Lao People’s Democratic Republic: Third Review under the Poverty Reduction and Growth Facility, and Requests for Waiver of Performance Criterion and Extension of the Arrangement
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International Monetary Fund
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Publication Date:
06 Oct 2003
eISBN:
9781451822441
Language:
English
Keywords:
ISCR; CR; PRGF; PRGF loan; PRSP preparation status report; Lao P.D.R.; Lao authorities; bank financing; Lao P.D.R. authorities; financial support; debt clearance; financing gap; Poverty reduction strategy
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Lao People's Democratic Republic (Lao PDR) showed commendable growth owing to its strong macroeconomic performance and structural reforms under the economic program. Executive Directors commended the fiscal performance, bank restructuring, and the private sector developments, and stressed the need to strengthen monetary and exchange rate policies. They welcomed the poverty reduction strategy and emphasized the need to accelerate structural reforms. They agreed that Lao PDR successfully completed the third review under the Poverty Reduction and Growth Facility (PRGF), and approved a waiver and an extension of the PRGF arrangement.

Abstract

Lao People's Democratic Republic (Lao PDR) showed commendable growth owing to its strong macroeconomic performance and structural reforms under the economic program. Executive Directors commended the fiscal performance, bank restructuring, and the private sector developments, and stressed the need to strengthen monetary and exchange rate policies. They welcomed the poverty reduction strategy and emphasized the need to accelerate structural reforms. They agreed that Lao PDR successfully completed the third review under the Poverty Reduction and Growth Facility (PRGF), and approved a waiver and an extension of the PRGF arrangement.

I. Introduction

1. Since April 2001, when the Executive Board approved the Lao P.D.R.’s PRGF-supported program, the government has made progress in setting a firmer foundation for economic reform. Progress has been made in monetary management, bank restructuring, and expenditure control, but revenue mobilization and debt management problems have continued. In particular, the third review has been delayed since January 2003 because of the need to take corrective actions for a budget revenue shortfall, and to implement the remedial measures for the misreporting of external debt. Going forward, risks remain from the weak fiscal system, limited implementation capacity, vested interests, and some policymakers’ caution about the reliance on market mechanisms.

2. At the conclusion of the 2002 Article IV consultation and the second review under the PRGF on August 26, 2002, Directors welcomed Lao P.D.R.’s robust growth and progress under the program. However, they expressed concern at the pick-up in inflation and warned that sustained growth would require measures to ensure fiscal sustainability, especially to improve revenue performance. Most Directors considered the phased approach to bank restructuring appropriate, but emphasized the need to improve loan quality and the strict application of commercial lending criteria. They also stressed the importance of complementary state-owned enterprise (SOE) reforms, especially asset sales and price adjustments. Directors welcomed the integration of the PRSP approach into the government’s own poverty reduction program, but stressed that there should be prioritization of budget expenditure for pro-poor programs.

3. In the attached letter dated August 28, 2003, the authorities request the completion of the third review under the PRGF-s up ported program, a waiver for the performance criterion on external debt, and an extension of the PRGF arrangement for one year, through April 24, 2005. The policies through March 2004 in support of this request are set out in the accompanying Memorandum of Economic and Financial Policies (MEFP).1

II. Recent Developments and Program Performance

Recent developments

4. Real GDP growth in 2002/03 weakened slightly to 5¼ percent, down ½ percentage point from the previous fiscal year (Table 3).2 Growth was supported by relatively strong increases in industrial production and agriculture, despite floods. However, slower private investment from more cautious bank lending policies, and weakness in tourism, dampened growth.

5. After surging in mid-2002, and remaining high until May 2003, inflation has now started to decline. The kip depreciated by 14 percent during May-September 2002, as a result of fiscal weaknesses in April-September 2002, and a surge in demand for foreign exchange to repay foreign currency bank credit.3 Reflecting this, inflation rose from about 7 percent (12-month basis) in the first part of 2002 to 15 percent in September 2002. Fiscal tightening starting October 2002 has helped to stabilize the exchange rate. However, food, utility, and petroleum price increases raised inflation further to 18 percent in May 2003. Since then, inflation has started to fall as the pass-through of the mid-2002 exchange rate slide has run its course. Inflation is expected to fall to about 10 percent by September 2003.

uA01fig01

CPI and Exchange Rates

(In annual percent change)

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

uA01fig02

Commercial Bank and Parallel Exchange Rates

(Kip/US$)

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

6. Excessive government capital spending caused the fiscal problems in 2001/02 The fiscal program for 2001/02 was premised on revenue at 13 percent of GDP, a cut from the optimistic projections in the budget. This was to be offset by cutbacks in expenditure from budgeted levels (based on newly introduced expenditure controls), additional foreign financing, and a small amount of domestic bank financing (excluding the one-off proceeds from a hydroelectric project refinancing). The revenue outcome was in line with the program, and cash shortages triggered the inbuilt restraint on current expenditure, which came in well under budget. However, this was not the case with domestically financed capital expenditure, which remained unchecked and exceeded budget levels. This was financed by budget arrears (about 0.7 percent of GDP), especially at the provincial level, and the high import content of the expenditures added to pressure on the exchange rate even though the bank financing ceiling was observed.

7. In 2002/03 the revenue ratio declined sharply but better expenditure controls prevented a deficit overrun. Although revenue was projected to remain at 13 percent of GDP, actual collections are now only expected to reach 11.5 percent of GDP. This is mainly due to timber royalties falling by ¼ percent of GDP from their peak in 2001/02 because of stricter enforcement of the log export ban. Revenue was also depressed by slower GDP growth and the halving of the turnover tax on domestic products. In response to the revenue shortfall, petroleum taxes were raised at end-May by 17 percentage points, effectively doubling the tax rate. Meanwhile, stricter expenditure controls prevented a repeat of last year’s unfunded expenditures, with some large unproductive projects being suspended.

uA01fig03

Revenue and Expenditures

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

uA01fig04

Budget Deficit

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

These controls appear to have limited new arrears, reduced aggregate demand, and helped to stabilize the exchange rate.4 Thus, by end-June 2003, net credit to the government was only slightly above the ceiling, and it is expected to fall under the ceiling by September.

8. Credit policy has been restrained since May 2002. After excessive credit growth through early 2002 gave rise to a further increase in nonperforming loans, the authorities took steps to restrain credit and initiate bank restructuring. This resulted in significant credit repayments in May-September 2002. Because a large proportion of this credit was in foreign currency, the rapid pace of repayments added to the demand for foreign exchange and the downward pressure on the exchange rate.5 Since then, net domestic assets of the state commercial banks (SCBs) have been on a slight downward trend, with tightened credit appraisals and some repayments. The credit restraint and the recall of BOL foreign currency credit to banks have enabled gross international reserves to build up to 3.7 months of imports in June 2003. In November 2002, the SCBs raised short-term kip deposit interest rates by 3 percentage points to prevent a decline in real kip rates.

uA01fig05

Credit Developments

(In billions of kip; at constant exchange rates)

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

uA01fig06

International Reserves

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

Performance under the program

9. Program performance at September 2002 was mixed All but one of the end-September 2002 quantitative performance criteria were met (Box 1). However, the ceiling on contracting and guaranteeing external nonconcessional public debt was breached by the March 2002 loan for the Nam Mang 3 hydro-electric project ($50 million, 2½ percent of GDP). This loan was successfully renegotiated to concessional terms in November 2002, and the related misreporting issue was considered by the Board on July 9, 2003. Also, while complying with the ceiling on bank credit to the government, significant budget arrears were accumulated.

10. The mixed performance continued in relation to the March 2003 targets, highlighting the fiscal weakness. Budget revenue was well below expectations during the first half of the fiscal year, and the ceilings for net bank credit to the government and the NDA of the BOL were exceeded, further delaying the review until the corrective fiscal measures at end May. On the positive side, the ceiling for NDA of SCBs and the floor for net international reserves were met by wide margins.

11. Implementation of the structural conditionality was generally consistent with the program, although capacity and policy constraints in the fiscal area have slowed progress. The structural benchmark on strengthening and reorganizing the tax and customs departments was broadly met although much remains to be done. Regarding public expenditure management, understandings were reached at end-November 2002 on a medium-term plan (MEFP Appendix I). Expenditure data by type of administrative unit were developed for education, but the slower pace of computerization delayed the production of data for the health sector.

Lao P.D.R.: Summary of Performance Under the Program for the Third Review1

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Based on the attached MEFP Tables 1 and 2, and more recent information.

12. The structural program is on track in the banking area, but progress in state-owned enterprise reform is lagging. The structural performance criterion for two rounds of bank supervision inspections was met as scheduled at end-November 2002, with notable improvements in the depth and quality of the inspections. Under the AsDB’s Banking Sector Reform Program, four international banking advisors were placed in the SCBs. The state auditor completed its 2001 audit of the BOL on schedule in August 2002, although it was not at international standards. SOE reform has lagged significantly, especially progress towards agreement with the World Bank on restructuring programs for five large SOEs. The enterprises are seeking additional financing to revitalize their operations but the government and the Bank are looking for options that do not involve additional public resources.

III. Program for 2003/04

13. The 2003/04 program is focused on strengthening macroeconomic stabilization and accelerating the related structural agenda. This focus provides a foundation for the government’s broader reform agenda, covering social, environmental, financial, and private sector development issues being developed under the National Poverty Eradication Program. The authorities explained that the slow progress resulted from the need to build consensus and coordinate these broader reforms. However, they stressed that they attach the highest priority to macroeconomic stability. For example, they noted that while fiscal decentralization had been initiated for broader development objectives, it has led to a deterioration in expenditure control and revenue performance that the government now intends to correct by recentralizing some of the tax, customs, and treasury functions.

14. Real GDP growth is projected to pick up to about 5¾ percent in 2003/04 as a result of increased private investment and a modest recovery in tourism.6 Inflation should decline further, to about 8 percent by September 2004, with further utility price increases keeping inflation above that of the trading partners. Exports are expected to grow relatively strongly, especially agricultural products, garments, and tourism receipts, which will increase gross international reserves to about 3.8 months of imports by September 2004. Looking further ahead, the pick up in growth from the large Nam Thuen 2 hydro-electric project has now been put back to 2005 because of the need to find other partners, after the largest shareholder withdrew from the project to narrow the focus of its investment portfolio.

Fiscal policy

15. In preparing the budget for 2003/04, the authorities recognize that the broader objectives need to be met within realistic financial constraints. To achieve this, the government will follow through on recent tax increases, embark on fiscal reforms in 2003/04 to strengthen the fiscal institutions, improve the efficiency of spending, and keep some funds unallocated. With the identified program loans at about the same level as 2002/03, no domestic bank financing of the budget is envisaged (except for the issue of government bonds to pay down old budget arrears).7

16. Revenue in 2003/04 is targeted to increase to 12.2 percent of GDP (MEFP ¶8). Preliminary estimates envisage that this increase would come mainly from the full-year effect of the petroleum tax increases implemented in late 2002/03 (0.6 percent of GDP), and some additional increases in excises on beer and tobacco that will more than offset the further loss of timber royalties. The staff would have preferred the reversal of the turnover tax reduction enacted in 2002/03 to be included in this budget. However, the authorities were concerned that such a quick reversal would damage their creditability and also noted that it entailed only a modest direct revenue loss (0.2 percent of GDP). They would review this measure in the context of the 2004/05 budget. To improve the transfer and accounting of revenues, especially those of the central government, the customs and treasury departments will be developed into national operations. Also, the tax department is being strengthened and the central large taxpayer unit will be expanded. When fully implemented, these measures could have a substantial revenue impact because they will limit the unauthorized diversion of funds, especially at the local levels. However, because the revenue impact is hard to quantify, and implementation will depend on cooperation from the provincial governments, no revenue impact has been explicitly included in the 2003/04 budget. Separately, concerns about the state of preparation for the VAT have led the government to put back its introduction to 2006.

17. The new Presidential Decree on Tax Incentives, being very broad and potentially costly, is a significant risk to the revenue outlook. This decree codifies the prevailing tax exemptions on import and profit taxes for domestic and foreign investors, but also has scope to extend them by regions and sectors. The staff argued that there were more cost effective methods to promote the private sector, and that the budget could ill afford a further shrinkage of the revenue base. In response to these concerns, the authorities explained that this initiative to promote the domestic private sector, especially in remote areas and in new sectors, including health, education, electricity generation, and infrastructure, would not be allowed to undermine the fiscal position. Meanwhile, they would work with Fund staff to formulate implementing regulations to safeguard budget revenues, which the authorities believe can be done with the existing decree, but would be prepared to revise the decree, if necessary. This decree is not currently being implemented because the implementing regulations have not been issued, and the authorities agreed to continue this (as a continuous structural performance criterion) pending the formulation of appropriate regulations.

18. Domestic expenditures will shift towards current expenditures in 2003/04, which will rise by 0.9 percent of GDP (MEFP ¶9). The rise comes mainly from the 42 percent increase in the wage bill (reflecting a new 30 percent civil service wage increase, on top of the 15 percent granted in late 2002/03). Such increases in civil service wages are needed to offset the ongoing large increases in utility tariffs and recent petroleum tax increases, and to gradually restore the real wage level to that of the mid-1990s. These wage increases are especially important for social sector workers who make up a significant share of government employment. Also both domestic and foreign debt service is likely to rise significantly due to the servicing of debt clearance bonds and Russian debt. Offsetting this will be a cut in domestically financed capital expenditure, which will fall from 4.9 percent to 4.0 percent of GDP. In addition, this category includes an unallocated amount of 0.8 percent of GDP which would be available only if budget revenues are on track. In line with a policy of stricter appraisals of investment, the budget only includes funding for existing projects and there are no allocations for new projects, while they are evaluated and prioritized this year.

19. Recognizing the serious deficiencies in public expenditure management, the government is embarking on a range of reform measures In line with the plan (MEFP Appendix I) for 2003/04, these reforms will both tighten expenditure controls and improve information systems, through the development of a national treasury, the rationalization of government bank accounts, and the introduction of a classification of expenditure by administrative unit. To correct past poor fiscal management, the government will accelerate clearance of the budget arrears identified in the recent survey of arrears and the bank restructuring process, amounting to KN 600 billion (3 percent of GDP) as of September 2002. About two-thirds of this will be cleared by end 2003/04, mainly by the issuance of debt clearance bonds, which will also partly finance bank restructuring.8 Post-2001 arrears are being cleared by a combination of securities, cash, and tax netting, within the budget, and as noted earlier, tighter disbursement procedures have significantly reduced the likelihood of new arrears on capital expenditure.

Monetary and exchange rate policies

20. The monetary program will continue to be based on limits on central bank credit to reduce inflation.9 Net credit to the government by the BOL will decline slightly, providing scope for a further increase in gross international reserves to $228 million (3.8 months of imports) by September 2004, while limiting reserve money growth to 1510 percent in 2003/04. The BOL will phase the redemption of its securities so as to avoid undue increases in liquidity.

21. SCBs will continue to be subject to overall credit limits. Their credit will be limited to 16 percent in the year to September 2004 (slightly higher than nominal GDP growth) while total commercial bank credit is expected to grow slightly faster, at 18 percent. As SCBs gradually resume lending, it will be important that they do so cautiously and under new appraisal procedures that appropriately price risk, especially on foreign currency loans. Under this scenario, broad money is expected to grow by 19 percent in the year to September 2004, although it could be lower if banks reduce deposit interest rates, given their high level of excess reserves.

22. The prevailing flexible exchange rate regime, and the policy of maintaining the margin with the parallel rate at less than 2 percent, are appropriate and will be maintained. Under this approach, the exchange rate has been a visible indicator of policy slippages, signaling when corrective action is needed. The authorities have a strong preference for a stable exchange rate, since the high level of dollarization means that exchange rate changes will only result in limited adjustment in relative prices.

External debt management policies

23. The Lao and Russian governments have made significant progress toward a mutually agreeable solution of their outstanding debt issue. Understandings have been reached recently consistent with terms of Russia’s Memorandum of Understanding as a creditor in the Paris Club (using an exchange rate of SUR 0.6 per dollar and a 70 percent upfront discount), resulting in a face value of debt of $387 million. This will need to be followed by the end of 2003 with a specific agreement on the terms, including interest, grace period, and payment modalities (cash, goods, and/or investment).

24. Reflecting the high level of external debt and a narrow export base, the government will refrain from contracting and guaranteeing new nonconcessional external public debt (MEFP ¶18).11 As part of the Ministry of Finance’s effort to improve the monitoring of all public sector external debt, the database has been made more comprehensive by the inclusion of SOE external debts. However, in late May 2003 (before the monitoring system became effective) the state-owned Lao Airlines signed a three-year lease for a new Airbus without a government guarantee at a relatively low rental, less than for a smaller propeller aircraft leased earlier.12 Based on the commitments from the government to not provide financial support to Lao Airlines, which the staff will monitor closely, the $3 million (in NPV terms) debt has been allowed under the program. The net present value of Lao P.D.R.’s public external debt is high at 113 percent of exports, excluding debt to Russia. A debt sustainability analysis will be undertaken after agreement on the specific terms of the debt to Russia is reached.

Banking reform

25. State bank restructuring is on track under the detailed program supported by the AsDB and World Bank (MEFP ¶14–16). In particular, SCBs have implemented operational restraints, limited credit growth, and recovered 8 percent of gross credit through end-June 2003. The four international bank advisors (IB As) started work in the main operational areas, including credit appraisals. In addition, the two small SCBs have merged and rationalization has begun. In 2003/04 the program will contain (i) half yearly financial targets and more comprehensive annual performance tests;13 (ii) a mechanism for upgrading the role of the BOL and the IB As in case of poor performance by the SCBs in 2003, and (iii) the submission, by January 2004, of amendments to the Decree Law on Commercial Banks to, inter alia, permit foreign bank branches to operate on a nationwide basis (a structural benchmark). As part of the overall policy framework, the government has now decided that it would also seek strategic shareholders in one of the two remaining SCBs by 2005.

26. Despite the encouraging implementation of banking reforms, risks remain. In particular, it will take time for these SCBs to develop a fully commercial orientation and many difficult restructuring decisions still need to be taken. Moreover, the risk of expansion of bad credit is still present in view of the slow reform of SOEs, as highlighted by the emergence of new NPLs. The introduction of greater competition in the banking sector should add pressure for reform over the medium term, although it may be difficult to attract reputable investors in the SCBs in the near term.

27. The BOL will continue to strengthen bank supervision capacity. Despite an established regulatory framework, its implementation by the BOL is still in the early stages. The implementation of on-site inspections will again be a structural performance criterion, but requiring higher standards, and these will be part of the first performance test of SCB restructuring.

State-owned enterprise reform

28. Of the targeted structural reforms, progress has been slowest for SOEs. Under the World Bank’s FMAC, the main element of the reforms is for five large SOEs to develop and implement restructuring programs (MEFP ¶17) on which little progress has been made. Indeed, the proposals by the enterprises themselves focused only on the need for additional financial support. The government has now started to utilize international experts, with funding under the FMAC, to assist, develop, and implement the reform plans. For the Phoudoi conglomerate (the largest bad debtor), a key bottleneck is the extent of sales of noncore assets to pay down its nonperforming loans. Lao Airlines, which has foreign management advisors, is expected to reach agreement with the Bank under the FMAC program on a restructuring plan by the end of the year, which would include seeking a joint venture partner.

PRSP and links to broader reforms

29. Formulation of the country-led National Poverty Eradication Program (NPEP) is well advanced. The government has incorporated the NPEP process into its broader socioeconomic development plan that is the basis for its general economic reforms as well as its poverty reduction and sector specific policies. Among the issues raised has been the relative size and role of the public and private sectors. After consultations with stakeholders, government ministries, mass organizations,14 private sector, and donors, a final version is expected by late 2003.

30. The PRGF and operations of the World Bank and the AsDB are aligned to support the government’s efforts at economic reforms and direct poverty reduction under the umbrella of the NPEP. The integrated structural conditionality of the three institutions is shown in Box 2. In addition, the Bank and the AsDB are working with the government, including through Business Roundtable meetings, to identify and eliminate major impediments to private sector development, and to support direct poverty reduction programs in health, education, agriculture, rural roads, and social and environmental safeguards.

Structural Measures Supported by International Financial Institutions

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Program monitoring and safeguards

31. The program will be monitored by both quantitative and structural targets Quantitative performance criteria will be specified for end-September 2003 and end-March 2004, Compared to the previous financial program, indicative targets have been added for reserve money in kip (to more closely monitor domestic liquidity creation) and budget revenue (MEFP Table 1). The structural conditionality is given in MEFP Table 2, and discussed in Box 3. Because of the delay in completing the third review, the authorities have requested a one-year extension of the PRGF arrangement, through April 24, 2005. The fourth and fifth reviews have been scheduled for end-January and end-July 2004, respectively.

Table 1.

Lao P.D.R.: Phasing of Disbursements Under the PRGF Arrangement

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Source: IMF, Finance Department, and staff projections.
Table 2:

Lao P.D.R.: Fund Position and Indicators of Fund Credit, 2002-2012

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Source: Data provided by the IMF Finance Department; and Fund staff estimates and projections.

32. The authorities are requesting a waiver for the nonobservance of the end September 2002 performance criterion for contracting and guaranteeing nonconcessional public debt. This debt was contracted for the Nam Mang 3 hydroelectric project, and the waiver is requested on the basis of the loan terms being made concessional in November 2002. Waivers for the end-March 2003 performance criteria are not being sought because the lag in the implementation of the broader structural agenda does not warrant the fifth disbursement.

33. While the core policies of the program are monitorable through reasonably accurate financial statistics, there are severe statistical weaknesses in some areas. Weaknesses in the availability of trade, national accounts, and fiscal data constrain economic analysis, decision making, and financial accountability. Recognizing this, the government intends to adopt the Generalized Data Dissemination System (MEFP 1J21) to provide a more structured approach for improving statistics and promoting policy transparency. The government is considering to adapt the recommendations of the STA mission in 2002 that reviewed macroeconomic statistics and socio-demographic data for monitoring poverty reduction outcomes.

34. Onsite inspection under the Fund’s safeguards assessment identified significant vulnerabilities, and the BOL has agreed to implement the high priority recommendations (Annex I and MEFP ^22). Building on the earlier audit, the BOL has agreed that the audit of the 2002 accounts will be conducted by the State Audit Authority, with the close assistance of an international audit firm, and the audit of the 2003 accounts will be conducted jointly with an international firm. The BOL will also progressively correct the deviations from international accounting standards (IAS) identified in the 2001 and subsequent audits, starting with provisioning for its loans. Progress towards adopting IAS for the 2004 financial accounts will be discussed in the fourth PRGF review, and in light of the outcome of the 2002 audit.

IV. Staff Appraisal

35. Over the past two years, there has been welcome progress in macroeconomic stabilization and structural reforms. The inflation pressures that emerged in mid-2002 from fiscal weaknesses and complications in monetary policy have now subsided. With the exchange rate stable for close to a year, inflation should continue to decline. At the same time, the need to bring down inflation again and the delay in the third review have made policy makers aware of the need for structural reforms to sustain macroeconomic stability. More generally, the PRSP-based process of the NPEP is building a consensus that, while many obstacles remain, poverty reduction can only be achieved through market-based growth from the private sector.

Lao P.D.R.: Structural Conditionality

Coverage of structural conditionality in the current program

Structural conditionality for the 2003/04 program is set out in the attached MEFP dated August 28, 2003, especially Table 2. Structural conditionality focuses on improving fiscal management and banking supervision. These areas are critical to achieving the program’s main objectives of maintaining macroeconomic stability and developing the structural foundation for faster growth with poverty reduction.

Status of structural conditionality from earlier programs

The structural conditions for the third review of the PRGF-supported program were implemented on time, except for the benchmark on the BOL audit where the basic work was completed according to schedule, but the audit fell short of international standards. This audit arrangement was a step to build the authorities’ exposure to international standard audits, and the authorities have now agreed to a joint audit for 2003.

The structural conditions for the first and second reviews were implemented, typically with a slight delay of 1-2 months, but always in advance of their respective reviews. An exception was the benchmark on the medium-term plan for public expenditure management for the second review, which was subsequently made part of the third review. The plan is now completed, and its implementation is underway.

Structural areas covered by World Bank and AsDB lending and conditionality

The World Bank’s FMAC, approved in June 2002, has the theme of improving financial management in the SCBs, SOEs, the budget, and forestry, the latter being a large revenue source. The FMAC conditionality covers the initial steps of SCB restructuring, credit restraints, pricing and restructuring of SOEs, and expenditure management, especially on the public investment program. It covers an 18-month period, to be followed by PRSCs.

The AsDB’s Executive Board approved the Banking Sector Reform Program (BSRP) at end November 2002 aimed at securing operational improvements in SCBs, which also include legal, judicial, and private sector development components.

These components have been closely coordinated with the FMAC and PRGF.

Other relevant structural conditions not included in the current program

The coverage of the economic reform programs of FMAC, BSRP, and PRGF is comprehensive. The main issue will be to ensure effective implementation of the reform agenda rather than a more comprehensive coverage. Nevertheless, as the government becomes more engaged in private sector development, business and trade deregulation could be added to the agenda.

36. The main challenge to macroeconomic stability remains a durable improvement in fiscal performance. After a major weakening in budget revenue, the government has now responded with a corrective plan that includes tax measures and institutional reforms to be launched in 2003/04. The authorities will have to implement these reforms decisively to raise the revenue ratio as previously planned, and will need to be prepared to counter resistance, especially from provincial governments. The envisaged fiscal reforms to increase the efficiency and accountability of public spending, through stricter project evaluation and tighter management of finances, are welcome given the major deficiencies.

37. The staff are seriously concerned that the recent decree on tax incentives for investment could lead to significant revenue losses. While the authorities’ recent focus on private sector development is laudable, more attention should be given to regulatory and administrative reform. To protect macro stability and the program’s revenue objectives, it will be critical for the authorities to delay implementing this decree, and to ensure that the implementing regulations safeguard revenue, including if necessary, by also revising the decree.

38. Monetary policy should continue to support the reduction in inflation Firm control over central bank credit should reinforce the recent decline in inflation. State bank credit could resume modest growth following recent cutbacks with the implementation of stricter credit appraisals. The staff considers the continuation of the flexible exchange rate to be appropriate.

39. The progress made so far at bank restructuring is welcome, especially the use of stricter credit appraisals. Despite this, much remains to be done to establish commercially oriented state banks. Enhancing competition by expanding the role of reputable foreign banks and diversifying the shareholding of one of the two SCBs, after an initial period of restructuring, will be important steps to achieve this aim. At the same time, it will be critical to maintain momentum in upgrading the quality of bank supervision.

40. Delays in SOE reform are a concern and the government needs to move ahead more decisively to complement banking reform. The restructuring of SOEs should involve significant sales of non-core assets to pay down their NPLs. Price adjustments should continue, and operational improvements should be accelerated while imposing hard budget constraints on SOE operations, and seeking joint venture partners to provide funding for their viable operations.

41. The BOL has moved decisively to address the vulnerabilities identified in the safeguards assessment. The decision to have the BOL’s 2003 accounts jointly audited with an international audit firm is a major contribution to correcting these vulnerabilities. The progressive introduction of international accounting standards will also support transparency in its financial accounts.

42. The continued progress at developing Lao P.D.R.’s poverty reduction strategy is welcome. The participatory approach has been successful in opening a debate on key economic issues especially the relative emphasis on public and private investment. In order to make more effective use of the available public resources it will be critical to implement expenditure management reforms.

43. Given the high debt ratio and still-narrow export base, a cautious approach is needed with debt management. Continued debt management problems indicate the need for pro-active implementation of the Ministerial Instruction on External Debt Management by the Ministry of Finance, especially regarding SOE debt. The recent agreement on aspects of the Lao P.D.R.’s outstanding debt with the Russian Federation is constructive.

44. Significant risks remain in the program. As has been the case, the biggest risk to the program remains the fiscal position. The recent tax and planned structural fiscal measures have the potential to reduce this risk. At the same time, while the initiative to promote the private sector is welcome, poorly controlled and expensive tax incentives could threaten the revenue base. Pressures to rebuild the state sector by utilizing more public resources would also put the program at risk, and should be resisted.

45. The staff recommends the completion of the third review under the PRGF arrangement. Policy implementation under the program has improved and the authorities’ recent measures are indicative of their commitment to enhance program performance. The staff supports the authorities’ request for a waiver for the non-observance of the external debt ceiling for end-September 2002, on the basis of the deviation being temporary.

Figure 1.
Figure 1.

Lao P.D.R.: Selected Economic Indicators, 1998-2003

Citation: IMF Staff Country Reports 2003, 308; 10.5089/9781451822441.002.A001

Source: Data provided by the Lao P.D.R. authorities; and Fund staff and Information Notice System (INS) estimates.
Table 3.

Lao P.D.R.: Selected Economic and Financial Indicators, 2000–2004

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Latest data are for June 2003 unless otherwise indicated.

Staff estimate. The government estimates real GDP growth in 2002/03 to be 5.9 percent.

Data for July 2003.

Fiscal year basis (October-September).

Money and credit data and official reserves data from 2001 onwards are presented on a fiscal year basis; Money and credit data for 2002 and 2003 are at constant exchange rates.

Percent change excludes the impact of provisioning on pre-2000 NPLs of SCBs.

Convertible currency debt only; Russian debt is included as of 2003, and based on preliminary agreement between the Lao and Russian government including a 70 percent discount on claims valued at SUR 0.6 per U.S. dollar.

In percent of exports of goods and services, excluding NT2.

Data as of August 20, 2003.

As of May 2003.

Table 4.

Lao P.D.R.: General Government Operations, 2000/01–2003/04

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Includes KN 194 billion in unallocated domestically financed capital expenditures in 2003/04.

The overall budget deficit for 2001/02 includes estimated expenditure arrears of KN 130 billion.

Figures for 2001/02 include the transfer of $33 million from EDL to the government from the Theun-Hinboun Power Company (THPC) refinancing.

Bank financing excludes the valuation adjustments on the stock of government foreign currency deposits and credit in all years.

Excludes Russian debt and SOE commercial debt.

Table 5.

Lao P.D.R.: General Government Operations, 2000/01-2003/04

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Includes KN 194 billion in unallocated domestically financed capital expenditures in 2003/04.

The overall budget deficit for 2001/02 includes estimated expenditure arrears of KN 130 billion.

Figures for 2001/02 include the transfer of S33 million from EDL to the government from the Theun-Hinboun Power Company (THPC) refinancing.

Bank financing excludes the valuation adjustments on the stock of government foreign currency deposits and credit in all years.

Excludes Russian debt and SOE commercial debt.

Table 6.

Lao P.D.R.: The Bank of the Lao P.D.R., 2002–2004

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Reserve money for the program from March 2003 onwards.

At constant exchange rates for the program until September 2004.

Cumulative from the start of the fiscal year (which runs from October to September).

Table 7.

Lao P.D.R.: Monetary Survey, 2002–2004

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

At constant exchange rates for the program until September 2004; excludes provisioning of pre-2000 NPLs of SCBs.

Adjusted for the short-term borrowing for Lao Brewery.

Excludes debt clearance bonds.

Cumulative from the start of the fiscal year (which runs from October to September).

Excludes bank recapitalization.

Table 8.

Lao P.D.R.: Summary Macroeconomic Framework, 2000–2006

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

It is expected that the construction of the large NT2 hydroelectric project will begin in 2005.

Fiscal year ending September.

The overall budget deficit for 2001/02 includes estimated expenditure arrears of KN 130 billion.

Estimates for private savings and investment are highly tentative as no expenditure based national accounts have yet been established. In particular, private savings reflect unrecorded imports.

Comprises government investment and selected state owned enterprise investment.

Table 9.

Lao P.D.R.: Balance of Payments, 1999–2006

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Includes debt service to official creditors and estimates for debt service to commercial creditors, but does not include obligations to the Russian Federation which are being clarified in the context of bilateral negotiations.

The large hydroelectric project Nam Theun 2 (NT2) is valued at US$ 1.1 billion (60 percent of CDP), to be implemented over 2005–09, and would be financed by foreign investment.

For 2001–06, excludes liabilities to banks, debt securities issued abroad, and non-bank trade credits, but includes prospective amortization on external debt.

The financing gap in 2003 comprises $ 10 million from the AsDB and $6 million under the PRGF; and in 2004, $10 million from the AsDB, $10 million from the World Bank, and $13 million under the PRGF.

Table 10:

Lao P.D.R.: Debt and Debt Service 1999–2006 1/

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Debt service and the stock of debt are calculated on the basis of existing debt, and currently identified disbursements, disbursements from the Fund, the World Bank, the AsDB, and debt contracted to finance NT2.

Preliminary rescheduling agreement between Russia and Lao P.D.R., based on a 70 percent discount on Russian claims valued at SUR 0.6 per US dollar.

Including future disbursements under the current arrangement.

Three year average of exports of goods and services.

Excluding Russian debt, pending final agreement on the terms of the rescheduling.

Table 11.

Lao P.D.R.: External Financing Needs and Sources, 1999–2006

(In millions of U.S. dollars)

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Sources: Data provided by the Lao P.D.R. authorities; and Fund staff estimates and projections.

Excluding the IMF.

Original maturity of less than one year. Includes all short-term outflows.

Includes those transactions that are undertaken for the purpose of financing a balance of payments deficit or an increase in reserves.

Includes both grants and loans.

Includes all other net financial flows, and errors and omissions.

The financing gap in 2003 comprises $10 million from the AsDB and S6 million under the PRGF; and in 2004, $10 million from the AsDB, $10 million from the World Bank, and $13 million under the PRGF.

ANNEX I Lao P.D.R.—Fund Relations

(As of June 30, 2003)

I. Membership Status: Joined 7/05/61; Article XIV

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans:

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V. Latest Financial Arrangements:

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VI. Projected Obligations to Fund (SDR million; based on existing use of resources and present holdings of SDRs):

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VII. Implementation of HTPC Initiative

The Lao P.D.R. could be eligible for assistance under the HIPC Initiative. A loan-by-loan DSA will be undertaken with the newly available data, which together with the outcome of the negotiations on the debt to the Russian Federation, will be needed to evaluate whether to seek HIPC relief.

VIII. Safeguards Assessments

Under the Fund’s safeguards assessment policy, the Bank of the Lao P.D.R. (BOL) is subject to a full safeguards assessment with respect to the PRGF arrangement, which was approved on April 25, 2001. An off-site safeguards assessment of the BOL was completed on December 17, 2001. The assessment concluded that high risks may exist in the external audit mechanism, and financial reporting framework, internal audit mechanism, and system of internal controls and recommended an on-site assessment. The FIN on-site safeguards assessment mission took place in early December 2002. It noted that the BOL has taken initial steps to strengthen its safeguards framework with the creation of an internal audit department and the initiation of external audits. However, staff noted that significant vulnerabilities remain and the BOL must continue to strengthen its external audit, adopt a recognized financial reporting framework, and develop its internal audit function further.

To address the significant vulnerabilities, staff recommended that the BOL: (i) contract an audit firm with international experience and exposure to conduct joint audits with the state auditor for financial years ending December 2003 and 2004; (ii) adopt International Accounting Standards (IAS) as its financial reporting framework beginning with the financial year ending December 31, 2004; (iii) establish a formal monthly process of reconciling accounting data to program data reported to the Fund; and (iv) train internal audit staff to become proficient in conducting internal audits professionally.

IX. Exchange Rate

In September 1995, the Lao P.D.R. adopted a managed floating exchange rate system, abolishing the official rate. From October 1997, commercial banks have been encouraged to follow the parallel market closely. On August 20, 2003 the commercial bank exchange rate was kip 10560 (buying) and kip 10680 (selling) per U.S. dollar.

X. Last Article IV Consultation Discussions

The last Article IV consultation discussions were held in Vientiane during April 24-May 8, 2002. The staff report (EBS/02/129) was discussed by the Executive Board on August 26, 2002. The Lao P.D.R, maintains an exchange system free of restrictions on the making of payments and transfers for current international transactions.

XI. Technical Assistance (since 1998)

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XII. Resident Representative

Mr. Eric Sidgwick assumed the post of resident representative in Vientiane on June 26, 2000.

ANNEX II Lao P.D.R.: Fund-Bank Relations Annex1

Partnership for Development

The Government (GOL) of the Lao Peoples’ Democratic Republic (PDR) aims to achieve rapid economic growth in order to improve the living conditions of its poor and graduate from its status as a least-developed country. The development strategy to achieve these goals has been articulated in the National Socioeconomic Development Plan (2001-05), the Interim Poverty Reduction Strategy Paper (I-PRSP) and the recently-prepared preliminary draft of the National Poverty Eradication Plan (NPEP), scheduled to be discussed at the National Assembly in October 2003. This strategy seeks to:

The World Bank Group - International Finance Corporation (IFC), Mekong Project Development Facility (MPDF), World Bank Institute (WBI) and the World Bank (Bank)-provides technical and financial support to Lao PDR in the implementation of this strategy. The Bank itself supports analytical work in the structural reform areas cited above, in poverty diagnostics, in key sectors and in capacity building for the public sector, in addition to concessional financial assistance of around US$30 million a year. As agreed during the recent Country Assistance Strategy (CAS) consultations and as requested by the Government, the Bank intends to place increased emphasis on human resource development in its new credits, in addition to its existing broad role in basic infrastructure and agriculture. The WBI provides training in support of capacity building initiatives. The IFC, together with its MPDF, the private sector arm of the Group, promotes private sector development through technical assistance, strengthened dialogue between public and private sectors and direct financing of private-sector projects.

IMF-World Bank Collaboration in Specific Areas

In broad terms, the International Monetary Fund (IMF or Fund) has taken the lead in supporting the Government in strengthening the macroeconomic framework for ensuring macro economic stability. This support covers tax, fiscal, monetary, interest-rate and exchange rate policies, and balance of payments and related statistical issues. In addition, some aspects of three structural policy areas that have an important bearing on macroeconomic performance (e.g. financial sector, public expenditure management, trade policy) are also part and parcel of the Fund’s work program. The Bank has taken the lead in supporting the Government in poverty diagnostics, analysis and advice, poverty and social impact assessments, SOE reform and restructuring, private sector development, and legal/judicial development, in addition to natural resource management and sectoral reforms. The Bank also shares responsibility with the Fund in structural areas of the financial sector, public expenditure management and trade policy as well as in supporting the Government in the development of the poverty reduction strategy. Both institutions also collaborate closely with the Asian Development Bank (AsDB) in the financial sector and in public expenditure management, and with the UN agencies in the trade policy area and poverty reduction strategy.

The Bank also plans to initiate new work on capacity enhancement in the public sector as well as in legal and judicial development. The Government has indicated that while various types of capacity-building is going on in different parts of the public sector, and the Bank projects have components that address this issue in the sectors, there is a need for greater focus, systematic effort and scaling up of capacity enhancement efforts. Two missions visited Vientiane in May and July 2003, to discuss with various agencies their assessment of what is needed and a brainstorming session was organized by the National Organization for the Study of Policy and Administration (NOSPA), with participation of several agencies and ministries in July 2003. The Government’s recent governance report has emphasized its commitment to the rule of law and the need for implementing that in the country; the Bank plans to support this area, especially in the context of private sector development.

Bank and Fund Policy Dialogue

Poverty Reduction Strategy. The World Bank has been leading the work in supporting the Government’s poverty diagnostics, poverty and social impact of policies, and supporting the consultations for the poverty reduction strategy. Both the Bank and the Fund have been jointly (together with UNDP) involved in the Government’s process of formulating their medium-term poverty reduction strategy. In April, 2001, the GOL submitted an I-PRSP to the Boards of the World Bank and the IMF, and in August 2002, a Progress Report on the preparation of the full PRSP. More recently in May 2003, GOL circulated the first draft of the full PRSP, which in Lao PDR is the National Poverty Eradication Program (NPEP). This was presented at the May 2003 mini Roundtable Meeting (RTM) of donors and NGOs for comments. Participants at the mini-RTM suggested that further consultations would be needed to develop a consensus among all development partners. Also, further substantive work would be needed for specifying the appropriate medium-term macroeconomic framework, costing the proposed public investment and current expenditure program, prioritizing the proposed reform measures in the various areas, including a timeline, and developing targets and indicators for monitoring the implementation of the NPEP. A second draft was circulated in August 2003, in preparation of the September 2003 RTM. The final document is scheduled to be submitted to the National Assembly in October 2003, with the Bank and the Fund’s Joint Staff Assessment (JSA) of the strategy expected soon thereafter.

Public Expenditure Management. In 2002, the Bank completed a Public Expenditure, Financial Management and Procurement Review, jointly with the IMF, the AsDB and the Government, and the IMF completed a FAD mission review of the treasury, budget reporting and accounting systems. These assessments provided a further basis for the Government’s reform program that is being supported by the IMF’s PRGF and by the Bank’s financial support in the form of the Financial Management Adjustment Credit (FMAC)2, and the technical assistance provided by the Financial Management Capacity Building Credit (FMCBC), the IDF grant for public financial management, and the PPIAF grant for tariff-studies. In particular, the FMAC seeks to enhance transparency, accountability and efficiency through the publication of the budget, improvements in procurement, greater balance between recurrent and capital expenditures and the development of a better chart of accounts for classifying expenditures. These actions complement several of the PRGF structural benchmarks in respect of treasury reforms, budget reporting and public accounting.

Given the current situation of public financial management, reforms are expected to continue for some time to make such management adequately transparent, accountable and efficient. The final NPEP expects to incorporate not only the public investment and current expenditure plan that would be needed to achieve the goals set out in that strategy, but also reforms in public financial management that would be needed to manage effectively the rising revenues from natural resources and general taxes. Firm entrenchment of this reform process, along with clear, monitorable performance benchmarks, and an established track record will be necessary for the World Bank and other donors to continue expanding support to Lao PDR, including possible support for future projects to export power to neighbors, like the large Nam Theun 2 (NT2) power project.

The Bank is currently completing, jointly with the Government, an examination of the likely sources of growth for Lao PDR, the institutional development that is necessary for better public financial management and the likely impact of both on poverty and human development. Work on intergovernmental fiscal relations is also planned. The Bank expects to support public financial management reforms over the medium term through a cycle of Poverty Reduction Support Credits (PRSCs), with the first one covering the first-year program under the NPEP; self-standing technical assistance projects may also be provided in this area, if needed.

Financial Sector Reforms. The World Bank has worked closely with the IMF and the AsDB to support the Bank of the Lao PDR (BOL) in developing and implementing a multi-year banking reform program, with technical assistance provided by the AsDB. The Bank’s ongoing FMAC supports restructuring of State-owned Commercial Banks (SCBs) and their move to a more commercial basis of operation, as well as the development of rural micro-finance institutions. Reflecting the Bank’s view that SCBs must be put on a commercial footing, the conditionality under FMAC includes detailed provisions on the restructuring of SCBs, including non performing loans (NPL) resolution process, proper and regular reporting by SCBs, as well as international audits so as to improve transparency and accountability. In addition, it supports the development of an appropriate policy framework for rural and micro finance institutions through a consultative process. This restructuring is supported by AsDB with the provision of technical assistance in the form of international banking advisors in the SCBs, as well as a recent multi-year program loan to support ongoing restructuring. The IMF is taking the lead in strengthening banking regulation and supervision, and complementing the Bank and AsDB work on SCB restructuring, by focusing on the financial aspects of restructuring which has implications for fiscal stability.

The Bank recognizes, together with the IMF, that the restructuring of SCBs and the reform of regulation and supervision is not only important for the proper functioning of the financial sector, but also for fiscal and macro-stability in Lao PDR, as NPLs and the losses from NPLs have impacted the budget adversely and could do so in the future. The Bank’s FMAC, supported by the FMCBC, and the PRGF seek to break this destabilizing cycle as a key step in the process of better management of public resources and fiscal stability, and expects this support to be needed over the medium-term; the Bank’s cycle of PRSCs will provide such support together with the PRGF and the AsDB’s program loans.

Trade Policy. The IMF and the Bank have both worked on trade policy issues for some time, and this was an integral part of the earlier analytical work and programs. More recently, the Bank is conducting workshops and carrying out analysis of trade issues. The WBI conducted several seminars on trade policy issues through the GDLN facility, and in April 2003, organized a face-to-face workshop on WTO accession and its potential for exports and poverty reduction, in a peer-learning mode, which was attended by more than a dozen senior Lao officials. The Bank completed the updating of earlier work on Lao PDR’s trade regime and exports, and plans to lead a bigger piece of diagnostic work on trade policy and export potential during October 2003 - June 2004; this will be done jointly with the Government (led by the Ministry of Commerce) under the Integrated Framework program. Reforms in this area are also expected to be supported by the proposed PRSC.

The Bank’s Key Roles in Policy Dialogue

Poverty and Social Impact Analysis. This work, supported by the Bank, is being mainstreamed into the various pieces of the Bank’s analytical and advisory assistance (AAA) and so there will be no single piece of work designated as the PSIA. Instead, all future pieces of Bank AAA work, agreed in consultation with the Government and the NPEP process, will not only diagnose the problems at hand and identify the technical solutions to the problems/constraints being analyzed, but go on to assess the ex ante poverty and social impact of those potential solutions and policies, before developing recommendations. Most of the AAA work is also being conducted in a more consultative mode using some of the processes developed for the NPEP. The ongoing Sources of Growth study, the planned Poverty Assessment and Public Expenditure Tracking work, and the planned Trade Policy Diagnostics will all be done in this mode; the IMF will provide relevant inputs for this work in the specific areas where the Fund leads (e.g. tax policy, exchange rate policy).

State-Owned Enterprises (SOEs). The SOEs have been large users of resources and certainly have been the main creditors of SCBs; they have also been the main contributors to the problem of NPLs at SCBs. Accordingly, the FMAC supports the Government’s ongoing SOE reform program aimed at improving and institutionalizing the reporting and recording of annual performance of all SOEs, the restructuring of the five large SOEs (BPKP, Pharmaceutical Factory No. 3, Nam Papa Lao, Lao Airlines and Electricité du Lao), drawing up of memorandums of restructuring for another five large SOEs, and appropriate pricing policy for public utility SOEs. The latter requires the development of appropriate tariff policies for water, telecommunications and aviation to ensure cost-recovery tariffs and transparent subsidies where applicable, so that the impact of pricing on the commercial viability of those SOEs are predictable and favorable.

For this purpose, the Bank is supporting, through technical assistance, the preparation of multi-year restructuring plans for the above five SOEs, the development of the monitoring system for SOE performance and detailed tariff studies in telecommunications and aviation. The SOE reform effort not only seeks to move SOEs towards greater efficiency and more commercially viable operation, but also expects to limit future contingent liabilities of SOEs that may undermine medium-term fiscal stability.

The Bank will support the implementation of the SOE’s multi-year restructuring plans, the monitoring system as well as the utilities’ tariff-policies beyond the second-tranche release of FMAC; this will be done through the PRSCs, the technical assistance grants and credits, and analytical work.

Private Sector Development The World Bank Group (World Bank, IFC, MPDF) supports the development of the private sector, both economy-wide and in sectors. This includes analytical work by the Bank and surveys by MPDF, both aimed at identifying economy-wide and sectoral constraints to private sector growth, the development of private-sector projects for funding with support from MPDF, and training of SME managers and bankers. The Bank has provided inputs to the private sector component of the NPEP and plans to hold workshops and surveys of provincial climates for private sector, with a view to developing jointly with Government and the private sector a detailed multi-year strategy for promoting the private sector. The Government plans to establish a private sector forum for conducting regular public-private sector dialogue and MPDF expects to support this effort. The World Bank’s sector programs in education, health and transport are supporting the development of a policy framework supportive of private participation.

Forestry Development. The Government is involved in a continuing process of reforming its forestry sector and improving the implementation of forestry programs and projects. The Bank is cooperating with the Government, including trying to ensure that the Government’s objectives and strategy for forestry are nested within and consistent with the overall National Socio-economic Development Plan, NPEP/PRSP, Rural Development Program, and Agriculture Development Strategy. Through these, the Government is, inter alia, seeking to:

  • Stabilize or increase forest cover and condition;

  • Ensure protection of water resources and critical infrastructure through forest conservation; and,

  • Put forest resources to work directly for the reduction of rural poverty through partnerships with local communities.

The Nam Theun 2 hydro-power Project. This project, involving the construction of a dam to export power to Thailand, constitutes an opportunity to: (i) combat widespread poverty in the Lao PDR through additional revenues gained from electricity exports; (ii) meet Thailand’s energy needs; and (iii) promote sustainable development. The government has asked for World Bank support for this project through an IBRD partial risk guarantee and an IDA environmental and social project.

A World Bank decision on support to the proposed project is linked to: (i) Lao PDR establishing and implementing a viable development policy framework and national programs for poverty reduction and social and environmental protection; (ii) the technical, financial, economic and implementation aspects of the proposed project, as well as the design and implementation of safeguards policies, being sound; (iii) broad support from the international donor community and global and local civil society for Lao PDR’s development framework and the proposed project; and (iv) satisfactory resolution of the shareholding, management and contracting issues resulting from the recent decision of the lead sponsor to withdraw from the project.

The Government and the remaining private sponsors have indicated their intent to seek a new lead private sector sponsor to replace the lead sponsor, Electricité de France (EDF). To this end, the Government has asked the Bank to help provide appropriate advisory assistance which the Bank is in the process of doing.

World Bank Strategy and Lending Operations

Country Assistance Strategy (CAS). The last CAS was presented to the Bank’s Board in April 1999 and the next one is proposed to be presented around the middle of 2004; this timing is aimed at using the NPEP (i.e. full PRSP, to be completed in October 2003) as the basis for the next CAS.

The overarching objectives of the last CAS was poverty reduction, focusing on sustained growth to improve Lao PDR’s social indicators, and graduate from the present rank of Least Developed Countries by the year 2020. The last CAS focused on supporting the stabilization of the economy, to be accomplished in close collaboration with the IMF. This consisted of a lending and non-lending (analytical and advisory assistance) program, with the former amounting to US$111 million of new commitments during July 1, 1999 to June 30, 2003. Since 2001, there has been a jump in the non-lending program for Lao PDR, given the special emphasis given to low income countries facing especially difficult conditions.

Analytical and Advisory Activities (AAA). The current sources of growth in the Lao PDR economy will be examined in a new Country Economic Memorandum (CEM)/Sources of Growth Report, which is expected to be completed by November 2003.

The World Bank’s Main Non-Lending Work

(recently completed and ongoing)

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Lending Operations

As of June 30, 2003, IDA credits totaling about US$687.2 million equivalent had been approved for Lao PDR including support for adjustment operations, rural development, forestry, transport, energy, telecommunications, education, health, industry, and capacity building.

IDA: Commitments and Disbursements to the Lao PDR, 1977–2003

(In millions of U.S. dollars; as of June 30, 2003)

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Source: World Bank, 2003.

In the last three years, lending operations have focused on the above mentioned CAS objectives, with an average commitment of about US$37 million, while disbursements averaged US$34 million. The level and composition of the lending program for the next four years will be determined in the context of the forthcoming CAS, currently scheduled for FY 2004.

ANNEX III Lao P.D.R.—Relations with the Asian Development Bank1

The Asian Development Bank (AsDB) has extended development assistance to Lao P.D.R. since 1970. In the 1970s and 1980s, AsDB assistance was focused mainly on economic growth projects involving infrastructure development in the transport and energy sectors. AsDB has been active in financial sector development since the latter part of the 1980s. Since the early 1990s, the emphasis of AsDB assistance to Lao P.D.R. has been broadened to include rural development, social development and environment. Since the late 1990s, the AsDB has focused its activities on poverty reduction.

AsDB worked with the Government and other stakeholders to formulate its new Country Strategy and Program in 2001 to guide its future operations in Lao P.D.R. for the next five years. The theme of AsDB’s interventions in Lao P.D.R, will be poverty reduction by broadening community participation and opportunities. The core strategies for poverty reduction are; sustainable economic growth, inclusive social development, and good governance. The main strategic focus will be on four operational priorities including rural development and market linkages, human resource development, sustainable environmental management, and financial and private sector development and regional integration. To help achieve the Government’s goal of poverty reduction and sustainable development, a Poverty Reduction Partnership Agreement was signed between the Government and AsDB in September 2001. The Partnership Agreement includes a number of detailed monitoring indicators.

Lao P.D.R. is a key actor in the Greater Mekong Sub-Region (GMS) program as a land-link among the other member countries. The AsDB will aim to explore various options to maximize the benefits to Lao P.D.R. from sub-regional cooperation. To enhance the development impact of projects and ensure their close monitoring, AsDB’s interventions will focus primarily on the poor northern region provinces and along the East-West corridor, which links Thailand to Savannakhet and Vietnam.

Since 1989, the AsDB has approved 43 loans (including five structural and sectoral adjustment loans) for a total of $937.8 million, of which $612.7 million has been disbursed to Lao P.D.R. As of end-June 2003, 22 of these loans are still active. The AsDB also approved 169 technical assistance projects since 1989, for a total of $80.4 million. Of this, $33.0 million were from AsDB, $34.3 million from the Japan Special Fund, and $13.1 million from other sources.

In 2003, the AsDB will approve 2 loans with the planned commitments of $46 million.

Table 1.

Lao P.D.R.: AsDB Commitments and Disbursements, 1998-2003

(In million of US dollars)

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Planned. Figures including GMS sub-regional projects.

Source: Data provided by the Asian Development Bank.

ANNEX IV Lao P.D.R.—Statistical Issues

The overall coverage, quality, and timeliness of macroeconomic statistics in Lao P.D.R. need to be significantly improved for effective monitoring of economic developments, policy formulation, and program compliance. In this regard, a multisector STA mission visited Vientiane during October 2002 in order to facilitate in the preparation of the General Data Dissemination System (GDDS) metadata. It provided key recommendations including in areas where technical assistance and training would be needed. The mission recommended greater coordination between the various agencies responsible for compiling macroeconomic statistics, including through the formation of an inter-agency working group. The authorities indicated the intention to participate in the GDDS, but have not nominated the GDDS coordinator. The authorities also need to finalize the GDDS metadata to formally endorse the strategy for the improvement of statistics.

Economic and financial data are published in periodic reports by the National Statistical Center (NSC) and the Bank of the Lao P.D.R. (BOL). Since 1996, the Lao P.D.R. has been included in the International Financial Statistics (IFS) publication.

National accounts

National accounts statistics consist of annual estimates of GDP by activity at current and constant 1990 prices which broadly follow the System of National Accounts 1968 (1968 SNA). The lack of regular surveys to collect comprehensive data on current economic activities and the use of inadequate compilation methods raise questions about the coverage and reliability of the GDP estimates. The estimates rely heavily on data on quantity of production or quantity indicators collected by line ministries. The Swedish International Development Agency (SIDA) is providing technical assistance to the NSC to compile new series of GDP by activity and by expenditure at current and constant 2002 prices. With SIDA support, the Lao Expenditure and Consumption Survey 2002-2003 (LECS 3) is being conducted which will be finalized by end 2003. Furthermore, the October 2002 multisector STA mission recommended to the authorities to establish a system for collecting data on current economic activities based on regular surveys and to implement compilation methods in accordance with the System of National Accounts 1993 (1993 SNA).

Prices

The NSC compiles a monthly CPI which is available on a timely basis. The latest CPI was introduced in January 2000 (with December 1999 as the reference period) using the results of the 1997/98 Lao Expenditure and Consumption Survey (LECS) for deriving a consumption basket. It comprises nine product categories covering major urban centers, including Vientiane. The NSC plans to revise the weights and review the sample of outlets and products on the basis of the LECS 2002. The NSC is also working on the development of a producer price index (PPI) on a quarterly basis with SIDA’s assistance. The project is planned to be completed by the end of 2003.

Government finance

Government finance statistics are weak and there is scope to significantly improve their accuracy, coverage and transparency. The Budget Department produces monthly, quarterly, and annual revenue and expenditure statistics. Most data are currently recorded on a cash basis. Expenditure data by economic type are compiled by central government and the provinces. Data on bank and nonbank financing of the budget, including treasury bill operations, need to be made consistent with the monetary accounts. The recently introduced social security fund and off-budget activities are not included in fiscal data. Annual budget and outturn data are not disseminated according to an international standard, which complicates fiscal analysis. As last year, in April 2003, the authorities published in the Official Gazette the 2002/03 budget data by central government ministry and province and the 2001/02 outturn, which allows the identification of key spending categories.

Budget planning, execution, reporting, and cash management require significant upgrading, as noted by the October 2002 FAD mission on public expenditure management. Moreover, greater decentralization in 2000/01 further complicated the timely reporting of fiscal data from lower government levels, as monitoring systems are weak and skilled staff limited. This continues to hamper the accurate reporting of various items to the central budget, such as timber related royalty payments.

While the budget data are published in the Official Gazette, no government finance data are presented in IFS country page or the Government Finance Statistics Yearbook. Fund technical assistance on the GFS framework would be valuable.

Central government debt data are compiled by two departments of the MOF; external debt by the External Financial Relations Department and domestic debt by the Budget Department. Debt data are comprehensive and are available by type of debt holder and instrument. Efforts are being made to further improve coverage, particularly relating to SOE debt.

Monetary accounts

The BOL regularly reports its balance sheet (with a 2-week lag) and commercial bank balance sheet (with a 4-week lag) to APD for program monitoring purposes, and to STA for publication in IFS with a lag of between one to two months. Although the authorities have made several improvements in compiling monetary statistics in recent years, the reporting by some banks, especially new branches of foreign banks, continues to be weak. A new chart of accounts for the BOL and commercial banks was introduced in October 1998. Most of the major recommendations made by the 1999 money and banking statistics mission have been implemented. The mission reviewed the new chart of accounts and found them sufficiently detailed to meet internationally accepted standards for the compilation of monetary statistics, but suggested some improvements in their presentation. The 2002 STA mission recommended further improvements in the chart of accounts, and also in the presentation and valuation of monetary data.

A follow-up mission is planned to take place towards the end of 2003. The mission will work to improve institutional coverage and classification of data from the new chart of accounts.

Balance of payments

Data on foreign reserves are reported on a weekly basis, and also derived from the monetary survey at the prevailing kip per U.S. dollar end-month exchange rate.

Balance of payments statistics need significant improvements in the frequency and coverage in the following areas: (1) customs trade data, (2) the commodity composition of external trade, (3) services and income, (4) actual foreign direct investment flows, (5) separation of current and capital transfers as well as coverage of some type of grants, especially from international nongovernment organizations, (6) the reconciliation of fiscal and balance of payments data on external loans and grants, and (7) data quality and monitoring of external debt, especially of state owned enterprises. Since 2001, the MOF has adopted the Commonwealth Secretariat-Debt Recording and Management System (CS-DRMS) for processing and maintaining external debt data.

The introduction of new customs procedures, the Customs 2000 system and equipment, has been implemented (with FAD technical assistance) which started to produce more accurate trade data in October 2000. However, for a range of technical reasons, the customs department has not yet produced these data on a regular basis. The Fund missions have emphasized that this problem needs to be urgently addressed.

In order to produce accurate balance of payments updates on a regular basis, there is an acute need to improve the coordination between the agencies involved in BOP compilation, viz., the BOL, the NSC, the Customs and the External Financial Relations Departments of the MOF, the Department of International Cooperation (DIC) of the Committee of Planning and Cooperation (CPC), and the commercial banks.

Lao P.D.R.: Core Statistical Indicators

(As of August 20, 2003)

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International reserves are available on a bi-weekly basis.

Monthly budget revenue and expenditure generally reported with 3-week lag, but budget financing reported on an irregular basis.

Source A: Central Bank, B: Ministry of Finance, C: National Statistical Center.

Data are directly reported by the authorities via the resident representative’s office (E - electronic . C - facsimile).

All data are eventually published in periodic reports by the BOL and the National Statistical Center. No explicit embargoes apply. These data (except fiscal data) have also been published in International Financial Statistics (IFS) since the April 1996 issue (C - unrestricted use, O - other irregular basis).

ANNEX V Lao P.D.R.: Social and Demographic Indicators

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Source: 2003 World Development Indicators CD-ROM, World Bank.

Includes latest data in the range for 1995–2001.

ATTACHMENT

Lao People’s Democratic Republic Peace Independence Democracy Unity Prosperity

Vientiane, August 28, 2003

Dear Mr. Köhler,

The attached Memorandum of Economic and Financial Policies (MEFP) sets out the objectives and policies of the Government of the Lao People’s Democratic Republic (Lao P.D.R.) to be implemented through March 2004. This latest MEFP continues to build on the policy discussions since the Executive Board of the International Monetary Fund (IMF) approved a three-year arrangement for the Lao P.D.R. under the Poverty Reduction and Growth Facility (PRGF) on April 25, 2001. All performance criteria for September 2002 were met, except the one on contracting or guaranteeing of nonconcessional public sector external debt with a maturity of more than one year, and a waiver is being requested on the basis of the new concessional loan terms. On this basis and the generally satisfactory performance under the PRGF-supported program in 2002-03, we request the completion of the third review and the fourth disbursement under the arrangement.

The Government believes that the policies and measures set forth in the attached MEFP are adequate to achieve the objectives of the reform program supported by the PRGF arrangement, but will take further measures that may be appropriate for this purpose. During the remaining period of the arrangement, the Government of the Lao P.D.R will continue to consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund’s policies on such consultation. The Government will continue to provide the Fund with such information as it requires to assess the Lao P.D.R.’s progress in implementing the economic and financial policies under the program.

As with previous PRGF reviews, the Government agrees to make these PRGF-related understandings public and authorizes the Fund to publish this letter and the attached memorandum, including through the Fund’s external website.

In view of the delay related to the third review, the Government of the Lao P.D.R. hereby requests a one-year extension of the PRGF arrangement through April 24, 2005. The Government also requests that the fourth and fifth reviews be conducted by end-January, 2004 and end-July, 2004, respectively.

Finally, we would wish to assure you that the Government of the Lao P.D.R. is determined to fully implement the PRGF-supported program, and we hope we can count on the continued support of the Fund in our endeavors.

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Memorandum of Economic and Financial Policies of the Government of the Lao People’s Democratic Republic August 28, 2003

I. Introduction

1. The reform program of the Government of the Lao People’s Democratic Republic aims at raising economic growth, promoting broad-based development, and reducing poverty. Our efforts are being supported by an arrangement under the Poverty Reduction and Growth Facility (PRGF), in coordination with complementary programs supported by the World Bank and Asian Development Bank (AsDB). This memorandum reviews the implementation of the PRGF-supported program to June 2003 and lays out the economic and financial policies for the third annual program through March 2004.

II. Performance under the Program

2. Economic performance in 2002/03 is expected to be mixed. Real GDP growth is estimated by the Government to remain at 5.9 percent. It is noted that the IMF staff estimate that growth is likely to decline to 5.3 percent due to the weaker external environment, the slowdown in tourism, reduced credit growth, and lower investment. Inflation, which was 7. percent (year-on-year) in early 2002, rose rapidly to 17 percent in June 2003, reflecting the effects of the depreciation of the nominal exchange rate (14 percent between May and September 2002) and higher oil prices in early 2003. The unfunded budget expenditures in 2001/02 that contributed to the kip depreciation in mid 2002 have been corrected. In particular, since October 2002 firmer financial policies from expenditure and bank credit controls and increases in interest rates have stabilized the exchange rate. Gross international reserves grew to $207 million, 3.7 months of imports, by June 2003.

3. All but one of the end-September 2002 quantitative performance criteria were observed. The performance criterion for contracting and guaranteeing nonconcessional external public debt was exceeded because of a $50 million loan for the Nam Mang 3 hydroelectric project, but in November 2002 the loan was made concessional. Two performance criteria set for end-March 2003, net domestic assets of the BOL and net credit to the government, were breached by modest margins as budget revenue during the first half of 2002/03 remained weak. In response, the Government enacted a fiscal package at end May to bring the fiscal program back on track. For June 2003 all benchmarks were met, except for the ceiling on net bank credit to government (which was exceeded by a small amount) and the contracting of nonconcessional external public debt, the latter on account of the lease by Lao Airlines.

4. In structural areas, the reform of state commercial banks (SCBs) has started. Bank restructuring has begun as evidenced by, among other developments, recent loan recoveries. In November 2002, the AsDB approved the Banking Sector Reform Program Loan (BSRPL) and all four international advisors have begun their assignments and recent loan recoveries indicate significant change in lending behavior. On state-owned enterprise (SOE) reform, the Government has begun technical work on the restructuring strategies and programs for five large SOEs, including Electricité du Laos (EDL), the Phoudoi conglomerate, Pharmaceutical Factory No. 3, and Lao Airlines.

III. Macroeconomic Framework and Policies

5. In line with the Socio-Economic Development Plan for 2002/03 and the plan for 2003/04, we will continue to strengthen macroeconomic stability, reduce inflation to single digits, and maintain relatively stable exchange rates. These policies are aimed at accelerating development, especially rural areas, to promote poverty reduction. Thus, we expect real GDP growth to increase to about 6.2 percent (IMF staff estimate 5.8 percent growth) and inflation (12-month basis) to fall to about 10 percent by September 2003 and to 8 percent by September 2004.

Fiscal policies for 2002/03-2003/04

6. Despite the weakness in revenue, the Government will continue to implement the 2002/03 budget in a way that supports macro stability. Budget revenue for 2002/03 is expected to be about 95 percent of the budget (IMF basis) in nominal terms, but equivalent to 11½ percent of GDP, compared to 13 percent of GDP in 2001/02. In response to the emerging shortfall, the Government introduced a package of revenue and expenditure measures at end-May 2003. This comprised mainly reapplying the tax rates on petroleum as specified in the Tax Law, notably the re-imposition of the 5 percent turnover tax and the excise on petroleum (equivalent to a total of 17 percent ad valorem increase, effectively doubling the tax rate). The overall revenue yield from the package is expected to be KN 81 billion (0.4 percent of GDP) for the remainder of 2002/03; equivalent to KN 226 billion on an annual basis (1.1 percent of GDP). The fiscal measures also include the reduction and postponement of the wage increase (KN 30 billion), and reduced allocations for domestically-financed capital expenditure (at least KN 30 billion). With these measures (and program loans of $17 million), bank financing is expected to be 0.2 percent of GDP.

7. The Government is in the process of clearing domestic arrears of KN 600 billion (3 percent of GDP) that have eroded the health of the banking system. Of the old arrears to contractors that have borrowed from the banks, totaling KN 360 billion, one third is to be paid off by September 2003 through the issuance of government bonds. Budget arrears from enterprise accounts at Treasury, which rose to KN 240 billion by September 2002, are also being cleared, of which KN 130 billion were cleared by end July 2003 through a combination of securities issues and the netting with tax liabilities. Strict expenditure controls have limited new arrears.

8. Looking ahead, the fiscal stance in 2003/04 will reverse the sharp slide in the revenue to GDP ratio while also continuing to limit bank financing. The Government will propose a 2003/04 budget that includes revenue at KN 2,900 billion (12.2 percent of GDP), excluding capital return. This will be achieved by first, maintaining the statutory duty, excise, and turnover tax rates on petroleum as well as the mobile phone excise tax which would increase revenue by 0.6 percent of GDP. The increase in excise on luxury goods, including alcohol and tobacco, is projected to yield 0.1-0.2 percent of GDP. Second, we will issue, in consultation with Fund staff, implementing regulations for Presidential Decree 01 on tax incentives to ensure that budget revenue is safeguarded (a structural benchmark). While we believe that the appropriate regulations can be formulated for this purpose, we would be prepared to revise the decree, if necessary, to safeguard budget revenue. Third, we will not grant tax incentives under Decree 01 or under any other legislation that may come into effect after August 27, 2003 until the fourth PRGF review (a continuous structural performance criterion). Finally, we are introducing a national structure for the treasury and customs departments with field staff in all provinces paid by, and under the control of, the central Ministry of Finance (a structural benchmark), and transferring 20 of the largest enterprises in the provinces to the central large tax payer unit (a structural benchmark). At the same time, we will continue to review the impact of turnover tax reductions on revenue (estimated at 0.2 percent of GDP), investment, and economic activity.

9. Current expenditure will rise by 0.9 percent of GDP. This is mainly due to the wage increase of 30 percent for civil servants at the beginning of the year to offset the significant increases in utility prices. Capital expenditure will be significantly reduced mainly due to the cuts in new domestically financed expenditure, including large projects in the pipeline, while externally financed capital expenditure are expected to remain steady. In addition, the budget will contain KN 194 billion in unallocated expenditures. Taken together with the projected increase in program loans, there will be no bank financing of the budget deficit.

10. To improve public expenditure management, we are implementing the reform plan described in Appendix I covering commitment controls, treasury operations, fiscal reporting, budget planning and execution, and auditing. In particular, we will continue to extend the new accounting system, enabling the introduction of the compilation of expenditure data by administrative unit at the central government level in the 2003/04 budget (structural benchmark). We will also complete a census of arrears as of end September 2003, by March 2004. We plan to seek additional technical assistance from donors to help implement some of these measures.

Monetary and exchange rate policy

11. The BOL will continue its firm monetary policy to reduce inflation. With the increase in foreign financing and the build-up of government deposits at the BOL in the year to March 2004, gross official international reserves will be at 3.7 months of imports. As a result, reserve money is expected to increase by 14 percent during the year through end-March 2004. Reflecting the limited availability of bankable projects, the kip component of reserve money is expected to remain high, but to decline later this year in line with a gradual pick-up in bank credit. While the SCBs will continue to restrain credit and improve credit quality, under the PRGF-supported program, SCB credit will be able to resume to a moderate growth rate of 9.5 percent through end-March 2004. However, actual credit growth will need to be based on a careful assessment of risk, especially for foreign exchange credits. With the resultant inflow of deposits, broad money is expected to grow by about 18 percent in end-March 2004. We will also develop sales of transferable government securities.

12. We will continue to maintain a flexible exchange rate regime and limit the margin between the parallel and bank rates to under 2 percent. The Foreign Exchange Decree Law has been promulgated and implementing regulations are expected to be issued by June 2004.

IV. Key Structural Reforms

13. In order to meet our poverty reduction objectives, we are committed to accelerate the implementation of the structural reform agenda with a view to achieving a higher sustainable growth rate and strengthening public resource management.

Banking sector reform

14. With the support of the AsDB, the World Bank, the European Union, and the IMF, the Government has begun to implement its banking sector reform program to secure operational improvements in the SCBs. These restructuring plans call for significant operational improvements over 3-4 years supported by international bank advisors and monitored in relation to performance targets, with the first test at end-September 2003. With the strengthening of the SCBs, we will aim to seek a strategic investor for one of the two SCBs by 2005.

15. Steady improvements in banking supervision will be made to complement bank restructuring. Given the capacity constraints, we will develop a targeted approach. On-site inspections will focus on the SCBs, especially examining asset quality, including verifying loan classification and adequacy of provisioning, adherence to BOL regulations on large borrower limits, foreign exchange exposure, and monitoring off-balance sheet operations. Completion of on-site inspections of the two SCBs as of September 2003 will be a structural performance criterion for end-November 2003. Off-site supervision is also being developed to help direct on-site inspectors to those areas in individual bank operations that need special attention. As part of strengthening the existing prudential regulations, we will require matured letters of credit to be recorded as credit and provisioned accordingly, and revise BOL Regulation 98 to clarify the terms for the reclassification of restructured loans and to improve reporting and monitoring of open foreign exchange positions.

16. To enhance competition in the banking system, we will equalize minimum capital requirements for banks with domestic and foreign shareholders, and allow foreign bank branches to operate on a nationwide basis. In that connection, the amendments to the Decree Law on Commercial Banks will be submitted to the Standing Committee of the National Assembly by January 2004.

SOE reform

17. Plans for the restructuring of the five large SOEs are under preparation. These plans will be reviewed by the Government and international experts, funded by the World Bank’s capacity building credit, will be assisting in the development and implementation of enterprise-specific restructuring plans. Sales of substantial non-core assets will be included in these plans to help resolve NPLs of SCBs. In addition, price adjustments of key utilities will continue with a view to reaching cost recovery levels within the time frames specified under the World Bank’s Financial Adjustment Credit (FMAC). With regard to Lao Airlines, we expect that the company will cover the costs of its recent three-year lease of an Airbus, contracted without a government guarantee. The Government will not provide any financial support to the company, state bank lending, if any, will be on fully commercial terms, and we will ensure that the company’s operations are consistent with the restructuring plan to be agreed under the FMAC.

External debt

18. We will refrain from contracting and guaranteeing nonconcessional public external debt. Overcoming past deficiencies, we have implemented the remedial measures to strengthen the monitoring and reporting of all public sector external debt, including (i) the revision of the Ministry of Finance Instruction 912 to include both external debt contracted by SOEs with government guarantee, and external debt without government guarantee; and (ii) the provision of a comprehensive report of all public sector external debt, including on all SOE external debt.

19. We have recently reached agreement in principle on our external debt to Russia. After rescheduling on the basis of a 70 percent upfront discount the resulting debt stock will be $387 million, to be repaid over 33 years. Specific repayment terms will be agreed by the end of this year.

Other measures

20. The Government is continuing to develop its National Poverty Eradication Program (NPEP), which would serve as a basis for the Poverty Reduction Strategy Paper. The final document is now expected to be completed by October 2003, for presentation to the Boards of the Fund and the World Bank shortly thereafter.

21. We intend to participate in the IMF’s General Data Dissemination System (GDDS). In preparation for this, we will soon nominate a GDDS coordinator, and are continuing to work on finalizing the metadata. The multisector statistics mission has prepared recommendations and an action plan to overcome weaknesses in macroeconomic statistics, and both are being reviewed and verified.

22. The BOL is implementing the recommendations of the safeguards assessment conducted by IMF staff. In particular, the audit of the BOL’s 2001 accounts was completed at end-August on schedule with the assistance of an international audit firm, and the financial statements were reformulated to bring them closer to international accounting standards (IAS), and published. We have agreed to implement all the high priority recommendations of the on-site assessment. In that connection, the BOL has agreed to close and interactive cooperation with an international audit firm to assist the State Audit Authority (SAA) conduct the audit of the BOL’s 2002 accounts at international standards of auditing (ISA) and for the audit of the 2003 accounts to be conducted jointly with an international audit firm. As a start towards adopting IAS, we will adopt loan provisioning in the BOL’s accounts consistent with BOL Regulation 98, to be phased in over four years starting with the 2003 accounts. Also the monetary data reported to the Fund have been reconciled to the accounting records.

V. Program Monitoring

23. Quantitative performance criteria for end-September 2003 and end-March 2004 on net domestic assets of the BOL and SCBs, net bank credit to government, net international reserves, public external debt, and external arrears (Table 1) will be included in the program. To supplement the quarterly monitoring of the financial program, indicative targets have been introduced complementing the ceiling on net domestic assets of the BOL, for kip-denominated reserve money, and for budget revenue (excluding grants). The structural policy undertakings for the fourth review, to be conducted by end-January 2004 and the fifth review by end-July 2004, are included in Table 2. The fourth review will focus on fiscal performance and the progress on the structural benchmark for the implementation regulations of Presidential Decree 01, as discussed in Para.8.

Table 1.

Lao P.D.R.: Quantitative Performance Criteria and Benchmarks, 2002–March 2004

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Sources: Data provided by the Lao P.D.R. authorities. The full definition of terms is contained in the Technical Memorandum on Program Monitoring (TMPM) (Appendix II).

Performance criteria

Net domestic assets of the BOL are defined as reserve money minus net foreign assets (NFA) of the BOL adjusted for the valuation changes arising from the difference between the program and actual exchange rates.

For purposes of verifying compliance with the program, the ceiling for net domestic assets of the BOL, and net bank credit to the government have been/will be adjusted upward (downward), while the floor on net official international reserves will be adjusted downward (upward) by any shortfall (excess) in external nonproject budget support and, until March 2003, any excess (shortfall) in debt service payments. Net credit to the government will be adjusted upwards for the issue of debt clearance bonds.

Comprising Banque du Commerce Exterieur Lao and Lao Development Bank. Net domestic assets of the SCBs are defined as total deposits of these banks, less net foreign assets, net claims at the BOL, and net claims on government, alt calculated at the program exchange rate. Net domestic assets of the SCBs will be adjusted downwards for the issue of debt clearance bonds.

Indicative target.

Cumulative from the start of the fiscal year (which runs from October to September).

Net official reserves are calculated as net international reserves on a BOP basis less foreign currency component of required reserves. For the program until March 2004, we subtract the foreign currency component of reserve money.

Ceiling applies to debts contracted or guaranteed by the government, public enterprises, or the BOL on nonconcessional terms. Ceilings are flows from March 2003 onwards. Excludes normal import-related credit and any borrowing associated with debt rescheduling. This performance criterion applies to debt as defined in point No. 9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274 (00/85), August 24, 2000). Excludes the three-year lease contracted by Lao Airlines on May 27, 2003, with total monthly lease payments during the three-year period of $3.42 million.

Continuous performance criterion.

Program adjuster until March 2003, excluding IMF.

Foreign exchange component of reserve money for the revised program from March 2003 onwards.

Table 2.

Lao P.D.R.: Key Structural Policy Actions Under the Third Annual PRGF-Supported Program

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Attachments
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APPENDIX I Action Plan for Improving Public Expenditure Management

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APPENDIX II Government of the Lao People’s Democratic Republic Memorandum of Economic and Financial Policies Technical Memorandum on Program Monitoring

1. This Technical Memorandum on Program Monitoring (TMPM) defines the concepts used to determine observance of the quantitative and structural performance criteria and benchmarks, and indicative targets, specified in the Memorandum of Economic and Financial Policies (MEFP) of the Government of the Lao People’s Democratic Republic (Lao P.D.R.), dated August 28, 2003, under the Poverty Reduction and Growth Facility (PRGF) arrangement (Sections I and II), and details the requirements for program monitoring and reporting (Section III).

I. Quantitative Performance Targets1

A. Definitions2

Item 1: Net domestic assets of the Bank of the Lao P.D.R. (NDABOL)

2. Defined as reserve money (RM) minus net foreign assets of the BOL (NFABOL).

  • Reserve money is defined as the sum of notes and coins issued by the BOL, excluding BOL holdings of currency, and deposits of commercial banks and the domestic nongovernmental sectors at the BOL. Reserve money excludes all BOL securities.

  • Net foreign assets of the BOL (NFABOL) are defined as the gross foreign assets of the BOL (GFABOL) less gross official foreign liabilities of the BOL (GOFLBOL). GFABOL include holdings of SDRs by the BOL, the Lao P.D.R.’s reserve position in the Fund, all foreign exchange holdings and foreign assets of the monetary authorities, including official holdings of monetary gold. Foreign exchange holdings of the monetary authorities include claims of the BOL and the Ministry of Finance (MOF) on nonresidents in the form of bank deposits and all foreign government securities, regardless of maturity. Foreign exchange assets of commercial banks held as collateral against BOL credits are not included as gross foreign assets of the BOL. The yen proceeds from the Japanese commodity grants are excluded from gross foreign assets of the BOL and included in other items (net). GOFLBOL comprise foreign liabilities of the BOL with original maturity up to, and including, one year, and the use of Fund resources.

Item 2: Net credit to the government from the banking system (NCG)

3. Defined as claims on the general government by the banking system less deposits of the general government with the banking system. Claims include bank loans and advances to the general government, as well as bank holdings of all government bonds and treasury bills, regardless of maturity, but exclude government lending funds as defined below.

  • Deposits of the general government with the banking system exclude the yen proceeds from the disbursements of the Japanese commodity grants from September 2001.

  • Government lending funds (GLF) of the BOL are defined as the sum of the kip value of long-term foreign liabilities of the BOL (i.e., with original maturities exceeding one year, except liabilities to the IMF) denominated in foreign currencies.

Item 3: Net domestic assets of the state commercial banks (NDASCB)

4. These state commercial banks include Banque pour le Commerce Exterieur Lao (BCEL) and the Lao Development Bank (LDB).3 NDASCB is defined as the sum of deposit liabilities less net foreign assets, net credit to government, and net claims on the BOL.

Item 4: Reserve money (in kip)

5. Reserve money (in kip) is defined as total reserve money (paragraph 2) minus all non government foreign currency deposits held at the BOL.

Item 5: Budget revenue (excluding grants)

6. Budget revenue (excluding grants) is defined as total tax and nontax revenues received by the government within the framework of the state budget, excluding capital return.

Item 6: Net official international reserves (NIRBOL)

7. NIRBOL is defined as “freely available” GFABOL minus GOFLBOL minus the foreign currency component of banks’ required reserves, clearing deposits, and other foreign currency deposits at the BOL. Freely available reserves are defined in the IMF’s Data Template on International Reserves and Foreign Currency Liquidity: Operational Guidelines and comprise of liquid or marketable foreign exchange assets readily available to the BOL (and exclude illiquid foreign assets especially those in nonconvertible currencies). The yen proceeds from the disbursements of the Japanese commodity grants are not included in NIRBOL.

Item 7: Publicly contracted or guaranteed on concessional external debt

8. Ceilings on external debt are calculated as commitments from end-March 2003 onwards, and will be monitored on a continuous basis for the length of the PRGF arrangement. They exclude concessional credits, use of Fund resources, normal trade-related credits, and any borrowing associated with debt rescheduling. For the length of the PRGF arrangement, neither the government, the BOL, nor any other agency acting on behalf of the government will contract or guarantee short-term external loans.

  • This performance criterion applies not only to debt as defined below, but also to commitments contracted or guaranteed for which value has not been received. For the purpose of this memorandum, the term “debt”, as specified in point No.9 of the Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 12274-(00/85), August 24, 2000) will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services at some future point (s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debt can take a number of forms, the primary ones being as follows:

    (i) loans, i.e., advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

    (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and

    (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period (s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of this memorandum, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair, or maintenance of the property.

    Under the definition of debt set out above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

  • Short-term external debt includes all short-term external debt obligations having an original maturity of up to one year, but excludes short-term trade credits.

  • The public sector is defined to include the Government of the Lao P.D.R., the Bank of the Lao P.D.R., state-owned enterprises, or any other agency acting on behalf of the government.

  • Nonconcessional external debt is defined as debt having a grant element of less than 35 percent. The grant element of a debt is determined by comparing the net present value (NPV) of the financing costs and principal repayments with the nominal value of the debt. The NPV of financing costs and principal repayments will be calculated with a discount rate based on the OECD CIRRs (6-month average as of February 15, 2003) for the currency of a debt, plus a margin. For debts with a repayment period of less than 15 years, the discount rate will be equal to the CIRR rate of the previous six months plus a margin of ¾ percent. For debts with maturities of 15 years or more, the discount rate will be equal to the average of the CIRRs for the previous ten years plus a margin that varies according to the maturity of the debt. The margins are 1 percent for debts of 15 to 19 years; 1.15 percent for debts of 20 to 29; and 1¼ percent for debts of 30 years or more.

  • Excluded from this performance criterion is the three-year lease of an Airbus by Lao Airlines, as specified in the contract signed on May 27, 2003, with total monthly lease payments during the three-year period of $3.42 million.

Item 8: External payments arrears

9. Defined as the stock of external arrears on debt contracted or guaranteed by the government or the BOL, except on debt subject to rescheduled or debt forgiveness. For purposes of the program, external payments will be considered as arrears if they are not paid within 30 days of the date they are due. For the length of the PRGF arrangement, neither the government nor the BOL will accumulate new external payments arrears. Overdue debt and debt-service obligations arising in respect of commercial obligations incurred directly, or guaranteed by, the government or the BOL, that are in dispute, will not be considered as external payment arrears for the purposes of program monitoring. As of end-June 2003, there were no external payments arrears.

B. Test Dates

10. Quarterly quantitative targets have been established for items 1 to 6. The quantitative target on item 7 and 8 will be applicable on a continuous basis.

11. Quantitative targets (items 1, 2, 3, 6, 7, and 8) for the test dates of end-September 2003 and end-March 2004 are performance criteria, and the disbursement associated with observance of end-September 2003 performance criteria will also be contingent on the completion of the fourth review. Items 4 and 5 are indicative targets.

C. Program Monitoring Exchange Rates

12. In assessing observance of the program targets, the level of foreign currency assets and liabilities, excluding those denominated in SDRs, will be first converted into U.S. dollars at the test date midpoint market exchange rate. Only assets and liabilities identified as being in foreign currencies in the September 2002 balance sheets of the BOL and commercial banks would be subject to valuation adjustments.

13. For performance criteria and targets specified in kip, the U.S. dollar value of foreign currency assets and liabilities will be converted into kip at the midpoint program exchange rate of KN 10,800 = US$1. SDR assets and liabilities will be valued at a fixed midpoint program exchange rate of SDR1 = US$1.40086. Non-U.S. dollar and non-SDR foreign assets and liabilities will be converted first into U.S. dollars using midpoint market exchange rates prevailing at end-period.

D. Program Adjusters

14. The program ceilings for NCG (and NDASCB) will be adjusted upwards (downwards) by the amount of the issue of debt clearance bonds to settle the stock of outstanding budget arrears prior to 2001/02.

II. Structural Performance Criteria and Benchmarks

15. The on-site inspections and the reports to the BOL Governor are to follow the formats recommended by the IMF banking supervision advisor. The reports, which will be provided to the IMF (excluding customer specific information) would also detail progress made in developing the on-site examination system and the steps being taken to address identified areas of weaknesses.

III. Program Monitoring and Reporting Requirements

16. Data required to monitor performance under the program, including those related to performance criteria and benchmarks, will be provided to the IMF’s Resident Representative and are listed in the table below.

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1

With a fourth disbursement (SDR 4.5 million), Lao P.D.R.’s outstanding use of Fund resources will amount to SDR 29.9 million (56.5 percent of quota) at end-September 2003. Assuming full disbursement under a revised schedule for the PRGF Arrangement (Table 1), Lao P.D.R.’s outstanding use of Fund resources would amount to SDR 34.1 million (64.4 percent of quota) at end-2005 (Table 2).

2

Staff estimate. The authorities estimate real GDP growth to have been about 5.8 percent in each of the past three years. The Lao fiscal year runs October-September.

3

The margin with the parallel market remained below 2 percent, except for a few days when there were particularly large movements in the parallel market.

4

Although the authorities have indicated that measured arrears have declined, there is still uncertainty about this coverage. Another census/survey of arrears will be conducted for end-September 2003.

5

Many borrowers of foreign exchange loans from the SCBs did not have a formal source of foreign exchange. Thus repayments may have required them to obtain foreign exchange from the parallel market.

6

The authorities are projecting real GDP growth of 6.2 percent. The budget projections have factored in a lower growth rate.

7

The budget estimates for project loans show high estimates of disbursements, which seem to be optimistic. Any shortfalls will be offset by reductions in externally financed capital expenditure.

8

These bonds will be used to settle budget obligations to contractors for capital projects with NPLs at the SCBs mainly incurred before 2001.

9

The monetary program through September 2003 is essentially the program agreed in November 2002.

10

The definition of net international reserves for program monitoring purposes (MEFP Table 1) has been revised starting March 2003, with all foreign currency components of reserve money now excluded (previously only required reserves were excluded).

11

The financing gaps in 2003 and 2004 are fully identified: in 2003 comprising $10 million from the AsDB and $6 million under the PRGF; and in 2004, $10 million from the AsDB, $10 million from the World Bank, and $13 million under the PRGF.

12

The Minister of Finance has stated that he did not have knowledge of this lease when he gave assurances to the staff in early June that there was no nonguaranteed SOE debt. These assurances were part of the background information for the Board’s decision on July 9, 2003 to grant a waiver for the noncomplying disbursement as a result of the misreporting of external debt. To improve the monitoring of external debt, the program ceiling on nonconcessional external debt has now been made continuous.

13

The government’s recent plan to clear old arrears to contractors who have NPLs at SCBs differs from the original bank recapitalization plan because it utilizes loan-by-loan resolution of these pre-2000 NPLs (about 75 percent of the total). Other NPLs will be addressed after this process has been worked through.

14

These mass organizations represent women, workers, and youth within the framework of the Lao People’s Revolutionary Party.

1

Prepared by the staff of the World Bank. Contact person: Mr. Alessandro Magnoli, Country Economist, Poverty Reduction and Economic Management Department, East Asia and Pacific Region, phone (202) 473-1653.

2

This is a two-tranche adjustment operation of US$17 million, with the first tranche of US$7 million disbursed in January 2003. The second-tranche release has been delayed and is now expected to be disbursed when all the actions are completed (January 2004).

1

Prepared by the Asian Development Bank.

1

For items 1 to 8 in Table 1.

2

Variables with foreign currency components are to be valued according to Section I.C.

3

Following the merger of the Lane Xang and Lao May banks into LDB all references in Appendix II to Lane Xang Bank and Lao May Bank now apply to LDB.

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Cover IMF Staff Country Reports
Lao People’s Democratic Republic: Third Review under the Poverty Reduction and Growth Facility, and Requests for Waiver of Performance Criterion and Extension of the Arrangement
Author:
International Monetary Fund
Volume/Issue:
Volume 2003: Issue 308
Publisher:
International Monetary Fund
ISBN:
9781451822441
ISSN:
1934-7685
Pages:
79
DOI:
https://doi.org/10.5089/9781451822441.002

CPI and Exchange Rates

(In annual percent change)

Commercial Bank and Parallel Exchange Rates

(Kip/US$)

Revenue and Expenditures

(In percent of GDP)

Budget Deficit

(In percent of GDP)

Credit Developments

(In billions of kip; at constant exchange rates)

International Reserves

(In millions of U.S. dollars)
Figure 1.

Lao P.D.R.: Selected Economic Indicators, 1998-2003