Lao People's Democratic Republic
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
13 Aug 1997
eISBN:
9781451822403
Language:
English
Keywords:
ISCR; CR; foreign currency; monetary policy; banking system; central bank; capital expenditure; exchange rate; financial system; treasury bill; banking sector; economic development
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This paper reviews economic developments in Lao People’s Democratic Republic during 1996. The paper notes that real GDP growth of nearly 7 percent was readied despite disappointing growth in the agricultural sector in the aftermath of the floods. It highlights that the significant reduction in inflation in 1996 was brought about despite significant hikes in food prices as a result of those floods. The paper also indicates how the 1995/96 budget contributed to the financial tightening needed after the 1995 surge in inflation.

Abstract

This paper reviews economic developments in Lao People’s Democratic Republic during 1996. The paper notes that real GDP growth of nearly 7 percent was readied despite disappointing growth in the agricultural sector in the aftermath of the floods. It highlights that the significant reduction in inflation in 1996 was brought about despite significant hikes in food prices as a result of those floods. The paper also indicates how the 1995/96 budget contributed to the financial tightening needed after the 1995 surge in inflation.

I. Introduction

1. For almost a decade, the Lao P.D.R. has been going through a profound transformation of its economy. The reforms—since 1989 supported by Fund arrangements—have had beneficial effects. The economy has been growing annually at 5-8 percent since the beginning of the 1990s, the macroeconomic conditions have been relatively stable, and market processes have been introduced in most segments of the economy. These trends broadly continued in 1996 (Table 1).

Table 1.

Lao P.D.R.: Selected Economic and Financial Indicators, 1992-96

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

Fiscal data are on a fiscal year basis (October-September).

Lending rates were liberalized in July 1995 and deposit rates in January 1996. The rates reported here are those quoted by the BCEL, the largest commercial bank.

Excludes debt to nonconvertible area; includes debt to the Fund (SAF and ESAF).

As a ratio of exports of goods and nonfactor services.

Average of buying and selling rate. Data for 1997 are end-April.

2. The first part of this document briefly highlights the main developments in 1996, complementing the previous Recent Economic Developments paper (SM/96/94) which gave a more complete overview of the period since 1992. Chapter II, “Income and Production” notes that real GDP growth of nearly 7 percent was reached despite disappointing growth in the agricultural sector in the aftermath of the floods. Chapter III, “Prices, Employment and Wages” notes that the significant reduction in inflation in 1996 (from 25 percent to 7-9 percent) was brought about despite significant hikes in food prices as a result of those floods. Chapter IV, “Public Finance” indicates how the 1995/96 budget contributed to the financial tightening needed after the 1995 surge in inflation. While the budgetary outcome was better than anticipated, it is also noted that the 1996/97 budget is facing some shortfalls that need to be addressed in the immediate future. Chapter V covers “Privatization” and points out that the divestiture of the state-owned enterprises is largely completed. The attention is now focusing on the commercialization of the 32 “strategic” state-owned enterprises (SOEs), a process started in 1996 which is to be carried through in 1997. Chapter VI, “Money and Banking” discusses the policy measures taken in 1996 to reduce inflation. It notes that the use of indirect instruments became the main method of monetary policy during the year. Finally, Chapter VII, “External Sector,” notes that the current account worsened somewhat in 1996, while overall balance of payments developments remained favorable. The commercial bank exchange rate remained stable during the first three quarters of 1996 and was subsequently adjusted in line with the movements in the parallel market rate.

3. The second part of the document contains four chapters focusing on specific issues of importance for the Lao P.D.R. Chapter VIII addresses the issue of medium-term fiscal sustainability. Chapter IX discusses the adoption of and refinements to the indirect monetary policy framework against the background of ongoing banking sector reforms. Chapter X analyzes the origins and current determinants of dollarization in the Lao P.D.R. and concludes that building credibility in policy making, in conjunction with banking sector reform, is the key to a lasting reversal. Chapter XI highlights the short-term costs and medium- and long-term benefits for the Lao P.D.R. from joining ASEAN and AFTA. Lastly, recent trends in inflation, comparing the old and the new CPI indices, are discussed in the Appendix.

II. Income and Production

A. Overall Developments

4. In 1996, real output grew by 6% percent, close to the 1995 rate of 7 percent. While the agricultural sector grew at a below-target rate of only 2¼ percent in 1996, owing to poor harvests (in particular, of rice) as a result of flooding in mid-year, output remained buoyant in the industrial and the services sectors, which grew at 17 percent and 8¾ percent respectively, slightly fester than in 1995 (Table 2).

Table 2.

Lao P.D.R.: Real GDP Growth, 1992-96

(In percent)

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Source: Data provided by the Lao authorities.

B. Developments by Major Economic Sectors

5. The share of agriculture (including crops, livestock, fishery, and forestry) in real GDP has gradually declined, white industry and services have expanded their share (Table 8 and Chart 1). In 1996, agriculture accounted for 52 percent of real output, down from 58 percent in 1991. Meanwhile, the share of industry (mining, manufacturing, construction, and the production of electricity and water) grew to 21 percent in 1996, up from 17 percent in 1991. The services sector (transportation, communications, wholesale and retail trade, and others) retained a share of 25 percent. Of the different sectoral developments, the recent expansion of production capacity of hydropower, mining, telecommunications, and tourism has benefited the most from foreign direct investment.

Table 3.

Lao P.D.R.: Consumer Price Indices, 1992-97

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Source: Data provided by the Lao authorities.
Table 4.

Lao P.D.R.: General Government Operations, 1992/93-1996/97

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

Includes revisions made in April 1997.

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.

Table 5.

Lao P.D.R.: Monetary Survey, 1993-96

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

Net credit to Government in 1994 included KN 14 billion of government bonds issued for recapitalization of state-owned commercial banks. Bad loans amounting to KN 14 billion were written off from the bank’s portfolios. Includes liabilities from borrowing under the structural adjustment facility and the enhanced structural adjustment facility.

Excluding bad loan write-off.

Broad money divided by reserve money.

Table 6.

Lao P.D.R.: Sources of Broad Money Growth, 1995-96

(Increase as percent of previous period broad money)

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Sources: Data provided by the Lao authorities; and staff estimates.
Table 7.

Lao P.D.R.: Balance of Payments, 1992-96

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

Includes short-term private capital and unrecorded imports.

Table 8.

Lao P.D.R.: GDP by Industrial Origin, 1992-96

(In billions of kip, at 1990 constant market prices)

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Sources: Data provided by the Lao authorities; and staff estimates.
CHART 1
CHART 1

LAO P.D.R. REAL GDP AND MAIN ECONOMIC SECTORS, 1992-96

Citation: IMF Staff Country Reports 1997, 068; 10.5089/9781451822403.002.A001

Source: Data provided by the Lao authorities.

6. Agriculture. Rice remains the most important crop although its share in crop production has declined (from 68 percent in 1991 to about 60 percent in 1996) (Table 9). Droughts and floods in recent years have hampered rice production. Farmers are increasingly turning to production of cash crops (including coffee, tobacco, and sesame seeds), an increasing volume of which has been exported to neighboring countries.

Table 9.

Lao P.D.R.: Output of Major Commodities, 1992-96

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

7. Forestry. The implementation of the hydropower projects in recent years has required clearing of forests in would-be-flooded reservoirs. Over the past few years, logging averaged about 400,000 - 600,000 cubic meters a year, some 80-90 percent from hydropower development areas. One-third to one-half of the log production is used domestically (mainly in the construction industry), the rest is exported. New machines have been imported to process timber more efficiently, and the country’s exports of timber have increased.

8. Industry. Manufacturing still accounts for the largest share of industrial output (70 percent in 1996), but mining, the production of electricity (both grew by 37 percent in 1996) and the supply of water (15 percent growth) expanded rapidly in 1996. The most noteworthy developments are:

9. Mining and quarrying. These activities consist mainly of the extraction of tin and gypsum, mostly for domestic consumption in the fast-growing construction sector. Recently, important lignite and coal deposits were discovered,1 and exploration for oil and gas has begun.

10. Manufacturing. Overall, this sector grew in 1996 at a rate comparable to that of 1995, with food manufacturing, wood processing, and garment production remaining the most important components. However, the garments industry lost its Generalized System of Preferences (GSP) status with the European Union (EU) in 1996, as a result of which the country’s garment production declined by 25 percent from its 1995 level. Ten enterprises, employing 3,000 workers closed their doors in 1996, while many of the other garment enterprises worked at 50 percent of their capacity. Negotiations are ongoing between the government and the EU to reinstate GSP status.

11. Electricity. The development of the country’s hydropower resources remains one of its key economic initiatives. The Lao P.D.R. has an estimated technically exploitable hydroelectric potential of 18,000 MW, of which less than 2 percent has been developed. Growth in electricity production was boosted by the heavy rainfall in mid-1996. About 60 percent of the total output was exported (to Thailand and Vietnam), generating approximately 10 percent of the country’s total export earnings. Meanwhile, domestic electricity consumption has been growing at 8-10 percent a year. Domestic demand for electricity is still concentrated in urban areas (with the largest consumption in Vientiane). Nationally, less than 20 percent of households are electrified. Domestic electricity is provided at subsidized rates. In 1996, the government signed an agreement with Cambodia to cooperate in supplying electricity to areas along the common border.

12. Services. Growth in this sector in 1996 continued to reflect expansion in transportation and communications, wholesale and retail trade, and tourism. Relating to infrastructure development in the country, construction services have also expanded but are not adequately measured in official statistics.

III. Prices, Employment and Wages

A. Price Developments

13. Based on the Bank of the Lao P.D.R. (BOL) consumer price index, the twelve month inflation rate declined from 25 percent in December 1995 to 7 percent in December 1996, averaging about 13 percent in 1996. Based on the CPI compiled by the National Statistics Center (NSC)—the official CPI since the beginning of 1997—the 12 month rate of inflation was 13 percent at the end of the year (Table 3). This new index is compiled on the basis of a more recent consumer basket of goods and services, as well as prices in several provinces.2 The divergence between the two inflation rates is almost entirely due to the broader coverage of the new CPI. The higher recorded inflation stems from developments in the Khammouane, Savannakhet, and Champassak provinces, where the price of rice rose considerably in the wake of the floods.3 As discussed in the Appendix, calculation of the CPI excluding the food component, points to a core inflation of only 6½ percent during the year. At end-March 1997 inflation was 12½ percent, still reflecting the aftermath of the food price increases.

B. Employment and Wages

14. There are no official statistics on unemployment and wage rates for the country as a whole. A survey in the Vientiane municipality, conducted in 1992 and repeated in 1994, showed an unemployment rate of 2.6 percent. About 50 percent of the unemployed had work experience. There is a growing shortage of skilled workers in the country, and demand for such workers (managers, professionals, and technicians) in the private sector has bid up their wages, which have reached levels comparable to those of the neighboring countries (Table 10). Meanwhile, foreign workers have filled the void. In 1996, about 11,000 foreign workers were employed in Lao P.D.R., nearly 65 percent in construction projects. Official estimates of average wages for foreign workers are not available.

Table 10a.

Lao P.D.R.: Wages by Economic Sector, 1992, 1994

(In kips per month)

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Source: Data provided by Ministry of Labor.
Table 10b.

Lao P.D.R.: Wages by Occupation, 1994

(In kips per month)

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Source: Data provided by Ministry of Labor.

IV. Public Finance

15. The Lao P.D.R.’s public finances have undergone dramatic changes since 1988. The general budget has been unified (1992), the tax system has undergone substantial innovations, the expenditure control system has been centralized, and expenditure discipline has been greatly enhanced. Together with improvements in the administration, these measures have put the Lao P.D.R. on the road to fiscal sustainability.4 The 1995/96 budget delivered a generally better than planned outcome (Table 4).5 The goals set for the 1996/97 budget maintained the trend toward consolidation.

A. The 1995/96 Budget

16. The government objectives for the 1995/96 budget—augment budgetary savings and reduce net domestic bank credit—were largely met. The current surplus, at 2¾ percent of GDP was ½ percent of GDP higher man originally budgeted, mainly stemming from higher than expected revenue collection and strict control over current expenditure. In contrast, the overall balance excluding grants (9 percent of GDP) was only marginally better than budgeted, because of higher-than-budgeted capital expenditure. In the end, grants were about KN 30 billion lower than budgeted, which left the deficit after grants at 5½ percent of GDP.

17. Revenue collection reached 13 percent of GDP (compared to 12½ percent planned), mainly because of favorable developments in nontax revenue. Tax revenue reached 10¾ percent of GDP. A new, comprehensive tax law came into effect in January 1996. Its highlights were a reduction in the profit tax rate from 60 to 35 percent, the introduction of ad valorem excise duties, a broadening of the income tax base accompanied by an adjustment of the rates, and an expansion of the turnover tax base with the introduction of two new rates. Tax inflows were very slow during the first quarter of the fiscal year, which prompted the government to take corrective measures. Timber royalty collection was stepped up, the urban land tax was increased from KN 8 to 30 per square meter, and excise duties on selected petroleum products were increased.6 In the end, income and turnover tax, excise duties and timber royalties exceeded the plan while there was a shortfall in profit taxes and trade taxes, the latter because of an unsold stock of cars held in customs warehouses. Nontax revenue, at 2¼ percent of GDP was KN 12 billion higher than originally budgeted. Dividend payments from SOEs and higher leasing revenues—partly the result of a higher exchange rate—were the main factors behind this outcome.7

18. Firm control over expenditure kept current expenditure at 10¼ percent of GDP, slightly lower than planned. The wage bill, at 4.8 percent of GDP, represented 47 percent of current expenditure. The wage bill increase over 1994/95 was under 15 percent, less than the average inflation in the fiscal year. The new decree on procurement was instrumental in ensuring improved control over spending for materials and supplies. Transfers also remained within the budget limits, despite high spending at the beginning of the fiscal year in the wake of the severe floods. Severance payments remained significantly below the original budget provision because voluntary departures were a minor fraction of total separations from civil service (2,700). With 800 new Wrings, the civil service was further reduced to 68,108 (Table 11).8 This signaled the end of the downsizing of the civil service as the government is now focusing increasingly on reallocation, retraining and selective hiring. A ceiling of 70,000 civil servants was announced for the remainder of this century.

Table 11.

Lao P.D.R.: Personnel and Salaries of Civil Servants, 1992/93-1996/97

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Sources: Data provided by the Lao authorities.

Data relate to beginning of fiscal year (October). Military personnel is excluded.

Excludes bonuses and other compensations.

Includes wages, salaries, and other compensations of military and nonmilitary personnel.

19. Capital expenditure, at 12¼ percent of GDP, was higher than budgeted, because the government bought a small airplane for official use. Foreign financed capital spending was roughly as budgeted, with project loans higher and project grants lower than originally budgeted. Capital spending on social sectors went up from 13½ percent of total capital spending in 1994/95 to 17½ percent, offset by lower spending on economic sectors (still nearly 70 percent).

20. As concessional foreign financing exceeded the deficit, government domestic debt could be substantially reduced. The banking sector’s net claims on the government were reduced by KN 15 billion while the government also reduced its debt toward the nonbank sector. Government deposits in the BOL increased by KN 14 billion mainly reflecting the release of the first tranche of the World Bank SAC III.

B. The 1996/97 Budget

21. Targets. The 1996/97 budget aimed to raise the current surplus to 3½ percent of GDP and reduce the overall deficit excluding grants to below 8 percent of GDP. Concessional foreign financing was expected to exceed the deficit, which together with the proceeds from the sale of Lao Telecom would enable the government to further build up deposits with the banking system. Revenue was targeted to increase by ½ percent of GDP, benefitting from the full-year effect of the tax measures taken in 1995/96 and the introduction of excise duties on electrical goods.9 Current expenditure was set to remain broadly unchanged at 10 percent of GDP. There was to be a shift to spending on education and health. Despite an adjustment in base salaries by about 12 percent to compensate for past purchasing power loss, the wage bill would remain below 5 percent of GDP. Capital expenditure was set to be guided by the Public Expenditure Review (PER) recommendations, with a further increase in spending on social sectors.

22. First six months. While expenditure has been broadly on track, revenue collection has been suffering from delays, stemming from a variety of factors. One reason is the continued lack of qualified personnel and computer equipment, in particular in the provinces. Fast improvements in the tax administration are becoming an urgent matter, to enable the authorities to keep pace with an increasingly sophisticated tax regime in a growing economy. Transitory factors of a technical nature are (a) the coming into effect of the Business Law, requiring re-registration of all companies. Only after registration can they register with the tax department and pay income taxes; and (b) a change in the practice of paying dividends, moving from quarterly payments to payments at the end of the financial year—which for most of the 32 SOEs is February-March. Finally, leasing receipts suffer from the feet that some leases have not been renewed and that some companies are feeing problems and therefore requested to be exempt from lease payments in 1996/97. The government is taking measures to meet the revenue targets by improving collection of timber royalties, increasing excise duties on selected petroleum products and introducing a stamp duty. As a test resort, nonpriority capital expenditure may be curtailed to achieve the overall deficit target.

V. Privatization

A. Overview

23. Divestiture of the “nonstrategic” public enterprises in the Lao P.D.R. has gained impetus since the early 1990s and is nearing completion. The focus is currently shifting to the commercialization of the remaining 32 “strategic” SOEs, eight of which are banks and the remainder mainly utility companies and the logging concerns. In 1996, IS enterprises were divested and commercialization of five selected SOEs was initiated. Plans for 1997 call for a start of the commercialization of the other strategic SOEs and privatization of the remaining 44 nonstrategic ones.

B. Progress in 1996

24. By 1996, most of the small and medium-sized SOEs and a considerable portion of the larger ones had been privatized. In 1996,15 of the remaining 59 nonstrategic SOEs were divested, totaling 2,000 staff (Annex II). Lao Telecom was by far the largest with 850 employees. In line with the strategy to retain partial ownership in the larger, more modem enterprises, after lengthy negotiations, 49 percent of the equity in Lao Telecom was sold in November to Thai investors for US$ 45 million, providing a substantial contribution to the country’s international reserves and the financing of the 1996/97 budget. The total value of SOEs sold in 1996 was US$47.2 million. Of these 15 enterprises, 5 were leased and the remainder were sold, mainly to domestic partners through management buy-outs.

C. Remaining Agenda

25. The 44 enterprises that remain to be divested are mostly small (with the exception of Lao Tobacco for which the government is rethinking its strategy) and most of them are located in the provinces. Management buy out or liquidation will be the dominant divestiture techniques.

26. In 1997, the government intends to finalize the commercialization of five selected strategic SOEs, Electricité du Laos (EDL), Nam Papa (Water), Postes du Laos, Industrie Pharmaceutique No.2, and Imprimerie Nationale (Printing). This is to be accomplished by (i) converting and registering them into public joint-stock companies; (ii) appointing Boards of Directors; and (iii) agreeing on performance plans setting out technical, commercial and financial objectives, and specifying performance improvement targets. In 1997, commercialization of the other nonbank SOEs will also start. Commercialization of these SOEs may in some cases involve a major financial restructuring. Both EDL’s and Nam Papa’s financial positions, for instance, have recently weakened reflecting EDL’s participation in large-scale projects on a debt basis and Nam Papa’s investment program. Such financial restructuring would have implications for the government budget. Responsibility for all aspects of privatization and commercialization was transferred to the State Assets Department (MOF) in the course of 1996. The Department is establishing a computerized data-base management system to monitor leases, state assets, and the performance plans of the strategic enterprises.

VI. Money and Banking

A. Banking System

27. The commercial banking system in the Lao P.D.R is dominated by eight state-owned banks, including an agricultural promotion bank. At end-1996, the largest of these banks, the Banque du Commerce Exterieur (BCEL), managed about 45 percent of the sector’s deposits and 30 percent of the loans. In addition to these banks, there are two joint-venture banks with foreign participation, six branches of Thai banks and one of a Malaysian bank (Public Bank).10 Only the state-owned banks have branches outside Vientiane. The BOL, the country’s central bank, has no branch network. The market shares of the three segments of the commercial banking system were as follows at the end of 1996 (in percent):

Share of Loans and Deposits

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B. Financial Sector Reform

28. Following the 1994 recapitalization of the state-owned banks, banking reform lost momentum, and the situation in the sector deteriorated slightly.11 Many reforms, to be implemented with technical assistance by the Asian Development Bank (AsDB) and the World Bank, were delayed owing to technical problems or difficulties in setting priorities. In 1996, reform was resumed with the implementation of new prudential regulations for commercial banks, including foreign exchange exposure limits, improvements in the BOL’s banking supervision capacity, and the introduction of a new accounting system for commercial banks. However, its implementation at the beginning of 1997 has been delayed by software and training problems. Delays have also been incurred in the external audits of the state-owned banks, delaying their planned restructuring. This restructuring is intended to reduce the number of banks, strengthen their balance sheets, and improve the quality of their services. A government working group issued a plan to reform agricultural lending policies. As part of this plan, commercial banks are no longer required to lend 10 percent of their deposits to the agricultural sector. In addition, the 1997/98 budget will contain the subsidy element involved in lending to the agricultural sector.

C. Monetary Developments

29. Following successful tightening in 1995, monetary developments in 1996 were slightly less favorable, with broad money increasing by 25 percent (compared to 16 percent in 1995). In particular, the first and fourth quarters of 1996 were expansionary with quarterly growth rates exceeding 10 percent (Tables 5 and 6).

30. Following a jump in credit to the private sector in the first quarter of 1996, the authorities managed to constrain this component of domestic credit. During the year as a whole, private sector credit grew by 20¾ percent. About 30 percent of the stock of commercial bank credit to the private sector at end-1996 was directed to agriculture, 24 percent to manufacturing, 20 percent to commerce, and 17 percent to construction.12 Credit to SOEs increased by 33½ percent during 1996, mainly due to higher than targeted disbursements in November and December, explaining part of the excessive growth in broad money at the end of 1996. In addition, net government deposits with the banking system decreased in December, in spite of a loan disbursement by the AsDB.

31. Reflecting a period of expansion of the banking system, monetization accelerated in 1991-94. However, little progress was made in 1995 and 1996. The income velocity of money (broad money including foreign currency deposits) declined from 15 in 1991 to 7¾ in 1994, and has remained fairly stable since.13 U.S. dollars and Thai baht circulate freely and the share of foreign currency deposits in broad money increased during 1995 from 30 percent to over 42 percent at year end, and peaked at 45 percent by March 1996, reflecting a loss of confidence in the domestic currency. As the exchange rate was stabilized, confidence in the kip increased, and the ratio declined to about 40 percent by December 1996.14 The economy is still largely cash based and progress in improving the payment system has been slow. Paying by check, however, has increased steadily during 1996 and this trend should be reinforced following the issuance of the decree on the use of checks in October 1996. New banknotes with denominations larger than KN 1,000 are scheduled to be issued in the third quarter of 1997. Taken together, these measures are expected to help reduce dollarization.

32. The BOL removed its guidelines on commercial bank kip lending rates in June 1995 and on deposit rates in January 1996. Nevertheless, interest rate movements have remained limited, reflecting lack of competition in the financial system. Real interest rates became positive with the decrease in inflation in 1996, though the premium for kip deposits over dollar/baht accounts was marked by the kip depreciations between October 1996 and March 1997. Also, although the spread between lending and deposit rates decreased somewhat (to about 8 percent for the BCEL), it remained large (Table 13).

Table 12.

Lao P.D.R.: General Government Revenue and Expenditures, 1992/93-1996/97

(In billion of kip)

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

Includes the revisions made to revenue in April 1997.

Mainly current expenditure

Table 13.

Lao P.D.R.: Interest Rates, 1992-96

(In percent; end of period)

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Source: Data provided by the Lao authorities.

In June 1995, the maximum lending rate was abolished. The guidelines on minimum deposit rate were abolished in January 1996.