SINGAPORE, July 12, 2024 – The Lao PDR economy is projected to grow moderately by 4.5 percent in 2024 from 4.2 percent in 2023. Significant macroeconomic challenges, including kip depreciation and persistent high inflation, could hamper growth prospects. Concerns over elevated public debt service has increased uncertainty while weighing on sentiments. The authorities are encouraged to maintain a tight monetary policy stance and improve public debt sustainability to restore price and exchange rate stability.

This preliminary assessment was made by the ASEAN+3 Macroeconomic Research Office (AMRO) following its Annual Consultation Visit to Lao PDR from June 17 to June 28, 2024.

The mission was led by AMRO Lead Economist Sumio Ishikawa. AMRO Director Kouqing Li and Chief Economist Hoe Ee Khor participated in the policy meetings. The discussions focused on the risks and challenges facing the Lao PDR economy, particularly those related to the monetary, fiscal and external sectors; as well as policy recommendations to strengthen macro-financial stability.

Economic development and outlook

“Lao PDR’s economic growth is projected to pick up to 4.5 percent in 2024 from 4.2 percent in 2023. However, inflation remains elevated, and the exchange rate has continued to depreciate. There is an urgent need for tight monetary policy and stronger fiscal discipline to restore macroeconomic stability,” said Dr. Ishikawa.

Lao PDR continues to grapple with strong macroeconomic headwinds. Amid high debt service obligations, the kip has continued to depreciate in 2024, with the gap between the bank and parallel rates widening in recent months. Inflation accelerated to 31 percent year-on-year in 2023, with food prices increasing at the fastest rate, and is projected to remain high at about 25 percent in 2024.

Although the balance of payments swung to a surplus in 2023, Lao PDR’s external position remains vulnerable and foreign exchange reserve buffers remain low. The Bank of the Lao PDR (BOL) has further tightened monetary policy to absorb liquidity, including through the issuance of short-term bills. In its efforts to stabilize the exchange rate and to increase the supply of foreign currency in the market, the BOL implemented a new regulation mandating the repatriation and a minimum conversion requirement of export proceeds into the local currency.

The budget recorded a fiscal surplus in 2023 as growth in revenues outpaced expenditure. Fiscal balance is projected to revert to a moderate deficit in 2024 as increased expenditure and higher external interest payments more than offset higher revenues from the restoration of VAT rate from 7 percent to 10 percent. While public debt is expected to moderate over the medium term, gross financing needs remain high amid an increase in debt service due in the coming years.

Risks, vulnerabilities, and challenges

A continuing depreciation of the kip would heighten inflationary expectations and fuel a further increase in consumer price inflation. External debt burdens would also rise, exacerbating the already strained government finances. An escalation in kip depreciation would pose a significant challenge, particularly to state-owned enterprises (SOE) with large foreign currency debt and revenue in kip, while complicating the effectiveness of monetary policy.

Prolonged El Niño conditions and extreme weather conditions could affect major economic sectors, in particular the hydropower and agriculture sectors, and may intensify inflationary pressures.
Risks to public debt sustainability persist, as foreign currency debt service remains elevated. The authorities face significant challenges in issuing offshore bonds, which has been exacerbated by the downgrade of its sovereign credit rating in the Thai market. Refinancing risks and costs have also increased in recent years.

Policy recommendations

AMRO encourages the BOL to maintain a tight monetary policy. The issuance of short-term instruments to absorb excess liquidity is essential given the urgent need to reduce inflationary expectations and stabilize the exchange rate. In the long run, a market-based pricing mechanism, such as through bill auctions, should be implemented.

To stabilize the foreign exchange market, a more timely adjustment of the reference rate should be considered. Repatriation and conversion requirements should be implemented in close consultation with the exporters. These measures should be time-bound and periodically assessed, and policy details should be clearly communicated to the relevant stakeholders in a timely manner.

Amid ongoing economic headwinds, banking sector soundness should be strengthened, with decisive policy measures to raise the capital buffer in a systemically important bank and to enhance the supervisory and regulatory framework.

Fiscal discipline should be strengthened to restore fiscal sustainability. Public financial management systems should be improved to prevent the recurrence of arrears. Revenue mobilization efforts should continue by expanding the tax base and increasing the share of income-based taxes. The authorities should leverage the electronic tax systems to broaden the tax base and reduce tax compliance costs. VAT collection from digital services vendors to Lao PDR users should also be monitored.

The government should consider a more comprehensive restructuring of its external debt. This could help to lower its annual debt service payments over the medium term to a level that is consistent with its medium-term balance of payments projections. SOE reforms in the electricity sector should be accelerated to prevent the materialization of government contingent liabilities. In particular, a roadmap to increase the average electricity tariffs to the cost recovery level should be considered.

Promoting a more inclusive and sustainable growth calls for ambitious structural reforms across a wide range of sectors. These include strengthening transport and connectivity infrastructure, creating a more business-friendly environment, and accelerating progress toward addressing the effects of climate change. These measures would help to attract stronger inflows of foreign direct investment, thus providing a boost to competitiveness and growth prospects.

The AMRO team would like to express its appreciation to the Laotian authorities and other counterparts for their cooperation and insightful discussions during the mission.

About AMRO

The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute toward securing 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.