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Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Lao People's Democractic Republic

Continued macroeconomic stability was accompanied by moderate economic growth in 2001 as the benefits of past reforms became evident. Inflation was significantly lower than in previous years and the fiscal situation began to improve. The outlook is positive, with continued prudent macroeconomic management and potential large-scale investment contributing to the overall picture.

Macroeconomic Assessment

Economic performance in the Lao People’s Democratic Republic (Lao PDR) remained steady in 2001 in the face of slower global and regional economic growth. GDP growth was estimated at 5.5%, a decline from 5.9% in 2000. Slower export and agriculture sector growth and limited FDI offset the benefits of a substantial drop in inflation, greater macroeconomic stability, and a strong improvement in tourism.

Growth in 2001 was well balanced as agriculture, industry, and services all reported moderate rises in output. Agriculture, which employs around 85% of the population and accounts for about half the economy, grew at an estimated rate of 3.9% during the year. This represents a slowdown after several years of strong expansion, led by extensive investment in irrigation and increased (albeit informal) cross-border trade in agricultural commodities with neighboring Thailand. Industry remained the fastest-growing sector, with construction and garments playing a key role. The services sector, which accounts for about a quarter of the economy, also saw steady growth of around 6% in 2001. Tourism continued to play an important role, contributing both to GDP growth and the balance of payments. Tourism has strengthened steadily every year since the mid-1990s.

As a result of continued sound macroeconomic management, prices became more stable. Inflation was reported at 7.8% in 2001 (Figure 2.8), below the Government’s target of 10%. This represents a significant reduction from the very high inflation rates in 1998 and 1999 and is one of the lowest rates of price increases since the economy reopened to the outside world in 1986. The kip depreciated by 13.7% against the US dollar in 2001 from its level in 2000.

The external front was stable: the trade deficit remained constant at about 13% of GDP, while the current account deficit increased slightly to 7.2%. Exports remained firm at around $425 million. Leading exports included timber and wood products, electricity (from hydropower plants), and garments. Unregistered cross-border trade in agricultural commodities with Thailand was also significant. In 2001, foreign investment was estimated at $30 million, below the levels in previous years, which often exceeded $100 million a year. Foreign currency reserves remained steady in 2001 and at the end of the year were sufficient to cover 2.5 months of imports.

The Lao PDR is officially classified as a heavily indebted poor country, though official statistics overstate the seriousness of the country’s foreign debt problem. Approximately half the debt is owed to the Russian Federation. This debt is carried on the books at an unrealistic exchange rate and is not currently being serviced. The governments of the Lao PDR and the Russian Federation are renegotiating the terms of the debt, which will lead to a significant reduction in its book value.

Policy Developments

Until a few years ago, weak fiscal policy resulted in large fiscal deficits. In recent years, this issue has been partially addressed, though the fiscal deficit remains substantial at 8% of GDP. Current revenues amounted to around 15% of GDP in 2001 and total expenditures to around 23% of GDP. In the medium term—by 2005—the Government is committed to increasing its revenues to around 18% of GDP. It is also determined to increase the share of spending in the social sector relative to GDP. In 2001, the deficit was almost entirely financed through grants and concessional loans from abroad. This trend is expected to increase in the future, although with price stability, the Government may be able to finance its deficit through domestic bonds as well.

Despite the rise in government spending in recent years, further action is needed to improve the balance between capital and recurrent outlays. In fiscal year 2001, capital expenditures accounted for around 65% of the total. As a result, spending in the social sector (which relies heavily on recurrent expenditures) has suffered. Fiscal decentralization has also raised uncertainties about the role of the provinces in determining spending and in collecting revenues.

The inflationary bout of 1998 and 1999 was largely caused by the Bank of the Lao PDR monetizing the Government’s budget deficit. As part of the program to reduce inflation, the Bank stopped purchasing government bonds, effectively ending central bank financing of the budget deficit. The large volume of dollars and baht circulating in the country limits the role of monetary policy. Foreign currency deposits account for at least 75% of total liquidity and foreign currency is widely accepted for domestic transactions.

Finance sector reform remains a priority for the economy. Currently, the system is dominated by three state-owned commercial banks (SOCBs) and the Agriculture Promotion Bank, although foreign banks and joint ventures also operate, primarily in Vientiane. In the past, SOCBs focused on lending to SOEs and the percentage of nonperforming loans is quite high. The Government is in the process of reforming the finance sector, with the support of ADB, IMF, and the World Bank. SOCBs have largely stopped lending to the Government. This reform will help the finance sector direct its lending to projects on the basis of their economic efficiency and contribution to GDP growth. It will also force SOEs to further commercialize their operations, as it will reduce their reliance on easy credit from the SOCBs.

In 1998, 39% of the population lived below the poverty line, determined by an estimate of minimum caloric needs. Poverty is not evenly distributed: in the north, 53% of the population are poor compared with 12% in Vientiane prefecture. Evidence suggests that economic growth has had a positive effect on poverty reduction, not equitably though: between 1993 and 1998, while per capita income grew by 25%, the proportion of poor people dropped only by 7 percentage points. The gains that the poor might have expected to realize from economic growth have been reduced due to increased inequality. New investment will have to concentrate more on providing physical and social infrastructure and to adjust the macroeconomic policy environment so that the poor are able to better capture the benefits of growth.

Outlook for 2002–2003

The outlook for 2002–2003 is generally positive due to the anticipated economic recovery of the region and increased investment in the hydropower and mining sectors. GDP growth is expected to pick up, reaching 6.1% in 2003.

Recent efforts to reduce inflation have been successful and this downward trend should persist. With sustained prudent monetary policy, inflation should reach 6% in 2003. Several years of relatively low inflation should help stabilize fluctuations in the kip and may increase its use for domestic transactions. Exports are expected to increase by around 9% in both 2002 and 2003. Tourism is also likely to continue growing.

Both government revenues and expenditures are expected to rise modestly in the medium term, with revenues reaching around 15% of GDP by 2003, given ongoing reforms in tax collection and improved coordination with provincial tax authorities. Expenditures are forecast to rise to 22.8% of GDP by 2003. Further reforms in public expenditures should improve their quality, with a greater share going to recurrent expenses and human resources development.

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