R O B U S T G R O W T H A M I D S T I N F L A T I O N A R Y C O N C E R N S

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1 R O B U S T G R O W T H A M I D S T I N F L A T I O N A R Y C O N C E R N S Lao PDR Economic Monitor May UPDATE THE WORLD BANK Lao PDR

2 The World Bank Lao PDR Country Office Patouxay Nehru Road P.O Box 345 Vientiane, Lao PDR All rights reserved This publication is a product of the staff of the World Bank. The findings, interpretations, and conclusions expressed herein not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. THE WORLD BANK TEAM APPRECIATES FEEDBACK ON STRUCTURE AND CONTENT OF THE MONITOR For further information please contact World Bank Lao PDR Country Office. Mr. Somneuk Davading on structure and content (sdavading@worldbank.org) Ms. Keomanivone Phimmahasay on data issues (kphimmahasay@worldbank.org) The World Bank Lao PDR Country Office Patouxay Nehru Road P.O Box 345 Vientiane, Lao PDR Phone: (856-21) 45-1 Fax: (856-21)

3 L a o P D R E c o n o m i c M o n i t o r - M A Y ROBUST GROWTH AMIDST INFLATIONARY CONCERNS Lao PDR Economic Monitor M a y U P D A T E Lao PDR Economic Monitor - MAY 211 UPDATE is issued in Lao and English by the World Bank Office in Lao PDR. This update reports on recent economic developments and medium-term outlook for the country as well as recent progress made by the Government in key reform areas. The paper was prepared by the World Bank Office s macroeconomic policy team consisting of Somneuk Davading (Task Team Leader), Keomanivone Phimmahasay (Research Analyst) and Genevieve Boyreau (Senior Country Economist - reviewer) under the overall supervision of Mathew Verghis (Lead Economist for South-East Asia Region). We are grateful to the Government (especially BOL, MOF, MPI/LSB, MEM, MOIC, LNTA, MAF and other ministries), LNCCI (including key business associations) and other organizations for providing inputs. We would like to thank our World Bank colleagues: Richard Record, Konesawang Nghardsaysone, Saysanith Vongviengkham, Minh Van Nguyen, Shabih Mohib, Ratchada Anantavrasilpa for their inputs on reform agenda; Meriem Gray, Alounsavath Davong, Remy Rossi, Vattana Singharaj, Boualamphan Phouthavisouk, and other staff for design, printing and dissemination of the Monitor. 1

4 E x e c u t i v e S u m m a r y EXECUTIVE SUMMARY Lao PDR s real GDP growth will remain robust in 211 with projected growth of 8.6 percent compared to 8.4 percent in 21. Natural resources and manufacturing sectors are expected to drive growth this year. The expected growth in the garment exports (by about 15-2 percent in this year) follows the EU relaxation in raw material sourcing requirement and increased orders by key garment producers. The service sector also shows signs of improvement, particularly in transport, tourism (hotels and restaurants) and retail trading. Agriculture (fishery, livestock and crops) is expected to benefit from the recent increase in regional demand and higher food prices. Out of 8.6 percent growth in 211, about 3.6 percentage points come from the resource sectors, about 1 percentage point each from manufacturing and agriculture,.5 percentage points from construction and 2.5 percentage points from services. The Consumer Price Index (CPI) headline inflation has risen in recent months due to higher commodity prices. Recent global food prices have limited impact on Lao inflation, as domestic food prices follow global trends in a limited extent due to the subsistence nature of food production and relatively limited food exports. The recent rise in energy (fuel) and other nonfood prices is putting upward inflationary pressures on the country. The CPI inflation (yoy) has increased to about 7.7 percent in March 211 from 5.8 percent in December 21 driven largely by fuel. Fuel prices (yoy) climbed by 8.7 percent in March 211 from 3.7 percent in December 21 while core inflation (excluding food and energy) rose from 2.6 percent to 7.5 percent during the same period. By contrast, food inflation (especially locally-produced core food items, such as sticky rice, meat and vegetables) has declined during the last six months to 7.2 percent in March 211 from 14.2 in September 21 supported partly by Government s inflationary control measures, such as increase in food supply to the local markets (using rice reserves), a stable exchange rate policy, and temporary ban on rice exports from the country as well as increase of the rice stockpile in 211. Nevertheless, food prices in Lao PDR remain vulnerable to shocks, especially natural disaster (flood and draught), animal disease outbreak and other seasonal factors. The annualized inflation is about 6 percent in 21 and projected at around 7. percent in 211. Higher copper and gold prices, combined with the withdrawal of quasi fiscal spending are pushing the fiscal deficit down this year. The budget deficit is expected to drop to 2.8 percent in FY1/11 from 5.7 percent of GDP in FY9/1 due to slow expansion of expenditure (for both current and capital spending) and projected higher revenue (especially resource tax revenues) as well as strong GDP growth. Domestic revenue is expected to increase to 14.4 percent of GDP in FY1/11 from 13.3 percent in FY9/1 following anticipated transfers of taxes, royalties and dividends from the resource sectors as a result of higher commodity prices. Thus, the resource revenue to GDP ratio is projected to climb significantly to 4.1 percent in this fiscal year from 2 percent in FY9/1. In the same time, the non-resource revenue to GDP ratio is likely to drop from 11.9 percent to 11.3 percent due to high GDP growth and slower expansion in non-resource revenue (about 1 percent growth in nominal terms). The non-mining as well as non-resource deficits are expected to increase slightly to 6.3 percent and 11 percent of GDP in this fiscal year from 6.2 percent and 1.9 percent in FY9/1, respectively. The total revenue (including grants) is expected to increase to 18.3 percent of GDP from 17.5 percent in FY9/1 driven by higher non-project grants (about 3.3 percent of GDP). Overall spending is expected to decline to 21.1 percent of GDP in FY1/11 from 22.3 percent in FY9/1. This is due to the phasing out of quasi-fiscal spending (domestically funded capital expenditure) and a decline in recurrent spending (due to the completion of major events, such as the South East Asia Games and the 45th Anniversary of the Vientiane Capital). The wage bill is expected to remain stable this fiscal year while an increase (in nominal terms) for compensations and transfers is budgeted to support expansion of public services to remote areas, especially for social sectors. Lao export earnings are projected to soar in 211 driven by higher commodity prices and increased regional demand. Lao exports grew rapidly by almost 43 percent (in nominal terms) in 21 (boosting total merchandise exports to about $2 billion) and are projected to grow by nearly 3 percent in 211 driven largely by resource exports (electricity and copper). Resource export growth (in nominal terms) is estimated at 59 percent in 21 and about 32 percent in 211 contributing to further increase in resource trade surplus in this year (to $1,224 million - or about 13.9 percent of GDP - from $915 million in 21). Similarly, non-resource exports are expected to grow by 26 percent in 211 (or to $732 million - about 8.3 percent of GDP - from $581 million in 21). Imports rose by about 11 percent in 21 and are expected to grow by 22 percent in 211 driven by higher imports of capital and consumption goods as well as the rise in petrol prices (of which resource imports about $836 million - or around 9.5 percent of GDP - compared to $596 million in 21). The

5 L a o P D R E c o n o m i c M o n i t o r - M A Y big increase in consumer imports is likely to widen non-resource trade deficit in 211 (to $1,716 million - or 19.5 percent of GDP - from $1,517 million in 21). Although overall trade balance is expected to improve the current account deficit is expected to widen slightly to about 9.4 percent of GDP in 211 from about 8.6 percent in 21 mainly on the account of larger transfers of profits and debt service payments abroad by large resource projects. Thus, resource current account surplus is expected to decrease to 4.8 percent of GDP in this year from about 5.5 percent in 21. Non-resource current account deficit is expected to increase to $1,237 million in or about 14.1 percent of GDP - from $1,56 million in 21 driven by higher non-resource imports. The capital account surplus is projected to increase from 9.9 percent of GDP in 21 to 12.1 percent in 211 with a corresponding surge of new investment, especially from large resource mega projects such as the Hongsa Lignite power plant, the expansion of the Phubia Mining gold production facility, other small and medium-sized hydropower and other non-resource projects. As a result, resource capital account surplus is projected to rise to 8 percent of GDP in 211 from 5.1 percent in 21. In the same time, non-resource capital account surplus is likely to decrease to 4.2 percent of GDP in 211 from 4.7 percent in 21 due to high GDP growth. Overall balance was in surplus at 1.3 percent of GDP in 21 and is expected to increase to 2.8 percent in 211 due to strong resource account surplus (about 12.7 percent of GDP in this year compared to 1.7 percent in 21). Net foreign assets (NFA) and foreign reserves picked up by the end of 21 after continuous decline during the preceding two quarters. Foreign exchange reserves dropped sharply by 18 percent (yoy) in the third quarter, recorded at $531 million. Nevertheless, they started to bounce back in the fourth quarter following transfers of operational expenditures and taxes payments of foreign companies and equity investment in the 2 listed state-owned companies in the recently opened new stock exchange through IPOs denominated in Kip, thereby bringing in dollars in official reserves. As a result, foreign reserves reached more than $72 million by end-21 (covering 3.1 months of imports of goods and services). Net foreign assets have followed a similar pattern with a rebound of more than 1 percent (quarter on quarter) in the fourth quarter. Reserves and NFA are expected to build up in coming months in 211 along with stronger investment inflows and larger tax profits payments from mining projects. The Lao kip has appreciated slightly against the US dollar in the past few months while depreciating against the Thai baht. The kip has appreciated marginally by.2 percent against the US dollar during February-March but depreciated by 2.3 percent against baht in the same time. Overall, kip has appreciated by.9 percent against the US dollar and by.4 percent against baht during the last six months (October 21 - March 211). Credit growth has slowed by end-21 due to the phasing out of the BOL s direct lending to local government projects and increasing drying up of bank liquidity. The credit growth decelerated y-o-y to about 46 percent in December 21 from 91 percent in December 29 due to significant slowdown in lending to both SOEs and private sector. Credit to SOEs declined mainly due to the phasing out of the Bank Of Laos (BOL) direct lending to local infrastructure activities while private credits slowed partly because of recent tightening of bank liquidity (the commercial banks loan to deposit ratio rose to about 75 percent in 21 from 55 percent in 28) as well as BOL s guidance to slow rapid credit growth and reduce NPL risks. The GOL (BOL) is anticipating credit growth to stabilize at around 25-3 percent in 211. Broad money (M2) grew fast (yoy) by 39.1 percent in 21 and this trend is expected to continue in 211, driven by strong GDP growth and high deposits (which grew by 43.3 percent in 21). The dedollarisation rate increased to 46.2 percent in 21 from 42.2 percent in 29 as local people s confidence in kip has risen notably in recent years. Structural reforms have been progressing on different fronts. The treasury reform continues to gain pace with good progress being achieved in consolidation of spending units accounts into the National Treasury and the launch of the pilot of Treasury zero-balance account at the BOL and its provincial branches. The Government has started implementation of the new public investment management mechanism, which includes allocation norms for the capital budget. The application of the formula has resulted in a public investment program PIP allocation more favorable to poorer provinces. With regard to regional and global integration, a Prime Minister s decree on Import and Export of Goods, which will introduce national treatment and most favored nation principles into Lao Law, is expected to be signed by the Prime Minister in the near future (The decree has been reviewed and approved in principles by the GOL very recently). This decree is the last piece of requirement for WTO accession. The preparation of Trade Facilitation Strategy and Action Plan, which envisages improved coordination among concerned agencies and strengthened institutional set up for trade facilitation issues, has progressed well. 3

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7 L a o P D R E c o n o m i c M o n i t o r - M A Y TABLE OF CONTENTS EXECUTIVE SUMMARY PART I RECENT ECONOMIC DEVELOPMENTS 1.1 GROWTH AND INFLATION 1.2 GOVERNMENT S REVENUE AND EXPENDITURE 1.3 EXTERNAL BALANCE 1.4 MONETARY SECTOR PART II - STRUCTURAL AND POLICY REFORMS 2.1 PUBLIC EXPENDITURE POLICY AND MANAGEMENT REFORMS 2.2 FINANCIAL SECTOR REFORM 2.3 TRADE REFORM 2.4 PRIVATE SECTOR DEVELOPMENT ANNEXES ANNEX 1 LAO PDR AT A GLANCE TABLE ANNEX 2 GLOBAL ECONOMIC OUTLOOK ANNEX 3 - ACRONYMS AND ABBREVIATIONS FIGURES AND TABLES Figure 1. Growth and Inflation, (percent change) Figure 2. Resource Sectors Contribution to GDP Growth, (percentage points) Figure 3. Real GDP Growth: Contribution by Sector (percentage points) Figure 4. Monthly CPI Inflation (yoy percent change) Figure 5. Food Prices (yoy percent change) Figure 6. Lao Glutinous Rice Price vs Thai Figure 7. Domestic Revenues (percent of GDP), FY8-12 Figure 8. Resource Revenues (percent of GDP), FY8-12 Figure 9. Key Government Expenditures (percent of GDP), FY28-12 Figure 1. GOL s Fiscal Performance (percent of GDP), FY28-12 Figure 11. Exports by Sector (US$ m), Figure 12. Current Account Balance - CAB (percent of GDP), Figure 13. Balance of Payments (percent of GDP), Figure 14. FDI in Lao PDR (US$ million), Figure 15. Kip Exchange Rate (Index Dec-26 =1) Figure 16. Nominal and Real Effective Exchange Rates Figure 17. NFA and foreign reserves have rebounded Figure 18. Credit growth has declined by end-21 Figure 19. Contribution to Annual Bank Credit Growth Figure 2. Monetary sector growth (yoy percent change) Figure 21. Bank Lending (percent of GDP) Table 1. GOL s four priority sectors expenditures Note: all dollar figures are in US dollars unless otherwise indicated. 5

8 R e c e n t E c o n o m i c D e v e l o p m e n t s PART I RECENT ECONOMIC DEVELOPMENTS 1.1 GROWTH AND INFLATION Lao PDR s real GDP growth will remain robust in 211 with projected growth of 8.6 percent compared to 8.4 percent in 21. Natural resources 1 and manufacturing sectors 2 are expected to drive growth this year. The expected growth in the garment exports (by about 15-2 percent in this year) is due to the EU relaxation in raw material sourcing requirement and increased orders by key garment producers. The service sector also shows signs of improvement, particularly the transport and tourism sectors (hotels and restaurants) and retail trading. Agriculture (fishery, livestock and crops) is expected to benefit from the recent increase in regional demand and higher food prices. Out of 8.6 percent growth in 211, about 3.6 percentage points come from the resource sectors 3, about 1 percentage point each from manufacturing and agriculture,.5 percentage points from construction and 2.5 percentage points from services. With gradual recovery of the global economy and dynamic regional demand, Lao PDR s economic outlook continue to be encouraging, with the economy projected to grow over the coming years on average at about 8 percent a year. This projection assumes sustained levels of global commodity prices (mainly metals and agriculture) as well as a good recovery in tourism and garment industries, implementation of large hydropower projects under construction and in the pipeline (especially Hongsa Lignite Power Plant), dynamic demand for main Lao export products from the neighboring countries (especially Thailand, China and Vietnam) and the European Union, and full operations of new large hydropower projects, such as NT2, Nam Ngum 2 and Nam Like 1-2 in 211 and onwards. Further expansion of mining output is assumed for copper and gold in (by MMG and Phubia). Figure Figure 11. Growth and Inflation, (percent change) Figure Figure 22. Resource Sectors Contribution to GDP Growth, (percentage points) Real GDP growth (%) Nonresource sectors (percentage points) Headline inflation (%, annual average) Resources (percentage points) Real GDP growth (%) Source: GOL (MPI) and staff estimates and projections. * Yearly average for 211 Source: GOL (MPI) and staff estimates and projections. * Yearly average for Hydropower (with full operation of NT2, new operations of Nam Ngum 2 and Nam Lik 1-2) and sustained mining extraction (copper and gold output expansion by MMG and Phubia projects). 2 Based on steady growth in cement and construction materials, as well as the garment and food and beverage industries. 3 Almost 3 percentage points come from the electricity sector (out of which around 1.3 percentage points come from NT2 and the rest from Nam Ngum 2 and Nam Lik 1-2). About.6 percentage points come from the mining sector - mostly copper and gold.

9 L a o P D R E c o n o m i c M o n i t o r - M A Y Figure Figure 33. Real GDP Growth: Contribution by Sector (percentage points) Agriculture and forestry Mining and quarrying Manufacturing Construction Electricity, gas, and water Services Real GDP growth (percent) -2 Source: Staff estimates and projections Although until now recent global food price increases have had limited impacts on overall Lao CPI inflation, the rise in fuel and other nonfood prices and uncertainty in global commodity markets is putting upward pressures on the CPI inflation. The headline inflation has increased in recent months due to energy and other nonfood commodity prices. The CPI inflation (yoy) has increased in recent months to about 7.7 percent in March 211 from 5.8 percent in December 21 driven largely by fuel and other nonfood prices. Fuel prices (yoy) climbed by 8.7 percent in March 211 from 3.7 percent in December 21 while core inflation (excluding food and energy) rose from 2.6 percent to 7.5 percent during the same period. However, the food inflation (especially locally-produced core food items, such as sticky rice, meat and vegetables) has declined during the last six months to 7.2 percent in March 211 from 14.2 in September 21 supported by Government s inflationary control measures, such as increase in food supply to the local markets (using rice reserves), a stable exchange rate policy, and temporary ban on rice exports from the country as well as increase of the rice stockpile in 211. Nevertheless, food prices in Lao PDR remain vulnerable to shocks, especially natural disaster (flood and draught), animal disease outbreak and other seasonal factors. The annualized inflation is about 6 percent in 21 and projected at around 7. percent in 211. Food prices in Lao PDR follow to a limited extent the global trend due to the subsistence and limited tradable nature of food consumption. However, they may be linked to regional markets for glutinous rice in Thailand and Northern Viet Nam. Commercialized rice (especially sticky rice which is predominant food in Lao PDR) is influenced by localized supply shocks and seasonality. Unlike Thailand and Vietnam Figure Figure 44. Monthly Inflation (yoy percent change) Dec-8 Figure Figure 55. Food Prices (yoy percent change) Dec-8 Mar Feb-9 Energy inflation (percentage points) Food inflation (percentage points) Core inflation (percentage points) Headline inflation (%, annual average) Jun-9 Source: Lao PDR authorities (MPI) and staff calculations Apr-9 Aug-9 Rice Vegetables Meat Poultry Fish The rest Total food inflation (%, y-o-y) Jun-9 Oct Aug Dec Oct-9 Feb Dec-9 Apr Feb-1 Jun-1 Apr-1 Source: Lao PDR authorities (MPI) and staff calculations Aug Jun Aug Oct Dec-1 Oct Dec-1 Mar-11 7

10 R e c e n t E c o n o m i c D e v e l o p m e n t s who produce and exports mainly ordinary (non-glutinous) rice to the international markets, Lao PDR produces mostly glutinous (sticky) rice around 9 percent of total rice outputs, which are mostly consumed domestically. Estimates suggest that about 1 percent or 3, metric tons is commercialized, some of which may be exported to regional markets in neighboring countries. Anecdotal evidence shows increased formal and informal milled glutinous rice exports to Vietnam, and to a lesser extend exports of paddy to Thailand may have been behind the stark increase of rice prices over the 2nd quarter of 21. Government reacted by restricting formal; cross-border rice exports, has issued a stockpiling policy, and is considering imposing price controls. It remains unclear how price controls can be effectively implemented at the provincial and district level. Figure Figure 66. Lao Glutinous Rice Price vs Thai Glutinous Rice Price Index (Dec25=1) Thai glutinous rice 1% (export price, fob) Lao glutinous rice, grade 1(domestic price) Dec-5 Mar-6 Jun-6 Sep-6 Dec-6 Mar-7 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Source: Lao authorities (DOS) and Thai Rice Exporters Association and staff calculations. 1.2 GOVERNMENT S REVENUE AND EXPENDITURE The budget deficit (as percentage of GDP) declined further in last fiscal year (FY9/1). The fiscal deficit decreased to 4.6 percent of GDP (2.7 percent came from the off-budget spending) in FY9/1, from 6.7 percent in FY8/9. The GoL s domestic revenue increased by 17.2 percent (in nominal terms) in FY9/1 due to higher tax collection, especially from VAT, resource royalties and customs duties. Nevertheless, the revenue to GDP ratio climbed only slightly to 13.9 percent in FY9/1 compared to 13.8 percent in F8/9 due to the rapid GDP growth - see Figures 7-1. High commodity prices and the withdrawal of one-off spending items will positively impact the Government fiscal balance this year. The budget deficit is expected to drop to 2.8 percent in FY1/11 from 4.6 percent of GDP in FY9/1 due to slow expansion of expenditure (for both current and capital spending in nominal terms) and higher revenue (especially resource tax revenues) as well as strong GDP growth, and is projected to remain below 3 percent over the medium term - see Figure 1. Domestic revenue is expected to increase to 15.1 percent of GDP in FY1/11 from 13.9 percent in FY9/1 following transfers of taxes, royalties and dividends from the resource sectors as a result of higher commodity prices and copper output expansion (around $27 million projected resource revenues including $22 million from mining taxes in this FY and much higher in the medium term). Thus, the resource revenue to GDP ratio is projected to climb significantly to 4.1 percent in this fiscal year from 2 percent in FY9/1. In the same time, the non-resource revenue to GDP ratio is likely to drop from 11.9 percent to 11.3 percent due to high GDP growth and slower expansion in non-resource revenue collection (about 1 percent growth in nominal terms) - see Figure 8. The non-mining as well as non-resource deficits are expected to increase slightly by.1 percent of GDP, or to 6.3 percent and 11 percent of GDP in this fiscal year from 6.2 percent and 1.9 percent in FY9/1, respectively. The total revenue (including grants) is expected to increase to 19.2 percent of GDP from 18.2 percent in FY9/1 driven by higher nonproject grants (about 3.3 percent of GDP) - see Figure 7. Overall spending is expected to decline to 22 percent of GDP in FY1/11 from 22.7 percent in FY9/1 - see Figure 9. This is due to the phasing out of quasi-fiscal spending (domestically funded capital expenditure) and a relative decline in recurrent spending (due to the completion of major events,

11 L a o P D R E c o n o m i c M o n i t o r - M A Y such as the South East Asia Games and the 45th Anniversary of the Vientiane Capital). The wage bill is expected to remain stable this fiscal year while an increase (in nominal terms) for compensations and transfers is budgeted to support expansion of public services to remote areas, especially for social sectors. Figure Figure 77. Domestic Revenues (percent of GDP) Revenue and grants Tax Nontax Source: Lao PDR authorities (MOF) and staff calculations and projections 19.2 Domestic revenue Resource revenue FY8 FY9 FY1 FY11 FY Figure Figure 88. Resource Revenues (percent of GDP), FY8-12 Nonresource revenue Resource revenue Mining Hydropower FY8 FY9 FY1 FY11 FY12 Source: Lao PDR authorities (MOF) and staff calculations and projections..9 Figure Figure 99. Key Government Expenditures Figure Figure 1 1. GOL s Fiscal Performance (percent of (percent of GDP), FY28-12 GDP), FY Current expenditure Others/contingencies Capital expenditure Expenditurte FY8 FY9 FY1 FY11 FY12 Source: Lao PDR authorities (MOF) and staff calculations and projections Revenue and grants Budget deficit Nonresource deficit Total expenditurte Nonmining deficit FY8 FY9 FY1 FY11 FY EXTERNAL BALANCE Source: Lao PDR authorities (MOF) and staff calculations and projections. Lao Exports and Imports Lao export earnings are projected to soar in 211 driven by higher commodity prices and strong regional demand. Lao exports grew rapidly by almost 43 percent (in nominal terms) in 21 (boosting total merchandise exports to about $2 billion) supported by increased regional demand, the operational start of new hydropower projects, and favorable commodity prices (especially for minerals). They are projected to grow by nearly 3 percent in 211 driven largely by resource exports (electricity and copper). Resource export growth (in nominal terms) is estimated at 59 percent in 21 and about 32 percent in 211. Thus, resource trade surplus is likely to rise to about $1,224 million in this year (or about 13.9 percent of GDP) compared to $915 million in 21. Similarly, non-resource exports are expected to grow by 26 percent in 211 (or to $732 million - about 8.3 percent of GDP - from $581 million in 21). 9

12 R e c e n t E c o n o m i c D e v e l o p m e n t s Imports are also expected to rise at a quicker pace in 211. Imports rose by about 11 percent in 21 and are expected to grow by 22 percent in 211 driven by higher imports of capital and consumption goods as well as the rise in petrol prices. The large increase in consumer imports (due to increase in demand and commodity prices) is likely to widen non-resource trade deficit in 211 (to about $1,716 million - or around 19.5 percent of GDP - from $1,517 million in 21). The commencement of construction of the Hongsa Lignite power plant and the expansion of the Phubia Mining gold production facility are expected to significantly contribute to import rise in 211. Overall, Lao PDR s trade deficit has narrowed in recent years (from about $1,33 million in 28 to $62 million in 21 and is projected to decline further to $492 million in 211) due to strong resource export growth (which is expected to outweigh import expansion). Figure Figure Exports by Sector (US$ m), Mining Electricity Wood & Wood Products Garments Agriculture Other World Commodity Prices, Copper Gold Coffee Maize Rubber Rice Source: Staff estimates and projections based on data from Lao authorities (MOIC) and partner countries Source: WB DECDG s recent estimates and projections. Current Account Balance The current account deficit has become increasingly exposed to mining export earnings, thereby offsetting a large non-resource current account deficit. The current account deficit is projected to widen slightly due to larger net income transfer in 211. Although the overall trade balance is expected to improve slightly, the current account deficit is projected to widen to about 9.4 percent in 211 from about 8.6 percent in 21 mainly on the account of larger transfers of profits and debt service payments abroad by large resource projects - see Figure 12. Resource current account surplus is expected 4 to decrease to 4.8 percent of GDP in 211 from about 5.5 percent in 21 due to notable increase in net income transfers abroad (especially debt services from power projects including Hongsa Lignite Power Plant). Mining current account surplus is expected 5 to rise to 9.7 percent of GDP in 211 from about 9.1 percent in 21 and, in the same time, power sector s current account deficit is likely to widen in 211 and 212 (due to large increase in interest payments). Non-resource 6 current account deficit is expected to increase to $1,237 million in this year from $1,56 million in 21 driven by higher non-resource imports. Nevertheless, its GDP ratio remains unchanged at 14.1 percent in see Figure 12 below. Figure Figure Current Account Balance - CAB (percent of GDP), Mining CAB Power CAB Non-resource CAB Current account balance (CAB) Source: Staff estimates and projections

13 L a o P D R E c o n o m i c M o n i t o r - M A Y Capital Account Balance The commencement of resource sector investment in pipeline will enhance capital account surplus in 211. The net flow of capitals declined to 9.8 percent in 21 from 12.3 percent of GDP in 29 due to a temporary plunge in foreign investments in the resource sectors (especially hydropower - see Figure 13) and a large increase in income transfers by resource projects (repatriation of profits of around $384 million compared to about $15 million in 29). However, the capital account surplus is expected to rebound to 12.2 percent in 211 with a corresponding surge of new investment especially from large resource mega projects such as Hongsa lignite coal-fired power plant ($3.7 billion project), Phubia s new gold production facility (about $15 million) and several other medium and smaller investment projects across non-resource sectors (especially construction and services) - see Figure 14. As a result, resource capital account surplus is projected to rise to 8 percent of GDP in 211 from 5.1 percent in 21. In the same time, non-resource capital account surplus is likely to decrease to 4.2 percent of GDP in 211 from 4.7 percent in 21 due to high GDP growth. Overall balance was in surplus at 1.3 percent of GDP in 21 and is expected to increase to 2.8 percent in 211 due to strong resource account surplus (about 12.7 percent of GDP in this year compared to 1.7 percent in 21). Figure 13 Figure 14 Figure 13. Balance of Payments (percent of GDP), Mining CAB Power CAB Non-resource CAB CAB Overall balance Capital account balance Source: BOL and staff estimates and projections Figure 14. FDI in Lao PDR, (US$ million) Agriculture Manufacturing, etc. Services Mining Power Gross FDI inflows Net FDI flows Source: MPI and staff estimates and projections. 1.4 MONETARY SECTOR Exchange Rate The Lao kip has appreciated slightly against the US dollar in the past few months while depreciating against the Thai baht. The kip has appreciated marginally by.2 percent against the US dollar during the last two months (February-March) but depreciated by 2.3 percent against the Thai baht in the same time. Overall, kip has appreciated by.9 percent against the US dollar and by.4 percent against baht during the last six months (October 21 - March 211). Nevertheless, the effective exchange rate of kip depreciated by 1.5 percent in nominal terms (NEER) and 1.4 percent in real terms (REER) during October 21 - March 211 largely due to recent depreciation of US dollar against major currencies in the region (including the Thai baht). 4 Resource current account surplus covers trade balance and net income from the mining and hydropower sectors. 5 The surplus in mining trade balance has off-set the transfers of profits and debt service payments abroad and thereby contributed to mining current account surplus. 6 Deficits on the sector s trade balance and net income contributed to power sector s current account deficit. 11

14 R e c e n t E c o n o m i c D e v e l o p m e n t s Net foreign assets and foreign reserves picked up by the end of 21 after continuous decline during the preceding two quarters. Foreign exchange reserves dropped sharply by 18 percent (yoy) in the third quarter, recorded at $531 million. Reserves started to bounce back in the fourth quarter following transfers of operational expenditures and taxes payments of foreign companies and new foreign investments. Foreign reserves reached more than $72 million by end-21 (covering 3.1 months of imports of goods and services). Net foreign assets have also followed a similar pattern with a rebound of 13.5 percent (yoy) by end-21, reaching more than $75 million. The slowing down of credit growth as of end 21 has eased the pressure on foreign reserves and NFA levels. The net foreign assets (NFA) and international reserves are expected to rise in 211 and beyond with a projected strong growth in exports and rebound in net capital inflows combined with anticipated further slowdown in credit growth in 211 (see more details in Bank Lending below). Figure Figure Kip Exchange Rate (Index Dec-26 =1) Kip/US$ Kip/Baht Dec-6 Mar-7 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Source: BOL and staff calculations. Nominal and Real Effective Figure 16 Exchange Rates NEER Dec-6 Mar-7 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Source: IMF REER Figure Figure NFA and foreign reserves have rebounded Broad money (yoy % change, left axis) Credit to the economy (yoy percent change, left axis) Gross official reserves (US$ m, right axis) Net Foreign assets (US$ m) 45 (Q-to-Q percent change) International reserves Net foreign assets Dec-6 Mar-7 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Source: BOL and staff calculations. Bank Lending Credit growth has slowed by end-21 due to the phasing out of the BOL s direct lending to local government projects and the slowdown of private credit. The credit growth decelerated y-o-y to about 46 percent in December 21 from 91 percent in December 29 due to significant slowdown in lending to both SOEs and private sector. Credit to SOEs declined mainly on the account of the phasing out of BOL s direct lending to projects while private credits slowed partly because of recent tightening of bank liquidity (the commercial banks loan to deposit ratio rose to about 75 percent in 21 from 73 percent in 29 and 55 percent in 28) and GOL s policy to slow rapid credit and

15 L a o P D R E c o n o m i c M o n i t o r - M A Y reduce future NPL risks. Private credit growth slowed to 43.8 percent in December 21 from 88 percent in end- 29 while credit to SOEs dropped to 53.4 percent from 99.8 percent at end-29. The GOL (BOL) is projecting credit growth to stabilize to about 25-3 percent in 211. Broad money (M2) grew fast (yoy) by 39.1 percent in 21 (compared to 31 percent in 29) and this trend is expected to continue in 211, driven by strong GDP growth (8.4 percent in 21 and projected 8.6 percent in 211) and high deposits (which grew by 43.3 percent in 21 and projected 3-4 percent in this year). Overall, kip deposits increased (yoy) by 57 percent while foreign currency deposits climbed by 33.2 percent in 21. The dedollarisation 7 rate increased to 46.2 percent in 21 from 42.2 percent in 29. As percent of GDP, total credit was 25.9 percent, M2 about 33.7 percent and deposits around 27.6 percent in 21. The reported non-performing loans (by BOL) dropped from 3.7 percent in June 21 to about 3 percent in end-21. It is not clear however whether this improvement is due to enhanced loan portfolios of banks or a mechanic impact from new loans expansion. Figure Figure Credit growth has declined by end-21 Figure Figure Contribution to Annual Bank Credit Growth (yoy percent change) Credit to private sector (percentage points) Credit to private sector Credit to SOEs Credit to SOEs (percentage points) Deposits Credit to the economy Credit to the economy (yoy percent change) Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Dec-6 Mar-7 Jun-7 Sep-7 Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Source: BOL and staff calculations. Source: BOL and staff calculations. Figure Figure 2 2. Monetary sector growth (yoy Figure Figure Bank Lending (percent of GDP) percent change) Credit to the economy (% of GDP) Total deposits (% of GDP) Total deposits Broad money (M2) Broad money (M2), (% of GDP) Loan/deposit ratio (%, right axis) Source: BOL and staff calculations. Source: BOL and staff calculations. 7 In the context of Lao PDR, dedollarisation rate is the ratio of kip deposit to the total deposit (This simple formula is used by BOL as a proxy for estimating the dedollarisation rate in the country due to data limitation on composition of kip and foreign currencies outside bank). 13

16 S t r u c t u r a l a n d P o l i c y R e f o r m s PART II STRUCTURAL AND POLICY REFORMS 2.1 PUBLIC EXPENDITURE POLICY AND MANAGEMENT REFORMS Public finance management reforms continue to be implemented within the overall umbrella of the Public Finance Management Strengthening Program (PFMSP). Since 28, PFMSP has covered reforms on both the revenue and expenditure sides as mandated by the Budget Law 27. There has been progress in the development of a new fiscal transfer system, establishment of greater control of public finance resources, alignment of policies to the budget, and strengthening of external oversight and audit functions. The centralization of the Treasury, Customs, and Tax functions mandated by the revised 26 State Budget Law was completed by the end of 29. To facilitate budget execution and reporting, the MOF has developed the GFIS and progressively rolled it out to central ministries/agencies and provinces. Efforts have been made to improve the budget coverage, through bringing off-budget funds and service delivery agencies technical revenue on budget. A treasury single account (TSA) framework has been developed with a phased implementation approach. On the revenue side, VAT has been brought into implementation since January 21 and ASYCUDA implementation has commenced since July 21. The new Audit Law was promulgated by the national assembly (NA) in July 27, allowing the State Audit Organization (SAO) to directly report to the NA instead of the Executive branch of Government; SAO has performed the audit of budget execution reports and submitted them to the NA. Key recommendations of budget execution reports are incorporated into the NA s Resolutions and followup actions have been taken by the Government. A peer review of its development needs was carried out by the Office of the Auditor-General of New Zealand, and a 1-year Action Plan for capacity development and a 3-year Implementation Plan have been prepared. SAO aims to follow international standards on auditing, and to develop its work on performance audit. The NSEDP framework which was discussed at the Round Table meeting in November 21 continues its central focus on improving the governance of public finances for improving service delivery. This focus will be operationalized through the PFMSP. In order to fully implement the PFMSP, the Government will require significant capacity enhancement, continued political commitment and technical assistance. Key Reform Progress The operationalization of the revised Budget Law continues to progress, through the implementation of the PFM- SP medium-term plan. The GOL has completed the centralization of the Treasury, Customs, and Tax functions nationwide by end-29. This has enabled greater control over the revenue sources and more timely budget execution. The revenue sharing and distribution framework has been designed and finalized while budgetary allocation norms have been prepared. Implementation of new revenue assignments between central and local levels (based on the implementing decree of the Budget Law) is expected to start in FY21/11. A multi-donor trust fund launched in February 29 continues to provide financial support to implementation of critical reforms under the PFMSP. A Public Expenditure and Financial Accountability (PEFA) assessment has been completed in 21, establishing a baseline for monitoring the performance of Lao PDR PFM system over time. A Public Expenditure Review was also conducted during 21. The results of the PEFA assessment and policy recommendations from the PER together provide inputs to the GOL for formulation of the PFMSP medium-term implementation plan for The PFMSP Mid-Term Review was conducted in November 21, reviewing the progress with PFMSP implementation and recommending reform priorities for the next five years. A medium-term PFMSP implementation plan for has been formulated, incorporating recommendations from the mid-term review. A number of important reforms have been implemented to facilitate improved budget execution and treasury reform. The MOF has completed the administrative integration of provincial treasury units into the National Treasury. The Government has adopted a new decree on the National Treasury, providing a new legal basis for the treasury operations and the integration of the operations nationwide. The decree also establishes new tasks for the National Treasury, including the improved management of the Government finances. The MOF has adopted a strategy for implementing a Treasury Single Account (TSA) in the Bank of Lao PDR (BOL) with a view to consolidating all

17 L a o P D R E c o n o m i c M o n i t o r - M A Y Government cash balances in the BOL under the control of the National Treasury through transferring Government unit bank accounts to the National Treasury and improving the Government banking arrangements. The MOF together with line ministries has started the transfer of their bank accounts to the National Treasury. The MOF and BOL have started the pilot implementation of the TSA (zero-balance Treasury account) at the BOL branches as a part of the implementation of the first phase of the TSA arrangement. The MOF has completed roll-out of a locally developed government financial information system (GFIS) to all provinces and line ministries. The GFIS supports the day-to-day treasury operations both at the National Treasury and its provincial offices with following main functionalities: (i) budget recording and distribution, (ii) processing payment and receipt transactions, and (iii) fiscal reporting. The GFIS has recently been upgraded to be operated on a unified Chart of accounts and budget nomenclature aligned with Government Finance Statistics (GFS) and with centralized system architecture, allowing real time access to budget execution data once transactions are entered into the system. At the moment, the MOF has recruited an international consultant firm to help designing a full function treasury system- the Treasury Information Management System (TIMS). The consultant team is expected to start its work from mid 211. The design consultant will provide analysis, business process review and functional requirements definition leading to an international open procurement process to identify and select a preferred product to be implemented as TIMS. All necessary ingredients for successful implementation of the VAT in the Lao PDR were put in place with the exception of IT applications, which were prepared and tested but are not yet operational. More specifically, the VAT Implementation Decree and the VAT Implementation Instructions put in place a coherent set of rules that allow for the VAT to be enforced in accordance with international standards, while detailed procedures were developed and embedded in formal instructions that allowed for proper administration and collection of the tax by the Tax Authorities. VAT law was formally entered into force since January 21. Significant challenges remain with VAT implementation. They include full registration of businesses with a turnover above the registration threshold, making the VAT ICT system and the refund system fully operational to allow for quick processing and payment of refunds to exporters. Further training of staff and outreach to taxpayers is required to ensure that staff in charge as well as VAT Taxpayers are aware of and knowledgeable about the existing legal and procedural Instructions and that they implement these properly and consistently. In addition, Government is reviewing the General Tax Law with a view to revising it to abolish of the turnover tax and align the threshold for the application of the presumptive tax regime with the VAT registration threshold. In addition the revision would review the impact of the minimum tax on the business environment as well as the use of excise taxes as revenue source. The Lao Customs Department is now moving ahead with the introduction of the ASYCUDA World system. ASYCUDA provides a platform for the introduction of modern risk-managed techniques for customs that will streamline trade facilitation procedures and improve the efficiency of revenue collection. The first phase (currently underway and estimated to last approximately nine months) provides for the development of a prototype system. A key initial step, now almost complete, is the mapping of existing customs clearance procedures in order to identify redundancies that can be eliminated as well as changes that will need to be made as part of ASYCUDA implementation. Reforms are also ongoing as part of efforts to harmonize procedures within international norms including, for example, the introduction of the ASEAN Single Administrative Document in March 21 and the approval of new WTO consistent regulations on Customs Valuation in July 21. SAO continues with the implementation of its 3-year plan for capacity development and is making important impact on enhancing government accountability. SAO has completed the audit of the budget execution for FY28/9 and submitted timely its report to the National Assembly. The debate of the audit findings at December 21 National Assembly was live-broadcasted by TV and widely reported in public media. The NA subsequently issued a resolution to impose strict measures to correct the wrongdoings found by the audit. SAO is preparing a summary of the audit report to be disseminated to the public for the first time. SAO financial and human resources have been further strengthened with its budget allocation and staff doubled for the FY The introduction of budgetary allocation norms for the education and health sectors has been progressing gradually. Effort has been made in designing the budget allocation norms since 28 to move forward to a more 15

18 S t r u c t u r a l a n d P o l i c y R e f o r m s rule-based budgeting. Progress has been made on the technical aspects in designing formulae for the budget allocation norms for the social sectors and these formulae have been discussed and agreed in principle upon by MOF and line ministries concerned. However, the implementation has made slow progress due to inadequate explanations and insufficient understanding of the provincial and sectoral authorities on this initiative. Recently, MOF and concerned sector ministries have made their collective effort in working out the details of the unit costs, which will be used in the budget allocation norm formulae so that the budget norms for the education and health sectors can be applied from FY211/12. T able 1 GOL s Priority Sectors Expenditure 26/7 27/8 28/9 Priority Sectors Recurrent Spending (percent of total recurrent spending)* Total four sectors Agriculture Infrastructure Education Health (percent of total expenditure) Total four sectors Agriculture Infrastructure Education Health Total Priority Sectors Spending (percent of total expenditure) Total four sectors Recurrent Capital Agriculture Significant progress has been made in improving the timeliness of civil servants salary payments and strengthening public sector performance. The GOL piloted an electronic salary payment system (ESPS) in 28 to replace manual cash payment. Currently, salaries of all civil servants at the central level and all provinces, where ATM facilities are available, are deposited to their individual bank accounts and can be withdrawn through ATMs. Priority sectors recurrent spending as a ratio to total recurrent expenditure increased notably in FY8/9. The share of recurrent expenditure of the four priority sectors as percent of total recurrent expenditure rose to 19.9 percent in FY8/9 from 17.7 percent in FY7/8. In the same time, the ratio for education increased to 13.5 percent in FY8/9 from 12 percent in FY7/8 and, for health it climbed from 3.3 percent to 3.6 percent, respectively. However, the sectors recurrent spending to total expenditure ratio dropped slightly to 9.6 percent in FY8/9 from 9.7 percent in FY7/8 due to large increase in capital spending, especially for SEA games and other local infrastructure projects. Overall, the four sectors total spending as share of total public expenditure increased to 45.8 percent in FY8/9 from 39.7 percent in FY7/8 and, as share of GDP, it rose to 1.5 percent from 7.3 percent, respectively. Infrastructure** Education Health (percent of GDP) Total four sectors Recurrent Capital Agriculture Infrastructure Education Health Source: Lao authorities (MOF) and staff calculations. Note: * Total recurrent expenditure includes salaries and benefits, transfers, administrative expenses, and other recurrent spending. ** includes off-budget spending on local infrastructure project

19 L a o P D R E c o n o m i c M o n i t o r - M A Y FINANCIAL SECTOR DEVELOPMENT The formal financial sector remains dominated by State Owned Commercial Banks (SOCBs), but signs of competition have been seen recently due to the role that joint-venture and private banks have been playing in the very recent past. The financial system is dominated by banks, with non-bank financial institutions (NBFI) representing only.8 of overall financial sector assets as of June 21. SOCBs are still dominant with around a 6 percent share of total banking sector assets, but this share is declining. The assets of private and joint venture banks have increased recently as new private banks emerged. In the past two years, 6 new commercial banks 8 commenced operations in Lao PDR and brought the total number of banking institutions to 23, consisting of 4 SOCBs, 3 joint-ventures, 2 private and 14 foreign bank branches. Increased competition by recent entries of new private banks has provided an incentive for SOCBs to improve their performance, risk management, governance, and products and services. Lao PDR launched its first stock exchange. With support from the Korean and Thai Stock Exchanges, the Lao Government opened its first Lao Stock Exchange (LSX) on January 11, 211. The Government sees the development of its capital markets as an avenue to fund its socio-economic development plan, and hopes the security market will be able to facilitate long term funding for the business sector. So far, two state-owned enterprises (SOEs), namely Electricite du Laos (EDL GEN) and Banque Pour le Commerce Exterieur Lao (BCEL), were listed in the new market as the pioneers. The recently appointed Lao Securities Exchange Commission has been developing the regulatory and supervisory framework for capital markets. In addition, development of necessary infrastructure to support a vibrant capital market, such as payment and clearance systems, is very important to ensure the success of the new stock exchange. The size of the formal financial sector is gradually increasing, while relatively low by international standards and similar levels of income per capita. Monetization rate has increased fairly quickly in recent years but remains relatively low. Broad money (M2) to GDP ratio was about 34.1 percent in 21, up from 29.2 percent in 29. The financial system remains dominated by State-Owned Commercial Banks (SOCBs), which account for 59.3 percent of total banking assets in 21, while 6 new banks (mainly private and joint venture banks) have recently entered the domestic market. The asset size of three SOCBs increased by 36 percent yoy in 21 compared to the total industry growth of 5 percent while the asset of private and joint venture banks grew rapidly by over 9 percent. Nevertheless, BCEL remains the largest market player in the Lao banking industry with a share in terms of asset size and deposits of around percent (21). A growing share of the population has access to formal financial services, with increasing access points, while starting from a very low base. Access points to the formal financial system, such as bank branches, have grown from 62 in 27 to 84 branches in December 21. The number of sub-service units expanded (from 66 in 27 to 198 in 21) as banks made use of their ability to reach out for a greater number of deposits. The number of ATMs has increased rapidly from 12 in 26, to 51 in 27, to 248 in 21. Access is more developed in urban areas, and especially in Vientiane, but it is catching up outside Vientiane, where most of the commercial bank branches have been created (53 out of 8 in 21). Bank service units located outside Vientiane have tripled since 27, from 54 to 15. Similarly, there are now 88 ATMs outside Vientiane, compared to only 9 ATMs three years ago. The microfinance industry is gradually improving. In order to promote development of the microfinance sector, BOL has set up a new department called Financial Institution Supervision Department in late 21 to oversee microfinance development activities in the country. A new decree on microfinance, which consolidated and elevated the previously separate regulations on deposit taking, non-deposit taking and credit unions, is under Government s review. The new decree is expected to introduce opportunities for participation of foreign investment. So far, there are three regulations which regulate Micro Finance Institutions (MFIs) in Lao PDR: (1) the Regulation for Deposit Taking MFI (key requirements: the loan size limit at 1 million Kip per customer and minimum initial capital 8 These banks include: Booyong Bank, International Commercial Bank Lao Limited, Vietnam Army Bank, ST Bank, Lao-French Bank, and Indochina Bank. 17

20 S t r u c t u r a l a n d P o l i c y R e f o r m s of 1 billion kip), (2) the Regulation for Savings and Credit Unions (the MFI can take deposits and lend only within their member group), and (3) the Regulation for Non-Deposit Taking MFI (it allows for a diverse set of microfinance services but relying on savings as the basis for lending). As of December 21, there were 28 MFIs registered under BOL s regulations (compared to 1 MFIs in December 27), with 7 deposit taking and 9 non-deposit taking and 12 SCUs. With support from donors, BOL arranged several MFI trainings on accounting, business planning, management information systems and loan delinquency management in the past year. Payments and clearance systems and credit reporting systems are still underdeveloped. There is a clearing house in the Bank of Lao PDR where banks meet once a day to clear payments which is functional. The main domestic payment instruments are cash and checks, and checks are cumbersome to use. ATMs are available to customers, but banks do not share or network. BOL is going to review and develop a legal and regulatory framework that supports payment systems development with the overall objective of improving the safety and efficiency of the national payments system as well as legitimating the settlement transactions in Lao PDR. A joint venture company was set up to provide ATM pool service with limited success so far. Efforts are being made to establish a credit bureau to complement the existing credit information bureau (CIB) at BOL. Currently, all credit reports of corporate, enterprise and personal customers with loan amount more than 2 million kip are reported to the CIB as part of the credit analysis process of all commercial banks in the country. However, further improvement is needed for small loans (mainly from Microfinance projects) as most microfinance customers do not have adequate documentation, such as passport, ID card and or House registration documents. Some measures were taken to strengthen bank supervision. The Bank of Lao PDR reviewed and updated the existing prudential ratios applying to commercial banks in accordance with Basel principles. Two revised regulations were the net open position (NOP) and loan classification regulations. Under the new guideline (No. 818, 2 October 21), the limit of NOP of single currency and all currency increased from 15% and 2% to 2% and 25% respectively. The revision was based on the BOL s assessment of the characteristics of the Lao economy and the dollarization degree. New loan classification was also approved (No. 324 dated 19 April 211). Under the new regulation, loans will be classified into 5 classes instead of existing 3 classes. The new Pass and Special Mention classes will be added to the existing substandard, Doubtful and Loss classes. The basic principle in loan classification will be based on number of past due date. 2.3 TRADE REFORM Lao PDR has been gradually integrating into the world economy through accession to regional and multilateral trade organizations such as the ASEAN Free Trade Area and the World Trade Organization (WTO). The country initially applied to join the WTO in 1997, and is now making solid progress towards accession. The GOL is implementing a sector-wide approach to trade-related reforms based on the 26 DTIS/IF Action Matrix 9, to help address the supply-side constraints that inhibit export competitiveness. New institutional structures are being put in place and new investments are being made in customs and border administration as part of efforts to support improved trade facilitation. GOL is also now starting to update the DTIS with a new set of trade and integration priorities. Exports have recovered swiftly and strongly following the global financial crisis, driven by both rapidly rising prices in key export commodities, as well as increased flows of minerals and the start-up of exported power generation in major hydropower facilities. Exports of non-natural resource based products, including in agribusiness and light manufacturing are also growing, although this process is being somewhat overshadowed by growth in the natural resource sectors. Key Reform Actions Taken Progress towards WTO accession continues to be made, but key challenges remain ahead. The sixth meeting of the Lao WTO Working Party (WP) took place in September 21, at which the Lao delegation reported the progress on legislative reforms. These include new regulations on Import and Export procedures, legislation to establish SPS and TBT enquiry and notification points, a new Investment Law, new customs procedures including steps towards achieving compliance with the WTO Valuation Agreement. A key landmark is the approval of a new Decree in February 211 which formally introduces the principle of national treatment into Lao law

21 L a o P D R E c o n o m i c M o n i t o r - M A Y and establishes the principle of equal trading rights. However, key legislative gaps remain including much of the necessary subsidiary legislation relating to sanitary and phytosanitary measures, and regulations on intellectual property. Laos continues to make headway with the concluding of bilateral agreements, having signed agreements with China and Japan in 21. Agreements have been reached, but not yet signed with India and New Zealand, and Laos is close to reaching an agreement with the EU. Eventually Lao PDR s accession to the WTO will depend on concluding agreements with all WP members on goods and services. The GOL has drafted the elements of the Working Party report, which will need to be upgraded to a full Working Party report to be submitted to the WTO Ministerial Conference or General Council by the WP. The final report will recommend that Laos be admitted as a member. The seventh Working Party meeting is planned for May 211. Lao PDR is progressively complying with requirements to reduce tariffs under AFTA Common Effective Preferential Tariff. As of August 29, all remaining products on the sensitive list were brought into the inclusive list, of which 71 percent of products have a zero tariff. Lao PDR is required to reduce tariffs to zero on all inclusive list products imported from ASEAN countries by the year 215. Important work on trade facilitation is progressing with key steps taken during 21. A national coordinating body for trade facilitation the National Trade Facilitation Secretariat was formally established in October 21, by a Decision of the Deputy Prime Minister. A Trade Facilitation Strategy and Action Plan has also now been completed and was formally endorsed in March 211 for submission to the government for approval. The strategy and action plan identifies an agenda for improving trade facilitation and cooperation among border agencies with a proposed implementation structure and clear responsibilities for lead agencies as well as pre-defined performance indicators. Similarly, work has progressed with the developed on customs reform and modernization with the development of a new prototype system (ASYCUDA World), with streamlined procedures. Deployment of the pilot system is due to commence at the Lao-Thai Friendship Bridge in Thanaleng in May The action matrix was formulated based on the recommendations of the Diagnostic Trade Integration Study (DTIS) and is implemented under the National Integrated Framework (IF) Governance Structure. 19

22 S t r u c t u r a l a n d P o l i c y R e f o r m s 2.4 PRIVATE SECTOR DEVELOPMENT The Lao PDR Constitution of 1991 protects state, collective, and private forms of ownership. During the 199s an active legislative program laid the foundations for developing market based rules and institutions to support private sector development. Today, agricultural production and most manufacturing production are in private hands, and SOEs only cover around one percent of employment. Nearly 97 percent of manufacturing units are small (less than 1 employees). Of the medium and large units, around one third are privately owned by Lao PDR citizens and just over half are joint ventures with foreigners. The remainder is owned by government. Foreign investment inflows have increased rapidly, in both resource and non-resource sectors (mainly hydropower, mining, agriculture, processing industries, and tourism). Between 23 and 21, actual investments increased from $11 million to almost $8 million, with hydropower and mining now accounting for some 8 percent of inflows. The main foreign investors are from Thailand, China and Vietnam, with other countries such as France, Australia and South Korea also registering with significant investments. Laos has an increasingly strong higher level regulatory business environment, but significant gaps remain with regard to inconsistent and partial implementation of key laws, and remaining gaps in the subsidiary legislation. Key Reform Progress A key recent landmark during 21 was the approval of a new Unified Investment Promotion Law in May 21 (retroactively promulgated to apply from July 29). The new law replaces previously separate domestic and foreign investment laws and, with the pending issuance of a Prime Minister s Decree, eliminates the need for new investors to obtain an investment license. Thus the new law abolishes lengthy and cumbersome licensing approval procedures for general investment activities, and - in principle - creates a level-playing field for both domestic and foreign investors by harmonizing business entry procedures and investment incentives. With the new Law, foreign investors in general business activities can proceed straight to registration under the Enterprise Law. Implementation of the Enterprise Law and the Law on Processing Industry is continuing. Several important steps have recently been taken by GOL to simplify business entry, such as elimination of the minimum capital requirement for starting a business, introduction of a simplified business registration system in major provinces as part of the Enterprise Law implementation, and abolishment of establishment licenses for general manufacturing firms based on the Law on Processing Industries. Several mechanisms for public-private dialogue to identify and address business constraints have been established and are operational at both the central and provincial levels, such as the Lao Business Forum ( January 211), Provincial Public-Private Dialogues, and direct dialogues between LNCCI and various business associations and the GOL. However, the efficiency and effectiveness of these dialogues need to be enhanced further as several issues raised in past dialogues still have not been resolved, such as the tourist arrival fee, investment incentives, procedures for importing assistance goods funded by ODA, and other issues. New data from the World Bank s 21 Investment Climate Assessment suggests that the key constraints as reported by the domestic private sector have evolved from hard infrastructural challenges (such as transport, communications and energy infrastructure as reported in the 26 ICA), to softer aspects of the business environment (such as access to finance, tax administration and labour skills). In addition, poor productivity outweighs the advantage of low labour costs and leaves Laos at a net competitive disadvantage compared to other countries in the region. Firms serving the domestic market appear more productive and earn greater returns than exporters (the opposite of that seen in most other developing countries), which suggest (i) low levels of competition on domestic markets including barriers to entry, and (ii) emerging signs of losses of international competitiveness by non-resource sector exporting firms as a result of increased labor costs pushed up by monetary inflows as a result of the hydropower and minerals booms. The 21 Investment Climate assessment also shed light on a disconnect between actual business practices and what the law mandates. Looking at three comparable indicators (time to obtain a construction permit, time to clear customs for exports and import) shows that it takes systematically less time to obtain a permit or to clear customs in practice (survey based) compared to what a regulatory based estimate such as the World Bank Doing Business Indicators say. It may signal opportunities to further streamline laws and regulations which both respond to the need of the private sector of simple business procedures, while addressing the need of effectively regulating its expansion.

23 L a o P D R E c o n o m i c M o n i t o r - M A Y

24 A n n e x ANNEX 1 LAO PDR AT A GLANCE TABLE Key Development Indicators* 21 Population, mid-year (millions) GNI (Atlas method, US$ billions) GNI per capita (Atlas method US$) GNI per capita (PPP, international $) Lao PDR ,5 East Asia & pacific 1,93 5,12 2,644 5,426 Low income ,355 GDP growth (%) GDP per capita growth (%) Local prices Consumer prices (annual % change) Implicit GDP deflator Exchange rate (period average, kip per 1 US$) Structure of the Economy GDP (US$ millions) Agriculture (% of GDP) Industry (% of GDP) Services (% of GDP) 4, , , , Balance of Payments and Trade (US$ millions) Exports of goods (fob) Imports of goods (cif) Exports of goods and services Imports of goods and services Net trade in goods and services Current account balance (% of GDP) Non-resources current account (% of GDP) Reserves, including gold Government Finance (FY) (% of GDP) Total revenue (including grants) Revenue Taxrevenue Current expenditure Overall surplus/deficit External Debt and Resource Flows Total external public debt (% of GDP) Total debt service (% of exports) Foreign direct investment (US$ millions) Source: World Development Indicators ans staff estimates based on Lao authorities data. * Preliminary estimates for 21

25 L a o P D R E c o n o m i c M o n i t o r - M A Y ANNEX 2 GLOBAL ECONOMIC OUTLOOK The global economic outlook is expected to be positive in 211. The overall world economic growth (yoy) continues to remain fairly strong at about 4.4 percent this year (6.5 for emerging and developing economies and 2.4 percent for advanced economies - IMF WEO, April 211). Nevertheless, pressures from the unbalanced recovery of the world economy exist, especially with regard to unemployment, commodity prices, and capital flows. However, the global outlook and the length of the global recession still remain uncertain at this time. This paper bases its country-level projections for Lao PDR s FDI and export demand on IMF (WEO April 211) and the World Bank s projections (EAP Update March 211) for the regional and global economic outlook and commodity prices, presented in Annex Table 1 below. A nnex T able 1 The Global Economic Outlook in Summary (percentage, change from previous year, unless otherwise specified) e 21f 211f 212f Global conditions Global conditions World Output 1/ World trade volume Consumer prices Advanced Economies United Sates Emerging and Developing Economies 2/ Developing Asia Commodity prices (percentage change of USD terms) Non-oil commodities 3/ Agriculture Food Metals and minerals Copper Oil price 4/ Manufactures unit export value 2/ London Interbank Offered Rate (%) 5/ on USD Deposits on Euro Deposits On Japanese Yen Deposits Real GDP growth World Advanced Economies United States Euro Area Japan United Kingdom Central and Eastern Europe Emerging and Developing Asian Economies Developing Asia China India Indonesia Thailand Middle East and North Africa Source: IMF (WEO, April 211) Note: 1/ The quarterly estimate and projections account for 9 percent of the world purchasing power parity weights 2/ The quarterly estimates and projections account for approximately 79 percent of the emerging and developing economies. 3/ Average based on commodity export weight 4/ Simple average of prices of UK Brent, Dubai, and West Texas Intermediate crude oil. The average oil price was US$ 79.3 a barrel in 21; the assumed price based on futures markets is US$17.16 in 211 and US$18. in / Six-month rate for the US and Japan. Three month rate for the Euro Area 23

26 A n n e x ANNEX 3 - ACRONYMS AND ABBREVIATIONS AFTA ASEAN Free Trade Area NFA Net Foreign Assets ASEA Association of Southeast Asian Nations NPL Non-Performing Loan ATM Automatic Teller Machine NSEDP National Socio-Economic Development Plan BCEL Banque Pour Le Commerce Extérieur Lao NT2 Nam Theun 2 Project BOL Bank of Lao PDR ODA Official Development Assistance CIB credit information bureau PEFA Public Expenditure and Financial Accountability CPI Consumer Price Index PFMSP Public Finance Management Strengthening Program DT MFI Deposit Taking MFI PIP public investment programs DTIS Diagnostic Trade and Integration Study REER Real effective exchange rate EAP East Asia & Pacific SAO State Audit Organization EdL Electricité du Lao SOCBs State Owned Commercial Banks ESPS Electronic Salary Payment System SOE State-Owned Enterprise FDI Foreign Direct Investment SPS Sanitary and Phyto-Sanitary FY Fiscal Year (Oct-Sept) TBT Technical Barrier to Trade GDP Gross Domestic Product TIMS Treasury Information Management System GFIS government financial information system TSA Treasury Single Account GFS Government Finance Statistics VAT Value Added Tax GOL The Government of Lao PDR WB World Bank ICT Information and Communication Technology WEO World Economic Outlook IF Integrated Framework WP Lao WTO Working Party IMF International Monetary Fund WTO World Trade Organization LNCCI Lao National Chamber of Commerce and Industry LSX Lao Stock Exchange MFI Micro Finance Institutions MOF Ministry of Finance NA National Assembly NBFI Non-Bank Financial Institution NDT MFI Non-Deposit Taking MFI NEER Nominal effective exchange rate

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