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

Lao People’s Democratic Republic’s growth is expected to moderate but remain fairly robust, supported by large projects in train, strong mineral exports, and expansionary policies. The staff report for the Lao People’s Democratic Republic’s 2009 Article IV Consultation highlights economic developments and policies. The largest impact has been on the mining sector, but delays in hydropower projects are also evident. Inflation is expected to remain low and stable, assuming no significant pickup in commodity prices. However, overly expansionary fiscal and credit policies pose a risk to macroeconomic stability.

Abstract

Lao People’s Democratic Republic’s growth is expected to moderate but remain fairly robust, supported by large projects in train, strong mineral exports, and expansionary policies. The staff report for the Lao People’s Democratic Republic’s 2009 Article IV Consultation highlights economic developments and policies. The largest impact has been on the mining sector, but delays in hydropower projects are also evident. Inflation is expected to remain low and stable, assuming no significant pickup in commodity prices. However, overly expansionary fiscal and credit policies pose a risk to macroeconomic stability.

I. Introduction

1. The LIC DSA for Lao P.D.R. indicates that the country continues to face a high risk of debt distress. The high level of concessionality of official borrowing keeps debt service ratios relatively contained. However, public external debt stock indicators are expected to remain at or above policy-dependant indicative thresholds throughout half of the projection period under the baseline, and could increase further in the event of weaker macroeconomic performance or greater accumulation of nonconcessional debt. The global financial crisis has lowered growth prospects due to delays in investment projects and softer external demand, and the external position has weakened.4 The fiscal position is under strain, as are international reserves.

II. Background and Assumptions

2. Lao P.D.R.’s external public and publicly-guaranteed (PPG) debt stock remains elevated. Strong economic growth, appreciation of the kip, and favorable external conditions contributed to a decline in the debt ratio over the past few years—the stock of external PPG debt in nominal terms was US$2.9 billion at end-2008, or 53 percent of GDP, down from 81 percent at end-2005. Nominal debt stocks also declined as share of exports of goods and nonfactor services, from an estimated 241 percent at end-2005 to around 143 percent currently. The corresponding net present value (NPV) of debt at end-2008 was 35 percent of GDP or 91 percent of exports. Despite these improvements, Lao P.D.R.’s debt stock indicators are generally above the policy-based indicative thresholds (Figure 1). Debt service ratios, however, are below the indicative thresholds, reflecting the high degree of concessionality of existing debt.

Figure 1.
Figure 1.

Lao P.D.R.: Indicators of Public and Publicly-Guaranteed External Debt under Alternatives Scenarios, 2009–29 1/

Citation: IMF Staff Country Reports 2009, 284; 10.5089/9781451822649.002.A002

Source: Staffs’ projections and simulations.1/ The most extreme stress test is the test that yields the highest ratio in 2019. In figure b. it corresponds to a one-time depreciation shock; in c. to an exports shock; in d. to a one-time depreciation shock; in e. to an exports shock and in picture f. to a one-time depreciation shock.

Lao P.D.R.: External Public Debt Indicators at End-2008

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Source: IMF staff estimates.

3. Around 69 percent of PPG debt in Lao P.D.R. is held by multilateral creditors, mainly the Asian Development Bank (AsDB—39 percent) and International Development Association (IDA—23 percent). About 29 percent is held by bilateral creditors—mainly Russia, China, Thailand, and Japan.5 The remaining 2 percent of PPG external debt comprises 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. As new emerging market creditors increase their presence in Lao P.D.R., the government should ensure appropriate concessionality from these lenders, given its current indebtedness. This further underlines the need for the authorities to strengthen the capacity in debt management and develop a borrowing strategy to ensure that new debt is contracted with a view to maintaining debt sustainability.

Lao P.D.R.: Stock of Public and Publicly-Guaranteed External Debt at End-2008

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

Includes direct borrowing by state-owned enterprises on nonconcessional terms.

4. The size of domestic public debt is currently small, and comprises mainly treasury bills and bank recapitalization bonds. At end-2008, the stock of recorded domestic public debt amounted to 2.1 percent of GDP. Total public debt, including both domestic and external, stood at 55.2 percent of GDP. Increasing off-budget public investment by lower levels of government and quasi-fiscal operations will lead to a significant increase in the domestic debt this year. Over the medium term, in the absence of an increase in external donor assistance and/or fiscal adjustment, domestic debt is set to rise substantially. The baseline scenario assumes that sizeable budgetary deficits over the next few years will put an upward pressure on domestic debt, until fiscal adjustment leads to a stabilization of the domestic debt stock at around 8–9 percent of GDP in the medium and long term.

5. The baseline scenario is based on current policies. It incorporates the most recent outlook for global growth in the face of the ongoing global crisis. In 2009–11, growth would remain robust (averaging 6 percent), supported by large resource projects already under construction as well as the loose fiscal and credit conditions. Over the medium term, growth accelerates—some resource-related projects which had been placed on hold enter the construction phase, and structural reforms aimed at fostering greater private sector participation begin to take hold. As the transition to a market economy advances, private sector-led growth is enabled by a restructured and vibrant domestic financial sector and an improved business climate. External vulnerability is reduced as large resource sector projects start generating export receipts (Box 1).

III. External Debt Sustainability Analysis

6. Under the baseline scenario, public external debt stock indicators remain at elevated levels over the medium term, declining to the indicative thresholds only toward the middle of the projection period (Figure 1 and Table 1a). The net present value (NPV) of public external debt picks up slightly over the medium term before declining steadily to 20 percent of GDP over the longer term. Debt service ratios (both as a share of exports and government revenues) fall continually and remain below indicative thresholds throughout, despite falling concessionality.

Table 1a.

Lao P.D.R.: External Debt Sustainability Framework, Baseline Scenario, 2006–29 1/

(In percent of GDP, unless otherwise indicated)

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Source: Staffs’ simulations. 0

Includes both public and private sector external debt, excluding contingent liabilities.

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 PV of private sector debt is equivalent to its face value.

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

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

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 PV of new debt).

7. External debt sustainability is most vulnerable to a depreciation of the nominal exchange rate (Table 1b).6 In the same way that the sustained strong appreciation of the kip over the past couple of years served to bring the debt ratio down considerably, a 30 percent depreciation of the kip would lead to a sharp jump in the NPV of debt-to-GDP and debt-to-revenue ratios, which would remain above the respective debt stock thresholds through most or all of the projection period. Indicative thresholds (both related to GDP and revenue) would be reached only over the very long term. Lower export growth (by one standard deviation in 2010–11) would push the NPV of debt-to-exports up to double its baseline level over the first half of the projection period and in excess of indicative thresholds throughout.

Table 1b.

Lao P.D.R.: Sensitivity Analysis for Key Indicators of Public and Publicly-Guaranteed External Debt, 2009–29

(In percent)

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Source: Staffs’ projections and simulations.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), noninterest 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. Debt dynamics are considerably worse under an alternative scenario in which key variables are at their historical averages. This is largely driven by the fact that this scenario assumes that FDI remains at the historical average (2.7 percent of GDP), compared to the medium-term baseline assumption (8.1 percent of GDP between 2009–14), implying substantial additional debt financing. In case of a significant decline of FDI, all debt indicators would rise steadily over the projection period and remain more than 50 percentage points above indicative thresholds. However, the comparatively optimistic baseline scenario is justified by the positive structural changes to the economy and significant improvements in policy achieved over recent years.

9. Lao P.D.R.’s external debt dynamics are highly sensitive to assumptions regarding investment and performance of the resource sector. Large resource-related projects now account for some 10 percent of GDP, with this share expected to nearly double over the medium term. Under the baseline, the global crisis is assumed to delay the near-term investment pipeline by two years, but leave unaffected construction of future planned projects. In addition, profitability is expected to rebound in the medium term as global demand and prices strengthen. Under a less positive scenario, lower growth would lead to a deterioration in debt dynamics.

IV. Public Sector Debt Sustainability

10. Under the baseline, PPG debt is expected to rise over the medium term reflecting a deterioration of the fiscal position and rising quasi-fiscal liabilities (Figure 2 and Table 2a). In the absence of fiscal measures, revenue shortfalls—resulting from the global slowdown and the impact of the global crisis on mining profits—and higher expenditure (both on- and off-budget) lead to a large domestic financing requirement which cannot be met through a drawdown in government deposits. Domestic debt rises from 2 percent of GDP in 2008 to around 8–9 percent of GDP in the medium term and stabilizes at that level in the long term. As fiscal adjustment is pursued over the longer term—in part by constraining domestically financed development expenditure in the face of rising domestic debt—PPG debt declines to around 35 percent of GDP.

Table 2a.

Lao P.D.R.: Public Sector Debt Sustainability Framework, Baseline Scenario, 2006–29

(In percent of GDP, unless otherwise indicated)

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Sources: Lao P.D.R. authorities; and staffs’ 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.

Figure 2.
Figure 2.

Lao P.D.R.: Indicators of Public Debt Under Alternative Scenarios, 2009–29 1/

Citation: IMF Staff Country Reports 2009, 284; 10.5089/9781451822649.002.A002

Sources: Lao P.D.R. authorities; and staffs’ estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in 2019.2/ Revenues are defined inclusive of grants.

11. The NPV of the public debt-to-GDP ratio rises over the medium term before tapering off over the remainder of the projection period. The impact of the global crisis on growth and fiscal revenues drives the near-term debt dynamics. The impact of expiring grace periods and falling concessionality are offset by assumed fiscal adjustment, leading the NPV of debt service-to-revenue lower over the projection period.

12. Public debt ratios are particularly sensitive to a real kip depreciation over the medium term (Figure 2 and Table 2b). The impact is somewhat less over the longer term. A one-time 30 percent real depreciation of the kip exchange rate would raise the NPV of public debt-to-GDP and public debt-to-revenue ratios to 58 and 370 percent, respectively. The impact on the debt service-to-revenue ratio is relatively mild, leading to an increase to around 22 percent; however, this impact is more sustained over the longer term.

Table 2b.

Lao P.D.R.: Sensitivity Analysis for Key Indicators of Public Debt, 2009–29

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Sources: Lao P.D.R. authorities; and staffs’ estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.