Press Release No. 15/78

Press Release: IMF Executive Board Concludes Article IV Consultation with Lao People’s Democratic Republic

February 26, 2015

On January 14, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Lao People’s Democratic Republic.

Real GDP growth is expected to moderate from 8 percent in 2013 to 7½ percent in 2014. Domestic activity has slowed, and credit growth has declined from excessive levels. Inflation has declined to 3 percent from 6½ percent at end-2013, largely due to weaker food and fuel price momentum. However, the current account deficit is expected to remain large at 25 percent of GDP in 2014; and, at 1 month of prospective imports of goods and services, international reserves (US$0.7 billion, August 2014) do not offer adequate protection against external shocks. Bank balance sheets are showing signs of weakness, with rising nonperforming loans (NPL) and weaker capital and profitability. Public and publicly guaranteed debt (excluding arrears) is projected at 60 percent of GDP in nominal terms (52 percent of GDP in present value terms) in 2014.

As growth continues to moderate in the near term, inflation is projected to remain in the mid-single digits. The current account deficit is projected to improve to about 21 percent of GDP in 2015, but with lower capital inflows, reserves would rise only slightly to 1¼ months of imports. Risks are on the downside. A more expansionary fiscal stance would worsen the external position. The economy is also exposed to external shocks, notably a regional growth slowdown and a deterioration in terms-of-trade and capital inflows. With a thin reserves cushion, these shocks could force large movements in the exchange rate, leading to debt defaults, and undermining growth, financial stability, and fiscal sustainability.

Following a sharply expansionary and procyclical stance in 2013, the authorities started to tighten fiscal policy in 2014, mainly through curbs on civil service compensation and capital spending cuts. Public investment cuts have helped limit the Bank of Lao P.D.R.’s quasi-fiscal lending and lower private credit growth. Strict enforcement of regulation on banks’ net open foreign exchange positions and the limits on foreign-currency lending has helped reduce foreign-currency liquidity risk at banks. However, excess kip liquidity in the banking system has risen, and greater exchange rate flexibility, observed in the second half of 2013, has not resumed.

After years of rapid credit growth, financial stability concerns are coming to the fore. Accumulation of public investment arrears has led to losses in the business sector, with impact on banks. The system’s nonperforming loan ratio (NPL) is estimated to have doubled during the first half of 2014. In the same period, state-owned banks’ average NPL is reported to have increased from 2 percent to about 8 percent, with average capital-to-asset ratio declining to 3 percent. Direct exposure to foreign currency through lending and deposits remain high, with the foreign-currency shares in total lending and deposits standing at 48 percent, down from 50 percent in 2013.

Executive Board Assessment²

The Executive Directors welcomed policy corrections initiated by the Lao P.D.R. authorities and the progress made in macroeconomic stabilization in the past year. Directors nevertheless noted that the economic outlook remains clouded by significant vulnerabilities in the external, fiscal, and financial sectors. A regional growth slowdown, deterioration in global metal prices, and capital flow volatility continue to pose external risks. To address these vulnerabilities, Directors emphasized the need for continued fiscal consolidation, greater exchange rate flexibility, tighter monetary conditions, strengthened financial supervision, and improved bank resolution and crisis prevention frameworks.

Directors considered that a more ambitious medium-term fiscal consolidation anchored around a nonmining deficit target of no more than 5 percent of GDP would help strengthen the external position and reduce public debt. While welcoming recent progress in fiscal consolidation, Directors stressed the need to ensure steady consolidation into the medium term and create space for well-targeted social and capital spending and possible banking sector contingent liabilities. In this regard, they recommended further revenue mobilization, the rationalization of current and off-budget capital expenditures, and containing public sector employee compensation, including by accelerating civil service reform. Directors also encouraged enhanced fiscal transparency and strengthened public financial management, including the elimination of fiscal arrears.

Directors recommended letting the exchange rate move more flexibly within the official band, supported by the tightening of kip liquidity, with interventions limited to preventing excessive exchange rate volatility. They noted that this approach would avoid a potentially destabilizing devaluation, given the risk from currency mismatches; help contain inflation; and support interbank market functioning.

Directors welcomed measures to improve foreign currency liquidity at banks, but noted increasing financial stability concerns from growing credit impairment and undercapitalization at state-owned banks. They recommended prompt recognition of nonperforming loans, the phasing out of regulatory forbearance, strengthening supervisory and lending practices, and recapitalizing state-owned banks to help safeguard macro-financial stability. Technical and capacity-building assistance from the Fund would be helpful in this regard. Directors welcomed the passage of the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) law, and advised full implementation of the action plan agreed with the Financial Action Task Force.

Directors emphasized the need for more resources to enhance the quality, availability, coverage, and publication of economic and financial data, and encouraged the authorities to request further Fund technical assistance in this regard.

Directors welcomed progress on product and labor market openness and gains in poverty reduction. To support more inclusive and broad-based growth, they recommended further trade integration and improvements in education and health infrastructure. Directors noted that the benefits of financial deepening and financial access by small and medium-sized enterprises could be enhanced through the adoption of a clear and unified accounting framework; strengthened creditors’ rights, credit analysis, and financial transparency; and implementation of an effective debt resolution process.