancing further integration with ASEAN, they agreed that further efforts were necessary to improve the business environment, including through infrastructure investment. A particular area of focus was the promotion of small and medium-sized enterprises. The new laws on Investment Promotion and on Special Economic Zones are also aimed at reducing red tape, and new regulations on Public Private Partnerships should help finance new infrastructure.

26. Statistics. Significant constraints are imposed on surveillance by weak data, particularly in external sector and financial statistics, although some progress has been made since the last Article IV consultation (Informational Annex). Shortcomings are largely due to a lack of capacity. Development partners (including the Fund) have devoted significant resources in Laos to capacity development in this area. In this connection it is encouraging to note the authorities’ interest in joining the e-GDDS and bringing statistical quality, coverage and dissemination in line with their peers in ASEAN.

Staff Appraisal

27. Economic setting. Growth is expected to slow to under 7 percent as the economy faces headwinds from a less favorable external environment and a slow-down in agriculture. Inflation has risen slightly but is expected to remain contained. Private sector credit growth will remain between 15 and 20 percent, concentrated in construction and services. In the medium-term growth is expected to rebound slightly to around 7 percent, supported by hydro-electric projects and transportation investments. The external position is assessed to be vulnerable to shocks and requires strengthening.

28. Risks. The outlook is subject to domestic and external risks. On the domestic side, a sustained reversal in fiscal consolidation would lead to a further increase in public debt, a loss in confidence and a deterioration of the external position. Weakness in the banking system, coupled with high dollarization, could also lead to deposit flight and pressure on the exchange rate. Continued erosion of competitiveness from the kip’s real appreciation, coupled with weak productivity and low investment, could threaten growth. On the external side the thin reserves cushion and a tightly managed exchange rate make Laos vulnerable to a deterioration in the terms of trade or a reversal of capital flows. A slowdown in China would affect FDI, exports and growth.

29. Resuming fiscal consolidation. Anchoring fiscal policy on a goal of reducing the public debt ratio to 55 percent of GDP by 2021 will lower the debt distress rating in the DSA to moderate, and help build fiscal buffers. This will require sustained efforts to increase revenue and rationalize expenditure. The authorities’ initiatives on tax administration, exemptions and new taxes are welcome. A revision of the exemption regime and the efficiency and composition of expenditures will further help achieve a growth-friendly consolidation. In this connection, the formulation of a comprehensive medium-term fiscal framework, including a medium-term revenue strategy, a medium-term debt strategy and a public investment review, would allow for a sustained approach that could be executed over a number of years.

30. Putting the debt ratio on a downward trajectory. The DSA assesses Laos’ external PPG debt to be at high risk of debt distress, which is a deterioration from last year’s Article IV consultation. The high proportion of public debt in foreign currency makes it particularly vulnerable to changes in the exchange rate. In the transition to a lower debt ratio it will be particularly important to continue to emphasize concessional financing, and adopt clear guidelines for the issuance of sovereign debt and guarantees and the use of such borrowing. In particular, the continued issuance of foreign currency sovereign bonds in the Thai market on non-concessional terms (DSA Box 1), and the use of part of the proceeds for current spending, seems to be in conflict with desirable debt management practices.

31. Addressing banking sector risks. The authorities have made commendable efforts to improve supervision and detect risks, and their plan to restructure public banks is welcome. Moving rapidly to address bank weakness, including through the prompt recapitalization of state-owned banks, and further improving supervision, will be important to reduce the risk of an external shock being amplified through the banking system. At the same time, addressing foreign currency lending risks through additional macroprudential measures will help reduce balance sheet risks. Developing the crisis management framework would also help the central bank prepare for possible contingencies. An early removal of interest rate caps will be important to developing local financial markets and reducing dollarization.

32. Moving towards greater exchange rate flexibility and accumulating reserves. Even as Laos puts in place policies to support the tightly managed exchange rate in the short-term, it is necessary to put in place conditions that will allow it to adopt more exchange rate flexibility in the medium-term. The sequencing of reforms should include: a) developing local financial markets; b) actively managing liquidity to affect market interest rates; c) developing the framework for monetary policy; and d) developing the foreign exchange market and tools to manage exchange rate risk. During this process allowing some limited exchange rate flexibility will support the accumulation of reserves and promote the development of foreign exchange risk management and the foreign exchange market. A higher buffer of international reserves is needed to address foreign currency risks, given the high current account deficit, the tightly managed exchange rate, dollarization and balance sheet mismatches in the non-bank private sector.

33. Addressing structural constraints will help secure more sustainable and inclusive growth. Improving the business environment and upgrading skills and human capital will support investment and productivity growth, and the diversification of exports, and help Laos take advantage of growing export opportunities in the region. Enhancing financial inclusion will also support macro-financial stability and growth.

34. The collection and dissemination of economic and financial statistics continues to require improvement. Sustained effort will be required to secure progress, which will be important for informed policymaking and surveillance. Staff welcomes the authorities’ commitment to improving statistics.

35. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Box 1.Lao P.D.R.: External Sector Risks for Laos’ Economy1

Because of high dollarization and a relatively open capital account, Lao P.D.R. is exposed to international financial volatility and the global monetary cycle. Developments in China are also a key risk.

Source: IMF staff calculations.

1 The response is derived based on a regression of US dollar currency deposits in Lao banks and VIX. The projection is based on local projection method in Jorda (2005).

2 The response is derived from a regression of the financial conditions index (FCI) and VIX. The projection is based on local projection method in Jorda (2005).

3 A conditional forecast simulation is performed using a VAR model with a Litterman prior containing China’s industrial GDP growth (quarterly data), Lao’s exports to China (monthly data) and the kip-RMB exchange rate (monthly).

1 Prepared by Sohrab Rafiq.

Box 2.Lao P.D.R.: Unlocking the Credit Cycle and Its Phases1

After a rapid episode of financial deepening, credit growth has slowed, due to both weaker demand and banking sector weakness. The credit cycle is currently in the repair/recovery phase and risk appetite seems to be recovering.

Laos has experienced rapid financial deepening as measured by credit-to-GDP. The credit-to-GDP ratio rose from around 9 percent of GDP in 2007 to around 50 percent by end-2014, one of the fastest financial deepening episodes witnessed. The credit gap was 10 percent of GDP in 2012; a leading indicator of an impending financial crisis according to the BIS (Drehman and others, 2013). From 2013 to 2014 the credit gap abruptly closed as credit growth slowed. Structural Bayesian analysis suggests that much of the slowdown in credit growth reflects a combination of loan supply and credit demand shocks. This implies that both weaker demand, reflecting slower economic growth, and credit market supply shifts, reflecting banking sector weakness and/or liquidity constraints, have driven the credit cycle in recent years.

Total Credit in Lao P.D.R.

(Percent of GDP)

Sources: Bank of Lao; and IMF staff calculations.

Source: IMF staff calculations

1 The model is calculated using a Bayesian VAR with sign restrictions with theoretical priors from Bernanke and Blinder (1998) to identify credit market shocks. See Rafiq, S. 2015. “The Effect of U.S. Unconentional Monetary Policy on Asia Froniter Economies” IMF Working Paper No. 14/18 for estimation details. The baseline described the no-shock scenario.

Gauging the current phase of the credit cycle provides an understanding of financial risks. A Markov Chain model suggests that, relative to historical trends, the credit cycle in Laos is currently in the repair/recovery phase. In credit repair, banks try to improve their balance sheets. Indeed, in a bid for FX liquidity, the deposit spread between Lao and foreign banks for FX deposits has risen over the past two years. As risk appetite begins to rise, the Bank of Lao should closely monitor liquidity conditions, while working preemptively to improve banking sector supervision to better monitor and control the potential buildup of risks.

Credit Cycle Regimes in Lao P.D.R. 1

(Percent)

Source: IMF staff calculations.

1 A Markov Chain model is estimated to disentangle Laos’ credit cycle into boom, bust and repair/recovery phases of the credit cycle. Since 2000 the typical Laos credit boom (bust) cycle has lasted 31 (11) months.

1 Prepared by Sohrab Rafiq.

Box 3.Lao P.D.R.: Dollar Credit Cycle, Dollarization and Private Currency Mismatches: How Large Are Risks?1

Laos’ economy is highly dollarized, and currency mismatches on balance sheets are a potential source of macro-financial risk. The data shows that private currency mismatches principally exist in the non-bank sector, which has significantly increased its foreign borrowing in recent years. To mitigate vulnerabilities, financial safety nets need to be pre-emptively strengthened, while surveillance of cross-border financial flows should be improved.

Laos is a highly dollarized economy, and the risk-taking channel increases the potential for valuation mismatches arising from exchange rate effects. These risks have grown since 2010 as US dollar cross-border bank and non-bank borrowing has grown significantly. Available data shows:

  • Laos’ total net FX exposure, according to BIS data, is around 4.2 percent of GDP: 1.2 percent of GDP for banks and 3 percent of GDP for the non-bank private sector. The non-bank private sector in Lao P.D.R. is a larger net debtor to the rest of the world than banks. The non-bank sector in Laos is, therefore, a potential conduit for the transmission of global financial conditions to the domestic economy.

  • Balance sheet data from two public banks in Lao (BCEL and BFL) show FX assets to be, in total, around 1 percent of GDP larger than liabilities.

BIS Claims and Liabilities Banks and Non-Bank Sectors

(Percent of GDP)

Sources: Bank for International Settlements; and IMF staff calculations.

Claims BIS Reporting Banks on Lao P.D.R.

(Millions of US dollars)

Sources: Bank for International Settlements; and IMF staff calculations.

Estimates suggest that net FX liabilities of the economy will rise by 3.8 percent of GDP (2.7 percent of GDP for banks and 1.1 percent of GDP for the nonbank private sector) following a 30 percent kip/dollar depreciation. From current levels, this would aggregate total currency mismatches to around 8 percent of GDP. Due to valuation effects, gross foreign reserves held at the Bank of Lao would rise from 7 to around 8.6 percent of GDP. It is worth noting that these estimates are likely to be very conservative since BIS data does not include Chinese banks, which are an important source of project funding in Laos.

Potential Balance Sheet Impact from Exchange Rate Adjustment
% of GDPUS dollar (millions)
30 percent depreciation3.8477

Lao P.D.R. is a net debtor to the rest of the world, and balance sheet risks call for preemptively widening and deepening financial safety nets. In addition:

  • The Bank of Lao should gradually make more use of the exchange rate bands to allow for greater exchange rate flexibility, which would help sensitize economic agents to the risks of foreign borrowing.

  • De-dollarization policies should be expedited, and focus on market-based measures to promote the kip (interbank market development), supported by credible macro prudential policies.

  • Banks’ net open positions should be closely monitored and surveillance of cross-border financial flows should be enhanced.

1 Prepared by Sohrab Rafiq.

Box 4.Lao P.D.R.: External Sector Assessment1

The external position is highly vulnerable and needs strengthening. The kip is estimated to be overvalued by between 20 and 40 percent, a decline in competitiveness compared to previous assessments, and reserves continue to be inadequate for precautionary needs.

Staff estimated EBA-Lite based on the macroeconomic balance and equilibrium REER approaches, both suggesting that the kip is overvalued by 20–40 percent. The macroeconomic balance approach indicates a 20 percent overvaluation. The current account norm used is lower than the previous assessment as growth estimates and fuel import prices are lower for the foreseeable future. The equilibrium real exchange rate approach indicates a 38 percent overvaluation, and could be related to the recent nominal appreciation of the kip with respect to major partner country currencies (renminbi and baht).

Lao P.D.R. Exchange Rate Assessment
Art. IV 2016Art. IV 2015Art. IV 2013
MBREERMBREERMB
Underlying CA balance 1/−9.3−9.3−16−15.1
CA norm−3.9−8.5−9.0
Required improvement in the CA−5.4−7.9−6.2
Implied over (+) / under (-) valuation 2/20.138.329.412.924.3

Non-resource current account balance is used in the analysis. The 2015 Article IV was based on the CGER methodology and, therefore, may not be directly compatible with the 2016 EBA-lite estimates.

Using the elasticity of -0.27 estimated in the EBA-Lite framework. MB -- Macroeconomic balance approach

Non-resource current account balance is used in the analysis. The 2015 Article IV was based on the CGER methodology and, therefore, may not be directly compatible with the 2016 EBA-lite estimates.

Using the elasticity of -0.27 estimated in the EBA-Lite framework. MB -- Macroeconomic balance approach

Trends in the balance of payments are consistent with the overvaluation of the kip. A significant proportion of Lao’s balance of payments is inelastic to price and exchange rate movements, particularly imports related to FDI projects, electricity exports under fixed price and quantity contracts, and natural resource exports (metals) priced in dollars. Nevertheless, even as the overall current account deficit fell by 4 percentage points of GDP from 2014 to 2015, the non-resource current account deficit, (which remains high at 7½ percent of GDP), only fell by one percentage point, reflecting slow growth in tourism and non-resource related exports and higher growth of non-resource non-petroleum imports.

Reserve Adequacy

(2015)

Source: IMF staff estimates.

Reserve coverage metrics are significantly lower than the level desirable for countries with a fixed exchange rate regime and highly dollarized financial sector, according to the Fund’s reserve adequacy metric. As of December 2015, reserves were equivalent to about 1 month of prospective imports of goods and services, about 13 percent of broad money, 30 percent of foreign currency deposits and about 8 percent of GDP. These reserve coverage levels are significantly below the traditional metrics of at least three months of prospective imports or up to 50 percent of broad money, respectively. Although the authorities consider reserves as adequate under their methodology (which excludes a measure of FDI-related imports), the numbers used by IMF staff are consistent with the IMF’s internationally comparable methodology.

Staff’s overall assessment is that the external position is vulnerable to shocks and requires strengthening. Fiscal consolidation and a gradual depreciation of the exchange rate within the current regime would help reverse the trend appreciation and increase international reserves.

1 Prepared by Manuk Ghazanchyan and Sohrab Rafiq.

Box 5.Lao P.D.R.: Adjustment Scenario 1

An adjustment scenario including recommended policies would result in lower growth in the near term, but more robust and sustainable growth in the medium-term. It would also result in a less risky path for the economy and make it more resilient to external shocks, including lower debt, a smaller current account deficit and the accumulation of reserves.

The adjustment scenario is based on the following assumptions:

  • Resumption of fiscal consolidation. Sustainable fiscal and expenditure measures would bring the fiscal deficit to 3½ percent of GDP on average, which would be sufficient to lower the debt to GDP ratio to 55 percent of GDP, including the additional 1.8 percent of GDP cost of recapitalizing public banks.

  • Gradual exchange rate adjustment. The real exchange rate would adjust by 23 percent over 5 years, through both nominal depreciation and productivity growth, realigning the REER with long-term fundamentals.

  • Banking sector reforms. Strengthening of state-owned banks management and recapitalization

  • Structural reforms to boost competitiveness and long-term productivity.

Macro Framework Under Adjustment Scenario
ActualProj.Alternative Scenario Projections
2015201620172018201920202021
Real GDP7.56.95.86.27.27.98.1
Inflation2.42.02.12.32.62.93.1
Current account (in percent of GDP)−16.8−17.1−15.1−13.7−12.8−12.3−12.1
Fiscal deficit (percent of GDP)2.75.95.73.53.43.23.2
Public debt (in percent of GDP)65.867.866.964.561.258.055.0
Reserves (in months of imports)1.51.92.22.52.93.54.2
Source: IMF staff estimates.Note: In percent, unless otherwise stated.
Source: IMF staff estimates.Note: In percent, unless otherwise stated.

Sources: National authorities; and IMF staff calculations.

1 Prepared by Sohrab Rafiq.

Figure 2.Lao P.D.R.: Growth Continues to Moderate and Inflation Is Contained

Figure 3.Lao P.D.R.: External Vulnerabilities Remain Elevated

Figure 4.Lao P.D.R.: External Linkages Are Concentrated in Regional Partners

Figure 5.Lao P.D.R.: Fiscal Consolidation Has Been Reversed

Figure 6.Lao P.D.R.: Financial Conditions Have Tightened but Remain Accommodative

Table 1.Lao P.D.R.: Selected Economic and Financial Indicators, 2011–171/
2011201220132014201520162017
Proj.Proj.
GDP and prices (percentage change)
Real GDP growth8.07.98.08.07.56.96.8
CPI (annual average)7.64.36.44.11.32.22.3
CPI (end year)7.74.76.62.40.92.12.3
Public finances (in percent of GDP)
Revenue and Grants22.424.123.923.224.018.519.4
Of which: Resources3.43.73.23.02.22.12.1
Of which: Mining2.73.02.22.01.30.90.8
Of which: Hydro power0.70.70.91.00.91.21.3
Of which: Grant6.06.45.75.35.02.32.8
Expenditure24.124.629.627.826.724.424.6
Expense11.312.017.315.215.716.415.9
Net acquisition of nonfinancial assets 2/12.912.612.312.611.08.08.7
Overall balance−1.7−0.5−5.6−4.5−2.7−5.9−5.2
Nonmining balance 3/−4.5−3.5−7.8−6.5−4.0−6.8−6.1
Public and public guaranteed debt (in percent of GDP)56.056.862.564.965.867.869.0
Money and credit (annual percent change)
Reserve money16.227.27.730.36.69.811.0
Broad money28.731.018.823.414.713.016.0
Bank credit to the economy 4/45.826.634.514.216.817.215.0
Bank credit to the private sector39.335.136.311.719.317.618.0
Balance of payments
Exports (in millions of U.S. dollars)3,1203,3233,8834,6874,3874,8045,124
In percent change42.16.516.920.7−6.49.56.7
Imports (in millions of U.S. dollars)4,6426,3827,3528,0177,5337,6848,708
In percent change28.137.515.29.1−6.02.013.3
Current account balance (in millions of U.S. dollars)−1,502−2,808−3,195−2,450−2,116−2,351−2,813
In percent of GDP−18.6−29.9−29.6−20.7−16.8−17.1−19.0
Gross official reserves (in millions of U.S. dollars)6777406628169871,4761,587
In months of prospective goods and services imports1.21.10.91.21.51.91.9
External public debt and debt service
External PPG debt
In millions of U.S. dollars3,6664,2625,4896,0616,4957,4228,240
In percent of GDP45.545.350.951.151.754.155.6
External PPG debt service
In percent of exports2.74.25.15.65.27.17.7
Exchange rate
Official exchange rate (kip per U.S. dollar; end-of-period)8,0197,9828,0308,0968,119
Real effective exchange rate (2005=100)135.0136.3144.9153.5166.6
Nominal GDP
In billions of kip64,72775,25184,57295,406102,543112,188122,518
In millions of U.S. dollars8,0629,40010,78811,85112,56113,72214,831
Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Public finances are on a fiscal year (October to September) while other data are on a calendar year.

Includes off-budget investment expenditures.

Net lending/borrowing excluding mining revenue.

Includes Bank of Lao P.D.R. lending to state-owned enterprises and subnational levels of government.

Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Public finances are on a fiscal year (October to September) while other data are on a calendar year.

Includes off-budget investment expenditures.

Net lending/borrowing excluding mining revenue.

Includes Bank of Lao P.D.R. lending to state-owned enterprises and subnational levels of government.

Table 2.Lao P.D.R.: Balance of Payments, 2014–21
20142015201620172018201920202021
Projections
(In millions of U.S. dollars; unless otherwise indicated)
Current account−2,450−2,116−2,351−2,813−3,181−3,516−3,638−3,302
Merchandise trade balance−3,330−3,146−2,880−3,584−3,969−4,374−4,452−4,212
Exports, f.o.b.4,6874,3874,8045,1245,5965,8426,1076,705
Mining and hydropower1,8461,8272,3952,3742,1722,4212,7642,304
Other exports2,8412,5602,4092,7503,4253,4213,3434,401
Imports, c.i.f.8,0177,5337,6848,7089,56510,21510,55810,917
Mining and hydropower2,9512,6922,4492,1941,7971,6281,266776
Mining projects4634354363742372191340
Hydropower projects2,4882,2572,0131,8201,5601,4091,133776
Petroleum imports720376323402451501556606
Other imports4,3464,4654,9136,1127,3178,0868,7359,535
Services (net)386469543608614763812871
Of which: Tourism6216847388038109621,0111,072
Income (net)−283−245−512−448−470−582−685−681
Interest payments−256−182−392−434−438−458−530−452
Of which: Public−180−117−159−185−211−234−253−268
Mining and hydropower−58−53−215−232−209−200−180−161
Mining projects000811000
Hydropower projects−59−52−216−240−221−200−180−161
Dividends and profit repatriation−301−309−383−296−321−440−497−530
Of which: Mining and hydropower−241−247−318−243−241−296−419−447
Of which: Mining projects−171−158−107−96−83−69−550
Hydropower projects−71−89−211−147−158−227−364−447
Other274245262282289316342300
Transfers (net)778807499612644676687720
Private176185194204214225236248
Official602622304408430451451472
Capital and financial account2,6092,2902,8422,9243,2183,6283,2263,153
Public sector7381,318840842802746720688
Disbursements8631,4751,0931,1341,1451,0881,0621,030
Amortization−125−157−252−292−342−342−342−342
Banking sector (net)−18789890561500499600750
Private sector1,8901831,1121,5221,9162,3831,9071,714
Foreign direct investment (net) 1/2,5272,0952,3122,5722,5162,3831,9071,714
Of which: Mining and hydropower projects2,2671,8501,5371,9621,7581,5831,061820
Of which: Mining projects10−5−15−20−8−400
Hydropower projects2,2581,8551,5521,9821,7661,5881,061820
Other private flows 3/−637−1,912−1,200−1,050−600000
Overall balance15917449111137112−411−149
Core Balance (CA+FDI+ODA)5111,227729174−213−787−1,431−1,340
Financing−159−174−491−111−37−112411149
Central bank net foreign assets−159−174−491−111−37−112411149
Assets (increase -)−154−171−490−110−36−111412150
Liabilities (reduction -)−5−3−1−1−1−1−1−1
Memorandum items:
Current account balance (in percent of GDP)−20.7−16.8−17.1−19.0−19.7−19.9−18.9−15.7
Excluding official transfers−25.7−21.8−19.4−21.7−22.4−22.5−21.2−17.9
Resource current account balance (in percent of GDP) 2/−11.9−9.3−4.3−2.0−0.51.74.74.4
Nonresource current account balance (in percent of GDP)−8.8−7.6−12.9−17.0−19.3−21.6−23.5−20.1
Imports excluding hydropower and mining related9.0−4.48.124.419.310.58.29.1
Gold production (000s oz.)1692222442051201201200
Gold price (U.S. dollar per oz.)1,2661,1601,2761,3431,3731,3871,3961,418
Copper production (000s ton)1561661611378777670
Copper price (U.S. dollar per ton)6,8635,5104,8164,9604,9855,0115,0405,065
FDI (in percent of GDP)21.316.716.817.315.613.59.98.2
Gross official reserves8169871,4761,5871,6221,7331,3211,170
In months of prospective imports of goods and nonfactor services1.21.51.91.91.81.91.41.1
(Excluding imports associated with large resource projects)1.92.12.52.32.12.11.51.2
Nominal GDP at market prices11,85112,56113,72214,83116,13517,64319,28021,027
Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Includes repayment of private debt. FDI in the balance of payments includes both equity and debt, whereas only the non-debt portion is included in the debt sustainability analysis.

Pertains to large mining and hydropower (resource) projects.

Includes errors and omissions.

Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Includes repayment of private debt. FDI in the balance of payments includes both equity and debt, whereas only the non-debt portion is included in the debt sustainability analysis.

Pertains to large mining and hydropower (resource) projects.

Includes errors and omissions.

Table 3.Lao P.D.R.: General Government Operations, 2013/14–2021
Calander year
2013/142014/152015/1620172018201920202021
Est.Proj.Proj.Proj.Proj.Proj.
(In percent of FY GDP, unless otherwise indicated)
Revenue and Grants23.224.018.519.419.719.920.120.2
Of which: Resource revenue 1/3.02.22.12.11.91.81.91.8
Nonrenewable resources2.01.30.90.80.60.50.40.2
Renewable resources1.00.91.21.31.21.31.51.6
Non-resource revenue15.016.814.114.515.215.515.816.1
Taxes15.715.714.314.314.815.015.415.5
Of which: Resource revenue 1/2.41.71.71.61.41.41.41.2
Nonrenewable resources1.81.20.90.80.60.50.40.2
Renewable resources0.60.50.80.80.80.91.01.0
Nonresource revenue13.214.012.512.713.413.714.014.3
Income and profit taxes3.13.22.92.62.62.62.72.8
Income taxes1.11.11.01.01.01.11.21.2
Profit taxes2.02.11.91.61.61.51.51.6
Of which: Mining0.60.60.40.40.30.30.20.1
Of which: Nonmining1.41.51.51.21.31.31.31.5
VAT4.24.43.83.94.04.24.34.3
Excise duties3.63.33.03.33.63.73.63.7
Import duties1.61.31.51.51.61.71.71.8
Royalties1.50.91.21.21.11.11.11.0
Mining1.20.60.50.40.30.20.20.1
Hydropower0.30.40.70.80.80.90.90.9
Other taxes1.72.41.81.81.81.82.02.0
Other revenues2.33.31.92.32.32.32.42.4
Of which: Dividends0.80.90.90.90.80.70.80.9
Of which: Resource revenue 1/0.60.50.40.50.50.40.50.6
Nonrenewable resources0.20.10.00.00.00.00.00.0
Renewable resources0.40.40.40.50.40.40.50.6
Non-resource revenue1.72.81.61.81.81.91.91.7
Grants 3/5.35.02.32.82.72.62.32.3
Expenditure27.826.724.424.624.925.025.125.2
Expense15.215.716.415.916.216.216.116.2
Compensation of employees9.28.78.68.28.28.28.28.2
Transfers2.62.53.02.72.82.92.92.9
Interest payments0.91.11.31.61.71.81.81.8
Of which: External0.20.91.11.11.21.21.21.2
Other recurrent (including arrears)2.53.33.53.43.43.43.33.3
Net acquisition of nonfinancial assets 3/12.611.08.08.78.78.88.99.0
Externally financed7.07.65.05.55.45.35.15.0
Net lending/borrowing−4.5−2.7−5.9−5.2−5.2−5.1−5.0−5.0
Net acquisition of financial assets−0.6−1.60.00.00.00.00.00.0
Domestic−0.6−1.60.00.00.00.00.00.0
Foreign0.00.00.00.00.00.00.00.0
Net incurrence of liabilities5.95.05.95.25.25.15.05.0
Domestic5.10.93.24.14.34.34.54.6
Foreign0.84.12.71.10.90.80.50.4
Discrepancy0.70.70.00.00.00.00.00.0
Net lending including discrepancy−5.2−3.4
Nonmining balance 2/−6.5−4.0−6.8−6.1−5.8−5.6−5.4−5.2
Operating balance8.08.32.13.53.53.73.93.9
Domestic financing4.42.53.24.24.44.44.64.7
Mining revenue2.01.30.90.80.60.50.40.2
Hydropower revenue1.00.91.21.31.21.31.51.6
Nonresource revenue15.016.814.114.515.215.515.816.1
GDP (fiscal year)92,697100,759109,777119,935131,294144,549159,533175,952
GDP (calander year)102,543112,188122,518134,219147,992163,380180,143
Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Resource revenue comprises royalties, taxes, and dividends from the mining and hydropower sectors.

Net lending/borrowing minus mining revenues.

Data was revised to bring on budget grant-financed capital expenditure.

Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Resource revenue comprises royalties, taxes, and dividends from the mining and hydropower sectors.

Net lending/borrowing minus mining revenues.

Data was revised to bring on budget grant-financed capital expenditure.

Table 4.Lao P.D.R.: Monetary Survey, 2013–16
20132014201520162016
Q1Q2Proj.
(In billions of kip, unless otherwise indicated)
Bank of Lao P.D.R. (BoL)
Net foreign assets4,6735,9987,4448,6516,1839,301
In millions of U.S. dollars5837419151,0687651,148
Net domestic assets10,54513,82813,68612,50213,49613,891
Government (net)4321574192−471−500
Claims1,1191,1191,1171,1171,1171,117
Deposits−687−962−1,113−925−1,589−1,600
State-owned enterprises5,6426,5916,4756,3936,3846,384
Banks4,2234,4895,2665,2545,7296,056
BoL securities−1,949−1,260−2,066−2,868−2,860−2,950
Other items (net)2,1973,8504,0063,5314,7144,900
Reserve money15,21719,82621,13121,15319,67823,191
Currency in circulation7,9068,3618,2908,4328,1659,780
Bank Reserves7,31111,46512,84012,72110,29113,411
Of which: Foreign currency3,0904,8455,4265,3764,3225,667
Monetary survey
Net foreign assets2,2511,803−2,029−4,925−8,523−9,235
In millions of U.S. dollars281223−249−608−1,055−1,140
Of which: Commercial banks−302−519−1,165−1,675−1,820−2,288
Net domestic assets40,15850,51962,02864,53469,72677,029
Government (net)1,8723,6544,7945,0555,4156,254
Budget1,2853,0674,2074,4674,8285,667
Claims2,8935,9887,0677,4207,9059,067
Deposits−1,609−2,922−2,860−2,953−3,077−3,400
Other588588588588588588
Credit to the economy41,06646,88254,76656,01359,53264,186
In kip21,09823,81327,25027,16928,09732,603
In foreign currencies19,96823,06827,51628,84431,43531,583
Of which: Private credit32,63136,44543,47643,95647,35251,110
In kip17,75920,42723,93123,79324,720
In foreign currencies14,87216,01819,54520,16322,632
Other items (net)−2,781−172,4673,4674,7796,589
Broad money41,78452,32259,99959,61061,20367,794
Currency in circulation6,4906,3165,8805,8865,5956,644
Kip deposits17,58023,05027,48627,85028,25431,057
Foreign currency deposits (FCDs)17,71422,95626,63325,87327,35430,094
(Annual percent change, unless otherwise indicated)
Reserve money7.730.36.63.8−7.99.8
Broad money17.025.214.712.411.213.0
Credit to the economy34.514.216.816.722.517.2
Credit to the private sector36.311.719.318.125.717.6
In kip39.115.017.217.419.0
In foreign currencies33.27.722.019.033.8
Deposit growth18.930.317.614.612.413.0
Memorandum items:
Velocity2.01.81.71.91.81.7
Money multiplier2.72.62.82.83.12.9
Loan/deposit (percent)92.579.280.392.495.694.5
In kip (percent)101.088.787.185.487.5
In foreign currency (percent)84.069.873.477.982.7
Gross official reserves (in millions of U.S. dollars) 1/6628169879958371,075
Exchange rate, end-of-period (kip per U.S. dollar)8,0208,0908,1328,1038,079
Nominal GDP (in billions of kip)84,57295,406102,543112,748112,748112,748
Dollarization rate (FCDs/broad money; in percent)42.443.944.443.444.744.4
Gross reserve/Reserve Money353338383438
Required reserves2,1212,7583,2263,1743,3143,645
Excess reserves (percent of GDP)5.07.88.28.57.37.6
Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates.

Defined as foreign assets of the Bank of the Lao P.D.R.

Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates.

Defined as foreign assets of the Bank of the Lao P.D.R.

Table 5.Lao P.D.R.: Medium-Term Macroeconomic Framework, 2013–21
201320142015201620172018201920202021
Projections
Output and prices(Percent change, unless otherwise indicated)
Real GDP8.08.07.56.96.86.77.06.97.0
Consumer prices (annual average)6.44.11.32.22.32.73.13.33.1
Consumer prices (end-period)6.62.40.92.12.32.62.93.13.1
GDP per capita (in U.S. dollars)1,5941,7181,7871,9112,0082,1122,2292,3452,464
Public finances (in percent of GDP)1/
Revenue23.923.224.018.519.419.719.920.120.2
Tax and nontax revenue18.318.019.016.216.617.017.317.717.9
Mining2.22.01.30.90.80.60.50.40.2
Hydro power0.91.00.91.21.31.21.31.51.6
Others15.115.016.814.114.515.215.515.816.1
Grant5.75.35.02.32.82.72.62.32.3
Tax revenue15.815.715.714.314.314.815.015.415.5
Expenditure29.628.826.724.424.624.925.025.125.2
Expense17.315.215.716.415.916.216.216.116.2
Net acquisition of nonfinancial assets 2/12.312.611.08.08.78.78.88.99.0
Overall balance−5.6−4.5−2.7−5.9−5.2−5.2−5.1−5.0−5.0
Nonmining balance 3/−7.8−6.5−4.0−6.8−6.1−5.8−5.6−5.4−5.3
Balance of payments
Current account balance−3,195−2,450−2,116−2,351−2,813−3,180−3,515−3,637−3,301
In percent of GDP−29.6−20.7−16.8−17.1−19.0−19.7−19.9−18.9−15.7
Trade balance−3,469−3,330−3,146−2,880−3,584−3,969−4,314−4,452−4,212
Exports3,8834,6874,3874,8045,1245,5965,8426,1076,705
In percent change16.920.7−6.49.56.79.24.44.59.8
Of which: Resources2,0341,8461,8272,3952,3742,1722,4212,7642,304
In percent change0.6−9.2−1.031.1−0.9−8.511.514.2−16.6
Other1,849.42,841.42,560.22,409.22,749.83,424.53,420.73,342.64,401.0
Imports7,3528,0177,5337,6848,7089,56510,21510,55810,917
In percent change15.29.1−6.02.013.39.86.83.43.4
Of which: Resources2,7052,9512,6922,4492,1941,7971,6281,266776
In percent change33.69.1−8.8−9.0−10.4−18.1−9.4−22.2−38.7
Services and income (net)3610322430159144181127190
Income (net)−211−283−245−512−448−470−582−685−681
Services (net)246386469543608614763812871
Transfers238778807499612644676687720
Capital account balance3,1182,6092,2902,8422,9243,2183,6283,2263,153
Of which: FDI2,2862,5272,0952,3122,5722,5162,3831,9071,714
Overall balance−7715917449111137112−411−149
Debt and debt service (excluding unidentified arrears)
Public and public guaranteed debt (in percent of GDP)62.564.965.867.869.070.370.069.167.8
Public Domestic debt (in percent of GDP)11.613.714.113.813.514.615.516.417.5
External debt (in percent of GDP)86.992.795.598.1100.2100.499.597.494.4
External public and public guaranteed debt (in percent of GDP)50.951.151.754.155.655.754.552.750.3
External public debt service (in percent of exports)5.15.65.27.17.79.19.810.511.0
Gross official reserves
In millions of U.S. dollars6628169871,4761,5871,6221,7331,3211,170
In months of imports0.91.21.51.91.91.81.91.41.1
In months of imports (excluding resource projects)1.41.92.12.52.32.12.11.51.2
Memorandum items:
Nominal GDP (in billions of kip)84,57295,406102,543112,188122,518134,219147,992163,380180,143
Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Fiscal year basis (October to September) from 2013 to 2016 and calander year basis from 2017 to 2021.

Includes off-budget investment expenditures.

Net lending/borrowing minus mining revenue.

Sources: Data provided by the Lao P.D.R. authorities; and IMF staff estimates and projections.

Fiscal year basis (October to September) from 2013 to 2016 and calander year basis from 2017 to 2021.

Includes off-budget investment expenditures.

Net lending/borrowing minus mining revenue.

Table 6.Lao P.D.R.: Financial Soundness Indicators, 2009–15
2009201020112012201320142015 2/
Capital adequacy ration (Basel I)20.121.625.920.920.8
State-owned commercial banks (SOCBs)3.84.86.06.7
Joint-venture banks9.09.930.3
Foreign bank branches34.037.712.1
Private banks33.534.154.3
NPL ratio3.83.82.21.82.14.23.2
State-owned commercial banks1.31.51.92.78.2
Joint-venture banks1.31.61.31.94
Foreign bank branches10.510.83.93.84.2
Private banks1.91.20.10.10.2
Return on assets (select SOCBs only) 1/
Banque pour le Commerce Exterieur Lao3.13.2
Lao Development Bank
Agricultural Promotion Bank
Number of banks23252531323740
State-owned commercial banks4444444
Joint-venture banks2222233
Foregin bank branches10111119192326
Private banks7886777
Sectoral allocation of bank credit (in percent of total)
Industry and handicraft19192016182124
Construction4121318212017
Materials and technical supplies8544533
Agriculture131613810109
Commerce23232124212018
Transportation3444432
Services8131716121110
Other229810101217
Source: Bank of Lao P.D.R., External Audit Reports.

Profit before tax divided by total balance sheet assets.

Data as of Q2 2015

Source: Bank of Lao P.D.R., External Audit Reports.

Profit before tax divided by total balance sheet assets.

Data as of Q2 2015

Table 7.Lao P.D.R.: Millennium Development Goals Indicators
Millennium Development GoalsIndicatorBaselineCurrent Status2015 Target
1. Eradicate extreme poverty and hungerProportion of population below the national poverty line4623.224
Employment-to-population ratio84.977.7no target
Prevalence of underweight children under five years of age442722
Prevalence of stunting in children under five years of age484434
2. Achieve universal primary EducationProportion of pupils starting grade 1 who reach grade 5487095
Literacy rate in the age group of 15–24 years7173.199
3. Promote gender equality and empower WomenNumber of girls per 100 boys enrolled in:
Primary7991100
Lower secondary7089100
Upper secondary6783100
Tertiary4277100
Share of women in wage employment3834no target
4. Reduce child mortalityUnder–five mortality rate1707970
Proportion of one-year-old children immunized against measles335590
5. Improve maternal HealthProportion of births attended by skilled birth personnel144250
Maternity mortality rate (per 100,000 live births)796357260
6. Combat HIV/AIDS, malaria and other diseasesHIV prevalence among general pop. (percentage)0.10.28less than 1
7. Ensure Environmental SustainabilityProportion of land areas covered by forests (percentage)49.140.365
Consumption of ozone-depleting substances (mt)43.32.50
Sources: United Nations and Government of Lao P.D.R.(http://www.la.one.un.org/images/publications/MDGs_Factsheet).
Sources: United Nations and Government of Lao P.D.R.(http://www.la.one.un.org/images/publications/MDGs_Factsheet).

The fiscal year in Laos runs from October 1 to September 30. Starting in 2017, the fiscal year will coincide with the calendar year.

The coincident indicator is constructed using a state-space model and Kalman filter estimation (see Rafiq, S. 2016, IMF Working Paper No. 16/214), using three high frequency indicators of economic activity: real exports (to proxy for industrial production); real imports (to proxy for domestic private consumption); and tourism growth (to proxy for service sector activity). A value greater than zero indicates above trend growth; a value below zero indicates slowing economic activity.

While the de jure arrangement is a managed float, since January 2015 the kip has been maintained within a 2 percent band against the U.S. dollar, and the de facto classification is a stabilized arrangement.

There has also been a sharp rise in claims by BIS reporting institutions on banks in Laos. As of the third quarter of 2015, BIS exposure was approximately 10 percent of GDP, compared to 1 percent of GDP in 2012.

The cost of recapitalizing public banks is estimated at about 1.8 percent of GDP.

The process of off budget public investment spending at the state and local level was ended in 2014, and a committee has been established to resolve arrears.

The authorities’ estimate of trade flows is lower than the duly adjusted partner country data. Discrepancies are concentrated in trade with major partners and can be explained by differences in valuation, under-recording due to exemptions, informal border trade, and contraband. For a systematic study of the discrepancies, see Hamanaka, S. (2011), “Quality of the Trade Statistics of the Lao P.D.R.,” South East Asia Research, 19, 3, pp 595–633. Staff have updated this study to 2014/15 with similar results.

Detailed recommendations have been made in this area by the IMF Technical Assistance mission on Interbank Market Development in July 2015, and include as a first step the development of the Bank of Lao’s liquidity management framework.

These elements are described in detail in the IMF paper: “Evolving Monetary Policy Frameworks in Low-Income and Other Developing Countries” (IMF, 2015).

For a description of these trade opportunities for Laos, see IMF, Asia and Pacific Department (2016), “China’s Changing Trade and the Implications for the CLMV Economies.”

Lao P.D.R. has a micro finance sector which serves mainly agricultural clients and is supervised by the Bank of Lao, but it makes up less than 1 percent of assets in the overall financial system.

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