Public Information Notice: IMF Concludes Article IV Consultation with Lao P.D.R.
December 2, 1999
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On November 22, 1999, the Executive Board concluded the Article IV consultation with Lao P.D.R.1
The Lao P.D.R. embarked upon major reforms in 1989 supported by the International Monetary Fund (IMF). As a result, real GDP growth averaged 7 percent through the mid-1990s and inflation was kept low. Other market-oriented economic reforms included an overhaul of the tax system, and the introduction of a two-tier banking system and an external trade regime with relatively low tariffs. In addition, the authorities privatized many state enterprises.
However, in recent years macroeconomic conditions have deteriorated. GDP growth in 1998 slowed to 4 percent, due to unstable macroeconomic conditions exacerbated by the effects of the Asian crisis. The domestic currency, the kip, depreciated by almost 90 percent against the U.S. dollar since mid-1997. Inflation rose sharply in 1998 and reached a peak of 167 percent (on a 12-month basis) in March 1999. This resulted from the central bank financing large fiscal deficits in 1997 and 1998. The fiscal deficit (including grants) widened to 10 percent of GDP in 1998. Foreign investment inflows fell to about $60 million a year in 1998 and 1999 from $104 million in 1997 (6 percent of GDP) reflecting delayed hydropower investments as a result of the economic crisis in Thailand. With lower imports, and aided by higher power exports from a newly completed plant, the external current account deficit (excluding official transfers) is estimated to have declined to 11 percent of GDP in 1998 from 16 percent in 1997. Gross official reserves fell to 2.1 months of imports at end-1998 from 2.7 months at end-1997 and have largely remained constant since.
Periodic attempts at macroeconomic policy tightening were made in late 1998 and early 1999 but failed to contain credit expansion. In the second half of the year, more determined tightening was implemented, and as a result the depreciation of the kip was halted and price increases started to slow. However, because of high inflation seen earlier in the year, end-year inflation is projected to decline only to about 100 percent. Broad money is expected to grow by 133 percent this year. GDP growth is projected to remain at 4 percent. In addition, progress on structural reforms has remained slow, and largely limited to a merger of state-owned commercial banks leaving most of the urgently needed banking reforms to future efforts. Furthermore, the use of administrative restrictions has become more pervasive in external trade, and foreign exchange shortages continue at commercial banks.
Executive Board Assessment
Executive Directors acknowledged the extent of reform that the Lao economy had undergone over the past decade, as well as the difficulty of the challenges that lay ahead. Nevertheless, Directors expressed serious concern over the deterioration in macroeconomic performance in 1998 and early 1999. Weak fiscal management and substantial central bank financing had resulted in triple-digit inflation, a sharp depreciation of the exchange rate, and a further weakening of the banking system.
While noting the impact of the regional crisis on the economy, Directors regretted that the efforts to tighten policies since late 1998 had not been sustained or effective in stabilizing the economy. They therefore urged the authorities to decisively implement and sustain tight fiscal and monetary policies, and to vigorously implement structural reforms, particularly to improve the operation of the banking system, so as to foster an environment conducive to private sector-led growth.
Directors considered that weak fiscal policies and the consequent central bank financing of budget deficits had been the primary cause of macroeconomic instability. They stressed that improving the revenue mobilization effort is critical to strengthening the fiscal position, and that the expenditure compression of the recent past is unsustainable. Regarding the method of revenue mobilization, Directors emphasized the urgent need to adopt immediately a market-based exchange rate for customs valuation, and to improve tax administration, in particular through the full utilization of the large taxpayer unit and through addressing the need for more effective revenue collection at the provincial level.
On expenditure, Directors noted the need to prioritize public investment expenditure in line with the recommendations of the public expenditure review by the World Bank. They considered it vital to maintain adequate expenditure on the social sectors and infrastructure maintenance as well as to prevent an excessive decline in public sector wages.
Directors observed that rapid credit growth associated with the weak fiscal situation had resulted in sharp price increases and depreciation of the currency. They welcomed the efforts, started in mid-1999, to contain central bank credit, and urged the authorities to maintain tight policies to further reduce inflation and restore confidence in the domestic currency. They considered that the restoration of positive real interest rates was essential in that connection. Noting the weaknesses in the functioning of the foreign exchange market, Directors encouraged the authorities to move to an interbank system in which the exchange rate is determined by market forces.
Directors stressed the critical need to revive structural reforms after a two year hiatus, but were encouraged by the authorities' commitment to implement the necessary reforms. In particular, Directors emphasized that a well-functioning banking system was vital for medium-term growth, and urged the authorities to strengthen banking supervision and to improve management and operations of the state-owned commercial banks. Directors also underscored the need for strengthened efforts to address the problems of state-owned enterprises (SOEs) and encouraged the authorities to work closely with Fund and Bank staff to assess recent SOE performance and reinvigorate the privatization process. Directors called for further trade liberalization, with early elimination of informal discretionary trade restrictions, and a lowering of import tariff rates taking into account possible adverse revenue implications.
Directors noted the critical importance of improving the legal framework, coupled with strengthened enforcement, with emphasis on greater openness and transparency, to encourage private sector development. They stressed that these actions are particularly necessary in view of the recent decline in regional demand for energy exports and the need to create an attractive environment for foreign and domestic investment.
Directors emphasized that significant progress in restoring economic stability and reviving key structural reforms would establish the basis for initiating discussions on a program that could be supported by a Poverty Reduction and Growth Facility (PRGF) arrangement, and hoped that it would be possible for such discussions to start reasonably soon. Directors stressed the desirability of resolving outstanding issues with external creditors.
Directors regretted that there are continued shortcomings in statistical data which hamper effective surveillance and complicate the design of a potential Fund-supported program. They strongly urged the authorities to address these problems, and disseminate key data on a timely basis.