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p. 1 of 4 BACK | NEXT I. Current Development Trends and Issues II. Implementation of the Country Strategy and Program III. Portfolio Management Issues IV. Country Performance and Assistance Levels

Country Strategy and Program 2004-2006: Lao People’s Democratic Republic

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I. Current Development Trends and Issues

A. Recent Political and Social Developments

1. Political stability has been maintained in the Lao People’s Democratic Republic (Lao PDR), and there have been no major changes in composition of the leadership. The National Assembly election was held on 24 February 2002. Most elected National Assembly members are younger and better educated than previous members. The Government introduced its decentralization policy in 2000 to reflect local conditions and cultural and ethnic differences in the development process. However, fiscal decentralization with insufficient institutional capacity at the local level raised uncertainties about revenue collection and expenditure management. In October 2002, the National Assembly endorsed strong measures to reinforce financial monitoring. The Government is expected to implement its decentralization policy in a more gradual manner with an emphasis on building clear institutional arrangements and capacities at the local level and within central monitoring agencies.

2. Cooperation with neighboring countries has been strengthened. The Prime Minister participated in the first Greater Mekong Subregion (GMS) Summit in Phnom Penh, Cambodia in November 2002. The Lao PDR hosted the Association of Southeast Asian Nations (ASEAN) Ministers meetings in the areas of Agriculture and Forestry, Labor, Health, and Environment. It will host the ASEAN Summit and the ASEAN Tourism Forum in 2004. The European Union (EU) officially opened a resident office in the Lao PDR in May 2003. It has been confirmed that the Mekong River Commission Secretariat will move to Vientiane in 2003. A major challenge facing the Lao PDR is to carefully examine and nurture its competitiveness in order to fully realize the potential benefits of international cooperation.

3. The age profile of the country continues toward youth, about 54% are younger than 20 years of age and almost 70% are under 30 years of age. Approximately 100,000 people enter the labor market each year while the formal nonagriculture sector cannot absorb more than about 10,000 per year at present. It becomes increasingly important to create employment opportunities to assure social and economic stability and to reduce poverty in the country. In this context, there is an urgent need to develop the private sector, primarily small and medium enterprises (SMEs). Job opportunities in neighboring countries are an important “safety valve”. In this regard, a recent significant development is the agreement between Thailand and the Lao PDR for Lao PDR citizens to work legally in Thailand. This will help prevent human trafficking.

4. The Government recently conducted the 2002/03 expenditure and consumption survey.1 A national committee for the Millennium Development Goals (MDGs) was established in 2003 to oversee progress toward their achievement. The Asian Development Bank (ADB), as a part of the United Nations country team in the Lao PDR, is an active participant in the monitoring process. The country’s progress toward the MDGs has been generally satisfactory. The details are set out in Appendix 1, Table A1.¹.

B. Economic Assessment and Outlook

5. In fiscal year (FY)2001/02, gross domestic product (GDP) grew by about 5.7%, the same as in FY2000/01. This performance is impressive given the subdued global economic environment. Industry remained the fastest growing sector, with growth of 9.8%. The services sector, which accounts for about a quarter of the economy, grew at around 5.8%, up from 5.5% in FY2000/01. Agriculture grew at an estimated rate of 4.0%, despite severe flooding that destroyed about 7% of total rice fields. The agriculture sector employs around 80% of the population and accounts for approximately half of GDP. The impact of severe acute respiratory syndrome on the Lao PDR economy has been relatively limited, as the outbreak occurred after the peak tourism season in the country. The Lao PDR is expected to achieve GDP growth of about 5.5% in FY2002/03.

6. The Bank of Lao PDR has generally stopped financing the Government’s deficit. The average inflation rate in 2002 was 10.6%, up from 7.9% in 2001. Inflation rates have increased to about 15% during late 2002–mid 2003, due to kip depreciation and increased food prices. The Government is trying to maintain prudent monetary and fiscal policies to ensure that inflation does not start accelerating again. Tax collection and administration in particular will have to improve if inflationary pressures are to be contained. The International Monetary Fund (IMF) released the first and the second tranches under the Poverty Reduction and Growth Facility (PRGF) in 2002, but has delayed the third tranche release mainly because of concerns over revenue collection. While the foreign exchange rate was volatile in mid-2002, it has largely stabilized at KN9,500–KN10,500 per dollar.

7. In 2002, revenues accounted for 14.5% of GDP and expenditures were around 17.8% of GDP. The Government met the budget gap largely with grants and concessionary loans. The Ministry of Finance’s preliminary estimates indicate that tax collections for the first 6 months of 2003 were significantly below this year’s target. There is an urgent need for the Government to address systemic weaknesses in tax policy and administration. Despite some improvement, capital expenditure still accounted for 54% of total expenditure in 2002. According to a new Decree on the Public Investment Program (PIP), the Government should assess more closely the recurrent expenditure requirement for capital expenditures.

8. In 2002, the trade deficit increased to 7.3% of GDP while the current account deficit fell to 0.3% from 3.2% in 2001. Exports and imports grew by 2% each in 2002, respectively. The main export earners were electricity, garments, gold, tin, gypsum, timber, wood products, and coffee. In FY2001/02, foreign direct investment (FDI) was estimated at $41 million, up from $24 million in FY2000/01. The value of approved FDI in FY2001/02 was $493.8 million, compared to $42 million in FY2000/01. During the first 6 months of FY2002/03, 74 FDI projects valued at $283.7 million were approved. There are prospects for a substantial rise in FDI in 2003 and 2004, led by the hydropower and mining sectors, although this will depend on global economic conditions. Gross official reserves rose to $191 million or the equivalent of about 4 months of imports in 2002 from $133 million in 2001.

9. The Lao PDR is included in the list of the eligible heavily indebted poor countries (HIPCs). However, the Government does not intend to seek debt relief under the HIPC initiative. Approximately half of the total debt is with the Russian Federation and most of this is not being serviced as a result of bilateral negotiations in early 1990s. The Lao PDR is currently negotiating with the Russian Federation on disposition of this debt.² Most of the debt in convertible currency is long-term concessional lending from bilateral and multilateral sources of funds. The debt servicing is equivalent to approximately 8% of the country’s exports of goods and services. Looking forward, when revenues from new and proposed private development projects come onstream, the debt service burden as a share of exports is likely to decline. A debt-sustainability analysis will be jointly conducted by ADB, IMF, and the World Bank in the second half of 2003.

10. A private sector consortium plans to develop the 1,070 megawatt Nam Theun 2 (NT2) hydropower project, with total investment of about $1.1 billion, based on a build-own-operate-transfer arrangement with the Government of the Lao PDR. The project will generate significant revenues for the Lao PDR through the sale of electricity to Thailand. It will offer an important opportunity for the country to boost socioeconomic development, reduce poverty, create employment and business opportunities, and improve the country’s debt service capacity. This project, however, also has various potentially significant social and environment risks. ADB is undertaking due diligence of the project on a noncommittal basis in close coordination with the World Bank and other potential cofinancing partners.

C. Implications for the Country Strategy and Program

11. A full Country Strategy and Program (CSP) (2002–2004) was prepared in September 2001, following extensive stakeholder consultations. There have been no significant changes in the country’s socioeconomic development since the last CSP update in August 2002, and thus the CSP’s strategic thrust and priority areas remain valid. Importance of the private sector in such areas as hydropower, mining, and tourism has increased, and subregional integration and linkages have been increasingly emphasized in the country’s development process. These positive developments will facilitate implementation of the CSP.

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