Lao People’s Democratic Republic: Joint IMF/World Bank Debt Sustainability Analysis 2008

This 2008 Article IV Consultation highlights that Lao People’s Democratic Republic’s (PDR) economy has performed well in recent years, owing to generally stable macroeconomic conditions and a rapidly expanding natural resource sector. Real GDP growth has averaged more than 7 percent since 2004. Growth is projected to reach 7½ percent in 2008, driven by similar factors as last year, as well as higher mining output. The medium-term outlook for Lao PDR remains positive, but hinges on sound development of the resource sector and other steps to strengthen competitiveness.

Abstract

This 2008 Article IV Consultation highlights that Lao People’s Democratic Republic’s (PDR) economy has performed well in recent years, owing to generally stable macroeconomic conditions and a rapidly expanding natural resource sector. Real GDP growth has averaged more than 7 percent since 2004. Growth is projected to reach 7½ percent in 2008, driven by similar factors as last year, as well as higher mining output. The medium-term outlook for Lao PDR remains positive, but hinges on sound development of the resource sector and other steps to strengthen competitiveness.

I. Introduction

1. The LIC DSA for Lao P.D.R. indicates that the country continues to face a high risk of external debt distress. The The public external debt service ratios are expected to remain relatively low, owing to the concessionality of most of Lao P.D.R.’s official external borrowing. However, the public external debt stock indicators are still well above the policydependant indicative thresholds, and could increase further depending on the macroeconomic performance and the concessionality of external borrowing.

II. Background and Assumptions

2. Lao P.D.R.’s external public and publicly-guaranteed (PPG) debt stock remains at elevated levels, but debt indicators have become more favorable in recent years, supported by strong economic growth, a more stable macroeconomic environment, and favorable external conditions. The total stock of external PPG debt in nominal terms was US$2.4 billion at end-2007, or 60 percent of GDP, down from 77 percent at end-2005 and 66 percent at end-2006. It also declined as share of exports of goods and nonfactor services, from an estimated 244 percent at end-2005 to 165 percent at end-2007. At these levels, Lao P.D.R.’s debt stock indicators are still significantly above the policy-based indicative thresholds (Figure 1.). However, debt service ratios remain below the indicative thresholds, reflecting the high degree of concessionality (see table below).

Figure 1.
Figure 1.

Lao P.D.R.: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, Baseline Scenario, 2008–28

Citation: IMF Staff Country Reports 2008, 350; 10.5089/9781451822632.002.A002

Source: Staff projections and simulations.

3. Around 70 percent of PPG debt in Lao P.D.R. is held by multilateral creditors (see table below), mainly the Asian Development Bank (AsDB) and International Development Association (IDA). Slightly more than 25 percent is held by bilateral creditors—mainly Russia, China, and Japan. New emerging market creditors are increasing their presence in Lao P.D.R., necessitating the government ensure appropriate concessionality from these lenders, given its current indebtedness. The remaining 5 percent is estimated to be external debt incurred by public entities on nonconcessional terms and guaranteed by the government, mainly for hydropower development and electricity generation, including to finance equity stakes. In addition, some of this debt reflects financing provided by multilateral and bilateral creditors to the government on concessional terms and on-lent to state enterprises on nonconcessional terms.

Lao P.D.R.: Stock of Public and Publicly-Guaranteed External Debt at End-2007

article image
Sources: Lao P.D.R. authorities; and IMF and World Bank staffs’ estimates.

Includes direct borrowing by or on-lent funds to state-owned enterprises on nonconcessional terms.

4. The size of domestic public debt is comparatively small. At end-fiscal year 2006/07, the stock of domestic public debt amounted to 1.8 percent of GDP. Total public debt, including both domestic and external, was at 62.6 percent of GDP.

5. Under the baseline scenario, the main underlying assumptions reflect the continued pursuit in Lao P.D.R. of sound macroeconomic and financial policies and structural reforms in support of growth and poverty reduction, and reduced external vulnerability (Box 1.).

Main Assumptions for the Baseline Scenario (2008–28)

  • Real GDP growth is projected to average 7½ percent a year during 2008–13, with a modest pick-up in nonresource sector growth (mainly from agriculture, light manufactures, and tourism and other services) and continued strong resource sector growth. Over the longer term, growth is projected at 7 percent a year, given an expected leveling off in resource sector growth, but a further rise in nonresource sector growth, including from a broader export base. Growth prospects are predicated on the maintenance of macroeconomic stability; implementation of envisaged financial, trade, and regulatory reforms; and improvements to public infrastructure and services, helping to raise productivity. Prices of key commodities are broadly in line with the current WEO assumptions. 1

  • The external current account deficit is projected to decline from 18–19 percent of GDP a year during 2008–10 to 8½ percent by 2013 and further to 1 percent by 2025. Over the medium term, resource project-related imports moderate, world oil prices stabilize, and new hydropower projects (with large exports) come on stream. In the long run, nonresource export and services growth also picks up, although staffs assume after reaching around 30 percent of GDP in 2015, total exports would decline to around 25 percent by 2025, then begin to rise again, based on a conservative forecast of mining output. However, nonresource export growth requires strengthened competitiveness and regional integration, through improving the investment climate, streamlining business regulation, and meeting trade commitments. The overall external position is expected to stay reasonably strong reflecting private capital and official inflows. However, foreign direct investment declines significantly starting in 2013, given fewer new mining and hydropower projects, but picks up again in the outer years as foreign investment in the nonresource sector overtakes that in the resource sector.

  • External financing is assumed to be largely on concessional terms.

    • Multilateral creditors: For 2008–09, projected loan disbursements (including existing loans) average around US$80 million. Thereafter, they are assumed to grow (in U.S. dollar terms) at 5 percent a year.

    • Bilateral creditors: For 2008–09, projected loan disbursements average around US$125 million a year. During 2010–14, they increase to an average of US$145 million in part to reflect new financing expected for electricity development (see below), but thereafter fall back slightly to an average of US$135 million.

    • Commercial creditors: Staffs assume that two-thirds of planned investment in Electricité du Laos’s (EDL) Power Development Plan 2007–2016 will be executed. One-half of the external financing requirement is assumed to be met through government on-lending to EDL’s of funds received from bilateral and multilateral creditors. The rest is assumed to be borrowed directly by EDL on nonconcessional terms, but guaranteed by the government. Finally, a small amount of nonconcessional borrowing is assumed for non-EDL related energy sector projects, as well as by non-energy related state enterprises.

  • Macroeconomic stability is underpinned by a moderate fiscal stance. The overall deficit is expected to stay in the range of 1–1 1/2 percent of GDP over the medium term, mostly financed externally (on concessional terms). Revenue would rise by about 3/4–1 percentage point to around 16 percent of GDP by fiscal year 2012/13 (October–September) on increased tax buoyancy and a broadening of the tax base. Resource revenue is projected to come down slightly and level off at around 3 percent of GDP by 2010/11, but driven increasingly by electricity output and exports. Grants would stabilize around 1.2–1.3 percent a years from 2008/09, based on the latest government projections. Expenditure would rise slightly over the medium term to around 18¼ percent of GDP—with about one-third as capital outlays.

1 Copper prices for 2010–13 are assumed to be higher than the current WEO assumptions, based on discussions with mine operators in Lao P.D.R. From 2010, the price per metric ton is kept constant at US$5,000.

III. External Debt Sustainability

6. Under the baseline scenario, external debt stock indicators will remain at elevated levels over the medium term, but are expected to decline below the relevant indicative thresholds within the projection period (Figure 1. and Table 1). The net present value (NPV) of public external debt is expected to decrease from 46 percent of GDP at end-2007 to 34 percent at end-2013, and to 14 percent of GDP by 2028, crossing the 30 percent indicative threshold by 2016. The debt service ratios (both as a share of exports and government revenues) are expected to remain well below the indicative thresholds for the entire projection period

Table 1

Lao P.D.R.: External Debt Sustainability Framework, Baseline Scenario, 2008–28 1/

(In percent of GDP, unless otherwise indicated)

article image
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.

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

Defined as grants, concessional loans, and debt relief.

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).

Lao P.D.R.: External Public Debt Indicators at End-2007

article image
Source: IMF staff estimates.

7. External debt sustainability is most vulnerable to real exchange rate and export price shocks (Tables 2a and 2b). In particular, real exchange rate shocks (including from shocks to the GDP deflator or the nominal exchange rate) have the largest impact on the NPV of debt-to-GDP as well as the NPV of debt-to-revenues ratios. 4 Compared to 2008, a onetime 30 percent nominal depreciation of the kip exchange rate relative to the baseline would raise the NPV of public external debt-to-GDP by 10 percentage points over the medium term, and it would only fall below the 30 percent threshold in 2021. Similarly, a decline in export value growth (including from commodity price shocks) in 2009–10, by one standard deviation below its historical average, would raise the NPV of external debt-to-exports by about 60 percentage points over the medium term before falling back below the threshold in 2021.

Table 2a.

Lao P.D.R.: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, Baseline Scenario, 2008–28

(In percent)

article image
Table 2b.

Lao P.D.R.: Sensitivity Analyses for Key Indicators of Public and Publicly Guaranteed External Debt, Baseline Scenario, 2008–28(continued)

(In percent)

article image
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.

8. Under an alternative scenario, Lao P.D.R.’s external debt situation could deteriorate if expected returns to large resource project-related investments (mainly hydropower) do not fully materialize (Figure 1. and Table 3.), especially given the nonconcessional nature of borrowing for this purpose. Assuming the volume of mining and hydropower exports is 25 percent below the baseline and the value of nonresource exports 10 percent below from 2009 onward, the NPV of public external debt-to-GDP ratio would only 4 The cross the 30 percent indicative threshold by 2019. 5 The achievement of other thresholds would be similarly delayed.

Table 3.

Lao P.D.R.: External Debt Sustainability Framework, Alternative (High Investment–Low Growth) Scenario, 2008–28 1/

(In percent of GDP, unless otherwise indicated)

article image
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.

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

Defined as grants, concessional loans, and debt relief.

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).

IV. Public Sector Debt Sustainability 6

9. The trajectory of public debt is expected to follow closely that of external debt, as much of public debt is from external creditors (Figure 2. and Table 4.). The NPV of public debt-to-GDP ratio is expected to decrease from 50 percent at end-fiscal year 2006/07 to 39 percent at end-2012/13, and to 16 percent by end-2027/28.

Figure 2.
Figure 2.

Lao P.D.R.: Indicators of Public Debt Under Alternative Scenarios, Baseline Scenario, 2007/08–2027/28 1/

Citation: IMF Staff Country Reports 2008, 350; 10.5089/9781451822632.002.A002

Source: Staff projections and simulations.1/ Most extreme stress test is test that yields highest ratio in 2017/18.2/ Revenue including grants.
Table 4.

Lao PDR: Public Sector Debt Sustainability Framework, Baseline Scenario, 2004/05–2027/28

(In percent of GDP, unless otherwise indicated)

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

Gross 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 excluding grants.

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

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