Lao People's Democratic Republic and the IMF
News Brief: IMF Completes First Review of Lao P.D.R.'s PRGF Program and Approves US$5.6 Million Credit
Country's Policy Intentions Documents
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Lao People's Democratic Republic—Letter of Intent
Dear Mr. Köhler,
On April 25, 2001, the Executive Board of the International Monetary Fund (IMF) approved a three-year arrangement for the Lao People's Democratic Republic (Lao P.D.R.) under the Poverty Reduction and Growth Facility (PRGF). The purpose of this letter is to inform you on the progress achieved in implementing the first-year economic program, and to request the second disbursement following the completion of the first review under the arrangement.
The attached Memorandum on Economic and Financial Policies (MEFP) supplements the MEFP of March 26, 2001, and sets out the government's objectives and policies to be implemented in the year through September 2002 to build on the progress achieved, and help increase economic growth and further reduce poverty. On the basis of the generally satisfactory performance under the PRGF-supported program in 2001 we request the completion of the first review under the arrangement, waivers for the nonobservance of three quantitative performance criteria for end-June and one structural performance criterion for end-September, and modification of one structural performance criterion for end-March 2002.
The government believes that the policies and measures set forth in the MEFP are adequate to achieve the objectives of the reform program supported by the PRGF arrangement, but will take further measures if deemed necessary. During the remaining period of the arrangement, the Lao P.D.R. will continue to consult with the Managing Director on the adoption of measures that may be appropriate, at the initiative of the government or whenever the Managing Director requests such a consultation. The government will continue to provide the IMF 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.
The government intends to make these understandings public and authorizes the IMF to publish this letter and the attached memorandum, including through the IMF's external website. A decision on the publication of the staff report will be made by the time of the Executive Board meeting.
We can assure you that the government of the Lao P.D.R. is determined to fully implement the program, and we hope we can count on the continued support of the IMF in our endeavors.
Supplementary Memorandum on Economic and Financial Policies of the Government of the Lao People's Democratic Republic
February 7, 2002
1. The Government of the Lao People's Democratic Republic's plan of economic reform and poverty reduction is being supported by a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF). Consistent with the goals set out in our Memorandum on Economic and Financial Policies (MEFP) dated March 26, 2001, this supplementary memorandum reviews the implementation in the first program year 2001 and sets out our policies for the fiscal year ending September 2002.
II. Performance Under the Program
2. Despite the slowdown in the regional economies during 2001, the performance of the Lao economy was satisfactory. For 2000/01, the Government estimates real GDP growth to have been as planned, at 6.4 percent.1 However, the IMF staff estimate a lower growth rate of about 5.2 percent for the calendar year 2001, because of slower export growth and the weaker external environment. Inflation has remained subdued, in line with the program, at about 7.5 percent at end-2001 despite the depreciation of the kip.
3. While macroeconomic outcomes have generally been in line with the program, fiscal slippage emerged because of implementation problems with the decentralization initiative, administrative weaknesses, and slower growth from the downturn in the external environment. Total revenue for 2000/01 was 13.5 percent of GDP, compared to 13.9 percent of GDP under the program, with weaker performance in direct and turnover taxes and import duties. Although current expenditures were restrained in response to the revenue shortfall, this was offset by extra investment spending of provinces taking advantage of the decentralization initiative. With lower than expected assets sales and sales of government securities, domestic bank financing of the budget was KN 150 billion more than targeted in June 2001. This underperformance in bank financing continued through September 2001, widening to KN 246 billion, 1.7 percent of GDP. Since then, significant actions were taken to strengthen the fiscal position, including through quick tax audits and tighter controls on expenditures and government bank accounts.
4. Monetary policy has been successful at reducing inflation. Despite the large amount of financing for the budget, the BOL limited the excessive increase in the net domestic assets of the BOL (NDABOL) to KN 46 billion as of June 2001, only one third of the fiscal slippage. In the September quarter, the BOL issued additional securities to further limit the monetary impact of the budget slippage, in advance of more sustained fiscal measures.
5. State commercial bank (SCB) credit growth was in line with the program through June 2001. Subsequently, SCB credit increased substantially, by $24 million, on account of the loan for the Lao Brewery share purchase. These shares were resold to a foreign investor in January 2002 and the loan will be repaid shortly thereafter. Excluding this loan, the increase in credit of the SCBs, as measured by their net domestic assets, was only 1.7 percent in the year to December 2001.
6. The underlying change in net international reserves (NIR) has been consistent with the program. However, for technical reasons the base level of NIR in the program was overstated by about $12 million due to the inclusion of funds which are not freely available; thus the June 2001 level of reserves was about $11 million below the target. At end-December 2001 reserve coverage was 2.4 months of imports.
7. Progress has been generally steady on structural reforms:
III. Macroeconomic Framework and Policies October 2001–September 2002
8. We remain committed to the strategy of the PRGF-supported program, for promoting growth with equity through macroeconomic stabilization, economic reform, and integration into the regional economies. The National Assembly approved the National Socio-Economic Development Plan (NSEDP) for 2001/02 with a target for real growth in the range of 6–6½ percent. The Government acknowledges that Fund staff currently projects real GDP growth at about 5 percent, owing to a more fragile external environment, providing a prudent basis for the financial program. Inflation should be reduced to 6 percent by September 2002. The current account deficit is anticipated to remain manageable at 4½ percent of GDP (including grants), as weaker export prospects are offset by reduced import demand. By creating a favorable environment for investment, and with an anticipated recovery in external demand by 2003, medium-term growth in real GDP would be at least 6 percent, inflation would be reduced to about 5 percent, and gross official reserves should reach three months of import coverage.
9. The government will improve fiscal discipline in the 2001/02 budget after the weaker-than-expected performance in 2000/01. The overall deficit in the program is targeted to remain at about 5 percent of GDP and would be financed largely through concessional external loans with only limited recourse to domestic bank financing (0.3 percent of GDP).2 As outlined in the NSEDP for 2001/02 we are aiming at a significant increase in revenue collections. For the purposes of the program a conservative estimate of a ½ percent of GDP increase in revenue is projected, given the uncertainty about the economic environment and the effect of administrative measures. To make progress towards meeting the goals in our National Poverty Reduction Program (NPRP) current expenditures for social sector and human resource development will increase substantially, but cutbacks in capital expenditures will keep the ratio of total expenditure to GDP broadly constant. If revenue falls below program expectations we will take offsetting action through restraint on domestically funded capital expenditures, while protecting operations and maintenance, local counterpart funds, and key social sector spending.
10. The revenue target for 2001/02 will be mainly achieved by a further strengthening of tax administration and compliance. The key revenue measures in the 2001/02 budget include: adjusting the customs valuation exchange rate monthly to 100 percent of the bank exchange rate, and implementing the amendments to the Tax Law to improve compliance. In addition, we are committed to significant improvements in tax and customs administration through (i) strengthening the implementation of the national network of Customs and Taxation Departments and (ii) strengthening the capacity of four key provincial tax offices, initially focusing on Vientiane Prefecture, to assess and collect taxes from large taxpayers. We have also made customs duties a fully national tax to strengthen the own resource base of the central government and we are considering merging customs staff in the Vientiane Prefecture with headquarters staff, as a first step in developing a national customs administration. To further strengthen the tax base we are tentatively planning to introduce a VAT in 2003/04 and have established a VAT implementation committee and started drafting the legal framework to meet this goal.
11. Overall expenditure will be restrained to 22 percent of GDP, with increased allocations for the social sectors and operations and maintenance. Basic civil servant wages were increased by 25 percent from the start of 2002 to continue the process of compensating for past inflation. The budget makes provision for at least 1 percent of GDP for clearing capital and 0.7 percent of GDP for current arrears. The reintroduction of effective commitment controls, for quarterly salary and provincial recurrent expenditures and case-by-case for large capital expenditures, will contribute to avoiding the accumulation of new arrears. Provincial government and line ministry bank accounts are being streamlined. To more closely monitor budget implementation under the program, the fiscal accounts will be regularly reconciled with the banking data.
12. The government will take decisive steps to improve public expenditure management. As identified in the Public Expenditure Review (PER), improvements are needed to strengthen macroeconomic stability, provide more effective cash management and treasury operations, and upgrade the information base for budget planning, execution, accountability, and transparency. By March 2002 we will develop an improved budget nomenclature and a unified chart of accounts that identifies expenditures by ministry/province and sector, for introduction in the 2002/03 budget. The 2001/02 budget, covering central government line ministries and provinces, and the outturn for 2000/01, will be published in February, and full details of the budget, covering expenditures classified by ministry/province and sector will be published in the Official Gazette by March 2002. In addition, by April 2002 we will agree with Fund staff on a comprehensive medium-term action plan for public expenditure management improvements for implementation in the remainder of the PRGF arrangement. This would include the identification of plans and timeframe to classify current and capital expenditures by program within each sector. As a prelude to move the presentation of the fiscal accounts to an internationally standard basis, the government will request technical assistance from the Fund's Statistics Department.
Monetary and exchange rate policy
13. Monetary policy will continue to be oriented towards restraining inflation while permitting prudent lending by commercial banks. With the sharp reduction in the bank financing requirement of the budget, additional sales of treasury bills (with greater flexibility in treasury bill yields), and the closer monitoring of the central government's fiscal position, the need for BOL financing of the budget will be eliminated. In addition, the BOL will continue to reduce its credit to banks so as to keep the BOL's net domestic assets broadly constant (including the proceeds from the disbursement of external concessional loans).
14. To support economic growth while limiting the additional risks to SCB portfolios, SCB credit growth in 2001/02 will be limited to 16 percent while total commercial bank credit would be permitted to grow by 18 percent (excluding the credit for the Lao Brewery share purchase, which will be fully repaid in early 2002). Although explicit ceilings will limit SCB credit growth, the more effective implementation of prudential measures will reduce the demand for credit. If the nonperforming loans (NPLs) of any of the SCBs on the post-2000 loans exceed 15 percent, the level of their total credit will be frozen.
15. The BOL will continue to manage the exchange rate flexibly, permitting the banks' exchange rate to adjust so as to maintain the margin with the parallel market rate at less than 2 percent and avoid multiple exchange rates. The government and the BOL will adjust macroeconomic policies to correct any persistent weakness in the kip especially with respect to the currencies of neighboring countries. We will also continue to improve the functioning of the interbank foreign exchange market.
IV. Key Structural Reforms
16. We will continue to deepen the implementation of the structural reforms to establish a sustainable higher growth rate and to manage public resources more effectively for poverty reduction.
17. The MOF, BOL, and the SCBs have developed individual restructuring plans. These have been prepared in the form of Memoranda of Understanding on Restructuring and cover the main policy commitments, and are consistent with principles indicated in Appendix I of the MEFP of March 26, 2001.
18. The main elements are:
19. Enterprise policies remain aimed at protecting macroeconomic stability and supporting bank restructuring, while also laying the foundation for a more efficient sector to support faster economic growth. In conjunction with the World Bank, we will begin the restructuring process of five large SOEs, three are large defaulting borrowers, the Phoudoi conglomerate, Nam Papa (Water) and Lao Aviation, one large loss maker, Pharmaceutical Factory #3, and EDL, a main revenue earner. Drafting of the restructuring plans of an additional 5 large defaulters will start by October 2002.
20. In addition, we are strengthening the financial position of the large SOEs by adjusting prices, many of which have lagged behind inflation. Water prices were adjusted in April and November last year, by an average of about 100 percent, to provide the resources for more effective maintenance, and further adjustments will be considered in June 2002. Electricity prices were adjusted by 3–3½ percent per month through end-2001. A recent study on electricity prices is being reviewed by Government and a decision on the path of future price adjustments required to achieve cost recovery in 2002 is expected in April. In the case of Lao Aviation, prices were raised in July 2001, and will be raised again in April this year, but further adjustments will be required to enable the airline to achieve commercial viability and cost recovery. World Bank technical assistance is being considered to conduct a study on the airline's fare structure, and by March, we expect to be able to establish a revised timeline for fare adjustments to reach a cost-recovery level by October 2002.
21. To promote private sector development, we are currently streamlining administrative procedures for foreign investment, including through the single window approach. In addition, we are working with the AsDB and the World Bank to develop a more comprehensive approach in this area.
22. We acknowledge that the Stage One safeguard assessment by the Fund found that the BOL has a high risk in all five of the vulnerabilities in the assessment. To address these concerns we will fully implement the recommendations of the IMF Safeguards Report. In particular, we will:
Poverty reduction strategy
23. The Government of the Lao P.D.R. is planning to finalize its NPRP by August 2002. The NPRP will be fully consistent with the requirements of the PRSP and builds on the interim PRSP (I-PRSP) published in April 2001, and the Participatory Poverty Assessment published in June 2001. Importantly, the elaboration of our NPRP will be both nationally owned and participatory, involving all segments of society, including the Lao Women's Union, the Lao Youth Organization, the Trade Union Federation, and the Lao Front for Reconstruction, and, most importantly, the poor themselves.
24. We are also expeditiously putting in place the informational and analytical basis for the full PRSP, through;
25. In view of the Lao P.D.R.'s vulnerable external position, we will limit the contracting or guaranteeing of new nonconcessional external debt. In addition, we will continue to upgrade the monitoring of our external debt through the External Debt Monitoring Unit in the Ministry of Finance. The negotiations with the Russian Federation are ongoing, and another round of negotiations is planned in 2002.
26. The government will undertake a number of prior actions ahead of the IMF Executive Board consideration of the first PRGF review, in order to keep the program on a solid footing (Table 6). Table 5 contains quantitative performance criteria for end-March and end-September 2002 and quantitative benchmarks for end-June 2002; structural policy undertakings are summarized in Table 7. The second review under the PRGF arrangement, which we are aiming to complete by June 2002, will focus on the economic program for the remainder of 2001/02, including adjustments to fiscal policy required in the mid-year budget review in March 2002, and the development of plans for reforms to the SCBs, SOEs, taxation, and public expenditure management, for the remainder of the PRGF period.
27. To help strengthen program implementation, technical assistance will continue to be sought from the IMF in bank supervision, tax policy and administration, and national accounts and government finance statistics.
Table 1. Summary Macroeconomic Framework 1998–2004
1The fiscal year runs October through September. The government is considering requesting technical assistance from the Fund to improve the compilation of the GDP estimates.
2IMF definitions and GDP estimates.
Main Elements of State Commercial Bank Restructuring
The state commercial banks need to be restructured in order to create robust banking institutions. With the technical assistance of the Asian Development Bank and the World Bank, the government has adopted the Memoranda of Understanding for Restructuring (MoURs) that set out the main elements of the restructuring program. To ensure credit discipline and to move the banks to a more sustainable direction, comprehensive operational restructuring and financial recapitalization will be phased in during the period 2002–05. This support will be conditional on performance improvements, which will be closely monitored.
Government of the Lao People's Democratic Republic
|Monetary data (to be provided by BOL)|
|A report on loans, deposits, reserves at the BOL, and excess reserves of BCEL, LXB, and LMB; and the outstanding stock of BOL and Treasury securities, and the gross official reserve assets and liabilities of the BOL.||Weekly within one week of the end of each week.|
|The balance sheet of the BOL.||Monthly within two weeks of the end of each month.|
|The breakdown of NIRBOL in U.S. dollars (including the currency composition of foreign exchange holdings), GOFLBOL, and GLF.|
|The monetary survey, the consolidated balance sheet of the commercial banks, and the individual balance sheets of the three SCBs. Each of the three SCBs will also report all off-balance sheet obligations.||Monthly within four weeks of the end of each month.|
|Amount of bills offered by BOL in the central bank bills auction, amount sold to each bank, and the average yield in percent per month.|
|A report on the largest borrowers, in terms of credit outstanding, from the state commercial banks (5 largest for LXB and LMB, and 20 largest for BCEL) showing total amount of credit in original currency and credit risk rating.||Quarterly within four weeks of the end of each quarter.|
|Fiscal data (to be provided by MOF)|
|The consolidated accounts of the general government, including detailed data on tax and nontax revenues, current and capital expenditures, and net lending, reconciled with financing data. Financing components should be separated into foreign sources (grants, program and project loans), domestic sources (bank and nonbank), and receipts from asset sales.||Quarterly within four weeks of the end of each quarter.|
|External sector data (to be provided by MOF)|
|Commitments (with information on the terms), disbursements, stocks and debt service payments (principal and interest separately) on external debt contracted or guaranteed by the government, state-owned enterprises, or the BOL, in U.S. dollars, by creditor.||Quarterly within four weeks of the end of each quarter.|
|Stock of external payments arrears.|
|Total export and total import values in U.S. dollars, along with available commodity breakdown.|
|Other data (to be provided by NSC)|
|Overall consumer price index and a detailed breakdown by major categories of goods and services included in the consumer basket.||Monthly within two weeks of the end of each month.|