ASIAN DEVELOPMENT BANK

ASIAN DEVELOPMENT BANK COUNTRY STRATEGY AND PROGRAM (2002-2004) LAO PEOPLE S DEMOCRATIC REPUBLIC August 2001

CURRENCY EQUIVALENTS (as of 31 July 2001) Currency Unit Kip (KN) KN1.00 = $0.0001096 $1.00 = KN9,120.00 ABBREVIATIONS ADB Asian Development Bank ADTA advisory technical assistance AFTA ASEAN Free Trade Area ASEAN Association of Southeast Asian Nations COSS country operational strategy study CSP country strategy and program GMS Greater Mekong Subregion IMF International Monetary Fund IPF indicative planning figure Lao PDR Lao People s Democratic Republic LRM Lao Resident Mission NGOs nongovernment organizations O&M operations and maintenance ODA official development assistance PPTA project preparatory technical assistance QPRM quarterly portfolio review meeting RTM round table meeting SME small and medium-size enterprise SOCB state-owned commercial bank SOE state-owned enterprise TA technical assistance UDAA Urban Development Administration Authority NOTES (i) (ii) The fiscal year (FY) of the Government ends on 30 September. FY before a calendar year denotes the year in which the fiscal year ends. For example, FY2001 begins on 1 October 2000 and ends on 30 September 2001. In this report, $ refers to US dollars.

CONTENTS Page EXECUTIVE SUMMARY ii I. DEVELOPMENT AGENDA 1 A. Key Features of the Lao People s Democratic Republic 1 B. Current Political, Macroeconomic, and Social Trends 2 C. Current Developments 4 D. Development Priorities and Outlook 8 II. ADB s DEVELOPMENT EXPERIENCE 9 A. Factual Summary of ADB Assistance 9 B. Summary Evaluation of ADB Assistance 10 C. Portfolio Performance and Status 13 D. Conclusions and Lessons for the Country Strategy and Program 13 III. ADB s STRATEGY 15 A. Poverty Reduction 15 B. Thematic Priorities 16 C. Private Sector Development 20 D. Regional Cooperation 21 E. Risks 21 IV. OPERATIONAL APPROACH 22 A. Modalities of ADB Assistance 22 B. Participation of Civil Society, the Private Sector, and Local Governments 23 C. Strengthening Government Capacity 24 D. Aid Coordination 24 V. THREE-YEAR ASSISTANCE PROGRAM 25 A. Funding Level and Performance 25 B. Loan and Technical Assistance Program 25 C. Economic and Sector Work Program 25 VI. PERFORMANCE MONITORING AND EVALUATION 26 A. Agreed Upon Performance Indicators 26 B. Monitoring Process and Plan 26 APPENDIXES 27

EXECUTIVE SUMMARY The Lao People s Democratic Republic (Lao PDR) has a rich and varied natural resource base and is also the hub of the economic corridor linking the subregional economies. However, the Lao PDR s mountainous terrain, remote settlements, and low population density are barriers to access to and cost-efficient delivery of public services. Policy and administrative reform must be accelerated and institutions and human resources developed to realize the country s potential. During the last five years, the Lao PDR has achieved average economic growth of about 6 percent per annum and reduced the incidence of poverty from 45 to 39 percent. The incidence of poverty varies significantly across regions as well as between urban and rural areas, and is highest in the northern region and lowest in Vientiane Municipality. While economic growth has helped reduce poverty, the better-off have benefited more than the poor. Sustaining poverty reduction through equitable economic growth will be a major challenge. The Government s ambitious development goal is to reduce poverty by half by 2005 and eradicate it and for the Lao PDR to graduate from the status of least developed country by 2020. The Government targets broad-based economic growth of 6-7 percent per annum over the next five years. The strategic approach is to reduce poverty through human and rural development, and people s participation, focusing on (i) agriculture and forestry, (ii) education, (iii) health, and (iv) road infrastructure. To achieve its ambitious objectives with limited financial and human resources, the Government will need to prioritize and phase in its poverty reduction program. The Asian Development Bank s (ADB) 1996 Country Operational Strategy Study places high priority on sustainable economic growth through infrastructure investments, and secondary but important emphasis on policy reform, social services, and human development. The Study also emphasizes subregional cooperation. Operations evaluation findings show that ADB s past operations contributed to the country s economic development, poverty reduction, and regional integration. However, to maximize the development impact of ADB s operations in the Lao PDR, the following are needed: (i) more emphasis on synergy between various development activities, (ii) better social and environmental management in economic development planning and implementation, (iii) effective institutional development and capacity building, (iv) greater sustainability of investment projects, and (v) more emphasis on full participation and ownership of stakeholders. The theme of ADB s interventions in the Lao PDR over the next five years will be poverty reduction by broadening community participation and opportunities. Core strategies are (i) sustainable economic growth, (ii) inclusive social development, and (iii) good governance through policy and institutional development. ADB will thus focus on four operational priorities (i) rural development and market linkages, (ii) human resource development, (iii) sustainable environmental management, and (iv) private sector development and regional integration. The participatory poverty assessment highlights the need to improve rural infrastructure and increase market access in rural areas. With local community s participation, ADB will support the development of rural access roads, electricity, water supply, and other rural physical infrastructure. ADB investments will be complemented by improved basic education, skills, and health standards. To increase agricultural productivity, ADB will focus on (i) institutional development and policy reform; (ii) crop diversification, including livestock and commercialization; (iii) reducing shifting cultivation; (iv) rural finance development; and

iii (v) provision of extension services. Small-town development will help link the rural and urban areas. ADB will continue to widen the coverage of quality services in basic education, primary health care, and water supply, and to support development of isolated areas, women, and ethnic minorities. Social services will be made more relevant to community needs by increasing community participation in project preparation and implementation. ADB will strengthen policy dialogue to address the imbalance between current and capital expenditures to make social sector investment more sustainable and efficient. In a natural resource-based economy, all public investments have potentially important environmental implications. Environmental considerations will be increasingly integrated into earlier stages of economic planning and infrastructure development, including hydropower. ADB will work closely with other aid agencies, community groups, and civil society to improve the institutional, policy, and regulatory framework for sustainable environmental management. ADB will place more emphasis on community consultation and involvement, and on raising public awareness of social and environmental issues. ADB will consider investment support for river basin development and industrial tree plantation. Private sector development, particularly of micro- and small businesses, is critical to achieve sustainable economic growth and reduce poverty. To improve the business environment, ADB will focus on (i) restructuring state-owned commercial banks (SOCBs) and improving corporate governance, (ii) providing a level playing field for state-owned enterprises and the private sector, (iii) improving financial service delivery in rural areas, (iv) establishing regular dialogue between business groups and the Government, and (v) removing barriers to cross-border movement of goods and people. Infrastructure projects will develop potential markets, tourism, and enterprises. ADB will pursue internal and subregional economic integration to expand the economy s market base and broaden the country s opportunities. Most road networks in the land-linked Lao PDR contribute to subregional cooperation. The country program should be effectively linked with Greater Mekong Subregion (GMS) initiatives. The country strategy and program (CSP) aims to explore policy, administrative, and public expenditure options to maximize the benefits to the Lao PDR from subregional cooperation. Potential areas for subregional development cooperation include transport, tourism, power transmission, telecommunications, trade and investment, HIV/AIDS and other disease prevention, and environmental management. To enhance the development impact of projects and ensure their close monitoring, ADB s interventions in the Lao PDR will focus primarily on the northern region provinces, 1 which are the poorest in the country, and on Savannakhet Province, where the ongoing GMS: East- West Corridor Project connecting the Lao PDR with Thailand and Viet Nam will provide opportunities for access to markets. Weak capacity of the Government and local agencies and inefficient delivery of public services are major constraints to development. Institutional development, improved governance, and greater stakeholder participation in development will be an integral part of all ADB operations. ADB will particularly focus on improving (i) public finance management, (ii) government accounting and auditing, (iii) project implementation and monitoring; and (iv) the 1 Here, northern region provinces include Phongsali, Louang Namtha, Oudomxai, Bokeo, Louang Phrabang, Houaphanh, Sayaburi, Xaisomboun, and Xieng Khouang.

iv capacity of provincial authorities. Long-term institutional development and capacity-building programs for agencies will be prepared and reflected in ADB investment, as appropriate. Three lending scenarios are proposed for the 2002 2004 assistance plan. Considering recent achievements in macroeconomic stability, economic growth, poverty reduction, and social development, the current situation is a base case lending scenario. Subject to performance-based allocation, an indicative planning figure (IPF) of $45 million 55 million per year for lending, with additional IPF for subregional projects, is used to develop the 2002 2004 assistance plan. A base case scenario would be triggered by (i) stable macroeconomic outlook; (ii) formulation of and Government commitment to a SOCB restructuring plan and implementation of agreed upon interim measures; (iii) enactment and implementation of the prime minister s decree on social and environmental impact assessment; and (iv) implementation of monitoring systems for contract award, submission of audited financial reports, and compliance with loan covenants. A high case scenario would be triggered by (i) significant improvement in macroeconomic management; (ii) implementation of restructuring plan of the banking sector and rural finance; (iii) significant improvement in the balance between capital and current expenditures in social development; and (iv) significant improvement in contract award, submission of audited financial reports, and compliance with loan covenants.

v SUMMARIZED THEMATIC FRAMEWORK STRATEGIC THEME Poverty Reduction by Broadening Community Participation and Opportunities THREE PILLARS OF POVERTY REDUCTION Sustainable Economic Growth Inclusive Social Development Good Governance through Policy and Institutional Development OPERATIONAL PRIORITIES Rural Development and Market Linkages Human Resource Development Sustainable Environmental Management Private Sector Development and Regional Integration GEOGRAPHIC FOCUS OF INVESTMENT PROJECTS Northern Region Provinces (including Xaisomboun and Xieng Khouang) Savannakhet Province along the East-West Corridor PRIORITY REFORMS TO BE MONITORED DURING THE COUNTRY STRATEGY AND PROGRAM Regional, Ethnic, and Gender Equity in Development Enforcement of Social and Environmental Safeguards Increased Budget Share for Current Expenditure on Social Development Reduction of Barriers to Private Sector Development and Regional Integration Increased Domestic Resource Mobilization OPERATIONAL ISSUES AND APPROACHES Agreed Upon Sector Strategies, with Clear Targets and Long-Term Support Stakeholder Participation in Project Design and Implementation Mobilization of Local Resources for Social and Economic Development Long-Term Capacity Building and Institutional Strengthening Support Integrating Subregional Cooperation in Development Planning Improved and More Consistent Monitoring and Evaluation

I. DEVELOPMENT AGENDA 1 A. Key Features of the Lao People s Democratic Republic 1. Natural Resources 1. The Lao People s Democratic Republic (Lao PDR) has a rich resource base and unique biological diversity, and is the least densely populated country in Southeast Asia. Some three quarters of the population are involved in agriculture. Forests still cover more than one third of the country. Natural resource-based economic potential includes agriculture, forestry, fishing, tourism, mining and hydropower. Natural resource-based development is accelerating and could help achieve economic growth with equity, provided the poor (including ethnic minorities and rural women) have equitable access to resources and economic opportunities. However, much of the country is uncultivated and environmentally fragile. Deforestation and shifting cultivation remain major problems. Unexploded ordnances are a problem in up to half the districts. Some hydropower projects have had unintended environmental and social costs. Poverty must be reduced to discourage unsustainable shifting and poppy cultivation and thus ameliorate environmental pressures. Sustainable natural resource-based development requires adequate, enforced social and environmental safeguards. 2. Diverse Ethnic Groups and Cultures 2. The small population includes more than 70 ethnic groups 2. This diversity enriches the culture, but also has implications for development. Well-designed participatory approaches are particularly important to reflect ethnic differences. Language, livelihood patterns and other culture-specific issues need to be considered when providing social services, infrastructure and economic opportunities to ethnic groups. Targeting ethnic groups may increase costs, but may also be more cost-effective in reducing poverty in the poorest areas where ethnic minorities live. 3. Land Link to Major Subregional Economies 3. The Lao PDR was once an isolated, landlocked economy, with limited and high-cost access to foreign markets. The Government has adopted more open economic policies and a development strategy that emphasizes the country s location at the hub of trade routes linking emerging regional economies. The Government recognizes that regional cooperation offers significant opportunities for the Lao PDR as a land link in the Greater Mekong Subregion (GMS). Infrastructure must be improved to realize the potential economic benefits of the Lao PDR s geographic location. Complementary policy and administrative reforms are needed to facilitate the cross-border movement of goods, people, and investment. 4. Mountainous Terrain and a Fragmented Domestic Market 4. Mountainous terrain, remote settlements, and low population density are barriers to access and the cost-efficient delivery of social and other services. Physical constraints, 1 The country strategy and program (CSP) was prepared by the Asian Development Bank s (ADB) country team (led by G. H. Kim, Programs Officer, PW3) and the Government s country team (led by K. Pholsena, Vice President, Committee for Planning and Cooperation). Considerable consultations have been conducted with provincial authorities, other aid agencies, international nongovernment organizations, community-based organizations, and the private sector. 2 Lao PDR Government Report to the Seventh Round Table Meeting. November 2000. Fighting Poverty through Human Resource Development, Rural Development and People s Participation. Vientiane.

2 including a lack of direct access to seaports, poorly developed infrastructure, and a small domestic market, increase business costs and discourage commercial investment. Per capita infrastructure costs are high due to the sparse population. Weak public administration has exacerbated these constraints. A strategic approach is needed to reform institutions and the organizations required to provide critical rural services and infrastructure. The viability of many socioeconomic development investments will depend on the extent of internal and subregional economic integration. 5. Transitional Economy 5. The country is in transition to a market-oriented economy. The public sector still plays a major role in industry, the financial sector, and some services. Frequent policy and institutional changes, bureaucratic interference in business decisions, and administrative discretion add to business costs. Institutions are weak in terms of protecting property rights, enforcing contracts, and providing professional and financial services. Institutional weaknesses and severe public sector budget constraints inhibit the delivery of public services, and limit capacity to maintain physical infrastructure, reducing the development impact of past public investments and official development assistance (ODA). In some sectors, improving the quality and sustainability of public investments and services is more urgent than increasing public investment, and will require reforms in public administration and ODA delivery. Alternative arrangements for delivering services are being tested, including the increased involvement of local authorities, private enterprise, and civil society. 6. Underdeveloped Human Resources 6. Key indicators of human development, including life expectancy, infant and maternal mortality, and education levels, are among the lowest in the region. The United Nations Development Programme s (UNDP) human development index gives the Lao PDR a rating of.484 and a ranking of 140 out of 174 countries, making the Lao PDR one of the poorest developing member country in the region. 3 Low education, health, and nutrition standards are major constraints to productivity growth. The education and health status of women is particularly disappointing. Women s potential contribution to development is weakened by their limited participation in higher value-added economic activities. UNDP s gender-related development index gives the Lao PDR a rating of.469 and a ranking of 117 out of 143 countries. Some 70 percent of the workforce has not completed primary school, and poor technical and management skills discourage business investment. Accelerated human development is an important goal in itself, but is also essential to achieve sustainable economic growth and reduce poverty. B. Current Political, Macroeconomic, and Social Trends 1. Political Trends 7. Political stability has been sustained over the last 25 years by the one-party state. The newly appointed political leadership is committed to pursuing reforms and reducing poverty through (i) sustainable social and economic development, (ii) balanced and equitable development, (iii) administrative and political development, (iv) external cooperation, and (v) national security. Fulfilling these commitments and the emerging aspirations of a changing society which has an increasing proportion of well-educated young people will require 3 United Nations Development Programme. 2001. Human Development Report. New York.

3 accelerated public sector and economic reforms. Decentralized development activities through greater community participation is important. However, implementation capacity remains weak, and much remains to be done to ensure that local institutions are accountable. The recent decision to transfer public service management responsibilities from the Lao People s Revolutionary Party to the Government is an important initial step to improve public sector professionalism. 8. The Lao PDR s commitment to regional integration is reflected in the country s membership in the Association of Southeast Asian Nations (ASEAN) since 1997, commitment to the ASEAN Free Trade Area (AFTA), and active involvement in other regional initiatives such as the GMS Program and Mekong River Commission. The Government is also investigating possible membership in the World Trade Organization. Despite these positive developments, challenges remain in meeting the existing and proposed commitments and in developing the capacity and policy environment to maximize national gains from regional integration. 2. Macroeconomic Trends. 9. In 1997 1999, the country suffered macroeconomic instability, triggered by expansionary fiscal policy and the regional financial crisis. From 10 20 percent before the crisis, inflation rose to 87 percent in 1998 and 134 percent in 1999. The kip sharply depreciated by about 80 percent against the dollar between 1997 1999. Capital spending increased from approximately 50 percent of total government expenditures to approximately 75 percent during the crisis, mainly because the Government invested heavily in irrigation systems. Depreciation of the kip also increased the kip-denominated amount of externally funded projects. Inflation eroded the value of recurrent expenditure, particularly government salaries. 10. Tighter fiscal and monetary policies since mid-1999 and the recovery of neighboring economies have helped restore stability in the Lao PDR economy, which grew by 7.3 percent in 1999 and 5.9 percent in 2000. Agriculture (particularly paddy crops), manufacturing (primarily textiles), and tourism all contributed significantly to economic growth. Inflation is expected to be below 10 percent in 2001. The exchange rate has stabilized at around KN8,000 to $1. The fiscal deficit is still high at around 9 percent of gross domestic product (GDP). Tax revenues have gone up from 10.6 percent of GDP in 1999 to 14.0 percent in 2000. The Government is taking steps to restore the balance between capital and recurrent spending. Capital spending now accounts for about 65 percent of total government expenditures. Exports have grown by about 8 percent since 1998, and the balance of payments, although in deficit, is improving. Tourism, textiles, and electricity are key exports. The current account deficit was less than 6 percent in 1999 and 2000, a substantial improvement from previous years when the deficit was 10 20 percent. 11. In April 2001, the Lao PDR and International Monetary Fund (IMF) entered into an agreement to permit the country to borrow under IMF s Poverty Reduction and Growth Facility. The agreement is an important endorsement of the country s commitment to economic reform. Macroeconomic management priorities include strengthening domestic resource mobilization to reduce the economy s heavy dependence on external assistance, and increasing current expenditure allocations (especially for social services). Reforms in fiscal management and the financial sector are critical. Achieving targeted annual growth rates of 6-7 percent 4 over the next five years will require additional reform of state-owned enterprises and the financial sector, and continued commitment to opening the economy. Given limited public resources and weak 4 ADB staff estimates.

4 public sector management, an active private sector is critical. To maintain the inflation rate at less than 10 percent, the Bank of Lao should keep its commitment to not financing future budget deficits by printing money. 3. Social Trends 12. Progress has been made in social development. The adult literacy rate increased from 50 to 74 percent in the last decade, infant mortality declined from 104 to 75 per 1,000 births in 1995 2000, and life expectancy increased from 50 years in 1995 to 55 years in 2000. 5 However, rural areas have improved much more slowly than urban areas, and have gender disparities in education and employment. The disparity is growing between Mekong river basin communities and those in the uplands and highlands. The lowland population is increasingly involved in market economy activities, including growing trade with Thailand. Lowlanders generally have better education and health services, and better access to physical infrastructure. New transport and electricity infrastructure is resulting in rapid expansion of settlements and micro- and small business activity in some larger provincial towns. Most uplanders, however, still live in a largely nonmonetized economy, and have poor access to health, education, transport, power, and markets. C. Current Developments 1. Poverty Situation a. Assessment 13. The 1997/98 expenditure and consumption survey reveals a decline in poverty incidence from 45 percent in 1992/93 to 39 percent in 1997/98. The incidence of poverty varies considerably across regions and provinces as well as between urban and rural areas (Table 1). The incidence of the poor and ultrapoor 6 is highest in the northern provinces and lowest in Vientiane Municipality, which also enjoyed the largest decline in poverty, from 24.4 to 12.2 percent of the population. In contrast, poverty in the northern region declined only slightly from 58.4 to 52.5 percent. Consequently, the estimated Gini coefficient for per capita consumption increased from 0.29 in 1992/93 to 0.36 in 1997/98. While consumption inequality may not be as high as in many other Asian countries, it has increased markedly in the last five years. According to participatory poverty assessments, poverty in the Lao PDR is generally influenced by livelihood systems, including agriculture and forestry production, rural infrastructure, basic education, and primary health care. The burden of poverty is disproportionately borne by women (Box 1). 5 Lao Reproductive Health Survey 2000, NSC/UNFPA 2000 and Government reports. 6 Those at 80 percent or less of the food poverty line.

5 Regions Table 1: Poverty Incidence in Lao PDR by Region Consumption Population (average annual Living in growth 1992/93 to Poverty (%) 1997/98) Consumption (real kip/capita, 1997/98) Poverty in Urban Areas (%) Poverty in Rural Areas (%) Vientiane Municipality 59,577 10.8 12.2 16.7 4.5 Northern Region a 25,770 4.9 52.5 43.3 53.5 Central Region 32,586 4.7 34.9 27.7 35.9 Southern Region 29,504 4.4 38.4 35.8 38.7 Total 32,848 5.8 38.6 26.9 41.0 a Northern provinces include Phongsali, Louang Namtha, Oudomxai, Bokeo, Louang Phrabang, Houaphanh, and Sayaburi. However, in this CSP, Xaisomboun and Xieng Khouang will also be considered as northern provinces. Source: Lao PDR Government Report to the Seventh Round Table Meeting. November 2000. Fighting Poverty through Human Resource Development, Rural Development and People s Participation. Vientiane. Box 1: A Day in the Life of a Poor Woman Mrs. Khem is a Khmou woman living in a poor village. She is the mother of five children. Last year, one of her sons died of an illness. She gets up before dawn to pound rice. While she is pounding, the baby cries and she puts the baby on her back. She fetches more water and then starts the cooking fire and puts on the rice. Her husband and other children wake up and have breakfast while she breastfeeds the baby. She also prepares some food for the day s work. They walk two hours up the mountain to get to the field. She begins to clear the grass from the fallow. Cutting and burning the grass is women s work. The fallow soil is not very productive. On the same amount of land, they used to produce enough rice to feed the family for a year. Now the rice only lasts for five months. Her husband and sons join her at about 11 a.m. from foraging for products that can be exchanged for rice. Today they have found a large bamboo rat which they will eat for dinner and collected some damar resin for sale in the market. With her daughters, she prepares lunch for the family. Following lunch, her husband naps while she feeds the baby. Her husband and sons return to the forest and she continues to clear the field. In the late afternoon, she gathers some bamboo shoots and firewood. Her husband returns with a rare argus pheasant that they have trapped and will sell to a wildlife trader. On the two-hour walk back, she carries the firewood on her back and the baby on her front, the bag with bamboo shoots is slung over her shoulders. Her daughter carries heavy calabashes and bags of corn. The bamboo rat is carried live dangling from a shoulder pole by her youngest son. The oldest son carries the pheasant. When they arrive, just after nightfall, she builds a fire and puts a new container of rice on to steam and goes to fetch some water. She returns to feed the pigs and chicken again and prepares dinner with her daughters. The bamboo rat is skinned and cleaned and prepared for a stew. After dinner, she feeds the baby, washes the dishes, and cleans up with her daughter. By the time she goes to bed at 9 p.m., her husband is already asleep. She lives the same way as her mother and grandmother did, with the notion that their lifestyle is their fate something that they cannot change by themselves. Source: ADB/SPC, Participatory Poverty Assessment, 2000. b. Pro-Poor Growth 14. Economic growth has done much to reduce poverty in the Lao PDR, but has not done so equitably, especially in reducing the number of ultrapoor. Based on the preliminary findings, 7 the 7 Kakwani, N. and E. Pernia. 2000. What is Pro-Poor Growth? Asian Development Review. Vol. 18. Manila.

6 elasticity of poverty incidence relative to growth 8 for 1992 1998 was 0.21: that is, for every 1 percent increase in growth, poverty incidence declined by about 0.21 percent. Growth has benefited the better-off more than the poor, and inequality has increased. The population just above the poverty line is considered vulnerable to external shocks. Given the scattered and remote population, which lives largely outside the monetized economy, specific pro-poor growth polices must be developed to build the capacity of the poor and empower them to partake of economic growth. c. Governance 15. Recent participatory poverty assessments 9 found evidence of links between good governance and poverty reduction. The poorest areas have generally had little contact with the Government and limited access to basic public services such as health, education, transport, power supply, or markets. The assessments identified insecure land tenure and lack of transparency in land titling as among the most pressing problems of poverty. At the local level, full participation of village leaders and their constituents in decision making for development projects has been key to poverty reduction (Box 2). The poor need to have strong ownership of efforts to improve their lives. Effective governance and accountability require mechanisms and capacity to work with all stakeholders, including established village leadership structures, to identify needs and help develop and deliver solutions. Institutional and regulatory weaknesses result in limited accountability, administrative discretion, and ambiguity, which reduce the efficiency of public service delivery, invite corruption, and discourage investment. Red tape particularly constrains small, labor-intensive enterprises, which are essential to the Government s development strategy. The capacity of public sector agencies should be improved by enhancing officials professionalism. Box 2: Village Cooperation in Fighting Poverty Mr. Khamone is the chief of a Khmou village located 30 minutes away by foot from the main road. In 1995, he retired from the military, where he was a captain responsible for food supply. In 1997, he was elected as a village chief. He decided, based on his experience and observations from all over the country, that he would work to eradicate poverty in his village of 37 households. After becoming village chief, he called a meeting of the village and established a rule with the agreement of the villagers: Whoever is lazy and doesn t work to improve the livelihood of their household will be fined. The village decided to increase their income and agricultural production. At first, they did not know how to increase their income, so they had a meeting to decide on cash crops. They decided to plant paper mulberry, which is easy to grow and has bark that can be easily sold. They also decided to grow sesame and pepper, which can be sold at the local market. They also started collecting palm hearts from the forest for resale in the market. It was agreed that each household would plant at least one of the cash crops. After two years, they have no food shortages in their village. Last year, household cash incomes varied from KN3 million 6 million, a substantial increase for most households. As for Mr. Khamone, he has just purchased a rice mill for the village. I am doing this for the real life. We won t concede to have less than other villages. Now some households are richer than I am. Source: ADB/SPC Participatory Poverty Assessment, 2000. 8 The elasticity of poverty incidence relative to growth is derived by the overall change in the poverty situation by the pure growth effect (i.e., subtracting the equity effect). Growth is viewed as weakly pro-poor if greater than zero but less than 0.33, moderately pro-poor if between 0.33 and 0.66 and strongly pro-poor if greater than 0.66. 9 State Planning Committee. October 2000. Poverty in the Lao PDR: Participatory Poverty Assessment. Vientiane.

7 d. Social Development 16. Urban areas are more developed than rural areas, and the uplands have less access to health, education, transport, electricity, and markets than the Mekong corridor. Uplanders (often ethnic minorities) see migration as a way to prosperity and as one of few options to improve living standards. Rural women are especially disadvantaged. They are traditionally primary production managers, small-enterprise traders, primary cash earners, small-credit users, and key agriculturists, and play key roles in education and health. However, they suffer from lack of access to and control of economic resources and opportunities as well as from poor health and education. Balanced social development is a goal as well as a prerequisite for sustained acceleration of economic growth. Mountainous terrain, remote settlements, ethnic diversity, and low population density are barriers to access and add to the cost of delivering socioeconomic services. A recent participatory poverty assessment found that poor villagers view education as unavailable, unaffordable and/or secondary to securing their livelihood. Much remains to be done to develop and establish appropriate institutional arrangements for expanding basic services to rural areas where livestock is often the only form of social insurance. 2. Private Sector Development 17. The private sector produces most agriculture output and some 75 percent of service sector output. The private sector is also increasingly active in handicrafts and manufacturing (mainly small-scale agricultural processing, timber, and textiles). The next five years may see large private investments: Nam Ngum 2 and 3, and Nam Theun 2 hydropower projects; gold and copper mines in Sepon and Xaisomboun Special Region; and plantation forestry. However, the state remains dominant in some sectors, including energy, and many private enterprises depend on close links with the state sector to remain viable. Cumbersome bureaucratic requirements and procedures (e.g., lengthy procedures for business licenses); poorly developed market institutions (property rights, land titling and access to land, contract enforcement mechanisms, professional services, business legislation, financial institutions, etc.); and lack of transparency in tax collection and law implementation remain major constraints to private investment. An often inconsistent and frequently changing regulatory framework clouds the investment environment. Corruption adds to business costs and discourages private investment. Regular consultative mechanisms between business groups and high authorities are immediately needed to continuously identify and address institutional constraints to private sector investment. Throughout Asia, including the People s Republic of China and Viet Nam, small and medium-size enterprises (SMEs) play a vital role in reducing poverty and generating employment and income growth. 3. Environment 18. Most of the population (especially the poor) rely on natural resources for their livelihood. Population growth, limited cultivation area, and poor soil conditions force the rural poor to engage in shifting cultivation, with detrimental consequences to the environment, long-term productivity, and rural incomes. The Government aims to replace shifting cultivation of upland rice with sedentary farming by providing improved rural infrastructure and other services. Social concerns should be fully considered during implementation of the Government policies. There is also a need to address environmental issues such as the unsustainable commercial exploitation of forests and adverse environmental impacts of infrastructure projects.

8 4. Regional Cooperation 19. The Government recognizes that regional cooperation can help narrow the gap between the Lao PDR and other regional economies, and that active membership in ASEAN and AFTA will enable Lao PDR to strengthen its role as a land link, at the center of the GMS. It is important to explore policy, administrative, and public expenditure options to maximize national benefits from regional cooperation, and to ensure their equitable distribution. Potential areas for expanded regional development cooperation include transport, tourism, power transmission, telecommunications, trade and investment, HIV/AIDS and other disease prevention, prevention of human and drug trafficking, environmental management, and river basin development. D. Development Priorities and Outlook 1. Objectives and Priorities of the Lao PDR 20. Government development priorities are presented in its strategies for socioeconomic development from now to 2020 and 2010 and fifth five-year socioeconomic development plan (2001-2005). The Government s ambitious targets are to (i) reduce the proportion of poor families by more than half and stop poppy cultivation by 2005; (ii) basically eradicate poverty and stop shifting cultivation by 2010; and (iii) graduate from the status of least developed country by 2020 by becoming a natural resource-based industrialized economy. The strategic approach is to fight poverty through human development, rural development, and people s participation by focusing on (i) agriculture and rural development, (ii) education, (iii) health, and (iv) road infrastructure. The Government is preparing a national poverty reduction strategy, which will take its focus from the Socioeconomic Plan (2001-2005). The Government wants to facilitate greater people s participation in development, and recently adopted a decentralization policy that focuses on provinces as strategic units, districts as planning and fiscal units, and villages as implementing units. The Government established the urban development administration authorities (UDAAs) to decentralize urban development. Accelerated human and institutional developments is the prerequisites for national development. The Government recognizes that governance is a vital link between economic growth and poverty reduction and that environmental sustainability is a prerequisite for continued sustained economic growth [and] poverty alleviation. 10 2. Public Finance and Investment 21. The biggest barrier to realizing development goals is inadequate domestic resources to finance recurrent expenditures for social development and maintenance of physical assets. Weak tax collection, public expenditure planning, and management, and an overreliance on ODA financing of public expenditure (about 80 percent of capital expenditures) remain major concerns. The turnover tax, excise taxes on luxury goods, and trade taxes account for around 50 percent of Government revenue. The property, income, and profit taxes account for less than 20 percent of total revenue. A large percentage of taxes are collected from trade. As the Lao PDR joins the world economy, the country will need to diversify its tax base and depend more on domestic sources. Notwithstanding recent improvements in tax collection, Government revenue is still only around 14 percent of GDP. The Government is thus considering introducing the value-added tax system. Private investment must also be encouraged to provide appropriate public services and invest in commercial business to help bridge the domestic investment and 10 Lao PDR Government Report to the Seventh Round Table Meeting. November 2000. Fighting Poverty through Human Resource Development, Rural Development and People s Participation. Vientiane.

9 savings gap and finance the ambitious development agenda. The Government stresses the need to step up domestic resource mobilization and improve the quality and efficiency of publicly financed services and infrastructure. With the provinces now accounting for approximately 30 percent of total public investment, the Government strategy recognizes that public expenditure efficiency requires building local administrative capacity. 3. Role of External Assistance 22. External assistance has (i) filled the financing gap by providing up to 80 percent of public investment in recent years, (ii) helped expand physical infrastructure, and (iii) increased per capita incomes and improved key indicators of human development. The Government recognizes that it needs external assistance to finance the ambitious development agenda. At the same time, the Government is concerned about (i) its capacity to maintain and fully utilize recently developed physical assets, (ii) the cost-effectiveness of some assistance, and (iii) the fact that human development indicators have not satisfactorily risen despite substantial external assistance for human development. Given the rising external debt, the Government stresses the need for more efficient and effective ODA-financed initiatives through decentralization and greater stakeholder participation at all stages of the project cycle. Development partners have expressed similar concerns through the round table meetings (RTMs), most recently in November 2000. The Government hopes to use RTMs to address remaining constraints to effective ODA delivery. 4. ADB s Assessment of the Development Agenda 23. ADB endorses the Government s emphasis on poverty reduction, human resource development, and equitable delivery of social and economic services. ADB welcomes the Government s emphasis on increasing stakeholder participation, decentralization, and public service efficiency. The Government development agenda is ambitious, and will need to be phased in and perhaps further prioritized to reflect limited financial and human resources. Past heavy reliance on ODA contributed to disproportionately high capital expenditure at the expense of current expenditure, especially in the social sectors as well as in operations and maintenance (O&M) of assets. Better domestic resource mobilization and more current expenditure allocations for social services are prerequisites for ADB support for the development agenda. Domestic resources should be the primary source of development funding, with external resources playing a supplementary role in financing the resource gaps. The financial sector should be deepened from its currently low level of 18 percent of GDP. Economic growth of 6 7 percent per annum is planned for the next five years. Past performance and regional experience suggest that such growth is achievable, but sustainable acceleration of economic growth requires (i) a competitive and open market economy, (ii) high labor productivity through improved health and education, and (iii) sustainable management of natural resources. II. ADB s DEVELOPMENT EXPERIENCE A. Factual Summary of ADB Assistance 24. ADB has approved 49 loans totaling $887.5 million, and 174 technical assistance (TA) grants totaling $83.5 million to the Lao PDR from 1968, when operations there began, until the end of 2000 (Table 2). Nearly half of all ADB loans were approved in the last five years. Until the 1980s, assistance focused on transport and energy infrastructure development. Since the late 1980s, ADB has promoted financial sector development. The focus of support broadened during the 1990s to include rural development, social development, and the environment.

10 Table 2: Summary of ADB Loans and Technical Assistance to the Lao PDR (as of 31 December 2000) Loan TA Sector 1996 2000 1970 2000 1996 2000 1968 2000 Number $ mn Number $ mn Number $ mn Number $ Mn Agriculture and Natural 3 35.8 11 126.8 9 6.13 43 22.82 Resources Energy 2 82.0 13 223.3 7 3.57 18 11.34 Finance and Industry 1 25.0 2 50.0 5 3.03 26 9.21 Multisector and Other 12 5.98 23 9.61 Social Infrastructure 7 132.0 12 183.4 12 6.76 36 17.05 Transport and 4 151.0 11 304.0 6 3.34 28 13.50 Communications Total 17 428.8 49 887.5 51 28.81 174 83.52 Percent of Total 48 100 = not available, mn = million Source: Asian Development Bank. B. Summary Evaluation of ADB Assistance 25. The last country operational strategy study (COSS) for the Lao PDR was prepared in July 1996. The strategy placed high priority on sustainable economic growth through infrastructure investments, and secondary but important emphasis on policy reform, social services, and human development. The COSS also emphasized subregional cooperation to enhance the landlocked economy s market opportunities. 1. Relevance 26. The COSS continues to be relevant to the Lao PDR s development constraints. Infrastructure development is a clear priority for a country that has a small, scattered, and remote population, and mountainous terrain. ADB s past investments have considerably improved the national road network. The key concerns now are to (i) ensure sustainability of infrastructure, (ii) better address development s adverse social and environmental impacts, and (iii) ensure that the social and economic benefits of development are equitably distributed. To improve relevance, selected social services should be targeted at poor areas, and operations equity issues explicitly addressed. ADB interventions can be made more relevant by (i) building on past interventions and/or complementing ongoing interventions, (ii) ensuring direct linkages among all elements of the strategy, and (iii) paying more attention to developing medium-term approaches to addressing financial and institutional weakness. 2. Efficiency 27. ADB assistance should be more consistently efficient and effective. ADB support in some sectors (e.g., transport) has been relatively efficient, but less so in others. The cost efficiency of ADB support could be increased by a narrower geographic focus, and better project designs that take into account real institutional capacities. Greater emphasis on communitybased rural infrastructure projects might be more costly in terms of time and ADB staff resources for preparation, but the cost savings to communities and the Government could be substantial in the long term. Increased involvement of local communities in project preparation and implementation could make development projects more efficient. Recent experience suggests that a series of loosely related TA projects is not a cost-efficient modality for institutional strengthening. Institutional strengthening is an ongoing process, and any assistance

11 must take a sufficiently long-term view of the institution s development needs. Without a strongly committed host agency, development impact will be unsatisfactory. 3. Effectiveness 28. ADB-financed projects have contributed to economic, social, and institutional development, and to recent progress in reducing poverty. Long-term support to power, road transport, and other infrastructure development has developed physical assets and institutional capacity, enhancing economic opportunities for isolated rural communities. ADB support to primary health and education activities is beginning to improve service delivery and to make it more equitable. ADB has also created a decentralized institutional framework through urban sector interventions. However, the road network is underutilized because of inadequate linking of infrastructure developments to market opportunities and improved social services. Past gains in infrastructure development may be undermined by inadequate attention to O&M expenditure, and the impact of the recent regional financial crisis on resource mobilization. Development could have been more effective if more attention had been paid to (i) analyzing local conditions, (ii) identifying priority needs, and (iii) ensuring community participation and ownership in the development process, and if support to sector development had been focused and sustained in line with clearly articulated sector strategies agreed upon by the Government, ADB, and other development partners. ADB support to policy and institutional reform in key sectors such as agriculture, finance, and water supply has been less effective than envisaged. 4. Major Sector Reviews: Success and Failures 29. Recently completed and ongoing economic and sector work that fed into this country strategy and program (CSP) included (i) agriculture, education, rural finance, road, energy, environment, and urban sector strategy studies; (ii) studies on primary health care, financial sector, and private sector; and (iii) the medium-term expenditure framework and public investment program. Key operations evaluation findings include the following: a. Agriculture and Rural Development 30. Rural infrastructure has been developed and agriculture production increased. Ministry of Agriculture and Forestry capacity in planning, policy analysis, applied research, and extension has been strengthened. The policy environment for private investment and trade in agriculture has improved. Agriculture along the Mekong river corridor has become more commercialized. Overall rice yields have increased with the improvement of irrigation systems. However, concerns include: the sustainability of some past investments, especially in irrigation; deforestation due to shifting cultivation; the limited scope for crop diversification and nonfarm employment; and the limited coverage and cultural inadequacy of research and extension services, especially in remote ethnic minority areas. b. Environment 31. ADB has helped strengthen institutional capacity, develop new environmental regulations and safeguards, increase awareness of environmental issues, conduct environmental impact assessment of some investments, and improve some urban environments. Some ADB investments in hydropower, however, have had unanticipated adverse environmental impacts; the integration of environmental issues into economic planning is weak, as is capacity to enforce environmental safeguards; and civil society is not yet fully involved in environmental protection.