## 2. External Sector Assessment ## Source details **Canonical URL:** [2. External Sector Assessment](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1545.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1545.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1545.pdf.json) --- ### Context - Economy moving toward a “soft landing”; priority to strengthen external position and preserve financial stability. - Real GDP growth moderating from 8 percent in 2013; credit growth has abated from excessive levels; inflation has declined. - Significant gains in poverty reduction preserved; inequality has increased slightly. - External vulnerabilities: - Current account in large deficit. - International reserves inadequate for precautionary needs. - Exposure to downside external shocks: regional growth slowdown, deterioration in terms-of-trade, and capital inflow reversals. - Bank balance sheets showing signs of weakness after rapid credit growth. - Public and publicly guaranteed debt risen to a level requiring attention. ### Macroeconomic developments, outlook, and risks - Growth and inflation - Real GDP growth projected at about 7½ percent in 2014. - Mining production weakening due to moratorium on new mines and decline in global metal prices. - Inflation reduced to 3 percent (October 2014) from 6½ percent at end-2013. - Fiscal developments (FY2014) - Fiscal deficit declined to 4¼ percent of GDP in FY2014 from 5½ of GDP in FY2013. - Current spending (including arrears payment of ½ percent of GDP) close to budget. - Capital expenditure higher than planned as government paid down arrears by 1½ percent of GDP. - Revenue collection rose by 15 percent (y/y); tax revenues fell short of budget by about 2½ percentage points of GDP. - Treasury deposits cover 1½ months of current spending. - Monetary and credit conditions - Credit growth declined to 16 percent (y/y) from 35 percent (y/y) at end-2013. - Banks’ excess reserves have risen to 7 percent of GDP, from 5 percent of GDP at end-2013. - External sector and reserves - Current account deficit expected at 25 percent of GDP in 2014. - Portion of current account deficit financed by volatile flows remains high at 7 percent of GDP. - BOL intervention led to nominal effective appreciation of 3½ percent (y/y). - Real effective exchange rate appreciated by 5 percent compared to a year ago. - Kip estimated to remain overvalued by 10–20 percent relative to medium-term fundamentals (CGER-type analysis). - Gross international reserves estimated at 1 month of prospective imports (US$0.7 billion, August 2014). - External debt rose to 84½ percent of GDP in nominal terms (83½ percent of GDP in present value terms). - Risk of external debt distress increased and is verging on a transition to high risk (DSA). - Financial stability - Limits on foreign-currency lending and BOL measures rebuilt U.S. dollar liquidity buffers. - System NPL ratio estimated to have doubled during first half of 2014. - State-owned banks’ average NPL increased from 2 percent to about 8 percent; average capital-to-asset ratio declined to 3 percent. - Foreign-currency shares in total lending and deposits at 48 percent, down from 50 percent in 2013. - Outlook and scenarios - Near-term: moderate further cooling of activity; inflation projected to remain in the mid-single digits. - Baseline: current account projected to improve gradually to about 21 percent of GDP; reserves to rise only slightly to 1¼ months of imports by end-2015. - Medium term baseline: growth close to official target of 7½ percent supported by resource-related FDI and gradual pickup in nonresource investment. - Even with projected developments, external position remains fragile; reserves projected around 2 months of imports would pose significant risk to sustained growth. - Alternative scenario: medium-term fiscal consolidation, greater exchange rate flexibility, and tighter domestic monetary conditions yield lower near-term growth but reduce vulnerabilities and support robust medium-term growth. ### External vulnerabilities and risk assessment - Key vulnerabilities - Very thin international reserves cushion. - High external debt and significant foreign-currency lending exposing banks and public finances to exchange rate shocks. - Large nonresource current account deficit weighing on overall balance. - Risk scenarios and transmission - Large, abrupt exchange rate depreciation (triggered by terms-of-trade shock or decline in private capital inflows) - Impact: MH — loan repayment difficulties, defaults, loss of confidence in banks, deposit flight, heightened public debt distress, adverse macro-financial feedback loop. - Policy response: accelerate fiscal consolidation and trade/investment reforms; activate banking crisis management plan; ensure emergency liquidity while maintaining monetary control; orderly bank recapitalization and resolution; strengthen safety nets; stand ready to raise interest rates; after nominal exchange rate stabilization, lower interest rates and adjust fiscal policy to support recovery. - More expansionary fiscal policy - Impact: LHW — worse external position; monetary control and business confidence undermined. - Policy response: broaden revenue base; reduce exemptions; strengthen administration; increase excise tax and VAT rate; curtail non-essential spending; tighten domestic monetary conditions further. - Fiscal arrears clearance delayed - Impact: HM/L — weaker business and bank balance sheets; weaker private investment growth. - Policy response: announce clearance plan; curtail current spending; take prudential measures to ensure robust banks’ liquidity and solvency. - Protracted slower growth in advanced and emerging economies, slowdown/financial risks in China (medium-term) - Impact: H/MM — weaker exports (mineral and electricity), tourism receipts, investment inflows, grants, and remittances. - Policy response: adopt monetary policy framework with greater exchange rate flexibility; improve business climate; accelerate capital market development to enhance productivity and attract FDI. ### Authorities’ views - Authorities broadly concurred with staff’s near-term macroeconomic and financial sector outlook and were concerned about weaker mineral export prices and potential capital flow volatility from China’s slowdown and tighter U.S. financial conditions. - Authorities considered international reserves adequate based on their preferred metric: close to target of 5 months of official merchandise imports associated with non-FDI activities (a significantly lower metric than staff’s). - Authorities noted high nonbank private sector dollarization, which they argued reduces the need for precautionary international reserves. ### Policy discussions and recommendations — overall - Recommended policy package to entrench stability: - Continued fiscal consolidation. - Greater exchange rate flexibility. - Tighter domestic monetary conditions. - Measures to strengthen sound lending practices and crisis prevention. - Tradeoff: package would yield somewhat lower near-term growth than baseline but reduce near-term vulnerabilities and support robust medium-term growth. ### A. Fiscal policy — findings and recommendations - FY2015 projection and stance - Staff estimates fiscal policy will ease slightly in FY2015 due to weak mining revenue and higher nonwage current spending. - Deficit projected to rise to 4¾ percent of GDP in FY2015 from 4¼ percent of GDP in FY2014. - Nonmining deficit largely unchanged at 6¼ percent of GDP. - Revenue budgeted to grow by 20 percent over previous year’s outturn. - Civil service compensation budgeted to rise by 7 percent compared to last year’s outturn. - Capital spending budgeted to rise by 8 percent. - Measures expected to produce 1¾ percentage points of GDP in fiscal savings, but large budgeted increase in nonwage current spending would reduce fiscal savings by 1 percentage point of GDP, yielding a mildly contractionary expenditure stance. - Medium-term risks - Unless revenue efforts are strengthened and expenditure rationalization intensifies, consolidation would weaken over the medium term. - Identification of remaining arrears proceeding slowly; staff’s baseline assumes ½ percent of GDP in arrears payment in FY2015 and additional 1½ percent of GDP over medium term. - Under current policies, deficits expected to deteriorate beyond 5 percent of GDP in the medium term, with the nonmining deficit averaging at 7 percent of GDP. - Public debt outlook - Public and publicly guaranteed debt (excluding unidentified arrears) projected at 60 percent of GDP in 2014 (52 percent of GDP in present value terms). - Maintaining current policy trajectory would increase public debt to about 65 percent of GDP in the medium term. - Mobilization of new capital for state-owned banks could add to future public debt. - Public debt sensitive to large, abrupt exchange rate movements due to reliance on external borrowing. - Composition adjustments recommended - Maintain high-quality capital spending while facing declining grants as percentage of GDP. - Increase spending on education and health. - Civil service reforms to reduce compensation as a share of GDP and free space for critical capital and social spending. ### Fiscal consolidation: objectives, revenue, and expenditure reforms - Anchor strategy around a nonmining deficit target of no more than 5 percent of GDP. - Revenue mobilization and tax reforms (proposals) - Broaden the tax base by eliminating exemptions (mainly in CIT and VAT). - Flatten the PIT rate schedule. - Introduce taxes on property value. - Strengthen tax administration: establish a large taxpayer unit; increase technical capacity to raise mining revenues. - Raise the threshold at which VAT registration becomes compulsory. - Undertake comprehensive review of the tax system. - Strengthen control over spending and cash resources via a treasury single account (TSA). - Expenditure strategy and priorities - Contain public wage bill sustainably, including by accelerating civil-service reform. - Curtail non-essential current spending. - Control off-budget capital spending and target capital expenditure to support growth potential. - Potential uses of savings: raise health and education shares, pay down arrears, address contingent liabilities from state-owned bank recapitalization. ### Monetary and exchange rate policy - Current approach: commitment to keep the exchange rate within a reasonably wide and adjustable band; staff supports as anchor for macro-financial stability. - Staff recommendations: - Allow USD/kip to move more flexibly within the official +/–5 percent band. - Adopt tighter fiscal and monetary policies to support gradual buildup of reserves to around 4 months of import cover. - Occasional, modest intervention to prevent rapid exchange rate movements and anchor expectations. - Drain excess kip liquidity: options include resumption of BOL bill issuance, raising reserve requirements on kip deposits, accelerating unwinding of quasi-fiscal lending. - Liquidity management: ongoing collaboration between BOL and IMF experts to develop the interbank market. - Authorities’ stance: agree on low inflation and external stability objectives but cautious on immediate tightening and greater flexibility; expect reserves to rise in 2015 from government foreign-currency revenues sale and local governments’ loan repayment to the BOL. ### Financial stability: risks and recommended actions - Current risks - Rising measured credit risks, NPLs concentrated in public infrastructure-related activity. - Forbearance on prudential norms granted as banks restructure delinquent loans. - Growing excess liquidity could enable banks to expand credit and loosen lending standards. - Recommended comprehensive agenda - Expeditious recognition of NPLs, supported by diagnostic assessments of systemic banks. - Ensure all banks achieve minimum-mandated CAR of 8 percent in a prompt, time-bound manner after diagnostics. - Develop resolution options to deal with NPLs. - Strengthen financial supervision, phase out regulatory forbearance on a timeline. - Prepare contingency plan for banking sector: resolution authority, emergency liquidity assistance framework with safeguards, bank resolution framework, communications strategy. - IMF ready to provide further TA on supervision, crisis management, and stress testing. - Sound lending practices and additional measures - Clear and uniformly applied accounting framework. - Strong supervisory oversight and enforcement. - Collect corporate and household balance sheet information and obtain TA on assessing balance sheet risks. - Measures already taken: strict enforcement of regulation on net open FX positions; limits on FX lending to borrowers without sufficient FX income; cash-on-hand requirements; access to FX swap facilities with other central banks. - Additional suggested measure: maximum credit exposures in relation to capital. ### Debt sustainability — assessment and projections - Risk of external debt distress remains moderate but is on the cusp of transition to high risk. - Nominal stock of PPG external debt: - US$4.5 billion in 2012. - about US$5.1 billion at end-2013. - PPG external debt as percent of GDP: - 47.7 percent in 2012. - 48.3 percent at end-2013. - Net present value (PV) of PPG external debt: - 32.5 percent of GDP at end-2012. - 39.8 percent of GDP at end-2013. - Currency composition: about three-quarters contracted in U.S. dollars, renminbi, and SDR; rest in yen, euro, Thai baht and others. - Recorded domestic PPG debt (excluding arrears): - 12 percent of GDP in 2012. - about 11 percent of GDP at end-2013. - Total domestic and external PPG debt including arrears: about 59 percent of GDP at end-2013. - Macroeconomic assumptions underlying DSA - Baseline annual GDP growth projections: 2014: 7.4 percent; 2015: 7.2 percent; medium term: revert toward 7.5 percent. - GDP deflator growth (in USD terms) projected about 1 percent. - Bilateral exchange rate vis-à-vis USD expected to depreciate about 3.5 percent year-on-year starting in 2016. - Stress-test outcomes - Exchange rate depreciation risk has largest impact on debt dynamics. - One-off 30 percent depreciation shock would cause breaches of indicative thresholds for PV of debt-to-GDP, debt-to-revenue, and debt service-to-revenue ratios over a prolonged period. - Historical scenario (10-year averages) makes debt dynamics unsustainable for all debt stock indicators. - Staff recommendations - Fiscal consolidation to address heightened vulnerabilities. - Strengthen public investment management capacity. - Ensure debt sustainability considerations when contracting new debt as concessionality declines. - Monitor exchange rate and currency composition risks. ### Trade integration, competitiveness, and inclusive growth - Accelerating trade integration and increasing education and health spending would build on strengths and promote competitiveness and growth inclusiveness. - Strengths and challenges - Lao P.D.R. ranks favorably among frontier and developing Asian countries on overall competitiveness scale. - Labor productivity low compared to richer ASEAN neighbors, but productivity growth among highest. - Constraints: low vocational and tertiary enrollment rates; wage inequality relatively low but linked to gender and ethno-linguistic differences. - Policy priorities - Financial market development, education and training, statistics, and infrastructure upgrades. - Revise trade-related laws and regulations to meet WTO and AEC commitments. - Develop social safety nets for vulnerable workers and marginalized rural poor and ethnic minorities. - Use IMF TA to upgrade national accounts, prices, government finance statistics, and balance of payments statistics. - Poverty and distributional indicators - Poverty rate halved from 46 percent in early 1990s to 23 percent in 2013 (basic needs line). - Gini coefficient was 36.2 in 2013, rising from 32.5 in 2003. - Net enrollment rate among poor children aged 11 to 15 years was 28 percent vs. 57 percent among nonpoor children in 2013. ### Data quality, reporting, and statistical capacity - Significant constraints on surveillance from weak data and inadequate reporting. - Key areas deficient: national accounts, government finance, monetary and financial, and external sector statistics. - Recommended actions - Implement Strategies for the Development of the National Statistical System. - Commit to sustained capacity improvement and better coordination among agencies. - IMF ready to provide further TA with support from Bangkok TA office and IMF office in Vientiane. - Procedural recommendation: next Article IV Consultation on standard 12-month cycle. - Selected data adequacy notes - Gross international reserves: August 2014 observation; reported as US$0.7 billion (1 month of prospective imports). - CPI latest observation: October 2014. - Central bank and consolidated banking system balance sheet latest observations: August 2013. - External current account balance latest observation: Q2 2014. ### Staff appraisal: summary of risks and priorities - Progress: - Fiscal deficit and credit growth reduced; measured cooling in activity expected. - Inflation eased and should remain in mid-single digits barring major supply shocks. - Immediate stress in FX funding receded due to measures to contain FX lending. - Remaining vulnerabilities: - External position fragile; international reserves inadequate by several metrics. - REER estimated overvalued by 10–20 percent. - Large current account deficit and tightly-managed, overvalued exchange rate constrain reserves accumulation. - Public debt rising; risk of external public debt distress moderate but increasing. - Emerging bank weaknesses after a credit boom may constrain growth and add to public debt. - Recommended policy package (condensed) - Steady fiscal consolidation anchored around nonmining deficit target of no more than 5 percent of GDP. - Raise revenue via base broadening and strengthened administration; accelerate civil service reform. - Curtail non-essential current outlays and off-budget capital spending to allow faster arrears clearance. - Greater exchange rate flexibility within official band and tighter domestic monetary conditions to build reserves to four months of import cover; absorb excess kip liquidity. - Comprehensive approach to lending practices, supervision, and bank restructuring: NPL recognition, diagnostics, ensure minimum CAR of 8 percent, phase out forbearance, strengthen supervision, develop crisis contingency plans. - IMF ready to assist with TA and development of detailed plans. *LAO PEOPLE’S DEMOCRATIC REPUBLIC — INTERNATIONAL MONETARY FUND (excerpt).* ### 2. External Sector Assessment ___________________________________________________________________ 17 ### 2. External Sector Assessment ### Context - The economy has been moving toward a “soft landing,” with the key priority now to strengthen the external position and preserve financial stability. - GDP growth is moderating from 8 percent in 2013; credit growth has abated from excessive levels; inflation has declined. - Significant gains in poverty reduction over the past decade have been preserved; inequality has increased slightly. - External vulnerabilities remain a concern: - Current account continues to be in large deficit. - International reserves remain inadequate for precautionary needs. - Exposure to downside external shocks: regional growth slowdown, deterioration in terms-of-trade, and capital inflow reversals. - Bank balance sheets showing signs of weakness after rapid credit growth. - Public and publicly guaranteed debt has risen to a level that requires attention. ### Macroeconomic developments, outlook, and risks - Growth and inflation - Real GDP growth projected at about 7½ percent in 2014. - Mining production continues to weaken due to a moratorium on new mines and decline in global metal prices. - Inflation reduced to 3 percent (October 2014) from 6½ percent at end-2013. - Fiscal developments (FY2014) - Fiscal deficit declined to 4¼ percent of GDP in FY2014 from 5½ of GDP in FY2013, mainly from expenditure consolidation. - Current spending (including arrears payment of ½ percent of GDP) was close to budget. - Capital expenditure came in higher than planned, as the government paid down arrears by 1½ percent of GDP. - Revenue collection rose by 15 percent (y/y); tax revenues fell short of budget by about 2½ percentage points of GDP. - Treasury deposits cover 1½ months of current spending. - Monetary and credit conditions - Credit growth declined to 16 percent (y/y) from 35 percent (y/y) at end-2013. - Sharp expansion in BOL’s net domestic assets contributed to rapid reserve money and deposit growth. - Banks’ excess reserves have risen to 7 percent of GDP, from 5 percent of GDP at end-2013. - External sector and reserves - Current account deficit expected to remain large at 25 percent of GDP in 2014. - Portion of current account deficit financed by volatile flows remains high at 7 percent of GDP (Table 2). - BOL intervened to keep USD/kip stable, resulting in an appreciation of 3½ percent (y/y) in nominal effective terms. - Real effective exchange rate appreciated by 5 percent compared to a year ago. - Kip is estimated to remain overvalued by 10–20 percent relative to medium-term fundamentals (CGER-type analysis). - Gross international reserves estimated at 1 month of prospective imports of goods and services (US$0.7 billion, August 2014), slight increase from 0.8 month at last Article IV. - External debt rose to 84½ percent of GDP in nominal terms (83½ percent of GDP in present value terms) from about 80 percent of GDP the previous year (76 percent of GDP in present value terms). - Risk of external debt distress increased and is verging on a transition to high risk (DSA). - Financial stability - Limits on foreign-currency lending and BOL measures have rebuilt U.S. dollar liquidity buffers. - USD/kip bid-ask spread narrowed; parallel exchange rate premium became negligible. - Measured credit risks have risen: system NPL ratio estimated to have doubled during first half of 2014. - State-owned banks’ average NPL increased from 2 percent to about 8 percent; average capital-to-asset ratio declined to 3 percent. - Foreign-currency shares in total lending and deposits at 48 percent, down from 50 percent in 2013. - Outlook and scenarios - Near-term: moderate further cooling of activity; inflation projected to remain in the mid-single digits. - Current account projected to improve gradually to about 21 percent of GDP; reserves to rise only slightly to 1¼ months of imports by end-2015 under baseline. - Medium term baseline: growth close to official target of 7½ percent, supported by resource-related FDI and gradual pickup in nonresource investment; resource current account may turn into moderate surplus as large-scale power projects raise exports and moderate resource imports. - Even with projected developments, external position would remain fragile; reserves projected around 2 months of imports would pose significant risk to sustained growth. - Alternative scenario: medium-term fiscal consolidation, greater exchange rate flexibility, and tighter domestic monetary conditions would yield lower near-term growth but reduce vulnerabilities and support robust medium-term growth. ### External vulnerabilities and risk assessment - Key vulnerabilities - Very thin international reserves cushion. - High external debt and significant foreign-currency lending expose banks and public finances to exchange rate shocks. - Large nonresource current account deficit weighing on overall balance. - Risk scenarios and transmission - Large, abrupt exchange rate depreciation (triggered by terms-of-trade shock or decline in private capital inflows) - Impact: MH (medium-high) — loan repayment difficulties, defaults, loss of confidence in banks, deposit flight, heightened public debt distress, adverse macro-financial feedback loop. - Policy response: accelerate fiscal consolidation and trade/investment reforms; activate banking crisis management plan; ensure emergency liquidity while maintaining monetary control; orderly bank recapitalization and resolution; strengthen safety nets; stand ready to raise interest rates; after nominal exchange rate stabilization, lower interest rates and adjust fiscal policy to support recovery. - More expansionary fiscal policy - Impact: LHW (low-high with high likelihood?) — worse external position; monetary control and business confidence undermined. - Policy response: broaden revenue base; reduce exemptions; strengthen administration; increase excise tax and VAT rate; curtail non-essential spending; tighten domestic monetary conditions further. - Fiscal arrears clearance delayed - Impact: HM/L (high-medium / low?) — weaker business and bank balance sheets; weaker private investment growth. - Policy response: announce clearance plan; curtail current spending; take necessary prudential measures to ensure robust banks’ liquidity and solvency. - Protracted slower growth in advanced and emerging economies, slowdown/financial risks in China (medium-term) - Impact: H/MM (high / medium-medium) — weaker exports (mineral and electricity), tourism receipts, investment inflows, grants, and remittances. - Policy response: adopt a monetary policy framework with greater exchange rate flexibility; improve business climate; accelerate capital market development to enhance productivity and attract FDI. ### Authorities’ views - Authorities broadly concurred with staff’s near-term macroeconomic and financial sector outlook and were concerned about weaker mineral export prices and potential capital flow volatility from China’s slowdown and tighter U.S. financial conditions. - Authorities considered international reserves to be adequate based on their preferred metric: close to target of 5 months of official merchandise imports associated with non-FDI activities (a significantly lower metric than staff’s). - Authorities noted high nonbank private sector dollarization, which they argued reduces the need for precautionary international reserves. ### Policy discussions and recommendations - Overall policy package recommended to entrench stability: - Continued fiscal consolidation. - Greater exchange rate flexibility. - Tighter domestic monetary conditions. - Measures to strengthen sound lending practices and crisis prevention. - Expected tradeoffs: - If implemented, package would result in somewhat lower near-term growth than the baseline but would reduce near-term vulnerabilities and support robust medium-term growth. A. Fiscal Policy — findings and recommendations - FY2015 projection and stance - Staff estimates fiscal policy will ease slightly in FY2015 due to weak mining revenue and higher nonwage current spending. - Deficit projected to rise to 4¾ percent of GDP in FY2015 from 4¼ percent of GDP in FY2014. - Nonmining deficit largely unchanged at 6¼ percent of GDP. - Revenue budgeted to grow by 20 percent over previous year’s outturn (higher excise and VAT on petroleum, luxury goods, and vehicles; stricter customs enforcement; strengthened revenue administration). - Staff expects weak mining revenue to offset administrative gains, resulting in an expansionary revenue stance. - Civil service compensation budgeted to rise by 7 percent compared to last year’s outturn. - Capital spending budgeted to rise by 8 percent. - These measures expected to produce 1¾ percentage points of GDP in fiscal savings, but a large budgeted increase in nonwage current spending would reduce fiscal savings by 1 percentage point of GDP, yielding a mildly contractionary expenditure stance. - Medium-term risks - Unless revenue efforts are strengthened and expenditure rationalization intensifies, consolidation would weaken over the medium term. - Identification of remaining arrears is proceeding slowly; plans to address them remain unclear. - Staff’s baseline fiscal projection assumes ½ percent of GDP in arrears payment in FY2015 and additional 1½ percent of GDP over medium term. - Under current policies, deficits expected to deteriorate beyond 5 percent of GDP in the medium term, with the nonmining deficit averaging at 7 percent of GDP. - Public debt outlook - Public and publicly guaranteed debt (excluding unidentified arrears) projected at 60 percent of GDP in 2014 (52 percent of GDP in present value terms), requiring immediate attention. - Maintaining current policy trajectory would increase public debt to about 65 percent of GDP in the medium term, making the authorities’ target of 40–45 percent of GDP by the mid-2020s infeasible under reasonable consolidation policies. - Mobilization of new capital for state-owned banks could add to future public debt. - Public debt is sensitive to large, abrupt exchange rate movements due to reliance on external borrowing. - Recommended composition adjustments - More growth-friendly expenditure composition desirable: maintain high-quality capital spending while facing declining grants as percentage of GDP. - Increase spending on education and health to improve long-term competitiveness and growth inclusiveness. - Civil service reforms could reduce compensation as a share of GDP and free space for critical capital and social spending. _Italic: IMF staff summary of Chapter 2, "External Sector Assessment."_ ### 16. Medium-term fiscal consolidation should be based on stronger revenue efforts and ### 16. Medium-term fiscal consolidation should be based on stronger revenue efforts and ### Fiscal consolidation: objectives and framework - Anchor strategy around a nonmining deficit target of no more than 5 percent of GDP. - Objectives: - Reduce near-term external vulnerabilities. - Lower public debt in the medium-term. - Support a buildup of international reserves. - Key fiscal credibility measure: - Explain deviations from budget targets in the mid-term budget review to the National Assembly and outline corrective steps. ### Revenue mobilization and tax reforms - Main reforms proposed: - Broadening the tax base by eliminating exemptions (mainly in CIT and VAT). - Flattening the PIT rate schedule. - Introducing taxes on property value. - Strengthening tax administration: establish a large taxpayer unit; increase technical capacity to raise mining revenues. - Raise the threshold at which VAT registration becomes compulsory. - Supporting measures: - Undertake a comprehensive review of the tax system to support medium-term revenue mobilization. - Strengthen control over spending and cash resources via a treasury single account (TSA). - Improve revenue forecasts, and the recording and processing of arrears. - A TSA would also facilitate BOL’s liquidity management. - Implementation support: - Priority areas could be further developed in close cooperation with the IMF. ### Expenditure strategy and priorities - Three main elements: - Contain the public wage bill sustainably, including by accelerating civil-service reform. - Curtail non-essential current spending. - Control off-budget capital spending and target capital expenditure to support growth potential, in line with implementation capacity. - Potential uses of savings: - Raise the shares of health and education spending in the budget. - Pay down arrears. - Address possible contingent liabilities from state-owned bank recapitalization. ### Authorities’ views on fiscal measures - Agreement with staff’s fiscal assessment and recommendations. - Implementation caveats: - Upgrading technology and staff capacity will take time. - Revenue-side actions underway or planned: - Investment to upgrade technology and staff capacity for tax administration. - Focus on large taxpayers and taxes on vehicles, petrol, and luxury goods, with collection based on transaction prices instead of outdated reference prices. - More electronic declaration and payments at customs check points; intensified efforts to counter smuggling; electronic tax payments to enhance compliance. - Expenditure-side actions: - Set expenditure based on more conservative revenue projections. - Contain public sector wage bill through limits on new intake. - Rationalize capital spending and off-budget expenditure. - High-level committee established to quantify and resolve arrears and debts related to public infrastructure projects; resolution could take several years. - Transparency and consultation: - National Assembly would welcome further fiscal transparency. - Authorities welcome consultation with the Fund on expenditure rationalization experience. ### Monetary and exchange rate policy - Current approach: - Commitment to keep the exchange rate within a reasonably wide and adjustable band; staff supports this as an anchor for macro-financial stability. - Risks of a tightly managed peg: - Increasingly risky as U.S. recovery firms and the Fed exits unconventional support, given the overvalued real exchange rate, loose domestic monetary conditions, and thin reserves cushion. - Staff recommendations: - Allow the USD/kip exchange rate to move more flexibly within the official +/–5 percent band. - Adopt tighter fiscal and monetary policies to support a gradual buildup of reserves to around 4 months of import cover. - Occasional, modest intervention in foreign exchange markets to prevent rapid exchange rate movements and anchor expectations. - Liquidity management: - Drain excess kip liquidity from the banking system to enhance BOL’s monetary and inflation control and support the interbank market. - Options include resumption of BOL bill issuance, raising reserve requirements on kip deposits, and accelerating unwinding of quasi-fiscal lending. - Ongoing collaboration between the BOL and IMF experts to develop the interbank market. ### Authorities’ views on monetary policy - Authorities agree on objectives of low inflation and external stability but are not convinced about immediate need for monetary tightening and greater exchange rate flexibility. - Views and expectations: - Movements in kip vs. USD and Thai baht can strongly influence domestic prices. - Greater exchange rate flexibility would promote reserve accumulation, which authorities desire, but well-anchored exchange rate expectations are important to keep import cost and inflation in check and avoid capital outflows. - Tighter U.S. monetary conditions could cause capital flow reversal and lower net inflows to Lao P.D.R.; gross international reserves expected to rise in 2015 from government foreign-currency revenues sale and local governments’ loan repayment to the BOL. - Draining excess liquidity is not a near-term priority as credit growth is already declining, though more government bond issuance for liquidity management could be considered in the future. ### Financial stability: risks and recommended actions - Current risks and developments: - Financial stability concerns are rising despite lower credit growth; measured credit risks have increased as corporate sector leverage has risen. - Rising NPLs reportedly concentrated in public infrastructure-related activity have reduced bank profitability and capital cushions. - Forbearance on prudential norms has been granted as banks restructure delinquent loans. - Growing excess liquidity could enable banks to expand credit and loosen lending standards. - Recommended comprehensive agenda: - Expeditious recognition of NPLs, supported by diagnostic assessments of systemic banks by appropriate experts. - Ensure all banks achieve the minimum-mandated CAR of 8 percent in a prompt, time-bound manner after diagnostics. - Develop resolution options to deal with NPLs. - Strengthen financial supervision, with a timeline for phasing out regulatory forbearance. - Prepare a contingency plan for the banking sector in event of financial distress, including: resolution authority, an emergency liquidity assistance framework with safeguards, a bank resolution framework, and a communications strategy. - IMF ready to provide further TA on financial sector supervision, crisis management, and stress testing. - Sound lending practices to enhance resiliency: - Clear and uniformly applied accounting framework. - Strong supervisory oversight and enforcement. - Credit culture based on transparency, creditors’ rights, independent credit analysis, and effective debt resolution processes. - Collect corporate and household balance sheet information and obtain TA on assessing balance sheet risks to improve monitoring of exchange rate exposure. - Measures already taken to reduce exchange rate risks: - Strict enforcement of regulation on net open foreign exchange positions. - Limits on foreign-currency lending to borrowers without sufficient foreign-currency income. - Cash-on-hand requirements. - Access to foreign-currency swap facilities with other central banks could mitigate foreign-currency liquidity shocks. - Additional measures suggested: maximum credit exposures in relation to capital. ### Authorities’ views on financial sector reforms - Authorities share staff’s assessment and plan to move toward risk-based supervision in the medium term. - Recent developments and intentions: - Entry of foreign and private banks expanded access and commercial orientation. - External auditing requirements and a depositor protection system have contributed to financial stability. - Suspension of banking license issuance to review progress and address weaknesses. - Emphasis on strong regulatory enforcement to enhance credit quality and lower foreign exchange risks. - Coordination between BOL and Ministry of Finance to prioritize fiscal arrears settlement to limit new NPLs. - Options to strengthen state-owned banks are under review. - Recent approval of the AML/CFT law by the National Assembly and commitment to implement remaining items in the action plan agreed with the Financial Action Task Force. ### Enhancing competitiveness and inclusive growth - Strengths and challenges: - Lao P.D.R. ranks favorably among frontier and developing Asian countries on overall competitiveness scale, reflecting progress in product and labor market openness, health, and education. - Labor productivity is low compared to richer ASEAN neighbors, but productivity growth is among the highest. - Leading contributors to productivity improvement: finance, real estate, business services, transport and communication, and construction. - Constraints: low vocational and tertiary education enrollment rates; wage inequality relatively low but partly due to gender and ethno-linguistic differences. - Policy priorities: - Financial market development, education and training, statistics, and infrastructure upgrades. - Upgrade quality, coverage, and publication of basic economic and financial data. - Revise trade-related laws and regulations to meet WTO and AEC commitments to support trade integration and improve business climate. - Develop social safety nets for vulnerable workers, including those with less formal work arrangements. - Use IMF TA to upgrade national accounts, prices, government finance statistics, and balance of payments statistics. - Authorities’ actions: - Revisions to trade-related laws and regulatory regime to promote trade integration under WTO and AEC. - Efforts to enhance SMEs’ financial access and promote private investment. - Public investment in health and education expected to increase gradually, prioritizing rural health clinics and vocational training. - Infrastructure investment decisions increasingly based on efficiency and social return. ### Staff appraisal: summary of risks and priorities - Recent progress: - Fiscal deficit and credit growth reduced; measured cooling in activity expected in near term. - Inflation eased and should remain in the mid-single digits barring major supply shocks. - Immediate stress in foreign exchange funding has receded due to measures to contain foreign-currency lending. - Remaining vulnerabilities: - External position fragile; international reserves inadequate by several metrics. - Real effective exchange rate estimated to be overvalued by 10–20 percent. - Large current account deficit and tightly-managed, overvalued exchange rate constrain reserves accumulation and leave anchor vulnerable. - Public debt rising; risk of external public debt distress is moderate but increasing. - Emerging bank weaknesses after a credit boom may constrain growth and add to public debt. - Recommended policy package: - Steady fiscal consolidation anchored around a nonmining deficit target of no more than 5 percent of GDP. - Raise revenue via base broadening and strengthened administration; accelerate civil service reform to contain wage bill. - Curtail non-essential current outlays and off-budget capital spending to allow faster arrears clearance and necessary social and capital spending. - Greater exchange rate flexibility within official band and tighter domestic monetary conditions to build reserves to four months of import cover; absorb excess kip liquidity to limit exchange rate pass-through to prices and support interbank market. - Comprehensive approach to lending practices, supervision, and bank restructuring: NPL recognition, diagnostic assessments, ensure minimum CAR of 8 percent, phase out forbearance, strengthen supervision, and develop crisis contingency plans. - IMF ready to assist with TA and development of detailed plans. *LAO PEOPLE’S DEMOCRATIC REPUBLIC — INTERNATIONAL MONETARY FUND (excerpt).* ### 37. Accelerating trade integration and increasing education and health spending would ### _cr1545 - 37. Accelerating trade integration and increasing education and health spending would ### Trade integration, competitiveness, and inclusive growth - Accelerating trade integration and increasing education and health spending would build on existing strength, and promote competitiveness and growth inclusiveness. - Authorities have made progress on product and labor market openness and significant gains in poverty reduction. - Further trade integration is expected to: - improve the business climate, - promote private investment, - promote institutional reform. - Formal social safety nets for vulnerable workers, the marginalized rural poor, and ethnic minorities are recommended to ensure future growth benefits are better shared. ### Data quality, reporting, and statistical capacity - Significant constraints on surveillance arise from weak data, inadequate reporting, and minimal progress since the last Article IV consultation. - Key areas of deficiencies: national account, government finance, monetary and financial sector, and external sector statistics. - Shortcomings are largely due to lack of capacity. - Recommended actions: - Implement the Strategies for the Development of the National Statistical System. - Commit to sustained dedication to capacity improvement and better coordination among agencies. - The IMF stands ready to provide further TA, with active support from the technical assistance office in Bangkok and the recently established IMF office in Vientiane. - Procedural recommendation: next Article IV Consultation should take place on the standard 12-month cycle. ### Poverty reduction, inclusive growth, and vulnerabilities (Box 1) - Progress and outcomes: - The poverty rate, measured using a “basic needs” poverty line adjusted for inflation, was halved from 46 percent in the early 1990s to 23 percent in 2013. - Dramatic decline in maternal and child mortality rates and mortality from malaria and tuberculosis; country on track to achieve gender parity in primary education. - Public education and health spending described as "on the low side, compared to other LICs." - Remaining challenges and distributional patterns: - Large fraction of households remain close to or below the poverty line and vulnerable to macroeconomic shocks. - Vulnerable households tend to be rural, in northeastern and southern areas, isolated from main markets, belong to ethnic minority groups, and headed by persons with low education attainment. - Large school enrollment gap at lower secondary level: net enrollment rate among poor children aged 11 to 15 years was 28 percent, compared to 57 percent among nonpoor children in 2013. - Remittances have lowered poverty among recipient households but contributed to rising inequality. - Gini coefficient was 36.2 in 2013, rising marginally from 32.5 in 2003. - Policy actions suggested (based on cross-country experience): - Establish a policy framework that ensures macroeconomic stability and reduces vulnerabilities to shocks. - Support productivity growth, particularly in rural areas, through improvements in literacy and education, access to markets, health services and sanitation, and the investment climate. - Target resources toward the rural poor and ethnic minorities to address inequality of opportunities. - Strengthen social sustainability through policies directed to inclusive growth and fair resource allocation, in particular, land. - Provide employment opportunities and capacity building for farmers (training, equipment, education) to raise crop yields and conserve natural resources and the environment. - Target social spending and assistance for the vulnerable, and extend coverage beyond basic education and health services to enhance resilience to macroeconomic shocks. - Improve data monitoring, data quality, and publication to ensure information accuracy and reliability. ### External sector assessment (Box 2) - Overall assessment: the external position is highly vulnerable and requires strengthening. - Exchange rate and valuation: - The real effective exchange rate (REER) is estimated to be overvalued by 10–20 percent. - CGER-type analysis suggests the kip is overvalued by about 18–20 percent in real effective terms. - Equilibrium real exchange rate approach indicates an overvaluation of 13 percent, following the large real effective appreciation registered in 2008–13. - Estimates are subject to uncertainty due to weak data and a relatively high degree of dollarization. - Balance of payments and reserves: - External competitiveness has been eroded by persistent, high labor cost growth during 2009–13 (upward of 20 percent per year). - Despite robust foreign capital inflows dominated by FDI in hydropower projects, private non-FDI flows are estimated to have declined in 2013. - The core balance of payments—the portion of the current account not financed by FDI or official development assistance—is estimated to be in deficit at 10 percent of GDP, a slight improvement from 13 percent of GDP in 2012. - Measured against several metrics, gross international reserves are well below regional comparators and do not offer adequate protection: - In August 2014, reserves were equivalent to about 1 month of prospective imports of goods and services, 12 percent of broad money, and about 28 percent of foreign-currency deposits. - These metrics are all well below the levels desirable for countries with a fixed exchange rate regime and highly dollarized financial sector, according to the Fund’s reserve adequacy metric. - Recommended policy mix to reduce vulnerabilities: - Fiscal consolidation. - Tighter domestic monetary conditions. - A more flexible exchange rate. - Higher reserves. - Over time, structural reforms to improve productivity, particularly in the nonresource sector, to bolster external competitiveness. ### Exchange rate pass-through to inflation (Box 3) - Estimated methodology: Bayesian Vector Autoregression model (BVAR) using quarterly data over 2000–13, controlling for changes in producers’ marginal cost through international commodity, fuel, and food prices. - Main findings: - Exchange rate pass-through in Lao P.D.R. is partial and limited. - The inflation response from a 1 percent depreciation is less than one-tenth of a percent over the first two quarters. - The pass-through elasticity peaks in the sixth quarter, after which it declines. - The bilateral USD/kip and THB/kip exchange rates have similar pass-through over time. - The pass-through elasticity in Lao P.D.R. is in line with regional comparators, ranging from 0.15 in Indonesia to around 0.3 in the Philippines. - Lao P.D.R.’s median pass-through was about 0.2, but the margin of error in estimation is high. - Cross-country dynamics vary: Myanmar and Thailand show swift responses declining after two quarters; other countries, like the Philippines, can take up to two years to reach full impact. *Prepared by IMF staff; sourced from the IMF country report text provided.* ### Box 4. Lao P.D.R.: Tax System Productivity ### Box 4. Lao P.D.R.: Tax System Productivity ### Overview - Room for tax productivity improvement and revenue collection is substantial—up to twice or three times today’s levels—in corporate income tax (CIT), personal income tax (PIT) and the value-added tax (VAT). - A productive tax system can raise substantial revenue through a broad tax base, allowing tax rates and compliance costs to be kept low. - This box provides a high-level profile of the structure and performance of Lao P.D.R.’s tax system compared to regional peers, benchmarking the tax structure and revenue performance of three major taxes: CIT, PIT, and VAT. - All structure and performance benchmarking data are from FY 2012–13 and are sourced from the USAID Collecting Taxes Database. ### Aggregate revenue context - Lao P.D.R.’s tax revenue effort compared well with the LIC average at about 15½ percent of GDP in 2012. - Lao P.D.R. underperformed when viewed against the regional and world averages of 17 percent and 19 percent, respectively. ### Corporate Income Tax (CIT) - Statutory CIT rate: 35 percent. - Comparators: LIC average 29 percent; neighboring countries 24 percent; world average 24 percent. - CIT collection: comes in at the LIC average of 2½ percent of GDP. - Regional and world CIT revenue productivity: 5¾ and 3⅓ percent of GDP, respectively. - Key implication: At Vietnam’s CIT productivity level, Lao P.D.R.’s CIT collection would almost triple, ceteris paribus. ### Personal Income Tax (PIT) - PIT productivity is well below the regional average. - Contributing factors cited: - Excessive segmentation of the tax rate schedule. - Lack of a dedicated office to deal with large taxpayers, which hampers compliance work. - Key implication: PIT collection would almost double if productivity reached the average levels observed in the region, ceteris paribus. ### Value-Added Tax (VAT) - VAT statutory rate: similar to regional peers (rate not restated numerically in the box). - Underperformance drivers: - Low tax registration base. - Widespread use of exemptions and zero ratings. - Key implication: At Vietnam’s productivity levels, Lao P.D.R.’s VAT collection would almost double, ceteris paribus. ### Benchmarking and data notes - Regional comparators include Brunei, Cambodia, Indonesia, Malaysia, Myanmar, Philippines, Singapore, Thailand, Timor-Leste and Vietnam. - Countries with GNI per capita of less than $1,215 are classified as low-income countries. - Revenue productivity comparisons and figures referenced are drawn from IMF's Fiscal Affairs Department revenue performance database and USAID Collecting Taxes Database (FY 2012–13). ### Policy implications and priorities (explicitly implied by findings) - Broaden tax bases to raise productivity and allow for lower statutory rates and reduced compliance costs. - For CIT: - Improve tax administration to capture revenue consistent with higher-productivity peers (example benchmark: Vietnam). - For PIT: - Simplify and reduce excessive segmentation in the tax rate schedule. - Establish or strengthen a dedicated large-taxpayer office to improve compliance. - For VAT: - Expand tax registration coverage. - Reduce exemptions and zero ratings where feasible to broaden the base and raise productivity. *Prepared by Allan Dizioli; data and benchmarking from FY 2012–13 USAID Collecting Taxes Database and IMF Fiscal Affairs Department revenue performance database.* ### 5. Improve maternal health ### 5. Improve maternal health ### Maternal and related development indicators - Proportion of births attended by skilled birth personnel: 144250 - Maternity mortality rate (per 100,000 live births): 796357260 ### Related health and environmental indicators (adjacent MDG entries) - HIV prevalence among general population (percentage): 0.10.28less than 1 - Proportion of land areas covered by forests (percentage): 49.140.365 - Consumption of ozone-depleting substances (mt): 43.32.50 - Note: 1/ Provisional poverty estimate for Lao P.D.R. for 2012/13. - Source: United Nations and Government of Lao P.D.R. ### Summary assessment of debt sustainability and risk - The risk of Lao P.D.R. facing external debt distress remains moderate, but it is on the cusp of a transition to high risk, with heightened vulnerabilities for public debt. - External debt distress indicators are more elevated than in last year’s DSA, owing to: - the higher initial external PPG debt stock and projected debt flows to support public investment, - less concessional borrowing terms over time. - Buffers are very limited in the case of adverse shocks. - Large and sudden exchange rate depreciation could significantly raise the debt-to-GDP and the debt service-to-revenue trajectories for external and public debt, given the considerable share of foreign currency denominated debt. - Revenues from large resource projects are expected to mitigate risks over the long term. - Baseline breaches of thresholds under both the traditional and probability approaches are minor and temporary; nonetheless, breaches suggest heightened vulnerabilities to be addressed through fiscal consolidation and strengthening public investment management capacity. ### External PPG debt levels, composition, and indicators - Nominal stock of PPG external debt: - US$4.5 billion in 2012 - about US$5.1 billion at end-2013 - PPG external debt as percent of GDP: - 47.7 percent of GDP in 2012 - 48.3 percent of GDP at end-2013 - Net present value (PV) of PPG external debt: - 32.5 percent of GDP at end-2012 - 39.8 percent of GDP at end-2013 - Creditor composition at end-2013: - Bilateral creditors: 64 percent of total external PPG debt - Multilateral creditors: remainder (AsDB––20 percent; IDA––12 percent of total external PPG debt) - Currency composition (about three-quarters contracted in U.S. dollars, renminbi, and SDR; the rest consists of yen, euro, Thai baht and others) - Share of total PPG external debt (U.S. dollar, multilateral, bilateral figures shown in table form in source) - Recorded domestic PPG debt (excluding arrears): - 12 percent of GDP in 2012 - about 11 percent of GDP at end-2013 - Total domestic and external PPG debt including arrears: about 59 percent of GDP at end-2013 ### Debt service and sensitivity considerations - High level of concessionality of official borrowing helps keep external debt service ratios manageable. - PPG external debt service indicators expected to remain below policy-dependent indicative thresholds throughout the projection period in the baseline. - Almost half of total external PPG debt is contracted in U.S. dollars and concessionality of new borrowing is declining under current DSA assumptions, increasing sensitivity to large sudden currency depreciation shocks. - Very thin buffers mean other adverse shocks, including delayed fiscal consolidation, could push external PPG debt beyond sustainable levels, with some indicators breaching thresholds. ### Indicative thresholds and end-2013 indicators (policy-dependent, CPIA = medium) - Relevant indicative thresholds for medium CPIA: - PV of debt-to-GDP ratio: 40 percent - PV of debt-to-exports ratio: 150 percent - PV of debt-to-revenue ratio: 250 percent - Debt service-to-exports ratio: 20 percent - Debt service-to-revenue ratio: 20 percent - End-2013 indicators (as presented): - Present value of debt, in percent of GDP: 40 40 - Present value of debt, in percent of Exports: 150 92 - Present value of debt, in percent of Revenue: 250 221 - Debt service, in percent of Exports: 20 5 - Debt service, in percent of Revenue: 20 12 ### Macroeconomic assumptions underlying the DSA and baseline projections - Baseline annual GDP growth projections: - 2014: 7.4 percent - 2015: 7.2 percent - Medium term: revert toward 7.5 percent - Average real GDP growth over the projected period expected to be lower than in 2013 DSA due to lower projected mining sector growth. - GDP deflator growth (in USD terms) projected to be about 1 percent (lower than in 2013 DSA). - Bilateral exchange rate vis-à-vis USD expected to depreciate by about 3.5 percent year-on-year starting in 2016 and thereafter, consistent with the authorities’ exchange rate band of +/-5 percent. - Comparison of selected assumptions: 2013 DSA vs 2014 DSA - GDP growth: 6.9 6.6 - GDP deflator in U.S. dollar terms (percent): 2.2 1.5 - Non-interest current account deficit: 12.3 10.6 - Primary deficit: 1.6 1.9 - Box 1 baseline assumptions (2014–34) highlights: - Real GDP growth projected to average 7.5 percent during 2014–19; moderate to 6.3 percent on average during 2020–34. - Inflation (GDP deflator in USD terms) projected to average about 1.5 percent in 2014–34. - Current account deficit estimated at about 28.9 percent of GDP in 2013 and expected to decline to 25 percent of GDP in 2014. - External financing assumed largely concessional in near term; degree of concessionality decreases over time with more bilateral and commercial creditors and a projected share of commercial borrowing reaching about 10 percent of total new disbursements in the long term. - Fiscal policy projected neutral in the medium-term; primary deficit projected to peak at 3.6 percent of GDP in 2016 and remain about 3.4 percent of GDP on average over the medium term, then decline gradually to around 1.4 percent of GDP on average. ### Staff recommendations and policy priorities - Address heightened vulnerabilities through fiscal consolidation. - Strengthen public investment management capacity. - Ensure debt sustainability considerations are taken into account when contracting new debt, especially as concessionality declines and borrowing shifts toward market-based terms. - Monitor exchange rate and currency composition risks given large share of foreign currency denominated debt. - Consider the prospective returns from hydropower and mining projects (royalties, dividends, profit tax payments) as mitigating factors over the long run. *Source: LAO PEOPLE'S DEMOCRATIC REPUBLIC — STAFF REPORT FOR THE 2014 ARTICLE IV CONSULTATION—DEBT SUSTAINABILITY ANALYSIS* ### 12. Under the baseline scenario, the PV of external debt to GDP ratio is projected to be above ### _cr1545 - 12. Under the baseline scenario, the PV of external debt to GDP ratio is projected to be above ### Baseline scenario: external debt projections and immediate implications - The PV of external PPG debt-to-GDP ratio is projected to be above the policy dependent indicative threshold and decline in the medium term, indicating elevated debt distress risk relative to the 2013 DSA. - The primary drivers of the deterioration relative to 2013 are: - higher debt stock at the end of 2013, and - higher projected new borrowing with less concessional terms as Lao P.D.R. graduates from LDC status. - The current DSA forecasts a breach in the PV of external PPG debt-to-GDP ratio until 2018. - Other debt and debt service indicators remain below the policy-dependent indicative threshold during the entire forecast period under the baseline. ### Historical and alternative scenarios: stress-test outcomes and key shocks - Historical scenario (key variables set at 10-year historical averages): - Debt dynamics become unsustainable for all debt stock indicators. - The scenario reflects 10-year averages of higher current account deficit, real GDP growth, and growth of exports of goods and services than assumed under the baseline, requiring higher debt accumulation. - Alternative scenarios: - Exchange rate depreciation risk has the largest impact on debt dynamics. - A one-off 30 percent depreciation shock would cause breaches of the indicative threshold for: - the PV of debt-to-GDP, - debt-to-revenue, and - debt service-to-revenue ratios over a prolonged period. - While the PV of external PPG debt declines over the projection period under some scenarios, liquidity indicators worsen as indicated by increasing debt service ratios, raising concerns about a possible foreign-currency liquidity crunch. - A scenario with a negative shock to FDI inflows (net official transfers and net FDI falling in 2014-15 below historical averages) would force reduction of the current account deficit to avoid worsening the external debt position. ### Risk measurement: probability approach and resulting classification - The borderline high/moderate classification was addressed using a probability approach, which incorporates a country’s individual CPIA score and average GDP growth rate rather than discrete CPIA categories. - Under the baseline: - The probability of debt distress is lower than the threshold for all indicators, with the PV of debt-to-GDP ratio breaching its threshold only briefly. - Overall classification: - Given the small breach under the baseline and multiple breaches under alternative scenarios, the debt distress risk is classified as high/moderate, suggesting moderate risk verging toward high risk. - The risk of debt distress is particularly sensitive to significant exchange rate depreciation and to the historical scenario, which produces multiple threshold breaches. ### Public Debt Sustainability Analysis (PPG and public sector) - Key projections and levels: - PV of total PPG debt in percent of GDP and in percent of revenue are both projected to remain elevated over the long run under the baseline. - PV of public sector debt was estimated at 50.5 percent of GDP in 2013 and is expected to remain high and above the threshold until the end of the projection period in the baseline. - Drivers of elevated public debt metrics: - Faster amortization schedule on existing 2013 debt. - Higher projected disbursement schedule to support growth amid fiscal easing and limited public investment management and implementation capacity. - Assumed eventual shift from concessional to market-based borrowing terms and higher borrowing interest rates over time. - Expected trajectory: - PPG debt-to-GDP, debt-to-revenue, and debt service-to-revenue ratios are expected to increase over the projection period under baseline assumptions. - Scenario insights: - Fixed primary balance scenario (unchanged primary balance from 2014 for the entire projection period) yields higher PV of the debt-to-GDP and debt-to-revenue ratios than the baseline in the second half of the projection period. - Sensitivities: - A sudden 30-percent depreciation of the kip against the U.S. dollar would immediately raise the PV of public debt-to-GDP in the medium-term, with unfavorable implications for debt sustainability. - Indicator guidance: - Given expected increases in revenues from hydropower production not fully captured in fiscal revenues, debt service-to-exports ratio may be a more appropriate liquidity indicator than debt service-to-revenue ratio. ### Authorities’ views and policy-relevant institutional constraints - Authorities’ assessment: - Broad agreement with the overall assessment, but authorities do not foresee difficulties in servicing debt and expect lower new borrowing than assumed in the DSA. - Expect strong royalty, dividends, and profits; anticipate no difficulty finding creditors and servicing outstanding loans. - Point to a relatively long maturity profile of loans and U.S. dollar returns from exporting sectors as mitigating factors. - Borrowing and regulatory constraints noted by authorities: - Expect increase in disbursements of new funds from some bilateral donors between 2014 and 2019. - Current regulations restrict new external commercial borrowing to no more than 25 percent of government revenue. - Restrictions on borrowing for infrastructure and social development allow financing only on concessional terms with interest rates below 3 percent and long-term maturity. - Authorities indicated these guidelines could be modified if financing needs and financial conditions change. - Borrowing is expected to shift from external to domestic sources over time as domestic financing becomes cheaper; better access to nonconcessional loans is also expected. - Sectoral perspective: - Authorities highlighted that a significant part of external debt is related to viable, large resource projects and that energy sector projects will generate high and stable economic returns upon completion. - Expect external borrowing from China to decline going forward, focusing on the energy sector and on guaranteed terms only. *Source: IMF Staff report content (extract). * ### 21. Although Lao P.D.R.’s risk of external debt distress remains moderate, it is on the cusp of a ### _cr1545 - 21. Although Lao P.D.R.’s risk of external debt distress remains moderate, it is on the cusp of a ### Assessment of external and public debt risk - Risk of external debt distress: assessed as "moderate" but on the cusp of transition to "high risk" with heightened vulnerabilities for public debt. - Debt service ratios: remain within the policy-dependent indicative thresholds in the baseline, primarily because of the still high concessionality of official borrowing. - PV of external debt-to-GDP ratio: breaches the indicative threshold for some years in the baseline, leaving almost no buffers in the case of adverse shocks. - Probability approach (Laos-specific indicators): debt distress probability remains below the threshold in the baseline for all indicators, except the external debt-to-GDP ratio, which breaches the threshold for a brief period. ### Stress tests and shock scenarios - Large sudden exchange rate depreciation: - Could significantly raise the debt-to-GDP trajectory for external and public debt. - Could significantly raise the debt service-to-revenue trajectories for external and public debt. - Would put public debt dynamics on an unsustainable path well above the baseline. - Would elevate concerns about the sizeable private external debt share. - Most extreme stress tests (as referenced in figures): - The most extreme stress test is the test that yields the highest ratio on or before 2024. - Identified most extreme shocks in figures include "One-time depreciation shock" and "Non-debt flows shock" depending on the indicator. ### Indicators, dynamics, and vulnerabilities - Concessionality: still high for official borrowing, which helps keep debt service ratios within thresholds under baseline assumptions. - Currency composition: considerable share of foreign-currency denominated debt, amplifying vulnerability to exchange rate shocks. - Buffers: breaches of PV of external debt-to-GDP leave almost no buffers against adverse shocks. - Private external debt: elevated and would add to risks under large exchange rate shocks. ### Policy recommendations (staff) - Fiscal consolidation: address heightened vulnerabilities through fiscal consolidation as recommended by staff. - Strengthen public investment management capacity: improve public investment management to mitigate public debt risks. - Broader macro-financial measures implied by the analysis (from accompanying discussion): - Tighter fiscal and monetary policies. - A more flexible exchange rate. - Strengthened banking supervision to build international reserves and ensure macro-financial stability. - Long-run structural priorities noted in related sections: promote inclusive growth and poverty reduction via diversification into nonresource sectors, sustainable development of natural resources, further trade integration, and upgrading health and education infrastructure. *Source: IMF staff report excerpt for Lao P.D.R. (Figures and tables referenced: indicators of public and publicly guaranteed external debt under alternative scenarios, probability approach, and public debt indicators; stress-test methodology and scenario descriptions as presented in the source content).* ### 2. IMF Work ### 2. IMF Work ### IMF Work Program - Periodic staff visits by IMF HQ team and resident representative based in Hanoi: July 2014 — June 2015 - Technical Assistance missions and status: - Technical Assistance mission on natural resource revenue administration: Completed December 2013 - Technical Assistance mission on tax administration: Completed January 2014 - Technical Assistance on bank-supervision and regulations: Completed December 2013; November, 2014 - Technical Assistance on consumer prices/producer prices: Completed February 2014 - Technical Assistance on national accounts statistics: Completed March 2014 - Technical Assistance on monetary policy implementation: Ongoing Implementation throughout FY15 - Technical Assistance on crisis management: Completed June 2014 - Article IV Consultation: - Article IV Consultation: October 2014 - Board discussion: January 2015 - TAOLAM assistance and regular activities (Implementation throughout FY15 unless noted): - TAOLAM assistance on external sector statistics compilation: Regular staff visits; Implementation throughout FY15 - TAOLAM assistance on strengthening fiscal reporting, Government Finance Statistics (GFS): Regular staff visits; Implementation throughout FY15 - TAOLAM on public financial management - implementation of the cash-based IPSAS: Regular staff visits; Implementation throughout FY15 - TAOLAM on macroeconomic framework: Regular staff visits which started in October 2013; Implementation throughout FY15 ### Joint Work Program - External Debt Sustainability Analysis: - October 2014 - November 2014 ### Key operational timeline items - Regular staff visits and implementation activities emphasized across external sector statistics, fiscal reporting/GFS, public financial management (cash-based IPSAS), and macroeconomic framework throughout FY15. --- ### Relations with the Asian Development Bank (AsDB) - AsDB Country Partnership Strategy (CPS) 2012-2016 aligned with government’s Seventh Five-Year National Socio-Economic Development Plan, 2011–2015. - CPS priorities: - Engagement in four priority sectors: agriculture, natural resources and rural development; education; energy; and water and other urban infrastructure and services. - Crosscutting concerns: private sector development, gender equity, public sector management, regional cooperation and integration. - Operational goals: maximize efficiency and sustainability through larger operations implemented over a longer period; maximize synergies with the Greater Mekong Subregion (GMS) strategic framework 2012–22; increase responsiveness to emerging issues. - ADF allocation and performance-based funding: - ADF allocation for biennial period 2013–14: US$156.01 million - CPA for the next allocation period (2015–16) to be finalized by the end of 2014. - As of end-2013: - Outstanding loans/grants approved: US$715.0 million - Amount awarded for contracts: US$368.3 million - Disbursed during 2013: US$76.4 million - Contracts awarded during 2013: US$102.6 million - Approvals in 2013: - ADB approved three new loan projects totaling US$115 million - ADB approved four new technical assistance (TA) projects totaling US$2.5 million - Project areas included water supply and sanitation, GMS rural infrastructure development, private sector development program; TA projects related to health and road sector governance, smallholder, and support for improved aid effectiveness. ### ADB historical commitments and disbursements (2003–13) — selected figures (in millions of U.S. dollars) - Commitments (selected years): 2003: 34.9; 2004: 54.8; 2005: 87.6; 2006: 60.7; 2007: 47.4; 2008: 46.6; 2009: 81.2; 2010: 55.3; 2011: 53.2; 2012: 73.6; 2013: 102.6 (commitments and disbursements estimated for 2013) - Disbursements (selected years): 2003: 54.7; 2004: 48.5; 2005: 78.7; 2006: 76.8; 2007: 74.8; 2008: 56.9; 2009: 75.9; 2010: 61.5; 2011: 73.2; 2012: 68.6; 2013: 76.4 - Note: Starting from 2006, the commitments and disbursements included both loans and grants. --- ### Statistical Issues ### I. Assessment of Data Adequacy for Surveillance - General: - Data provision has serious shortcomings that significantly hamper surveillance, especially national accounts, government finance, monetary and financial, and external sector statistics. - Shortcomings mostly due to lack of capacity; IMF conducting TA and training programs focused on national accounts, prices, government finance statistics, monetary and financial statistics, and external sector statistics. - National Accounts (NA): - Annual GDP by activity at current and constant prices (base year=2002), broadly following SNA 1993. - Participation in IMF STA project to implement SNA and ICP funded by Japan through JSA. - Methodology improvements made; progress updating base year from 2002 to 2010. - Movement toward completing a new annual expenditure measure of GDP and a preliminary GNI series. - Some progress toward development of a new quarterly GDP series. - Under new JSA funding Project, a Real Sector Statistics Advisor for Lao P.D.R. and Bangladesh was appointed in January 2014 (stationed in Bangladesh) to assist with improvement of national accounts. - Price Statistics: - Monthly CPI compiled (December 2010=100) using weights based on the 2007/08 Lao Expenditure and Consumption Survey. - An update on the weights is expected for this year to be implemented in 2016 CPI collection. - A PPI is under development and planned for availability in March 2015. - 2012 economic census data will be used to develop PPI weights and sample of establishments. - PPI coverage currently restricted to mining and quarrying, manufacturing, and electricity; planned progressive expansion to tourism, construction, agriculture, services and other activities. - Government Finance Statistics (GFS): - GFS remain weak; timeliness of fiscal reporting needs significant improvement. - Off-budget activities are not included in fiscal data, though they have expanded rapidly. - Annual budget and outturn data formats do not follow international standards for GFS. - Except for annual data in the Official Gazette, no fiscal data are disseminated in the country. - March 2014 JSA-funded mission assisted the Fiscal Policy Department (FPD) of the Ministry of Finance (MoF) in upgrading compilation and dissemination procedures for GFS in line with migration to GFSM 2001. - JSA financed a resident advisor to assist updating and implementing GFSM 2001 (GFSM 2014) migration action plans, provide training on GFS, promote interagency interaction, and coordinate GFS reporting with other fiscal reporting activities. - Authorities will be assisted in disseminating GFS data on their websites and reporting data for publication. - Monetary and Financial Statistics: - Classification of monetary data by institutional sector and by financial instrument as well as valuation principles need strengthening. - Latest monetary data reported to STA refer to December 2010. - Standardized Report Forms (SRFs) have yet to be introduced. - STA conducted a one-week training course for the Bank of Lao in February 2014 to build capacity of monetary compilers. - External Sector Statistics: - STA appointed an External Sector Statistics (ESS) Advisor to TAOLAM in February 2014. - Since appointment, the Advisor conducted three missions focused mainly on trade. - Missions assisted in reconciling discrepancy between imports data published by the Bank of Lao and imports derived from partner countries’ data in Direction of Trade Statistics; use of minimum prices to value vehicles and petroleum imports might explain some differences. - Several balance of payments components are missing due to lack of source data. - BOL balance of payments compilers designed an FDI survey questionnaire in context of World Bank’s LAOSTAT-Strengthening the National Statistical System Project. - Coordination on FDI needed as the European Union has also appointed an expert to assist on FDI statistics. - Implementation of new international transactions reporting system (ITRS) is ongoing; testing of new ITRS expected by June 2015. - BOL does not yet compile an international investment position statement. ### II. Data Standards and Quality - Lao P.D.R. is currently not a General Data Dissemination System (GDDS) participant. - Government expressed intention to collaborate with IMF to move macroeconomic statistics closer to international standards, including joining the IMF’s GDDS as framework for national data compilation and dissemination practices. - No Data ROSC mission has been conducted. - Financial sector surveillance: - Lao P.D.R. does not produce Financial Soundness Indicators (FSIs) yet. --- ### Table of Common Indicators Required for Surveillance (As of November 26, 2014) — selected entries - Exchange Rates: - Date of Latest Observation: 11/25/14 - Date Received: 11/25/14 - Frequency of Data: D - Frequency of Reporting: D - Frequency of Publication: D - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: - Date of Latest Observation: August 2014 - Date Received: 10/21/14 - Frequency of Data: M I Q - Reserve/Base Money: - Date of Latest Observation: August 2014 - Date Received: 10/21/14 - Frequency of Data: M I Q - Broad Money: - Date of Latest Observation: August 2014 - Date Received: 10/21/14 - Frequency of Data: M I Q - Central Bank Balance Sheet: - Date of Latest Observation: August 2013 - Date Received: 10/21/14 - Frequency of Data: M I Q - Consolidated Balance Sheet of the Banking System: - Date of Latest Observation: August 2013 - Date Received: 10/21/14 - Frequency of Data: M I Q - Interest Rates: - Date of Latest Observation: September 2014 - Date Received: 10/21/14 - Frequency of Data: M - Consumer Price Index: - Date of Latest Observation: October 2014 - Date Received: 11/02/14 - Frequency of Data: M - Revenue, Expenditure, Balance and Composition of Financing — General Government: - Date of Latest Observation: September 2014 - Date Received: 10/21/14 - Frequency of Data: I - Revenue, Expenditure, Balance and Composition of Financing — Central Government: - Date of Latest Observation: September 2014 - Date Received: 10/21/14 - Frequency of Data: Q I M - Stocks of Central Government and Central Government-Guaranteed Debt: - Date of Latest Observation: December 2013 - Date Received: 10/21/14 - Frequency of Data: NA - External Current Account Balance: - Date of Latest Observation: Q2 2014 - Date Received: 10/21/14 - Frequency of Data: Q I I - Exports and Imports of Goods and Services: - Date of Latest Observation: Q2 2014 - Date Received: 10/21/14 - Frequency of Data: Q I I - GDP/GNP: - Date of Latest Observation: 2012/13 - Date Received: 10/21/14 - Frequency of Data: A - Gross External Debt: - Date of Latest Observation: Dec 2013 - Date Received: 10/21/14 - Frequency of Data: A A I - International Investment Position: - Frequency of Data: NA Notes (as listed): - D: Daily; W: weekly; M: monthly; Q: quarterly; A: annually; I: irregular; NA: not available. - Additional explanatory footnotes on reserves, interest rates, financing, general government coverage, debt composition, and IIP scope appear in the table. --- ### Statement by the Staff Representative on Lao People’s Democratic Republic (January 14, 2015) — selected update - Information since staff report circulated on December 17, 2014 does not alter thrust of staff appraisal. - Real GDP growth: - 7.8 percent (y/y) in fiscal year 2014 (October 2013–September 2014). - For calendar year 2014, growth is estimated at around 7½ percent, broadly in line with staff’s forecast. *Source: _cr1545 - 2. IMF Work* ### 3. Inflation edged down slightly on a year-on-year basis to 2.8 percent in November ### 3. Inflation edged down slightly on a year-on-year basis to 2.8 percent in November ### Inflation and near-term outlook - Inflation: 2.8 percent in November (3.0 percent in October), reflecting slowing nonfood price increases and lower energy prices. - Inflation in 2014 is likely to be slightly lower than staff’s forecast. - Staff projection: inflation is projected to remain in the mid-single digits as growth moderates in the near term. - Authorities’ view: CPI inflation was 2.8 percent in November 2014 from 6.6 percent a year ago; expected to moderate at 5.6 percent in 2015. ### Recent macroeconomic developments and growth - Real GDP growth: moderated from 8 percent in 2013 to 7½ percent in 2014 (staff statement). - Authorities’ reported growth: 7.8 percent in FY 2014, from 8.0 percent in 2013 and 7.9 percent in 2012. - Authorities’ projection for 2015: economic growth projected at 7.5 percent driven by industry and services at 9.0 percent and agriculture at 3.0 percent; staff projection of 7.2 percent. ### External position and reserves - Current account deficit: expected to remain large at 25 percent of GDP in 2014 (staff). - Projected current account deficit: about 21 percent of GDP in 2015 (staff). - International reserves: US$0.7 billion, August 2014 (1 month of prospective imports of goods and services); projected to rise only slightly to 1¼ months of imports with lower capital inflows. - Authorities’ reported current account deficit: expected to come down to 25 percent of GDP in 2014 and to 21.3 percent of GDP in 2015. - Gross official reserves (table): 662 (2013), 750 (2014 est.), 870 (2015 proj.) in millions of U.S. dollars. - Reserves in months of prospective imports (table): 1.0 (2013), 1.1 (2014 est.), 1.2 (2015 proj.). ### Financial sector and banking system risks - Bank balance sheets: signs of weakness with rising nonperforming loans (NPL) and weaker capital and profitability. - System NPL ratio: estimated to have doubled during the first half of 2014. - State-owned banks’ average NPL: reported to have increased from 2 percent to about 8 percent during the first half of 2014. - State-owned banks’ average capital-to-asset ratio: declined to 3 percent (first half of 2014). - Foreign-currency exposure: foreign-currency shares in total lending and deposits at 48 percent (down from 50 percent in 2013). - Authorities’ measures: strict enforcement of regulation on banks’ net open foreign exchange positions and limits on foreign-currency lending; measures to improve foreign currency liquidity at banks. ### Fiscal developments and public debt - Public and publicly guaranteed debt (excluding arrears): projected at 60 percent of GDP in nominal terms (52 percent of GDP in present value terms) in 2014 (staff). - Fiscal stance: after sharply expansionary and procyclical stance in 2013, authorities started to tighten fiscal policy in 2014 through curbs on civil service compensation and capital spending cuts. - Budget deficit: declined to 4.2 percent of GDP in 2014 from 5.6 percent of GDP a year ago (authorities). - Authorities’ 2015 plan: maintain the budget deficit around 4.7 percent of GDP in 2015 by containing recurrent expenditure, improving tax administration, and strengthening public financial management. - Public finances (table, selected items as percent of GDP): - Revenue and Grants: 23.9 (2013), 23.6 (2014 est.), 22.5 (2015 proj.) - Expenditure: 29.6 (2013), 27.9 (2014 est.), 27.2 (2015 proj.) - Overall balance: -5.6 (2013), -4.2 (2014 est.), -4.7 (2015 proj.) - Nonmining balance: -7.8 (2013), -6.3 (2014 est.), -6.2 (2015 proj.) - Authorities’ fiscal measures: suspension of wage rise in civil service, recruitment quotas, committee to resolve arrears, reforms to procurement and project management, VAT/accounting law amendments, revised customs and budget laws, tax administration strengthening, change from reference price to actual transaction price for automobile, fuel imports and luxury goods valuation. ### Executive Board assessment and policy recommendations - Board summary: welcomed policy corrections and macro stabilization progress but noted significant vulnerabilities in external, fiscal, and financial sectors. - Key Board recommendations: - Continued fiscal consolidation anchored around a nonmining deficit target of no more than 5 percent of GDP. - Further revenue mobilization, rationalization of current and off-budget capital expenditures, and containment of public sector employee compensation (including accelerating civil service reform). - Enhanced fiscal transparency and strengthened public financial management, including elimination of fiscal arrears. - Greater exchange rate flexibility within the official band, supported by tighter kip liquidity and interventions limited to preventing excessive volatility. - Tighter monetary conditions, strengthened financial supervision, prompt recognition of nonperforming loans, phasing out regulatory forbearance, strengthening supervisory and lending practices, and recapitalizing state-owned banks. - Technical and capacity-building assistance from the Fund where helpful. - Full implementation of the AML/CFT law’s action plan with the Financial Action Task Force. - More resources to enhance the quality, availability, coverage, and publication of economic and financial data; encouraged authorities to request further Fund technical assistance. - Measures to support inclusive growth: further trade integration, improvements in education and health infrastructure, adoption of a clear and unified accounting framework, strengthened creditors’ rights and credit analysis, improved financial transparency, and implementation of an effective debt resolution process. ### Monetary and exchange rate policy framework - BOL objectives: attain price and exchange rate stability by setting annual target band for exchange rates and reference rates for commercial banks. - Exchange rate management: limit currency fluctuations vis-à-vis major currencies within ±5.0 percent per annum. - Commercial banks and FX bureaus required to maintain buying and selling rates within: - ±0.25 percent of BOL’s daily reference rates for US dollar, - ±0.5 percent for Euro and Thai Baht, - ±2.0 percent for other currencies. - Authorities’ reported exchange rate developments: Kip appreciated by 3.5 percent in nominal effective term and 5.0 percent in real term in 2014 compared to a year ago; appreciation broadly in line with regional currencies and flexible within the target band. ### Selected economic and financial indicators (selected entries from table) - Real GDP growth: 8.1 (2010), 8.0 (2011), 7.9 (2012), 8.0 (2013), 7.4 (2014 est.), 7.2 (2015 proj.) - CPI (annual average): 6.0 (2010), 7.6 (2011), 4.3 (2012), 6.4 (2013), 4.3 (2014 est.), 5.0 (2015 proj.) - CPI (end year): 5.8 (2010), 7.7 (2011), 4.7 (2012), 6.6 (2013), 3.6 (2014 est.), 5.6 (2015 proj.) - Exports (millions of U.S. dollars): 2,196 (2010), 3,120 (2011), 3,323 (2012), 3,882 (2013), 4,119 (2014 est.), 4,498 (2015 proj.) - Imports (millions of U.S. dollars): 3,574 (2010), 4,635 (2011), 6,340 (2012), 7,283 (2013), 7,604 (2014 est.), 7,756 (2015 proj.) - Current account balance (in percent of GDP): -20.0 (2010), -17.3 (2011), -30.2 (2012), -28.9 (2013), -25.0 (2014 est.), -21.3 (2015 proj.) - External PPG debt (percent of GDP): 48.1 (2010), 46.7 (2011), 47.7 (2012), 48.3 (2013), 48.5 (2014 est.), 48.7 (2015 proj.) - Bank credit to the private sector (annual percent change): 48.4 (2010), 39.3 (2011), 35.1 (2012), 36.3 (2013), 14.0 (2014 est.), 24.0 (2015 proj.) *Source: IMF Executive Board conclusion and Lao P.D.R. authorities’ statements, Press Release No. 15/78, February 26, 2015 (Article IV consultation with Lao People’s Democratic Republic).* ### 17. The authorities welcome staff’s assessment that the BOL’s commitment to keep the ### _cr1545 - 17. The authorities welcome staff’s assessment that the BOL’s commitment to keep the ### Exchange rate policy and monetary stance - Authorities welcome staff’s assessment that the BOL’s commitment to keep the exchange rates within a reasonably wide and adjustable band has provided an anchor for macro-financial stability. - Authorities are cautious about staff’s recommendation to tighten monetary conditions given: - slowdown in credit growth from 34.5 percent of GDP in 2013 to 15.7 percent in 2014 - relatively low level of inflation ### External sector and reserve management - BOL measures to strengthen international reserves include: - suspension of foreign currency lending to local governments and state-owned enterprises since last few years - collecting outstanding loans - intensifying enforcement of foreign currency related regulations - enhancing the mechanism for regulating foreign exchange transactions to monitor daily trading activities in a more real-time basis - Authorities expect to maintain adequate foreign exchange reserves to cover imports at least for 5 months by the end of 2015. - Authorities urge caution in using trading partners’ export data as a proxy for Laos’ imports because a significant part of unrecorded import content is re-exported to other countries. - Authorities agree there could be scope for exploring the discrepancy in the measurement of imports and enhancing the authorities’ data collection system. ### Financial sector soundness and supervision - Banking sector described as sound with: - strong capital base - ample liquidity - low level of NPLs - Prudential and supervisory actions taken or underway: - tightened prudential regulation to closely monitor credit quality and ensure good underwriting standards, especially for banks with NPL ratio of more than 3% - regulations to control single lending limits to mitigate concentration risk - prohibition of connected lending to shareholders, directors and subsidiaries - Adoption and capacity building: - authorities are in the process of adopting Basel II capital standard with technical support from the WB and the Bank of Thailand - supervisory capacity and regulatory framework are being strengthened - enhancements under the ASEAN Banking Integration Framework underway - AML/CFT law has recently been approved by the National Assembly, helping enable business environment and strengthen public confidence in the banking system - Money and capital markets development: - creating FX trading monitoring system - promoting active interbank market - strengthening financial market infrastructure - introduced End of Day Liquidity Management Program (EoDLMP) since May 2014 to ensure adequate liquidity in the banking system - regulations related to the derivative markets are underway - Licensing policy: - temporarily suspended new licenses to private banks until 2016, pending overall performance assessments of the banking sector and crafting a new licensing policy ### Structural reforms and statistics - Recent laws and regulations enacted include those related to: - AML/CFT - import licensing - custom valuation - investment - technical barriers to trade - intellectual property right - Administrative and trade facilitation measures: - establishment of a one-stop shop to coordinate the application for foreign investment - modernization of the electronic data interchange system to better facilitate cross-border trades - Authorities believe initiatives will create a conducive business climate for more broad-based and inclusive growth. - Statistical capacity: - authorities are strengthening macroeconomic and financial sector statistics and improving compliance with international guidelines - authorities welcome the Fund’s technical assistance to enhance statistical capacity going forward ### Conclusion and policy priorities - Authorities cite successful implementation of the 7th national socio-economic plan and are crafting a new plan to address bottlenecks in achieving LDC graduation by 2020. - Main intended policy directions: - enhance business environment - improve efficiency of public services - reform public financial management - build up fiscal and monetary policy space - strengthen banking regulatory and supervisory framework - enhance access to financial services - Authorities welcome constructive policy dialogue with the mission team and express appreciation to the Mission Chief, Mr. Ahuja, and the Fund for continuing support. *Source: IMF staff and Lao authorities text as provided in the content unit.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr1545.pdf_