Lao People's Democratic Republic
Recent Economic Developments

This paper reviews economic developments in Lao People’s Democratic Republic (PDR) during 1992–95. To highlight in more detail the factors that contributed to Lao PDRs macroeconomic performance during 1992–95, the paper analyzes the developments in macroeconomic variables and policy actions. It also notes that real GDP growth, averaging about 7 percent during 1992–95, was attributable to a rapid expansion of manufacturing, construction, and tourism, as well as strong growth in agriculture in 1992 and 1994.


This paper reviews economic developments in Lao People’s Democratic Republic (PDR) during 1992–95. To highlight in more detail the factors that contributed to Lao PDRs macroeconomic performance during 1992–95, the paper analyzes the developments in macroeconomic variables and policy actions. It also notes that real GDP growth, averaging about 7 percent during 1992–95, was attributable to a rapid expansion of manufacturing, construction, and tourism, as well as strong growth in agriculture in 1992 and 1994.

Lao P.D.R.: Basic Data, 1991–95

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Sources: Data provided by the Lao authorities; and staff estimates and projections.

Up to 1992, the fiscal year coincided with the calendar year. Beginning in 1992, the fiscal data are on a fiscal year basis (October–September).

Data shown refer to maximum rates offered by banks.

Excludes debt to nonconvertible area of Rub 796 million at end-1993; includes debt to the Fund (SAF and ESAF).

As a ratio of exports of goods and nonfactor services.

Average of buying and selling rates. From September 1995, the official rate shown is the average commercial bank rate.

I. Introduction

The Lao People's Democratic Republic is in the process of large-scale systemic reforms as part of a medium-term adjustment program, supported by Fund arrangements since 1989. These reform efforts yielded considerable progress in both structural transformation and macroeconomic management. The basic elements of a market-oriented economic system now in place include: a market-based price system; a growing private sector; a two-tier banking system; and a broadly open foreign trade regime. The Government was able to establish financial stability, based on buoyant output growth, and a strengthening of the external position in recent years. These trends continued in 1995 though the country suffered from a period of price and exchange rate pressures that required strong corrective action.

In order to highlight in more detail the factors that contributed to the Lao P.D.R.'s macroeconomic performance since 1992, the rest of this document analyzes the recent developments in macroeconomic variables and policy actions. Chapter II, “Income and Production,” notes that real GDP growth, averaging about 7 percent during 1992-95, was attributable to a rapid expansion of manufactur ing, construction, and tourism, as well as strong growth in agriculture in 1992 and 1994. The former was fostered by domestic and foreign investors responding to the new opportunities opened up by the reforms.

Chapter III, “Prices, Employment, Wages, and Income Distribution” discusses the sharp acceleration in the inflation rate—from about 6½ per cent (period average) in 1994 to 19½ percent in 1995. The major reasons for this acceleration are identified as the loosening of monetary policy in late 1994, compounded by depreciations of the currency. In the second half of 1995, food prices were affected by adverse supply conditions associated with the extensive flooding. The chapter also reviews the main features of the labor market and income distribution.

The maintenance of macroeconomic stability in the early 1990s is attributable largely to the tightening of financial policies during this period. The structure of the government, its tax and expenditure arrangements, and fiscal performance in this context are analyzed in Chapter IV, “Public Finance.” During 1992-95, the overall deficit (with grants) was lowered to about 4 percent of GDP, while it was possible to achieve a surplus on current operations (excluding grants) of over 1 ½ percent of GDP in 1994/95. 1/ These improvements were achieved through a series of tax reforms that augmented the revenue base and through restraint on less productive current and capital expenditure. Important steps were also taken to improve fiscal management, including actions to accelerate the centralization of tax collection and expenditure systems.

Rationalization of the public enterprise sector has been very extensive in the Lao P.D.R. Starting in 1989, over 90 percent of the state-owned enterprises have been privatized and, as described in Chapter V, “Privatization,” by the end of 1997 only a core of strategic enterprises will be left in state hands. Those enterprises will be placed onto a fully commercial basis, through restructuring of both nonfinancial enterprises and the state-owned banking sector.

Monetary and credit policy, together with financial sector reform, also played a major role in improving macroeconomic performance. Chapter VI, “Money and Banking,” discusses the Government's actions since 1992 to achieve its inflation targets through restraining monetary growth and limiting excessive credit growth to public enterprises. Also discussed are the measures taken in 1995 to re-establish financial control in the wake of sharp credit expansion in late 1994. The chapter discusses the Government's more recent efforts to make the financial sector more market-oriented through a greater reliance on indirect tools of monetary management, a phased liberalization of interest rates, and increased competition in the banking system.

Chapter VII, “External Sector,” reviews the progressive liberalization of external trade in recent years and the move to full integration into the world economy—total merchandise exports and imports were the equivalent of 53 percent of GDP. Nevertheless, trade remains concentrated with Thailand, and other countries in the region. There was a marked improvement in the current account deficit (excluding official transfers) from 15 percent of GDP in 1992 to an average of 12 percent of GDP during 1994-95. At the same time, aid flows continue to be maintained, while private capital inflows associated with hydropower projects increased sharply. Gross foreign reserves of the banking system more than doubled from their end-1992 level to $191 million at end-1995, equivalent to five months of total imports. Official reserves amounted to $92 ½ million, equivalent to nearly two months of imports.

Annex I analyses the foreign exchange developments of 1995 in terms of the institutional structure, the pressures that triggered the depreciation, and the policy response. In particular, it highlights the role of the parallel market and the impact of monetary expansion in late 1994 and early 1995 and the difficulties of formulating financial policies under conditions of significant and changing levels of currency substitution and dollarization. Discussion of the policy response explores the reestablishment of financial stability through direct and indirect monetary measures combined with fiscal restraint. The corrective measures culminated in the introduction of a managed floating exchange rate system, under which the exchange rate has stabilized since mid-September 1995.

Annex II summarizes the main features of the current tax system, following the recent changes introduced in 1996 as part of the new tax law.

II. Income and Production

The database on income and production remains weak. No information is available on the expenditure breakdown of GDP, and the production estimates, especially in the services category, are based on outdated weighting schemes. Therefore, the National Statistics Center (NSC) is receiving technical assistance from Statistics Sweden to improve real sector statistics under a program that will continue until 1997.

1. Overall developments

Production in the Lao economy continues to be dominated by the agricultural sector, even though its importance has declined in recent years. The sector's contribution to real GDP dropped from 58 percent of real GDP in 1991 to about 56 percent in 1995, while the industrial sector increased its share in real GDP from 17 percent to about 19 percent during the same period, with manufacturing being the main contributor. The services sector's share of real GDP was almost constant at 25 percent as the surge in tourism-related activities was compensated by a retrenchment in the public services.

The economy remains vulnerable to fluctuations in weather conditions because agriculture, in particular paddy production, is heavily dependent on rainfall. To compensate for this vulnerability, the Government has been promoting the industrial and services sectors, especially electricity, tourism, transportation, and trade. In this context, the strategy has aimed at improving the country's infrastructure (roads, bridges, airports, and telecommunications) while strongly pushing for the development of hydro-power for exports; to this end, foreign assistance and investment are being channeled into these areas. Potential exists for gold and oil, but these projects are still in the exploration stage.

2. Developments by main economic sectors

There has been buoyant growth in real GDP, averaging 7 percent during 1992-95 (Table 1). This buoyant activity was supported by a rapid expansion of manufacturing, construction, and tourism as well as strong agricultural growth in 1992 and 1994. The main sub-sectors contributing to output growth are crops (30 percent), livestock and fishery (23 percent), and manufacturing (13 percent) (Chart 1 and Table 9).

Table 1.

Lao P.D.R.: Real GDP Growth, 1991–95

In percent

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Source: Data provided by the Lao authorities.


Citation: IMF Staff Country Reports 1996, 054; 10.5089/9781451822397.002.A001

a. Agriculture

The agricultural sector includes crops, livestock and fishery, and forestry products. Subsistence agriculture and small-scale animal husbandry dominate agricultural activity and most of the production is undertaken by private farmers. The Government's objectives are to eliminate slash-and-burn practice, promote cultivation for commercial purposes, and secure food self-sufficiency.

Crops: Paddy remains the most important crop although its share of value added of total crops has declined from 68 percent in 1991 to 61 percent in 1995. Rice production has followed a distinct pattern of alternating good and bad years in the last 20 years. For example, paddy production levels in 1991, 1993, 1995 were lower than those in 1990, 1992, and 1994, respectively (Table 10). During the bad years, especially in 1991 and 1993, there have been irregular rainfalls, with flood devastating production in southern provinces compounded by simultaneous drought affecting northern provinces. In 1995, there was a severe flood (not accompanied by a major drought) which accounted for a loss of about 14 percent of paddy output. These severe climatic conditions in the Lao P.D.R. have hampered a steady growth in agricultural production, discouraging farmers cultivating for commercial purposes.

Production of other crops, including corn, sweet potato, cassava, coffee, and tobacco, has also seen ups and downs in the past, but has steadily increased in the last three years because of higher demand for both exports and domestic consumption. Farmers have gradually shifted from paddy cultivation to these more profitable crops. The contribution of such crops to agricultural production, however, remains marginal, totalling only 15 percent of total crop value added. Following 1993, a year of low production for all crops, the output of corn rebounded in the next two years with an average annual increase of 33 percent to reach 80,000 tons in 1995, partly in response to higher demand for animal feed. Sweet potato and cassava's production increased on average by about 23 percent annually to reach 164,000 tons in 1995. Production of coffee increased on average by 16 percent each year to reach 10,000 tons in 1995, partly as a result of the Government's policy to promote coffee exports. Producers can export crops free of duty and farm equipment imports are duty-exempt. The production of tobacco, grown primarily for domestic cigarette production, has shown an average annual increase of 55 percent in the last two years.

Livestock and fishery: Husbandry techniques, such as regular vaccination and proper livestock feed, are only applied in major urban areas, i.e., Vientiane Municipality, Savannakhet, and Champassak. Production of buffalo and pigs has increased, on average, by about 3 percent per year, and production of cattle and poultry has increased by about 6 percent per year (Table 10). Local authorities have recently encouraged the construction of fishery ponds to supply fish to urban areas. However, catches from the Mekong River and these ponds have remained insufficient for domestic consumption.

b. Forestry

In the past, illicit logging and slash-and-burn agricultural practices have led to rapid depletion of the forest: only about 40 percent of the total land area is covered by forest in the 1990s as compared with 70 percent in the 1950s. The Government's objective is to push strongly for reforestation, giving incentives (e.g., land tax waivers) to farmers for tree planting.

Most of the forest resources are exploited for exports in the form of logs, timber, and other processed wood. While the authorities have insisted that illegal logging has been reduced in recent years, there are indications that tree cutting still exceeds government quotas. Furthermore, discrepancies between the data on log production provided by the Agriculture and Forestry Ministry and those provided by the NSC complicate the interpretation of the production and export figures. According to the NSC data, production was about 200,000 cubic meters in 1991-92 reflecting the Government's ban on logging, rising to about 500,000 cubic meters, on average, in 1993-95, with the granting of licenses to clear trees as part of the hydropower project construction. In value-added terms, forestry products only account for 6 percent of GDP.

c. Industry

The industrial sector comprises mining, manufacturing, construction, and electricity, with manufacturing contributing over 70 percent of the total. Electricity production, although relatively unimportant at present, will likely become a main contributor to GDP in a few years, as the export-oriented hydropower projects are completed.

Mining and quarrying: Mining and quarrying consist mainly of the extraction of tin, gypsum, barite, and coal. Whereas most of the production of barite and coal is used domestically, most of the production of tin and gypsum is exported. Growth in real value added in these sectors exhibited large swings in 1991-95. The sector's share in total industry in real terms amounts to only 1 percent and the mining potential in the Lao P.D.R. remains largely untapped. Based on geological surveys carried out by foreign consulting firms, there are indications of possible deposits of gold and oil; drilling started in 1995.

Manufacturing: Manufactured commodities in descending order of share in manufacturing are as follows: beer (26 percent), as Lao Beer has continued to promote exports; wood products, such as logs, plywood, parquet (11 percent), which are mostly exported; and soft drinks (7 percent). Other products which have exhibited important increases in production in recent years include: garments. as the number of garment factories, operating mostly as joint ventures with foreign companies, has grown from 29 in 1992 to 55 in 1995, employing a sizeable portion of the economically active population in urban areas; cigarettes and medicines (including vaccines). Since 1994, new factories have been established, producing such products as shoes, paint, fertilizer, plastic, and cement.

Construction: The value added of construction as percentage of total industry has increased from 17 percent in 1992 to 20 percent in 1995, reflecting the growth of public and private investment in roads, residential houses, government offices, hotels, banks, and shopping centers.

Electricity: The production of electricity decreased in 1995 because of low rainfall early in the year. Despite the floods later on, the overall water flow during 1995 was less than in 1994. Electricity production currently contributes a relatively small share (1.4 percent) to GDP. However, the country's hydropower resources are being developed, principally for export. The country has an estimated hydroelectric potential of some 18,000 MW (generated from over 60 possible project sites on the Mekong tributaries in the Lao P.D.R.), of which less than 2 percent has been developed. At present, the largest hydropower plant is Nam Ngum 1 with an installed capacity of 150 MW and an average annual energy generation of 860 GWH; the second largest plant is Xeset with an installed capacity of 45 MW and an average annual generation of 180 GWH. With completion of the Nam Song Diversion project, scheduled for early 1996, the average annual output will increase to about 1,200 GWH.

Domestic demand for electricity is now concentrated in urban areas, with the greatest consumption in Vientiane where 70 percent of households are connected. Outside Vientiane province, electricity consumption is negligible. Nationally, only 16 percent of households are electrified. One of the Government's objectives is to extend rural electrification to promote better socio-economic conditions in rural communities. At present about 70 percent of the total output of the Nam Ngum 1 and Xeset power plants is exported, generating about 25 percent of the country's total export earnings.

The existing installed capacity is ample to satisfy domestic demand which experiences a peak of about 80 MW and an annual consumption of about 300 GWH. Demand from neighboring countries for electrical power has been secured with a Memorandum of Understanding (MOU) signed with the Thai Government to supply 1,500 MW to Thailand by the year 2000, and more recently, a MOU with the Vietnamese Government for the sale of electricity to Vietnam amounting to 1,500-2,000 MW before the year 2010. A second MOU with Thailand is under negotiation to sell an additional 2000 MW after year 2000. Although the export unit price is negotiated with foreign parties, electricity prices for domestic consumption continue to be controlled by the Government (see below).

To guarantee that domestic demand—which is estimated to grow at about 8 percent per annum (taking into account rural electrification)—will continue to be satisfied and to create a permanent source of foreign exchange (by exporting over 90 percent of electricity produced), concession agreements for the development of some 23 power projects have been signed between the Government and international developers that would increase the installed capacity by an additional 6,800 MW (and carry a total estimated construction cost of $9.5 billion). Projects with scheduled completion dates include the Theun Hinboun (by 1998), Hoa Ho (by 1999), Nam Leuk (by 1999), Nam Theun 2 (by 2000), and Nam Ngum 3 (by 2000), which in total would increase the installed capacity by 1480 MW (and carry a total estimated construction cost of $2.2 billion).

For small projects, the Government will endeavor to obtain official financing. However, development of large projects will be undertaken by private sector initiative under a joint-venture with the Government, or as a Build-Own-Transfer (BOT) or Build-Own-Operate-Transfer (BOOT) scheme with equity participation by the Government. In addition, the Lao P.D.R. has received substantial multilateral (AsDB, UNDP, and World Bank) and bilateral assistance in the development of hydropower resources.

d. Services

Throughout 1992-95, the services sector accounted for about one fourth of GDP. The most important components of this sector are “wholesale and retail trade”, and “transportation, storage, and communications”, which together contributed more than 50 percent of the service sector. “Public services” have gradually declined in importance in the 1990s owing to the implementation of the civil service retrenchment program. In contrast, the value added of the hotels and restaurants sub-sector has experienced a rapid growth (by seven times during 1992-95) with the construction of many private hotels in Vientiane. “Ownership of dwellings” and “banking, insurance, and real estate” sub-sectors have also exhibited a strong growth in the last three years as a result of a rapid increase in private housing (including for rental to foreigners) and the establishment of new joint-venture and foreign banks.

III. Prices. Employment. Wages and Income Distribution

1. Prices developments

The rate of inflation is measured in terms of the consumer price index (CPI) compiled by the Bank of the Lao P.D.R. (BOL) based on price quotations collected in the Vientiane markets for a basket of 70 goods. 1/ According to this index, the average annual inflation rate dropped steadily from 60 percent in 1989 to its lowest level of 6.3 percent in 1993; then following a slight increase in 1994, it rebounded to 19.4 percent in 1995 (Table 2). After the authorities were able to sustain a tightening of monetary policy up to 1993 that resulted in a dampening of inflation, lax credit policy starting in 1994 in the midst of buoyant economic activity in the private sector allowed a reversal in the path of inflation. Month-to-month inflation, that fell from an average level exceeding 5 percent in 1989 to less than one percent in 1992-94, accelerated in the beginning of 1995 to a level exceeding 5 percent in March-May and only declined in October-December. 1/ In the first three months of 1996, food prices have remained high because of continued shortages arising from the floods in 1995. As a result, though month-to-month inflation has declined, the overall CPI in March remains 25 percent higher than 12 months earlier.

Table 2.

Lao P.D.R.: Consumer Price Index, 1991–96

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Source: Data provided by the Lao authorities.

Following the price reform initiated in mid-1987, most prices are determined by market forces. However, the Government still sets the prices of public utilities (electricity, water, postal services, telephone), transportation (bus and air fares), petrol (diesel, regular, super), and rents of housing for foreigners. 2/ In addition, for a few services, e.g., water, electricity, and air tickets, foreigners are charged double or triple prices. Except for electricity, the controlled prices were adjusted upward in 1995 to take into account the recent inflation. For example, water charges for various usages doubled in March 1995, postal charges were increased in August 1995 by about 50 percent for domestic mail, and the prices of gasoline increased in October 1995 by 17.5 percent for super, 13.2 percent for regular, but only 8.8 percent for diesel.

The major factors for the recent surge in inflation starting in March 1995 were rapid increases in prices of a few food items: glutinous rice (but not ordinary rice), pork (and to a lesser extent beef and chicken), garlic, lettuce, and tomatoes. Construction material, most of which was imported, was another important category contributing to the CPI increase. Most of these prices exhibited annual increases exceeding 30 percent.

2. Employment

Information on the employment situation of the Lao P.D.R. as a whole is unavailable. Some information is available on the labor markets in four major urban areas—Vientiane, Savannakhet, Champassak, and Luang Prabang—based on a government survey conducted in 1992. Another labor survey was conducted in 1994, which however did not follow a similar approach and coverage, thus making comparisons difficult. However, it was possible to compile series containing two periods of comparable aggregates. For example, the 1992 survey's results showed that out of a population of potential workers (aged years 15 and older), 71 percent were economically active; the 1994 results showed a corresponding ratio of 67 percent. Both surveys showed similar ratios of male and female workers: 52 percent, and 48 percent of total active population, respectively. In addition, based on the two surveys, the unemployment rates increased from 2.6 percent in 1992 to 5.6 percent in 1994. Government officials attribute the increase in the urban unemployment rate to migration of the population from rural to urban areas at a faster pace than job creation and absorption.

Among those working in the urban areas, 32 percent are working in the wholesale and retail trade sector, 22 percent in the Government, and 13 percent in manufacturing (including garments); the rest are engaged in other industrial sectors and services.

3. Wages

Based on the 1992 and 1994 labor surveys the largest increase in wages was observed in the mining sector with a 70 percent annual increase in average, while the manufacturing, hotels and restaurants, community services, and government sectors, showed annual increases of more than 30 percent during 1992-94 (Tables 11a and 11b). Teachers and “specialist/experts” enjoyed the highest annual increases, averaging above 50 percent, while the managers, administrative staff, farmers and fishermen received annual increases exceeding 35 percent.

Based on these series, a crude (unweighted) average of earnings of urban employees is estimated at KN 41,000 (equivalent to $45) per month in 1994. From 1992 to 1994, this average wage has increased by 27 percent on an annual basis (while the CPI has increased by 7 percent on an annual basis during this period).

4. Poverty and Income distribution

Despite several years of significant economic growth, the Lao P.D.R. is still among the poorest countries in the region. Based on several social indicators, the country faces conditions which prevailed in some of its East Asian neighbors 30 years ago. Poverty incidence is high and per capita income low in this mainly agricultural and rural economy. Illiteracy remains high and life expectancy low. The 1996-2000 public investment plan allocates an increasing share to education, health and social development to increase welfare throughout the country.

The country ranks fairly well among developing countries in terms of equality of income distribution. It follows a trend common to many East Asian countries which have, more than other developing countries, been able to combine high economic growth with a more equal income distribution. A World Bank study estimated a Gini coefficient of 0.32 (1993), close to Vietnam and Indonesia.

Besides rural/urban disparities, a central issue of income distribution in the Lao P.D.R. is the danger of growing regional disparities. The Center of the country exhibits the best social indicators, owing to the strong growth of the Vientiane Municipality and Province. Meanwhile, despite the presence of a more modern farming sector, better roads and access to the markets and faster overall growth than in the North, the South displays the worst social indicators of poverty incidence, access to hospitals and medical practitioners, child immunization and malnutrition. The authorities are committed to addressing these problems of interregional income distribution.

IV. Public Finance

1. Structure of the nonfinancial public sector

The nonfinancial public sector consists of the Central Government, 17 provincial governments (including the Prefecture of Vientiane), and public enterprises. The public sector was fundamentally restructured in 1992 to enhance the efficiency and effectiveness of fiscal management. 1/ Restructuring included the establishment of a unified general budget and of a treasury in the Ministry of Finance to carry out the execution of the budget. 2/ The general budget now encompasses all revenues and expenditures nationwide. As a result of the unification, provincial administrations ceased to have independent budgets and were delegated authority by the Central Government to execute local expenditures of the general budget. Before the unification, disbursements were made at the local level by the provincial branches of the Central Bank.

Since 1992, further steps have been taken to centralize tax collection and expenditure control systems, publish the budget documents and implement legislation establishing an annual budget cycle. Under the new system, provincial authorities act as agents for the Central Government in the collection of revenues and execution of expenditure. Provincial treasury offices have been established in the principal provinces. Eventually all provinces will have such an office. Pending the adoption of new budget accounting and auditing standards, scheduled for 1996, the treasury has been working with a simplified public accounting system. This system ensures prior control of all expenditure categories at both commitment and payment stages. Public procurement is subject to guidelines designed to ensure competitive bidding and transparency.

2. Tax reform and the new tax law

a. Tax system

Reform of the Lao tax system started as early as 1988. Since then, the tax system has undergone substantial innovations consistent with the needs of a market-based economy. The tax law, adopted in 1995 and implemented in early 1996, provides the country with a relatively efficient tax system containing all major taxes. However, to reap fully the benefits from the system, further improvements in the tax administration are called for.

Even though the Lao P.D.R. had a tax system in place before the start of the public sector reform, the principal sources of domestic budgetary revenue were negotiated transfers from state-owned enterprises (SOEs). As these enterprises were granted financial autonomy (see Chapter V), the revenue system had to be adjusted. A major overhaul and simplification of the tax system was announced in a decree of June 1986 and took effect with the 1988 budget.

Although the general direction of the tax reforms since 1988 has been to design a system that increasingly meets the needs of a market economy, the search for such a system has gone through stages of innovations and corrections. In a first stage, the existing system of profit transfers from SOEs was replaced in 1988 by standard profit and turnover taxes. 1/ The tariff structure was rationalized and the maximum duty rate was lowered to 70 percent from the high level of 200 percent and more. 2/ Taxes on export profits were introduced at rates varying from 50 percent to 80 percent.

The second stage, which was spread over the subsequent years, consisted of the introduction of several new taxes and adjustments to the existing taxes, to correct for their highly differentiated nature. Newly introduced taxes were: personal income tax on employment and nonemployment incomes of Lao citizens with a progressive tax schedule (1989); 3/ export duties (1989); taxes on agricultural land and other natural resources (1989); excise duties on petroleum products and selected luxury items; a minimum profit tax of 1.5 percent of turnover; and a business registration tax, ensuring all taxpayers register at the Tax Department (all 1991).

In addition, existing taxes were gradually reformed: the rates of profit taxes were lowered and unified at 45 percent, with the exception of a 60 percent rate on bank profits (1989); the base of turnover taxes was extended to cover a wide range of services (1989); and the turnover tax was rationalized from five into two rates, 5 percent and 10 percent (1991); a minimum threshold for income tax of KN 150,000 annual income was introduced; the tax on agricultural land was replaced by a land tax on both urban and rural land (1992); among the natural resource taxes—introduced to promote environmental conservation—timber royalties became the most important; export taxes on most items were abolished in 1994 to promote exports.

The third phase took place in 1995 with the codification and consolidation of the existing provisions of the major domestic taxes into a new tax law. This new law was adopted by the National Assembly in late 1995 and the implementation regulation was signed in early 1996. In addition to a codification, this new law also introduced changes to the existing tax system (see Annex II for more details). The major changes are:

Turnover tax

The base has been expanded, so that most imported goods (including raw materials and capital goods) and domestically produced goods are covered. The number of exemptions has been greatly reduced. Two new rates have been added: in addition to the 5 percent and 10 percent rates, there are now also rates of 3 percent and 15 percent. The former applies mainly to agricultural products and foodstuff, while the 15 percent rate applies to luxury items. These modifications will have a beneficial impact on the buoyancy of this tax.

Income tax

The minimum threshold for income tax has been raised from an annual income of KN 150,000 to KN 360,000 and the tax rate for the lowest bracket has been raised from 2 percent to 10 percent. The minimum threshold applies to both income from employment and self-employment. 1/

Profit taxes

The rate has been reduced and made uniform at 35 percent for banks and nonbanks. To minimize the impact on government revenue of the lower tax rate on banks, state-owned commercial banks have been instructed to pay higher dividends toward the budget. The minimum profit tax (applicable to gross turnover of the previous year of enterprises subject to the extended or ordinary accounting system) has been lowered from 1 percent to 0.5 percent.

Excise duties

The system of specific excises has been replaced by ad valorem duties for all items. The new rates are set in such a way that the effective rate of taxation on the individual items remained broadly unchanged. The switch to ad valorem duties will also allow greater buoyancy.

b. Revenue collection

Collection of tax and nontax revenues takes place through five channels. The customs department collects duties on international trade at five regional customs posts. Taxes on domestic activities and imports are collected by the tax department. The provincial authorities collect about 40 percent of the taxes that fall under the tax department's responsibilities. The land tax is collected by the land registration department (Cadastre). Timber royalties are collected directly by the budget department through the provincial authorities. Finally, nontax revenues are the joint responsibility of the state assets department (leasing, dividends and overflight) and the budget department (all other categories).

Tax administration remains weak and is a major impediment for the authorities to get all potential benefits out of the present tax system. Weaknesses range from a lack of control over provincial authorities' collection procedures to insufficient inspection of enterprises' tax declarations. Lack of proper inspection and cross verification of income declarations from enterprises finds its origin in understaffing of the tax department and a shortage of computer equipment. Other collecting departments face similar problems of understaffing. This is particularly true for the Cadastre which relies on volunteers to collect the land taxes throughout the country. Customs administration is also in need of additional staffing and equipment. Lack of staff at major border posts leads to lax monitoring and control procedures. Progress has been made since 1994—the achievement of the tax revenue targets of the 1995/96 budget depends to a large extent on better collection and control procedures—but further improvements are still needed.

c. Overview and outstanding issues

The changes introduced to the tax system since 1989 have greatly improved its efficiency. The system now contains all the representative major taxes that compose a modern tax system. The structure of the taxes is simple, the major taxes have a reasonably broad base and the individual taxes are structured in such a way that their distortionary effects are limited. The progressive personal income tax and the differentiated turnover tax also yield equity to the system.

Chart 2a compares the shares of the major revenue categories between the start of the reforms (1988) and the 1995/96 budget, which was prepared on the basis of the provisions adopted in the new tax law. The major change in the composition clearly took place between 1988 and the 1992/93 budget. The share of turnover tax fell from 26.2 percent to 12.6 percent and reliance on profit taxes decreased from 22.5 percent to 7.6 percent. While the share of trade taxes remained fairly stable—reflecting a combination of increasing trade and lower rates—the share of income taxes started growing slowly and timber royalties became the major single tax category.



(in percent of total revenue)

Citation: IMF Staff Country Reports 1996, 054; 10.5089/9781451822397.002.A001

Source: Calculations based on data provided by Ministry of France

Since 1992/93, the relative shares of major tax categories have not been changing drastically. The 1995/96 budget still relies for 25 percent on trade taxes and for 13 1/2 percent on timber royalties. The share of trade taxes still shows an increase over time. On the other hand, the share of profit and income taxes has only been going up slowly. The contribution of timber royalties has been declining since 1992/93, reflecting a combination of a gradual reduction in the authorities' reliance on this tax category and collection problems (see below).

The above tendencies underline the need for further improvements in the tax system. The tax revenue/GDP ratio is still low given the government's budgetary needs. The revenue buoyancy of the system is still below its potential. The system still continues to rely heavily on trade taxes, taxes on natural resources (timber royalties) and non-tax revenues, sources that tend to be inelastic in the long run. Finally, the capacity to administer the increasingly sophisticated tax system remains limited.

3. Expenditure

Fiscal adjustment since the early 1990s has also greatly benefitted from improved control of spending. A major change in procedures was the 1992 decision to take away the power from the provincial authorities to make spending decisions independently. Fiscal centralization involved the consolidation of the Central Government and provincial budgets into one single budget document. Since this reform, provincial authorities have been implementing expenditure decisions as mandated by the Central Government.

While fiscal centralization has enhanced control over the execution of the budget by the central government, further improvements are needed in the area of monitoring and controlling expenditure. The Treasury network is not yet fully established, budgetary accounts lack transparency, line ministries still enjoy some spending discretion, and quality and timeliness of data reporting—particularly from provincial authorities—need improvement. 1/

Although the annual budget formulation has improved, further improvements are needed. Budget allocation requests are prepared by the line ministries and these requests are generally based on an extrapolation of past expenditure patterns, with little regard for overall planning needs.

Comparison of government expenditure composition over time shows the reduction between 1988 and 1992/93 in the portion of capital expenditure (Chart 2b). One reason for this downward trend in the early 1990s was that, as privatization of SOEs progressed, investment activities previously performed by the Central Government were transferred to the private sector. Since 1992/93, however, the share of capital expenditure has increased by almost 15 percentage points, reflecting greater attention to capital expenditure planning, including from 1994 the use of an annually updated public investment program (PIP).



(in percent of total expenditure)

Citation: IMF Staff Country Reports 1996, 054; 10.5089/9781451822397.002.A001

Source: Calculations based on data provided by Ministry of France

The chart also indicates the impact of the reorientation in current expenditure since the late 1980s. The wage bill rose sharply from 15 percent in 1988 to almost 26 percent in 1992/93 as the size of the civil service increased and wages rose. Since then, the ongoing civil service reform has assisted in reducing the wage bill to 22 percent in 1995/96. As retrenchment is coming to an end, the share of severance payments is now decreasing. The relative importance of transfers exhibited a similar path as the cost of pensions rose substantially by 1992/93 before declining slightly.

4. Budget implementation and fiscal policy in 1994/95 and 1995/96

a. The 1994/95 outturn

The 1994/95 budget was set to achieve a current surplus (excluding grants) of 1.5 percent of GDP. Revenues were targeted to yield 13.3 percent of GDP (up from 12.7 percent in the preceding year), while spending would shrink from 24.2 percent of GDP in 1993/94 to 22.8 percent. This reduction was to be achieved by reducing capital expenditure and on-lending by 1.4 percent of GDP. The overall fiscal deficit was planned to be 9.5 percent of GDP (without grants), down from 11.5 percent the year before (Table 3).

Table 3.

Lao P.D.R.: General Government Operations, 1991/92-1995/96 1/

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Sources: Data provided by the Lao authorities; and staff estimates.

The fiscal year was changed from a calendar year basis to October-September in 1992.

Includes revisions made to revenue projections in January 1996.

Excludes KN 14 billion of government bonds issued to recapitalize the state-owned commercial banks in August-September 1994.

Including grants.

Excluding grants.

Comprising bank and nonbank financing, and receipts from government asset sales.

The final results for 1994/95 show revenue at 12.5 percent of GDP, 0.8 percent below the target. The current surplus target was achieved because expenditures turned out to be lower than programmed despite the higher rate of inflation. While the overall deficit before grants was slightly higher than budgeted, higher levels of grant-financed capital spending led to a deficit after grants which was below the original target (4.2 percent of GDP).

The 1994/95 budget was executed in a context of rising inflation and a depreciating currency. In addition, severe floods hit large parts of the country in the second half of the fiscal year. The first half of 1994/95 was characterized by some slippage, mainly in revenue collection. More particularly, timber royalty receipts lagged mainly because of problems in the collection process. In early June the Government adopted a package of measures yielding a deficit reduction of about 3/4 percent of GDP. The measures included a strengthening of collection procedures for timber royalties to recover the arrears of the first half and secure timely collection during the second half, as well as intensified control over profit and income declarations for tax purposes. Cuts were also approved in selected expenditures, including materials and supplies, transfers and lower-priority capital outlays.

The shortfall in revenue compared with the original budget was almost exclusively due to timber royalties. Although the authorities were able to improve collection of royalties towards the end of 1994/95, they were unable to collect all of the arrears. Land tax also did not deliver the planned amounts in revenue, mainly owing to administrative problems related to the collection of this tax. Most other important tax categories achieved or even exceeded their targets, thereby compensating for the shortfall in timber royalties. However, part of these favorable results in profit and incomes taxes is related to the higher than expected inflation in 1994/95, while the exchange rate depreciation also had a beneficial impact on some revenue categories such as leasing and overflight charges.

Total expenditure, at 22.2 percent of GDP, was 0.6 percentage point lower than targeted under the second year ESAF arrangement, due to lower-than-planned current expenditure. While expenditure on wages and salaries turned out to be 3 percent higher than originally budgeted, in most other categories savings were achieved. Expenditures on material and supplies were 14 percent lower than the original budget, in line with the cuts planned about mid-year. These cuts affected mainly purchases of vehicles and other equipment from abroad. Transfer payments were only slightly lower than the original plan, but severance payments were much lower—about 60 percent of the budgeted amount—because of a slowdown in the retrenchment program. The civil service reform program for 1994/95 had originally targeted a gross departure of 6,200 staff, with severance payments of KN 3.8 billion. However, because the authorities' emphasis shifted from retrenchment to reallocation and retraining, only 3,407 staff were laid off and severance payments only amounted to KN 2.2 billion. With new hiring of 2,400 staff, net retrenchment for 1994/95 was limited to 1,007 staff. This lower number also explains the slight excess in spending on wages and salaries compared with the original budget. At the end of fiscal year 1994/95, the civil service comprised 68,108 staff and the total wage bill amounted to KN 68.3 billion.

Capital spending in 1994/95 was also less than planned owing to cuts in lower-priority capital outlays and delays in implementing projects. Several projects were affected by a shortage of construction companies or detailed plans to execute the project. Investment in communication, transportation, and construction amounted to about 48 percent of total capital expenditure, down from 60 percent in 1993/94. Agriculture absorbed 12 percent while investment in industry was 19 percent of the total. Capital expenditure on education, health, social welfare, and rural development amounted to almost 20 percent, compared with 15 percent in the previous budget year. The larger than planned inflow of grants, as well as KN 2 billion proceeds from asset sales, enabled the Government to reduce its use of domestic bank financing by more than KN 10 billion. The decrease in nonbank financing reflected the redemption of bonds issued in 1992/93 to the public offset by an increase in enterprises' deposits with the treasury and a decrease in the treasury's cash holding. 1/

b. The 1995/96 budget

The 1995/96 budget is set to continue progress toward fiscal sustainability by broadening the tax base and further reorienting current and capital expenditure. A surplus on current operations of 2.3 percent of GDP is targeted while the overall balance (before grants) is aimed at 9.6 percent of GDP (compared with 10.2 percent in 1994/95).

i. Revenue

Overview: The budget programs an increase in revenue to 13.1 percent of GDP. This increase is based on improvements in the tax administration and on new measures as part of the ongoing reform process of the tax system. Improvements in tax administration consist of better collection methods, mainly for profit, income and turnover taxes. Promotion of better and generalized accounting practices is seen as an important tool to ensure that more enterprises are covered by the tax collection system and that tax evasion be reduced. Customs revenues will benefit from tighter surveillance on exempted goods.

The 1995/96 revenues will also benefit from the full-year impact of increases in excise duties on cigarettes and alcohol, introduced in April 1995, from the adoption of the market-based exchange rate for tax valuation purposes, and from the full pass-through of higher import costs to the domestic price of petroleum products.

First four months and timber problems: Results of the first four months of 1995/96 indicate a small shortfall in tax revenues compared with the original budget. This shortfall is almost entirely due to lower-than-budgeted receipts of timber royalties while receipts for most other tax categories are well on track (Table 4).

Table 4.

Lao P.D.R.: Budgetary Developments, October 1995-January 1996

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Source: Data provided by the Lao P.D.R. authorities.

The shortfall in timber royalties is related to the logging of lower quality wood, a drop in world prices and lagging payments. There are also administrative problems in the collection process, which in turn, are related to supervisory problems of the operations of the three logging companies.

Table 5 provides some indication of the extent of the collection problems in the 1994/95 budget. Actual logging was about 30 percent higher than the assigned logging quota—another part of the supervisory problem. While budget revenues fell only slightly short of the budgeted amount, this amount itself was on the low side since it only represented about 87 percent of potential royalties based on the assigned quota. However, it is only 67 percent of the potential royalties when the actual logging is taking into account.

Table 5.

Lao P.D.R.: Logging and Timber Royalties, 1994/95-1995/96

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Sources: Ministries of Trade, Forestry and Finance, and staff calculations.

Problems with respect to royalty collection emerged again in 1995/96. Revenue from timber royalties during the first four months only amounted to 10 percent of the total originally planned for the year (Table 4). However, renewed efforts since January 1996 to improve royalty collection and recovery of arrears from 1994/95 have enabled the Government to increase revenue from this source to almost $14 million at end-March (Table 5). At a more general level, reliance on timber royalties would be decreased in line with the authorities' environmental plans which call for conservation of the country's natural resources and a reforestation policy.

1995/96 revenues in a broader perspective: The combination of efforts to improve tax collection and widen the tax base on the one hand and to reduce certain key tax rates on the other is reflected in a 1995/96 budget wherein the relative shares of major tax categories have not changed drastically compared with 1994/95 or even 1992/93 (Chart 3a). The share of trade taxes in particular still shows an increase over time. On the other hand, despite several tax reform measures, the share of profit taxes increases only marginally compared with 1994/95, while those of income and turnover tax show a decline compared with the previous year's budget.

ii. Expenditure

Current expenditure is set to increase by 17.3 percent over the 1994/95 budget outturn, leading to an reduction in terms of GDP from 10.8 to 10.3 percent. The wage bill will be KN 78.4 billion, an increase of 14.8 percent, well below the average expected inflation rate for 1995/96 of over 18 percent. The civil service labor force is targeted to remain approximately the same, implying an increase in the average wage per civil servant of nearly 18 percent.

As part of the ongoing civil service reform, the authorities have targeted a net retrenchment of zero for 1995/96, consisting of 1,600 departures and approximately the same number of new hiring. However, it will be difficult to achieve even this retrenchment target. The number of voluntary departures has decreased significantly since the salary increase of 1994, so the authorities have to identify other ways to retrench staff. The final outcome might be a slight increase in the number of civil servants (at present 68,000). However, this number would still be below the ceiling of 70,000 set by the Government for the remainder of this century. Severance payments are budgeted at KN 2.6 billion, in line with a gross departure of 1,600 staff. Pensions are budgeted to grow by 14 percent compared with 1994/95. In this context, the authorities are studying a reform of the social security system to keep it affordable.

The item ‘transfers’ include large amounts for flood relief in the wake of the severe floods that hit parts of the country in mid-1995. Most of these amounts were spent in the first quarter of 1995/96.

The large inflow of multilateral and bilateral loans allows the authorities to increase capital expenditure in 1995/96 slightly in real terms. The focus is on core investment projects and on appropriate levels of investment in education, health, and social welfare, in line with the 1995/96 PIP which targets a 20 percent share of total capital investment for these categories. The budget on communications and transport is set to grow by 44 percent compared with 1994/95, while all other categories (agriculture investment, industry) are not planned to grow in real terms.

The large inflows of foreign finance sources also allow the Government to reduce its reliance on domestic financing and further build up its deposits with the central bank. Domestic nonbank financing is also targeted to be scaled back. Revenue from asset sales has been conservatively estimated at KN 15 billion. However, if the sales of the two remaining large state enterprises go through as intended (Lao Telecom and Lao Tobacco, see next Chapter), revenue from asset sales will substantially exceed this target. Lao Telecom alone could raise about KN 40 billion in 1996.

V. Privatization

The Lao P.D.R. started earlier in the transition process and has gone further than most other formerly centrally planned economies in privatizing the state-owned enterprise (SOE) sector. In 1988, the total number of SOEs was estimated at about 640, 1/ of which approximately 260 were in the industrial and small-scale manufacturing sectors. These SOEs accounted for about 10 percent of GDP at the time and employed about 10 percent (16,000 workers) of the nonagricultural labor force. About 30 percent of these enterprises, mainly the larger ones, were under the control of the central government while the remainder were under the provincial authorities' control.

1. Strategy

The main purpose of privatization was to reduce the role of the Government in the economy and to strengthen private sector activity. Privatization was also driven by growing concerns about the poor economic performance of the SOEs. The Government's strategy, embodied in Decree No. 19 of March 1988, consisted of two parts. First, the decree established the principle of operating autonomy, and, second, the decree initiated the process of privatization. 1/

During the first two years, no real strategy was backing the privatization efforts. Guidelines for privatization were adopted through Decree No. 17 (1990), stipulating that the enterprises to be privatized had to be ranked according to the following criteria: (i) cost to the budget; (ii) need for capital; (iii) scope for attracting investors; and (iv) ability of workers to manage or own the SOE. In addition, the Government planned to publish a list of SOEs to be retained in the public sector. Enterprises to be retained were “…those having importance to the national economy, society, defense and internal security.” 2/ However, due to a lack of public capital, privatizations since 1990 have included enterprises that fall under the “strategic” categories. Over time, the Government has allowed private participation in all areas except forestry and defense. The list was not published until 1995 and contained 32 SOEs, reflecting the narrowing of the definition of “strategic enterprises”.

2. Privatization during 1989-95

Since the start of the program through end-1995, over 500 SOEs have been privatized, leaving only 59 enterprises to be divested in 1996-97, in addition to the 32 “strategic” ones to be retained (Appendix II).

During the first year, 1989, about 100 small enterprises were privatized through leasing. 3/ However, the legal underpinnings of these leases were weak, leading to several cases of mismanagement and failure. In addition, the operational autonomy granted to SOEs led to problems such as salary increases, management bonuses, and reduced transfers to the government budget.

The Government responded to these problems by accelerating divestiture and tightening financial supervision over the SOEs. In 1992, a Privatization Unit was established under the State Committee for Planning and Cooperation to plan and coordinate privatization. During 1991-92 several important SOEs were privatized, many of them to foreign investors. The pace slowed down in 1993-95 mainly because the most commercially viable SOEs had been sold in the first two years. Nevertheless, by the end of 1995, a total of 75 centrally managed SOEs were privatized, including most of the major SOEs and leaving the authorities with only a number of very small ones and a few large strategic enterprises.

Of the 69 enterprises for which data on the method of privatization are available, 46 were leased, 21 were sold outright (including buyouts by management or employees), and 2 were sold in installments. Thirteen SOEs were privatized through joint-ventures with foreign investors (either through leases or outright sales). Buy-outs by management have become more popular since 1994 because of the limited appeal of many of the remaining SOEs. In 1995, 9 out of the 11 privatized enterprises were sold to management. The total value of the SOEs sold in the period 1989-95 amounts to $72.6 million. The annual value sold peaked in 1993, when a total value of $22.4 million was sold, with the sale of Lao Brewery representing almost half of the total amount.

The effects on the government budget have remained limited, except for the peak-year, 1993. Revenue from asset sales represented KN 14.6 billion in the 1992/93 budget, while it has ranged from KN 1 billion to KN 6 billion in the other fiscal years between 1992 and 1994/95. 1/ Annual revenue from leasing ranged from KN 3.7 billion in 1991 to KN 5 billion in the 1994/95 budget. Starting in the 1995/96 budget, revenue from leasing will decrease because of the diminishing reliance on leasing as a privatization technique since 1994. As a result, many expiring leases are not renewed (but offered for outright sale).

The direct effects on the balance of payments have also been limited, with the exception of 1993. The sales in that year generated an inflow of $30 million, mostly on account of Lao Brewery. In 1991, 1992, and 1994, the inflows were limited to about $1 million, and close to $7 million in 1995. So far there is no evidence of significant indirect effects, in the form of additional foreign investment.

Although data on employment are far from complete—only available for 33 SOEs privatized so far—there are clear indications that the immediate effects on employment were bearable. Those 33 SOEs employed a total of 3,687 workers at the time of privatization, and 431 were dismissed immediately after privatization. No data are available regarding possible subsequent job losses. Generally, foreign investors and joint ventures took over the largest part of the work force and laid off fewer workers than domestic investors. Most likely, this indicates that foreign investors showed most interest in the larger and more efficient enterprises.

3. Outlook for 1996-97

For 1996 and 1997, the Government plans to reform the 32 SOEs designated “strategic” in 1995 while finishing the divestiture of the other 59 through privatization or liquidation before end-1997.

Over time, the Government has narrowed the definition of “strategic”. About half the group of 32 is composed of banks (8), public utility services (electricity, water, post) and the three logging companies. It is the Government's intention to merge or, at a later date, possibly privatize some of the banks as part of a wider effort to restructure the banking system and modernize banking techniques and management (see also Chapter VI).

The total value of these SOEs is currently estimated at KN 245 billion. Almost 57 percent of this value is represented by Electricité du Laos (EDL), by far the largest company on the list. The 32 companies employ 9,200 workers, two-thirds of which are employed by 3 companies (EDL, the largest logging company, and the Post Office). The Government is determined to run all the strategic SOEs on a commercial basis. Each nonbanking enterprise will be registered as a joint-stock or limited liability company with well-defined commercial and financial performance goals. Boards of Directors will be appointed in each of these SOEs. The process will start in 1996 with 5 enterprises—three of them being the utility enterprises—while the remainder will be converted in 1997.

The 59 enterprises to be divested have an estimated value of KN 96.3 billion and employ 5,400 workers. The largest among them is Lao Telecom (68 percent of total value and 16 percent of employment). On the other hand, the list contains many small enterprises: 19 out of 59 have an estimated value of less than KN 50 million, while 34 employ less than 50 workers. The small size of these SOEs will make them hard to sell. The Government is preparing to liquidate several of these enterprises if investors show no interest by 1997.

A list has been prepared (Appendix II) which identifies SOEs to be offered in 1996. Of a total of 47 slated for privatization in 1996, the authorities intend to set up joint ventures, at least for the two largest companies (Lao Telecom and Lao Tobacco) and perhaps for another 4-5 smaller ones. About 30 will be offered for outright sale to management while 3 will be divested from the central to the provincial level (leaving the actual privatization in the hands of the latter). Most likely, 6 or 7 will be liquidated because of their lack of attractiveness. If all these transactions go through, the number of enterprises left to be divested in 1997 will be very small.

Most attention in 1996 goes to the sale of Lao Telecom and Lao Tobacco. The Government has currently received two bids for Lao Telecom and is expected to close a deal some time this year. Lao Telecom has an estimated value of KN 65 billion and Lao Tobacco is valued at KN 3.6 billion. Sale of both would have a significant impact on the government budget and the balance of payments. The 1995/96 budget conservatively targeted asset sales at KN 15 billion. Thus, the sale of Lao Telecom would generate significant windfall revenue for the 1995/96 budget. Similarly, the foreign capital inflow would assist the authorities in achieving their net foreign assets target.

4. Conclusion

Privatization in the Lao P.D.R. can certainly be marked as a success in terms of its speed. The problems that have arisen in the process, particularly in the first years, are mainly associated with the methods of privatization. The most important problems were heavy reliance on leasing, weak accounting, lack of resources, and lack of clear ranking and transparency.

Fixed-term leasing has been the main mode of privatization, partly reflecting—at least in the initial period—the authorities' reluctance to divest major parts of the state's assets and the legal prohibition on selling state land. As leasing does not change the ownership structure—only the management structure—this method of privatization does not really stimulate investment. Monitoring the leased SOEs proved to be costly and difficult, and when the leases expire, the authorities have to go through the privatization process once again. Recognizing these difficulties, since 1994-95 the authorities have moved away from leasing to outright sales, joint ventures and management buyouts. In addition, to improve the monitoring process in general, the Department of State Property in the Ministry of Finance is setting up a computerized system for monitoring leases, state assets and SOE performance.

Privatization has also been hindered by weak accounting practices of the SOEs. For most SOEs, no reliable data on financial history, net worth or profitability are available, generally undermining the private sector's confidence in the units offered for sale. Only recently have SOEs started using international accounting methods and audits in a systematic way.

For a long time, the Privatization Unit was not properly equipped for a task as demanding as privatization. Because of the shortage of staff, the Unit had difficulty in fulfilling the wide range of tasks that were assigned to it, including surveying, valuing, prioritizing for privatization and finding bidders and monitoring. More resources and training will be provided, herein helped by external technical assistance.

Another problem during the first years was the lack of clear ranking criteria. In the absence of such criteria, each line ministry prioritized for privatization based on this own objectives. Such criteria were only established in 1995, including availability of a recent independent audit, the ability to provide a clear and definitive legal separation from the state, the size of the SOE, and the expected demand from private sector investors.

On the whole, the privatization process could have been more transparent. Public knowledge of the program has been limited with little information on the SOEs offered for privatization. The Government often contacted potential bidders directly, instead of going through the media. The publication in 1995 of the list of “strategic” enterprises and of the enterprises to be privatized in 1996-97 has certainly added to the transparency, but was late in the process.

The authorities seem to consider the current plans as the endpoint of the divestiture strategy. Commercialization and introduction of international accounting and auditing standards will certainly reduce the need for subsidiary the remaining SOEs, taking away a critical reason for further privatization. However, as past experiences has demonstrated, the notion “strategic” can be subject to change.

Another sector is banking. Thus far, none of the state-owned banks has been considered for privatization. The Government is planning to commercialize them, just like the other strategic SOEs. In addition, technical assistance 1/ has been provided to help the authorities undertake a comprehensive restructuring and rationalization of these banks to modernize their management, accounting and credit practices. The Government has left its options open regarding the need to merge some of these banks.

VI. Money and Banking

1. Banking System

Since 1988, the Government of the Lao P.D.R. has implemented a series of measures to reform the banking system to improve the mobilization and allocation of resources. In 1990, a two-tier banking system was introduced with the formal establishment of the Bank of the Lao P.D.R. (BOL) as an autonomous central bank. The Central Bank Law was amended in 1995 with a view toward strengthening the authority of the BOL. However, in the event it is not clear whether the BOL's independence was enlarged because the new law appoints the Deputy Prime Minister as the chairman of the BOL board (the decision-making body), while the Minister of Finance and the BOL Governor are vice-chairmen.

State-owned commercial banks were developed from branches of the central bank. Among them, the Banque du Commerce Exterieur (BCEL) is the largest, managing about 40 percent of the sector's deposits and over 20 percent of the loans. 1/ The BCEL also handles the bulk of the country's foreign exchange operations. The banking sector expanded further in 1992, with the opening of foreign and joint-venture banks. Each new bank was required to deposit at least $5 million as part of its capital with the BOL. 2/ The newest state-owned bank, the Agricultural Promotion Bank (APB), was established in 1993 to promote the development of the agricultural sector. At end-1995, the banking sector comprised eight state-owned commercial banks, and nine private banks (seven foreign banks and two joint-venture banks). 3/

2. Financial deepening

A rapid expansion of the banking system and an increase in the public's confidence in the banking system during 1991-94 have led to a significant degree of financial deepening. During this period, the stock of broad money more than tripled while the velocity of money (measured as the ratio of GDP to an annual average of the stock of broad money) declined from 15 in 1991 to 7.8 in 1995. In addition, there was a marked changed in the composition of broad money—with the ratios of narrow money to quasi-money moving gradually in percentage of broad money from 55:45 to 35:65.

Several reasons account for these developments: (1) monetary policy has been successful in containing inflation, maintaining a stable exchange rate, and keeping interest rates positive in real terms; (2) banking services have been expanded through the establishment of autonomous state-owned commercial banks, the opening of foreign exchange bureaus, and the entry of foreign banks, bringing new expertise in banking; and (3) the general public has increasingly become responsive to market conditions such as movements in prices, interest rates, and exchange rates.

Despite the increasing confidence, the country still remains plagued by a fairly high degree of currency substitution and dollarization. 1/ U.S. dollars and Thai baht circulate freely and accounts in these currencies can be opened by residents. While the share of foreign currency deposits in broad money has been fluctuating considerably about 35 percent since the early 1990s, Charts 1 and 2 in Annex I generally demonstrate its sensitivity to exchange rate developments. When tensions in the exchange markets grow (expressed by a larger premium in the parallel market), the share of foreign currency deposits tend to increase. For example, in early 1995 when pressures on the exchange rate increased significantly, the share increased from less than 30 percent in March to more than 42 percent in November. While building confidence in the economy and in the Government's policies is the long-term remedy for eliminating currency substitution, several technical measures can help facilitate this process (see Annex I).

3. Monetary policy

a. Monetary policy instruments

Since 1990, with the removal of government directives on credit allocation, commercial banks have gained considerable autonomy in lending decisions. Since its establishment, the BOL has begun to gradually develop indirect instruments for monetary control. In October 1990, a reserve requirement of 5 percent on all deposits was introduced to absorb excess liquidity. 2/ In January 1992, a formal credit window was established at the BOL to accommodate short-term liquidity needs of the commercial banks. In May 1994, this credit window was replaced by a discount facility. 3/ To pave the way for open market operations, the BOL issued six-month bonds in January 1992 to commercial banks and state enterprises, 4/ and in March 1994, treasury-bill auctions were introduced.

A high-level Monetary Policy Committee was established at the BOL to improve the monitoring of monetary developments in conjunction with developments in the other economic sectors, including budget, prices and exchange rates, and to provide better policy advice to the BOL. In November 1994, the BOL doubled the reserve requirement ratio to 10 percent in response to growing excess reserves on the banks' books, and discouraged the banks' recourse to their overdraft facility by increasing the overdraft interest rate from 24 percent to 30 percent.

However, the above measures did not prove to be sufficient to contain the excessive growth in money and credit, as well as the ensuing inflation. Thus, in June 1995 the BOL had to implement a number of additional measures. Reserve requirements were increased to 12 percent. Six-month central bank bills were issued to the nonbank public; 1/ the interest rate on overdrafts was raised to 35 percent. Compliance with the credit/deposit ratio (a minimum of 60 percent, maximum of 80 percent) was enforced for all commercial banks. 2/ In addition, in September 1995 the BOL imposed temporary bank-specific credit ceilings, limiting annual credit expansion by state-owned banks to 25 percent. For private banks, guidelines were issued to restrict growth in their lending also to 25 percent on an annual basis. 3/ In the event, commercial banks' excess reserves declined from a level of about KN 9 billion in the beginning of 1995 to about KN 1 billion at the end of 1995, 4/ demand pressures and credit expansion were curtailed, and inflation subsided in the last quarter of 1995.

The BOL's response to the 1995 events was an example of the so-called “belt-and-braces” approach whereby indirect instruments are complemented by direct measures to ensure effectiveness. The indirect measures—particularly the sale of central bank bills—proved to be effective, but the lack of a planning device such as a reserve money program made it initially difficult to plan the amount and timing of the operation. Hence, it was felt safer to impose temporary credit ceilings on the banks until a reserve money program is functional.

b. Interest rates

Since its establishment, the BOL has gradually been moving toward interest rate liberalization. The BOL has advanced the liberalization slowly to allow commercial banks to adapt to, and learn from, the market mechanism and give itself time to improve its capacity to conduct indirect monetary policy. Reflecting the slow liberalization process, the collection of data on interest rates by the BOL has also developed slowly. Until recently, there was no systematic procedure for collecting data on interest rates actually charged by banks. However, the data collection has improved since mid-1995, when all banks were requested to report a range of rates (minimum, maximum) depending on type of credit and deposit by currency of denomination.

Before July 1991 interest rates were officially fixed. Thereafter, banks were allowed to set their own interest rates within central bank guidelines for upper and lower limits on deposit and lending rates. In July 1993, the system was simplified to a maximum rate for loans and a minimum rate on savings deposits, along with guidelines on lending rates to the agricultural sector. In July 1995, the minimum rate on savings deposits was revised upward to 16 percent because of the re-emergence of inflation, while the maximum lending rate was abolished (Table 14). The BOL is planning further interest rate liberalization in 1996 through the removal of guidelines for the minimum deposit rate.

The APB lends to farmers at preferential rates (10, 8, and 7 percent for short-, medium-, and long-term loans, respectively) when funds are obtained from the BOL's on-lending agricultural loans (at 5, 3, 2 percent). 1/ When funds are mobilized from other sources, lending to the agricultural sector may be carried out at negotiated rates. Other commercial banks seldom lend to the agricultural sector because of high transaction costs and risks. However, when they do not lend to the agricultural sector, the banks must in principle deposit ten percent of their deposits with the APB to support agricultural lending; in practice, only a few commercial banks comply with this central bank guideline. 2/

When the BOL removed the guidelines on lending rates, the maximum lending rate offered by banks increased from 22 percent to 28 percent, but has remained fairly stable thereafter (Chart 4). Kip deposit rates have traditionally remained close to the minimum set by the BOL. Rates on baht accounts were in the 3 ¾ - 10 percent range in 1995, depending on the maturity, while those on dollar accounts ranged from 2 percent to 6 percent.



(Percent change)

Citation: IMF Staff Country Reports 1996, 054; 10.5089/9781451822397.002.A001

Sources: Data provided by the Lao authorities.


(in percent)

Citation: IMF Staff Country Reports 1996, 054; 10.5089/9781451822397.002.A001

Source: Data provided by the Lao authorities.1/ Deposit rate: minimum rate on commercial bank savings deposits as set by the BOL. Lending rate: before July 95: maximum commercial bank lending rate as set by the BOL; rate was liberalized in July 95. Post-July 95 observations are averages of bank lending rates. Treasury bill yield: weighted average of auction rates.

The rigidity of interest rates even after liberalization may be due to a number of factors, including: (i) commercial banks were unfamiliar with setting their own rates and were not willing to unsettle the market by changing the rate, and commercial banks were continuing to maintain a constant spread between deposit and lending rates (about 7 percent between maximum lending rate and maximum deposit rate); or (2) the BOL's collection procedures for data on interest rates were poor and did not reflect the rates actually applied by banks.

The treasury bill yield, which is a weighted average of rates offered for a six-month financial instrument in an auction environment, provides a measure that should best reflect the market forces of supply and demand for funds. Treasury bill auctions started in March 1994 with a yield comparable to the interest rate on a six-month time deposit offered by commercial banks. Yields moved upward sharply in mid-1995 with the signs of inflation and started easing back in October 1995 when inflation appeared to have subsided. As the money market in the Lao P.D.R. is still in its infant stage, rates in the market still lack a representative character. The rate on interbank kip lending remains very close to the minimum savings rate, with on average only one transaction per month in 1995.

4. Monetary developments

Substantial improvements have been made to the classification of monetary accounts in past years with Fund technical assistance. However, monetary analysis continues to be hampered by the lack of information on cash transactions in foreign currencies (baht and U.S. dollar) effected outside the banking system, so that the measure of broad money currently available does not reflect the true liquidity (means of payments) circulating in the economy. This state of currency substitution partly explains why the link between money growth and inflation remains very unstable (Chart 3).

The desire to promote the development of the private sector led to a relaxation of the monetary stance in 1992. As a result, growth of credit to the nongovernment sector accelerated from 23 percent during 1992 to 52 percent during 1993 (Table 6). Broad money growth peaked in 1993, owing to high real deposit rates in combination with the commencement of operations of six foreign banks—which also contributed to the increase in net foreign assets.

Table 6.

Lao P.D.R.: Monetary Survey, 1992–95

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Source: Data provided by the Lao authorities.

Net credit to Government in 1994 includes KN 14 billion of government bonds issued for recapitalization of state-owned commercial banks. Concurrently, bad loans amounting to KN 14 billion were written off from the bank's portfolios.

Excluding bad loan write-off.

Broad money divided by reserve money.

Monetary developments in 1994 were characterized by a slowdown in broad money growth in the first half followed by a sharp acceleration in the second half (Table 7). The slowdown during the first-half was due primarily to the waning impact of the foreign banks' entry on the growth of foreign currency deposits. The acceleration during the second half was due mainly to the rapid growth of credit to the nongovernment sector to accommodate the private sector's rising demand for credit. During this period the capital position of the commercial banks was improved by a recapitalization and bad debt write-off financed by the Government (see below). Banks reacted by accelerating new lending. At the same time, net credit to the Government increased as the Government used its bank deposits to finance a higher-than-expected overall budget deficit. Overall, during 1994, broad money grew by 32 percent, half of the growth rate in 1993, while credit to the nongovernment sector grew at a rate similar to that in 1993.

Table 7.

Lao P.D.R.: Sources of Broad Money Growth, 1994–95

(Increase as percept of previous period broad money)

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Sources: Data provided by the Lao authorities; and staff estimates.

During 1995, the expansion of broad money decelerated, with a rate of growth of 16.4 percent, equivalent to half of the growth rate in 1994. The banking system's net foreign assets advanced strongly by about KN 19 billion due mainly to the BOL's effort in building up official reserves (BOL's net foreign assets alone increased by KN 16 billion). The moderate path of net domestic assets reflected, however, the impact of the corrective financial measures during the year—increasing by only 7 ½ percent. Net claims on the Government declined significantly by about KN 12 billion during the year owing to tight fiscal policies and substantial foreign financing, allowing a sizable expansion of credit to the nongovernment sector in the first three quarters. The growth of credit to the nongovernment sector slowed down in the last quarter, in response to the BOL's monetary tightening measures.

The slowdown of broad money growth during 1995 reflected the depreciation of the kip and the associated uncertainty in the economy, as well as the subsequent tightening of monetary policy. In the first quarter, broad money grew roughly in line with nominal GDP, though there was a shift from foreign currency deposits to kip assets, possibly reflecting increased currency substitution. The second and third quarters were characterized by a marked slowdown in broad money growth, with the kip components of broad money declining in each of the quarters, owing to withdrawal of kip deposits to purchase foreign exchange and to acquire foreign currency deposits and other assets. Foreign currency deposits also increased in kip terms with the depreciation of the official exchange rate during this period. In the last quarter, foreign currency deposits increased at a slower pace, while currency in circulation and kip deposits stabilized as exchange rate pressure eased. Overall, the growth of foreign currency deposits was the principal factor underlying the growth of broad money in 1995 (Chart 2)—accelerating the dollarization of the economy.

5. Financial sector reform

Following the establishment of a two-tier banking system, many initiatives have been taken to improve the efficiency of the financial system. Progress has been made through the creation of autonomous state-owned banks, elimination of directed lending, entry of foreign banks, interest rate liberalization, and development of indirect instruments of monetary management, including the introduction of regular treasury bill auctions.

To improve the portfolios of state-owned commercial banks, recapitalization was undertaken in 1994 with technical and financial support from the AsDB. The recapitalization comprised an injection of cash of KN 4 billion to improve the banks' capital and the issuance of KN 14 billion of government bonds to write-off an equivalent amount of nonperforming loans. Since the clean up operation, the authorities have been closely monitoring the commercial banks' portfolios and there are indications that new doubtful loans were accumulating again toward the end of 1995.

The renewed signs of problems with banks' portfolios emphasize the need to accelerate financial reforms in the areas of bank supervision and bank accounting. In this regard, the authorities are implementing the recently adopted new accounting plan for commercial banks in 1996 and introducing limits on foreign currency exposure of commercial banks, while strengthening the banking supervision capacity of the central bank with the support of technical assistance from international organizations.

A plan for restructuring state-owned commercial banks is under study with assistance from the AsDB. Under this plan, state-owned banks will undergo an external audit, and management practices and bank operations will be modernized. The restructuring may result in the merger of some state-owned banks. Other future steps will include developing an efficient interbank market and a secondary market for government securities. As an interim step to the establishment of an interbank market for foreign exchange, the authorities are introducing auctions of foreign exchange in mid-1996.

VII. External Sector

1. Background

The progressive liberalization of external trade since the mid-1980s and the phasing out in 1990-91 of bilateral trade payment agreements with CMEA countries have facilitated the country's progression toward full integration into the world economy. Total merchandise exports and imports as percent of GDP rose from 37.5 percent in 1988 to 53.2 percent in 1995. In addition, by 1992, the share of trade in nonconvertible currency had been reduced to negligible amounts, from 42 percent in 1988.

In spite of the impressive growth performance in recent years, the geographical location of the Lao P.D.R., with no direct access to the sea, remains an important impediment to trade. Consequently, its trade is largely dependent on neighboring Thailand, which accounts for more than 40 percent of all trade, as well as on Vietnam and China (Table 20 and 21).

While still dependent on foreign aid flows, the Lao P.D.R.'s external position improved with strong export growth and a shift towards private capital. In 1995, official transfers and concessional loans accounted for about 36 percent of merchandize import financing, which represents almost a halving of the 1991 level. Foreign direct investment, on the other hand, has accounted for an increasing share of the financing of the current account. With large hydropower projects planned in the coming years, foreign direct investment is expected to continue to grow in importance.

The trade system is free of any restrictions. The tariff structure is simple, consisting of 6 main tariff lines and a few exceptional rates for special goods. The exchange rate was floated in September 1995, after which it has been stable at about KN 930 per U.S. dollars.

2. Recent developments in the balance of payments

Since 1992, the overall performance of the balance of payments has been generally strong, with continued reserve accumulation achieved except in 1994 owing to strong import growth, lower-than-expected net foreign disbursements and investments. Accordingly, the ratio of current account deficit to GDP (excluding official transfers), which stood at 8.8 percent in 1992, rose sharply to 15 percent in 1994, but declined to 11.4 percent in 1995 (Table 8).

Table 8.

Lao P.D.R.: Balance of Payments, 1991–95

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Sources: Data provided by the Lao authorities; and staff estimates.

Includes short-term private capital and unrecorded imports.

During 1992-95, the share of exports grew from 11.3 percent of GDP to 19.8 percent on the strength of manufactures, in particular wood products and garments exports. The share of imports rose from 22.5 percent of GDP to 48.4 percent during the same period, partly reflecting the increased foreign capital inflows associated with project financing. Nevertheless, the share of consumption goods as percent of total imports remained at about 50 percent during the same period. Nonfactor income was dominated by travel, rising from $18 million to $51 million during the last four years. Nonfactor payments showed similar developments, with travel expenditure rising from $10 million to $30 million, and construction related services payments rising from a negligible amount in 1992 to $30 million in 1995.

Official transfers, which fell in 1992 to $63 million, remained well above $100 million during the subsequent three years, mostly related to project financing. Loan disbursements increased gradually over the same period, rising from $71 million in 1992 to $105 million in 1995, led by concessional loans from the AsDB. As a result of these capital inflows, net foreign assets of the banking system improved from $52 million in 1992 to $86 million in 1995. The level of gross reserves of the banking system rose in tandem with imports such that it fluctuated about four months of imports.

a. The trade account

The value of exports is estimated to have grown by 16 percent in 1995, representing a volume growth of 13 percent. While this was still close to twice the real GDP growth, it was much lower than the average growth rate of nearly 40 percent per annum during the last three years. The slowdown was mainly attributed to lower wood and motorcycle exports.

Exports of logs remained at about the 1994 level in volume terms. However, the unit value declined substantially owing to the sharp decline in the quality of logs. This in part reflected the growing share of soft woods cut in connection with the clearing of areas for hydropower project construction; strict quotas on logging as well as on exports remain in place for environmental reasons. The value of semi- and finished-wood products rose, however, as more wood was processed domestically, raising the value added of exports, and partly compensating for the lower quality of wood. Exports of motorcycles declined in 1995 because increasing quantities were exported from Thailand directly to Vietnam and China using the sea route, and partly because the neighboring countries set up their own assembly plants. The drop in car re-exports from $14.5 million in 1993 to zero in 1995 in turn reflected a ban on car imports from the Lao P.D.R. imposed by the Yunnan province of China in December 1994. About 500 to 600 cars were initially stock piled in the border areas. However, the traders managed to sell off most of this inventory to domestic as well as to foreign markets in 1995.

Coffee exports, on the other hand, increased sharply from $3.1 million in 1994 to $21.3 million in 1995. This reflected the destocking of coffee beans in response to higher prices and increased production. The unit value of coffee exports increased much faster in 1995 than the world prices as contracts were made in advance so that Lao's export unit values would follow the world prices with a certain lag. Agricultural product exports remained strong in spite of the flood in the second half of 1995—the flood affected the autumn crops with a likely adverse impact on exports in 1996. Forest products declined somewhat in 1995, accounting for about 10 percent of the total. Most of the agricultural and forest products were exported to Thailand and Vietnam. Garment exports remained on its strong growth path, partly facilitated by large foreign investments in this area.

The Lao P.D.R. generated 1,080 GWH of electricity in 1995 from an installed capacity of 200 MW from Nam Ngum 1, Selabam, and Xeset. Domestic consumption accounted for about 310 GWH, with the remaining exported to Thailand. As the overall level of electricity generation in 1995 was lower than in 1994, when the Lao P.D.R. had steady rain falls throughout the whole year, the surplus available for export was reduced. 1/

After growing rapidly during the last few years, recorded imports in 1995 declined marginally in volume terms, or rose only by 4.1 percent in value terms. Imports of consumption goods, which grew by 45 percent on average per annum during 1991-94 increased by only 2 percent in 1995, owing to restrictions imposed on the availability of foreign exchange in the middle of the year. However, a large portion of import demand was believed to have been met through unrecorded imports, shown up in the unusually large errors and omissions. Imports of investment goods, however, remained buoyant reflecting domestic economic activities and foreign investments, especially relating to hydropower projects.

Imports of raw materials for garments increased by 30 percent while parts for motorcycles declined by 60 percent, both reflecting the export performance in 1995. Imports of gold and silver declined in 1995, also affected by restrictions imposed on the availability of the foreign exchange. Limited amounts of electricity were imported from Thailand and Vietnam in the North to supply power in remote areas closer to these countries.

The magnitude of unrecorded imports through border trade is estimated at 10 percent to 15 percent of the recorded imports. Since the border trade involved not only imports of commodities but currencies and some exports, a large part of total border trade was not captured in the banking system nor in the national incomes accounts. In this respect, those captured indirectly in the errors and omissions of the balance of payments represented only a small fraction of total unrecorded imports.

b. Services and transfers

Net nonfactor service receipts declined in 1995, after reaching a peak in 1993, with increased payments for travel and project related services. Services receipts were dominated by travel, followed by payments by embassies and international organizations, and transportation. On the payments side, project related services payments further increased in 1995 to $30.2 million. Together with travel related payments, they accounted for more than 80 percent of total services payments.

Net factor income showed a similar pattern as non-factor services, declining in 1995 after reaching a peak in 1993. Repatriation of income generated from foreign direct investment and interest on official foreign borrowing accounted for 84 percent of total factor payments.

Private transfers doubled to $22 million in 1995 from $10 million in both 1993 and 1994. As almost 40 percent of the total was remitted during the last quarter, the increase may have partly reflected the higher returns on domestic currency denominated assets which hovered between 16-19 percent during the fourth quarter while the exchange rate remained stable. Reflecting the overall global trend, grants declined from a total of $124.7 million in 1994 to $109.3 million in 1995. Bilateral grants still accounted for 82 percent of total official transfers, with Japan remaining the far most important donor country followed equally by Germany, Sweden, and France. Japan also provided program grants in the form of commodity aid.

c. The capital account

Loan disbursements during 1995 rose sharply compared with those of the previous few years mainly on account of the sharp increase in AsDB loans. The latter provided loans of $15 million under the Agricultural Sector loan, $12 million under the Fourth Road improvement project, $10 million for the Nam Song Hydropower project, and about $21 million for various basic infrastructure building projects. The World Bank also provided a total of $27 million (all IDA loans). 1/ A large share of the IDA loan was in connection with the highway improvement project. Other multilaterals included the Nordic Fund and the International Fund for Agricultural Development.

Foreign direct investment rose sharply in 1995 to $84 million after a drop to $43 million in 1994 from $78 million in 1993. The drop in 1994 reflected the significantly smaller privatization proceeds and capital inflows associated with endowments for establishing foreign banks in the Lao P.D.R. In 1995, the sharp increase reflected the foreign direct investment in hydropower projects, especially in Nam Theun-Hinboun, Houay Ho, and Nam Theun 2. Although the Nam Theun 2 project is still undergoing a feasibility study, about $25 million is estimated to have been spent on preliminary construction and assessment work.

Since 1988, the authorities have approved a total of 587 foreign direct investment projects valued at $5.6 billion. Of these projects, 76 percent was hydropower related, followed by hotel/tourism (7 percent), oil (6 percent), and industry/handcraft (3 percent). Foreign direct investment approvals is estimated to have declined in 1995 from the previous year with the strengthened assessment and monitoring of foreign investments by the Lao authorities introduced in the middle of the year. This tightened grip on the approval of foreign investments will be loosened once internal assessments of past foreign direct investments have been completed.

d. International reserves

Gross reserves of the banking system rose in tandem with imports such that the former in months of imports remained between 3.2 (in 1991) and 4.2 months (in 1993) during 1991-1995. Much of the increase in official reserves in 1993 was due to the required capital deposits of new commercial banks, 90 percent of which can be drawn by the banks at the time of commencing of operation, as noted earlier. Official reserves of the BOL on the other hand, declined in 1994 to 1.3 months of imports, but recovered to 1.9 months of imports in late 1995 (Table 8).

3. Regional issues

The Lao P.D.R.'s most important trading partner remains Thailand. Imports from Thailand as percent of total declined only marginally from 52 percent in 1991 to 48 percent in 1995. Japan, Vietnam, Singapore, and China also remained important; these countries together accounted for another 24 percent of total imports. Exports to Thailand declined, however, from 66 percent of total in 1991 to 41 percent in 1995. At the same time, in line with the pickup in economic activities in Vietnam, the share of exports to the latter increased from 16 percent to 25 percent during the same period. Exports to France, the United States, and Russia also increased rapidly, together accounting for more than 13 percent of total exports (Table 20).

The prospects of the Lao P.D.R.'s trade is mixed. On the one hand, its trading arrangement with neighboring countries and the EU have had some set backs. The EU revoked the Generalized System of Preference accorded to the Lao P.D.R. on garments exports in 1995 after confirming that raw materials for textile and garments exports did not meet the minimum value added criteria. In addition, a greater share of trade between Thailand and China, and between Thailand and Vietnam, is taking place through the sea routes. In addition, with Vietnam establishing more assembly plants for light manufacturing industries, the scope for exports or re-exports from the Lao P.D.R. is diminishing. On the other hand, large foreign investments in the past are beginning to yield results.

The Lao P.D.R. plans to join the ASEAN by 1997, and preparatory work is underway. In addition, a committee was set up in 1995 to consider Lao's application to the World Trade Organization (WTO). The Ministry of Commerce, jointly with the Ministry of Finance and the Ministry of Foreign Affairs, is preparing proposals on the trade regime and tariff structure in connection with the WTO membership. A plan is expected to be completed in early 1996.

4. External debt

At end-1995, the Lao P.D.R.'s external convertible currency debt is projected to amount to $0.7 billion (Table 29), while debt incurred through the Council of Mutual Economic Assistance (CMEA) is valued at $1.4 billion at the official exchange rate of the Central Bank of Russia of TR 0.59 per U.S. dollar. 1/ Total debt is equivalent to 120 percent of GDP, or in net present value terms, to about 52 percent of GDP and 207 percent of the exports of goods and non-factor services. About 94 percent of convertible debt is owed to multilateral creditors. The main multilateral creditors are the AsDB ($280 million) and IDA ($267 million).

5. Exchange and trade system

Before early 1995, the official exchange rate used to be determined by the Central Bank and took close account of movements in the parallel market. In response to rising inflation and an exchange rate that came increasingly under pressure, the official exchange rate was abolished in September 1995. Since then, the rates have been set by commercial banks according to market forces, and the nominal commercial bank and parallel market exchange rates have been stable at about KN 920 and KN 940 per U.S. dollar, respectively. 2/

The Lao P.D.R.'s trade regime is free of any restrictions. Any individuals or ventures can obtain an import-export license subject to meeting minimum requirements established to safeguard the trading system. Import prohibition is imposed on narcotics, and defense related and national heritage items. Special permission is required only for medicines, woods/timber, and sport/hunting guns.

The tariff structure has been further simplified in February 3, 1995 to 6 main tariff lines, i.e., 5, 10, 15, 20, 30, and 40 percent. Special tariff rates have been applied to vehicles (50, 80, 100, 150 percent), cigarettes (60 percent), and beer (80 percent).

Lao People's Democratic Republic: Recent Economic Developments
Author: International Monetary Fund
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