Lao People's Democratic Republic
Selected Issues and Statistical Appendix
Author:
International Monetary Fund
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Publication Date:
12 Jan 2005
eISBN:
9781451822540
ISBN:
9781451822540
Language:
English
Keywords:
ISCR; CR; debt burden; SOE debt; stock indicator; GDP deflator; revenue effort
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This Selected Issues paper and Statistical Appendix for the Lao People’s Democratic Republic underlies debt sustainability analysis. Sensitivity analysis reveals that if the pace of economic reforms falters, the debt burden—high even in the baseline case—could become unsustainable. The low level of development and the high share of the subsistence agricultural sector limit the revenue collection capacity. Weak technical capacity and highly fragmented revenue administration are the main structural weaknesses affecting revenue performance.

Abstract

This Selected Issues paper and Statistical Appendix for the Lao People’s Democratic Republic underlies debt sustainability analysis. Sensitivity analysis reveals that if the pace of economic reforms falters, the debt burden—high even in the baseline case—could become unsustainable. The low level of development and the high share of the subsistence agricultural sector limit the revenue collection capacity. Weak technical capacity and highly fragmented revenue administration are the main structural weaknesses affecting revenue performance.

I. Debt Sustainability Analysis 1

A. Introduction

1. Lao P.D.R. has an elevated debt burden that places it in a high risk category among low-income countries. At end-2003 Lao P.D.R’s stock of public and publicly guaranteed (PPG) external debt, in NPV terms, was US$ 1.2 billion. This is high in comparison to standard macroeconomic indicators, comprising 59 percent of GDP, 218 percent of exports, and 534 percent of government revenues. Although, Lao P.D.R. is eligible for HIPC debt relief, the authorities have emphasized that they do not intend to seek 1 HIPC assistance (Box 1).

2. Most of Lao P.D.R.’s debt—about 70 percent of the nominal stock at end-2003—comprises concessional loans from multilateral creditors, primarily the World Bank and the AsDB. The biggest bilateral creditor is Russia, which accounted for almost 80 percent of the stock of bilateral debt at end-2003. State-owned enterprises (SOEs) account for a little under 5 percent of the debt-stock.

3. The stock of Russian debt at end-2003 is estimated at US$ 387 million, after applying a 70 percent upfront discount and an exchange rate of 0.6 roubles to the dollar. An agreement was reached between Lao P.D.R. and Russia in December 2003, which granted an NPV reduction of about 20 percent on the consolidated debt stock. The Lao authorities have subsequently approached Russia for more concessional terms, which would help ease the high debt service payments forecast for the near future.

4. While debt stock indicators are high, the medium-term debt service is manageable, provided economic reforms are maintained. This is particularly important for ensuring fiscal sustainability, as the debt service indicators on the fiscal side are at elevated levels.2 The baseline scenario presented in this paper makes three key assumptions: (i) exports and GDP continue to grow robustly, (ii) fiscal revenues rise as a percentage of GDP, and (iii) public borrowing as a percentage of GDP decreases over the medium-term, and the authorities maintain a high average level of concessionality in new borrowing. Even under such a favorable scenario the debt service requirements could put pressure on the government budget in the near term, with a risk of crowding out priority social expenditures. More concessional terms on Lao P.D.R.’s debt to Russia would help ease this constraint.

Lao P.D.R.’s HIPC Eligibility

Lao P.D.R. currently meets the eligibility criteria and fulfills all the conditions necessary to benefit from the enhanced HIPC Initiative. It is a PRGF-eligible and IDA-only country, with a GDP per capita of US$320 in 2003. The NPV of public and publicly guaranteed external debt (PPG) at end-2003, after the application of a stock-of-debt reduction on Naples terms on Paris Club debt and assuming comparable treatment by all other official bilateral and commercial creditors, would amount to about $1 billion, corresponding to an NPV of debt-to-exports ratio of 198 percent.1/ Thus the country is well above the 150 percent threshold required for HIPC under the exports criterion.2/

The Lao authorities have emphasized that they do not intend to avail themselves of HIPC debt relief. Their view is that the transactions costs of the HIPC procedure and possibly reduced access to bilateral and commercial inflows would outweigh the gains from debt relief in the medium-term.

1/ This figure is based upon the application of the HIPC DSA methodology. It differs from the debt-to-exports ratio shown in Table 1, for three main reasons First, instead of a common discount rate of 5 percent on all debt, the HIPC framework utilizes currency-specific discount rates. Second, it uses a three year backward-looking average of exports in the denominator, rather than current year exports. Third, it assumes an application of traditional debt relief (Naples terms). 2/ Lao P.D.R. does not qualify for HIPC debt relief under the fiscal criterion, since its revenue-to-GDP ratio is beneath the 15 percent threshold.

B. Baseline Analysis

External Sustainability

5. The baseline scenario reflects continuing economic reform and good policy implementation, allowing fairly rapid growth of GDP and exports, and continued fiscal reforms, leading to a fall in the public sector borrowing requirement over time. The main macroeconomic assumptions include (i) increases in real GDP averaging about 6 percent over the 2004–2019 period, driven in part by developments in the electricity and mining sectors3; (ii) increases in exports in US$ terms averaging over nine percent, driven in part by increases in electricity and mineral exports; (iii) a gradual reduction in the public sector borrowing requirement (including SOEs) from 6.6 percent of GDP in 2004 to 5 percent of GDP by 2019; and (iv) a grant element of between 40 and 50 percent for future public sector borrowing.

6. The debt stock indicators remain above indicative thresholds throughout the projection period, despite improving substantially over time (Table 1 and Figure 1). The NPV of debt-to-GDP declines from 58.6 percent at end-2003 to 37.8 percent in 2019. The NPV of debt-to-exports follows a similar path, declining from over 200 percent in 2003 to just under 150 percent by the end of the projection period.4 Once the construction phase of the NT-2 dam is completed in 2009, debt ratios are projected to improve, on account of falling current account deficits, and robust GDP and export growth.

Table 1.

Lao P.D.R.: External Sustainability Analysis of Public and Publicly Guaranteed External Debt, 2003–19

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Export growth is lower by 2 percent per annum from 2006. Real GDP growth falls to 5 percent by 2009 and stays at that level.

7. Debt service indicators suggest a more modest and manageable debt burden both in the short- and medium-terms. Public external debt service is projected to average about 9.5 percent of exports during the 2004–2019 period with the projected trajectory remaining relatively flat during this period (Table 1 and Figure 1). Generally the relatively low debt service to exports indicators reflect: (i) a stable and relatively high grant element on the debt stock resulting in a relatively low debt service requirement, and (ii) high export growth during the period when debt service requirements increase as a result of the end of grace periods.

Fiscal Sustainability

8. The baseline macroeconomic scenario (Table 2 and Figure 2) is premised on fiscal reforms to enable greater revenue-generation. In particular, it is assumed that tax revenues as a percentage of GDP rise from 11.3 percent of GDP in 2004 to 14.5 percent of GDP in 2019. This would allow the public sector borrowing requirement to fall over time, as described in the previous section, while allowing a steady increase in government expenditures in the social sectors, in line with the government’s poverty reduction strategy, to make the Millennium Development Goals more achievable.5

Table 2.

Lao P.D.R.: Fiscal Sustainability Analysis of Public Debt, 2003–19 1/

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Government debt, including domestic debt. Based on The Lao P.D.R. fiscal year (October–September).

No reforms or administrative gains; revenues as a percentage of GDP stay at 2004 level.

Table 2a.

Lao P.D.R.: Medium-Term Fiscal Projections (Baseline Scenario)

(In percent of GDP, unless otherwise specified)

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Fiscal year ending in September.

Excludes amortisation on short-term domestic debt.

9. Similar to the external analysis, the debt-stock ratios6 start at a very high level and remain elevated throughout, despite falling substantially over the period. The downward path of these ratios are due mainly to improving revenue performance on a steadily rising GDP base, and a falling public sector borrowing requirement.

10. The debt service-to-revenue ratio rises to close to 25 percent in the next few years, putting priority social expenditures at risk. Although grants will ease the servicing requirements to some extent7, any slippage in revenue reforms could lead to a compression of non-interest spending that may not be sustainable. The debt service-to-revenue ratio also underscores the importance of SOEs borrowing prudently to finance only commercially viable projects. In the near-term the debt service-to-revenue ratio is higher by 4–5 percentage points when SOE debt is included. If any of the SOEs were to have difficulty servicing their debt, it would add to the already high burden on the government’s budget.

Summary of Baseline Debt Sustainability Indicators

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Note: Figures in italics are under the indicative thresholds.

Threshold over which countries with similar evaluations of policies and institutions would have an at least 25 percent chance of having a prolonged incident of debt distress in the coming year. Lao P.D.R. lies within the bottom quintile of countries ranked by the World Bank’s Country Policy and Institutional Assessment Index (CPIA).

11. The baseline scenario assumes that the Russian debt is serviced according to the schedule agreed in December 2003. To the extent that the Lao authorities are successful in obtaining more concessional terms, that would reduce the pressure on the government budget, particularly in the near term. A rescheduling of the Russian debt closer to Naples terms could lower the debt service-to-revenue ratio by 1–2 percentage points per year between 2004 and 2010.

12. In the medium-term the debt service-to-revenue ratio falls to a more sustainable level, averaging about 17.5 percent between 2010 and 2019. This trajectory is due to steady improvements in revenue as a percentage of GDP. While the NT-2 project will boost revenues when it becomes operational, the improvement in debt service ratios reflects primarily sustained revenue reforms and prudent new borrowing.

The Effect of NT-2 on Debt Indicators

The NT-2 project will have a substantial positive impact on external public debt indicators. In 2010, US$ exports and real GDP are projected to grow at 27 percent and 11 percent respectively, with the commencement of electricity exports from the project. The relatively small increase in the public debt burden arising from financing the government’s participation in NT-2 is more than offset by the increases in exports and GDP.

The impact of NT-2 causes the NPV of debt-to-exports ratio to fall by about 25 percent, from 181 percent without the NT-2 project to 156 percent in 2010, and from 162 percent to 146 percent in 2019. The impact on the fiscal side is less pronounced, although still positive, because of the small impact of NT-2 on both public sector debt and fiscal revenues. The NPV of debt-to-revenue ratio falls from 364 percent to 355 percent in 2010 and from 242 percent to 233 percent in 2019.

C. Sensitivity Analysis

Alternative Macroeconomic Scenario

13. Sensitivity analysis is undertaken on the basis of an alternative macroeconomic scenario, in which economic reforms proceed only slowly (Tables 1 and 2, and Figures 1 and 2). Although the NT2 project and the Oxiana mines are still expected to have a positive impact in the alternative scenario, a slackening pace of structural reforms could lead to lower growth rates of GDP and exports in the medium term, and insufficient fiscal reform could lead to lower revenue generation compared to the baseline.8

14. The alternative macroeconomic scenario assumes lower export and GDP growth, and weaker revenue generation. The growth rate of exports is two percentage points lower than in the baseline scenario, beginning in 2006. GDP growth is similarly kept below the baseline from 2006 onwards, and flattens out at 5 percent per annum over the medium term. The VAT expected to be implemented in 2006/07 is not introduced, and administrative reforms such as the centralization of administration fail to gain hold. Under such a scenario tax revenues as a percentage of GDP are projected to stay at their 2004 level of 11.3 percent of GDP.

15. On the external side there is not much qualitative difference from the baseline. The NPV of debt-to-GDP ratio remains above the indicative threshold throughout, following the same declining path as in the baseline, but only reaching 41 percent in 2019 instead of 37.8 percent in the baseline. Similarly, the NPV of debt to exports declines after 2005 but falls to a ratio of 190 percent in 2019 instead of the 146 percent projected under the baseline scenario. The debt service burden remains manageable throughout under the alternative scenario.

16. On the fiscal side, the alternative scenario emphasizes the risk to the government budget, particularly over the near-term. The debt-service burden as a percentage of revenues is considerably higher. In particular, over the next few years the debt service-to-revenue ratio is 2–3 percentage points higher than the already elevated ratio of the baseline scenario, and the ratio does not fall below 20 percent even by the end of the projection period. If this scenario were to transpire, the fiscal envelope for social expenditures would be squeezed, greatly impeding the government’s poverty-reduction strategy and adversely affecting the attainability of the MDGs. The risk of debt-distress would also increase.

Bound Tests

17. The standardized shocks of the low-income DSA template may not be well suited for analyzing risks to Lao P.D.R.’s debt sustainability. For example, on the external side, a very large negative shock to exports in the first two periods only (as assumed in the template’s stress tests) seems implausible, because in 2005 the scheduled expansion of the gold mine and the opening of a new copper mine would add US$100 million to exports. It would seem more plausible and therefore more interesting to examine the effect of a gradual slowdown in the growth rate of exports in the medium term. However, for completeness, we also include tables showing the effects of standardized shocks (Tables 3a, 3b, 4a and 4b). These tables support the view that the main risk to the baseline on the external side is lower-than-projected exports, while the main risk on the fiscal side is poor revenue effort, leading to a deteriorating primary balance.

Table 3a.

Lao P.D.R.: External Debt Sustainability Framework, Baseline Scenario, 2003–2019 1/

(In percent of GDP, unless otherwise indicated)

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Source: Staff simulations.

Includes both public and private sector external debt.

Derived as [r − g − ρ(l+g)]/(l+g+ρ+gρ) times previous period debt ratio, With r = nominal interest rule; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. Fur projections also includes contribution from price and exchange rate changes.

Assumes that NPV of private sector debt is equivalent to its face value.

Current-year interest payments devided by previous period debt stock.

Table 3b.

Lao P.D.R.: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2003–19

(In percent)

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Source: Staff projections and simulations.

Exports values are assumed to remain permanently at the lower level, hut the current account as a shave of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels)

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Table 4a.

Lao P.D.R.: Public Sector Debt Sustainability Framework, Baseline Scenario, 2003–2019

(In percent of GDP. unless otherwise indicated)

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Sources: Country authorities; and Fund staff estimates and projections.

General government gross debt.

Gross financing need is defined as the primary deficit plus debt service pins the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Table 4b.

Lao P.D.R.: Sensitivity Analyses for Key indicators of Public Sector Debt, 2003–2019

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Sources: Lao P.D.R. authorities, and Fund staff estimates and projections.

D. Conclusion

18. Lao P.D.R. currently has a high stock of debt, placing it in a high risk category among low-income countries. The NPV of debt in relation to GDP, exports and government revenues are all at elevated levels. The country is eligible for HIPC debt relief, although the authorities have stated that they do not intend to avail themselves of the facility.

19. In the medium-term the debt service burden is manageable, but only if economic reforms—especially on the fiscal front—are maintained. Sensitivity analysis reveals that if the pace of economic reforms falters the debt burden, high even in the baseline case, could become unsustainable. The NPV of debt-to exports and debt-to-revenue would rise from the already elevated levels of the baseline scenario. The debt service-to-revenue ratio would also rise further, making it difficult to maintain or increase the envelope for social expenditures and putting at risk the government’s poverty reduction efforts.

Figure 1.
Figure 1.

Lao P.D.R.: External Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003–2019

(In percent)

Citation: IMF Staff Country Reports 2005, 009; 10.5089/9781451822540.002.A001

Source: Staff projections and simulations.1/ Export growth is lower by 2 percent per annum from 2006. Real GDP growth falls to 5 percent by 2009 and stays at that level.
Figure 2.
Figure 2.

Lao P.D.R.: Fiscal Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003–2019

(In percent)

Citation: IMF Staff Country Reports 2005, 009; 10.5089/9781451822540.002.A001

Source: Staff projections and simulations.1/ Fiscal revenues are assumed to remain at 11.3 percent of GDP.

II. Lao P.D.R.—Strategy For Revenue Mobilization9

A. Background

20. This paper assesses the recent revenue performance in Lao P.D.R. and outlines a strategy to address the decline in the revenue to GDP ratio since 1999/00.10 One of the paper’s conclusions is that the reduction in revenue was partly due to a number of external factors, notably a decline in timber royalties, which may not be easy to reverse. Nevertheless, slow progress in reforms also contributed, and revenue collections are below their long-run potential. An acceleration of reforms is necessary to bring revenue closer to its potential, but revenue goals need to be set realistically, given that more advanced reformers in the region have not yet been able to raise their revenue effort much higher than Lao P.D.R..

21. The main elements of the reform strategy proposed in this paper are:

  • Retain the introduction of a single rate VAT as the leading structural improvement in taxes.

  • Focus reform efforts on the centralization of the revenue administration to improve efficiency and to facilitate the introduction of the VAT. The centralization may require a more comprehensive reform of intergovernmental relationships.

  • Administrative reforms should continue to focus on large taxpayers, but this should be augmented over time by efforts to better identify medium-sized taxpayers, where the new private sector growth is most likely to have occurred.

  • Strict control should be maintained over tax incentives, to prevent erosion of the tax base.

Recent Revenue Performance

22. The revenue performance has been disappointing relative to the original expectation under the PRGF program. The program envisaged an increase in revenues by 2 percent of GDP (to 15 percent) between fiscal years 1999/00 and 2002/03. The original revenue gain was expected to be generated by the introduction of a VAT in 2003, and supporting administrative reforms in the interim. However, instead of rising, revenues remained flat, as a percent of GDP, in the first two years of the program, before falling by 2 percentage points of GDP in 2002/03 to just over 11 percent of GDP (Figure 1).

Figure 1.
Figure 1.

Lao P.D.R.: Revenue Performance 1989/99–2002/03

Citation: IMF Staff Country Reports 2005, 009; 10.5089/9781451822540.002.A001

23. The sharp decline in revenues in 2002/03 can be traced to a number of specific factors. Three factors in particular were important:

  • A sharp fall in timber royalties (1.0 percent of GDP). The drop is partly explained by the commencement of more stringent enforcement of an export ban on unprocessed timber, although weak government control over politically powerful groups involved in timber production, is also believed to have been a significant contributory factor.

  • A decline in profit tax (0.4 percent of GDP). A detailed analysis of the factors behind the decline was inhibited by data limitations, but it has been widely attributed to lower tax receipts from state-owned enterprises (SOEs). In the past, SOEs paid taxes despite low profitability. This situation changed in 2002/03, when reforms in the state commercial banks reduced lending to non-profitable SOEs, constraining their ability to pay taxes.

  • Lower non-tax revenues (0.5 percent of GDP). The latter reflected a combination of factors, including a decline in dividends from SOEs, and lower fees and charges, associated partly with the decline in tourism following the SARS outbreak.

24. However, the more general deterioration in the underlying revenue effort, reflects difficulties in addressing more-deep-seated structural weaknesses. Technical capacity of the revenue administration has remained weak due to a slow progress in administrative reforms. A decentralization initiative of 2001 impeded the reform effort and reduced incentives to collect revenue by provinces. A proliferation of tax exemptions in attempt to stimulate investments has further narrowed the revenue base. It is also now recognized that the original revenue objectives may have been too optimistic, as forging a consensus on reforms and of overcoming acute capacity constraints turned out to be more difficult than expected.

B. Revenue Collection Performance in International Perspective

25. International comparisons suggest that the revenue effort in Lao P.D.R. is below the long-run potential. To assess the potential, revenue and tax revenue ratios for a large group of countries were regressed on variables commonly used in the literature on modeling international differences in the revenue collection.11 Fitted values from the regressions indicate that both the revenue and the tax revenue ratio in Lao P.D.R. is around 6 to 7 percentage points below potential. Residuals from the regressions—which can be interpreted as a measure of the revenue effort corrected for differences in wealth, the level of development, and openness—are between the 20th and 30th percentile in the sample. The results suggest that the revenue collection was weak by international standards, even when taking into account different characteristics of the economy.

26. While the international comparisons are valuable in assessing a long-term revenue potential, they do not recognize all political and administrative factors influencing the revenue effort in the short- to medium-term. It is therefore useful to compare the revenue effort in Lao P.D.R. with other countries in the region at a similar level of political and economic development, and pursuing similar economic reforms.

27. While Lao P.D.R.’s revenue effort is lower than most of its neighbors, the discrepancy narrows markedly once agriculture is excluded from GDP (Table 1). Lao P.D.R., Cambodia, and Vietnam all rely heavily on subsistence agriculture. As noted above, the subsistence agriculture reduces the breadth of the tax base; the use of non-agricultural GDP may therefore be a better measure to compare relative revenue efforts in the region. For similar reasons, revenue from natural resources (oil in Vietnam and timber in Lao P.D.R.) have also been excluded. The results suggest that revenue effort in Lao P.D.R.—where the share of agriculture in GDP is the highest (around 50 percent)—does not compare unfavorably with its neighbors. Indeed, the ratio of tax revenues to non-agricultural GDP is broadly comparable to Vietnam and Thailand, and significantly higher than Cambodia.

Table 1.

Lao P.D.R.: Comparative Tax Structure in Selected Southeast Asian Countries

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Sources: Staff reports.

Excluding revenues from timber royalties for Lao P.D.R. and oil revenue for Vietnam.

28. The regional comparisons suggest that progress in the revenue collection needs to be projected cautiously. Nevertheless, progress can be made in closing the gap relative to the revenue potential through accelerating the process of revenue reform. The next two sections therefore discuss obstacles to reach the revenue potential and possible solutions to these problems.

C. Structural Causes of the Revenue Weaknesses

29. The main structural weaknesses are: (i) a weak technical capacity of the revenue administration; and (ii) a highly decentralized revenue administration, in which provinces have weak incentives to collect and remit revenue to the national budget. A tendency to emphasize promoting investment at the expense of the revenue collection has been an additional complicating factor.

Administrative capacity

30. The authorities have introduced a range of reforms in tax and customs administration, with technical assistance from the Fund and other international donors. In tax administration, the reforms have included the introduction of self-assessment and taxpayer identification numbers (TIN) for the largest taxpayers12—supported by a simple computer system—and the introduction of improved audit methods. A large taxpayer unit (LTU) has been established at the central level, although this effort was diluted as some taxpayers were subsequently relocated to provincial offices. In customs administration, positive steps included the modernization and streamlining of duty assessment procedures, the development of new valuation rules, and the introduction of a new computer system.

31. However, the revenue administration continues to be hampered by a number of technical difficulties. In the tax administration, the audit techniques have remained underdeveloped, and registration requirements for enterprises have remained limited, with no legal provisions for enforcing the use of the taxpayer identification number. These administrative shortcomings have facilitated tax evasion, especially for smaller businesses. There are indications that many of the medium taxpayers (especially in the tourism sector) exploit administrative loopholes by hiding in the presumptive tax system. In customs, the application of procedures is not uniform, and problems continue with the quality and timeliness of data generated by the reporting system.

Decentralization

32. Decentralization has weakened the system of revenue collection by fragmenting the administration of major taxes. Under the current system, the central government controls mainly tax revenues collected by the central large taxpayer unit and royalties.13 Other revenues are collected by provinces. Although provinces generating “revenue surpluses” are in principle required to remit the surplus to the center, they have in practice little incentive to do so. They also have a strong incentive to grant ad hoc tax exemptions in order to promote investment in their respective regions.

Tax incentives

33. Tax incentives are widespread, narrowing the revenue base. The law on promotion of foreign investment provides for significant reductions in customs duties and turnover tax to foreign companies. Foreign companies also benefit from the lower profit tax rate than domestic businesses. The law on domestic investments grants exemptions to businesses operating in certain regions and broadly defined sectors, significantly eroding the revenue base. Additional case-by-case profit tax relief is given to both the foreign and domestic enterprises.

34. Staff estimates suggest that revenue losses resulting from different structural factors is substantial, although precise estimation is difficult. Calculations of the revenue leakage in customs (Table 2) indicate that it ranges from 30 to 60 percent of the theoretical revenue. The paucity of data does not allow for the estimation of the leakage from other taxes.

Table 2.

Lao P.D.R.: Estimation of the Leakage at Customs

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Source: IMF Direction of Trade Statistics.

Project imports are estimated at 75 percent of capital expenditure.

The observed rate is the ratio of customs duty collection to the value of imports reported by the Customs Department in 2001/02. The notional rate is a weighted average tariff calculated from 2001/02 customs data. The observed rate is lower than the notional rate due to legal exemptions granted by customs.

D. Future Challenges and Strategy

35. Revenue mobilization is key to ensuring fiscal sustainability given Lao P.D.R.’s substantial expenditure needs and the existing debt burden. The authorities’ National Growth and Poverty Eradication Strategy sets out a strategy to achieve ambitious poverty reduction goals. Although the strategy is not fully costed, it is clear that additional resources will be needed to fully fund its key social sector goals. At the same time, the debt burden remains significant (see accompanying selected issues paper on debt sustainability). Debt sustainability analysis presented in this paper suggests that—given expenditure needs—a gradual increase in the revenue ratio to 13 percent in 2008/09 and to 14½ percent in 2018/19 is necessary to maintain fiscal sustainability.

36. Revenues from mining projects and the hydropower sector will fill only part of the need for additional revenue. Revenues from gold and copper mining projects by the Australian company Oxiana are projected to gradually increase raise revenues by 0.5 percent of GDP. Revenues from existing hydropower projects, notably Theun-Hinboun Power Company will likely rise by 0.3 percent of GDP after completion of a restructuring plan for the state-owned electricity company (EDL), and expiration of certain tax exemptions. Revenues from a new large hydropower plant Nam Theun 2 (NT2) are projected to raise government resources by an additional 0.5 percent of GDP shortly after the completion of the project in 2009/10.

37. In any event, revenues from these sources will be largely offset by a decline in customs revenues as a result of tariff reductions under the ASEAN Free Trade Arrangement (AFTA). Tariffs on almost all permitted imports from the region will be reduced to 0–5 percent over the period through 2008, and it is estimated that this will reduce customs duties by 0.7 percent of GDP over this period. The bulk of the net increase in revenues over the medium term will therefore have to come from reforms to broaden the tax base and improve revenue administration (Figure 2).

Figure 2.
Figure 2.

Lao P.D.R.: Factors Affecting Revenue Ratio

(cumulative impact)

Citation: IMF Staff Country Reports 2005, 009; 10.5089/9781451822540.002.A001

Tax Policy Reforms

38. The main tax policy change in the medium term should be the introduction of a VAT. The introduction of a VAT, if implemented effectively, will broaden the tax base—principally by reducing exemptions—and help consolidate reforms in tax administration. It is estimated that a standard rate of 10 percent rate would increase revenue by 0.6 percent of GDP (Table 3).

Table 3.

Lao P.D.R.: Estimation of Potential VAT Revenue

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Assumes that capital formation constitutes 20 percent of GDP.

Assumes 25 percent collection leakage.

39. The authorities have presented a proposal to the National Assembly to introduce the VAT in January 2007. The proposal presented to the National Assembly contains a number of welcome features. In particular, the VAT will be a consumption based tax with a single 10 percent rate and a zero rate for export with a limited number of exemptions. Some elements of the proposal may require further consideration. For example, the proposed threshold VAT taxpayers—KN 240 million or US$ 23,000—is set at a relatively low level, which may overstretch the authorities’ administrative capacity in the early phases of the VAT’s implementation. The proposal also contains a relatively complex regime for taxpayers below the threshold (it is based on gross profit and has multiple rates).

40. Preparations for the VAT will need to start soon, if the target of introducing the VAT by early 2007 is to be achieved. The first step should be for the authorities to publish the government’s proposal for the main parameters of the VAT and the modalities for its implementation. This would help launch a consultative process that would help inform the preparation of the VAT law, which should, on this timetable, be completed by end-2005. The plans for introducing the VAT will need to be closely coordinated with the strategy for centralizing the revenue administration, as the latter is critical for the VAT to proceed.

Customs and Tax administration reform

41. The development of a unified national customs administration is a key priority. In early 2004, the authorities developed a phased strategy to achieve this objective. The initial focus was on re-establishing central control over the seven main international checkpoints. Key steps in this process were to include enhanced supervision of the checkpoints by visiting headquarter teams, the transfer of authority over the staff at the checkpoints to the Customs Department, and the deposit of revenues collected into central government accounts. Work was to continue in parallel on the development of a proposal for a new national customs organization. Once control over the main checkpoints was established, the process was to be extended to the remaining checkpoints. Under the current timetable for the VAT, a fully centralized national customs service would need to be in place by 2006.

42. Improvements in the technical capacity of customs administration are necessary to support the main reforms. In particular, the existing operation of the computer system should be improved, post clearance controls enhanced, and the operations of the inspection division of the Customs Department strengthened. These measures would help ensure the uniform application of customs procedures by provinces and limit the revenue leakage in the short term.

43. Creating a strong national tax administration is also essential to improve the revenue performance. As with the reform of the customs service, efforts should initially focus on establishing control over the major provincial LTUs, while working on modernizing the organizational structure of the Tax Department. Control should then be gradually expanded over the remaining provincial LTUs, with the view to establishing a fully integrated national tax administration significantly in advance of introducing the VAT.

44. Technical capacity of the tax administration also needs to be strengthened. The main priorities are to improve the compliance of large taxpayers and to prevent taxpayers from hiding under the presumptive tax regime. For large taxpayers, the LTUs should enforce the compliance of non-filing and non-licensed companies, establish and implement a risk-based compliance file selection system for others, and improve the information management system. For all taxpayers, registration requirements need to be better enforced and business register should be enhanced to identify taxpayers hiding under the presumptive tax regime. To this end, the MoF should conduct a comprehensive assessment of taxpayers, preferably based not only on turnover, but also on employment or any other easily verifiable information.

45. The rationalization and strengthening of the framework for intra-governmental fiscal relations is likely to have an important bearing on the revenue reform agenda. The provinces are unlikely to cede control over revenues until such a framework is in place. The framework will need to define carefully the assignment of revenue responsibilities and instruments to different levels of government. A clear allocation mechanism for national revenues across provinces should also be established.

Tax incentives

46. Tax exemptions should be limited and other forms of investment incentives considered in the medium-term. Reducing the scope of exemptions will improve the revenue effort, and facilitate the implementation and enhance the efficiency of the VAT. Some progress was made in this area following the promulgation of the implementing regulations for Presidential Decree 01 (PD01) on tax incentives. In particular, the new implementing regulations provided for greater control over the policy of granting exemptions by the center, and a provision ring-fencing VAT from the current indirect tax exemptions. PD01 has recently been superseded by new investment laws, approved by the National Assembly in October 2004 but it remains to be clarified whether these laws will retain the key elements of PD01. A more general review of the investment incentive regime is needed as the current heavy reliance on tax holidays and exemptions is unlikely to be cost effective. If tax incentives are to be granted, a consideration should be given in this context to using more efficient incentives, especially those that allow for faster recovery of investment costs, such as investment allowances, investment tax credits, and accelerated depreciation.14

E. Conclusions

47. The revenue collection in Lao P.D.R. is below its potential, but is not unusually low by regional standards. The low level of development and the high share of the subsistence agricultural sector limit the revenue collection capacity. These factors need to be taken into account in projecting future revenue gains.

48. Weak technical capacity and highly fragmented revenue administration are the main structural weaknesses affecting revenue performance. In addition, tax incentives to promote investments hamper the revenue effort by narrowing the revenue base.

49. An increase in the revenue ratio is possible with the implementation of comprehensive reforms centered around the introduction of the VAT. The key reforms are the recentralization of the revenue departments and improvements in their technical capacity. The process of the introduction of the VAT should be used to advance the reform agenda in these two areas. A comprehensive reform of inter-governmental relations may be required for a successful implementation of the reforms. Technical assistance would be essential in making progress in both policy and administrative reforms.

ANNEX 1 International Comparisons of the Revenue Collection

The empirical analysis is based on a data set comprising key fiscal and macroeconomic variables for 149 countries from 1971–2001. A total of 2,797 observations are available. The revenue data are taken from GFS, with additional information compiled from statistical appendices to annual Article IV consultation reports (REDs and statistical appendices). Macroeconomic variables are taken from WEO (openness) and World Bank WDI (GDP per capita at 1987 PPP prices and share of agriculture in GDP). Results from a fixed-effects estimation for the panel are reported in Table 1. All variables have expected signs and are statistically significant, with an exception of per capita GDP in the regression explaining the revenue/GDP ratio. Residuals discussed in the text include individual effects estimated from the model.

Table 1.

Fixed-Effect Panel Model for Revenue and Tax Revenue Collection

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significant at 1 percent level.

significant at 5 percent level.

STATISTICAL APPENDIX

Table 1.

Lao P.D.R.: Real GDP by Industrial Origin, 1999–2003

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

Fund stall estimates differ from the official figures for 2003.

Table 2.

Lao P.D.R.: Real GDP Growth, 1999–2003

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

Fund staff estimates differ from the official figures for 2003.

Table 3.

Lao P.D.R.: Nominal GDP by Industrial Origin. 1999–2003

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

Fund staff estimates differ from the official figures for 2003.

Table 4.

Lao P.D.R.: Output of Major Commodities, 1999–2003

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Source: Data provided by the Lao P.D.R. authorities.
Table 5.

Lao P.D.R.: Consumer Price Indices, 2000–2004

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Source: Data provided by the Lao P.D.R. authorities.
Table 6.

Lao P.D.R.: Consumer Price Indices Components, 2002–2004

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Source: Data provided by the Lao P.D.R. authorities.
Table 7.

Lao P.D.R.: General Government Operations 1999/00–2003/04

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

In 2002/03 and 2003/04 the bonds were Debt Clearance Bonds issued to state bunks to settle budget obligations to contractors with NPLs.

In 2001/02 includes a transfer of $33 million from EDL to the government from the Theun-Hinboun Power Company refinancir

Table 8.

Lao P.D.R.: General Government Revenue 1999/00–2003/04

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates.
Table 9.

Lao P.D.R.: General Government Expenditures 1999/00–2003/04

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates.
Table 10.

Lao P.D.R.: Monetary Survey, 2000–2004 1/

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

Valued at current exchange rates.

Table 11.

Lao P.D.R.: Balance Sheet of the Bank of the Lao P.D.R., 2000–2004 1/

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

Valued at current exchange rates.

Table 12.

Lao P.D.R.: Summary Balance Sheet of All Commercial Banks, 2000–2004 1/

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

Valued at current exchange rates.

Table 13.

Lao P.D.R.: State Commercial Banks, 2000–2004 1/ 2/

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

Comprises Banque pour le Commerce Extérieur and Lao Development Bank.

Valued at current exchange rates.

Table 14.

Lao P.D.R.: Interest Rates, 2000–2004

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Source: Data provided by the Lao P.D.R. authorities.
Table 15.

Lao P.D.R.: Balance of Payments, 1999–2003

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

Includes debt service to official creditors and estimates for debt service to commercial creditors.

Table 16.

Lao P.D.R.: Composition of Exports, 1999–2003

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates.
Table 17.

Lao P.D.R.: Composition of Imports, 1999–2003

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

Estimates based on the assumption that 50 percent of total are consumption goods.

Includes gold for re-export.

Estimate included for unrecorded imports in 2000 due to weaknesses in customs data.

Table 18.

Lao P.D.R.: External Aid and Loan Disbursements. 1999–2003

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

Includes project related and general technical assistance.

Table 19.

Lao P.D.R.: International Reserves, 1999–2003

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Source: Data provided by the Lao P.D.R. authorities.
Table 20:

Lao P.D.R.: Debt Stock and Debt Service 1999–2003 1/

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

Debt service and the stock of debt are calculated on the basis of existing debt, and currently identified disbursements, disbursements from the Fund, the World Bank, and the AsDB.

Table 21.

Lao P.D.R.: Composition of Net Foreign Income. 1999–2003

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Sources: Data provided by the Lao P.D.R. authorities; and Lund staff estimates.
Table 22.

Lao P.D.R.: Composition of Net Services, 1999–2003

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates.
Table 23.

Lao P.D.R.: Domestic and Foreign Investment by Sector, 1999–2004

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Source: Data provided by the Lao P.D.R. authorities.
Table 24.

Lao P.D.R.: Domestic and Foreign Investment by Country, 1999–2004

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

Lao P.D.R.: Summary of Tax System as of July 31, 2004

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Source: Ministry of Finance.

References

  • Shah, A (Ed.), 1995, Fiscal incentives for investment and innovation, New York: Oxford University Press.

  • Tanzi, Vito, 1992, “Structural Factors and Tax Revenue in Developing Countries: A Decade of Evidence”, in Open Economies: Structural adjustment and Agriculture, ed. by I. Goldin and A.L. Winters (Cambridge, UK., and New York: Cambridge University Press), pp. 205–41.

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1

Prepared by Shekhar Aiyar, in collaboration with World Bank and Asian Development Bank staff.

2

The debt service indicators on the external side are not high.

3

The Nam Theun 2 (NT-2) hydroelectric power project is expected to commence exports in 2010. An Australian mining company, Oxiana, is scheduled to open a new copper mine next year and extend its existing gold mine over the next few years, boosting exports substantially.

4

Box 2 compares these debt stock indicators, and debt service indicators, to their indicative thresholds.

5

Non-interest expenditures rise by 2 percentage points of GDP over the projection period, from about 16 percent in 2004 to 18 percent in 2019. Assuming that population grows at 2 percent per annum, this is equivalent to an increase in dollar expenditures per person of about 7 percent per annum over the entire period.

6

As noted in Table 2, on the fiscal side public debt includes domestic debt (which is relatively small), and the analysis uses the Lao P.D.R. fiscal year rather than calendar years.

7

As Table 2 shows, the debt service-to-revenue ratio including grants remains at or just above 20 percent in the near-term, before declining over the medium-term.

8

The alternative scenario considered here is likely to be of more actual relevance than the standardized alternative scenarios of the low-income DSA template, which are premised entirely on historical patterns.

9

Prepared by Wojcicch Maliszcwski.

10

Fiscal years runs from October to September.

11

The explanatory variables used in the regression are: per capita GDP (to reflect a possibility that wealthier countries have proportionally higher revenues to support larger public sectors); the share of agriculture in GDP (a proxy for the level of development and the breadth of the tax base); and openness (defined as a sum of exports and imports of goods, to reflect an administrative ease of collecting revenues at the border). See Tanzi (1992) for a full discussion of “tax effort” regressions. See Annex 1 for specification details, data description, and results.

12

Out of a total of 63,000 taxpayers, the 600 largest payers account for 70 percent of the total tax collection.

13

The center collects approximately 45 percent of total revenues.

14

For empirical evidence on cost effectiveness of general and selective incentives, see Shah (1995).

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Cover IMF Staff Country Reports
Lao People's Democratic Republic: Selected Issues and Statistical Appendix
Author:
International Monetary Fund
Volume/Issue:
Volume 2005: Issue 009
Publisher:
International Monetary Fund
ISBN:
9781451822540
ISSN:
1934-7685
Pages:
69
DOI:
https://doi.org/10.5089/9781451822540.002
  • Figure 1.
    View in gallery
    Figure 1.

    Lao P.D.R.: External Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003–2019

    (In percent)

  • Figure 2.
    View in gallery
    Figure 2.

    Lao P.D.R.: Fiscal Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003–2019

    (In percent)

  • Figure 1.
    View in gallery
    Figure 1.

    Lao P.D.R.: Revenue Performance 1989/99–2002/03

  • Figure 2.
    View in gallery
    Figure 2.

    Lao P.D.R.: Factors Affecting Revenue Ratio

    (cumulative impact)

Figure 1.

Lao P.D.R.: External Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003–2019

(In percent)
Figure 2.

Lao P.D.R.: Fiscal Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003–2019

(In percent)
Figure 1.

Lao P.D.R.: Revenue Performance 1989/99–2002/03
Figure 2.

Lao P.D.R.: Factors Affecting Revenue Ratio

(cumulative impact)