fbpx

Lao PDR: Fiscal Consolidation and Structural Reforms to Ensure Economic Stability and Recovery

2022-09-12T13:03:59+08:00September 12, 2022|Press Release|

Lao PDR: Fiscal Consolidation and Structural Reforms to Ensure Economic Stability and Recovery

Image: Khonesavanh.KMV / Shutterstock.com

SINGAPORE, September 12, 2022 – Lao PDR’s economy is expected to recover gradually from the pandemic crisis, expanding by 3.5 percent in 2022.1 Challenges in external financing, public debt sustainability, and domestic financial stability continue to weigh on economic prospects in the short to medium term. Strengthening fiscal consolidation and financial supervision, and expediting structural reforms, are key to macroeconomic stability while targeted policy support for economic recovery should continue.

These conclusions are highlighted in the 2022 Annual Consultation Report on Lao PDR published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was produced based on AMRO’s Virtual 2022 Annual Consultation Visit to Lao PDR, and data and information available up to March 15, 2022.

Recent developments and outlook

After growing at an average of 7.2 percent per annum over the past 10 years, the economy was hit by the COVID-19 pandemic. GDP growth declined to 3.3 percent in 2020 and an estimated 3.5 percent in 2021. Aided by the ramp-up in vaccination and more targeted containment measures, the Laotian economy has adapted to surges in COVID-19 infections, and gradual recovery in economic activities continued even during the worst wave in late 2021. The completed Lao-China railway will contribute to agricultural exports to China and revive tourism; continued expansion of power generation capacities, and a gradual resumption of service sector activities, including tourism, logistic (dry port), mining and new infrastructure, are expected to support economic recovery in 2022-2023.

High food inflation, triggered by natural disasters, pushed headline inflation to 5.1 percent in 2020 before moderating to 3.8 percent in 2021. Amid elevated import prices, especially of fuel, and a gradual economic recovery in 2022, inflation is projected to rise to 14.3 percent in 2022 before moderating to 4.6 percent in 2023.2

In 2020, the trade balance recorded a surplus of 3.9 percent of GDP, a 6.4 percentage point increase from 2019. Trade balance remained in surplus in 2021, as imports were constrained by the pandemic and the large depreciation of the domestic currency. Net capital inflow remained positive, supported by robust FDI inflows into the infrastructure and mining sector. However, international reserves declined slightly in 2021 due to large unrecorded outflows. Lao PDR’s gross international reserves are relatively low, sufficient to cover less than two months of imports of goods and services.

New credit to the private sector remained subdued in 2021, reflecting weak economic activity, the cautious lending behavior of banks and tight liquidity conditions. The Bank of Lao PDR’s pandemic support measures continued to provide essential support to help affected businesses and households. Financial soundness indicators of the overall banking system seemed less affected by the pandemic, with nonperforming loan (NPL) ratio stable at around 3 percent, and capital adequacy ratio well above the minimum requirement level.

With the rebound in revenue collection and the reduction in fiscal spending, the fiscal deficit declined significantly to 1.5 percent of GDP in 2021. However, the government debt-to-GDP ratio jumped to 73.7 percent of GDP in 2021 from 61.9 percent in 2020, mainly because of the arrears resolution related to past public infrastructure projects, and the increase in the nominal value of external debt due to the depreciation of the Lao kip. The government remains committed to fiscal consolidation, and the 2022 budget aims to maintain the low fiscal deficit at 2.1 percent of GDP through significant revenue growth to offset the spending increase.

Risks, vulnerabilities, and challenges

Risk is tilted to the downside. In particular, given its relatively weak public health system, repeated COVID-19 infection waves and subsequent containment measures may weaken the economic recovery and worsen the disparities in economic performance across sectors.

Notwithstanding revenue-enhancing measures, it will continue to be challenging to secure sufficient funding to service the external debt in the medium term amid unfavorable market conditions and sovereign credit rating downgrades. The high and rapidly rising government debt has raised concerns on debt sustainability, while the debt profile is found vulnerable to external shocks. The debt-to-GDP ratio is projected to remain elevated in the medium term without strong fiscal consolidation. Contingent liabilities from state-owned enterprises (SOEs) and public private partnership (PPP) projects could add to the financial burden of the government.

Structural external imbalances continue to put pressure on Lao’s weak external buffer and the Lao kip exchange rate. The high external debt service burden and reliance on imports of consumption and investment goods have created structural challenges for the economy’s external position. Given the low foreign reserves, a wide gap has emerged between the official and parallel market exchange rates which have exacerbated the currency mismatch of liquidity demand and supply in the banking sector.

Risks to financial stability stem from deteriorating asset quality and weak economic recovery. With about 15 percent of total bank loans restructured, seemingly stable financial soundness indicators may underestimate the risk of asset quality deterioration. The heterogeneity among banks also implies heightened risks for some banks with thin capital buffers and high NPL ratios. Withdrawal of regulatory forbearance could lead to a sudden increase in NPLs and should be supported by enhanced supervision.

Policy recommendations

Monetary policy should remain accommodative to support the economic recovery. More flexible exchange rate management will help further narrow the exchange rate gap and ease the mismatch in liquidity demand and supply in different currencies. More targeted policy lending programs — such as small and medium sized enterprise lending — should be strengthened. Enhancing supervision and a well-phased withdrawal of pandemic measures are essential to maintain financial sector stability.

Given the limited fiscal space, fiscal consolidation efforts through revenue enhancement should be strengthened, while improving the efficiency of fiscal measures. The government’s commitment to maintaining a fiscal deficit of below 2 percent of GDP in the medium term is commendable. However, the plan should be supplemented by concrete action plans and effective measures to enhance its credibility. The authorities should continue to improve the transparency and reliability of the financing and debt management plan. Upgrading the public finance management framework will strengthen the role of fiscal policy. Risks from contingent liabilities should be properly addressed by improving SOE and PPP management.

Accelerating structural reforms is essential to achieve a more inclusive, sustainable, and diversified recovery. In particular, enhancing the business environment is critical toward attracting more FDI into manufacturing and other non-traditional sectors. Strengthening vocational training and job-matching programs will help improve the supply of skilled workers to growing industries, and enhance long-term growth potential. Close cooperation with development partners and strong coordination among government agencies are essential to facilitate the development of appropriate and effective mitigation and adaptation policies for climate change.

1Based on AMRO’s updated growth projection in July 2022.

2Based on AMRO’s updated inflation projection in July 2022.

About AMRO

The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute towards securing macroeconomic and financial 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 the implementation of the regional financial arrangement, the Chiang Mai Initiative Multilateralisation (CMIM), and provide technical assistance to members.

Media Contact

John Cramer

Senior Communications Officer, AMRO

Email: media@amro-asia.org

Sign up to keep abreast of latest economic developments in the ASEAN+3 region.