Robust Growth Amid Inflationary Concerns

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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

THE WORLD BANK

Lao PDR

Lao PDR Economic MonitorMay 2011 - UPDATE



The World Bank Lao PDR Country OfcePatouxay Nehru RoadP.O Box 345Vientiane, Lao PDR

© All rights reservedThis publication is a product of the staff of the World Bank. The ndings, interpretations, and conclusions expressedherein not necessarily reect the views of the Executive Directors of the World Bank or the governments they repre -sent.

For further information please contact World Bank Lao PDR Country Ofce.• Mr. Somneuk Davading on structure and content ([email protected])• Ms. Keomanivone Phimmahasay on data issues ([email protected])

The World Bank Lao PDR Country OfcePatouxay Nehru Road

P.O Box 345Vientiane, Lao PDR Phone: (856-21) 450- 010Fax: (856-21) 414-210

“THE WORLD BANK TEAM APPRECIATES FEEDBACK ON STRUCTURE AND CONTENT OF THE MONITOR”



L a o P D R E c o n o m i c M o n i t o r - M A Y 2 0 1 1

Lao PDR Economic MonitorM a y 2 0 1 1 - U P D A T E

Lao PDR Economic Monitor - MAY 2011 UPDATE is issued in Lao and English by the World Bank Ofce in LaoPDR. This update reports on recent economic developments and medium-term outlook for the country as well asrecent progress made by the Government in key reform areas. The paper was prepared by the World Bank Ofce’smacroeconomic 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) andother 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 Anantavrasilpafor their inputs on reform agenda; Meriem Gray, Alounsavath Davong, Remy Rossi, Vattana Singharaj, BoualamphanPhouthavisouk, and other staff for design, printing and dissemination of the Monitor.

ROBUST GROWTH

AMIDSTINFLATIONARY CONCER NS



E x e c u t i v e S u m m a r y

Lao PDR’s real GDP growth will remain robust in 2011 with projected growth of 8.6 percent compared to 8.4

percent in 2010. Natural resources and manufacturing sectors are expected to drive growth this year. The expectedgrowth in the garment exports (by about 15-20 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, particu-

larly in transport, tourism (hotels and restaurants) and retail trading. Agriculture (shery, livestock and crops) is expected

to benet from the recent increase in regional demand and higher food prices. Out of 8.6 percent growth in 2011, about

3.6 percentage points come from the resource sectors, about 1 percentage point each from manufacturing and agriculture,

0.5 percentage points from construction and 2.5 percentage points from services.

The Consumer Price Index (CPI) headline ination has risen in recent months due to higher commodity prices.

Recent global food prices have limited impact on Lao ination, 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 inationary pressures on the country. The CPI ination (yoy) has increased toabout 7.7 percent in March 2011 from 5.8 percent in December 2010 driven largely by fuel. Fuel prices (yoy) climbed by

8.7 percent in March 2011 from 3.7 percent in December 2010 while core ination (excluding food and energy) rose from

2.6 percent to 7.5 percent during the same period. By contrast, food ination (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 2011 from 14.2

in September 2010 supported partly by Government’s inationary 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 2011. Nevertheless, food prices in Lao PDR remain vulnerable to shocks, espe-

cially natural disaster (ood and draught), animal disease outbreak and other seasonal factors. The annualized ination is

about 6 percent in 2010 and projected at around 7.0 percent in 2011.

Higher copper and gold prices, combined with the withdrawal of quasi scal spending are pushing the scal decit

down this year. The budget decit is expected to drop to 2.8 percent in FY10/11 from 5.7 percent of GDP in FY09/10due 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

FY10/11 from 13.3 percent in FY09/10 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 signicantly

to 4.1 percent in this scal year from 2 percent in FY09/10. 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 10 percent growth in nominal terms). The non-mining as well as non-resource decits are expected to increase

slightly to 6.3 percent and 11 percent of GDP in this scal year from 6.2 percent and 10.9 percent in FY09/10, respec -

tively. The total revenue (including grants) is expected to increase to 18.3 percent of GDP from 17.5 percent in FY09/10

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 FY10/11 from 22.3 percent in FY09/10. This is due to the phasing out of quasi-scal spending (domesticallyfunded capital expenditure) and a decline in recurrent spending (due to the completion of major events, such as the South

East Asia Games and the 450th Anniversary of the Vientiane Capital). The wage bill is expected to remain stable this s-

cal 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 2011 driven by higher commodity prices and increased regional

demand. Lao exports grew rapidly by almost 43 percent (in nominal terms) in 2010 (boosting total merchandise exports

to about $2 billion) and are projected to grow by nearly 30 percent in 2011 driven largely by resource exports (electricity

and copper). Resource export growth (in nominal terms) is estimated at 59 percent in 2010 and about 32 percent in 2011

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 2010). Similarly, non-resource exports are expected to grow by 26 percent in 2011 (or to $732 mil-

lion - about 8.3 percent of GDP - from $581 million in 2010). Imports rose by about 11 percent in 2010 and are expected to

grow by 22 percent in 2011 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 2010). The

EXECUTIVE SUMMARY




big increase in consumer imports is likely to widen non-resource trade decit in 2011 (to $1,716 million - or 19.5 percent

of GDP - from $1,517 million in 2010).

Although overall trade balance is expected to improve the current account decit is expected to widen slightly to about

9.4 percent of GDP in 2011 from about 8.6 percent in 2010 mainly on the account of larger transfers of prots 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 2010. Non-resource current account decit is expected to increase

to $1,237 million in 2011 - or about 14.1 percent of GDP - from $1,056 million in 2010 driven by higher non-resource

imports. The capital account surplus is projected to increase from 9.9 percent of GDP in 2010 to 12.1 percent in 2011 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 2011 from

5.1 percent in 2010. In the same time, non-resource capital account surplus is likely to decrease to 4.2 percent of GDP in

2011 from 4.7 percent in 2010 due to high GDP growth. Overall balance was in surplus at 1.3 percent of GDP in 2010 and

is expected to increase to 2.8 percent in 2011 due to strong resource account surplus (about 12.7 percent of GDP in this

year compared to 10.7 percent in 2010).

Net foreign assets (NFA) and foreign reserves picked up by the end of 2010 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 ex-

penditures 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 ofcial reserves.

As a result, foreign reserves reached more than $720 million by end-2010 (covering 3.1 months of imports of goods and

services). Net foreign assets have followed a similar pattern with a rebound of more than 10 percent (quarter on quarter) in

the fourth quarter. Reserves and NFA are expected to build up in coming months in 2011 along with stronger investment

inows and larger tax prots payments from mining projects.

The Lao kip has appreciated slightly against the US dollar in the past few months while depreciating against theThai baht. The kip has appreciated marginally by 0.2 percent against the US dollar during February-March but depreci-

ated by 2.3 percent against baht in the same time. Overall, kip has appreciated by 0.9 percent against the US dollar and by

0.4 percent against baht during the last six months (October 2010 - March 2011).

Credit growth has slowed by end-2010 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 De-

cember 2010 from 91 percent in December 2009 due to signicant 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 2010 from 55 percent in 2008) 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 25-30 percent in 2011.

Broad money (M2) grew fast (yoy) by 39.1 percent in 2010 and this trend is expected to continue in 2011, driven by strongGDP growth and high deposits (which grew by 43.3 percent in 2010). The dedollarisation rate increased to 46.2 percent

in 2010 from 42.2 percent in 2009 as local people’s condence 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 applica-

tion 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 isthe 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.






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 REFORM2.4 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 Ination, (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 Ination (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), FY08-12

Figure 8. Resource Revenues (percent of GDP), FY08-12

Figure 9. Key Government Expenditures (percent of GDP), FY2008-12

Figure 10. GOL’s Fiscal Performance (percent of GDP), FY2008-12

Figure 11. Exports by Sector (US$ m), 2007-12

Figure 12. Current Account Balance - CAB (percent of GDP), 2007-2012

Figure 13. Balance of Payments (percent of GDP), 2007-12

Figure 14. FDI in Lao PDR (US$ million), 2007-12

Figure 15. Kip Exchange Rate (Index Dec-2006 =100)

Figure 16. Nominal and Real Effective Exchange Rates

Figure 17. NFA and foreign reserves have rebounded

Figure 18. Credit growth has declined by end-2010

Figure 19. Contribution to Annual Bank Credit Growth

Figure 20. Monetary sector growth (yoy percent change)

Figure 21. Bank Lending (percent of GDP)

Table 1. GOL’s four priority sectors expenditures

Note: all dollar gures are in US dollars unless otherwise indicated.

1

6

6

8

10

12

14

14

17

1819

21

22

23

6

67

7

7

8

8

9

9

9

10

11

11

11

12

12

13

13

13

13

13

17

TABLE OF CONTENTS



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 R ECENT E CONOMIC D EVELOPMENTS

Figure 1. Growth and Inflation, (percent change)

Source: GOL (MPI) and staff estimates and projections.* Yearly average for 2011

8.5

7.27.5 7.5

8.4 8.6

7.6

6.9

4.5

7.6

0.1

6.0

7.0

6.5

0

2

4

6

8

10

2006 2007 2008 2009 2010 2011 2012

Real GDP growth (%)

Headline inflation (%, annual average)

Figure 2. Resource Sectors Contribution toGDP Growth, (percentage points)

Source: GOL (MPI) and staff estimates and projections.* Yearly average for 2011-15

-0.4

2.02.5

3.9 3.6

2.3

7.6

5.6 5.0

4.6 5.0

5.3

7.27.5 7.5

8.4 8.6

7.6

-2

0

2

4

6

8

10

2007 2008 2009 2010 2011 2012

Nonresource sectors (percentage points)

Resources (percentage points)

Real GDP growth (%)

1 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 0.6 percentage points come from the mining sector - mostly copper and gold.

F igure 1 F igure 2

1.1 GROWTH AND INFLATION

Lao PDR’s real GDP growth will remain robust in 2011 with projected growth of 8.6 percent compared to 8.4

percent in 2010. Natural resources and manufacturing sectors are expected to drive growth this year. The expected

growth in the garment exports (by about 15-20 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 (shery, livestock

and crops) is expected to benet from the recent increase in regional demand and higher food prices. Out of 8.6

percent growth in 2011, about 3.6 percentage points come from the resource sectors , about 1 percentage point each

from manufacturing and agriculture, 0.5 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 prod-

ucts 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 2011 and onwards.

Further expansion of mining output is assumed for copper and gold in 2011-12 (by MMG and Phubia).

1 2

3




7

Figure 3. Real GDP Growth: Contribution by Sector (percentage points)

Source: Staff estimates and projections

-2

0

2

4

6

8

10

Agriculture and forestry

Mining and quarryingManufacturing

Construction

Electricity, gas, and water

Services

Real GDP growth (percent)

Figure 5. Food Prices (yoy percent change)

Source: Lao PDR authorities (MPI) and staff calculations.

1 0 . 0

8 . 6

6 . 0

5 . 0

3 . 4

1 . 3

0 . 0 0

. 5

- 2 . 7

- 2 . 0

0 . 4 0 . 9

2 . 7 2 . 9 4 . 3 4 . 3

4 . 0 4

. 7

6 . 8

1 1 . 1

1 4 .

0

1 4

. 2

1 3 . 2

1 1 . 0

8 . 8

-4

-2

0

2

4

6

8

10

12

14

16

D e c - 0

8

F e b - 0

9

A p r - 0

9

J u n - 0

9

A u g - 0

9

O c t - 0

9

D e c - 0

9

F e b - 1

0

A p r - 1

0

J u n - 1

0

A u g - 1

0

O c t - 1

0

D e c - 1

0

RiceVegetables

MeatPoultryFishThe restTotal food inflation (%, y-o-y)

Source: Lao PDR authorities (MPI) and staff calculations.

3 . 2

2 . 4

1 . 6

0 . 7

- 0 . 2

- 1 . 6

- 1 . 8

- 1 . 5

- 2 . 3

- 1 . 8

- 0 . 1 1 . 5

3 . 9 4

. 2 4 . 7 4

. 9 4 . 8 4 . 8 4

. 9

6 . 8 8 . 0 8

. 1 7 . 9

6 . 7

5 . 8

-4

-2

0

2

4

6

8

10

Energy inflation (percentage points)

Food inflation (percentage points)

Core inflation (percentage points)

Headline inflation (%, annual average)

M a r - 1 1

O c t - 1 0

A u g - 1 0

J u n - 1 0

A p r - 1 0

F e b - 1 0

D e c - 0 9

O c t - 0 9

A u g - 0 9

J u n - 0 9

D e c - 1 0

M a r - 0 9

D e c - 0 8

Figure 4. Monthly Inflation (yoy percent change)

F igure 3

F igure 4

F igure 5

Although until now recent global food price in-

creases have had limited impacts on overall Lao

CPI ination, the rise in fuel and other nonfood

prices and uncertainty in global commodity

markets is putting upward pressures on the CPI

ination. The headline ination has increased in re-

cent months due to energy and other nonfood com-

modity prices. The CPI ination (yoy) has increased

in recent months to about 7.7 percent in March 2011

from 5.8 percent in December 2010 driven largely

by fuel and other nonfood prices. Fuel prices (yoy)

climbed by 8.7 percent in March 2011 from 3.7 per-

cent in December 2010 while core ination (excludingfood and energy) rose from 2.6 percent to 7.5 percent

during the same period. However, the food ination

(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 2011 from

14.2 in September 2010 supported by Government’s

inationary 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 2011. Nevertheless, food prices in LaoPDR remain vulnerable to shocks, especially natural

disaster (ood and draught), animal disease outbreak

and other seasonal factors. The annualized ination is

about 6 percent in 2010 and projected at around 7.0

percent in 2011.

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. Commercial-ized rice (especially sticky rice which is predominant

food in Lao PDR) is inuenced by localized supply

shocks and seasonality. Unlike Thailand and Vietnam




Figure 6. Lao Glutinous Rice Price vs Thai

Source: Lao authorities (DOS) and Thai Rice Exporters

Association and staff calculations.

0

50

100

150

200

250300

350

400

D e c - 0 5

M a r - 0 6

J u n - 0 6

S e p - 0 6

D e c - 0 6

M a r - 0 7

J u n - 0 7

S e p - 0 7

D e c - 0 7

M a r - 0 8

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

Glutinous Rice Price Index (Dec2005=100)

Thai glutinous rice 10% (export price, fob)Lao glutinous rice, grade 1(domestic price)

F igure 6

who produce and exports mainly ordinary (non-glutinous) rice to the international markets, Lao PDR produces mostly

glutinous (sticky) rice around 90 percent of total rice outputs, which are mostly consumed domestically. Estimates

suggest that about 10 percent or 300,000 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 2010. 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.

1.2 GOVERNMENT’S REVENUE AND EXPENDITURE

The budget decit (as percentage of GDP) declined further in last scal year (FY09/10). The scal decit de-

creased to 4.6 percent of GDP (2.7 percent came from the off-budget spending) in FY09/10, from 6.7 percent in

FY08/09. The GoL’s domestic revenue increased by 17.2 percent (in nominal terms) in FY09/10 due to higher tax col-

lection, especially from VAT, resource royalties and customs duties. Nevertheless, the revenue to GDP ratio climbed

only slightly to 13.9 percent in FY09/10 compared to 13.8 percent in F08/09 due to the rapid GDP growth - see Figures

7-10.

High commodity prices and the withdrawal of one-off spending items will positively impact the Government

scal balance this year. The budget decit is expected to drop to 2.8 percent in FY10/11 from 4.6 percent of GDP in

FY09/10 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 10. Domestic revenue is expected to increase to 15.1 percent of GDP in FY10/11

from 13.9 percent in FY09/10 following transfers of taxes, royalties and dividends from the resource sectors as a result

of higher commodity prices and copper output expansion (around $270 million projected resource revenues including

$220 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 signicantly to 4.1 percent in this scal year from 2 percent in FY09/10. 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 10 percent growth in nominal terms) - see Figure 8. The

non-mining as well as non-resource decits are expected to increase slightly by 0.1 percent of GDP, or to 6.3 percent

and 11 percent of GDP in this scal year from 6.2 percent and 10.9 percent in FY09/10, respectively. The total revenue

(including grants) is expected to increase to 19.2 percent of GDP from 18.2 percent in FY09/10 driven by higher non-

project grants (about 3.3 percent of GDP) - see Figure 7. Overall spending is expected to decline to 22 percent of GDP

in FY10/11 from 22.7 percent in FY09/10 - see Figure 9. This is due to the phasing out of quasi-scal spending (domes-

tically funded capital expenditure) and a relative decline in recurrent spending (due to the completion of major events,




9

Figure 7. Domestic Revenues (percent of

GDP)

Source: Lao PDR authorities (MOF) and staff calculations and

projections

1 5 .

2

1 5 .

9

1 8 .

1

1 9 .

2

1 9 .

1

1 3 .

9

1 3 .

8

1 3 .

9

1 5 .

1

1 5 .

3

1 2 .

1

1 2 .

2

1 2 .

5

1 3 .

4

1 3 .

5

3 .

1

2 .

7

2 .

0 4

. 1

5 .

5

1 .

8

1 .

6

1 .

4

1 .

7

1 .

8

0

5

10

15

20

25

FY08 FY09 FY10 FY11 FY12

Revenue and grants Domestic revenueTax Resource revenue

Nontax

Figure 8. Resource Revenues (percent of GDP), FY08-12

1 0 .

8

1 1 .

1

1 1 .

9

1 1 .

0

9 .

7

3 .

1

2 .

7

2 .

0

4 .

1

5 .

5

2 .

4

2

. 2

1 .

6

3 .

5

4 .

6

0 . 7

0 .

5

0 .

4

0 .

6 0 . 9

0

2

4

6

8

10

12

14


Nonresource revenue Resource revenueMining Hydropower

Source: Lao PDR authorities (MOF) and staff calculations

and projections.

Figure 9. Key Government Expenditures

(percent of GDP), FY2008-12

Source: Lao PDR authorities (MOF) and staff calculations and

projections.

7.010.7 11.8 11.6 10.9

9.9

10.9 9.8 9.5 9.5

18.1

22.6 22.7 22.0 21.6

0

5

10

15

20

25


Current expenditure Capital expenditure

Others/contingencies Expenditurte

Figure 10. GOL’s Fiscal Performance (percent of

GDP), FY2008-12

Source: Lao PDR authorities (MOF) and staff calculations and projections.

1 3 .

4

1 5 .

9

1 8 .

2

1 9 .

5

1 9 .

6

1 8 .

1 2

2 .

6

2 2 .

7

2 2 .

3

2 2 .

1

- 2 .

7

- 6 .

7

- 4 .

6

- 2 .

8

- 2 .

5

- 5 .

1

- 8 .

9

- 6 .

2

- 6 .

3

- 7 .

1

- 7 .

3

- 1 1 .

4

- 1 0 .

9

- 1 1 .

0

- 1 1 .

8

-15

-10

-5

0

5

10

15

20

25


Revenue and grants Total expenditurteBudget deficit Nonmining deficit Nonresource deficit

F igure 7

F igure 9 F igure 10

F igure 8

1.3 EXTERNAL BALANCE

Lao Exports and Imports

Lao export earnings are projected to soar in 2011 driven by higher commodity prices and strong regional

demand. Lao exports grew rapidly by almost 43 percent (in nominal terms) in 2010 (boosting total merchandise ex-

ports 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 30 percent in 2011

driven largely by resource exports (electricity and copper). Resource export growth (in nominal terms) is estimated

at 59 percent in 2010 and about 32 percent in 2011. Thus, resource trade surplus is likely to rise to about $1,224 mil-lion in this year (or about 13.9 percent of GDP) compared to $915 million in 2010. Similarly, non-resource exports

are expected to grow by 26 percent in 2011 (or to $732 million - about 8.3 percent of GDP - from $581 million in

2010).

such as the South East Asia Games and the 450th Anniversary of the Vientiane Capital). The wage bill is expected to

remain stable this scal 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.




0

500

1000

1500

2000

2500

3000

2007 2008 2009 2010 2011 2012

Mining Electricity

Wood & Wood Products Garments

Agriculture Other

Source: WB DECDG’s recent estimates and projections.

0

100

200

300

400

500

600

2 0 0 2

2 0 0 3

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

2 0 1 5

Copper Gold CoffeeMaize Rubber Rice

Figure 11. Exports by Sector (US$ m), 2007-12

Source: Staff estimates and projections based on data from Lao

authorities (MOIC) and partner countries

World Commodity Prices, 2002-15F igure 11

Figure12. Current Account Balance - CAB-(percent of GDP), 2007-2012

3 .

3

5 .

1

9 .

4

9 .

2

9 .

5

8 .

3

- 1 0 .

6

- 1 1 .

8

- 8 .

8

- 3 .

6

- 4 .

8

- 6 .

6

- 1 1 .

9

- 1 1 .

9

- 1 4 .

2

- 1 4 .

1

- 1 4 .

1

- 1 2 .

2

-19.2 -18.7

-13.6

-8.6 -9.4 -10.6

-30

-20

-10

0

10

20

2007 2008 2009 2010 2011 2012

Mining CABPower CAB Non-resource CABCurrent account balance (CAB)

Source: Staff estimates and projections

F igure 12

Current Account Balance

The current account decit has become increasingly exposed to mining export earnings, thereby offsetting a large

non-resource current account decit. The current account decit is projected to widen slightly due to larger net income

transfer in 2011. Although the overall trade balance is expected to improve slightly, the current account decit is projected

to widen to about 9.4 percent in 2011 from about 8.6 percent in 2010 mainly on the account of larger transfers of prots

and debt service payments abroad by large resource projects - see Figure 12. Resource current account surplus is expected

to decrease to 4.8 percent of GDP in 2011 from about 5.5 percent in 2010 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 to rise to 9.7 percent of GDP in 2011 from about 9.1 percent in 2010 and, in the same time, power sec-

tor’s current account decit is likely to widen in 2011 and 2012 (due to large increase in interest payments). Non-resource

current account decit is expected to increase to $1,237 million in this year from $1,056 million in 2010 driven by higher

non-resource imports. Nevertheless, its GDP ratio remains unchanged at 14.1 percent in 2010-2011 - see Figure 12 below.

Imports are also expected to rise at a quicker pace in 2011. Imports rose by about 11 percent in 2010 and are

expected to grow by 22 percent in 2011 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 decit in 2011 (to about $1,716 million - or around 19.5 percent of GDP - from $1,517

million in 2010). The commencement of construction of the Hongsa Lignite power plant and the expansion of the Phu-

bia Mining gold production facility are expected to signicantly contribute to import rise in 2011. Overall, Lao PDR’s

trade decit has narrowed in recent years (from about $1,033 million in 2008 to $602 million in 2010 and is projected

to decline further to $492 million in 2011) due to strong resource export growth (which is expected to outweigh import

expansion).

6

4

5




11

Source: MPI and staff estimates and projections.

Source: BOL and staff estimates and projections.

Figure 13. Balance of Payments (percent of GDP),

2007-12

-19.2 -18.7

-13.6

-8.6 -9.4 -10.6

4.71.9

-1.31.3 2.9 1.5

23.920.6

12.39.8

12.3 12.1

-30

-20

-10

0

10

20

30

2007 2008 2009 2010 2011 2012

Mining CAB Power CAB Non-resource CAB CABOverall balance Capital account balance

838976

774 761

1103

1300

0

200

400

600

800

1000

1200

1400

2007 2008 2009 2010 2011 2012

Agriculture Manufacturing, etc.Services MiningPower Gross FDI inflows Net FDI flows

Figure 14. FDI in Lao PDR, 2007-12 (US$ million)


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 tomining current account surplus.

6 Deficits on the sector’s trade balance and net income contributed to power sector’s current account deficit.

Capital Account Balance

The commencement of resource sector investment in pipeline will enhance capital account surplus in 2011.

The net ow of capitals declined to 9.8 percent in 2010 from 12.3 percent of GDP in 2009 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 prots of around $384 million compared to about $105 million

in 2009). However, the capital account surplus is expected to rebound to 12.2 percent in 2011 with a corresponding

surge of new investment especially from large resource mega projects such as Hongsa lignite coal-red power plant

($3.7 billion project), Phubia’s new gold production facility (about $150 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 2011 from 5.1 percent in 2010.

In the same time, non-resource capital account surplus is likely to decrease to 4.2 percent of GDP in 2011 from 4.7

percent in 2010 due to high GDP growth. Overall balance was in surplus at 1.3 percent of GDP in 2010 and is

expected to increase to 2.8 percent in 2011 due to strong resource account surplus (about 12.7 percent of GDP in this

year compared to 10.7 percent in 2010).

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 0.2 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 appreci-

ated by 0.9 percent against the US dollar and by 0.4 percent against baht during the last six months (October 2010

- March 2011). 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 2010 - March 2011 largely due to recent depreciation of US

dollar against major currencies in the region (including the Thai baht).




Figure15 . Kip Exchange Rate (Index Dec-2006 =100)

Source: BOL and staff calculations.

80

85

90

95

100

105

110

D e c - 0 6

M a r - 0 7

J u n - 0 7

S e p - 0 7

D e c - 0 7

M a r - 0 8

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

M a r - 1 1

Kip/US$ Kip/Baht

Source: IMF

90

95

100

105

110

115

120

125130

D e c - 0 6

M a r - 0 7

J u n - 0 7

S e p - 0 7

D e c - 0 7

M a r - 0 8

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

M a r - 1 1

NEER REER

F igure 15

Nominal and Real EffectiveF igure 16 Exchange Rates

0

200

400

600

800

1000

1200

-25

0

25

50

75

100

125

D e c - 0 6

M a r - 0 7

J u n - 0 7

S e p - 0 7

D e c - 0 7

M a r - 0 8

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

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)

-15

-5

5

15

25

35

45

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

(Q-to-Q percent change)

International reserves Net foreign assets

Figure 17. NFA and foreign reserves have rebounded


F igure17

Net foreign assets and foreign reserves picked up by the end of 2010 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 $720 million by end-2010 (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-2010, reaching more than $750 million. The

slowing down of credit growth as of end 2010 has eased the pressure on foreign reserves and NFA levels. The net for-

eign assets (NFA) and international reserves are expected to rise in 2011 and beyond with a projected strong growth in

exports and rebound in net capital inows combined with anticipated further slowdown in credit growth in 2011 (see

more details in Bank Lending below).

Bank Lending

Credit growth has slowed by end-2010 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

2010 from 91 percent in December 2009 due to signicant 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 privatecredits slowed partly because of recent tightening of bank liquidity (the commercial banks’ loan to deposit ratio rose to

about 75 percent in 2010 from 73 percent in 2009 and 55 percent in 2008) and GOL’s policy to slow rapid credit and




13



0

50

100

150

200

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

(yoy percent change)

Credit to private sector Credit to SOEs

Deposits Credit to the economy

-9 -16 -16-1

21

5163 66

85 8398 92 91 85

63 5946

-40-20

020406080

100120

D e c - 0 6

M a r - 0 7

J u n - 0 7

S e p - 0 7

D e c - 0 7

M a r - 0 8

J u n - 0 8

S e p - 0 8

D e c - 0 8

M a r - 0 9

J u n - 0 9

S e p - 0 9

D e c - 0 9

M a r - 1 0

J u n - 1 0

S e p - 1 0

D e c - 1 0

Credit to private sector (percentage points)Credit to SOEs (percentage points)

Credit to the economy (yoy percent change)

Figure 18. Credit growth has declined by end-2010

Figure 19. Contribution to Annual Bank Credit

Growth



2 6 .

1

3 6 .

5

1 7 . 7

2 9 .

5

4 3 .

3

2

1 .

6

2 2 .

7 3

0 .

1

3 8 .

7

1 8 .

3

3 1 .

3 3

9 .

1

2 2 .

5

2 2 .

5

0

10

20

30

40

50

2006 2007 2008 2009 2010 2011 2012

Total deposits Broad money (M2)

7 .

4

7 .

7

1 2 .

2 2

1 .

5

2 6 .

3

1 3 .

1

1 9 .

4

1 9 .

4

2 3 .

3

2 8 .

0

1 9 .

8

2 3 .

9

2 4 .

1

2 9 .

2

3 4 . 1

52.5

37.9

55.2

73.0 74.5

0

20

40

60

80

0

5

10

1520

25

30

35

40

2006 2007 2008 2009 2010

Credit to the economy (% of GDP)Total deposits (% of GDP)Broad money (M2), (% of GDP)Loan/deposit ratio (%, right axis)

Figure 21. Bank Lending (percent of GDP) Figure 20. Monetary sector growth (yoy

percent change)



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 asa proxy for estimating the dedollarisation rate in the country due to data limitation on composition of kip and foreign currenciesoutside bank).

reduce future NPL risks. Private credit growth slowed to 43.8 percent in December 2010 from 88 percent in end-

2009 while credit to SOEs dropped to 53.4 percent from 99.8 percent at end-2009. The GOL (BOL) is projecting

credit growth to stabilize to about 25-30 percent in 2011. Broad money (M2) grew fast (yoy) by 39.1 percent in

2010 (compared to 31 percent in 2009) and this trend is expected to continue in 2011, driven by strong GDP growth

(8.4 percent in 2010 and projected 8.6 percent in 2011) and high deposits (which grew by 43.3 percent in 2010 and

projected 30-40 percent in this year). Overall, kip deposits increased (yoy) by 57 percent while foreign currency

deposits climbed by 33.2 percent in 2010. The dedollarisation rate increased to 46.2 percent in 2010 from 42.2

percent in 2009. As percent of GDP, total credit was 25.9 percent, M2 about 33.7 percent and deposits around 27.6

percent in 2010. The reported non-performing loans (by BOL) dropped from 3.7 percent in June 2010 to about 3

percent in end-2010. It is not clear however whether this improvement is due to enhanced loan portfolios of banks

or a mechanic impact from new loans expansion.

7



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

Public nance management reforms continue to be implemented within the overall umbrella of the PublicFinance Management Strengthening Program (PFMSP). Since 2008, PFMSP has covered reforms on both therevenue and expenditure sides as mandated by the Budget Law 2007. There has been progress in the develop-ment of a new scal transfer system, establishment of greater control of public nance resources, alignmentof 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 2006 State Budget Law was completed bythe end of 2009. To facilitate budget execution and reporting, the MOF has developed the GFIS and progres-sively rolled it out to central ministries/agencies and provinces. Efforts have been made to improve the budgetcoverage, through bringing off-budget funds and service delivery agencies’ technical revenue on budget. Atreasury single account (TSA) framework has been developed with a phased implementation approach. On therevenue side, VAT has been brought into implementation since January 2010 and ASYCUDA implementationhas commenced since July 2010. The new Audit Law was promulgated by the national assembly (NA) inJuly 2007, 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 follow-up actions have been taken by the Government. A peer review of its development needs was carried out bythe Ofce of the Auditor-General of New Zealand, and a 10-year Action Plan for capacity development and a3-year Implementation Plan have been prepared. SAO aims to follow international standards on auditing, andto develop its work on performance audit. The NSEDP 2011 - 2015 framework which was discussed at theRound Table meeting in November 2010 continues its central focus on improving the governance of publicnances for improving service delivery. This focus will be operationalized through the PFMSP. In order tofully implement the PFMSP, the Government will require signicant capacity enhancement, continued politi-

cal commitment and technical assistance.

S TRUCTURAL AND P OLICY R EFORMS

2.1 PUBLIC EXPENDITURE POLICY AND MANAGEMENT REFORMS

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 nation-

wide by end-2009. This has enabled greater control over the revenue sources and more timely budget execution. The

revenue sharing and distribution framework has been designed and nalized while budgetary allocation norms have

been prepared. Implementation of new revenue assignments between central and local levels (based on the implement-

ing decree of the Budget Law) is expected to start in FY2010/11. A multi-donor trust fund launched in February 2009

continues to provide nancial support to implementation of critical reforms under the PFMSP. A Public Expenditureand Financial Accountability (PEFA) assessment has been completed in 2010, establishing a baseline for monitoring

the performance of Lao PDR PFM system over time. A Public Expenditure Review was also conducted during 2010.

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 2011-2015. The PFMSP Mid-Term Review was con-

ducted in November 2010, reviewing the progress with PFMSP implementation and recommending reform priorities

for the next ve years. A medium-term PFMSP implementation plan for 2011-2015 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 Treas-

ury. The Government has adopted a new decree on the National Treasury, providing a new legal basis for the treasuryoperations and the integration of the operations nationwide. The decree also establishes new tasks for the National

Treasury, including the improved management of the Government nances. The MOF has adopted a strategy for im-

plementing a Treasury Single Account (TSA) in the Bank of Lao PDR (BOL) with a view to consolidating all




15

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 rst phase of the TSA arrangement.

The MOF has completed roll-out of a locally developed government nancial 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 ofces with following main functionalities: (i) budget recording and distribution, (ii)

processing payment and receipt transactions, and (iii) scal reporting. The GFIS has recently been upgraded to

be operated on a unied 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 transac-

tions are entered into the system. At the moment, the MOF has recruited an international consultant rm 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 2011. The design consultant will provide analysis, business process

review and functional requirements denition 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 speci-

cally, 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 2010. Signicant challenges re-

main 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 Instruc-

tions 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 efciency of revenue collection. The rst 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 implementa-tion. 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 2010 and the approval of new

WTO consistent regulations on Customs Valuation in July 2010.

SAO continues with the implementation of its 3-year plan for capacity development and is making impor-

tant impact on enhancing government accountability. SAO has completed the audit of the budget execution for

FY2008/09 and submitted timely its report to the National Assembly. The debate of the audit ndings at December

2010 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 rst time. SAO nancial and human resources

have been further strengthened with its budget allocation and staff doubled for the FY 2010-2011.

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 2008 to move forward to a more




Source: Lao authorities(MOF) and staff calculations.

Note: * Total recurrent expenditure includes salariesand benefits, transfers,

administrative expenses, and other recurrent spending.

** includes off-budget spending on local infrastructure project

GOL’s Priority Sectors Expenditure

2006/07 2007/08 2008/09

Priority Sectors Recurrent Spending

(percent of total recurrent spending)*

Total four sectors 18.9 17.7 19.9

Agriculture 1.8 1.7 1.8

Infrastructure 0.9 0.8 1.0

Education 12.8 12.0 13.5

Health 3.3 3.3 3.6

(percent of total expenditure)




Education 6.1 6.5 6.5

Health 1.6 1.8 1.7

Total Priority Sectors Spending

(percent of total expenditure)


Recurrent 9.0 9.7 9.6

Capital 37.3 30.0 36.1


Infrastructure** 21.7 17.8 26.4

Education 16.3 12.8 10.7

Health 3.2 3.5 5.6

(percent of GDP)


Recurrent 1.7 1.8 2.2

Capital 6.8 5.5 8.3



Education 3.0 2.3 2.5

Health 0.6 0.6 1.3

T able 1

rule-based budgeting. Progress has been made on the technical aspects in designing formulae for the budget alloca-

tion 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

insufcient 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

FY2011/12.

Signicant 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 sys-

tem (ESPS) in 2008 to replace manual cash pay-

ment. 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 FY08/09. The share of recurrent expenditure of

the four priority sectors as percent of total recurrent

expenditure rose to 19.9 percent in FY08/09 from

17.7 percent in FY07/08. In the same time, the ratio

for education increased to 13.5 percent in FY08/09

from 12 percent in FY07/08 and, for health it

climbed from 3.3 percent to 3.6 percent, respec-

tively. However, the sectors recurrent spending tototal expenditure ratio dropped slightly to 9.6 per-

cent in FY08/09 from 9.7 percent in FY07/08 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 FY08/09 from 39.7 percent in FY07/08 and, as

share of GDP, it rose to 10.5 percent from 7.3 per-

cent, respectively.




17

The formal nancial 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 playingin the very recent past. The nancial system is dominated by banks, with non-bank nancial institutions(NBFI) representing only 0.8 of overall nancial sector assets as of June 2010. SOCBs are still dominantwith around a 60 percent share of total banking sector assets, but this share is declining. The assets of pri-vate and joint venture banks have increased recently as new private banks emerged. In the past two years,6 new commercial banks commenced operations in Lao PDR and brought the total number of banking in-stitutions to 23, consisting of 4 SOCBs, 3 joint-ventures, 2 private and 14 foreign bank branches. Increasedcompetition by recent entries of new private banks has provided an incentive for SOCBs to improve their

performance, risk management, governance, and products and services.

2.2 FINANCIAL SECTOR DEVELOPMENT

Lao PDR launched its rst stock exchange. With support from the Korean and Thai Stock Exchanges, the Lao

Government opened its rst Lao Stock Exchange (LSX) on January 11, 2011. The Government sees the develop -

ment of its capital markets as an avenue to fund its socio-economic development plan, and hopes the security mar -ket 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 nancial 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 2010, up from 29.2 percent in 2009. The

nancial system remains dominated by State-Owned Commercial Banks (SOCBs), which account for 59.3 percentof total banking assets in 2010, 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 2010 compared to the total

industry growth of 50 percent while the asset of private and joint venture banks grew rapidly by over 90 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 35-45 percent (2010).

A growing share of the population has access to formal nancial services, with increasing access points, while

starting from a very low base. Access points to the formal nancial system, such as bank branches, have grown

from 62 in 2007 to 84 branches in December 2010. The number of sub-service units expanded (from 66 in 2007 to

198 in 2010) 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 2006, to 51 in 2007, to 248 in 2010. Access is more developed in urban areas, andespecially in Vientiane, but it is catching up outside Vientiane, where most of the commercial bank branches have

been created (53 out of 80 in 2010). Bank service units located outside Vientiane have tripled since 2007, from 54

to 150. Similarly, there are now 88 ATMs outside Vientiane, compared to only 9 ATMs three years ago.

The micronance industry is gradually improving. In order to promote development of the micronance sector,

BOL has set up a new department called “Financial Institution Supervision Department” in late 2010 to oversee mi-

cronance development activities in the country. A new decree on micronance, 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 10 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.

8




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 micronance

services but relying on savings as the basis for lending). As of December 2010, there were 28 MFIs registered under

BOL’s regulations (compared to 10 MFIs in December 2007), 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 efciency of the national pay -

ments 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 comple -

ment the existing credit information bureau (CIB) at BOL. Currently, all credit reports of corporate, enterprise and

personal customers with loan amount more than 20 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 fromMicronance projects) as most micronance 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 exist-

ing prudential ratios applying to commercial banks in accordance with Basel principles. Two revised regulations were

the net open position (NOP) and loan classication regulations. Under the new guideline (No. 818, 20 October 2010),

the limit of NOP of single currency and all currency increased from 15% and 20% to 20% 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 classication was also approved (No. 324 dated 19 April 2011). Under the new regulation, loans will be

classied 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 classication will be based on number of past due date.

2.3 TRADE REFORM

Key Reform Actions Taken

Progress towards WTO accession continues to be made, but key challenges remain ahead. The sixth meet-

ing of the Lao WTO Working Party (WP) took place in September 2010, at which the Lao delegation reported the

progress on legislative reforms. These include new regulations on Import and Export procedures, legislation toestablish SPS and TBT enquiry and notication points, a new Investment Law, new customs procedures includ-

ing steps towards achieving compliance with the WTO Valuation Agreement. A key landmark is the approval of

a new Decree in February 2011 which formally introduces the principle of “national treatment” into Lao law

Lao PDR has been gradually integrating into the world economy through accession to regional and multilat-eral trade organizations such as the ASEAN Free Trade Area and the World Trade Organization (WTO). Thecountry initially applied to join the WTO in 1997, and is now making solid progress towards accession. TheGOL is implementing a sector-wide approach to trade-related reforms based on the 2006 DTIS/IF ActionMatrix , to help address the supply-side constraints that inhibit export competitiveness. New institutionalstructures are being put in place and new investments are being made in customs and border administra-

tion as part of efforts to support improved trade facilitation. GOL is also now starting to update the DTISwith a new set of trade and integration priorities. Exports have recovered swiftly and strongly following theglobal nancial crisis, driven by both rapidly rising prices in key export commodities, as well as increasedows of minerals and the start-up of exported power generation in major hydropower facilities. Exportsof 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.

9




19

9 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.

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 2010. 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 nal report will recommend that Laos be admitted as a

member. The seventh Working Party meeting is planned for May 2011.

Lao PDR is progressively complying with requirements to reduce tariffs under AFTA Common Effective

Preferential Tariff. As of August 2009, 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 2015.

Important work on trade facilitation is progressing with key steps taken during 2010. A national coordinating

body for trade facilitation – the National Trade Facilitation Secretariat was formally established in October 2010, 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 2011 for submission to the government for approval. The strategy

and action plan identies 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 2011.




2.4 PRIVATE SECTOR DEVELOPMENT

The Lao PDR Constitution of 1991 protects state, collective, and private forms of ownership. During the 1990san 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 privatehands, and SOEs only cover around one percent of employment. Nearly 97 percent of manufacturing units aresmall (less than 10 employees). Of the medium and large units, around one third are privately owned by LaoPDR citizens and just over half are joint ventures with foreigners. The remainder is owned by government. For -eign investment inows have increased rapidly, in both resource and non-resource sectors (mainly hydropower,mining, agriculture, processing industries, and tourism). Between 2003 and 2010, actual investments increasedfrom $110 million to almost $800 million, with hydropower and mining now accounting for some 80 percent of inows. The main foreign investors are from Thailand, China and Vietnam, with other countries such as France,Australia and South Korea also registering with signicant investments. Laos has an increasingly strong higher level regulatory business environment, but signicant gaps remain with regard to inconsistent and partial imple-mentation of key laws, and remaining gaps in the subsidiary legislation.

Key Reform Progress

A key recent landmark during 2010 was the approval of a new Unied Investment Promotion Law in May 2010 (retro-

actively promulgated to apply from July 2009). 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 eld for both domestic and foreign investors by harmonizing business entry pro -

cedures 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 simplied business registration system in major provinces as part of the Enterprise Law implemen -

tation, and abolishment of establishment licenses for general manufacturing rms 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 2011), Provincial

Public-Private Dialogues, and direct dialogues between LNCCI and various business associations and the GOL. However, the

efciency 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 2010 Investment Climate Assessment suggests that the key constraints – as reported

by the domestic private sector – have evolved from hard infrastructural challenges (such as transport, communicationsand energy infrastructure as reported in the 2006 ICA), to softer aspects of the business environment (such as access

to nance, 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 rms as a result of increased labor costs pushed up by monetary

inows as a result of the hydropower and minerals booms.

The 2010 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.




21



A n n e x

ANNEX 1 – LAO PDR AT A GLANCE TABLE

Key Development Indicators*

2010

Population, mid-year (millions)

GNI (Atlas method, US$ billions)

GNI per capita (Atlas method US$)

GNI per capita (PPP, international $)

GDP growth (%)

GDP per capita growth (%)

Local prices

Consumer prices (annual % change)Implicit GDP deator

Exchange rate (period average, kip per 1 US$)

Structure of the Economy

GDP (US$ millions)

Agriculture (% of GDP)

Industry (% of GDP)

Services (% of GDP)

Balance of Payments and Trade

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)

Total revenue (including grants)Revenue

Taxrevenue

Current expenditure

Overall surplus/decit

External Debt and Resource Flows

Total external public debt (% of GDP)

Total debt service (% of exports)

Foreign direct investment (US$ millions)

6.4

6.5

1010

2,050

8.4

6.5

2007

4.57.6

9603

4,262

34.4

26.6

39.1

1215

2032

1440

2124

-684

-19.2

-11.9

531

13.611.9

11.9

8.7

-2.7

58.2

12.5

838

Lao PDR East Asia

& pacic

Low

income

1,930

5,102

2,644

5,426

8.0

7.2

2008

7.69.6

8635

5,563

33.1

27.6

39.3

1451

2484

1763

2602

-839

-18.5

-18.9

636

13.412.1

12.1

9.9

-2.7

54.0

10.4

976

976

510

523

1,355

6.3

4.1

2009

0.10.1

8498

6,107

31.7

28.9

39.4

1460

2424

1764

2551

-787

-13.6

-18.1

633

15.913.8

12.2

10.9

-6.7

55.4

15.6

774

2010

6.08.9

8235

7,491

30.0

31.4

38.6

2091

2693

2481

2845

-364

-8.6

-14.1

730

18.213.9

12.5

9.8

-4.6

51.5

16.2

761

(US$ millions)

(% of GDP)

Source: World Development Indicators ans staff estimates based on Lao authorities data.* Preliminary estimates for 2010




23

The global economic outlook is expected to be positive in 2011. 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 2011). Nevertheless, pressures from the unbalanced recovery of the world econ-omy exist, especially with regard to unemployment, commodity prices, and capital ows. 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 2011) and the World Bank’s projections (EAP Update March

2011) for the regional and global economic outlook and commodity prices, presented in Annex Table 1 below.

ANNEX 2 – GLOBAL ECONOMIC OUTLOOK

Global conditionsWorld Output 1/World trade volumeConsumer pricesAdvanced EconomiesUnited SatesEmerging and Developing Economies 2/Developing Asia

Commodity prices (percentage change of USD terms) Non-oil commodities 3/Agriculture

FoodMetals and mineralsCopper Oil price 4/Manufactures unit export value 2/London Interbank Offered Rate (%) 5/on USD Depositson Euro DepositsOn Japanese Yen Deposits

Real GDP growth

WorldAdvanced Economies

United StatesEuro AreaJapanUnited KingdomCentral and Eastern Europe

Emerging and Developing Asian EconomiesDeveloping AsiaChinaIndiaIndonesiaThailandMiddle East and North Africa

2007

5.27.3

2.22.96.45.4

14.120.1

25.76.25.9

10.75.5

2.42.0

5.22.7

2.12.72.32.65.5

8.310.613.0

9.46.34.96.3

2008

3.03.0

3.43.89.37.5

7.527.2

33.9-2.1-2.336.4

7.5

0.90.4

3.00.6

0.40.7

-0.70.73.0

6.07.69.07.36.12.65.2

2009e

-0.6-10.7

0.1

5.2

-15.8

-36.3

1.11.20.7

-0.5-3.4

-2.7-4.2-5.4-4.4-5.0

1.76.28.55.44.0

-3.51.7

2010f

5.012.4

1.6

6.2

26.3

27.9

0.50.80.4

53.0

2.81.73.91.3

9.49.5

10.310.46.17.83.8

2011f

4.47.4

2.2

6.9

25.1

35.6

0.61.70.6

4.42.4

2.81.61.41.7

7.98.49.68.26.24.04.1

2012f

4.56.9

1.7

5.3

-4.3

0.8

0.92.60.3

4.52.6

2.91.82.12.3

7.98.49.57.86.54.54.2

Source: IMF (WEO, April 2011)Note:1/ The quarterly estimate and projections account for 90 percent of the world purchasing power parity weights2/ The quarterly estimates and projections account for approximately 79 percent of the emerging and developing economies.3/ Average based on commodity export weight4/ Simple average of prices of UK Brent, Dubai, and West Texas Intermediate crude oil. The average oil price was US$ 79.03 a barrel in 2010;

the assumed price based on futures markets is US$107.16 in 2011 and US$108.00 in 2012.5/ Six-month rate for the US and Japan. Three month rate for the Euro Area

T able 1 A nnex

The Global Economic Outlook in Summary(percentage, change from previous year, unless otherwise specied)

Global conditions



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 Ofcial 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 & Pacic 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 nancial 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 InstitutionsMOF Ministry of Finance

NA National Assembly

NBFI Non-Bank Financial Institution

NDT MFI Non-Deposit Taking MFI

NEER Nominal effective exchange rate




25



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THE WORLD BANK OFFICE

1818 H Street, N.W.Washington, D.C. 20433Tel: (202) 472-1653Fax: (202) 522-1560/1557www.worldbank.org

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