Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431
Dear Mr. Köhler:
We have been authorized by the Government of the Lao People's Democratic Republic (Lao
P.D.R.) to Inform you that the Government has adopted an economic and financial program for
2001-03 that is designed to promote economic growth with equity and strengthen
macroeconomic stability. The attached Memorandum on Economic and Financial Policies
(MEFP) describes the economic and financial program that the Government of the Lao P.D.R.
intends to Implement during 2001. In support of our program, we are requesting a three-year
arrangement under the Poverty Reduction and Growth Facility (PRGF) in an amount equivalent
to SDR 31.7 million (60 percent of quota) in seven equal semi-annual installments in accordance
with the standard practice of the Fund In this regard.
The program provides for continued fiscal and monetary restraint and is centered on the
implementation of revenue enhancement, restraining credit of the BOL, restructuring state-owned
commercial banks, commercializing large enterprises, and developing the enterprise sector.
These reforms are consistent with the Interim Poverty Reduction Strategy Paper (I-PRSP) that the
Government has recently completed.
The Government believes that the policies and measures set forth in the attached MEFP are
adequate to achieve the objectives of the program for 2001, and stands ready to take additional
measures that may become necessary for this purpose. The Government will remain in close
consultation with the Fund in accordance with the Fund's policies on such consultations, and will
provide the Fund with such information as it requests on the progress made in policy
implementation and the achievement of program objectives. In any event, the Government of the
Lao P.D.R. will conduct with the Fund the first review of the arrangement by end-October 2001.
In view of facilitating the understanding of the on-going economic reform process, the
Government does not object to the publication of this letter, the MEFP, the I-PRSP and the
Joint-Staff Assessment in the network of information dissemination of the Fund.
Memorandum on Economic and Financial Policies
of the Government of The Lao People's Democratic Republic for 2001
March 26, 2001
I. Introduction
1. The key economic objectives of the Government of the Lao People's Democratic Republic
(Lao P.D.R.), outlined in the Five-Year Plan, 2001-05, are to raise the level of sustainable
broad-based economic growth and per capita income, and make significant in-roads in reducing
widespread poverty. This will be a major step toward our longer-term objective of graduating
from least-developed country status by 2020. The Poverty Reduction and Growth Facility
(PRGF)-supported program, covering the period 2001-03, is designed to establish stable
macroeconomic conditions and undertake the structural reforms necessary for sustainable
growth. Consistent with the broader poverty reduction objectives outlined in the government's
accompanying Interim Poverty Reduction Strategy Paper (I-PRSP), dated March 20, 2001, this
memorandum lays out the economic and financial policies that the government intends to pursue
during the first year of the PRGF arrangement, covering calendar year 2001.
II. The Current Setting and Near-Term Outlook
2. Over the past 18 months, the government has made very substantial progress at stabilizing
the economy and reducing high inflation. At the early stages of the Asian Crisis the government
decided to invest in the construction and rehabilitation of irrigation schemes. Although these
schemes made a major contribution to food self-sufficiency, especially in rice, the use of central
bank financing led to an upsurge in inflation, which reached 167 percent (12-month basis)
in early 1999. Since then, the tightening of macroeconomic policies has sharply reduced
inflation, which fell to about 10 percent by end-2000. The exchange rate has also
stabilized and has remained within a narrow range since late 1999. Real GDP growth
in 2000 is estimated at 5.7 percent, supported by more stable domestic conditions
and strong agricultural production (Table 1).1 Central bank financing of the budget
deficit was reduced in 1999/2000 as revenues were raised substantially (Table 2).2 The growth in credit to the economy slowed from
74 percent in 1999 to 41 percent in 2000, as monetary policy was
tightened and lending by nonstate banks slowed sharply. Import restraint and increases in exports
appear to have contained the external current account deficit (including official transfers) to
1.6 percent of GDP, while gross official reserves rose to about US$140 million
(2½ months of imports), reflecting in part the disbursement of the second tranche of the
Asian Development Bank (AsDB) Financial Sector Program Loan (US$11.5 million).
3. Notwithstanding these important achievements, we recognize that the macroeconomic
situation remains fragile, with major policy challenges ahead. The government believes that high
sustainable growth rates and lasting poverty reduction will require decisive efforts to sustain
macroeconomic stability and address underlying structural weaknesses. For such policies to
succeed, they must be backed by substantial external support to fill the financing gap that we
expect to emerge during 2001-03 as the reforms are implemented.
III. Medium-Term Macroeconomic Framework
4. Our medium-term framework for poverty reduction is set within the goal for 2020,
which we plan to achieve through: (i) continued implementation of the New Economic
Mechanism (NEM); (ii) structural transformation and capacity building; and
(iii) people-centered participatory development through the decentralization of
government responsibilities. Under these policies, over the next three years, the government will
maintain sound macroeconomic policies to further reduce inflation and sustain it at low levels,
supported by strong actions to reform the state banking and enterprise sectors, develop the
private sector, and attract foreign investment.
5. The program's macroeconomic framework for 2001-03 aims at raising GDP growth
to 7 percent by 2003, reducing inflation to about 5 percent (end-period), and
increasing import coverage of gross official reserves to 3 months (Table 1). To achieve the targeted growth rates, total investment
will need to rise to 30 percent of GDP. Because of the need to raise current budget
expenditure in key areas, public savings are projected to decline modestly. The external current
account (including official transfers) deficit is expected to rise to about 11 percent of GDP
(3 percent excluding Nam Theun 2).3
6. We will target our overall fiscal stance at protecting medium-term sustainability and
generating more resources for poverty reduction. Underpinning this effort will be greater
mobilization of revenue and prioritization of expenditures, and the decentralization of
administrative responsibilities. Reflecting the greater orientation to poverty reduction, the budget
deficit will remain at about 5 percent of GDP in 2000/01-2002/03 (IMF definition).
These deficits will be largely financed by external concessional assistance to support investment
and key structural reforms, and domestic bank financing will be avoided.
7. Monetary policy will remain prudent in order to achieve a sustained reduction in inflation.
In particular, credit from the Bank of the Lao P.D.R. (BOL) to government, banks and enterprises
will be tightly restrained. Banks' lending decisions will be guided by commercial lending criteria,
and policy (and policy-induced) lending through the state-owned commercial banks (SOCBs)
will be phased-out. Although the exchange rate will be managed flexibly to allow for adjustment
to real shocks, monetary policy will be adjusted to minimize exchange rate fluctuations.
IV. Macroeconomic Policies for 2001
8. In September 2000, the National Assembly approved the Socio-Economic Plan
for 2000/01 with targets of real growth in the range of 6-6½ percent and
average inflation of 10-15 percent. The government acknowledges that the Fund staff
currently projects, for calendar year 2001, real GDP growth to be about 5.7 percent
in the face of the weakening external economy, and inflation to be reduced to about
8 percent by year-end in light of recent favorable performance. In addition,
for 2001, the external current account deficit (including official transfers) is expected to
increase to 3.1 percent of GDP, and gross official reserves are targeted to rise to
US$152 million (2.5 months of imports). The key macroeconomic policies
consistent with these targets are described below.
9. The government will continue fiscal discipline in the 2000/01 budget. The overall
budget deficit is targeted to remain at 5 percent of GDP (IMF definition) to be financed
largely through concessional external loans with no recourse to bank financing of the budget
deficit (Table 2). As outlined in the Socio-Economic Plan
for 2000/01, we aim to increase revenue collections substantially. Under the program, we
are committed to raising revenue by at least 1 percent of GDP over the 1999/00
fiscal outturn to 14 percent of GDP. Total expenditure will rise by a smaller amount to
22 percent of GDP, with increased allocations for key recurrent spending and counterpart
funds for donor-financed projects. We believe that the larger revenue increase in the 2000/01
budget passed in September 2000 is achievable with the strong implementation of the revenue
measures. However, we acknowledge that attaining this target is subject to a degree of
uncertainty. If revenue shortfalls occur from the budgeted amounts, we will take offsetting
measures through expenditure adjustments, while protecting operations and maintenance, local
counterpart funds, and key social spending.4
10. The revenue target for 2000/01 is ambitious but will be achieved through
broadening the tax base, some increases in excise duties, and major improvements in tax and
customs administration. The key measures to increase revenues include; (i) using periodic
adjustments to maintain the exchange rate for tax assessments within 5 percent of the
current banks' exchange rate; (ii) increasing excise rates on beer, tobacco, soft drinks, and spirits;
and (iii) narrowing tax exemptions for investment under the Foreign Investment Law
through the issuing of the implementing regulations. In addition, the operation of the large
taxpayer unit (LTU) will be enhanced through the use of improved on-site audits and
strengthened procedures for delinquent taxpayers. In line with the decentralization policy, 3 to
4 parallel LTUs will be also set up in key provincial centers with appropriate control
mechanisms. To strengthen further the tax base, we have decided to introduce a VAT
in 2003, and have established the VAT Steering Committee to this end. Steps have also
been taken to strengthen the transfer of royalties, especially on timber exports, to the central
government accounts and thus reduce unidentified expenditures.
11. Overall expenditure will be restrained while ensuring increased funding for critical areas.
Operations, maintenance, and local counterpart spending will be increased for key social services
in support of poverty reduction, especially for primary education and basic health services, and
for vital social and economic infrastructure (in particular for rural development). The wage bill
will be increased by 20 percent to partially compensate for past inflation. The size
of the civil service will be reduced by 5 percent by the end of 2001/02. Subsidies to
state-owned enterprises (SOEs) will continue to be avoided.
12. The Public Expenditure Review (PER), to be conducted jointly by the World Bank,
AsDB, and IMF in the first half of 2001 will review the poverty focus of expenditures, the
balance between recurrent and capital expenditures, fiscal transparency, and the mechanisms for
expenditure planning and management. In addition, we will closely monitor the implementation
of the decentralization policy to determine its impact on the fiscal stance. An action plan to
implement the agreed recommendations of the PER, especially to improve expenditure
management and budget planning, will be developed during the first year of the program and be
included more specifically in subsequent annual arrangements. Toward our goal of fiscal
transparency, the budget for 2000/01, and its outturn for 1999/00 have been
published.
13. Continuation of the firm monetary policy will be based on the strict control of central
bank credit and prudent lending by commercial banks. Under this framework, the BOL will
refrain from providing credit to the government, banks, and other sectors of the
economy,5 thus limiting
the increase in the net domestic assets of the BOL to KN 97 billion (equivalent to
13 percent of reserve money at end-2000, excluding the counterpart for external assistance
to fill the financing gap). This would also allow for some reduction in BOL securities
outstanding, while achieving the target of net foreign assets of US$107 million; reserve
money would be expected to increase by 7 percent in 2001 (Table 4).6 Assuming a slight increase in the money multiplier, as
excess reserves are drawn down, broad money could be expected to grow
by 20 percent and credit to the economy to grow by 18 percent.
14.The BOL will supplement its control of the growth of its net domestic assets by
restraining SOCB lending. Their lending will be closely monitored and they will refrain from
extending new loans to defaulting borrowers. In light of recent commercial banks credit
expansion we will also need to set temporary direct limits on the growth of credit by the three
SOCBs under restructuring programs. Even with appropriate credit restraint, state bank credit
growth will be about 30 percent by September 2001, considerably more than
the 20 percent growth in the government's plan for 2000/01. However, by
end 2001 SOCB credit growth will be reduced to 17 percent. If the fall in inflation
continues, we will examine the scope to reduce nominal interest rates, while keeping them
positive in real terms.
15. The BOL will continue to manage the exchange rate flexibly, permitting banks' exchange
rates to adjust so as to maintain the margin with the parallel market rate at less than
2 percent and avoid multiple exchange rates. In the absence of real shocks, any significant
widening of the margin with the parallel market or persistent weakness of the kip, would be an
indication of the need to tighten monetary policy. In addition, we will continue to improve the
functioning of the recently-introduced interbank foreign exchange market. We plan to create the
conditions to enable the removal of the remaining exchange restrictions on current international
transfers and payments by the end of the PRGF arrangement's period and pave the way for
acceptance of the obligations of Article VIII, Sections 2, 3, and 4 of the Fund's Articles of
Agreement.
V. Structural Policies
16. Steady implementation of structural reforms will be needed to establish a sustainable
high economic growth path necessary for reducing poverty. Structural reforms will be geared
toward strengthening macroeconomic stability, reducing the drain on public resources from the
state-owned banking and enterprise sectors, attracting private investment, and increasing
financial transparency.
A. Banking Sector Reform
17. The reform strategy for the banking sector aims at fundamentally restructuring the deeply
insolvent state banks to avoid the recurrence of large nonperforming loans (NPLs) and foster
efficient financial intermediation. The government has adopted a reform approach designed to
limit the potential fiscal costs of restructuring and avoid moral hazard. Central to this approach
are improving the performance and governance of banks in parallel with recapitalization, and
phasing-out of directed lending through the SOCBs.
18. The restructuring plans for individual banks will be guided by the agreed main policy
elements, developed in conjunction with the AsDB and World Bank (see Appendix I).
The main elements are to:
- Foster meaningful operational improvements, especially better lending and risk control
practices. These would require significant changes in the operations of management, and phased
and conditional recapitalization based on objective criteria for performance improvements.
- Establish effective internal debt workout units in each of the SOCBs.
- Phase out policy lending through SOCBs and transfer such existing lending to a central
unit under the Ministry of Finance or a specialized policy lending institution, not financed by
deposits.
19. The fiscal costs of bank restructuring appear to be manageable. Based on a preliminary
portfolio assessment at end-1999 that put NPLs of the three SOCBs at 70 percent of total
loans, the capital deficiency is estimated at KN 400 billion, about 3 percent of
GDP.
20. As a first step in strengthening the enforcement of banking supervision regulations and
building on the AsDB-funded technical assistance, the loan classification requirements will be
strictly applied, as specified in BOL Regulation 98. In addition, no new loans will be
made to borrowers with loans in default, and the credit growth of the three SOCBs will be
restrained. To set a baseline for financial restructuring, external audits using international
standards were initiated for the three SOCBs for the 1999 and 2000 accounts in
March 2001. Also, on-site and off-site supervision will be reinforced.
B. Enterprise Development
21. In tandem with banking reform, the government will develop a medium-term program for
SOE reform and for private sector development. This program will aim at protecting
macroeconomic stability and supporting bank restructuring through curtailing losses, and
improving the efficiency and competitiveness of the enterprise sector. SOE reform will be needed
to facilitate Lao P.D.R.'s progress in regional and global integration, especially in light of the
substantial trade liberalization under the ASEAN Free Trade Area (AFTA) through 2008.
The government's envisaged program will have two separate strands:
- The commercialization of the 24 nonfinancial SOEs declared by the government
to be strategic, will be restarted. Initial emphasis will be on ensuring that their prices cover costs,
including debt service. In order to sustain the commercialization of Electricité du Laos,
agreement has been reached with the World Bank to keep increasing retail prices by
3-3½ percent per month through end-2001, and, in mid-2001, conduct a study on
pricing policy to achieve fuller cost recovery starting in 2002, including its social impact.
After adjustments in August and September, petroleum prices approximately cover costs, and
will henceforth be adjusted more frequently to avoid losses by the Lao State Fuel Company.
Domestic fares of Lao Aviation were increased by 20 percent in
December 2000 and will be adjusted again in May 2001. Further fare adjustments
will be made to ensure that by March 2002 Lao Aviation can achieve commercial viability
and meet all its costs (defined according to international standards).
- The remaining nonstrategic enterprises will be divested. The government recognizes that
the previous widespread leasing of enterprises has not led to the desired improvement in
efficiency and will examine alternative ownership arrangements at both the central and local
government levels.
22. A range of measures have also been adopted, or are being implemented, to promote the
private sector by removing barriers to entry and leveling the playing field vis-à-vis the
state sector. Implementing regulations for the 1994 Foreign Investment Law will soon be issued,
consistent with its liberalizing spirit and narrowly interpreting the scope of tax exemptions and
reductions. Further improvements in governance and transparency in public administration will
include the prompt publication of rule-making documents, including implementation regulations
and notices, clearer administration of property rights, and the removal of bureaucratic
impediments for the establishment and operation of enterprises.
23. In support of these reforms, the government will work with the World Bank to develop
an enterprise reform program by the end of the first year of the PRGF arrangement.
C. Other Structural Areas
24. The government is firmly committed to international integration as a means to
strengthen competitiveness, develop the private sector, and improve living standards. On the
trade front, significant improvements have already been made in simplifying customs procedures
to expedite trade flows. In addition, the government:
- Has recently simplified the documentary requirements for exports of garments and made
export licensing automatic for all products, except forestry and mining products, from
March 2001. Automatic licensing for exports will apply to all companies registered under
the Business Law.
- Will gradually liberalize imports in line with the anticipated increase in domestic
production and exports, and its commitment to regional integration. In particular, the government
will progressively liberalize imports according to commitments made under AFTA by
transferring about 429 items each year for the next 4 years from the temporary exclusion list to
the current inclusion list of 1,673 items which, are free of quantitative restrictions and subject to
regional tariff reductions. By 2005 only 5 percent of total tariff lines will be subject
to quantitative restrictions under the sensitive and general exception lists. These items mainly
relate to unprocessed agricultural products, motor vehicles, alcoholic beverages, tobacco
products, and items restricted for security and health reasons.
- Will endeavor to implement import licensing that may be applied to some items in the
temporary exclusion list in a nonrestrictive manner.
- Will apply the removal of quantitative restrictions from items in the inclusion list on a
multilateral basis from mid-2001, except for a few specified products.
- Will continue to seek entry into the WTO and improved access to major markets:
Europe, Japan, United States (through normal trade relations status) and other countries.
25. Proper management of forestry resources is essential for sustainable development and
preserving biodiversity, while also channeling more resources to the budget. In support of this
approach, the government will develop a comprehensive forestry strategy with SIDA, the World
Bank, FAO, and other donors during the first year of the PRGF arrangement.
VI. Statistical Issues and Policy Transparency
26. Steps are being taken to improve the quality and timeliness of data, and broaden
publication and dissemination of statistics. Efforts will be made to strengthen the quality of data
on the national accounts, balance of payments, in particular regarding trade and external debt,
and government finance statistics. To better inform the public of the intentions and outcomes of
economic policy and bolster investor confidence, the government has started to publish the
annual state budget and outturns. Finally, the BOL will publish its audited financial statements
and the monetary accounts by July 2001, and the National Statistical Center will start
publishing a range of monthly indicators, including the consumer price index and its components.
VII. External Debt and Program Financing
27. With the policies described above and in the I-PRSP, the external current account deficit
is projected to widen to an average of about US$67 million per year (3 percent of
GDP), including official transfers and excluding NT2, during 2001_03. Lao P.D.R.'s
capacity to secure external financing on appropriate terms will depend critically on maintaining
macroeconomic stability and timely implementation of reforms. Currently, the external financing
gap is projected to total about US$110 million during 2001-03, assuming prudent
access to external commercial borrowing (see below). In addition to PRGF support of
SDR31.7 million (60 percent of quota), this financing gap would be covered by
program lending under the joint World Bank-AsDB Financial Sector Adjustment Credit, a World
Bank forestry adaptable program loan and Poverty Reduction Support Credit, additional program
lending from AsDB, and bilateral assistance on concessional terms.
28. In view of Lao P.D.R's limited debt-servicing capacity, external borrowing will be kept in
check and closely monitored through the newly-established debt-monitoring unit to ensure a
sustainable debt burden. The government is currently negotiating with Russia and expects to
reach an agreement on the terms of its outstanding transferable ruble debt in 2001. As
regards the contracting or guaranteeing by the public sector (including by SOEs) of new
nonconcessional debt, the government will observe the external debt ceilings specified in Table 6. It is expected that probably no more than one-third of
the government's share of equity in NT2 (US$80 million total) will need to be financed,
and concessional financing is being explored with multilateral investment banks. The
government will not incur any arrears on external payments during the period of the
PRGF-supported program.
VIII. Program Monitoring
29. The period for the first-year PRGF-supported program will cover calendar
year 2001. Quantitative performance criteria and benchmarks are summarized in Table 6. The structural policy prior actions for approval of the
PRGF arrangement, performance criteria, benchmarks, and subjects for the reviews are shown in
Table 7. The first review under the PRGF arrangement will be
completed by October 2001, and will assess implementation of budget for 2000/01,
the main elements of the budget for 2001/02, especially revenue measures and
improvements in the management and poverty focus of expenditures, and the elaboration of
bank-specific restructuring plans. At that time, the quantitative performance criteria for
end-December 2001 will also be set. The second review will be undertaken by
end-April 2002 and will focus on the implementation of bank restructuring, the
development of a SOE reform program, and the macroeconomically significant issues of forestry
sector policies. Specific measurement and monitoring details, along with other program reporting
requirements, are described in the attached Technical Memorandum on Program Monitoring.
30. In connection with the Fund's new safeguard assessments designed to protect its
resources, the BOL is in the process of providing IMF's Treasurers Department with copies of
financial statements for the past three years and other required information. The BOL has also
initiated an external audit on international standards of its end-2000 accounts.
31. The government believes that the policies described above are adequate to achieve the
objectives of the program and, on this basis, hereby requests approval of the arrangement under
the PRGF. The government stands ready to take any additional steps that may be necessary and
will consult the Fund on this matter in line with established Fund procedures.
Attachments (Please use the free Adobe Acrobat Reader to view the attached Tables)
