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SINGAPORE, June 30, 2023 – The Lao PDR’s economy is expected to maintain its recovery from the COVID-19 pandemic in 2023. However, currency depreciation and surging inflation are challenges to sustaining the economic recovery. Sustained policy discipline in fiscal and monetary policies, is essential to re-establish macroeconomic stability. This preliminary assessment was made by the ASEAN+3 Macroeconomic Research Office (AMRO) after its Annual Consultation Visit to Lao PDR from May 18 to June 2, 2023.
The AMRO mission was led by Lead Economist, Sumio Ishikawa. AMRO Director, Kouqing Li, Chief Economist, Hoe Ee Khor and Deputy Director, Tetsuya Utamura, participated in the policy meetings. The discussions covered a wide range of macroeconomic and financial issues, focusing on vulnerabilities in the external, financial, and fiscal sectors, as well as achieving a more broad-based, inclusive, and sustainable growth.
“While Lao PDR’s economic growth is projected to accelerate to 4.8 percent in 2023 bolstered by the service sector, challenges in ensuring macro-financial stability remain,” said Dr. Ishikawa. “Downside risks include renewed currency depreciation, high inflation, banking sector soundness, and contingent liabilities of the government.”
Following the full reopening of borders, the tourism and logistics sectors will benefit from enhanced connectivity with neighboring countries, especially China, in 2023. Inflation surged to 23 percent year-on-year in 2022, driven by rising food and fuel prices, and is projected to average about 26 percent in 2023 before declining to 8 percent in 2024.
The external balances are expected to improve in 2023, supported by the recovery of tourism and FDI, on the back of enhanced connectivity and increased business opportunities in renewable energy. The exchange rate depreciated sharply in Q1-Q3 2022, triggered by an increase in fuel imports and amplified by accelerated currency substitution. Monetary tightening through the issuance of short-term Central Bank bills to mop up excess liquidity has helped stabilize the exchange rate.
A sustained cut in current expenditure and recovery in revenue led to an improvement in the overall fiscal balance in 2022. The deficit is expected to widen in 2023 due to a pick-up in capital expenditure and lower revenue in the absence of one-time licensing fees from crypto-industry and some mining pilot projects. Despite continued improvement in the primary balance, public debt has increased due to the issuance of arrear clearance bonds in 2021 and the valuation effects of recent currency depreciation.
Risks, vulnerabilities, and challenges
The external environment poses a risk to the economic outlook. Slower than expected recovery in China would weigh on Lao PDR’s growth and external position via lower exports and FDI. A possible spike in global energy prices could pressure the exchange rate, inflation and trade balance.
The government debt-to-GDP ratio would increase further with accelerated kip depreciation. Ongoing arrear clearance could also increase the government debt. Continued financial weakness in state-owned companies could impose a fiscal burden on the government.
Pockets of financial vulnerability remain as banks’ impaired loans could be higher. Nonperforming loans could increase upon the withdrawal of regulatory forbearance and/or if restructured loans of the electricity sector were to turn into bad debt. The recent kip depreciation would likely affect the debt servicing capacities of borrowers with foreign currency loans but with earnings in local currency.
The central bank should tighten its monetary policy further by reducing its monetary base. The central bank should reduce the growth of its credit provision to banks and other sectors in the economy, including the public sector, to avoid an excessive increase in monetary base. Issuing short-term BOL bills should be done judiciously, as the impact is temporary, and subsequent BOL bill redemption increases the monetary base. The central bank should sterilize the liquidity injection arising from the purchase of future debt-clearance bonds to reduce the pressure on the exchange rate and inflation. Sterilization can be done through issuing lower-interest BOL bills to banks or raising the reserve requirement ratio. The authorities are encouraged to adopt market-friendly policy measures to increase the FX supply in the onshore market. The implementation of FX management measures should be preceded by a careful assessment of risks. Policy measures to strengthen the banking sector’s soundness should be stepped up.
Ensuring fiscal discipline is crucial to prevent further arrears from recurring. The ceilings introduced to contain capital expenditure should be accompanied by rigorous monitoring of spending commitments and enforcement. Moreover, the authorities should step up their efforts to enhance public finance management.
The authorities should continue their fiscal consolidation efforts by improving revenue mobilization. The VAT rate should be restored to 10 percent from its current 7 percent level. The reform of the state-owned electricity company (EDL) should be accelerated so that it can repay its debt to the government, allowing the government to reduce its contingent liability. The government should consider raising electricity tariffs to the cost-recovery level for all sectors, while providing subsidies to offset the impact on vulnerable groups. Over the long term, the government should consider how to maximize the benefits from the transfer of the hydropower assets to the government under the Build-Operate-Transfer scheme, in order to strengthen its balance sheets.
Structural reforms should be expedited to bolster the momentum toward inclusive and sustainable growth. The authorities’ effort to establish the SME Promotion Agency is a welcome move to strengthen the SME Promotion Fund and enhance SMEs’ production capacity. The vocational training program should also be expanded to increase the supply of skilled workers, and business processes should be streamlined.
On behalf of AMRO, the mission team would like to express their appreciation to the Laotian authorities and other counterparts for their kind cooperation and insightful discussions.
The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute to the macroeconomic and financial resilience and stability of the ASEAN+3 region, comprising 10 members of the Association of Southeast Asian Nations (ASEAN) and China; Hong Kong, China; Japan; and Korea. AMRO’s mandate is to conduct macroeconomic surveillance, support regional financial arrangements, and provide technical assistance to the members. In addition, AMRO also serves as a regional knowledge hub and provides support to ASEAN+3 financial cooperation.