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p. 19 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia Cambodia Indonesia Lao People's Democratic Republic Malaysia Myanmar Philippines Singapore Thailand Viet Nam South Asia Central Asia The Pacific III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Lao People's Democractic Republic

The country maintained relatively stable macroeconomic conditions in 2002, although the Government's revenue collection was lower than target. Several reform efforts have moved forward, particularly in the financial sector, though more are needed. Economic growth in 2003 is expected to be favorable due to an expected significant rebound in FDI.

Macroeconomic Assessment

The pace of economic growth in the Lao People's Democratic Republic (Lao PDR) remained broadly stable in 2002. GDP growth was 5.8%, little changed from the previous year (Figure 2.8). Agriculture, which employs an estimated 80% of the workforce and accounts for about half of GDP, expanded by 4.0%. Industry remained the fastest growing sector—with construction and garments playing a key role—expanding by 9.8%. The services sector, which accounts for a quarter of the economy, grew by 5.8%. Tourism continued to play a major role, contributing both to GDP growth and the balance of payments. Income from tourism has increased steadily since the mid-1990s.

In FY2002 (ended 30 September 2002), the Government had an overall budget deficit of 8.3% of GDP, mostly financed by grants and external concessional loans. Revenue collection fell short of its target by about 10%. Fiscal decentralization, in a context of insufficient institutional capacity, impeded revenue mobilization. More public sector resources were allocated to the social sector, with the share of expenditures for education and health increasing from 11.4% in FY2001 to 19.1% in FY2002.

The acceleration in inflation in the second half of 2002 is of some concern. For the year as a whole, inflation increased to 10.6%, from 7.8% in 2001. The kip depreciated by 13% against the dollar. The spread between the official and market exchange rates remained at about 2%.

On the external front, electricity from hydropower plants, garments, and wood products were the leading exports. The trade deficit decreased to $198.7 million from $217.0 million in 2001, while the current account deficit decreased to about 5.6% of GDP from 6.9% over the same period. Foreign exchange reserves strengthened in 2002 and were sufficient to cover 3.5 months of imports of goods and services at year-end.

The value of new foreign investment projects approved in FY2002 rose, attributed largely to a gradual recovery in developing Asia and improved investment conditions domestically. In terms of external debt, approximately half of it is owed to the Russian Federation. This debt is on the books at an unrealistic exchange rate and is not currently being serviced. The governments of the two countries have been negotiating rescheduling terms of the debt since 2000 and it is expected that this will lead to a significant reduction of the book value of the debt. The debt service ratio was still a manageable 16.6% in 2002.

Policy Developments

In recent years, the Government has made concerted efforts to reduce its fiscal deficit. It has had some success and inflation rates have fallen as a consequence. However, the fiscal deficit remains substantial, but is now almost entirely financed through grants and external borrowings, rather than through credit creation by the Bank of the Lao PDR (BOL), as happened in the past. The Government hopes to contain the fiscal deficit through enhanced revenue mobilization efforts, but current targets are still modest and more could be done to improve revenue performance in three main areas: tax and customs administration, cutting exemptions, and adopting a VAT. To be effective, these measures need a commitment to sustained implementation by the Government. Tight constraints on expenditures are needed to control the size of the fiscal deficit. In terms of the components of the budget, there has been an imbalance between capital and recurrent expenditures, as the latter have not been allocated sufficient resources. Continuing efforts have been made to address this imbalance, as seen by the declining share of capital expenditures, which used to account for more than 60% of total expenditures.

There was also an increase in social sector spending as a share of expenditures, in particular, health and education. However, there is still room for improvement to address recurrent expenditures and social sector priorities. In addition, further reform measures in public expenditure management are needed, including the improvement of budget planning and execution, treasury operations, and auditing.

The principal objectives of monetary policy are to limit inflation and to stabilize the exchange rate. BOL monetized the Government's budget deficit and this created inflationary pressure in 1998 and 1999. Consequently, as part of the program to reduce inflation, BOL stopped purchasing government bonds as a way to finance the budget deficit. Starting in mid-2002, BOL also strengthened control of credit growth at state-owned commercial banks (SOCBs).

Financial sector reform remains a priority for the Government, and it is in the process of undertaking these reforms with the support of ADB, IMF, and the World Bank. Although foreign banks and joint ventures operate in Vientiane, the financial system is now dominated by three SOCBs and the Agricultural Promotion Bank (APB). In the past, SOCBs focused on lending to SOEs, and a high proportion of these loans became nonperforming. Reforms will help the financial sector direct its lending to projects on the basis of commercial and credit considerations. It will also force SOEs to further commercialize their operations, reducing their reliance on easy credits from the SOCBs.

To prepare for restructuring the SOCB operations, the Government has implemented several measures. These include strictly applying regulations on loan classification and provisioning, ensuring external auditing, prohibiting lending to borrowers in default, and applying sector-wide ceilings on SOCB credit growth. Furthermore, bank supervision is being strengthened through on-site examinations and independent assessments of SOCB prudential reports. The Government is also committed to the improvement of rural and micro finance, as seen by the restructuring of APB to enable it to operate on a sustainable commercial basis. An operational diagnostic study and external audit for APB were conducted, and a corporate vision to guide the restructuring has been adopted.

Reforms are also under way in the SOE sector, including restructuring as well as tariff hikes for electricity and water. Domestic airline fares are also to be increased. The Government has plans to develop and implement specific action plans for each SOE, including sales of noncore assets.

In the area of private sector development, reforms to the foreign investment framework were carried out in 2002, including streamlining approval procedures for the establishment and operation of foreign investment and simplifying the regulations and procedures for establishing businesses. During the Foreign Investment Forum held in Vientiane in May 2002 and attended by more than 300 foreign investors, the Government stated its commitment to expand the private sector, including facilitating SME development and attracting FDI to assist in the sustainable development of natural resources.

In 1998, 39% of the population lived below the poverty line. Poverty is not evenly distributed, tending to be higher and more concentrated in the northern region. Although evidence suggests that economic growth has had a positive effect in reducing poverty, the gains that the poor might have expected to receive from economic growth have been diluted due to increased inequality. The National Poverty Eradication Program and the Poverty Reduction Strategy Paper, to be completed in 2003, are expected to include specific policies to tackle poverty. Prioritized action plans and implementation of these plans are critical if the Program is to be successful.

Outlook for 2003-2004

The outlook is generally favorable due to an expected significant rebound in FDI. New regulations to promote it and the strong government commitment to support private sector development should contribute to a more conducive environment for private investment. GDP growth is expected to pick up, reaching 6.5% in 2004. Exports are likely to be supported by growth of external demand over the forecast period, as developing Asia continues to recover. Imports are forecast to rise due to higher capital goods requirements. With higher imports, it is expected that the trade and current account balances in 2003-2004 will deteriorate. Tourism will continue to contribute positively to the economy and the current account, but not enough to bring the current account into surplus.

Inflation is expected to fall to 7.0% by 2004 and the exchange rate to remain broadly stable. The maintenance of macroeconomic stability and the continued implementation of reforms in various sectors are likely to contribute to sustainable economic growth in the country.

In the medium term, government revenues are expected to rise modestly, provided that reforms in tax collection continue and coordination with provincial tax authorities improves.

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