Lao People’s Democratic Republic: Joint World Bank/IMF Debt Sustainability Analysis

The staff report for the 2007 Article IV Consultation on the Lao People’s Democratic Republic (PDR) explains economic performance. Growth is robust and increasingly reliant on large export-oriented mining and hydropower projects. The economic outlook is promising, but the outcome clearly depends on the government’s policy response to the emerging resource bonanza. The current fiscal regimes for the resource sector have several sound features, but some improvements are needed to align them to best international practices.

Abstract

The staff report for the 2007 Article IV Consultation on the Lao People’s Democratic Republic (PDR) explains economic performance. Growth is robust and increasingly reliant on large export-oriented mining and hydropower projects. The economic outlook is promising, but the outcome clearly depends on the government’s policy response to the emerging resource bonanza. The current fiscal regimes for the resource sector have several sound features, but some improvements are needed to align them to best international practices.

1. The debt sustainability analysis (DSA) conducted during the 2007 Article IV consultation discussions indicates that Lao P.D.R. continues to face a high risk of debt distress.1 The current DSA points to an improved outlook compared to the previous DSA. The stock indicators are expected to decline faster and the debt service burden is projected to be lower in terms of exports. Moreover, debt service ratios remain relatively low. However, despite these improvements, the debt stock indicators remain well-above the policy-based indicative thresholds and could increase further depending on future macroeconomic performance and the concessionality of external financing.

A. Background

2. Lao P.D.R.’s external public and publicly guaranteed debt (PPG) ratios have declined in recent years (Text Figure 1). While nominal debt stocks have increased, strong growth has led the nominal debt-to-GDP ratio to steadily decline since 2002. All debt service indicators reversed their upward trends in 2006, reflecting continued strong GDP and export growth helped by high commodity prices.

3. Despite these positive developments, Lao P.D.R.’s external public debt stock remains at an elevated level. The total external public debt stock amounted to US$2.4 billion (70 percent of GDP) at end-2006, with a net present value of US$1.7 billion. At these levels, Lao P.D.R.’s debt stock indicators are significantly above the policy-based indicative thresholds for countries with similar CPIA rating (Text Table 1).2 However, debt service ratios remain below the indicative thresholds due to a high degree of concessionality.

Text Table 1.

Lao P.D.R.: External Public Debt Indicators

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4. About 75 percent of Lao P.D.R.’s external public debt are concessional loans from multilateral creditors, primarily the AsDB and IDA (Text Table 2).3, 4 Debt to bilateral and commercial creditors amounted to approximately US$633 million. Traditional bilateral creditors include Russia and Japan. In recent years, neighboring countries, including China, Vietnam, and Thailand, are becoming increasingly active, although information is limited regarding their lending activities. Since the signing of the rescheduling agreement with Russia in 2003, Lao P.D.R. has not accumulated any external debt payment arrears.5

Text Table 2:

Summary of Public External Debt

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5. The size of domestic public debt is negligible. At the end of 2005/06, the stock of domestic public debt stood at around Kip 560 billion (1¾ percent of GDP).

B. Debt Sustainability Outlook

6. The medium- to long-term debt sustainability of Lao P.D.R. depends on the government’s choice of policies to deal with potentially adverse effects of the resource bonanza. The proactive scenario (baseline) assumes that policies are put in place in anticipation of adverse effects on the non-resource sector (such as greater appreciation of the real exchange rate-see Box 1).6 To examine the implications of an alternative policy response, staff have developed a reactive scenario, where policies are undertaken as the adverse effects materialize (Box 2). Under each scenario, standard stress tests are carried out to check the resilience of the debt outlook in the event of external shocks.

Macroeconomic Assumptions 2007–27

The assumptions in the baseline scenario are consistent with a proactive policy response to the recent increase in natural resource revenue. In particular, the government is assumed to save a large portion of resource revenue for future use, while pursuing fiscal consolidation of the non-resource budget. Moreover, improvements to the investment climate envisioned in the National Socio-economic Development Plan (NSEDP) are assumed to be realized.

Real GDP growth is projected to accelerate in the early years fueled by high investment demand in the resource sector, later stabilizing at around 6.5 percent increasingly supported by non-resource sector growth.

Inflation is projected to remain around the recent levels (4.5 percent) as the BoL’s enhanced set of market-based tools for conducting monetary policy helps to contain the monetary impact of external surpluses from natural resources.

The real exchange rate is expected to appreciate due to the resource sector boom, but only moderately.

Text Table 3.

Lao P.D.R. Key Macroeconomic Assumptions

(Proactive scenario)

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Export growth is volatile in the early years reflecting the mining output profile, commodity price changes, and the timing of the start of operations of the NT2 dam project. In the medium term, nominal export growth stabilizes at around 11 percent, increasingly driven by non-resource exports.

Import growth is projected to increase sharply in 2007-08 due to the dam construction projects, then to decline thereafter, stabilizing around 11 percent after 2012.

The non-interest current account deficit is projected to stabilize at around 1 percent of GDP from 2008 onward as construction-related imports decrease and electricity and non-resource exports increase. FDI is assumed to decline from an average of 13.9 percent of GDP in 2007-11 to 1.9 percent of GDP after 2012 as earlier levels were related to dam construction and mining projects that should be completed by that time.

Fiscal revenues are expected to increase from 12.7 percent of GDP in 2006 to around 13.5 percent of GDP in the long term, while total expenditures are assumed to remain roughly constant as a percent of GDP. As a consequence, the primary fiscal deficit is assumed to decrease from 3.7 percent of GDP in 2006 to around 1 percent after 2012.

External financing is assumed to be on highly concessional terms, with a grant element over 40 percent.

Reactive Policy Response (Alternative) Scenario

To examine the implications of a different policy response to the boom in natural resource revenues, the staff have also considered a reactive policy scenario characterized by higher expenditures and slower progress in structural reforms.

Under the reactive policy scenario the government spends all resource revenues, leading to a sharp increase in government expenditures. As a result, its net position with the banking system would remain unchanged. The BoL would take time in developing monetary management tools and inflationary pressures would emerge, exacerbating the appreciation of the exchange rate and adversely affecting the competitiveness of non-resource exports.

Efforts to enhance the business environment are projected to advance only gradually in this scenario, and SOCBs and SOEs continue to pose a fiscal risk and burden to the budget. GDP growth is projected to initially increase to nearly 8 percent, buoyed by higher consumption stimulated by government expenditures. Soon thereafter, however, non-resource exports would start to weaken, which could lead the BoL to loosen monetary policy in an attempt to counter declining activity and maintain consumption. The government is assumed to continue to borrow externally, while avoiding recourse to domestic financing. After an initial rapid growth, real GDP is projected to decelerate to 4-5 percent. Key assumptions of the reactive scenario are summarized in Text Table 4 below.

Text Table 4.

Lao P.D.R. Key Macroeconomic Assumptions

(Reactive scenario)

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C. Outlook for External Public and Publicly Guaranteed Debt

Proactive scenario (baseline)

7. The results of this DSA suggest Lao P.D.R. is still at a high risk of debt distress even with the proactive policy response assumed in the baseline scenario (Figure 1). However, the debt outlook is expected to improve in the projection period.

Figure 1.
Figure 1.

Lao PDR: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027

Citation: IMF Staff Country Reports 2007, 360; 10.5089/9781451822588.002.A003

Source: Staff projections and simulations.
Figure 1.
Figure 1.

Lao PDR: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2007-2027 (Continued)

Citation: IMF Staff Country Reports 2007, 360; 10.5089/9781451822588.002.A003

Source: Staff projections and simulations.
  • In the near term, debt stock indicators will remain at elevated levels, but they are projected to steadily decline to below the relevant indicative thresholds within the projection period. Lao P.D.R. had a high NPV debt-to-GDP ratio of 48 percent at end-2006, which, under the proactive scenario, is projected to decline substantially over time to reach below 20 percent by 2027, crossing the 30 percent indicative threshold by 2014 (Table 1). The NPV of debt-to-exports ratio is projected to decline from 135 percent to below 60 percent toward the end of the projection period.

  • The debt service ratios are expected to remain well below the thresholds. As a percent of exports or revenue, debt service during the entire projection period is expected to be at comfortable levels.

Table 1.

Lao P.D.R.: External Debt Sustainability Framework, Proactive Scenario (Baseline), 2007–2027 1/

(In percent of GDP, unless otherwise indicated)

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Source: Staff simulations.

comprehansive data on private sector external debt are not available.

Derived as [r - g - r(1 +g)]/(1 +g+r+gr) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = 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. For 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 divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the NPV of new debt).

8. The standard stress tests indicate that the Lao P.D.R.’s external debt outlook is fairly resilient to exogenous shocks under the baseline scenario (Figure 1 and Table 2). Except for the simulations based on historical averages, all stress tests lead to higher, but stabilizing ratios below the relevant thresholds. Under the historical trend simulation, the NPV of debt-to-GDP ratio and NPV of debt-to-export ratio would deteriorate to stay above the thresholds throughout the projection period, mainly because the historical averages incorporated little impact from the recent rapid development of mining and hydropower sectors, which are expected to improve Lao P.D.R.’s growth and export performance as well as its balance of payments and fiscal balance substantially in the medium term and beyond. Similarly, the debt service to exports ratio would worsen, although remaining below the thresholds.7

Table 2.

Lao P.D.R.: Proactive Scenario (Baseline), Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2007–27

(In percent)

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Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share 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.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Reactive scenario (alternative)

9. The risk of debt distress—already high in the proactive scenario—would deteriorate further under the reactive scenario (Figure 1 and Table 3). Although the debt stock indicators based on GDP and exports are still expected to decline over time, they would approach the relevant thresholds only toward the end of the projection period. The debt service burden in terms of exports, despite at a low level, would be higher than that under the proactive scenario. Finally, under the reactive scenario, the NPV of debt-to-revenue ratio would remain at an unsustainable level and the debt service burden in terms of government revenue would rise in early years, but stabilize at a higher level of around 20 percent toward the end of the projection period.

Table 3.

Lao P.D.R.: External Debt Sustainability Framework, Reactive Scenario (Alternative), 2007–2027 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 - r(1+g)]/(1+g+r+gr) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and r = 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. For 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 divided by previous period debt stock.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the NPV of new debt).

10. The standard stress tests under the reactive scenario further highlight the significant risk of debt distress in the event of exogenous shocks. All stress tests under reactive scenarios will lead the debt stock indicators to be well above the sustainability thresholds. The outlook on the fiscal side is more precarious as the NPV of debt-to-revenue ratio could rise to more than twice the threshold level. The stress tests will also cause the debt service indicators to rise significantly with the debt service to revenue ratio exceeding sustainable threshold (Figure 1 and Table 4).

Table 4.

Lao P.D.R.: Reactive Scenario (Alternative), Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, 2007–27

(In percent)

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Source: Staff projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share 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.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

Text Table 5:

Summary of Debt Sustainability Indicators under Alternative Scenarios

(In percent)

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D. Outlook for Total Public and Publicly Guaranteed Debt

11. Because the majority of public debt is to external creditors, the public debt trajectory will closely follow the external debt (Figure 2 and Table 5). Under the proactive scenario (Baseline), both the NPV of public debt-to-GDP and debt-to-revenue ratios (51 percent and 345 percent, respectively, at the end of 2005/06) are envisaged to fall steadily to 20 percent of GDP and around 120 percent of GDP, respectively, by 2026/27. The debt service to revenue ratio—which is currently relatively low due to high concessionality—is projected to decline to less than 7 percent by 2026/27.

Figure 2.
Figure 2.

Lao PDR: Indicators of Public and Publicly Guaranteed Debt, 2006/07-2026/27

(In percent)

Citation: IMF Staff Country Reports 2007, 360; 10.5089/9781451822588.002.A003

Source: Staff projections and simulations.1/ Most extreme stress test is “one time 30 percent real depreciation in 2007/08” a test that yields highest ratio in 2016/17.2/ Revenue including grants.
Table 5.

Lao P.D.R.: Public Sector Debt Sustainability Framework, Proactive Scenario (Baseline), 2003/04-2026/27

(In percent of GDP, unless otherwise indicated)

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

Gorss general government debt.

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

Revenues including grants.

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

Historical averages are for 2001/02-2005/06.