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p. 28 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : Southeast Asia

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Lao People's Democratic Republic

Growth was robust in 2004 and, for the first time since mid-2002, inflation slowed to single-digit rates (late in the year). Over the next few years, investment in mining and hydropower projects is likely to support growth. While macroeconomic performance has improved, the country still needs, in particular, to mobilize revenues for essential social and development expenditures, implement banking and SOE reforms, and improve the private sector environment.

Macroeconomic assessment of 2004

Growth is estimated to have picked up to 6.5% in 2004, with a strong push from an 11.4% upturn in the industry sector as mining expanded. The dominant agriculture sector recorded only modest growth of 3.5%, hampered by lower than forecast dry-season rice production. Rice still accounts for the majority of agricultural production in the Lao People’s Democratic Republic (Lao PDR), but other crops, including maize, sesame, cotton, and tobacco, are expanding their shares. The services sector grew by 7.3%, partly on account of a recovery in tourist arrivals, which were 30% higher in the first 5 months of 2004 than the year-earlier period when the regional SARS outbreak and local security concerns kept visitor numbers down (Figure 2.8).

According to preliminary findings of the third Expenditure and Consumption Survey that was completed in 2004, the incidence of poverty, based on minimum food consumption of 1,983 calories a day, declined to 32.7% in FY2003 (ended 30 September 2003) from 39.1% in FY1998, partly as a result of economic growth in recent years.

The Government made some progress in strengthening its weak revenue base. Revenue collection, excluding grants, is estimated to have risen to 11.9% of GDP in FY2004 from 11.0% in FY2003. Over the same period, central government expenditures fell to 16.7% of GDP from 18.8%, and the overall fiscal deficit narrowed to 4.8% from 7.8%. Efforts were made to address an imbalance in public spending, reflected in an increase in recurrent expenditures (such as wages, transfers, and interest payments) to 8.4% of GDP in FY2004 from 7.8% in FY2003, while capital and onlending expenditures declined from 11.2% to 8.8%.

Growth in broad money (M2) stayed at around 20% for a second consecutive year. Apart from cautious lending practices by banks, the Bank of the Lao PDR issued bonds and took other steps to maintain monetary control. The price of imported gasoline shot up, but this had limited impact on inflation, which slowed from 15.8% in 2003 to an estimated 10.6% in 2004. Food prices, accounting for 46.2% of the CPI basket, were relatively stable. In August, inflation fell to 9.2%, the first time since June 2002 that it has been in single digits; it declined to 8.7% at year-end. The exchange rate was broadly stable in 2004.

Exports, driven by minerals, electricity, garments, and coffee, increased by 7.6% in 2004, and imports by 9.5%. The merchandise trade deficit widened to $144.8 million from $126.6 million, as did the current account deficit to an estimated 0.5% of GDP from 0.3% (excluding official transfers) over this period. The level of external debt stock was estimated at nearly $2 billion in 2004. However, given the concessional nature of most of the debt, the debt service ratio stayed at the manageable level of 9.4% of exports.

Macroeconomic policy developments

The Government, moving to address perhaps its greatest challenge--raising the revenues needed for social and economic development--committed to introducing a VAT by January 2007. However, there is a potential problem with a tax exemption for investment, which may erode the revenue base, depending on how incentives under new laws on domestic and foreign investment are implemented. In FY2004, revenue collection achieved an estimated 99.8% of target.

Some progress was also made in reforming the banking sector, with the cabinet approving a proposal to lower entry barriers and improve market access for foreign and private banks. (The proposal still has to be cleared by the National Assembly.) An external audit and review for 2003 of the two dominant state-owned commercial banks (SOCBs)--Banque Pour Le Commerce Extérieur Lao and Lao Development Bank--indicates that NPL ratios remain at high levels, but the quality of new lending has improved as a result of enhanced credit policy and capacity-building efforts by international banking advisors.

Activity picked up a little with regard to reforming debt-burdened SOEs. The Government included five more SOEs in the group to be restructured--DAFI (a rural developer), Agriculture-Industry Development, Lao State Fuel, Lao Import-Export, and Road-Bridge Construction Company No. 13. Plans will be drawn up that aim to make the SOEs commercially viable and able to service their debts without public subsidies.

To promote private sector development, amendments to the laws on domestic and foreign investment were adopted to equalize tax incentives for foreign and domestic investors and streamline the investment process. The Government’s commitment to strengthening the business environment is explicitly stated in the National Growth and Poverty Eradication Strategy. A decree on promotion and development of SMEs issued by the prime minister in April 2004 authorized the establishment of a development fund that is envisaged to provide financial support to SMEs. To sustain private sector-led growth, further improvements are required in business registration processes and in making the application of regulations more transparent.

In the area of external economic relations, the first meeting of a working party for the country’s accession to WTO was held in Geneva in October 2004. Members of the working party generally supported the country’s membership bid and requested the Government to prepare a first set of offers for market access in goods and services. The US Congress and president approved legislation to normalize trade relations with the country, which brings into effect the 2003 bilateral trade agreement such that the country receives most-favored-nation (MFN) treatment for exports to the US.

Outlook for 2005-2007 and medium-term trends

GDP is projected to grow at around 6-7% annually over 2005-2007, underpinned by planned expansion of gold and copper mining projects and the planned construction of the Nam Theun 2 hydropower dam. Nam Theun 2 is expected to start producing electricity for export in 2009, which may accelerate growth further. Continued monetary discipline by the Bank of the Lao PDR, together with new revenue-raising measures, should keep inflation in the single- or low double-digit range. The external debt stock will remain high, although exports of hydropower from Nam Theun 2 in the medium term should allow for a reduction in the size of debt relative to GDP. Reasonably robust economic growth is expected to reduce the incidence of poverty and enable the country to achieve the income-target Millennium Development Goal by 2015.

In the longer term, accession to WTO, if achieved, is likely to encourage the development of a more predictable and transparent business environment, which, combined with enhanced market access, should facilitate private investment. The country’s trade liberalization is at present proceeding mainly through fulfillment of commitments under the ASEAN Free Trade Area (AFTA). To date, however, utilization of AFTA’s preferential tariff rates among member countries seems to be low (below 0.1% of AFTA imports in the case of the Lao PDR), apparently as a result of product exclusions and rules of origin requirements. This may be a problem for the Lao PDR in particular, because its trading partners are mainly in the subregion. To gain maximum benefits of trade policy reforms, the economy would benefit more from the MFN-based approach, which would facilitate trade by removing administrative burdens arising from the rules of origin requirements. The multilateral reform path through WTO accession may play a catalytic role to that end.

Potential risks to the outlook include a possibility of excessive fiscal expansion, which would worsen budgetary problems, and a rise in SOCB credit, which may undermine monetary policy. Public financial management needs to be strengthened on both the revenue side (with measures including the VAT) and the expenditure side (achieving a better balance between recurrent and capital spending).

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