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p. 9 of 12 BACK | NEXT Executive Summary I. Recent Economic Developments II. Short-and Medium-Term Economic Prospects and Policy Issues A. Policy Issues B. Short- and Medium-Term Prospects III. Poverty Reduction

Country Economic Review: Lao People’s Democratic Republic : II. Short-and Medium-Term Economic Prospects and Policy Issues

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B. Short- and Medium-Term Prospects

76. In 1986, the Lao PDR introduced new economic measures to stimulate economic growth and improve living standards. Despite several bouts with high inflation, GDP has grown substantially and the country is now well-integrated in the subregion. Poverty has declined although it appears that the nonpoor have been the biggest beneficiaries of recent economic growth.

77. Economic growth remains a prerequisite for poverty reduction and is crucial if the Lao PDR is to increase funding for social services, and construct and maintain basic infrastructure, as it has committed to in a number of policy statements. The population of the Lao PDR is estimated to be growing at a rate of 2 to 2.5 percent per annum, which will put a heavy burden on the economy to grow.

78. In the short term, the Lao PDR appears to have largely recovered from the negative effects of the regional financial crisis and the subsequent inflationary bout. Growth in 2000 appears to have been around 5.9 percent (Table 14). This is below the growth rate in 1999; all sectors reported reduced growth.

79. In 2001 and 2002, growth is expected to pick up slightly, led primarily by industry. Although agriculture is generally lagging the other sectors (as is expected in developing countries), it is still expected to grow at respectable rates. This is essential to reduce poverty, as the overwhelming majority of the poor live in rural areas. Due to the lack of extensive data, estimates for the Lao PDR are not based on econometric estimates but are designed to be internally consistent. These figures are based on estimates developed by ADB, IMF, and the Lao Government.

80. Tourism will continue to play an important role in economic growth. This will require additional and well-targeted investment that ensures environmental sustainability and at the same time increases the accessibility of the country. The trade deficit is expected to widen substantially due to increased foreign investment in the hydroelectric sector. This will be financed by FDI and loans from ADB and the World Bank. To avoid inflation, BOL will have to take steps to sterilize the inflow of foreign capital, which is expected to be substantial. Given the lack of instruments available to BOL, this may prove to be a substantial challenge.

81. The country’s economy will continue to be vulnerable to external shocks, especially from its neighbors. Economic relations with Thailand are key, as Thailand is a major source of investment and tourism, and is a key destination for exports. The Thai baht circulates widely in the Lao PDR and shocks to the baht could lead to shocks to the domestic money supply. In particular, further weakness in the baht will weaken the kip and may lead to increased inflation.

82. The Lao PDR will need to continue to diversify its export markets. One particularly attractive export is electricity; currently the Lao PDR is focusing largely on Thailand. However both Cambodia and Viet Nam are also potential purchasers of electricity. Estimates suggest in some parts of these countries, electricity purchased from the Lao PDR would be cheaper than relying on electricity generated from fossil fuels.

83. Although the Lao PDR’s total debt is large as a percentage of GDP, it appears to be manageable as a percentage of exports. The Government will need to reach a favorable settlement with the Russian Federation on the final disposition of nonconvertible currency debt. It will also have to monitor new debt carefully to ensure that total debt is maintained at a reasonable level. Increasing exports should be a priority so that the country can continue to service its debt. New loans will play an important role in the country’s long-term development by financing critical infrastructure.

84. In the long term, the Government is expecting growth to increase to 7.0 percent in 2003, which seems realistic given the country’s historical performance and successful adjustment. The Lao PDR will have to continue to reform and open its economy and continue investment in infrastructure and human capital.

85. Inflation has largely been controlled and is expected to remain under 10 percent in both 2001 and 2002, with a definite downward trend. In the long run, the Lao PDR will have to restore faith in the kip and reduce the role of foreign currency in the money supply. This will give BOL more flexibility to carry our monetary policy and also reduce the risk of inflation. At the same time, restoring confidence in the kip will require clear evidence of monetary and price stability.

86. Government expenditure is expected to stay relatively stable at 20 to 22 percent of GDP. The Lao PDR is committed to restoring the balance between capital and current expenditure (historically around 50 percent for each) and to substantially increase spending on health and education as a percentage of the Government’s budget. Salaries of government workers (both in administration and the social sectors) must also be increased to ensure that sufficient staff are available.

87. The Government is committed to increasing revenues, as a percentage of GDP, to between 14 and 15 percent in 2002, from around 10 percent in 1998. The overall deficit will remain large although external assistance agencies are expected to provide significant resources both in the form of grants and concessionary loans. For the Lao PDR to continue to receive such substantial inflows, it will need to continue to show its commitment to reform, sound economic management, and improving the living standards of the poor. Otherwise, assistance agencies will focus their efforts on other low-income countries.

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