News Brief: IMF Gives Final Approval of Second Review of Lao P.D.R.'s PRGF Loan
Lao People's Democratic Republic and the IMF
Country's Policy Intentions Documents
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Lao People's Democratic Republic—
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 economic program to date, and to request the third disbursement following the completion of the second review under the arrangement and the approval of the second annual program.
The attached Memorandum on Economic and Financial Policies (MEFP) supplements the MEFP of February 7, 2002, and sets out the government's objectives and policies to be implemented in the year through March 2003 to build on the progress achieved, and help increase economic growth and further reduce poverty .On the basis of the satisfactory performance under the PRGF-supported program in 2001 and in the first quarter of 2002, we request the completion of the second review under the arrangement, waivers for the nonobservance of one quantitative performance criteria for end-March and one structural performance criterion for end-April.
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 agrees to make these understandings public and authorizes the IMF to publish this letter, the attached memorandum, the PRSP Preparation Status Report, and the related Joint Staff Assessment, including through the IMP'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 endeavours.
July 8, 2002
1. The reform program of the Government of the Lao People's Democratic Republic aims at sustaining economic growth and reducing poverty. Our reform effort is being supported by a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF). This memorandum reviews the implementation of the PRGF-supported program to mid-2002, lays out the economic and financial policies for the remainder of the second-year program through March 2003, and updates the macroeconomic framework for 2002–2004.
II. Performance under the Program
2. Economic developments in 2001 and the first quarter of 2002 have generally been favorable. The Fund staff estimates that real GDP growth weakened only to 5.2 percent in 2001, reflecting renewed business confidence and continued aid flows, generally offsetting weaker regional conditions. Preliminary evidence suggests buoyant economic activity in the first quarter of 2002, with stronger external demand, a pick up in construction activity, and renewed domestic and foreign investment. Inflation on a year-on-year basis has been contained at 6.7 percent, largely owing to the timely implementation of stabilization policies that addressed the inflationary impact of fiscal slippages in 2000/01. Since September 2001, the exchange rate has remained broadly stable against the U.S. dollar. The ongoing reforms of the investment framework, including the streamlining of the approval procedures for foreign investment, have attracted new investment, especially in telecommunications, manufacturing, mining, and aviation.
3. While net credit to the government was under the March 2002 ceiling, revenue performance remains weak and the budget situation fragile. Revenue (excluding grants) for the first half of 2001/021 was only 37 percent of the annual program target, compared to 42 percent last year, largely owing to weaker than expected profit and turnover taxes, timber and hydro-power royalties, and dividends. Current expenditures are broadly in line with seasonal patterns, and the end-March 2002 bank financing ceiling was met by containing domestically financed capital spending to only 27 percent of the program target.
4. Monetary developments through end-March 2002 were generally consistent with the program. The ceiling on the net domestic assets (NDA) of the Bank of the Lao P.D.R. (BOL) was observed, reflecting improved control on budget financing and the sharp reduction in the BOL credit to banks. After being restrained in 2001, the net domestic assets of state-owned commercial bank (SCB) grew substantially- in late 2001 and early 2002, because of an expansion in other items net related to irregular lending, while formal credit grew moderately. As a result, the ceiling on NDA of SCBs for March was not met. Stronger export growth and restrained monetary policy enabled gross international reserves to reach 2½ months of imports of goods and services ($ 141 million), enabling the target for net international reserves to be met.
5. On the structural front, the Government is starting to reform the SCBs. Based on the signed Memoranda of Understandings on Restructuring (MoURs), key financial targets and benchmarks for the SCB's business plans have been elaborated. The structural performance criterion for the banking supervision measures to implement provisioning on new lending was complied with on May 27 after a delay, and the required restating of the SCB's 2001 accounts will be achieved as a prior action for the second review.
6. The program is broadly on track and all quantitative performance criteria for March 2002 were met, except for the NDA of the SCBs (Table 1). The structural conditionality was generally achieved (Table 2) except for the structural performance criterion on bank provisioning (which was implemented with a delay) and the structural benchmark for the development of the public expenditure management reform plan, which has been postponed for the third review (see paragraph 12).
III. Macroeconomic Framework and Policies
7. The Government aims at achieving its target of graduating from least developed country status by 2020 through broad-based reform policies. Under the PRGF-supported program, we will continue to pursue sound macroeconomic policies and give highest priority to strengthening financial management of the public sector, liquidating or privatizing poorly performing SOEs, while promoting private sector development and regional integration. In particular, we will continue to improve the policy environment to increase private foreign and domestic investment, raise productivity in agriculture, and develop further the infrastructure and transport links, especially with neighboring countries. These factors and the Nam Theun 2 (NT2) hydroelectric project are expected to contribute to achieving a real GDP growth rate of 6½ percent in 2004, while keeping inflation at or below 5 percent.
8. The external current account deficit (including official transfers and excluding NT2) is projected to be contained to 2¼ percent of GDP by 2004, and would be covered through prospective bilateral and multilateral support. As a result, we expect to achieve a gross international reserve target of 3½ months of imports of goods and services by 2004.
9. Within this framework, the macroeconomic outlook for 2002 is expected to reflect a pickup in regional activity and investment. Accordingly, real GDP growth in 2002 is projected to increase slightly to about 5½ percent. CPI inflation is expected to decline to 6 percent by end-2002. The current account deficit (including official transfers) is expected to be about 3¼ percent of GDP, due to stronger net exports. Gross official international reserves are expected to reach 2¾ months of imports of goods and services.
10. The Government will ensure that the projected 2001/02 budget deficit of 4¾ percent of GDP (IMF definition, including grants) is not exceeded. To this end, we will take further corrective actions aimed at strengthening revenue collection during the second half of the fiscal year. Accordingly, the Government will: (i) improve revenue collection for indirect taxes, especially by focusing on turnover taxes from large taxpayers in the Large Taxpayers Unit (LTU) and the Vientiane Municipal Office; and (ii) step up efforts to improve the effectiveness of royalty collection, especially from forestry, hydroelectricity, and overflight fees. Notwithstanding these measures, revenue in 2001/02 is likely to fall short of the program target by about 0.6 percent of GDP, owing to lower than programmed profit taxes, timber royalties, and dividends.2 Despite this revenue shortfall, we believe that there will be sufficient revenue to safeguard current spending on social sectors and maintenance, while reducing materials and supplies and other recurrent expenditures by 0.1 percent of GDP. However, the revenue shortfalls will also have to be offset through reductions in domestically-financed capital expenditure by about 0.5 percent of GDP, compared to the program target.
11. For the 2002/03 budget, revenue projections will be set on the basis of the most likely outcome of revenue collections. In the past, systematic shortfalls in revenue have resulted in budgetary overruns with unfunded spending leading to arrears and nonperforming loans in the banks. In addition, we will make revenue administration more efficient and better structured around large taxpayers. In particular, we will: (i) reinforce the central tax department; (ii) reorganize the tax and customs departments on a functional basis; and (iii) integrate an additional large provincial customs office into the national administration. Notwithstanding these efforts, we recognize the need to raise additional revenue from tax policy adjustments and to substantially curtail ad hoc exemptions and rate reductions to maintain future budget outcomes on a sustainable path. Preparations for the introduction of a VAT have begun and will be accelerated in 2002/03, including through continued improvements in administrative systems.
12. The Government is committed to public expenditure management reform. We have requested technical assistance from the IMF to help elaborate a more a detailed reform agenda and implementation timetable, including for strengthening the treasury and budget management systems, linking them to accounting, and building capacity. In addition, we will begin to implement a pilot program to compile education and health expenditures by classifying administrative units covering a significant number of districts, which will be extended in subsequent budgets. Both the detailed reform agenda and the extension of the expenditure classification are structural benchmarks for November 2002.
Monetary and exchange rate policy
13. Monetary policy will continue to be supportive of the Government's objective of reducing inflation. We will achieve that goal through strict control over the net domestic assets of the BOL (NDABOL). Accordingly, BOL financing of the budget over the current fiscal year will continue to be avoided and BOL credit to banks will be reduced further so that overall NDA of the BOL at end September 2002 will be at the same level as at end September 2001. As a result of the anticipated improvement in the external environment, the target for net official international reserves (NIR) has been revised upward for September 2002 to $102 million, corresponding to gross official international reserves of 2½ months of imports, and implying an 11 percent increase in reserve money. Under the policies since end-March 2002, to limit the growth of NPLs, the SCBs are now required to cease increasing their credit and other risk taking activities, given that their NPLs on post 2000 credit are over 15 percent. We will strengthen compliance with this measure, especially by extending BOL control over these risk operations. Accordingly, the NDA of SCBs will stay steady at KN 1,537 billion through September 2002.
14. The Government will continue to pursue a flexible exchange rate policy. Accordingly, the banks' exchange rate will be determined on a daily basis to limit the spread with the parallel market rate to under 2 percent. Macroeconomic policies will be adjusted to offset any sustained weakness in the kip, especially with respect to the currencies of neighboring countries.
IV. Key Structural Reforms
15. The Government has initiated the reform of the SCBs, with support from the World Bank's proposed FMAC, and the AsDB's proposed Financial Sector Program Loan III (FSPL3). The initial phase is to stem the losses of the SCBs, and we will continue to monitor the loan classification and provisioning on the post-2000 loans and require that they be reflected in the SCBs' financial statements. In addition, we will strictly implement the requirement to stop the growth of risk portfolios while their NPL ratios on their post-2000 loans are over 15 percent. It is expected that the clearance of government budget arrears, and the target of NPL resolution of KN 100 billion by March 2003, should substantially reduce the NPL ratios to about 15 percent at least for BCEL and the New Bank.
16. The preparation of the individual SCBs' draft Restructuring and Business Plans (RBPs), including performance targets has been completed. These targets include ceilings on NPLs on loans approved after the start of 2000, recoveries of NPLs, foreign exchange exposures, and capital adequacy ratios (CARs), which, together with qualitative benchmarks, (shown in Appendix I) will serve as a basis for broad-based restructuring operations over the next four years. In addition, agreement on the FSPL3 will trigger the financing for the external bank advisors, which are to be in place by end 2002. The advisors will provide advice on internal bank practices and review all proposed large credit decisions. Satisfactory performance in achieving the operational targets at end 2003, and beyond, will be an important factor in assessing whether or not to strengthen the management role of these advisors.
17. As a result of the recent problems in Lao May Bank, the cost of bank restructuring, originally estimated at $50 million for the cost of addressing the pre-2000 NPLs, has increased by $14 million. To address the problems in Lao May Bank, the worst performing state bank, as a prior action, the Government is developing a plan for upfront restructuring (see Appendix I). This plan basically comprises the centralization of credit decisions at headquarters and limits on new risk activities, including credit and contingent liabilities. We are conscious of the threat of asset stripping in all three SCBs during this phase of bank restructuring and will take strong steps to prevent this, including frequent onsite inspections to check on the quality of the assets, the implementation of which would be a structural performance criterion for November 2002. Should the SCBs' balance sheet and performance deteriorate further in the coming months, the pace of bank restructuring would be increased.
18. Strengthening banking supervision capacity is crucial for developing a sound banking system. The phased implementation of banking supervision will continue, now with the assistance of an advisor from MAE, including through compliance with BOL regulations on loan classifications, provisioning on new loans, loan concentration, and foreign exchange exposure. To promote competition and improve banking services, the Government is considering permitting foreign banks to operate outside Vientiane in 2003. Under this plan the minimum capital requirement for such banks would be gradually raised to $10 million.
19. The restructuring and strengthening of the SCBs is being closely coordinated with the reform of key large SOEs, under the umbrella of the World Bank's FMAC. The SOE component provides for: (i) restructuring of the largest SOE debtors to support the recovery of NPLs by banks (Pharmaceutical Factory No.3; Phoudoi and DAFI conglomerates, including sales of noncore assets; and Lao Aviation, under a management contract with Air France); (ii) enhancing oversight and accountability of SOEs; and (iii) strengthening the finances of key utilities through further tariff increases which have now begun and will continue to achieve cost recovery in 2003 for Nam Papa and Lao Aviation, and slightly later for EDL.
Trade and exchange system reform
20. We are committed to reforming the trade system to assist in the development of the economy. Since October 11, 2001, import and export procedures have been further simplified. Within indicative annual import plans proposed by importers at the start of the year, all goods can be freely imported by making declarations at the customs point, except for six product groups subject to quantitative restrictions (fuel, vehicles, cement, steel bars, sugar, and fertilizer), and those restricted for health and security reasons. Looking ahead, we will remove sugar and fertilizer from the list of controlled goods by end 2002. In addition to the requirements related to our accession to the World Trade Organization (WTO), we will continue to liberalize our trade regime through our commitments under the ASEAN Free Trade Agreement (AFTA).
21. The new Foreign Exchange Decree Law is expected to be passed shortly by the National Assembly. We recognize the advantages to the private sector of an efficient foreign exchange system, and are aiming to have the Decree Law and the implementing regulations maintain our exchange system free of restrictions on current international payments and transfers. To pave the way for accepting the obligations under Article VIII, we will request technical assistance from the IMF to review our exchange system.
External debt management
22. In view of the Lao P.D.R.'s limited debt-servicing capacity, we will maintain a prudent debt management policy. Accordingly, the contracting or guaranteeing of external public sector debt on nonconcessional terms will be sharply limited. Consistent with this policy, we are in the process of negotiating improved concessionality of the borrowing from Exim Bank of China for E.D.L.'s Nam Mang 3 hydroelectric project, and attempting to reduce the project costs and improve environmental and social safeguards. Given that this process is not expected to be completed until after end September 2002, we will examine the consistency of the outcome with the debt policy in the third review of the PRGF arrangement. In addition, we will continue to strengthen the debt management capability of the Ministry of Finance to monitor more closely the contracting or guaranteeing of all public sector external debt. In a renewed attempt to resolve our outstanding debt with the Russian Federation, we have invited a Russian delegation to visit Vientiane in the near future.
23. In addition to reconciling net official international reserves we have begun to address the weaknesses in internal audit and controls systems of the BOL identified in the Stage One Safeguards Assessment Report prepared by the IMF's Treasurers Department (TRE). In April, a high-level review was undertaken as required, based on a report by an expert from the German Bundesbank. The report, which assessed existing controls and recommended specific improvements over the next few months, was forwarded to TRE in June. In the meantime, with the assistance of an international accounting firm, the National Audit Office has begun the audit of the BOL's 2001 accounts in accordance with international auditing standards and will prepare pro-forma statements in accordance with international accounting standards. The results will be available by end-August (structural benchmark) and published by end-September.
Poverty reduction strategy
24. Preparations of the PRSP are advancing, as described in the PRSP Preparation Status Report. To foster the participatory process, the Government held a workshop on the PRSP process in April 2002, which included government officials from line ministries and members of mass organizations. The outcome of these discussions will help in the preparation of the Government's National Poverty Eradication Plan (NPEP), which will be fully consistent with the requirements of the PRSP. However, significant technical and resource constraints prevent us from completing the PRSP by end August 2002 and we are now aiming to finalize our NPEP by early 2003.
Transparency and statistics
25. The Government will reinforce policies aimed at widening transparency by stepping up efforts to upgrade the quality of economic and social statistics and broadening their dissemination. In line with past commitments, we intend to consent to the publication and the posting of all IMF Board documents pertaining to the second PRGF review and the PRSP Preparation Status Report on the IMF's website. A key priority is to compile budget data in accordance with GFS standards and to release comprehensive budget data in a timely manner and an informative format, including for lower levels of government. The Government will review prospects for participating in the IMF's General Data Dissemination System (GDDS) as a means of enhancing statistical development, based on the recommendations of the IMF's Statistics Department multitopic mission scheduled for October 2002.
V. Program Monitoring
26. The Government will achieve the quantitative performance criteria and benchmarks for the period to March 2003 as shown in Table 1. Prior actions for the second PRGF review, and structural performance criteria and benchmarks for the same period are described in Table 3. In view of the inclusion of SOE tariff adjustments in the FMAC, the corresponding performance criterion in the PRGF arrangement for October 2002 will be removed. The third review under the PRGF arrangement is expected to be completed by January 2003. It will focus primarily on: (i) the 2001/02 budget implementation and the 2002/03 budget outlook and the implementation of appropriate revenue measures; (ii) the implementation of key measures consistent with the overall plan to improve public expenditure management; (iii) progress in reducing the stock of budget arrears and the avoidance of new arrears, (iv) progress in implementing SCB and SOE reforms, including the issue of foreign banks operating outside Vientiane in 2003, and (v) the nonconcessional external borrowing for the Nam Mang 3 project.
1The fiscal year runs October–September.
2The revenue to GDP ratio is also lower than the program by 0.2 percent because of the recent revisions to nominal GDP.
Lao P.D.R.: Key Elements of the Bank Restructuring and Business Plans
The banking sector is mainly comprised of the SCBs which are deeply insolvent. In the recent past, the SCBs have experienced rising NPLs and foreign exchange exposures accompanied by falling profitability and capital asset ratios. Onsite inspections on SCB's classification and provisioning revealed NPLs on new lending (since January 1, 2000) at end 2001 of 20–25 percent for Banque pour le Commerce Exterieur du Laos (BCEL) and Lang Xang Bank (LXB), and 70 percent for Lao May Bank (LMB), compared to the notional limit of 15 percent. Preliminary investigation suggests that this weak performance reflects: inadequate credit analysis and monitoring, inappropriate rollovers of pre-2000 loans, and continued lags in the payment of government arrears to contractors.
In order to address these problems Memoranda of Understanding for Restructuring (MOURs) were signed by the three SCBs and the Bank of Lao PDR in late March 2002.
To operationalize these MOURs, the draft restructuring and business plans (RBPs) have recently been prepared with technical assistance from the AsDB which outline medium term plans for improving performance. The main elements are as follows:
Major near-term milestones for both BCEL and the New Bank are:
The banks will be subject to half-yearly performance monitoring. In the first year, this would comprise quantitative benchmarks for flow NPLs and foreign exchange exposure (indicative values are in the attached tables which will be refined later in 2002) and the implementation of operational measures.
Government of the Lao People's Democratic
|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.|
|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.|