## Lao P.D.R.: Assessment Letter for the Asian Development Bank and World Bank (March 10, 2005)

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### Economic conditions and outlook
- Macroeconomic stability indicators:
  - Exchange rate: kip strengthened to around KN 10,300 per dollar.
  - 12-month rate of inflation: 7 percent in February.
  - External reserves: 3½ months of imports.
- Recent growth and drivers:
  - Staff estimate growth at 6 percent in 2004, based upon a recovery in agriculture and hydroelectricity output and a rebound in tourism.
- Short-term projection (conditional on sound macroeconomic policies and specific policy actions):
  - Growth projected to rise to 7 percent driven by a sharp increase in mining output.
  - Inflation expected to remain in single digits.
  - Buoyant export growth and donor inflows should facilitate a further build-up in external reserves in 2005.
  - Positive outlook contingent on implementation of steps to strengthen the 2004/05 budget and contain credit expansion at the state banks.
- Medium-term assessment:
  - Outlook broadly unchanged from the 2004 Article IV Consultation.
  - Potential to sustain robust growth and achieve significant poverty reduction with a number of major foreign projects in the pipeline and progress on structural reform.
  - Key reform priorities: revenue mobilization, banking and state-owned enterprise reforms.
  - Given high public debt burden, prudent debt management and ensuring a high degree of concessionality on any new loans emphasized.

### Recent policy developments and staff recommendations
- 2004/05 budget concerns and recommendations:
  - Staff judged the approved National Assembly revenue target of 12.2 percent of GDP to be overambitious.
  - Proposed alternative revenue target: 11.4 percent of GDP for the 2004/05 budget.
  - Proposed limits on increases in wages and allowances: limit increases to 20 and 30 percent, respectively, to contain wage expense growth to sustainable levels.
  - Authorities intend to submit a revised budget to the National Assembly in April 2005 broadly in line with staff recommendations and seek approval of a package of tax measures including reform of the turnover tax.
  - Adoption and effective implementation of the revised budget deemed essential for safeguarding macroeconomic stability.
- Monetary framework for 2005:
  - Staff proposed a framework to consolidate recent decline in inflation by allowing the central bank’s net domestic assets to decline gradually over the year to accommodate a build-up in international reserves to around 4 months of imports.
  - Monetary stability hinges on fiscal discipline and tight control over credit growth at state banks.
  - Staff urged retention of tight limits on expansion of state banks’ net domestic assets and strengthening of regulatory regime governing extension of credits, particularly single borrower exposures.
  - Authorities are working on revised regulations with assistance of a Fund banking supervision expert.
- Structural reforms—status and actions needed:
  - Revenue reforms: only limited progress; a government instruction assigning responsibility for tax and customs operations to the provinces represents a setback, although center retains supervisory role per regulations.
  - Customs: progress strengthening oversight of largest customs posts; authorities plan to submit a new customs law to April 2005 session of the National Assembly—broadly consistent with Fund advice.
  - Tax department: reforms proceeding slowly; SIDA-assisted steps to prepare a plan for implementation of the VAT.
  - Investment laws: new laws passed in October consistent with staff understandings, but initial implementing regulations lack key provisions (control over tax incentives administration by Ministry of Finance and protection of future VAT from tax exemptions).
  - State banks and banking sector reform:
    - Some progress in operational reform of state banks, but recapitalization and implementation of governance agreements—especially credit management procedures—have been problematic.
    - Draft amendments to the banking law to strengthen competition finalized and forwarded to the National Assembly.
    - Specific concerns: cases where banks’ procedures were overridden, resulting in loans extended in breach of sound lending principles.
  - Fund safeguards policy: outstanding issues unresolved; staff unable to reach understandings on a compromise proposal to commission a targeted review of the central bank’s external reserves and reserve money by an international audit firm.

### Status of Fund relations
- PRGF arrangement:
  - Arrangement approved in April 2001 for SDR 31.7 million.
  - To date, three reviews completed with SDR 18.1 million disbursed (the third review completed in September 2003).
  - Completion of the fourth review delayed due to slow progress on structural reforms and outstanding safeguards issues.
  - Arrangement due to expire on April 24, 2005; no further disbursements expected before that date.
- Future engagement:
  - Fund expects to remain engaged in close policy dialogue after arrangement expiry.
  - Fund staff plan two missions to Lao P.D.R. in the year, one coinciding with the annual Article IV Consultation.
  - Fund staff agreed to provide assessment letters to the World Bank and other donor partners after each mission.

*Contact person: Mr. Ben Bingham (bbingham@imf.org, (202) 623-4258).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2006/_031005.pdf_