## 1. COVID-19 Containment and Mobility

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### Context and pandemic impact
- Pre-existing vulnerabilities were aggravated by the COVID-19 pandemic; containment measures included restrictions on movement and border closures in 2020–2021.
- Real GDP growth:
  - nearly flat in 2020
  - just over 2 percent in 2021
- Market access constraints from 2021 driven by concerns over public debt sustainability, slowing growth, low FX reserves, and tight FX liquidity.
- Central bank actions:
  - provided loans to the government in 2020 (repaid in 2021)
  - purchased government bonds from banks at the end of 2021 and increased its financing to banks
- Parallel market exchange rate developments:
  - depreciated significantly in mid-2021
  - exchange rate premium peaked at about 20 percent in mid-September 2021
  - premium narrowed to about 5 percent by end-2021 as the Bank of the Lao P.D.R. (BoL) allowed more official exchange rate flexibility
- Public debt:
  - escalated to just over 90 percent of GDP by end 2021, driven largely by issuance of public bonds to repay past expenditure arrears and recapitalize two public banks, and by exchange rate depreciation
- Policy and external support notes:
  - kip/USD exchange rate band widened from +/-0.25 percent to +/-1.5 percent in September 2021
  - three-year swap agreement with the PBoC for RMB6 billion (about US$900 million) announced in May 2020; for staff reporting, disbursements from this facility are counted as gross reserves and drawdowns from the swap line with the PBoC are included in public debt, adding about 2 percentage points of GDP to the debt ratio

### Recent developments (end-2021 into 2022)
- Recovery signals:
  - gradual recovery at end-2021 driven mainly by industry and agriculture
  - exports improved by more than expected (exports grew by 26 percent (y/y) in 2021)
  - services remained suppressed by containment measures but picked up at the start of 2022 as mobility restrictions were eased and the Lao-China high-speed railway and the Thanaleng Dry Port boosted transport and logistics
- Exchange rate and inflation pressures:
  - global commodity price increases (war on Ukraine) accelerated exchange rate pressures and increased inflation
  - kip depreciation from December 2021 to December 2022:
    - roughly 50 percent against the US dollar
    - over 40 percent against Thai baht
  - parallel exchange rate premia (against the USD):
    - reached close to 30 percent in mid-2022
    - narrowed to less than 5 percent by end-2022
  - kip/USD exchange rate band widened to +/-4.5 percent in October 2022
  - number of exchange rate bureaus significantly reduced in November 2022; ordered to close in early 2023
- Inflation and price effects:
  - inflation surged to 41 percent y/y as of February 2023
  - annual average rate for 2022 was 23 percent
  - items with larger imported share increased considerably more:
    - transport (16 percent of the CPI basket) increased by 50 percent y/y (YTD)
    - food and non-alcoholic beverages (46 percent of the basket) increased by 47 percent YTD
    - medical products increased by 48 percent
  - oil prices increased by around 40 percent in 2022 (y/y); fertilizers increased by 70 percent in 2022 (y/y)
- Fuel and distribution effects:
  - fuel shortages in May 2022, reflecting a combination of widening exchange rate premium and local fuel prices capped in kip based on the official exchange rate
- Living standards and welfare:
  - World Bank reports 43 percent of households have experienced a decline in real incomes since the onset of the pandemic
  - Rising inflation likely pushed an additional 2.9-3.7 percent of the Laotian population under the international poverty line (UNDP, 2022)
  - World Bank baseline: proportion of Laotian population living in poverty was 18.3 percent in 2019
  - household consumption rates have decreased; Consumer Sentiment and Business Tendency Survey (Macroeconomic Research Institute, March 2023) attributes lower consumption to caution over economic uncertainty and financial status
- Monetary conditions and banking pressures:
  - with inflation surging, real interest rates are significantly negative, creating disincentives to save and hold kip and putting pressure on kip deposits
  - low interest rates add to pressures on bank solvency
  - tighter global financial conditions in 2022 worsened the real interest rate differential against USD-denominated assets, likely exacerbating exchange rate pressures
- Growth outcomes:
  - real GDP growth estimated at 2.3 percent in 2022, slightly exceeding 2021 growth, boosted in part by a rebound in tourism after reopening
  - after BoP pressures mid-2022, the exchange rate premium at end-2022 was around 1 percent

### Government response and monetary policy measures
- Fiscal actions:
  - fiscal consolidation substantial, driven equally by expenditure cuts and recovery in revenue collection, and by interest payment deferrals
  - overall deficit improved by 4.3 percentage points of GDP in 2021
  - revenue and grants reached 15 percent of GDP in 2021, closing the gap with pre-pandemic ratios
  - total non-interest spending declined to 15.1 percent of GDP in 2021 (down from 16.8 percent in 2020) due to a moratorium on new public investment projects
  - debt servicing to China was deferred (reported amounts: US$220 million in 2020, US$450 million in 2021, and US$610 million in 2022)
  - mid-year outturns for 2022 suggest a primary balance in 2022 would be attainable
- Monetary policy and central bank measures:
  - BoL tightened monetary conditions; extension of credit to banks and government was fully offset by issuance of BoL bonds in June 2022 (BoL bonds only partially rolled over in January 2023)
  - BoL policy rate increased from 3.0 percent at the start of 2022 to 7.5 percent by February 2023
  - reserve requirements increased in 2023:
    - kip reserve requirement from 5.0 to 5.5 percent
    - FX reserve requirement from 5.0 to 8.0 percent
  - BoL tightened exchange controls, prioritized access to FX, closed FX bureaus, and strengthened FX repatriation and surrendering requirements (repatriation and surrendering requirements not currently enforced)

### Public debt, arrears, and fiscal risks
- PPG debt developments:
  - PPG debt increased by 16.4-percentage points of GDP from 2020 to 2021
  - PPG debt increased by 36.2-percentage point of GDP from 2021 to 2022, largely driven by currency depreciation, additional government arrears, domestic bond issuances to recapitalize banks, and SOE debts
  - about three quarters of PPG debt is denominated in foreign currency
- Arrears and bond issuances:
  - February 2023: government requested National Assembly approval to issue an additional Kip 8 trillion (around 3 percent of GDP) in arrears clearance bonds
  - staff’s Article IV consultations discussed Kip 23.5 trillion in potential additional obligations (verified and un-verified), included in staff’s debt estimates and adding about 11 percentage points of GDP to the debt ratio
  - authorities notified staff of a separate arrears item of Kip 10.5 trillion; at the time of writing, not clarified whether this was additional to an item of the same value already added to staff’s debt stock estimates

### External sector and reserves
- Trade and capital flows:
  - trade balance switched to a surplus in 2021-2022 with a sharp rise in exports despite oil import pressures
  - tourism and services exports were significantly hit by COVID-19 but began rebounding
  - FDI remained steady in 2019-2021 but dropped by half in 2022H1 compared to 2021H1
  - portfolio inflows went further into negative territory in 2020 and 2021 (close to zero in 2022H1)
- Reserves and coverage:
  - gross official reserves down by US$170 million by end-August 2022 (from end-December 2021)
  - gross official reserves projected to be US$1,101 million at end-2022, corresponding to 1.6 months of import coverage
  - estimated reserves include disbursements from a swap facility from the People's Bank of China
- REER and external position diagnostics:
  - since Jan 2021, the REER has depreciated by about 27 percent
  - REER model suggests the external position in 2022 was stronger than consistent with medium-term fundamentals and desirable policy settings (REER gap of -19.4 percent)
  - staff places more weight on the current account model
  - current account position improved considerably
  - net international investment position (NIIP) estimated at -143 percent of GDP and deteriorating
  - IMF staff views the appropriate current account (CA) norm to be -4.0 percent of GDP given external risks from the large and negative NIIP; under this norm the NIIP is projected to improve by about 29 percent of GDP by 2028 under the baseline (2022 Debt Sustainability Analysis)
  - the current account model indicates a gap of -2.0 percent of GDP, implying a real effective exchange rate gap of 6.8 percent

### Authorities’ views
- Authorities agreed Lao P.D.R. is experiencing economic and financial difficulties and that the surge in inflation resulted from significant exchange rate depreciation.
- Authorities emphasized positive developments over the past year, including:
  - easing of supply pressures
  - improvement in net trade
  - recent appreciation of the exchange rate
- Based on these factors, authorities assessed the real effective exchange rate was consistent with fundamentals.
- Authorities assessed FX reserve coverage to be higher using their methodology, which excludes some FDI-related imports.

---

### Baseline outlook: growth, inflation, and GDP

### Core baseline assumptions
- No further external shocks and no materialization of domestic risks.
- (i) For 2023, terms of trade stabilize after improving somewhat in the second half of 2022.
- (ii) Improvement in services after the reopening of borders in 2022 and hence that tourism picks up substantially.
- (iii) Fiscal policy and monetary policy continue to be tight, with no further lending from the BoL to government.

### Growth and inflation projections
- Growth:
  - Growth recovers at 4.0 percent in 2023.
  - Growth gradually increases to staff’s estimate of long-run potential of 4.75 percent.
  - Note: With no fiscal space, public capital spending remains subdued, precluding a return to pre-pandemic growth rates.
- Inflation and nominal GDP:
  - Average inflation is projected to fall, converging to 3 percent by 2025.
  - GDP deflator inflation projected to be lower than CPI inflation in 2022 and slightly higher than CPI inflation in 2023.
  - Nominal GDP is expected to grow at double digits in 2023 and stabilize in the 7-8 percent range thereafter.
- Tourism:
  - Pre-pandemic tourism was around 4 million visitors per year.
  - Visitor numbers were projected to reach 1.2 million in 2022 (at time of writing).

---

### Fiscal outlook and public debt dynamics

### Expenditure, revenue, and debt trajectory (baseline)
- Non-interest expenditure expected to remain anchored at 2021 ratios to GDP (around 15 percent).
- Moratorium on new capital expenditure; only existing projects to be completed, with projects of “high importance” possibly undertaken.
- Revenue assumptions:
  - revenue gains seen in 2021 expected to last, but baseline assumes no further improvements; total inflows constant around 15 percent of GDP.
  - VAT reduction from 10 to 7 percent in January 2022 will undermine revenue mobilization.
  - A portion of the increase in dividends observed in 2021 is assumed temporary; grants gradually decline in line with historical trends.
- Debt sustainability assessment:
  - Despite improvements in public finances, public debt would remain unsustainable under the baseline.
  - Small primary surpluses and nominal growth rates exceeding nominal interest rates imply a steady reduction in PPG debt ratios over time, but debt remains above 100 percent of GDP the next 7 years.
  - Present value of debt is above the 35 percent net present value threshold for the next 20 years.
  - Paths in three of the four stress tests—the present value of debt to GDP, the debt service to exports ratio, and the debt service to revenue ratio—are above thresholds.
  - Example: To lower the debt-to-GDP ratio to around 60 percent by 2027, a 10 percent of GDP primary surplus would be needed each year from 2023.
  - Staff judgment: debt is unsustainable.
- Arrears and staff estimates:
  - Staff’s estimates of public debt as of end-2022 include 23.5 trillion kip in arrears on old investment projects, in addition to 9.6 trillion kip of 2021 cleared arrears by issuing domestic bonds.

### Financing needs and composition
- Gross financing needs:
  - Gross financing needs increase to nearly 16 percent of GDP in 2023, and remain around that level for several years.
  - Increase arises mainly from external debt servicing that comes due in 2023 (including the swap line from the PBoC), which accounts for nearly 13 percentage points; the majority is due to China.
- External market access assumptions:
  - Disbursements from commercial bank loans and bond issuance in international markets assumed to resume gradually:
    - US$ 150 million in each of 2022 and 2023.
    - US$ 200 million in each of 2024 to 2026.
    - US$ 500 million for 2027 and beyond.
  - Given limited external access, the share of domestic financing would increase to nearly 12 percent of GDP in 2023.
  - Share of domestic debt in total PPG public debt expected to increase from 14 percent in 2021 to about 37 percent in 2030.
- Implication:
  - Assuming no further deferrals of debt servicing, no monetary financing, and absence of additional financing sources (e.g., asset sales), domestic banks are assumed to fill remaining government financing needs, resulting in significant crowding out of private credit.

---

### Risks, contingent liabilities, and tailored stress tests

### Main risk drivers (downside-tilted)
- Stresses to meet government financing needs could force large interest rate increases, raising domestic financing costs and rollover risk.
- Domestic investors might demand shorter-maturity bonds, increasing rollover and refinancing risks.
- Pressure to monetize the deficit could cause exchange rate depreciation, higher inflation, and increases in the kip value of liabilities.
- Deteriorating banking asset quality could trigger liquidity shortages, exacerbate pressures on bank balance sheets, and cause a funding crisis for the government.
- Risk that the government would not secure foreign exchange to service external debt and pay for imports without significant FX pressure.
- Uncertainty about the extent of expenditure arrears, with risk of additional liabilities to be serviced.

### Contingent fiscal liabilities and tailored stress tests
- Contingent liability sources: PPPs, SOEs, potential arrears, recapitalization needs of the banking sector.
- Customized contingent liability stress test calibrated shocks (values preserved exactly as in source):
  - SOEs (guaranteed and not guaranteed): default parameter assumed 8.3 percent of GDP in second year; US$ 890 million (6.3 percent of GDP) from guaranteed state enterprise debt; default parameter 2 percent of GDP for non-guaranteed SOEs.
  - PPPs: shock set to default value of 35 percent of the PPP capital stock (equivalent to 26.47 percent of GDP).
  - Discovery of domestic arrears: shock covering 0.5 percent of GDP.
  - Financial market / banking sector shock: assumed financial market shock 11.5 percent of GDP (includes LAK 4 trillion (1.5 percent of GDP) potential commercial bank recapitalization).
  - Total of calibrated shocks (2+3+4+5) in percent of GDP: 46.8.
- Operational assumption: additional financing needs due to stress test shock will be covered mainly by domestic financing.

### Debt sustainability and stress outcomes
- DSA findings:
  - PPG debt ratio estimated at 92.4 percent of GDP as of end-2021; PPG debt stock increased by 16.4 percentage points from 2020 to 2021 and by 36.2 percentage points from 2021 to 2022.
  - PPG debt stock projected to rise to 128.5 percent of GDP in 2022 and then gradually decline but remain above 100 percent for several years under the baseline.
  - PV of public debt-to-GDP ratio (selected):
    - 2021: 69.7
    - 2022: 100.9
    - 2023: 96.1
    - 2024: 93.6
    - 2025: 90.5
    - 2032: 72.2
    - 2042: 51.5
  - Gross financing need:
    - 2021: 5.4
    - 2022: 7.7
    - 2023: 16.3
    - 2024: 13.4
    - 2025: 15.1
  - Debt service-to-revenue and grants ratio:
    - 2021: 35.1
    - 2022: 52.4
    - 2023: 110.1 (peak)
  - DSA judgment: Lao P.D.R. is in external and overall debt distress and public debt is unsustainable under the current baseline.
- Tailored stress test results:
  - Natural disaster tailored shock: one-off 3 percentage points increase to external debt-to-GDP ratio in 2023.
  - Market financing tailored shock: 400-bps increase in cost of new external commercial borrowing, shortening of maturities by one-thirds, and one-off FX depreciation by 15 percent (calibrated for 2023).
  - Contingent liabilities shock: one-off 46.8 percentage point increase in the debt-to-GDP ratio in second year.
  - Under extreme shocks, three of four sustainability indicators (except PV of debt-to-exports ratio) exceed corresponding thresholds over the next decade.

---

### Monetary operation, banking sector, and financial stability

### Monetary operations and transmission
- Strengthening liquidity assessment and forecast, developing monetary instruments and an interest rate corridor would improve monetary transmission.
- National Assembly approved a target growth rate for M2 of 26 percent y/y, which would exceed nominal GDP growth.
- Banks appear to be holding deposits at the BoL in excess of requirements already; immediate impact on monetary conditions unclear.
- Increasing FX reserve ratios by more than kip ratios risks exacerbating FX pressures at banks.

### Foreign exchange management
- Authorities should continue to strive to unify market and official exchange rates to ease FX liquidity pressures.
- Recent measures (e.g., closing exchange bureaus, repatriation and surrendering requirements) raise incentive risks and can be counterproductive if relied on exclusively or for extended periods.
- Staff assessing jurisdictional implications of recent changes to the exchange system and the surrender requirements under the Institutional View.

### Banking sector conditions and vulnerabilities
- Aggregate indicators show substantial improvement in system-wide capital ratios and reduction in NPLs in 2022, likely because of interventions in two state-owned banks.
- For many banks:
  - Cash balances are low and liquidity ratios are low relative to other dollarized economies.
  - Profitability is low; large depreciation and inflation have produced valuation and financial losses and eroded kip-denominated capital.
  - About 70 percent of loan books are FX-denominated, inflating kip value of balance sheets and exacerbating currency and maturity mismatches.
  - One large domestic bank (60 percent state-owned) reported capital ratios of 5.7 percent in September 2022, below regulatory minimum of 8 percent.
- Forbearance:
  - Forbearance policies have concealed profitability and solvency strains; regime still in place with no firm exit plan.
  - Credit bureau limitations raise concerns about extent of evergreening; current levels of NPLs likely understated.

### Policy recommendations for banking sector and BoL
- Continue to raise interest rates to preserve depositor confidence and prevent shifts into FX; preserve positive real rates to support bank profitability.
- Recommend profits be retained to support solvency.
- Require banks to report detailed information on restructured loans subject to forbearance and assess necessary provisions and likely write-offs on a forward-looking basis.
- Design and communicate a gradual but clear exit from forbearance policies (set dates) to preserve borrower discipline.
- Issue instructions to banks to raise capital and set aside higher provisions.
- Improve prompt and corrective action framework linked to exceptional liquidity provision (ELA); continue developing risk-based supervision and bank restructuring framework.
- Revise regulations of net open positions in FX to contain FX-related risks.

---

### Structural policies, governance, AML/CFT, and data priorities

### Structural reforms and private sector enabling environment
- Need to transition growth from public capital spending to private-sector-led growth.
- Address private sector constraints: skills shortages, competition from informal firms, access to finance, and administrative burdens.
- Policies recommended: reduce regulatory burdens, simplify tax and regulation implementation, increase registration and labor formality, improve education and skills training.

### Governance and public financial management
- Accelerate implementation of reform plans: improve planning, allocation, and implementation of budgets; reduce accumulation of arrears on investment projects.
- Publish timely and comprehensive public procurement contracts; improve governance, operational performance, and financial position of SOEs.
- Implement new Financial Management Information System (FMIS) and Treasury Single Account (TSA) to provide timely, comprehensive, reliable fiscal data.
- Develop a credible medium-term fiscal consolidation plan and a fiscal financing strategy; IMF stands ready to provide technical assistance.

### AML/CFT and statistics
- Expedite AML/CFT implementation; amend AML/CFT law and address shortcomings ahead of APG/FATF assessment.
- Improve the quality, coverage and timeliness of economic data: national accounts, government finance, financial sector, and external sector statistics are priorities.
- Specific statistical needs: timely and accurate data on expenditure arrears; improved valuation principles and detail of monetary and financial statistics; BoL reporting of FSIs to IMF; enterprise surveys and IIP compilation.

---

### Authorities’ intended measures and staff recommendations (policy package)

### Authorities’ intended measures
- Committed to a tight fiscal stance, increasing the primary surplus via:
  - increasing domestic revenues (closing leakages on import duties; new excises; improving personal income tax collection; expected revenue from the Thanaleng Dry Port)
  - spending restraint (particularly on new capital expenditure and public wages)
- Plans to meet remaining financing needs through asset sales (including concessions), external borrowing (including bond issuances on the Thai market), and domestic sources.
- Continue tightening monetary conditions in 2023; BoL requested IMF TA for forecasting and policy analysis capabilities.

### Staff policy recommendations (coordinated package)
- Fiscal policy:
  - Immediate priority: reduce immediate fiscal and financial risks given 2023 debt servicing constraints.
  - Medium term: if financing pressures ease, direct consolidation gains to growth-enhancing expenditures (education, training, modernization of key export-oriented infrastructure) and restore some capital spending where warranted; expand social protection if financing allows.
  - Revenue mobilization measures:
    - Reverse VAT exemptions to previous 10 percent rate: could add as much as US$150-200 million per year (or about 1 percent of 2021 GDP).
    - Reform corporate tax incentives: replace profit-based system with cost-based system based on depreciation and additional tax deductions rather than reduced rates.
    - Reform land taxation and introduce a property tax; increase excises on alcohol, tobacco, fuel and luxury goods.
    - Improve large taxpayers’ compliance; revert decision to transfer tax collection of certain large taxpayers to nine provinces.
    - Note: corporate income tax gap estimated to be as high as 90 percent.
  - Public financial management:
    - Implement FMIS and TSA, publish procurement and audit reports, improve governance of SOEs, accelerate reforms to reduce arrears.
- Monetary and exchange rate policy:
  - BoL should continue tightening monetary conditions; refrain from monetization; constrain expansion of reserve money; absorb excess liquidity by issuing bonds; monitor reserve requirement effects.
  - Raise nominal policy rates further until expected real rates are positive to support expected decline in inflation and the exchange rate.
- Structural and governance reforms:
  - Address regulatory burdens, improve business climate, strengthen AML/CFT implementation, and improve transparency and data provision.

---

*Source: 1laoea2023001*

### 1. COVID-19 Containment and Mobility ___________________________________________________________25

### 1. COVID-19 Containment and Mobility

### Context
- 2020 and 2021: pre-existing vulnerabilities were aggravated by the COVID-19 pandemic; containment measures included restrictions on movement and border closures.
- GDP growth:
  - nearly flat in 2020
  - just over 2 percent in 2021
- Market access constraints from 2021 due to concerns over public debt sustainability, slowing growth, low FX reserves, and tight FX liquidity.
- Central bank actions:
  - provided loans to the government in 2020 (repaid in 2021)
  - purchased government bonds from banks at the end of 2021 and increased its financing to banks
- Parallel market exchange rate developments:
  - depreciated significantly in mid-2021
  - exchange rate premium peaked at about 20 percent in mid-September 2021
  - premium narrowed to about 5 percent by end-2021 as the Bank of the Lao P.D.R. (BoL) allowed more official exchange rate flexibility
- Public debt:
  - escalated to just over 90 percent of GDP by end 2021, driven largely by issuance of public bonds to repay past expenditure arrears and recapitalize two public banks, and by exchange rate depreciation
- Policy and external support notes:
  - the kip/USD exchange rate band was widened from +/-0.25 percent to +/-1.5 percent in September 2021
  - a three-year swap agreement with the PBoC for RMB6 billion (about US$900 million) was announced in May 2020; for staff reporting, disbursements from this facility are counted as gross reserves and drawdowns from the swap line with the PBoC are included in public debt, adding about 2 percentage points of GDP to the debt ratio

### Recent Developments (end-2021 into 2022)
- Recovery signals:
  - gradual recovery at end-2021 driven mainly by industry and agriculture
  - exports improved by more than expected
  - services remained suppressed by containment measures but picked up at the start of 2022 as mobility restrictions were eased and the Lao-China high-speed railway and the Thanaleng Dry Port boosted transport and logistics
- Exchange rate and inflation pressures (first half of 2022 and through 2022):
  - global commodity price increases (war on Ukraine) accelerated exchange rate pressures and increased inflation
  - kip depreciation from December 2021 to December 2022:
    - roughly 50 percent against the US dollar
    - over 40 percent against Thai baht
  - parallel exchange rate premia (against the USD):
    - reached close to 30 percent in mid-2022
    - narrowed to less than 5 percent by end-2022
  - kip/USD exchange rate band widened to +/-4.5 percent in October 2022
  - number of exchange rate bureaus significantly reduced in November 2022; ordered to close in early 2023
- Inflation and price effects:
  - inflation surged to 41 percent y/y as of February 2023
  - annual average rate for 2022 was 23 percent
  - items with larger imported share increased considerably more:
    - transport (16 percent of the CPI basket) increased by 50 percent y/y (YTD)
    - food and non-alcoholic beverages (46 percent of the basket) increased by 47 percent YTD
    - medical products increased by 48 percent
  - oil prices increased by around 40 percent in 2022 (y/y); fertilizers increased by 70 percent in 2022 (y/y)
- Fuel and distribution effects:
  - fuel shortages in May 2022, reflecting a combination of widening exchange rate premium and local fuel prices capped in kip based on the official exchange rate
- Living standards and welfare:
  - World Bank reports 43 percent of households have experienced a decline in real incomes since the onset of the pandemic
  - Rising inflation likely pushed an additional 2.9-3.7 percent of the Laotian population under the international poverty line (UNDP, 2022)
  - World Bank baseline: proportion of Laotian population living in poverty was 18.3 percent in 2019
  - household consumption rates have decreased; Consumer Sentiment and Business Tendency Survey (Macroeconomic Research Institute, March 2023) attributes lower consumption to caution over economic uncertainty and financial status
- Monetary conditions and banking pressures:
  - with inflation surging, real interest rates are significantly negative, creating disincentives to save and hold kip and putting pressure on kip deposits
  - low interest rates add to pressures on bank solvency
  - tighter global financial conditions in 2022 worsened the real interest rate differential against USD-denominated assets, likely exacerbating exchange rate pressures
- Growth outcomes:
  - real GDP growth estimated at 2.3 percent in 2022, slightly exceeding 2021 growth, boosted in part by a rebound in tourism after reopening
  - after BoP pressures mid-2022, the exchange rate premium at end-2022 was around 1 percent

### Government Response and Monetary Policy Measures
- Fiscal actions:
  - fiscal consolidation substantial, driven equally by expenditure cuts and recovery in revenue collection, and by interest payment deferrals
  - overall deficit improved by 4.3 percentage points of GDP in 2021
  - revenue and grants reached 15 percent of GDP in 2021, closing the gap with pre-pandemic ratios
  - total non-interest spending declined to 15.1 percent of GDP in 2021 (down from 16.8 percent in 2020) due to a moratorium on new public investment projects
  - debt servicing to China was deferred (reported amounts: US$220 million in 2020, US$450 million in 2021, and US$610 million in 2022)
  - mid-year outturns for 2022 suggest a primary balance in 2022 would be attainable
- Monetary policy and central bank measures:
  - BoL tightened monetary conditions; extension of credit to banks and government was fully offset by issuance of BoL bonds in June 2022 (BoL bonds only partially rolled over in January 2023)
  - BoL policy rate increased from 3.0 percent at the start of 2022 to 7.5 percent by February 2023
  - reserve requirements increased in 2023:
    - kip reserve requirement from 5.0 to 5.5 percent
    - FX reserve requirement from 5.0 to 8.0 percent
  - BoL tightened exchange controls, prioritized access to FX, closed FX bureaus, and strengthened FX repatriation and surrendering requirements (repatriation and surrendering requirements not currently enforced)

### Public Debt, Arrears, and Fiscal Risks
- PPG debt developments:
  - PPG debt increased by 16.4-percentage points of GDP from 2020 to 2021
  - PPG debt increased by 36.2-percentage point of GDP from 2021 to 2022, largely driven by currency depreciation, additional government arrears, domestic bond issuances to recapitalize banks, and SOE debts
  - about three quarters of PPG debt is denominated in foreign currency
- Arrears and bond issuances:
  - February 2023: government requested National Assembly approval to issue an additional Kip 8 trillion (around 3 percent of GDP) in arrears clearance bonds
  - staff’s Article IV consultations discussed Kip 23.5 trillion in potential additional obligations (verified and un-verified), included in staff’s debt estimates and adding about 11 percentage points of GDP to the 2022 PPG stock of debt
  - authorities notified staff of a separate arrears item of Kip 10.5 trillion; at the time of writing, not clarified whether this was additional to an item of the same value already added to staff’s debt stock estimates

### External Sector and Reserves
- Trade and capital flows:
  - trade balance switched to a surplus in 2021-2022 with a sharp rise in exports despite oil import pressures
  - tourism and services exports were significantly hit by COVID-19 but began rebounding
  - FDI remained steady in 2019-2021 but dropped by half in 2022H1 compared to 2021H1
  - portfolio inflows went further into negative territory in 2020 and 2021 (close to zero in 2022H1)
- Reserves and coverage:
  - gross official reserves down by US$170 million by end-August 2022 (from end-December 2021)
  - gross official reserves projected to be US$1,101 million at end-2022, corresponding to 1.6 months of import coverage
  - estimated reserves include disbursements from a swap facility from the People's Bank of China
- REER and external position diagnostics:
  - since Jan 2021, the REER has depreciated by about 27 percent
  - REER model suggests the external position in 2022 was stronger than consistent with medium-term fundamentals and desirable policy settings (REER gap of -19.4 percent)
  - staff places more weight on the current account model
  - current account position improved considerably
  - net international investment position (NIIP) estimated at -143 percent of GDP and deteriorating, presenting a substantial challenge to external sustainability
  - IMF staff views the appropriate current account (CA) norm to be -4.0 percent of GDP given external risks from the large and negative NIIP; under this norm the NIIP is projected to improve by about 29 percent of GDP by 2028 under the baseline (2022 Debt Sustainability Analysis)
  - the current account model indicates a gap of -2.0 percent of GDP, implying a real effective exchange rate gap of 6.8 percent

### Authorities’ Views
- Authorities agreed Lao P.D.R. is experiencing economic and financial difficulties and that the surge in inflation resulted from significant exchange rate depreciation.
- Authorities emphasized positive developments over the past year, including:
  - easing of supply pressures
  - improvement in net trade
  - recent appreciation of the exchange rate
- Based on these factors, authorities assessed the real effective exchange rate was consistent with fundamentals.
- Authorities assessed FX reserve coverage to be higher using their methodology, which excludes some FDI-related imports.

*Source: 1laoea2023001 - 1. COVID-19 Containment and Mobility*

### 9.      The baseline outlook is for a period of stabilization, during which growth rates

### 9.      The baseline outlook is for a period of stabilization, during which growth rates gradually pick up.

### Baseline outlook: growth, inflation, and GDP
- Baseline assumptions:
  - No further external shocks and no materialization of domestic risks.
  - (i) For 2023, terms of trade stabilize after improving somewhat in the second half of 2022.
  - (ii) Improvement in services after the reopening of borders in 2022 and hence that tourism picks up substantially.
  - (iii) Fiscal policy and monetary policy continue to be tight, with no further lending from the BoL to government.
- Growth projections:
  - Growth recovers at 4.0 percent in 2023.
  - Growth gradually increases to staff’s estimate of long-run potential of 4.75 percent.
  - Note: With no fiscal space, public capital spending remains subdued, precluding a return to pre-pandemic growth rates.
- Inflation and nominal GDP:
  - Average inflation is projected to fall, converging to 3 percent by 2025.
  - GDP deflator inflation projected to be lower than CPI inflation in 2022 and slightly higher than CPI inflation in 2023.
  - Nominal GDP is expected to grow at double digits in 2023 and stabilize in the 7-8 percent range thereafter.
- Tourism context:
  - Pre-pandemic tourism was around 4 million visitors per year.
  - At the time of writing, visitor numbers were projected to reach 1.2 million in 2022.

### Fiscal outlook and public debt dynamics
- Expenditure and revenue baseline:
  - Non-interest expenditure expected to remain anchored at 2021 ratios to GDP (around 15 percent).
  - A moratorium on new capital expenditure allows only existing projects to be completed; projects of “high importance” may, however, be undertaken.
  - Ratios of wages, benefits and other spending to GDP assumed to remain stable.
  - Interest payments projected to increase significantly in the next few years, driving a rebound in overall expenditure.
  - Revenue assumptions: revenue gains seen in 2021 expected to last, but baseline assumes no further improvements; total inflows constant around 15 percent of GDP.
  - VAT reduction from 10 to 7 percent in January 2022 will undermine revenue mobilization.
  - A portion of the increase in dividends observed in 2021 is assumed temporary; grants gradually decline in line with historical trends.
- Debt sustainability assessment:
  - Despite improvements in public finances, public debt would remain unsustainable under the baseline.
  - Small primary surpluses and nominal growth rates exceeding nominal interest rates imply a steady reduction in PPG debt ratios over time, but debt remains above 100 percent of GDP the next 7 years.
  - Present value of debt is above the 35 percent net present value threshold for the next 20 years.
  - Paths in three of the four stress tests—the present value of debt to GDP, the debt service to exports ratio, and the debt service to revenue ratio—are above thresholds.
  - Example: To lower the debt-to-GDP ratio to around 60 percent by 2027, a 10 percent of GDP primary surplus would be needed each year from 2023.
  - Staff judgment: debt is unsustainable.
- Arrears and staff estimates:
  - Staff’s estimates of public debt as of end-2022 include 23.5 trillion kip in arrears on old investment projects, in addition to 9.6 trillion kip of 2021 cleared arrears by issuing domestic bonds.

### Financing needs and composition of financing
- Gross financing needs and composition:
  - Gross financing needs increase to nearly 16 percent of GDP in 2023, and remain around that level for several years.
  - Increase arises mainly from external debt servicing that comes due in 2023 (including the swap line from the PBoC), which accounts for nearly 13 percentage points; the majority is due to China.
  - Smaller shares of external debt servicing are due to other bilateral creditors, bondholders and commercial banks, and smaller shares to the ADB and World Bank.
- External market access assumptions:
  - Disbursements from commercial bank loans and bond issuance in international markets assumed to resume gradually:
    - US$ 150 million in each of 2022 and 2023.
    - US$ 200 million in each of 2024 to 2026.
    - US$ 500 million for 2027 and beyond.
  - Given limited external access, the share of domestic financing would increase to nearly 12 percent of GDP in 2023.
  - Share of domestic debt in total PPG public debt expected to increase from 14 percent in 2021 to about 37 percent in 2030.
- Implication:
  - Assuming no further deferrals of debt servicing, no monetary financing, and absence of additional financing sources (e.g., asset sales), domestic banks are assumed to fill remaining government financing needs, resulting in significant crowding out of private credit.

### Risks (downside-tilted) and contingent liabilities
- Main risk drivers:
  - Stresses to meet government financing needs could force large interest rate increases, raising domestic financing costs and rollover risk.
  - Domestic investors might demand shorter-maturity bonds, increasing rollover and refinancing risks.
  - Pressure to monetize the deficit could cause exchange rate depreciation, higher inflation, and increases in the kip value of liabilities.
  - Deteriorating banking asset quality could trigger liquidity shortages, exacerbate pressures on bank balance sheets, and cause a funding crisis for the government.
  - Risk that the government would not secure foreign exchange to service external debt and pay for imports without significant FX pressure.
  - Uncertainty about the extent of expenditure arrears, with risk of additional liabilities to be serviced.
- Contingent fiscal liabilities:
  - Risks from PPPs and SOEs, potential arrears, and recapitalization needs from the banking sector could increase the debt burden.
  - Detailed information on the financial health of loss-making EDL and the extent of PPPs was not available at the time of writing.
- External environment:
  - Upside: net trade could improve if services (logistics and tourism) and remittances pick up.
  - Downside: a more adverse external environment in 2023 would have larger effects given low FX reserves and high debt burden, leading to more exchange rate pressure, tighter FX liquidity, and higher inflation.
- Medium-term structural risks:
  - Employment has not returned to pre-pandemic levels despite baseline assuming employment rates pick up to fulfill potential growth of 4.75 percent.
  - Gradual increase in productivity (TFP) may not be realized given cuts to education and health spending.
  - High vulnerability to natural disasters (floods, droughts, animal diseases) affecting agriculture, forestry, water resources, food security, health, and growth.

### Authorities’ views
- Authorities emphasized potential for recovery driven by:
  - Return of tourists, goods trade following railway and trade agreements, re-opening of China, and development of resource sectors including new hydroelectric power plants.
- Authorities agreed stabilizing the exchange rate is crucial to contain inflation but were more optimistic than staff about the decline in inflation.
- Based on assumptions of higher growth and fiscal balances, and with debt starting at a lower level, authorities were more confident debt sustainability could be restored quickly.

### Policy discussions and recommendations
- Overarching coordination:
  - Coordinated fiscal and monetary policies are needed: monetary tightening can help address debt vulnerability through exchange rate effects; fiscal consolidation lowers debt and helps contain inflation by stabilizing the exchange rate.
- Fiscal policy priorities:
  - Immediate priority: reduce immediate fiscal and financial risks given 2023 debt servicing constraints; additional consolidation should be used to ease financing pressures.
  - Medium term: if financing pressures ease, direct consolidation gains to clearly growth-enhancing expenditures (education, training, modernization of key export-oriented infrastructure) and restore some capital spending where warranted, while avoiding returning to a growth model driven by public capital spending.
  - Expand social protection if financing allows; current social protection is very limited.
- Revenue mobilization (recommendations):
  - Greater scope for tax revenue mobilization than further spending cuts.
  - Specific measures:
    - Reverse VAT exemptions to previous 10 percent rate: could add as much as US$ 150-200 million per year (or about 1 percent of 2021 GDP).
    - Reform corporate tax incentives: replace profit-based tax incentive system with cost-based system based on depreciation and additional tax deductions rather than reduced rates.
    - Reform land taxation and introduce a property tax; increase excises on alcohol, tobacco, fuel and luxury goods.
    - Improve large taxpayers’ compliance; revert the decision to transfer tax collection of certain large taxpayers to nine provinces.
  - Note: The corporate income tax gap estimated to be as high as 90 percent.
- Public financial management (PFM) and governance:
  - Accelerate implementation of reform plans: improve planning, allocation, and implementation of budgets; reduce accumulation of arrears on investment projects.
  - Publish timely and comprehensive public procurement contracts; improve governance, operational performance, and financial position of SOEs.
  - Implement new Financial Management Information System (FMIS) and Treasury Single Account (TSA) to provide timely, comprehensive, reliable fiscal data.
  - Develop a credible medium-term fiscal consolidation plan and a fiscal financing strategy; IMF stands ready to provide technical assistance.
- Authorities’ intended measures:
  - Authorities committed to a tight fiscal stance, aiming to significantly increase the primary surplus by increasing domestic revenues (closing leakages on import duties; new excises; improving personal income tax collection; expected revenue from the Thanaleng Dry Port) and spending restraint (particularly on new capital expenditure and public wages).
  - Plans to meet remaining financing needs through asset sales (including concessions), external borrowing (including bond issuances on the Thai market), and domestic sources.
- Monetary and exchange rate policy recommendations:
  - The BoL should continue tightening monetary conditions.
  - BoL actions to date: appropriately mopped up liquidity in mid-2022, although BoL bonds were only partially rolled over in January 2023.
  - Crucial actions:
    - Continue to refrain from monetization.
    - Constrain expansion of reserve money.
    - Absorb excess liquidity by issuing bonds.
    - Reserve requirements could be used but effects should be monitored closely.
    - Raise nominal policy rates further until expected real rates are positive to support the expected decline in inflation and the exchange rate.

*Source: IMF staff report excerpt.*

### 27.      Monetary transmission would be improved by reforms to the monetary operation

### 27.      Monetary transmission would be improved by reforms to the monetary operation

### Monetary operation framework and transmission
- Strengthening the assessment and forecast of liquidity, developing monetary instruments and an interest rate corridor would improve monetary transmission, allowing the BoL to improve management of kip liquidity and support a more transparent and effective conduct of monetary policy based on the policy rate.
- The National Assembly has approved a target growth rate for M2 of 26 percent y/y, which would exceed nominal GDP growth.
- Banks appear to be holding deposits at the BoL in excess of requirements already, therefore the immediate impact on monetary conditions is not clear and risks pushing banks to lower deposit rates.
- Increasing FX reserve ratios by more than kip ratios also risks exacerbating FX pressures at banks.

### Foreign exchange management and exchange rate policy
- Authorities should continue to strive to unify the market and official exchange rates to ease FX liquidity pressures.
- Recent measures to exert greater control over foreign exchange have been implemented, but some raise incentive risks:
  - Exchange bureaus have been closed. While this might increase FX flows through commercial banks, without an improvement in FX supply the policy risks pushing those needing FX to black market providers if the official exchange rate is not sufficiently flexible.
  - Authorities note that only about one third of FX earnings are repatriated to the country. The new FX management law adds repatriation stipulations and new requirements to report all earnings and route them through local banks and to surrender proceeds from exports, although these are currently not enforced. Such measures can be counterproductive if relied on exclusively and/or used for extended periods, creating incentives for avoidance and deterring inward investment.
- Staff are assessing jurisdictional implications of recent changes to the exchange system as part of a planned comprehensive jurisdictional assessment of Lao PDR’s exchange system.
- The surrender requirements of export proceeds may constitute a potential capital flow management measure, and is being assessed under the Institutional View for the Liberalization and Management of Capital Flows.
- Authorities are drafting sub-legislation to implement the new law and improving collaboration between customs and trade authorities to strengthen foreign exchange management, taking due care not to create disincentives for inward investment.

### Banking sector conditions and vulnerabilities
- Aggregate financial statistics show a substantial improvement in system-wide capital ratios and reduction in NPLs in 2022, but this is likely because of interventions in two state-owned banks.
- For most banks:
  - Cash balances are low, and banks’ liquidity ratios are also low even as compared to other dollarized economies.
  - Profitability is low. FX-denominated revenues may have supported incomes, but the large depreciation and the following steep inflation have produced large valuation and financial losses, while rapidly eroding kip-denominated capital resources. Borrowers are continuing to struggle with repayments. Interest rate mismatches, delays in loan repayments, and wage increases are expected to depress profits. There are also very high shares of business-related expenses in 2022, likely relating to FX losses on account of the depreciation of the exchange rate.
  - Many banks may have Basel-compliant capital adequacy ratios below minimum requirements. One large domestic bank (60 percent state-owned) reported capital ratios of 5.7 percent in September 2022, below the regulatory minimum of 8 percent. Two other state-owned banks were recently recapitalized by the government and partially privatized.
- Forbearance policies have concealed profitability and solvency strains. The forbearance regime is still in place and there are as yet no firm plans to return to standard prudential practices. Information about the outstanding stock of loans subject to forbearance was not available at the time of the consultation, raising questions about the extent of possible evergreening. The credit bureau does not have the capability of registering the number of times a loan has been restructured and it is unclear to what extent it can detect evergreening practices. Current levels of NPLs seem likely to be significantly understated.
- The significant exchange rate depreciation has inflated the domestic currency value of banks’ balance sheets, as about 70 percent of loan books are FX-denominated. Depositors have been shifting to FX deposits, exacerbating term mismatches on FX balance sheets and shrinking kip-denominated capital resources.

### Policy recommendations for the banking sector and BoL
- Continue to raise interest rates, to preserve depositor confidence and prevent withdrawals or large shifts into FX, which would exacerbate exchange rate pressures. Preserving positive real rates would also help support bank profitability and restore prudential buffers.
- Recommend profits be retained to support solvency, given the large increase in FX-denominated assets against current capital.
- Request banks to report detailed information on restructured loans still subject to forbearance and to immediately assess necessary provisions and likely write-offs on a forward-looking basis (i.e. not just whether regulations about size of current NPLs are met).
- Design and communicate a gradual but clear exit from forbearance policies (i.e. set dates), to preserve borrower discipline.
- Issue instructions to banks to raise capital and set aside higher provisions.
- Improve the prompt and corrective action framework, linked to the framework for exceptional liquidity provision (ELA) and continue developing risk-based supervision, the related regulatory environment, and the bank restructuring framework to ensure the authorities can act effectively in banking distress.
- The supervisor should revise the regulations of net open positions in FX to ensure FX-related risk levels are contained on banks’ balance sheets.

### Structural policies, governance, AML/CFT, and data
- Structural policies are crucial to support growth and employment and address macroeconomic imbalances. Growth before COVID-19 was driven by high investment in resource sectors but with very little growth in employment and productivity. Sustaining a tight fiscal stance implies a return to high levels of public investment is not possible; more private sector growth is required to boost FX revenues.
- Specific private sector constraints include: skills shortages in high-growth firms, competition from informal firms, access to finance, and administrative burdens. Lao P.D.R. would benefit from policies that reduce regulatory burdens on small businesses; consistent, simplified, transparent implementation of tax and regulation; increasing registration and labor formality; and improved educational attainment and skills training.
- Governance and anti-corruption implementation remains inadequate:
  - Weaknesses in management of public institutions, enforcement of regulatory frameworks, and monitoring of performance persist. Progress has been made on public financial management (e.g., a public debt bulletin), but weaknesses remain in planning, allocation, and implementation of budgets.
  - Full operationalization of the FMIS based on a sound Chart of Account and implementation of a Treasury Single Account are critical to improve budget preparation, predictability and control of budget execution, transparency, and accountability.
  - Improvements in governance of SOEs (e.g., corporate governance assessments of EDL and Lao Airlines) are important.
  - An Anti-Corruption Law (2012) criminalizes several activities, but effectiveness of implementation is unclear.
- Transparency and consistent implementation would underpin effective governance reform:
  - Publishing the State Inspection and Anti-Corruption Authority (SIAA) annual report and cases pursued would improve enforcement.
  - Publishing Covid-19-related public procurement contracts, names of awarded firms, and beneficial owners; auditing and publishing State Audit Organization reports on Covid-19-related expenses; and publishing audited BoL financial statements would improve transparency.
  - The regulatory framework for banking supervision is not aligned with Basel Core Principles. Financial stability would benefit from greater transparency in banks’ governance, related party lending, and reporting under IFRS.
  - More detailed and timely information about economic and financial challenges (e.g., size of expenditure arrears, financing needs, financial health of SOEs) and authorities’ plans (e.g., revenue mobilization, financing assumptions, debt rescheduling assumptions) would facilitate better assessments of growth potential.
- AML/CFT implementation should be expedited. Authorities updated a national risk assessment and are amending the AML/CFT law. Implementation should be swift as Lao P.D.R.’s assessment against the FATF standards by the Asia-Pacific Group (APG) is at an advanced stage; authorities should focus on addressing identified shortcomings.
- Improving quality, coverage and timeliness of economic data is critical. Shortcomings hamper surveillance, especially national accounts, government finance, financial sector, and external sector statistics. Examples:
  - Timely and accurate data on expenditure arrears is missing.
  - Timeliness, valuation principles and detail of monetary and financial statistics could be improved.
  - BoL could report FSIs to the IMF to help ensure quality review before dissemination.
  - IMF TA currently focuses on government finance statistics and external sector statistics; the WB will support Lao Statistics Bureau modernization.

### Authorities’ views and staff appraisal (outlook and risks)
- Authorities agreed with the need to tighten monetary conditions gradually due to bank maturity mismatches, using a combination of policy rate and reserve ratio increases and bond issuances. Authorities argue closures of FX bureaus would help tighten FX management and increase FX liquidity at commercial banks. Authorities emphasized due care to avoid disincentives for inward investment.
- Authorities emphasized that the banking system was profitable and well capitalized, with a system-wide CAR of 18 percent. Some banks were not experiencing liquidity issues; some were experiencing credit quality problems; data on outstanding restructured loans were being prepared.
- Staff appraisal:
  - The economic recovery faced new challenges in 2022; external commodity price shocks and exchange rate depreciation contributed to very high inflation damaging real incomes.
  - Growth in 2022 is estimated to have been 2¼ percent. The outlook for steady growth in 2023 and beyond is positive, supported by resumption of tourism and rebounds in goods trade and resource extraction.
  - Unsustainable public debt and rising vulnerabilities pose substantial risks. Even with primary surpluses maintained at current levels, public debt would remain very high for an extended period and financing needs significant. In the absence of substantial external financing, meeting financing needs domestically risks crowding out private investment or forcing monetary financing, further pressuring the exchange rate and progress on debt reduction.
  - Low FX liquidity and reserves, limited external market access and limited domestic capital markets compound risks.
  - Preventing these risks requires concerted action to improve public finances and raise productivity: mobilize revenues, improve public financial management (especially to prevent further expenditure arrears), and structural reforms to facilitate private sector employment and boost FX earnings.
  - Improvements in governance and transparency would improve prospects; shortcomings in data provision significantly hamper surveillance and more is needed in national accounts, government finance, financial sector, and external sector statistics.

*Source: 1laoea2023001 — IMF country report excerpt.*

### 46.      It is proposed that the next Article IV consultation with the Lao P.D.R. be held on

### 1laoea2023001 - 46.      It is proposed that the next Article IV consultation with the Lao P.D.R. be held on

### Article IV consultation timing
- It is proposed that the next Article IV consultation with the Lao P.D.R. be held on the standard 12-month cycle.

### COVID-19 containment and mobility: key observations
- As vaccinations coverage expanded... Covid-19 cases came down.
- Allowing to relax containment policy stringency,... increase mobility,...
- ...and reopen to international tourism... although there is substantial room for recovery.
- Figure highlights (datasets and sources): New Cases per Million People; Stringency Index; Total Vaccinations per Hundred People; Google Mobility Tracker (Retail and Workplace percent deviation from baseline); Historical Arrivals of International Visitors and Arrivals in 2022. Source: Our World in Data, national authorities, and IMF staff calculations.

### Monetary developments: findings
- Reserve money has grown robustly; controlling for exchange rate depreciation, M0 growth would have been lower recently.
- Domestic assets expanded significantly in 2022 supported by BoL’s lending to the government and banks.
- BoL issued bonds to mop up excess liquidity.
- Banks’ credit in kip to the government has been facilitated by BoL liquidity, but likely fueled by the recapitalization of 2 ailing public banks.
- High inflation, low nominal kip deposit rates, the kip depreciation and the BoL high-yield bonds have discouraged kip deposits but supported loan demand.
- Key indicators (sources: National authorities and IMF staff calculations):
  - Reserve Money Growth and Contribution of NFA and NDA (In percent, y/y).
  - Contribution to Growth of BoL's NDA (Net Claims on Government, Credit to the Economy (SOEs), Credit to Financial Institutions, Domestic Credits).
  - BoL bonds and other items contributions to NDA.
  - Banks' Exposure to the Government (In billions of Kip) showing Net Credit to the Government and Net Other Items; note: likely recapitalization of 2 ailing public banks.
  - Kip Credit and Deposit Growth (In percent, y/y): Credit (private sector) and Deposits.

### Fiscal sector developments and outlook: findings and projections
- Strong fiscal consolidation led to primary balance in 2021. A small primary surplus is expected in MT.
- Consolidation driven by compression of public spending, especially capital expenditure.
- Stabilization of significant revenue gains obtained in 2021; future revenue mobilization is unlikely and revenue growth is expected to be aligned with output growth.
- Rising interest payments drive a wedge between overall and primary balances, resulting in significant financing needs increasingly dependent on domestic sources.
- Fiscal figures and projections (selected visuals; sources: National authorities and IMF staff calculations):
  - Fiscal Balance (Percent of GDP): Overall balance and Primary balance for 2016–2027 (projections included).
  - Fiscal Expenditure composition (Percent of GDP): Compensation employees, Other (incl. transfers), Capital, Interest, Total (2016–2027, projections).
  - Contribution of Interest Payments to Overall Balance (Percent of GDP).
  - Composition of Fiscal Deficit Financing Sources (Percent of GDP): Domestic (net), Foreign (net), Total financing.
  - Nominal GDP and Revenue Growth (Percent, y/y) and Fiscal Revenues (Percent of GDP) with components Taxes, Grants, Non tax.

### External sector developments: findings
- After the trade balance switched to surplus in 2021, the current account deficit widened in 2022 with income repayment pressures.
- Export values increased substantially in 2021 on the back of a temporary rise in gold and paper goods exports, subsiding in 2022.
- Strong growth in 2021 was sustained in 2022 due to high energy prices; Thailand, China and Vietnam remain main trading partners.
- Services balance remained stable since the Covid-19 shock with a sharp drop in tourism inflows accompanied by a collapse in outflows.
- Overall, the current account deficit exceeded net financial flows in 2021-2022 wiping out a large part of the 2020 reserve accumulation (due to the PBoC swap inflow).
- Key metrics (sources: National authorities and IMF staff calculations and projections):
  - Current Account Balance (Percent of GDP) series 2012–2022 with trade, service, income, transfers contributions.
  - Contribution to Export Growth by product (electricity, other, copper and copper products, gold, paper goods, agriculture, wood pulp and waste paper).
  - Contribution to Import Growth by category (oil and diesel, equipment, autos, other).
  - Exports and Imports by Destination: shares for Thailand, China, Vietnam, Others.
  - Services Balance (In million US dollars) and Balance of Payments (Percent of GDP): Current account balance, Errors and Omissions, Financial account, Overall balance.

### Financial sector developments: findings
- After declining during the pandemic, credit growth has picked up since mid-2021.
- BoL actions on reference interest rates have not passed through to deposit rates, suggesting liquidity competition across banks.
- Banking sector shows sluggish risk appetite in a largely dollarized environment.
- NPLs appear dispersed across the system; regulatory forbearance has kept them at low levels.
- Key indicators (sources: National authorities; IMF staff calculations):
  - Credit Growth to the Private Sector (In percent): In Kip and In FX.
  - Lending-deposit Rate Spread: Kip and US Dollar (In percent).
  - Commercial Banks: Loan-to-Deposit Ratios (In percent) — Total, In Local Currency, In Foreign Currency.
  - Commercial Banks: FX Share in Credit and Deposit (In percent): Share of FX deposit and Share of FX credit.
  - Accrued Interest over Total Loans for Banks 1–7 (2020–2022).
  - Nonperforming Loans series (In percent): NPL net of provisions to capital and NPL to total gross loans (RHS).

### Medium-Term Macroeconomic Framework (Table 1) — selected series (preserve formatting as in source)
- Real GDP growth 1/4.7-0.42.12.34.04.04.14.24.34.5
- GDP Deflator3.35.13.817.616.13.53.03.03.03.0
- Consumer prices (annual average)3.35.13.823.015.13.53.03.03.03.0
- Consumer prices (end-period)6.33.25.339.3-1.47.63.03.03.03.0
- GDP per capita (in U.S. dollars)2,6032,5292,4962,0471,8581,8141,8881,9812,0812,189
- Revenue and Grants15.413.015.014.915.115.115.115.115.015.0
- Tax and nontax revenue13.811.513.013.313.613.713.813.913.914.0
- Grant1.61.52.01.61.51.41.31.21.11.0
- Expenditure18.818.616.316.518.518.618.518.618.017.9
- Current Expenditure12.612.011.111.013.013.113.013.112.512.4
- Net acquisition of nonfinancial assets6.26.65.25.55.55.55.55.55.55.5
- Overall balance-3.3-5.6-1.3-1.6-3.4-3.5-3.4-3.6-3.0-3.0
- Broad money18.916.324.032.320.1
- Credit to the economy 7.44.311.542.53.6
- Current account balance-1,711-953-107-912-368-863-1,151-1,320-1,263-1,021
- In percent of GDP-9.1-5.1-0.6-6.0-2.6-6.2-7.8-8.4-7.6-5.8
- Exports5,7646,1157,6957,9938,3068,6609,1639,73410,33611,187
- Imports6,6216,0926,8297,7557,6618,3069,1259,80810,52311,207
- Capital and Financial account balance2,3501,8178677463591,2281,3191,2101,5021,436
- FDI1,1021,0911,0725617589549931,0551,1011,150
- Public and public guaranteed debt69.176.092.4128.5123.1120.1116.0112.4108.3104.3
- External debt107.4119.4128.1164.8154.5148.2135.0124.5118.3113.7
- External public and public guaranteed debt 63.370.979.5104.593.587.679.673.469.767.0
- External public debt service (in millions of U.S. dollars)760.41154.8659.6548.31854.11394.31654.21502.21157.51115.3
- Gross official reserves (in millions of U.S. dollars)3/9981,3201,2671,1011,0921,4571,6251,5161,7542,170
- In months of imports 1.82.21.91.61.41.71.81.51.71.9
- Official exchange rate (kip per U.S. dollar; end-of-period)8,8699,28511,16617,238..................
- Nominal GDP (in billions of kip)163,080167,669180,751217,350262,354282,365302,785324,941349,204375,838

### Central Government Operations (Table 2a) — selected figures (In billions of kip)
- Revenue and Grants25,14421,78127,17732,38039,57242,65845,79048,96652,42356,196
- Taxes17,74815,76518,53423,08128,26030,56632,82635,27837,96341,008
- VAT5,4134,7215,7096,4658,1048,8229,46010,15210,91011,742
- Excise duties4,9723,6024,2885,8067,0587,5968,1458,7429,39410,111
- Net acquisition of nonfinancial assets10,07611,1239,46511,95414,42915,53016,65317,87219,20620,671
- Net lending/borrowing-5,457-9,382-2,331-3,548-8,928-9,996-10,316-11,583-10,462-11,181
- Net incurrence of liabilities5,3337,7422,3313,5488,9289,99610,31611,58310,46211,181
- Domestic2,4734,5902,6321,55521,03914,19118,91816,4808,0345,480
- Foreign2,8603,151-3011,994-12,111-4,195-8,602-4,8972,4285,702
- Primary balance-2,588-6,450-168125838770673547388192
- Fiscal balance-5,457-9,382-2,331-3,548-8,928-9,996-10,316-11,583-10,462-11,181
- Nominal GDP (in billions of kip)163,080167,669180,751217,350262,354282,365302,785324,941349,204375,838

### Balance of Payments and external ratios (Table 3b) — selected percent of GDP projections
- Current Account-9.1-5.1-0.6-6.0-2.6-6.2-7.8-8.4-7.6-5.8
- Merchandise trade balance-4.60.14.71.64.62.50.3-0.5-1.1-0.1
- Exports, f.o.b.30.733.041.552.258.962.162.362.362.263.2
- Imports, c.i.f.35.332.936.850.754.459.662.162.763.363.3
- Services (net) -0.4-0.5-0.7-1.2-0.1-0.6-0.9-1.4-1.4-1.4
- Income (net)-5.8-6.1-5.8-8.0-9.2-10.3-9.4-8.6-7.1-6.2
- Interest payments2.32.61.41.65.75.24.33.62.51.9
- Financial account12.49.74.74.92.58.89.07.79.08.1
- Direct investment (net)5.95.95.83.75.46.86.86.86.66.5
- Overall balance0.71.7-0.3-1.1-0.12.61.1-0.71.42.3
- Memorandum: Current account (w/o official transfers)-10.1-6.3-1.5-7.2-4.0-7.6-9.3-9.8-8.9-7.0

### Monetary survey (Table 4) — selected series (preserve formatting)
- BoL Net foreign assets6,1207,8396,8538,22511,57611,79615,34518,414
- BoL Net domestic assets14,71614,97417,01919,10020,89328,21426,59629,132
- Reserve money20,83522,81223,87327,32532,46940,01141,94147,545
- Currency in circulation7,8378,8239,20010,99012,19513,38610,81012,977
- Deposits12,99813,98914,67216,33520,27426,62431,13134,568
- Monetary survey Net foreign assets-11,268-7,769-9,248-7,260-2,0514,4415,1456,174
- Net domestic assets77,80882,44790,179103,447113,946134,283178,381214,153
- Broad money66,53974,67880,93096,186111,895138,724183,526220,327
- Foreign currency deposits (FCDs)31,70236,55439,89447,47056,71875,395121,077145,015
- Dollarization rate (FCDs/broad money; in percent)47.648.949.349.450.754.366.065.8
- Gross official reserves (in millions of U.S. dollars)8151,0188749981,3211,2671,0821,119

### Selected Financial Soundness Indicators (Table 5) — snapshots 2019Q2–2022Q3
- Regulatory capital to risk-weighted assets: 14.3,13.2,11.8,13.9,13.9,13.1,13.2,13.3,12.5,12.9,17.5,19.6,18.6,18.5
- Capital to assets (leverage ratio): 10.3,9.9,8.3,10.0,10.7,10.1,10.4,10.5,9.7,10.0,14.1,17.0,15.3,14.6
- Nonperforming loans net of provisions to capital: 10.8,12.2,12.7,12.2,10.7,11.9,9.6,10.1,11.0,9.7,4.5,4.6,4.6,5.8
- Nonperforming loans to total gross loans: 3.1,3.1,3.0,3.1,3.2,3.2,3.2,2.9,2.8,2.6,2.2,2.2,2.3,2.1
- Return on equity: 13.9,21.5,25.0,23.5,19.5,14.5,12.0,3.3,7.5,9.3,11.6,5.9,14.1,15.8
- Return on assets: 1.0,1.5,1.7,1.1,1.0,0.7,0.6,0.1,0.4,0.5,0.7,0.5,1.2,1.4
- Interest margin to gross income: 30.2,27.7,27.7,23.8,22.9,21.0,18.8,15.6,10.4,13.4,12.0,22.9,9.0,10.5
- Non-interest expenses to gross income: 40.9,39.8,40.4,60.9,67.6,70.9,74.4,79.1,87.0,83.4,84.5,73.7,88.5,85.3

*Source: National authorities; Our World in Data; Google Mobility Tracker; and IMF staff calculations as presented in the source content.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall assessment
- The external position of LAO P.D.R in 2022 is assessed to be weaker than the level implied by fundamentals and desirable policies.
- Assessment is based on:
  - a very large and deteriorating negative net international investment position which poses risk to the country’s external sustainability;
  - the EBA CA model which suggest that the external position in 2022 was weaker than that consistent with medium-term fundamentals and desirable policy settings;
  - reserves being below adequate levels.
- The assessment for 2022 is constrained by data availability and remains subject to considerable uncertainty around the degree of the temporary nature of these factors and the impact of Covid-19 developments.

### Potential policy responses
- Continued tight fiscal policy, fiscal consolidation based on tax revenue mobilization, and continued official exchange rate flexibility to:
  - help stabilize external debt;
  - help regain market confidence;
  - build reserves.
- Structural policies to:
  - reduce skills shortages;
  - target informality;
  - reduce start-up costs for investment;
  - improve transparency;
  - contribute to improving external competitiveness and diversification.

### Foreign assets and liabilities: position and trajectory
- Background:
  - Lao P.D.R.’s net international investment position reached -143 percent of GDP in 2021 based on estimates from Lane and Milesi-Ferretti (2022).
  - International investment position (IIP) official data are not currently available.
  - About half of the stock of international liabilities is in the form of debt (mostly classified as “other flows”).
  - Lao P.D.R’s NIIP lies below the threshold of -50 percent of GDP indicated by Catao and Milesi-Ferretti (2013) as a significant crisis predictor and is among the bottom 10 percent of a sample of 90 EMDEs.
- Assessment:
  - A very large and deteriorating negative net international investment position poses risk to the country’s external sustainability.
  - Compensating factors: about half of the stock of liabilities are composed of FDI and borrowing is long-term.
  - The Debt Sustainability Analysis (DSA) assesses external debt to be unsustainable under the current baseline (2022 Debt Sustainability Analysis).

### Current account
- Background:
  - The current account deficit as a share of GDP has sharply narrowed from an average of about 13 percent in 2013-2019 to 0.6 percent in 2021 and is expected to deteriorate to 6.0 percent in 2022.
  - Part of the adjustment started in 2019, prior to the Covid-19 crisis, due to a compression in imports linked to the slowdown in economic activity.
  - Exports rose sharply by 8.5 percent of GDP in 2021 and are expected to rise by 10.7 percent of GDP in 2022 (largely due to a drop in US$ GDP).
  - Electricity and agriculture exports played a dominant role in 2021-2022 combined with temporary factors such as the significant rise in gold and paper good exports in 2021.
  - Import values picked up with oil and diesel imports driving most of the increase in 2022 due to energy price increases.
  - The merchandise trade balance reached a surplus of 4.7 percent of GDP in 2021 and is expected to narrow to 1.6 percent of GDP in 2022.
  - Tourism and services exports declined sharply due to Covid-19, but tourism and services imports also declined, leaving the service balance somewhat stable.
  - The income deficit has been increasing, more than doubling from an average of 2.1 percent of GDP in 2015-2017 to 5.3 percent of GDP in 2018-2021 and further deteriorating to 8.0 of GDP in 2022, reflecting rising external debt and repayments linked to FDI (e.g. hydro projects).
  - 2022 projections are subject to a high degree of uncertainty against the backdrop of large external shocks.
  - Over the medium-term, the current account deficit is projected to widen with resumption of imports after the strong compression during the Covid crisis, a gradual tourism recovery, and a worsening income balance.
- Assessment (EBA-lite CA model and staff judgment):
  - The current account norm is estimated to be -6.7 percent of GDP in 2022 using the EBA-lite current account model.
  - Given external risks from a large and negative NIIP, IMF staff view the appropriate CA norm to be -4.0 percent of GDP.
  - This implies the NIIP is projected to reach −85 percent of GDP over a twenty-year horizon (compared to -113 percent of GDP with the unadjusted CA Norm), though with high uncertainty, as zero valuation effects are assumed.
  - The implied adjustment in the NIIP by 2028 is about 29 percent of GDP in line with the external debt adjustment under the baseline (2022 Debt Sustainability Analysis).
  - This results in a current account gap of -2.3 percent of GDP which translates into a real effective exchange rate (REER) gap of 6.8 percent.
  - The contribution of the policy gap to the norm is 0.5 percent as positive contributions.
  - The CA model suggests the external position in 2022 was weaker than the level implied by fundamentals and desirable policies.
- Adjustments made to the current account for features not fully captured in the regression model:
  - Remittances adjustor (component of Covid-19 adjustors) of 0.07 percent to account for a fall in remittances relative to projection of 0.2 percent of GDP (a transitory fall in remittances increases the adjusted current account balance).
  - Tourism adjustor of zero (component of Covid-19 adjustor).

### Real exchange rate (REER)
- Background:
  - In line with other countries in the region, the REER appreciated during the first half of 2020 (by 4.0 percent), followed by a depreciation during the second half of the year (of almost 7 percent).
  - Since Jan 2021, the REER has depreciated by about 27 percent, decoupling from other countries in the region.
- Assessment:
  - The EBA-Lite REER model produces a more negative REER gap than the current account model (-19.4 percent) for 2022.
  - The REER model suggests the external position in 2022 was stronger than that consistent with medium-term fundamentals and desirable policy settings.

### Capital and financial accounts: flows and policy measures
- Background:
  - FDI remained steady in 2019-2021 but dropped by half in 2022H1 compared to 2021H1.
  - After reversing in 2019, portfolio inflows went further into negative territory in 2020 and 2021 (remaining close to zero in 2022H1).
  - Other multilateral, bilateral and commercial financing fell to about US$500 million in 2021 from around US$1.1 billion in 2020 (excluding the swap with the PBoC).
  - Fitch downgraded Lao to CCC-, citing worsening liquidity risks, and announced it will stop rating Lao P.D.R. on commercial grounds.
- Assessment:
  - The sovereign's external debt repayment profile remains challenging, with an average of US$1.3 billion due in 2022-2025, including interest and principal, with more than half of external repayments due to China.

### FX reserve levels
- Background:
  - Gross official reserves stood at US$1,263 at end-2021 (down from US$1,320 million at end-2020), corresponding to 1.9 months of import coverage.
  - Further FX pressures in 2022 were accompanied by reserve losses of US$170 million by end-August 2022 (from end-December 2021).
  - Gross official reserves are project to be US$1,101 million at end-2022, corresponding to 1.6 months of import coverage.
  - On May 20, 2020, the BoL entered a three-year swap agreement for the amount of RMB6 billion (about US$900 million) with the People’s Bank of China (PBoC).
  - 2020 gross official reserves appear to include US$300 million of the swap.
  - In August 2021, Lao P.D.R. received about US$145 million as part of the general SDR allocation, equivalent to around 11 percent of Lao P.DR.’s gross international reserves, helping support reserves.
  - By September 2022, the authorities had sold 79 percent of its August 2021 SDR allocation in exchange for dollars.
  - The de jure exchange arrangement is a managed float, and the de facto exchange rate arrangement is classified as “other managed”.
- Assessment:
  - Reserve adequacy metrics for low-income countries suggest the optimal level of reserves for Lao P.D.R. is around 3 ½ to 5 ½ months of import coverage.
  - Over the medium-term import coverage is expected to be around 1.9 reflecting import recovery, protracted market access normalization and dwindling FDI.
  - Staff continue to assess reserve coverage as below adequate levels suggested by IMF adequacy metrics.

*Source: Annex I. External Sector Assessment (provided content).*

### Annex IV. Capacity Development Strategy

### Annex IV. Capacity Development Strategy

### Risk-based supervision
- The BoL has long engaged in risk-based supervision to improve its on-site and off-site oversight.
- A risk-based supervision manual was officially approved.
- Ongoing IMF TA on an Internal Capital Adequacy Assessment Process.

### Digital assets
- Lao P.D.R. has recently enacted legislation to pilot the mining and crypto trading activities as part of national efforts to transform into a digital economy and pursue growth.
- The BoL received technical assistance from the IMF on crypto assets oversight to help the BoL understand crypto asset risks and augment its capacity to manage those risks through regulatory and supervisory activities.

### Liquidity management and monetary policy
- The BoL requested technical assistance on liquidity management in addition to on-going capacity development on the macroeconomic framework.
- Liquidity management is identified as one of the most important foundations toward improving monetary operations.
- The BoL has received IMF support on FX operations and market-based reference exchange rates.

### Macroeconomic framework and forecasting
- The BoL requested technical assistance to develop a Forecasting and Policy Analysis System (FPAS) to strengthen its monetary policy framework.
- A scoping mission for potential FPAS technical assistance was undertaken in early 2023.
- Authorities requested TA to support development of:
  - a macroeconomic framework tool,
  - a debt dynamic tool to analyze the debt path,
  - the re-initiation of a multi-agency macroeconomic management working group (MOF, LBS, MPI, LASES, BoL).
- A mission is tentatively scheduled for July 2023.

### Debt management
- Authorities, faced with a high stock of public debt, are taking steps to modernize debt management.
- IMF TA delivered medium-term key recommendations to:
  - strengthen the institutional framework,
  - enhance operational capacity,
  - manage debt-related contingent liabilities,
  - help the authorities better understand the IMF-WB DSA framework and improve debt statistics.
- The IMF stands ready to support the authorities to better manage its debt.

### Revenue mobilization
- Authorities have received IMF TA on:
  - improving compliance risk management,
  - compliance improvement program,
  - HQ functions,
  - auditing,
  - integrity of the tax registry,
  - debt collections,
  - improving cooperation between the Lao Customs Department and Lao Tax Department.
- IMF TA on revenue mobilization is ongoing.

### Statistics
- Authorities have taken steps to improve statistics and engaged with the IMF on:
  - government finance statistics,
  - public sector debt statistics,
  - the chart of account,
  - national accounts,
  - improving the collection and reporting of external sector statistics to international best practice.

*Annex IV. Capacity Development Strategy*

### 3.      Restrictions have now been eased.

### 3.      Restrictions have now been eased.

### Reopening of borders and checkpoints
- The government of the Lao P.D.R. reopened international borders in May 2022.
- All local and traditional border checkpoints have been also reopened in September to facilitate trade and travelling of people in border areas.

### Gradual recovery of tourism and hospitality
- Government actions:
  - Promoting domestic tourism since 2021 with the Lao-Visit-Lao Campaign.
  - Opening of railway services and full operation of the Lao-China high-speed trains.
- Recovery outcomes and characteristics:
  - International arrivals in 2022 were 1.3 million—about 27 percent of pre-pandemic levels.
  - Of total international arrivals, almost 60 percent were from Thailand.
  - Over 90 percent of international arrivals were from four Asian countries: Thailand, Vietnam, China and South Korea.
  - International tourists tend to stay longer and have increased average spending from US$ 39 per day in 2019 to US$ 64 per day in 2022.
- Constraints:
  - With the current economic situation and rising prices, it is difficult to target local tourists as a key driver of service industry recovery.
  - Tourists from Europe, American, South Korea, China and Japan have not yet returned in substantial numbers.

### Exports and balance of payments developments (Annex IX)
- Exports:
  - Export receipts rose sharply in 2021, growing by 26 percent (y/y) in 2021 compared to an average of 6.3 percent in 2019-2020.
  - Exports of gold and paper goods contributed 17 percentage points of the growth in 2021.
- Capital flows and financial account:
  - The 2021 capital inflow reversal was driven by a sharp contraction in net other investment inflows.
  - Drivers of the drop include (i) lower net disbursements to the public sector, likely reflecting debt sustainability concerns; and (ii) capital flight reflecting larger savings abroad by residents.
- Foreign exchange (FX) pressures:
  - Despite the export performance, Lao P.D.R. experienced FX shortages, currency depreciation, and an increase in the premium between parallel and official exchange rates.
  - Authorities reported that FX receipts from exports are mostly not repatriated—only one third being repatriated in 2021.
    - According to information provided by the authorities, about two thirds were repatriated from mineral exports, but only about 19 percent from agriculture and 14 percent from electricity.
- Measurement challenges:
  - Errors and omissions averaged around 3.8 percent of GDP during 2012-2021.
  - Discrepancies between official and mirror trade data on imports persist; large and one-sided errors and omissions could reflect under-reporting of imports, capital flight over the years, among other measurement errors.
  - The IMF continues to provide technical assistance to improve external sector statistics.

### Sensitivity analysis of baseline projections (Annex X)
- Upside scenario:
  - With the authorities’ growth and primary fiscal surplus targets and some exchange rate appreciation, debt would remain very high.
  - Nominal debt is above 50 percent of GDP and its PV is above the DSA NPV threshold of 35 percent for the next ten years, and the three stress test thresholds are exceeded for at least five more years.
  - Scenario assumptions (authorities’ optimistic scenario):
    - Significantly stronger growth in 2022-23 and overshooting the long run trend in 2025-26 before stabilizing at 4.75 percent thereafter.
    - The primary balance is higher by 2 percentage points of GDP each year all the way to 2042.
    - Note: Authorities assume much lower inflation than in the baseline, which would reduce the benefits to public debt shown here.
- Downside sensitivities:
  - Exchange rate assumptions:
    - A scenario in which the average exchange rate depreciates by 10 percentage points more than in the baseline in 2023 and smaller additional depreciation for the following three years, with all other paths the same as in the baseline, illustrates the sensitivity of the debt ratio to the exchange rate.
    - Results show that the debt ratio would remain stalled at very high levels for a decade.
  - GDP deflator assumptions:
    - A deflator inflation rate 5 and 2 percentage points lower than the baseline in 2023 and 2024, respectively, would also see a slower reduction in debt.

### Risks from public debt (Annex XI)
- Global and regional context:
  - Total debt increased in low-income developing countries to 88 percent of GDP in 2021.
  - As of April 2022, about 60 percent of low-income countries were in, or at risk of, distress.
- Historical evidence on rapid debt accumulation:
  - Between 1970 and 2018, there were 256 episodes of rapid government debt accumulation and 263 episodes of private debt accumulation in a sample of 100 EMDEs.
  - Currency crises, characterized by a sharp and rapid depreciation (by 30 percent against USD, and over 10 percent from the previous year), were the most common in those episodes.
  - More than three-quarters of debt accumulation episodes associated with crises had currency crises.
  - Growth has typically been lower with a longer debt surge, or if crises occur.
- Policy-relevant point:
  - The optimal level of debt depends on country characteristics, financial market conditions, and government and private-sector behavior.

*Prepared by IMF staff as presented in the document.*

### conclusions on the optimal level of public debt, ultimately depending on policymakers’

### conclusions on the optimal level of public debt, ultimately depending on policymakers’ 

### Benefits and roles of public debt
- Debt can fund investment in growth-enhancing projects or social spending in EMDEs.
- Temporary debt accumulation can provide stimulus to help stabilize short-term economic downturns.
- Government debt can play a role in financial deepening if investors view it as a relatively safe asset.
- The benefits of debt largely depend on:
  - efficiency of a public sector,
  - a cyclical position of the economy,
  - financial market development.

### Costs and risks of higher public debt
- Some of the costs of higher debt include:
  - interest payments,
  - increasing likelihood of crises,
  - constrained fiscal space,
  - crowding-out of credits to private sectors.
- For LICs, past studies suggest that external debt exceeding 20-25 percent of GDP has adversely affected long-term growth.
- Given lower debt-carrying capacity of LICs than that of AEs, the sustainable gross PPG debt threshold in LICs should likely be much lower than 80 percent of GDP to avoid risks from sharp fiscal deterioration.

### Lao P.D.R.—debt sustainability assessment and recent developments
- The Lao P.D.R. is assessed to be in external and overall debt distress under the Low-Income Countries Debt Sustainability Framework (LIC-DSF).
- Compared to the 2019 Debt Sustainability Analysis, the country’s risk rating and debt sustainability have deteriorated due to:
  - an adverse macroeconomic environment (through a strong exchange rate depreciation),
  - an expansion of debt coverage to include guaranteed debt, expenditure arrears, and the issuance of domestic debt to recapitalize state-owned banks.
- PPG and external debt are projected to decline in the baseline scenario, reflecting small primary surpluses and economic growth above interest rates, but:
  - the present value of PPG debt-to-GDP ratio remains very high and above the indicative threshold for two decades.
- Most of the PPG external and public debt indicators for both solvency and liquidity have persistent breaches of their indicative thresholds.
- On-going negotiations about debt service deferral indicate debt distress and the significant and sustained breaches of debt thresholds in the DSA indicate a high probability of a future distress event.
- Other vulnerabilities and constraints identified:
  - significant financing needs,
  - low foreign exchange liquidity and reserves,
  - limited external market access since 2020,
  - limited potential for financing from domestic capital markets,
  - increasing rollover risks,
  - potential for additional exchange rate depreciation pressures,
  - possible accumulation of additional domestic arrears,
  - substantial contingent liabilities.
- Application of judgement: rating of “in debt distress” for both external and public debt and an assessment of unsustainable public debt.
- DSA sensitivity:
  - external debt is most vulnerable to shocks to exports and a depreciation of the currency,
  - public debt is most sensitive to the contingent liabilities shock.
- Adjustment options are limited, as the primary surpluses required to reduce debt indicators below risk thresholds within a few years are not politically feasible or socially desirable.

### Data and statistical context relevant to debt analysis
- Data provision has serious shortcomings that significantly hamper surveillance, especially regarding national accounts, government finance, financial sector, and external sector statistics.
- Specific statistical issues affecting debt analysis and surveillance:
  - Need for improved interagency coordination and capacity to reduce delays in data production and availability.
  - GFS and PSDS compilation improving, but:
    - data on on-lending, arrears, and related expenditure flows need particular attention,
    - PSDS coverage should be expanded from securities and loans to include comprehensive other accounts payable,
    - no quarterly PSDS data currently disseminated on the MoF website and to the IMF / World Bank quarterly PSDS database.
  - Introducing accrual concepts to GFS and PSDS compilation is recommended.
  - Recording of public-private partnerships needs investigation and more detail is recommended.
  - Monetary and financial statistics need strengthened classification by institutional sector and by financial instruments, strengthened valuation principles, and improved timeliness.
  - External Sector Statistics improvements underway, including enterprise surveys for the International Investment Position (IIP) and draft IIP and EDS statements pending BoL management approval.
- The Lao P.D.R. Composite Indicator of 2.15 indicates a weak debt-carrying capacity, based on the October 2022 IMF’s World Economic Outlook (WEO) and the 2021 World Bank’s Country Policy and Institutional Assessment (CPIA).

*Prepared by staff of the International Monetary Fund and the International Development Association (IDA).*

### 1.       The debt coverage in this Debt Sustainability Analysis (DSA) comprises debt owed by the

### 1laoea2023001 - 1.       The debt coverage in this Debt Sustainability Analysis (DSA) comprises debt owed by the

### Debt coverage and data limitations
- Debt coverage in this DSA comprises debt owed by the central government and government guarantees, including to state-owned enterprises (SOEs) (Text Table 1).
- Publicly guaranteed SOE external debt included in the DSA baseline is on-lent or guaranteed by the central government.
- There is no outstanding debt to the IMF.
- External debt is defined based on the currency criterion in this analysis.
- The debt stock includes:
  - a swap line with the People’s Bank of China (PBoC) in 2020 (included because the swap appears to be for balance of payments support to help shore up gross reserves),
  - past deferred interest payments in 2021 and 2022,
  - expenditure arrears.
- Authorities’ efforts to enhance debt transparency:
  - Government published an annual debt statistics bulletin for the first time in 2021 that includes publicly guaranteed external debt and domestic debt contracted by the central government.
  - The subsequent bulletin included more detailed information.
- Data gaps and exclusions from DSA coverage:
  - Information on debt owed by local governments and non-guaranteed SOE debt is lacking.
  - No information is available on the debt bulletin regarding borrowing of the central bank on behalf of the government.
  - Therefore, the DSA coverage does not include local governments, non-guaranteed SOE debt, or central bank borrowing on behalf of the government.
  - A contingent liability stress test is used with tailored settings under the DSF to investigate potential effects of the uncovered public debts.

### Customized contingent liability stress test: calibration and assumptions
- Purpose: analyze impact of additional public debt from contingent liabilities from PPPs and SOEs, additional occurrence of government arrears, and recapitalization needs from the banking sector (Text Table 2).
- Key calibrated shocks (values preserved exactly as in source):
  - SOEs (guaranteed and not guaranteed by the government):
    - Default parameter assumed for additional SOE-related shock: 8.3 percent of GDP in the second year of the projection.
    - Component breakdown:
      - US$ 890 million (6.3 percent of GDP) from potential need to cover guaranteed state enterprise debt.
      - Default parameter value of 2 percent of GDP to capture non-guaranteed SOEs (not included in the debt coverage).
    - Note: For guaranteed SOE debt, staff assumes an additional public debt increase equivalent to one-sixth of its outstanding debt as of end-2021.
  - PPPs:
    - Shock set to default value of 35 percent of the PPP capital stock (equivalent to 26.47 percent of GDP) to capture contingent liabilities from the private sector share of PPPs.
    - Data on PPP capital stock are from the World Bank’s Private Participation in Infrastructure Database.
  - Discovery of domestic arrears:
    - Shock covering 0.5 percent of GDP to analyze potential discovery of domestic arrears.
  - Financial market / banking sector shock:
    - Assumed financial market shock: 11.5 percent of GDP.
    - This includes LAK 4 trillion (1.5 percent of GDP) of potential commercial bank recapitalization and twice the default value (10 percent) given the financial sector remains weak.
- Total of calibrated shocks (2+3+4+5) in percent of GDP: 46.8.
- Operational assumption for financing the additional needs from the stress test shock:
  - The DSA assumes that additional financing needs due to the stress test shock will be covered mainly by domestic financing, given limited access to external borrowing in the next few years.

### Institutional and legal framework for debt management
- Public Debt Management Committee established and led by the Deputy Prime Minister.
- All borrowing (by central and provincial governments, SOEs, PPPs) must be approved by the National Assembly.
- Ministry of Finance negotiates all loans.
- A decree mandates SOEs to report debt data to the Ministry of Finance and to consult the ministry before significant borrowing.
- International Development Association (IDA), through its Sustainable Development Finance Policy (SDFP) Performance and Policy Actions (PPAs), has supported:
  - publication of an annual public debt bulletin,
  - compliance with a non-concessional borrowing ceiling,
  - approval of a decree on SOEs.

### Debt developments, composition, and key aggregates (end-2021)
- Total public and publicly guaranteed (PPG) debt estimated at 92.4 percent of GDP as of end-2021.
- External vs domestic composition:
  - Most of the PPG debt is external, representing 86.1 percent of the outstanding public debt or 79.5 percent of GDP.
  - Publicly guaranteed debt is included in the external PPG debt stock for 2019 and beyond; inclusion in 2019 accounts for a large portion of the debt increase not explained by automatic debt dynamics.
  - In 2021, guaranteed debt represents 15.8 percent of total PPG external debt stock.
  - The DSA treats as external PPG debt a swap line with the PBoC of US$ 300 million in 2020, with full repayment expected in 2023.
- Creditor composition highlights:
  - Lao P.D.R. relies mainly on bilateral borrowing; China is the largest creditor and holds nearly half of external PPG debt.
  - Multilateral creditors (mainly IDA and ADB) account for 12.6 percent of external PPG debt.
  - Sovereign bonds account for 7.9 percent of external PPG debt.
  - Commercial banks account for 7.5 percent of external PPG debt.
  - In terms of public external debt, 57.4 percent is on concessional or semi-concessional terms.
- Deferred servicing to China and inclusion in debt stock:
  - Debt servicing to China was suspended: principal repayments in 2020 of about US$ 220 million, and of both principal and interest payments in 2021 and 2022 of about US$ 450 million and US$ 610 million, respectively.
  - US$ 150 million of deferred principal is supposed to be repaid in 2023.
  - The deferred principal payments in 2020 and 2021 are included in 2021 debt stock in the debt bulletin.
  - Staff includes suspended interest payments (US$ 130 million in 2021 and US$ 190 million in 2022) in the debt stock for this DSA.
- Domestic debt:
  - Domestic debt estimated at LAK 23,234 billion or US$ 2,081 million at end-2021, representing 13.9 percent of total PPG debt or 12.9 percent of GDP.
  - Domestic bond issuance included in the stock at end-2021:
    - LAK 9.6 trillion (5.3 percent of GDP) issued to clear expenditure arrears in 2021.
    - LAK 5.4 trillion (3 percent of GDP) issued to recapitalize banks.
  - Domestic debt does not include domestic debt held by SOEs (not explicitly guaranteed by the government) due to technical difficulties consolidating data.
  - Remaining government arrears as of end-2021 (gap between reported arrears and domestic bond issuance to clear arrears): LAK 926 billion (0.5 percent of GDP).

### Arrears, issuance, and evolution of public debt
- Government-reported arrears and bond solutions:
  - Government reported LAK 10.5 trillion of public investment and recurrent expenditure arrears as of 2021; most cleared by issuing domestic bonds corresponding to LAK 9,577 billion (5.3 percent of GDP) in 2021.
- Additional arrears included in staff estimates:
  - Staff’s estimates of the debt stock as of end-2022 include an additional LAK 23.5 trillion (11 percent of GDP) in arrears on old investment projects, not cleared by issuing domestic bonds as of end-2022.
- Drivers of public debt increase in 2021:
  - Public sector debt estimated at 92 percent of GDP by end-2021.
  - PPG debt stock increased by 16.4 percentage points of GDP from 2020 to 2021.
  - Increase largely driven by currency depreciation, conversion of government arrears into domestic bonds, and domestic bond issuances to recapitalize banks.
  - Non-guaranteed SOE debts increased largely because of currency depreciation, adding to contingent liabilities.

### Private external debt and macro context
- Private external debt:
  - Total private external debt estimated to be 48.6 percent of GDP as of end-2021 (estimated given the large number of PPP contracts).
- Context of the DSA:
  - Conducted in the context of the 2023 Article IV Consultation.
  - Previous Low-Income Country DSA (LIC-DSF) considered by the IMF Executive Board in March 2022.
- Macroeconomic vulnerabilities and recent developments:
  - Long-term growth background:
    - In the 2000s and 2010s, Lao P.D.R. was among fastest growing countries; growth about 7 percent driven by public and private investment (hydropower, mining, transportation).
    - Poverty rate fell substantially over the same period.
    - Growth was partly fueled by public debt accumulation and did not support significant formal job creation.
    - Growth was slowing prior to COVID-19 due to rising public debt forcing slowdown in public investment; other factors included slowdown in credit growth and natural disasters.
  - COVID-19 and near-term growth:
    - GDP growth nearly flat in 2020 and just over 2 percent in 2021.
    - COVID-19 containment: restrictions on movement and border closures.
    - Very limited market access since 2020 as concerns over public debt sustainability, slowing growth, low foreign exchange reserves, and tight foreign exchange liquidity grew.
    - Central bank provided loans to the government in 2020 (repaid in 2021) and at end-2021 and increased financing to banks.
    - Parallel market exchange rate depreciated significantly in mid-2021 and exchange rate premium widened (over 20 percent in 2021Q3), narrowing to about 5 percent by end-2021 as BoL allowed more official exchange rate flexibility from September 2021.
  - Recovery and sectoral contributions:
    - Gradual recovery underway at end-2021, driven mainly by industry and agriculture; services remained suppressed by containment measures.
    - Start of 2022: services picked up as mobility restrictions eased and opening of Lao-China high-speed railway and Thanaleng Dry Port boosted transport, logistics, wholesale and retail trade; tourism started to recover; exports grew by 26 percent (y/y) in 2021 versus an average of 6 percent over previous two years.
  - Commodity price shock and inflation (early 2022 onward):
    - Increase in global commodity prices in first half of 2022 accentuated pressures on exchange rate, increased inflation, and eroded living standards.
    - Lao kip depreciated by over 50 percent against the US dollar and over 40 percent against the Thai baht in 2022.
    - Parallel exchange rate premia (against the USD) surged in mid-2022 before nearly closing by end-2022.
    - Inflation surged to 40 percent y/y as of January 2023.
    - Items with larger import shares increased considerably more.
    - Inflation in Lao P.D.R. substantially higher than neighboring countries; all broad sectors registered double-digit increases as of November, and measures of core inflation also increased.
    - Specific price increases in 2022:
      - Oil prices increased by around 40 percent (y/y).
      - Fertilizers increased by 70 percent in 2022 (y/y).
      - Transport (16 percent of CPI basket) increased by 50 percent YTD.
      - Food and non-alcoholic beverages (46 percent) increased by 47 percent YTD.
      - Medical products increased by 48 percent.
    - Social impact:
      - Fuel shortages experienced in May 2022 (widening exchange rate premium and local fuel prices capped in kip based on official exchange rate).
      - World Bank reports 43 percent of households have experienced a decline in real incomes since the onset of the pandemic.
      - Inflation highest on essential goods, resulting in cuts to food consumption, education, health care.
      - Poverty rates have increased.
      - Rising inflation could have pushed an additional 2.9-3.7 percent of the Laotian population under the international poverty line (UNDP, 2022).
  - External market access and financial conditions:
    - Weaker-than-expected global demand and tighter global financial conditions; export growth remained strong due to items such as paper goods and infrastructure links.
    - Interest rate differential against USD-denominated assets worsened as global financial conditions tightened and inflation surged more in Lao P.D.R., exacerbating exchange rate pressures.
- Fiscal consolidation:
  - Authorities eliminated the primary fiscal deficit in 2021.
  - Fiscal consolidation driven equally by expenditure tightening (suspension of new public investment projects), recovery in revenue collection, and interest payment deferrals.
  - Overall deficit improved by 4.3 percentage points of GDP in 2021, achieving a primary balance for the first time.
  - Total revenue and grants reached 15 percent of GDP.
  - Non-interest spending declined to 15.1 percent of GDP, down from 16.8 percent in 2020.
  - Mid-year outturns for 2022 indicate a primary surplus would have been attainable.
  - Note: persistence and size of past expenditure arrears are not included in fiscal accounts on a cash basis.

*Source: IMF DSA content unit 1laoea2023001*

### 18.3 percent in 2019 (World Bank, 2022: Lao People’s Democratic Republic Poverty Assessment 2020: Catching Up and

### 1laoea2023001 - 18.3 percent in 2019 (World Bank, 2022: Lao People’s Democratic Republic Poverty Assessment 2020: Catching Up and Falling Behind)

### Fiscal revenues and fiscal policy
- Nominal growth in fiscal revenues was 25 percent YoY in 2021, "far outstripped nominal GDP growth in 2021" and exceeded the average historical elasticity (buoyancy).
- Revenue outturn in 2021 is attributed to a combination of active revenue mobilization efforts and rebound from 2020’s historically low performance.
- Fiscal consolidation under the MoF’s Five-Year Plan relies heavily on spending austerity; there is no plan to increase social benefits.
- Combined public spending on social sectors (education, health, social protection) is low relative to regional and income peers and below international benchmarks (e.g., a recommendation of 4-6 percent of GDP for education).
- Spending cuts have reduced protection for households facing higher essential goods prices, likely suppressing private consumption; cuts to capital spending and to health and education budgets hold back medium-term growth.

### Central bank actions and domestic liquidity
- The Bank of the Lao P.D.R. (BoL):
  - Lent to government in 2020 and was repaid in 2021.
  - In 2021 purchased government bonds from banks that were issued to cover expenditure arrears and to recapitalize banks.
  - Tightened domestic financial conditions: BoL’s extension of credit to banks and the government in 2022 has been fully offset by the issuance of BoL bonds.
  - Increased its policy rate from 3.0 percent to 6.5 percent in 2022, and to 7.5 percent in February 2023, while raising banks’ reserve requirements.
  - Tightened exchange controls while allowing greater exchange rate flexibility; a new FX law lays out surrendering requirements but secondary legislation to implement those provisions has not yet been implemented.
- Domestic financing of the Ministry of Finance stood at LAK 16.7 trillion in 2021, including 1.9 trillion from the BoL. This figure includes 15 trillion of one-offs (so-called “triangulation” and investment bonds, issued to cover arrears).
- Reserve money grew strongly in 2022, mostly owing to exchange rate depreciation changing the domestic currency value of foreign currency-denominated assets; BoL domestic credit (NDA) growth was much more subdued.
- Banks’ credit in Kip picked up modestly but remains subdued compared to historical average.

### External position and reserves
- Despite nominal exchange rate depreciation, the external position in 2021 was still weak.
- Trade balance switched to a surplus in 2021-2022 with a sharp rise in exports, despite oil import pressures.
- Net international investment position is estimated at -143 percent of GDP and has been deteriorating.
- Gross official reserves were down by US$ 170 million by end-August 2022 (from end-December 2021).
- Gross official reserves are projected to be US$ 1,101 million at end-2022, corresponding to 1.6 months of import coverage.
- The 2023 IMF Article IV Staff Report assesses the external position in 2021 to be substantially weaker than the level implied by fundamentals and desirable policies.

### Financial sector
- The financial sector remains weak with wide variation in capital levels and asset quality across banks.
- Capital levels at several of the largest banks are below requirements; these positions could be overstated because of loan forbearance.

### Baseline macroeconomic outlook and assumptions
- Baseline assumes no further external shocks and no manifesting domestic risks; specific staff assumptions include:
  - For 2023, terms of trade stabilize after improving somewhat in the second half of 2022, allowing growth to improve despite tight global financial conditions and external demand.
  - Improvement in services after border reopening in 2022 and substantial pickup in tourism.
  - Fiscal and monetary policies remain tight, with no further lending from the BoL to government.
- Growth projections under baseline:
  - Growth recovers at 4.0 percent in 2023, gradually increasing to staff’s estimate of long-run potential of 4.75 percent.
  - Average inflation projected to fall, converging to a long-term rate of 3 percent by 2025.
  - GDP deflator inflation projected to be lower than CPI inflation in 2022 and slightly higher in 2023.
  - Nominal GDP expected to grow at double digits in 2023 and stabilize in the 7-8 percent range thereafter.
- Box 1 (Potential Growth Assumptions) key points:
  - Pre-crisis growth was driven almost entirely by capital accumulation.
  - Employment assumed to grow in line with UN working age population projections.
  - TFP growth increases above historical rates due to efficiency gains, implying potential real growth rate of 4¾ percent.

### Fiscal path and key macro assumptions (selected numeric projections)
- Non-interest expenditure expected to remain anchored at 2021 ratios to GDP (around 15 percent).
- Moratorium on new capital expenditure allowing only existing projects to be completed.
- Revenue and grants assumed roughly constant around 15 percent of GDP over the medium term.
- Text Table 4 (selected entries, Current DSA):
  - Real GDP (y/y growth): 2021 2.1, 2022 2.3, 2023 4.0, 2024 4.0, 2025 4.1, 2026 4.2, 2027 4.3, Long-term 4.7
  - GDP deflator (y/y growth): 2021 5.6, 2022 17.6, 2023 16.1, 2024 3.5, 2025 3.0, 2026 3.0, 2027 3.0, Long-term 3.0
  - Primary fiscal balance (percent of GDP): 2021 -0.1, 2022 0.1, 2023 0.3, 2024 0.3, 2025 0.2, 2026 0.2, 2027 0.1, Long-term -0.3
  - Revenue and grants (percent of GDP): 2021 15.0, 2022 14.9, 2023 15.1, 2024 15.1, 2025 15.1, 2026 15.1, 2027 15.0, Long-term 14.7
  - Primary expenditure (percent of GDP): 2021 15.1, 2022 14.8, 2023 14.8, 2024 14.8, 2025 14.9, 2026 14.9, 2027 14.9, Long-term 15.0
  - Fiscal balance (percent of GDP): 2021 -1.3, 2022 -1.6, 2023 -3.4, 2024 -3.5, 2025 -3.4, 2026 -3.6, 2027 -3.0, Long-term -2.6
  - Current account balance (percent of GDP): 2021 -0.6, 2022 -6.0, 2023 -2.6, 2024 -6.2, 2025 -7.8, 2026 -8.4, 2027 -7.6, Long-term -6.1
  - Exports of goods and services (percent of GDP): 2021 42.2, 2022 53.2, 2023 64.4, 2024 68.0, 2025 68.4, 2026 68.4, 2027 68.4, Long-term 70.0
  - Imports of goods and services (percent of GDP): 2021 38.2, 2022 52.8, 2023 60.0, 2024 66.1, 2025 69.0, 2026 70.3, 2027 70.9, Long-term 75.2

### Public debt, financing needs, and debt-service profile
- PPG debt stock:
  - Debt ratio estimated to have increased to 129 percent of GDP by end 2022.
  - Exchange rate depreciation contributed 30 percentage points to the estimated 36 percentage point increase in 2022.
  - New government arrears to private contractors contributed around 11 percentage points of GDP; bank recapitalization added 2 percentage points; deferred interest payments in 2022 added 1 percentage point.
  - In absence of clear information (except scheduled principal repayment of US$ 150 million in 2023), remaining principal and interest servicing not made in 2020-2022 is assumed deferred until 2027 but fully paid in the long run.
  - From 2022, assuming a small primary surplus and positive GDP growth, debt gradually declines: still above 100 percent until 2030 and around 60 percent in 2042.
- Gross financing needs:
  - Increase to nearly 16 percent of GDP in 2023 and remain at that level for several years.
  - Increase arises mainly from external debt servicing due in 2023 (including the swap line from the PBoC), which accounts for nearly 13 percentage points; the majority is due to China.
  - External market access assumed to be regained only gradually: bond and commercial market disbursement assumptions include US$ 150 million in 2022 and 2023, about US$ 200 million from 2024 to 2026, and US$ 500 million for 2027 and beyond.
  - Share of domestic financing increases to nearly 12 percent of GDP in 2023; share of domestic debt in total PPG public debt expected to increase from 14 percent in 2021 to about 37 percent in 2030.
  - Domestic banks assumed as main source of short- and medium-term domestic financing in baseline.
- Loan terms and composition assumptions:
  - Investment/triangular bonds account for 75 percent of the total debt stock as of end-2021.
  - Interest rate assumptions for domestic bonds are set in line with recent historical issuance; DSA assumes no relationship between policy rates and bond interest rates.

### External financing assumptions (Box 2)
- Total external disbursements average US$ 818 million from 2022 to 2027 and increase until 2042.
- Composition (2022–2027 averages and assumptions):
  - Multilateral financing: around 15 percent of total external financing from 2022 to 2027; around US$ 85 million on average from 2028 onward.
  - Bond issuance: US$ 150 million for 2022 and 2023; US$ 100 million every year from 2024.
  - Commercial bank loans: assumed zero for 2022 and 2023; about US$ 100 million from 2024 to 2026; US$ 400 million from 2027 onward.
  - Other external financing (bilateral): represents 52 percent of total external financing on average from 2022 to 2027 (average US$ 457 million), and 66 percent on average from 2028 to 2042, reaching US$ 1.7 billion.
- All remaining financing needs are met through domestic borrowing.

### Realism checks and risks
- Realism tools indicate baseline consistent with Lao P.D.R.’s historical experiences; historical scenario diverges mainly in explosive increases in present value of PPG external debt-to-GDP and -exports ratios after mid-2020s driven by large non-interest current account deficit in early 2010s (equivalent to 12.3 percent).
- Main risks center on stresses to meet government financing needs:
  - If no further deferrals of debt servicing and no monetary financing, domestic banks are assumed to lend to government; this implies significant crowding out of credit to private sector — private sector credit growth would shrink to 3 percent y/y in 2023 assuming broad money expands in line with nominal GDP growth.
  - Risk that required interest rate increases to attract investors would be very large, raising domestic financing costs; weak bank balance sheets and negative real interest rates could induce demand for shorter-maturity bonds, increasing rollover and refinancing risks.
  - Pressure on BoL to lend again to government without sterilization would expand reserve money, cause greater exchange rate depreciation than baseline, increase inflation, and raise the kip value of liabilities held by government and banks.
  - Deteriorating asset quality could trigger liquidity shortages and solvency crisis in banking system, causing funding crisis for government and further weakening exchange rate and purchasing power.
  - Even with domestic local-currency financing, risk remains that government cannot secure the foreign exchange needed to service external debt and pay for imports without significant FX pressure.

*Source: IMF staff materials contained in content unit 1laoea2023001.*

### 25.      The growth outlook is particularly uncertain, with risks tilted to the downside:

### 25.      The growth outlook is particularly uncertain, with risks tilted to the downside:

### Growth outlook and near-term risks
- Upside possibility:
  - Net trade could improve further if services (e.g., logistics and tourism) and remittances pick up, bringing valuable foreign exchange earnings.
- Downside risks:
  - External environment could be more adverse than expected in 2023, with the low level of FX reserves and high debt burden leaving very little room to absorb external shocks; likely consequences include more pressure on the exchange rate, tighter FX liquidity, and higher inflation.
  - Over the medium term, the economy risks long-term scarring:
    - Employment is yet to return to pre-pandemic levels, against the baseline assumption that employment rates pick up to fulfil the potential growth rate of 4.75 percent.
    - The assumption of a gradual increase in TFP might not be realized, given cuts to education and health spending.
  - High vulnerability to natural disasters (particularly floods and droughts) which have significantly affected agriculture, forestry, water resources, food security, health, and economic growth.

### Debt-carrying capacity and applicable thresholds
- Debt-carrying capacity assessment:
  - Composite Indicator (CI) index: 2.15, indicating a weak debt-carrying capacity (based on October 2022 WEO and 2021 World Bank CPIA).
  - CI in the previous 2019 DSA: 2.35.
- Indicative thresholds and benchmarks (unchanged):
  - PV of external debt-to-GDP ratio: 30 percent.
  - PV of external debt-to-exports ratio: 140 percent.
  - External debt service-to-exports ratio: 10 percent.
  - External debt service-to-revenue ratio: 14 percent.
  - PV of public debt-to-GDP ratio: 35 percent.

### Tailored stress tests added
- Natural disaster tailored stress test:
  - Rationale: increased exposure to natural disasters; 2018 disasters generated damages and losses estimated at 2 percent of GDP and recovery needs of around 3 percent of GDP.
  - Shock calibrated as a one-off 3 percentage points increase to the external debt-to-GDP ratio in 2023 (the second year of the debt projection period).
- Market financing tailored stress test:
  - Rationale: Lao P.D.R. accessing the Thai capital market since 2013 (temporary loss of market access in 2020).
  - Calibrations for 2023: 400-bps increase in the cost of new external commercial borrowing, a shortening of maturities by one-thirds, and a one-off foreign exchange depreciation by 15 percent.
- Contingent liabilities stress test:
  - Tailored parameter: a one-off 46.8 percentage point-increase in the debt-to-GDP ratio in the second year of the projection.

### External debt sustainability (baseline and stress outcomes)
- Baseline breaches (2023–2027):
  - Three out of four sustainability indicators breach their thresholds from 2023 to 2027.
  - Breaches for both solvency and liquidity ratios: PV of debt-to-GDP and debt service-to-export and debt service-to-revenue ratios.
- Magnitude and trajectories:
  - PV of the debt-to-GDP ratio: around 63 percent in 2022; estimated at about 40 percent in 2032.
  - External PPG debt service-to-revenue ratio: peaks at 97 percent in 2023; declines to 39 percent in 2032.
  - PPG debt service-to-exports ratio: trends above or around its sustainability threshold (10 percent) from 2023 to 2027.
  - PV of the debt-to-exports ratio: stays below its threshold (140 percent) over the entire projection period; highest value 119 percent in 2022.
- Stress test sensitivities:
  - Export shock: most severe deterioration for PV of debt-to-exports ratio and debt service-to-exports ratio.
  - One-time depreciation: most severe for PV of debt-to-GDP ratio and debt-service-to-revenue ratio.
  - Under extreme shocks, three of four sustainability indicators (except PV of debt-to-exports ratio) exceed corresponding thresholds over the next decade.

### Public sector debt sustainability
- Baseline breaches:
  - PV of total PPG debt-to-GDP ratio breaches its benchmark (35 percent) significantly over the projection period.
  - Debt service-to-revenue and grants ratio: 52 percent in 2022; 110 percent in 2023; 83 percent in 2032.
- Vulnerability to contingent liabilities:
  - Contingent liabilities shock (driven by SOE and PPP risks and a financial market shock) leads to:
    - PV of public debt-to-GDP ratio reaching 142 percent in 2023.
    - Debt service-to-revenue and grants peaking at 168 percent in 2029.

### Risk rating and overall assessment
- External and overall debt distress:
  - Lao P.D.R. is assessed to be in external and overall debt distress, reflecting ongoing negotiations about debt service deferral and significant debt vulnerabilities from large and protracted threshold breaches.
- Overall debt unsustainable under current baseline:
  - Key stressors: high debt service ratios, low foreign exchange reserves and liquidity, limited external market access since 2020, high dependence on domestic financing to close fiscal financing gap, and no fiscal space.

### Downside amplification channels and implications
- Gross financing needs:
  - Increase sharply in 2023 and exceed the 14 percent benchmark value.
  - With limited external financing, the baseline assumes domestic banks lend to government, implying significant crowding out of credit to the private sector and stressing the recovery.
  - Higher interest rates needed to induce private financing would reduce growth, increase government financing costs, and raise rollover risks.
  - Recourse to the BoL to finance the deficit would put further pressure on the exchange rate and increase the domestic currency value of external liabilities to government and banks.
- Other vulnerabilities:
  - Persistent global inflation could lead to tighter financial conditions.
  - Contingent liability realization would greatly stress public finances.
  - DSA vulnerabilities include: shocks to exports, currency depreciation, large exposure to PPPs, recapitalization needs of the banking sector, and impact of natural disasters.
  - Low level of reserves, a shallow domestic debt market, and limited access to capital markets compound vulnerabilities.
- Potential outcomes of stress:
  - Increased liquidity pressures from slowed financial inflows or domestic financing pressures could lead to solvency pressures in the banking system, funding stresses for the government, monetization or financial repression, and widening of the parallel exchange rate gap.

### Debt dynamics under alternative scenarios and fiscal implications
- Debt persistence:
  - Alternative scenarios indicate debt would remain high for the next 10 years even if growth reaches the authorities’ much-higher-than-baseline targets and with sustained primary surpluses.
- Feasibility of rapid debt reduction:
  - To reduce PPG debt to around 60 percent of GDP by 2027 (still somewhat risky for a heavily dollarized low-income economy) without harming development prospects and without debt restructuring, the government would have to run a primary surplus of about 10 percent of GDP on average each year for five years—deemed not socially feasible.
  - A commitment to sustained revenue-led fiscal consolidation would improve market perceptions and reduce pressures to finance domestically.

### Authorities’ actions and policy recommendations
- Government responses to date:
  - Government recognizes need to bring down public debt in its 9th Five-Year Plan and the National Agenda.
  - Government has sought external debt reprofiling.
  - Government achieved a small primary surplus via substantial fiscal consolidation: expenditure tightening (recurrent and suspension of new public investment projects), recovery in revenue collection, and interest payment deferrals.
  - Bank of the Lao P.D. (BoL) has allowed the exchange rate to depreciate, soaked up excess kip liquidity, and tightened rules on exchange markets.
- Recommended comprehensive adjustment package:
  - Fiscal policy:
    - Preferred growth-friendly fiscal consolidation based mainly on revenue mobilization, eliminating tax exemptions and VAT rate reductions, improving tax administration, and broadening the tax base.
    - Redirect spending to social and development needs with heightened attention to financial management.
  - Monetary policy:
    - BoL should continue bond issuances and interest rate increases to ease pressures on the exchange rate, reduce pressures on bank solvency, and facilitate foreign exchange inflows.
  - Structural reforms:
    - Complement fiscal and monetary measures to restore public finances and improve external balances and structural transformation.
    - With sustained fiscal restraint, growth must come from the private sector; address bureaucracy, difficult access to credit, labor market mismatches, competition from unregistered enterprises.
    - Improve governance through simpler regulation, consistent implementation, and anti-corruption measures.

*Source: 25.      The growth outlook is particularly uncertain, with risks tilted to the downside: (1laoea2023001 - 25.)*

### 39.      The authorities affirmed their intention to service debt repayments in full in 2023. Financing

### 1laoea2023001 - 39.      The authorities affirmed their intention to service debt repayments in full in 2023. Financing

### Authorities' financing intentions and debt servicing
- The authorities affirmed their intention to service debt repayments in full in 2023.
- Financing composition for 2023:
  - Mostly domestic financing through:
    - More tax revenue raised.
    - Sales of mining and hydroelectric concessions and fees.
    - Borrowing from commercial banks and domestic issuance of bonds.
  - A small share would be issued externally.
- Discussions and negotiations:
  - The Lao government has discussed with China holding debt servicing during 2020, 2021 and 2022 until negotiations about postponements has been completed.
  - There is not yet a schedule on when deferred amounts would be repaid.
  - The government is in negotiations with bilateral creditors about future repayments; no details were available at the time of the Article IV consultation.
- Legal/arrears note:
  - Under Lao law, government arrears to the private sector were not counted until a bond was issued.

### Public sector debt levels and projections (selected figures from Table 2: Public Sector Debt Sustainability Framework, Baseline Scenario, 2021–2042)
- Historical and projection path for Public sector debt (percent of GDP):
  - 2021: 92.4
  - 2022: 128.5
  - 2023: 123.1
  - 2024: 120.1
  - 2025: 116.0
  - 2026: 112.4
  - 2027: 108.3
  - 2032: 89.9
  - 2042: 63.6
  - Historical average: 61.2
  - Projection average: 108.5
- Public sector external debt (percent of GDP):
  - 2021: 79.5
  - 2022: 104.5
  - 2023: 93.5
  - 2024: 87.6
  - 2025: 79.6
  - 2026: 73.4
  - 2027: 69.7
  - 2032: 57.7
  - 2042: 50.2
  - Historical average: 54.3
  - Projection average: 74.2

### Identified debt-creating flows and fiscal balances (selected figures)
- Change in public sector debt (percent of GDP):
  - 2021: 16.4
  - 2022: 36.2
  - 2023: -5.4
  - 2024: -3.0
  - 2025: -4.0
  - 2026: -3.6
  - 2027: -4.1
  - 2032: -3.4
  - 2042: -2.0
- Identified debt-creating flows (percent of GDP):
  - 2021: 8.9
  - 2022: -7.8
  - 2023: -8.8
  - 2024: -4.2
  - 2025: -3.9
  - 2026: -3.6
  - 2027: -4.1
  - 2032: -3.5
  - 2042: -2.3
  - Historical average: 1.5
  - Projection average: -4.6
- Primary deficit (percent of GDP):
  - 2021: 0.1
  - 2022: -0.1
  - 2023: -0.3
  - 2024: -0.3
  - 2025: -0.2
  - 2026: -0.2
  - 2027: -0.1
  - 2032: 0.2
  - 2042: 0.5
  - Historical average: 2.8
  - Projection average: -0.1
- Revenue and grants (percent of GDP):
  - 2021: 15.0
  - 2022: 14.9
  - 2023: 15.1
  - 2024: 15.1
  - 2025: 15.1
  - 2026: 15.1
  - 2027: 15.0
  - 2032: 14.7
  - 2042: 14.8
  - Historical average: 17.7
  - Projection average: 14.9
  - Grants component:
    - 2021: 2.0
    - 2022: 1.6
    - 2023: 1.5
    - 2024: 1.4
    - 2025: 1.3
    - 2026: 1.2
    - 2027: 1.1
    - 2032: 0.6
    - 2042: 0.5
- Primary (noninterest) expenditure (percent of GDP):
  - 2021: 15.1
  - 2022: 14.8
  - 2023: 14.8
  - 2024: 14.8
  - 2025: 14.9
  - 2026: 14.9
  - 2027: 14.9
  - 2032: 14.9
  - 2042: 15.3
  - Historical average: 20.4
  - Projection average: 14.9

### Automatic debt dynamics and drivers (selected figures)
- Automatic debt dynamics (percent of GDP):
  - 2021: 8.8
  - 2022: -7.7
  - 2023: -8.4
  - 2024: -4.0
  - 2025: -3.6
  - 2026: -3.4
  - 2027: -4.0
  - 2032: -3.7
  - 2042: -2.8
- Contribution from interest rate/growth differential (percent of GDP):
  - 2021: -3.9
  - 2022: -7.7
  - 2023: -8.4
  - 2024: -4.0
  - 2025: -3.6
  - 2026: -3.4
  - 2027: -4.0
  - 2032: -3.7
  - 2042: -2.8
  - Contribution from average real interest rate (percent of GDP):
    - 2021: -2.4
    - 2022: -5.7
    - 2023: -3.5
    - 2024: 0.8
    - 2025: 1.1
    - 2026: 1.3
    - 2027: 0.7
    - 2032: 0.5
    - 2042: 0.2
  - Contribution from real GDP growth (percent of GDP):
    - 2021: -1.5
    - 2022: -2.0
    - 2023: -4.9
    - 2024: -4.7
    - 2025: -4.8
    - 2026: -4.7
    - 2027: -4.7
    - 2032: -4.2
    - 2042: -3.0
- Contribution from real exchange rate depreciation (percent of GDP):
  - 2021: 12.7
  - (subsequent values shown as "..." in source)

### Sustainability indicators (selected)
- PV of public debt-to-GDP ratio:
  - 2021: 69.7
  - 2022: 100.9
  - 2023: 96.1
  - 2024: 93.6
  - 2025: 90.5
  - 2026: 87.8
  - 2027: 85.4
  - 2032: 72.2
  - 2042: 51.5
- PV of public debt-to-revenue and grants ratio:
  - 2021: 463.7
  - 2022: 677.1
  - 2023: 636.9
  - 2024: 619.4
  - 2025: 598.5
  - 2026: 582.6
  - 2027: 568.7
  - 2032: 491.7
  - 2042: 348.6
- Debt service-to-revenue and grants ratio:
  - 2021: 35.1
  - 2022: 52.4
  - 2023: 110.1
  - 2024: 90.5
  - 2025: 101.3
  - 2026: 98.7
  - 2027: 93.5
  - 2032: 83.4
  - 2042: 49.9
- Gross financing need:
  - 2021: 5.4
  - 2022: 7.7
  - 2023: 16.3
  - 2024: 13.4
  - 2025: 15.1
  - 2026: 14.7
  - 2027: 13.9
  - 2032: 12.5
  - 2042: 7.9

### Key macroeconomic and fiscal assumptions (selected)
- Real GDP growth (in percent):
  - 2021: 2.1
  - 2022: 2.3
  - 2023: 4.0
  - 2024: 4.0
  - 2025: 4.1
  - 2026: 4.2
  - 2027: 4.3
  - 2032: 4.8
  - 2042: 4.8
  - Historical average: 5.7
  - Projection average: 4.2
- Average nominal interest rate on external debt (in percent):
  - 2021: 1.0
  - 2022: 1.3
  - 2023: 2.7
  - 2024: 2.8
  - 2025: 2.6
  - 2026: 2.5
  - 2027: 1.7
  - 2032: 2.1
  - 2042: 2.4
  - Historical average: 2.2
  - Projection average: 2.1
- Average real interest rate on domestic debt (in percent):
  - 2021: -0.8
  - 2022: -12.4
  - 2023: -9.6
  - 2024: 1.4
  - 2025: 1.9
  - 2026: 2.4
  - 2027: 2.2
  - 2032: 1.5
  - 2042: 1.5
  - Historical average: 3.2
  - Projection average: -0.4
- Inflation rate (GDP deflator, in percent):
  - 2021: 5.6
  - 2022: 17.6
  - 2023: 16.1
  - 2024: 3.5
  - 2025: 3.0
  - 2026: 3.0
  - 2027: 3.0
  - 2032: 3.0
  - 2042: 3.0
  - Historical average: 3.8
  - Projection average: 5.6
- Growth of real primary spending (deflated by GDP deflator, in percent):
  - 2021: -8.3
  - 2022: 0.3
  - 2023: 3.4
  - 2024: 4.5
  - 2025: 4.6
  - 2026: 4.2
  - 2027: 4.3
  - 2032: 4.8
  - 2042: 5.0
  - Historical average: 3.8
  - Projection average: 4.0
- Primary deficit that stabilizes the debt-to-GDP ratio (percent of GDP):
  - 2021: -16.3
  - 2022: -36.2
  - 2023: 5.1
  - 2024: 2.7
  - 2025: 3.8
  - 2026: 3.4
  - 2027: 4.0
  - 2032: 3.7
  - 2042: 2.5
  - Historical average: -8.7
  - Projection average: 0.2

### Stress tests, sensitivity analysis, and risks (selected highlights)
- Table 3 and Table 4 present sensitivity analysis for key indicators (PV of debt-to-GDP, PV of debt-to-revenue, debt service-to-revenue) under:
  - Alternative scenarios (e.g., key variables at their historical averages).
  - Bound tests (Real GDP growth, Primary balance, Exports, Other flows, Depreciation).
  - Tailored tests (Combined contingent liabilities, Natural disaster, Market Financing).
- Select sensitivity outcomes (PV of debt-to-GDP ratio, percent):
  - Baseline (2022–2032 row excerpt): 63 62 60 54 49 46 45 43 41 40 40 (columns correspond to 2022–2032).
  - Under A1 (key variables at historical averages): 63 63 66 67 68 73 79 86 93 99 104 (2022–2032).
- Bound and tailored tests show breaches of benchmarks in several tailored scenarios:
  - Example: C1. Combined contingent liabilities for PV of debt-to-GDP shows values rising to 73, 70, 69, 63, 58, 57, 57, 55, 54, 53, 53 (2022–2032) and other indicators show large increases (bold values indicate breaches in source tables).
- Market financing risk indicators:
  - Maximum gross financing needs (GFN) over 3-year baseline projection horizon flagged.
  - EMBI spreads correspond to the latest available data in the source; the figure indicates potential heightened liquidity needs assessed as "Moderate" with breach of benchmark: Yes.

### Authorities' statement and macroeconomic context (excerpt)
- Statement by Rosemary Lim, Executive Director for Lao PDR; Raja Anwar, Alternate Executive Director; and Inthiphone Xaiyavong, Advisor to the Executive Director — May 3, 2023.
- Key points from authorities:
  - Recovery in the Lao economy since the end of 2021 continued well into 2022, despite difficult external environment.
  - Depreciation of the Lao kip against major currencies such as the US dollar and Thai baht, amid rising food and energy prices, resulted in high inflation, raised the cost of living, and increased the domestic currency values of public debt.
  - Authorities remain committed to improving public finances and easing foreign exchange pressures in line with the National Agenda and the National Socio-Economic Development Plan for 2021-2025 (9th NSEDP).
  - Policy focus includes promoting private sector-led growth, creating a more favorable business climate, and accelerating governance and public administration reforms.
- Economic growth note (sentence fragment in source):
  - "Real GDP growth in Lao PDR increased to 4.4 percent in 2022, and is expected to grow to" (source truncates subsequent text).

*Source: 1laoea2023001 - Chapter/section text and tables as provided.*

### 4.5  percent  in  2023,  driven  by  the  return  of  tourists,  goods  trade  following  railway  and  trade

### 4.5 percent in 2023, driven by the return of tourists, goods trade following railway and trade agreements, and future development of resource sectors, including new hydroelectric power plants

### Growth outlook and drivers
- Growth projected at 4.5 percent in 2023, driven by:
  - return of tourists;
  - goods trade following the opening of the Laos-China high-speed railway and Thanaleng Dry Port;
  - future development of resource sectors, including new hydroelectric power plants.
- For the first eight months of 2022, the Lao section of the Laos-China railway carried more than 1 million tons of cross-border goods, including manufacturing, agriculture and mining products.
- Reopening of China and on-going implementation of the Regional Comprehensive Economic Partnership (RCEP) expected to further boost external demand for Lao products.

### Infrastructure, transport, and energy development
- Implementation of infrastructure projects under the 9th NSEDP will support medium-term growth.
- New transport links aim to connect domestic systems with:
  - the Laos-China railway;
  - ASEAN railway network (Singapore-Kunming Rail Link);
  - regional and international networks (Trans-Asian Railway).
- Government target: 15.8 percent annual growth for electricity generation, with potential gains from expanding transmission and distribution systems, streamlining investment regulations, and enhancing human resource capacity.

### Private investment, SEZs, and labor market measures
- Promotion of private investment and economic diversification through:
  - strengthened one-stop investment service center and two Prime Minister’s Orders to streamline investment procedures and regulations;
  - development of 12 Special Economic Zones (SEZ) with supporting infrastructure to attract FDI and strengthen linkages between foreign-owned firms and local firms.
- Labor market measures:
  - development of Labor Market Information Systems;
  - implementation of Active Labor Market Programs to achieve a well-functioning labor market.

### Macro challenges: exchange rate, inflation, and mitigation measures
- Official statistics: depreciation of the Lao kip in 2022 compared to 2021:
  - about 31.5 percent against the US dollar;
  - 23.2 percent against Thai baht.
- Inflation rose to 23.0 percent in 2022.
- Excise tax reductions on imported fuel:
  - diesel excise rate reduced from 21 percent to 0 percent;
  - regular gasoline excise rate reduced from 31 percent to 5 percent.
- Authorities implemented fiscal consolidation, tight monetary policy, and foreign exchange measures contributing to a more stable exchange rate of the Lao kip against the US dollar.
- Authorities agreed to continue tightening monetary conditions in 2023 to contain inflation, though they were more optimistic than staff about the decline in inflation.

### Fiscal policy measures and outcomes
- Commitment to tight fiscal stance via domestic revenue mobilization, reduction of public expenditure, and debt payment deferral.
- Five-year budget plan target: minimize the fiscal deficit to 1 percent on average and not to exceed 3 percent.
- Revenue-side measures:
  - Prime Minister’s Order on Enhancing Revenue Collection and Eliminating Revenue Leakage;
  - Tax Revenue Information System (TaxRIS) and integration of ASYCUDA into TaxRIS;
  - connections with databases of line ministries and relevant sectors (energy and mining, natural resources and environment, labor and social welfare, internal sector).
  - VAT rate to be increased from 7 percent to 10 percent after trial and reassessment.
  - Legislation development on land and construction tax, environmental tax, and amendments related to resource fees, concession fees and mineral export taxes.
  - Initiation of the Finlink system to centralize collection of taxes, customs, fees and public service charges and link with LAPNet.
- Expenditure-side measures:
  - Prime Minister’s Order on Streamlining Public Expenditure and Decree on Enhancing the Efficiency of Public Expenditure and Assets to improve transparency, competitive tendering, and fiscal discipline; halt poorly appraised public investment projects; determine ceiling of annual borrowings.
- Fiscal outcomes:
  - Fiscal deficit fell from -5.2 percent of GDP in 2020 to -1.2 percent in 2021 and -0.5 percent in 2022.
- Additional revenue plans:
  - closing import duty leakages, new excises, improving personal income tax collection, revenue growth from Thanaleng Dry Port;
  - strengthening tax authority capacity on oversight of e-tax systems and private sector tax declarations.
- Financing and debt measures:
  - negotiating deferral of interest and principal with bilateral creditors;
  - debt reprofiling and larger primary surpluses to reduce financing needs;
  - remaining financing to be sourced from sales of mining and hydroelectric concessions and fees, borrowing from commercial banks, and domestic and external issuance of bills.

### Monetary and exchange rate policies
- Tight monetary stance via issuance of bills, raising policy interest rate, and increasing reserve requirements for kip and foreign currency-denominated deposits.
- Policy rate changes:
  - raised from 3.1 percent in May 2022 to 6.5 percent in October 2022 and to 7.5 percent in February 2023.
- Reserve requirement changes in 2023:
  - kip reserve requirement increased from 5.0 to 5.5 percent;
  - foreign currency reserve requirement increased from 5.0 to 8.0 percent.
- Measures to improve foreign exchange management:
  - prioritized access to foreign exchange for fuel importing firms;
  - closure of foreign exchange bureaus in January 2023 so commercial banks supply foreign exchange directly to importing firms using the commercial banks’ exchange rate.
- BOL bill issuance:
  - June 2022: issued bills with total value of 5 trillion kip for general public;
  - February 2023 and March 2023: rolled over 2 trillion kip for general public and 1 trillion kip for open market operations.
- BOL requested IMF CDOT technical assistance to develop forecasting and policy analysis capabilities.

### Financial sector stability and regulatory reforms
- Banking system performance as of Q3 2022:
  - return on equity: 15.8 percent;
  - return on assets: 1.4 percent.
  - regulatory capital to risk-weighted assets: 18.5 percent;
  - capital to asset ratio: 14.6 percent (both above regulatory minimum of 8 percent).
  - non-performing loans: 2.1 percent of total gross loans.
- Liquidity indicators:
  - liquid assets to short-term liabilities ratio: 86.4 percent in Q3 2022 (up from 80.7 percent in Q4 2021).
  - cash reserve ratio of the banking system: about 4.3 percent, of which 3.8 percent is for foreign currency, above regulated level (2 percent) in Q3 2022.
- Operational actions:
  - two state-owned commercial banks restructured to improve performance.
  - BOL plans to gradually phase out COVID-19 exemptions in 2023.
  - CAR slump at Banque Pour Le Commerce Exterieur Lao Public (BCEL) in Q3 2022 attributed to flaws in data migration from implementation of International Accounting Standards; corrected in Q4 2022; BOL imposed prompt corrective action requiring a remedial plan.
- Prudential regulatory work in progress:
  - finalizing amendments to the Law on Commercial Banks;
  - Decision on Capital Adequacy Requirements (to align with Basel III);
  - Decision on Net Open Positions;
  - Decision on Liquidity Risk Management (including introduction of Liquidity Coverage Ratio);
  - Notice on Phasing out of Loan Forbearance.

### Structural reforms and AML/CFT
- Structural priorities to support growth, resilience, and inclusivity:
  - reduce regulatory burden on small businesses;
  - enhance consistent and transparent implementation of tax and regulation;
  - increase registration and labor formality;
  - improve educational attainment and skills training;
  - enhance trade facilitation, create a competitive environment for MSMEs, and develop human resources under the 9th NSEDP.
- AML/CFT reforms:
  - amending the Anti-Money Laundering and Combating Financing of Terrorism law (expected to be completed by 2024);
  - efforts to enhance implementation capacity and AML/CFT risk awareness among authorities;
  - commercial banks implementing AML monitoring rules and strengthening staff capacity;
  - National Committee for AML/CFT and AML Intelligence Office disseminating AML/CFT information via trainings and publications.

### Conclusion and policy priorities
- Authorities determined to place public debt on a downward trajectory to enhance fiscal sustainability and reduce inflation while promoting private sector development and raising labor productivity.
- Near-term policy focus:
  - ongoing fiscal and monetary consolidation;
  - sound exchange rate management to combat inflation;
  - efficient market functioning and financial stability.
- Authorities express commitment to implement recommendations and to continued engagement with the Fund.

*Source: IMF country report excerpt.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1laoea2023001.pdf_