Lao People's Democratic Republic and the IMF
Press Release: IMF Completes Third Review of Lao P.D.R.'s PRGF-Supported Program and Approves US$6 Million Credit
September 15, 2003
Country's Policy Intentions Documents
Free Email Notification
Lao People's Democratic Republic—Letter
of Intent, Memorandum of Economic and Financial Policies, and Technical
Memorandum of Understanding
Mr. Horst 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.DR. 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.
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 11 ½ 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.
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.
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.
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. Quantitative Performance Criteria and Benchmarks,
Table 1. Lao P.D.R.: Quantitative Performance Criteria
Table 2. Lao P.D.R.: Key Structural Policy Actions
Under the Third Annual
Action Plan for Improving Public Expenditure Management
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
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).
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.
Item 3: Net domestic assets of the state commercial banks (NDASCB)
4. These state commercial banks include Banque pour le Commerce Extérieur Lao (BCEL) and the Lao Development Bank (LDB). 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 nonconcessional 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.
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.
1 For items 1 to 8 in Table