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Country Strategy and Program Update 2006-2008: Lao People's Democratic Republic
I. Current Development Trends and IssuesA. Recent Political and Social Developments1. In 2004, the political situation in the Lao People’s Democratic Republic (Lao PDR) remained stable. Compared with 2003, few changes were made to important cabinet positions. The Lao People’s Revolutionary Party (LPRP) celebrated its 50th anniversary on 22 March 2005. In November 2004, the Lao PDR hosted the 10th Association of Southeast Asian Nations (ASEAN) summit. Leading up to the summit, several meetings were held between ASEAN and Australia, the People’s Republic of China (PRC), India, Japan, Republic of Korea and New Zealand. The Russian Federation participated at the foreign minister level meetings for the first time. The ASEAN leaders endorsed the Vientiane Action Programme to implement the ASEAN Vision 2020 for the next 6 years, and endorsed the Framework Agreement for the Integration of the Priority Sectors, which constitute more than 50% of the value of intra ASEAN trade. 2. The Government has started to prepare a five-year National Socio-Economic Development Plan (NSEDP) for 2006–2010, with a view to completing it in late 2005. The SEDP is expected to serve as a planning instrument to implement the broad policy recommendations in the 2004 National Growth and Poverty Eradication Strategy (NGPES), and will reflect the Government’s desire for the country to graduate from least-developed country status by 2020. B. Economic Assessment and Outlook3. Real gross domestic product (GDP) growth is estimated to have increased to 6.5% in 2004. There was 11.4% growth in the industrial sector, driven by an expansion in mining. The largest sector, agriculture, recorded growth of 3.5%. While rice still accounts for the majority of agricultural production, the production of cash crops has been increasing. The services sector grew by 7.3%, partly reflecting a recovery in tourist arrivals. Preliminary estimates indicate that the post-tsunami impact on tourism in Thailand has not had significant spillover effects in the Lao PDR. 4. The Government made progress in strengthening its revenue base in FY2004. Revenue collection, excluding grants, is estimated to have increased from 11% of GDP in FY2003 to 12% in FY2004. Central government expenditure declined from 18.8% of GDP in FY2003 to 16.7% in FY2004. The overall fiscal deficit narrowed from 7.8% of GDP in FY2003 to 4.8% in FY2004. Efforts were made to address an imbalance in public expenditure, reflected in an increase in recurrent expenditures (wages, transfers, interest payments) from 7.8% of GDP in FY2003 to 8.4% in FY2004. At the same time, capital and onlending expenditure declined from 11.2% to 8.8%. The government is taking action to raise the revenue required for social and economic development. It has committed to introducing a value-added tax by January 2007. 5. Growth in broad money supply (M2) remained around 20% for the second consecutive year. The price of imported gasoline and other petroleum products increased significantly, but this had little impact on inflation, which slowed from 15.8% in 2003 to an estimated 10.6% in 2004. Food prices, which account for 46.2% of the consumer price index basket, were relatively stable. Monthly inflation fell to an annual rate of 9.2% in August 2004, the first time since June 2002 it has been in single digits, and declined further to 8.7% by December. The exchange rate remained stable in 2004. 6. Exports, driven by minerals, electricity, garments, and coffee, increased by 7.6% in 2004 and imports grew by 9.5%. The merchandise trade deficit remained stable at about 6% of GDP in 2003–2004, and the current account deficit increased only marginally to an estimated 0.5% of GDP in 2004 (from 0.3% in 2003). In 2004, real capital inflows were largely driven by an expansion of investments in the mining sector, and are estimated to have reached $305 million. Foreign direct investment (FDI) commitments in 2005 remain robust, led by continued investment in the mining sector and the recently approved Nam Theun 2 hydroelectric project. The level of the country’s overall external debt stock was estimated at nearly $2 billion in 2004. However, given the concessional nature of the majority of debt, the debt service ratio remained manageable at 9.4% of exports. 7. In the area of external economic relations, the first meeting of a working party for the accession of the Lao PDR to the World Trade Organization (WTO) was held in Geneva in October 2004. Members of the working party generally supported the country’s membership bid and asked the Lao PDR to prepare a first set of offers for market access in goods and services. In accordance with the common effective preferential tariff (CEPT) scheme of the ASEAN Free Trade Area (AFTA), the Lao PDR has until 2008 to bring down tariffs of products on the inclusion list to no more than 5%. The level of actual CEPT utilization at the moment is reported to be low—below 0.1% of AFTA imports. On the export side, under the ASEAN Integration System of Preferences, which started on 1 January 2002, to date Thailand has granted preferential tariffs on bilateral basis to 187 products of the Lao PDR. The United States approved legislation to normalize trade relations with the Lao PDR, which brings into effect the 2003 bilateral trade agreement. This means the Lao PDR receives most-favored-nation (MFN) treatment in terms of lower tariffs for its exports to the US. Potential impacts of the phase-out of the Multi-Fiber Agreement in 2005 on garment exports from the Lao PDR are expected to be offset by the positive impacts of the new generalized system of preferences envisaged by the European Union, and normalization of trade relations with the US. 8. GDP is projected to grow at 6–7% annually during 2005–2007, underpinned by the planned expansion of gold and copper mining projects and the construction of the Nam Theun 2 hydroelectric project. Nam Theun 2 is expected to start producing electricity for export in late 2009, which will further accelerate growth. Continued monetary discipline by the Bank of Lao PDR, combined with new revenue collection measures, should keep inflation in single or low double digits, although there is still a risk that global oil prices could begin to affect inflation. The external debt stock will remain high, although exports of hydropower from Nam Theun 2 should allow for a reduction in the relative magnitude of the debt volume to the economy. C. Implications for Country Strategy and Program9. While the broad thrust of the current country strategy and program (CSP) remains valid, recent developments—in particular, approval of the Nam Theun 2 hydroelectric project—require a shift of focus within the CSP’s operational priorities. Accordingly, in the area of governance and capacity building, further emphasis will be given to public financial management to support implementation of the Nam Theun 2 revenue arrangements.
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