Document of The World Bank FOR OFFICIAL USE ONLY Report No. 53 195-LA INTERNATIONAL DEVELOPMENT ASSOCIATION PROGRAM DOCUMENT FOR A PROPOSED GRANT IN THE AMOUNT OF SDR 13.3 MILLION (US$20 MILLION EQUIVALENT) INCLUDING SDR 6.65 MILLION (US$lO MILLION EQUIVALENT) IN PILOT CRISIS WINDOW RESOURCES TO THE LAO PEOPLE'S DEMOCRATIC REPUBLIC FOR A SIXTH POVERTY REDUCTION SUPPORT OPERATION May 24,20 10 Poverty Reduction and Economic Management Department Southeast Asia Country Department East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. GOVERNMENT FISCAL YEAR October 1 - September 30 CURRENCY EQUIVALENTS (Exchange Rate Effective as of May 2010) Currency Unit: Kip US$l.OO = 8,276 WEIGHTS AND MEASURES Metric System Vice President: James W. Adams Country Director: Annette Dixon Sector Director: Vikram Nehru Country Manager: Patchamuthu Illangovan Lead Economist: Mathew A. Verghis Task Team Leader: Genevieve Boyreau FOR OFFICIAL USE ONLY ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities MPDF Mekong Private Sector Development Facility ADB Asian Development Bank MTEF Medium-term Expenditure Framework AFTA ASEAN Free Trade Area NBFIs Non-Bank Financial Institutions APB Agriculture Promotion Bank NEM New Economic Mechanism BCEL Bank pour le Commerce ExtCrieur Lao NGO Non-governmental Organization BOL Bank of Lao PDR NGPES National Growth and Poverty Eradication Strategy BPO Business Promotion Office NPEP National Poverty Eradication Program BRIC Bank Restructuring Implementation Committee NPL Non-Performing Loan CAS Country Assistance Strategy NPV Net Present Value CFAA Country Financial Accountability Assessment NSD National Statistical Department CPI Committee of Planning and Investment NSEDP National Socio-Economic Development Plan CPIA Country Policy and Institutional Assessment NT2 Nam Theun 2 COA Chart of Accounts PACSA Public Administration and Civil Service Agency DAFI Agriculture and Forestry Industry Development PFMSP Public Finance Management Strengthening Group Program DAI Agriculture Industry Development Import-Export PER Public Expenditure Review State-Owned Enterprise EDL Electricit6 du Laos PETS Public Expenditure Tracking Survey EFA Education for All PFA Production Forest Area EMIS Education Management Information System PRGF Poverty Reduction and Growth Facility EC European Commission PMO Prime Minister's Office FDI Foreign Direct Investment PrMO Procurement Management Office FMAC Financial Management Adjustment Credit PRSO Poverty Reduction Support Operation FMCBP Financial Management Capacity Building Project PPP Purchasing Power Parity GA Governance Agreements REF Rural Electrification Fund GFIS Government Financial Management Information RMF Road Maintenance Fund System IAS International Accounting Standards ROC Regional Operations Committee IBA International Banking Advisor RTM Round Table Meeting JBIC Japan Bank for International Cooperation SAC Structural Adjustment Fund LDB Lao Development Bank SOEMD State Owned Enterprise Management Department LDP Letter of Development Policy SIDA Swedish International Development Agency LECS Lao Expenditure Consumption Survey SME Small and Medium Enterprises LIC Low-Income Country SOE State-Owned Enterprise LICUS Low-Income Country Under Stress SOCB State Owned Commercial Bank LSFC Lao State Fuel Company STA Science and Technology Agency SUFORD Sustainable Forestry Capacity Building MAF Ministry of Agriculture and Forestry TA Technical Assistance MPWT Ministry of Public Works and Transport TFSCB Trust Fund for Statistical Capacity Building MDGs Millennium Development Goals TIN Tax Identification Number M&E Monitoring and Evaluation UN United Nations MEM Ministry of Energy and Mining UNDP United Nations Development Programme MFI Micro-Finance Institutions UNESCAP United Nations Economic and Social Commission for Asia and the Pacific MOE Ministry of Education UNESCO United National Educational, Scientific, and Cultural Organization MOF Ministry of Finance USBTA United States Bilateral Trade Agreement MOFA Ministry of Foreign Affairs VAT Value-Added Tax MOH Ministry of Health WTO World Trade Organization MOIC Ministry of Industry and Commerce WREA Water Resource and Environment Agency MPI Ministry of Planning and Investment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization. LAO PEOPLE'S DEMOCRATIC REPUBLIC PROPOSED SIXTH POVERTY REDUCTION SUPPORT OPERATION TABLE OF CONTENTS GRANT AND PROGRAM SUMMARY I INTRODUCTION 1 I1 COUNTRY CONTEXT 3 BACKGROUND 3 RECENT ECONOMIC DEVELOPMENTS 4 MACROECONOMIC OUTLOOK 9 DEBT SUSTAINABILITY 14 PROGRESS WITH POVERTY REDUCTION 17 TOWARDS ACHIEVING MDGs 17 I11 THE GOVERNMENT'S PROGRAM 20 REVIEW OF KEY POLICY REFORMS UNDER THE FIRST FOUR PRSOs 21 Iv BANK SUPPORT TO THE GOVERNMENT'S PROGRAM 26 LINK TO CAS 26 RELATIONSHIP TO OTHER BANK OPERATIONS 26 LESSONS LEARNED 28 ANALYTICAL UNDERPINNINGS 31 COLLABORATION WITH IMF AND OTHER DEVELOPMENT PARTNERS 32 V THE PROPOSED OPERATION 34 OPERATION DESCRIPTION 34 COMPONENT 1: INVESTMENT CLIMATE, COMPETITIVENESS AND 34 BUSINESS DEVELOPMENT COMPONENT 2: PUBLIC FINANCE MANAGEMENT AND IMPROVING 38 SERVICE DELIVERY VI OPERATION IMPLEMENTATION 47 POVERTY AND SOCIAL IMPACT 47 ENVIRONMENTAL ASPECTS 50 IMPLEMENTATION, MONITORING AND EVALUATION 51 FIDUCIARY ASPECTS 52 DISBURSEMENT AND AUDITING 53 RISKS AND RISK MITIGATION 53 LIST OF FIGURES Figure 1. GDP Growth, Inflation, and Impact of Resource Sector Projects, 2004-2009 4 Figure 2. Inflation is back into the positive, driven by energy and food prices 5 Figure 3. Disbursement of FDI in Lao PDR, 2004-2009 (US$ millions) 6 Figure 4. Exports by Sector (US$ m) and by Destination Country 7 Figure 5. Balance of Payments 7 Figure 6. International Reserves and Net Foreign Assets (US$ million) 7 Figure 7. Disbursement of FDI in Lao PDR, 2004-2009 (US$ million) 8 Figure 8. Real and Nominal Exchange rates 8 Figure 9. Medium-term Real GDP Growth and Inflation (percent) 11 Figure 10. Real GDP Growth: Contribution by Sector (percentage points) 11 Figure 11. Current Account Balance and Overall Balance of Payments, 2007-2008 and Projections for 2009-2012 (percent of GDP) 12 Figure 12. GOL's Revenue Performance, FY07-FY 11 12 Figure 13. Summary of the Medium-Term Fiscal Framework (percent of GDP) 13 Figure 14. Projected External Public Debt Service, 2007-2013, (US$ million and percent) 16 LIST OF TABLES Table 1. NT2 contribution to GDP growth and export earnings 9 Table 2. Summary of Macroeconomic Framework, 2006-20 12 10 Table 3. BOL PDR Bond Issuance 14 Table 4. Lao PDR External Public Debt Indicators at End-2008 15 Table 5. Selected Social Indicators for Lao PDR 19 Table 6. Monitoring Indicators for Public Finance Management Component of PRS04-7 41 Table 7 . Summary of Prior Actions for PRS06 44 Table 8. Pre-identified Candidate Prior Actions (Triggers) For PRSO-7 46 LIST OF BOXES Box 1. Lao PDR Financial Sector Strategy 23 Box 2. Good Practice Principles on Conditionality Applied in Lao PDR 30 Box 3. Health Financing Strategy in Laos 43 Box 4. Electricity tariff adjustment: Increasing cost recovery while protecting the poor 49 ANNEXES Annex 1: Letter of Development Policy 55 Annex 2: PRSO 4-7 Program Action Matrix 61 Annex 3 : PRSO Result Indicators 73 Annex 4: Indicators for General and EC Variable Tranche Monitoring 79 Annex 5 : Lao PDR at a Glance 83 Map IBRD 3343 1 GRANT AND PROGRAM SUMMARY LAO PEOPLE'S DEMOCRATIC REPUBLIC PROPOSED SIXTH POVERTY REDUCTION SUPPORT OPERATION Borrower Lao Peode's Democratic ReDublic (Lao PDR) Implementing Ministry of Finance Agency Financing Data IDA Grant from the Crisis Response Window Pilot Program Terms: Standard IDA grant terms Amount: SDR 13.3 million (US$20 million equivalent) including SDR 6.65 million (US$lO million equivalent) in pilot crisis window resources. Operation Type The proposed Sixth Poverty Reduction Support Operation (PRSO-6) is the third operation of the second programmatic series of four operations (PRSOs 4-7). PRSO-6 is a single tranche operation. Main Policy PRSO-6 focuses on two broad policy areas which are consistent with the goals and Areas strategies identified by the Government in the National Socio-Economic Development Plan 2006-10 (NSEDP). The NSEDP successfully incorporated the key principles of an effective Poverty Reduction Strategy. The priorities of the NSEDP are reflected in IDA'S Country Assistance Strategy and focus on: sustaining growth through improvement of the investment climate, facilitating trade and management of natural resources; 0 improving social outcomes through better public financial management system and service delivery. In addition, PRSO-6 is based on continued adequacy of the macroeconomic framework, reflective of the Government's commitment to macroeconomic stability. The operation has been jointly prepared by the Government and IDA, in close collaboration with AusAID, the European Commission and Japan. Key Outcome Within the NSEDP framework, the PRSO-6 aims to support Lao PDR in two key focus Indicators areas: Improving the investment climate, competitiveness, and business development in order to establish an environment conducive to sustainable export- and private sector-driven growth; Strengthening the overall public finance management framework to enable the Government to increase efficiency of the public resource allocation system, strengthen fiduciary controls, and improve service delivery. Reforms in these areas have improved the Government's ability to manage the impact of the economic crisis, particularly on the financial sector, and to cushion to some extent the shortfalls in budgetary revenues resulting from it. The PRSO series expects to contribute to a list of outcomes and indicators as follows: (i) streamlining of regulations for setting up and operating business as measured by the number of days it takes to start up a business; (ii) streamlining of cross-border procedures to reduce trade barriers; (iii) reduction in SOE losses, greater transparency and commercial viability; more modern and better performing banking sector; (iv) improved credibility of budget planning, transparency and comprehensiveness of budget reporting; and faster budget execution; (v) timeliness and quality of external audits; (vi) improving service delivery and management, allocation, and monitoring of education expenditures; and (vii) improved access to health care and financial protection; effective performance monitoring for health sector policy. Program PRSO-6 aims to support the Government's priorities as outlined in its NSEDP and Development supported by the CAS, namely by: (i) sustaining growth through improved investment Objectives and climate and competiveness; and (ii) improving social outcomes by improving the quality of Contribution to the public finance management framework and service delivery mechanism in the health CAS. and education sectors. PRSO-6 will contribute to the achievement of these objectives through improving management of key areas (regional integration, private sector development, and quality of investment in natural resource sector) and through strengthening of public financial management and service delivery capacities and targeted poverty reduction programs. The PRSO policy reform program is supported by complementary technical assistance from the World Bank and other development partners, in order to ensure that the Government receives comprehensive policy and implementing support to execute its reform program effectively. The European Commission, Japan and Australia will also provide parallel financing to the Government within the PRSO-6 framework. Risks and Risk There are four main risks that could affect the proposed operation: Mitigation Risk associated with a deterioration of the macroeconomic outlook which may come @om (i) delays in the start of operation of hydropower projects and/or construction of new power plants, and/or weaker regional demand for Laos key exports; (2) prolonged loss of foreign assets in the banking system in the context of rapidly growing credit and limited bank supervision, leading to a rapid deterioration of banking sector performance and heightened downward pressures on the exchange rate; (3) a reversal of the policy to contain fiscal deficit, quasi-fiscal activities and credit growth. As per PRSO-5 Letter of Development Policy, the Government has committed to phase out quasi-fiscal operations through BOL lending, slow credit growth in 2009 and intensify monitoring of commercial banks operations. The PRSO operation and Lao PDR country program mitigate this risk partially by the following avenues: (i) strengthened macroeconomic monitoring and dialogue with BOL; (ii) by providing budget support to facilitate the government exit strategy of the fiscal stimulus by easing the constraints of financing a multi-front reform program and competing needs; and (iii) a financial sector component that includes SOCB monitoring and strengthens bank supervision. High fiduciary risk due to a weak public financial management system. The weak financial management and monitoring system does not allow for timely reconciliation and reporting of public finance which raised the risk of possible leakages and diversion of public funds away from NSEDP priorities. The risk is heightened by provincial autonomy without adequate monitoring and accountability mechanisms. This risk is mitigated by a strong PFM program and complemented by a monitoring regime of SOE and SOCB performance embedded in the PRSO program matrix. Capacity constraints and skills shortage in the civil service contribute to the risk of slowing progress in reform implementation. The risk is mitigated by additional resources made available via the FMCBP, and analytical work led by the World Bank to improve the pay and compensation structure of the civil service. The UNDP is providing assistance to the Government on strengthening civil service performance management system. Operation ID P118814 IDA PROGRAM DOCUMENT FOR A PROPOSED SIXTH POVERTY REDUCTION SUPPORT OPERATION TO THE LAO PEOPLE'S DEMOCRATIC REPUBLIC I. INTRODUCTION 1. With the global economy on its way to recovery, Lao PDR's economy appears ready for another year of sustained economic growth, in which the start of Nam Theun 2 (NT2) commercial operations will be an important pillar. Economic growth is expected to be increasingly driven by resource exports (especially hydropower and mining). In 2010, it is expected that the start of NT2 commercial operations will contribute significantly to economic growth in 20 10. The recent recovery of commodity prices (especially metals and agriculture) and regional demand has boosted Lao export earnings in the second half of 2009 and will also encourage FDI rebound in 20 10 and 20 1 1. 2. The Lao economy weathered the global financial crisis relatively well, supported by higher than expected commodity prices leading to a sustained growth in the resource sector and significant expansion in public outlays which have acted as a fiscal stimulus. Real GDP growth in 2009 is estimated at 6.7 percent. Factors that have contributed to maintaining economic growth include: (i) a relative insulation from the global financial system and a limited although growing exposure to global trade; (ii) a sustained demand for natural resource exports (minerals and hydropower electricity), and lower energy and food prices; (iii) a large fiscal stimulus driven by increased on-budget expenditures (wages and domestic capital spending) and by off-budget quasi-fiscal spending by the Bank of Lao PDR (BOL) financing local infrastructure projects. 3. The good performance of the economy remains nevertheless vulnerable to a number of factors, calling for enhanced Government efforts to keep the pace of reforms and drive the economy away from expansionary policies back to a more sustainable path. These elements include (i) the need for the Government to sustain key structural reforms in a still uncertain environment; (ii) the need for a Government exit strategy out of the fiscal stimulus; (ii) existing vulnerabilities to price shocks, including commodity prices (copper, gold) and energy prices; (iii) the need to address the slowdown of the non-resource sector GDP growth, in particular in agriculture, manufacturing and tourism. Over the last couple of years, economic growth has been increasingly driven by the resource sector, while the non- resource sector has been relatively more impacted by the global crisis. 4. The proposed PRSO-6 will contribute to mitigate these vulnerabilities by supporting the government efforts to: (i) keep the pace of its reform program in a still uncertain environment, including addressing the slowdown of growth in the non-resource sector, and (ii) drive the economy back on a more sustainable macroeconomic path by exiting the off-budget fiscal stimulus and returning to a more orthodox and sustainable policy mix. It reflects a mature support program of policy and institutional reforms initiated in 2005, with strong Government ownership under leadership of the Ministry of Finance (MOF) and PRSO Steering Committee. It is the third operation of the second programmatic series of PRSOs in the Lao PDR. The PRSO-6 continues the focus on the areas consistent with the goals and strategies identified by the Government in the National Social and Economic Development Plan (NSEDP, 2006-2010).' The PRSO program supports the CAS four pillars, which in turn build on the Government's NSEDP. The four pillars of the CAS are: (i) sustain growth through improved management of key drivers - regional integration and private sector development, rural development, and natural resource management; (ii) improve social outcomes and reduce vulnerability 1 n A Joint Staff Advisory Note (JSAN) was discussed by the IMF and World Bank Boards i June 2008. 1 through strengthened public financial management and service delivery capacities and targeted poverty reduction programs; (iii) adopt a strategic approach to capacity development and partnership in support of better NSEDP results; and (iv) support the implementation of Nam Theun 2 (NT2) hydro-power project, focusing on the revenue management arrangements. PRSO-supported reforms are timely for improving the public financial management framework, as significant resources will accrue to the Government from the NT2 project and other natural resource sector developments. The PRSO-6 has been jointly prepared by the Government and IDA, in close collaboration with AusAID, the European Commission and Japan. 5. Poverty incidence in Laos was halved over the last 15 years, from 46 percent in 1993 to 28 percent in 2008. The Lao PDR Poverty Assessment (2006) showed that the greatest reductions in poverty headcount happened in the areas that were selected by the Poverty Reduction Strategy (NSEDP) as priority districts for poverty reduction efforts, including targeted interventions.* Preliminary results from the fourth round of the Lao Expenditure Consumption Survey (LECS) indicate that poverty has continued to decline (to approximately 28 percent in 2007/08) - see Section I1 for progress with poverty reduction). The impact of the global financial crisis has been small so far, mostly because most Lao households rely on subsistence agriculture, forestry and fishing. Nevertheless, households continue to be highly vulnerable to natural disasters, and as the economy becomes more open and market-oriented more exposed to financial shocks. 6. Policy dialogue under PRSO-6 is focused on two broad areas: (i) sustaining growth through improvement of the investment climate, facilitating trade, and enhancing management of natural resources; (ii) improving social outcomes through better public financial management systems and service delivery, as detailed in Section V. Building on sustained commitment by the Governments to reform changes in the two areas supported by the PRSO series, PRSO-6 proposes to support the following policy actions and institutional: sustaining growth through improvement of the investment climate, facilitating trade, and enhancing management of natural resources - improving the investment climate by streamlining investment and customs procedures, implementation of equal treatment to all firms importing or exporting across Lao borders as per WTO requirement, enforcing clear and transparent principles for awarding and monitoring licenses and environmental standards in the mining, finalization of a detailed action plan with clear milestones for the financial sector strategy, improving monitoring of the SOEs, including the state-owned commercial banks (SOCBs), and approving actionable restructuring plans for the four largest SOEs. improving social outcomes through better public financial management systems and service delivery - implementing the Public Financial Management Strengthening Program (PFMSP) and associated capacity building measures; completing the centralization of the Treasury, Customs, and Tax Departments; progress towards implementation of the Treasury Single Account (TSA), transforming the government financial information system for timely budget reporting and monitoring, clarifying roles and responsibilities of central versus local governments in expenditures and service delivery assignment in the social sectors, building capacity in the State Audit Organization (SAO) based on the Audit Peer review, formulating and implementing health and education strategies, and strengthening the reporting and data analysis in the health and education sectors. 7. In accordance with standard practice for PRSOs, progress in implementing this PRSO is monitored through a Program Matrix, updated annually as part of PRSO preparations. The 2 See Lao PDR Poverty Assessment, Report No. 38083-LA. 2 Program Matrix for PRSO-6 (Annex 2) lays out the 7 prior actions and accompanying policy actions to be completed by the Government within PRSO-6. The status of each prior action is presented in Table 7. 8. ? The PRSO-6 is underpinned by a strong program of analytical and advisory activities ( M A ) , both completed and ongoing, and reinforced by the satisfactory implementation of the NT2 ~ p r ~ j e c t .The design of the PRSO program was based on several key pieces of analytical work done by the World Bank and other development partner^.^ These reports are summarized in Section IV on Analytical Underpinnings. 9. The PRSO-6 pays attention to the criticality principle for budget support operations and capacity constraints in Government in the design of the operation. It incorporates lessons learned from the previous series (Section IV on Lessons Learned), especially with respect to addressing risks related to capacity constraints. In addition, as programmatic budget support, the operation seeks to increase funding predictability and the associated dialogue between the Government and development partners, sharper policy prioritization and strengthened donor coordination. The operation also takes into account the good practice lessons learned on application of conditionality. 11. COUNTRY CONTEXT BACKGROUND 10. The Lao PDR is among the world?s poorest countries, according to the Bank?s Atlas estimates. It is a land-locked nation of 236,000 square km with a population of around 6.0 million (2008). With an estimated per capita income of US$740 in 2008, Lao PDR is one of the poorest countries in East Asia and is classified by the UN as a Least Developed Country (LDC). Nevertheless, preliminary estimates suggest that poverty has declined from 33 percent in 2002/03 to 28 percent in 2007/8 (national poverty line). The country has significant natural resources including forestry, minerals and terrain suited to hydro-electric power with enormous trade potential. 11. Agriculture remains a mainstay of the economy, albeit with declining importance. It contributes around 32 percent of GDP (2009) and employs nearly 70 percent of the labor force; the industry sector accounts for almost 28 percent of GDP, and services for nearly 41 percent. Lao PDR exports mostly minerals; other large exports are electricity, garments, agricultural goods, and wood and wood products. Most of the country?s exports are destined for Thailand, Vietnam, China and Europe, as well as Australia and Taiwan. Imports consist mostly of industrial and capital goods, petroleum, food and other consumer products, coming for the most part from Thailand, followed by Vietnam, India, Japan, China, and South Korea. The economy has also been experiencing a surge in project investment imports and FDI, following the successful launch of the NT2 project. 12. Lao PDR has made good progress in the transition from a planned to a market economy, initially with the introduction of the New Economic Mechanism (NEM) in 1986. The NEM removed price controls, abandoned socialist cooperative farming as farmers were allowed to work on their plots and asserted ownership; the multiple exchange rate system was unified, government?s monopoly on trade removed, the number of SOEs reduced, and the establishment of private firms allowed. Over the past ten years (1998-2007), real GDP grew at an annual average rate of 6.4 percent - despite the sharp fall-off in 3 Implementation of the NT2 project is assessed in six-monthly performance reviews to the Board. 4 These include the Investment Climate Assessment (ICA), the Diagnostic Trade Integration Study (DTIS), the Public Expenditure Review & Integrated Fiduciary Assessment (PERIFA), the Public Expenditure Tracking Survey (PETS), the Financial Sector Assessment, periodic Lao Economic Monitors, as well as ongoing work, such as the Country Economic Memorandum on Natural Resource Management, the Pay and Compensation Review, and the Poverty and Social Impact Analysis (PSIA). 3 growth during the regional crisis of 1997-1999. Reforms stalled during the Asian regional crisis, as Lao PDR struggled to reestablish macroeconomic stability. 13. A significant decline in poverty has been achieved during the last decade. Relative to Lao PDR's national poverty line (based on minimum calorie intake), the incidence of poverty has fallen to around 28 percent in 2007/08 from 46 percent in 1992/93. Social indicators have been improving as well, although progress has been uneven. Moreover, on many indicators, Laos compares poorly with other countries in the region. RECENT ECONOMIC DEVELOPMENTS 14. Lao PDR has weathered the crisis relatively well, with growth only slowing down to 6.7 percent in 2009, from 7.5 percent in 2008. The financial sector is not integrated with global banking institutions, and was not exposed to foreign borrowing and lending. The slowdown in economic growth was mostly due to slower growth in exports in the non-resource sector (agriculture and tourism) and lower foreign direct investment. These effects have been somewhat less significant than initially expected, thanks to the combination of sustained demand for Lao exports of goods (minerals, garments, electricity) and lower energy prices, while a domestic boost of public spending on consumption and investment helped stimulate the domestic economy. Figure 1. GDP Growth, Inflation, and Impact of Resource Sector Projects, 2004-2009 Resource Sector Contribution t o GDP 4 GDP growth (%) - - CPI (% change, annual average) (percentage points) 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 2006 2007 2008 2009 2010 05 21' 2005 2006 2007 2008 2009 2010 2015* Miningand power sectors Source: Lao PDR authorities (MPg and staff estimates 15. The resource sector (mostly hydropower and mining projects) contributes an increasing share of economic growth while the non-resource sector contribution is declining (Figure 1). The contribution to growth of the resource sector has almost doubled in 2009 from 2008 to reach 2.6 percentage points, mainly driven by the construction of four hydro-power dams and an extension of a large copper plant. The remaining 4.1 percentage points come from manufacturing, construction, and agriculture which are estimated to contribute nearly 1 percentage point each, while services account for the remainder. The construction sector has performed well, growing at 1 1.3 percent, including private housing and businesses, to serve important events such as the South East Asian Games and Vientiane 450-year Anniversary and to expand local public infrastructure projects. The garment sector has been impacted by the global crisis, with a drop of around 10 percent in 2009, while the agriculture sector has witnessed some slowdown. 16. After a period of deflation in 2009, prices have started to go up again, mostly on the account of food and fuel prices. During the first 9 months of 2009, core and non core inflation have continuously declined but then started to rise in recent months. After being negative year-on-year until September 2009 4 (-1.8 percent) driven by a drop in food and energy prices headline inflation has been rebounded in last few months to 3.9 percent in December and 4.2 percent in January 2010. Main drivers are (i) the recent rebound in food and energy prices; and (ii) the implementation of new VAT. Core inflation (excluding food and energy) has remained stable at 2.3 percent as of December 2009.' Figure 2. Inflation is back into the positive, driven by energy and food prices - _l_______l_...__.l._ll.l^- ~ (12-month percent change)...._l_l__l___..... ___..._. I__ " .-_.l_._ .l_.._._ " "" Total CPI - Core CPI (excl. food and energy) - Food CPI Enerpy CPI I I -30 -35 m 00 s 3 E rn rn Source Lao PDR authorities and staff estimates 17. Despite a shortfall in domestic revenues due to the global crisis, total public revenues have remained stable in FY2009 as a share of GDP. The revenue to GDP ratio increased slightly from 13.9 percent of GDP in 2007/8 to 14 percent in 200819 while overseas development assistance rose from 1.3 percent of GDP to 2.1 percent at the same time, thereby offsetting the shortfall in domestic revenue. Tax revenue increased from 12.1 percent of GDP in FY2008 to 12.4 percent in FY2009 driven largely by higher profit from mining (mining sector's earning in 2008) and income taxes (mainly from increased public wages and also minimum wage for the country). However, nontax revenue dropped from 1.8 percent of GDP in FY2008 to 1.5 percent in FY2009 due to sharp decline in public administration fees, interest earnings and lower dividends from SOEs. Further, declining oil prices reduced revenues from fuel consumption taxes. 18. The 2008/09 fiscal stimulus contributed to a widening of fiscal deficit in 2008/09. Public spending increased significantly, through recurrent spending and a higher wage bill and capital spending boosted by extra expenditures allocated to infrastructure aimed at getting the country ready to host the South-East Asian Games. Quasi-fiscal operations by the Bank of Lao PDR (BOL) to finance public infrastructure projects also have contributed to a significant increase in public spending. BOL performed direct lending operations, which contributed 2.7 percentage points to the deficit and about 30 percent to the total credit growth y-0-y as of September 2009. As a result, the budget deficit in 2008/09 increased to 4.6 percent of GDP (lower than earlier projections of 6.8 percent due to delays in implementation of some non-priority public investment projects) compared to 1.8 percent in 2007/08. Since then, the Government has committed to returning to a more sustainable macroeconomic path and a phasing out of quasi-fiscal activities. 19. Credit growth has been growing fast over the last 2 years, and net foreign assets in the banking system declined markedly in 2009. Credit was growing 90 percent year over year as of end December 2009 (slightly down from the record high of 98 percent growth at the end of June 2009). An important contribution to credit expansion (22 percentage points) came from BOL's direct lending to local projects to finance public infrastructure and associated imports (cf. above paragraph). This direct ~~ 5 Energy prices are not available yet for the month of January. 5 lending has been financed through BOL sales of US denominated and, to a less extent, Kip-denominated bonds to commercial banks. This "swap" of banks net foreign assets for domestic credit and imports has therefore translated into a relatively modest growth in broad money (31 percent year over year as of October 2009), and a fall in net foreign assets (-25 percent over the same period). Figure 3. NFA have been swapped for credit growth --__Broad money(NV) - LHS - Net Foreign Assets - - - - - Credittothe wholeemnomy- RHS _" -e- Credittoprivatesector- RHS - 1 120 is, Source: IMF and Bank staffestimates, 2009. 20. The large import component included in the 2009 FDI drop has helped mitigating the net balance of payment impact of the global crisis. The current account deficit is estimated to have almost halved to 6.6 percent as a result of a fall in imports and lower prices of imported food and fuel while exports earnings grew moderately. The capital account surplus is estimated to lower down to 7.8 percent of GDP in 2009, due a drop in levels of foreign investment6 Official gross reserves remained broadly stable. However, the level was supported by an IMF US$65 million SDR allocation, and sales of foreign currency securities by the BOL to domestic banks. 21. Exports earnings were sustained in nominal terms in 2009, due to the relatively low exposure of the economy to the collapse in demand from industrialized countries, while demand from the region has remained relatively robust. Key Lao trade partners are from ASEANEAP region and European Union. Lao export growth is estimated to grow at 2.9 percent (in nominal terms) in 2009 driven by recent recovery of commodity prices (especially metal and agriculture) and increased copper output. Garment exports have been negatively impacted in 2009, but this impact has been mitigated by an increase of exports to Europe, offsetting the fall in US exports. Tourism is among the sectors that were affected by the recession in Europe and US, with tourism earnings in 2009 estimated to have declined by 10 percent, to US$248 million. Imports are estimated to drop by nearly 11 percent largely due to low energy prices and resource imports in 2009. Lao PDR exports not only metals and hydro-electricity, but also other products, such as garments, wood and wood products, and -- most recently -- agricultural products and imports investment goods (machinery and equipment, construction materials, etc.), fuel, raw materials for garment industries, agriculture and processing industries, and various consumer goods. 6 Since foreign direct investments go for a large share to finance imports of equipments in large projects (mining, hydropower), a decline in the capital balance mechanically leads to an improvement in the trade balance through reduced imports. 6 Figure 4. Exports by Sector (US$ m) and by Destination Country 1I Electricity Mining I by Destination Countries, 2008109 AgtiCUituE 8 Wood&WoodPmducts a Ganentr Other USA Other 1600 1400 1200 loo0 ' Thailand 46.9% 800 600- 400 200 0 m m m hlaysiaf \Vietnam 0.4'A 13.6% and staff estimates andprojections Figure 5. Balance of Payments Figure 6. International Reserves and Net Foreign 2006-09 (percent of GDP) Assets (USD million) @Current account balance (CAB) 1200 -__- - _"-" -- - - - QNon-Resource CAB Capital account balance WOverall Balance 15 7 15 10 400 j 5 0 200 -5 -10 -15 -20 +Net 2006 2007 2008 2009 Foreign Auets +Gross international reserves Source: Lao PDR authorities (BOL) and staffestimates/projections Source: Lao PDR authorities (BOL) and staff estimates. 22. The decline in foreign direct investment in 2009 was one of the primary channels through which the global financial crisis has affected Lao PDR. In the last few years, economic growth has been heavily dependent on FDI inflows, most of which has been to the natural resource sector. Disbursements of foreign investment declined by 20 percent compared to 2008, from 13.9 percent to an estimated 10.3 percent of GDP in 2009. The decline mostly happened as a result of deferred hydropower and mining sector projects, as well as slower growth in the non-resource industries. 7 - -" _ _ - - - Figure 7. Disbursement of FDI in-Lao PDR, 2004-2009 (US% millions) " "_ " -" l_l I_-_ E# Hydropower Mining 4 Nonresource industries fif Agriculture B Services 1000 ' 800 600 . , 400 * 200 - 0 2005 2006 2007 2008 2009 -I_ -- - - _ - - - 1- -" I Source Lao PDR authorities (MOIC) and staff estimates 23. After a period of pronounced appreciation, the kip nominal exchange rate has been relatively stable against the US dollar over the last year. This de facto peg against the backdrop of a depreciating US dollar led to a weakening of the kip against the Thai baht. The kip depreciated marginally by 0.1 percent against the US dollar and depreciated by 4 percent against the Thai baht over the last 12 months. The authorities have been promoting a stable kip to contribute to low inflation, to build people's confidence in the national currency and lower the dollarization rate of the economy. The kip has appreciated in real terms markedly in 2008, before depreciating, mostly on the ground of the nominal exchange rates movements and depreciation against the Thai baht. Figure ........................................ 8. Real and.............................................Exchange rates ........... Nominal ...... 130 I 125 120 I 115 I10 +RER - NER r 90; ~ g5 *... . . . . . . . . . . . ~ ~ 80 . ~ . . "~. ............... ~ ., . . . _ / _ _ ~ ..,.. .. .T ,......... ........ -i .... Source: Lao PDR authorities (BOL) and IMF Staffestimates/projections 8 MACROECONOMIC OUTLOOK 24. In the aftermath of the global economic crisis, Lao PDR's economic outlook appears positive, with the economy projected to rebound over the coming years to about 7 percent. This projection assumes sustained levels of global commodity prices (mainly metals and agriculture). The economy is projected to benefit from a recovery in tourism, implementation of large hydropower projects under construction and in the pipeline, a projected increase in demand for main export products from neighboring countries (especially Thailand, China and Vietnam) and the European Union, and the coming on stream of NT2 and other hydropower projects. NT2 is expected to generate in 2010 about US$155 million of annual export earning^.^ Table 1. NT2 Contribution to GDP Growth and Export Earnings I 2010 2011 2012 2013 2014 Total power sector contribution: 3.7 3.7 1.1 3.1 2.7 Of which: NT2 3 .O 1.5 0 0 0 Output (KW/h) 3,781 5,817 5,817 5,817 5,817 Output (in US$m) 170 262 262 262 262 Exports (in US$m) -- 9 1% of total output 155 239 23 9 239 239 Domestic sales (in US$m) -- 9% of total output 15 24 24 24 24 * VA (65% of output) 111 170 170 170 170 7 Four hydropower projects are scheduled to start operations in 2010 (Nam Theun 2, Xeset2, Nam Ngum 2 and Nam like 1-2). Among those, Nam Theun 2 will be by far this year the most critical driver for exports and growth. NT2 is scheduled to start commercial operations in April 2010. It will add by the end of the year about US$190 million to Lao exports (an increase of 13 percent) and 3 percentage points to GDP growth this year. Delay in the start of operations would have a significant impact on exports and growth in 2010. For example, a delay by a quarter (up to June 2010,) would imply a loss of export earnings by about US$65 million and a loss of 1 percentage point of GDP growth. The impact on public revenues would be small, as NT2 contribution to public revenues in the first years of operations is moderate (US$15.6 million in 2010). 9 Table 2. Summary of Macroeconomic Framework, 2006-20128 2006 2007 2008 2009 2010 2011 2012 Prel. Est Proj Real G D P 8.5 7.5 7.5 6.7 7.7 7.8 6.7 (excluding resources) 5.8 7.3 5.7 4.2 4.0 4.2 5.5 G N I per capita (in millions o f US dollars) 540 640 740 793 880 949 1.026 Consumer prices (end period) 4.7 5 6 3.2 3.9 4.5 4.5 4.5 Consumer prices ( Y o change, period-average) 6.8 4.5 7.6 0.1 4.5 4.5 4.5 'ublic f i n a n c e s ( i n p e r c e n t of GDP) 1/ Total revenue 14.7 15.3 15.3 15.7 18.4 19.0 19.1 Total revenue (without non-project grants) ... ... ... ... 15.8 ... ... Domestic Revenue 12.6 13.5 14.0 14.0 13.9 14.8 15.0 Grants 2.1 1.7 1.3 1.7 4.5 4.2 4.1 Grants (without non-project grants) ... ... ... ... 1.9 ... ... Expenditure 18.5 18.4 17.1 20.3 21.7 22.0 21.9 Expenditure (without non-project grants) ... ... ... ... 19.3 ... ... Current 9.2 9.2 10.1 10.3 10.3 10.5 10.9 Capital and onlending 8.5 8.4 7.2 7.4 10.2 11.5 11.0 Capital and onlending (without non-project grants) ... ... ... ... 7.6 . . ... Domestically financed 1.2 1.o 1.6 2.3 2.5 5.1 4.7 Externally financed 5.8 5.7 5.0 4.4 6.8 6.6 6.5 Onlending (net) 0.5 0.2 -0.3 -0.3 -0.2 -0.2 -0.2 Others and contingencies (and errors and omissions) /2 1.0 1.5 0.9 1.0 1.1 1.2 1.2 Above below-the-line discrepancy 0.8 0.8 -0.2 2.7* 1.2# 0.0 0.0 Measures (revenue a n d expenditure) ... ... ... 0.2 ... .,. ... O v e r a l l budget b a l a n c e (deficit) -3.8 -3.2 -1.8 -4.6 -3.5 -3.0 -2.8 o/w off-budget ... ... ... -2.7 -0.8 ... ... o/w on budget ... ... ... -2.0 -2.7 ... ... Tinancing 3.8 3.2 1.8 6.2 3.5 . 30 2.8 Domestic financing -1.1 -0.9 -1.2 3.8 1.6 2.0 2.0 F'oreign financing 4.9 3.8 3.0 2.4 1.9 1.0 0.8 Additional financing ... ... ... 0.2 ... ... ... Salance of p a y m e n t s (in m i l l i o n s of US dollars) C u r r e n t a c c o u n t balance (CAB) -329 -597 -696 -395 -198 -401 -493 In percent o f G D P -9.3 -14.0 -12.6 -6.6 -2.9 -5.3 -6.0 Non-resource C A B (in percent o f GDP)/3 -13.2 -13.9 -13.9 -12.1 -13.7 -13.0 -12.9 Trade balance -406 -713 -838 -603 -308 -522 -659 Exports 1,080 1,188 1,429 1,471 1,950 2,232 2,181 Imports 1,486 1,902 2,267 2,073 2,258 2,754 2,840 Services and income (net) -67 2 14 30 -68 -76 -54 Transfers 144 114 128 128 177 197 220 C a p i t a l a c c o u n t balance 335 674 872 464 282 527 506 In percent o f G D P 9.5 15.8 15.7 7.8 4.1 6.9 6.2 O v e r a l l balance 6 77 175 69 84 128 15 In percent of G D P 0.2 1.8 3.2 0.9 1.6 1.7 0.2 r r a d e ( i n p e r c e n t of GDP) Exports 30 7 27.8 25.8 24.6 28.2 29.3 26.8 Imports 42.2 44.5 40.9 34.6 32.6 36 1 34.9 Cxternal public d e b t stock /4 I n millions of US dollars (end period) 2,351 2,521 2,93 1 3,085 3,322 3,551 3,738 In percent o f G D P (end period) 63.1 59.1 53.1 54.5 55.7 54.8 53.4 External public debt service P P G debt service-to-exports ratio (in percent) 3.6 4.0 4.2 7.5 6.5 6.1 5.7 P P G debt service-to-revenue ratio (in percent) 10.8 10.8 11.8 16.8 16.1 15.8 14.8 k o s s official r e s e r v e s In millions o f U S dollars 336 53 1 636 645 724 912 974 In months of imports of goods and services 2.5 3.2 3.2 3.4 3.6 3.7 3.8 vlemorandum i t e m s : Jominal G D P (millions o f US dollars) 3,520 4,277 5,545 5,987 6,922 7,627 8,147 Cxchange rate (kip/US%, average) 10,160 9,603 8,635 8,498 8,477 8,520 8,562 Sources: StaEestimates and projections based on data provided by t h e Lao authorities. 1/ Fiscal year basis (October t o September). 2/ Includes payments on liabilities carried in fiom the previous budget years and arrears clearance. 31 Excluding resource Lmports and exports 4/ DSA 2009 data */ include off-budget spending #/include Ketsana recovery spending 8 The budget classification of the Government differs from that based on the GFS because of inclusion of debt payments above the line, instead of below the line (into financing). In addition, Government's projections of the revenues are slightly more optimistic than those of the World Bank. Thus, the targets committed to by the Government correspond to a different deficit. 10 25. Growth in 2010 is projected to about 7.7 percent, driven by strong expansion in the natural resource sector (mainly electricity exports from NT2, which will contribute 3.1 percentage points of GDP growth), steady growth in agriculture and a rebound in processing industry and tourism. Out of this growth, resources are expected to contribute 3.6 percentage points and non-resource sectors about 4.1 percentage points. The year of 2010 will be marked by several hydropower projects starting operations, especially NT2 and Xeset2 while Nam Ngum 2 and Nam Like 1-2 will be at the testing phase. Figure 9. Medium-term Real GDP Growth and Inflation (percent) k G D P a t constant market grjces -- P + I C ("A change, annual average) 9 8 76 7 6 5 45 4 3 2 1 0 2007 2008 2009 2010 2011 2012 Source staff estimates and projections __ Figure 10. Real GDP Growth: Contribution by Sector (percentage points) 1 Agriculture Mining 0 Hydropower Resourcecontribution t o growth ("A) Munufacturing Construction 3 Services d b Non-resource contribution t o growth ("h) r Other 9 91 8 8 7 7 6 6 5 5 4 4 3 3 2 2 - 1 1 0 0 -1 2007 2008 2009 2010 2011 2012 Source: Staflestlmates andprojeciions 26. The medium term balance of payments outlook is favorable. Trade is projected to pick up the pace in the medium term with some fluctuations. The current account is expected to remain in deficit due to a high level of imports of capital goods in the minerals sector. International reserves are projected to increase over the medium term as increasing foreign capital inflows are expected to finance more than the projected current account deficit. 27. Exports are expected to recover significantly in 2010 and grow by 33 percent, driven by electricity and minerals. Minerals benefit from high level of prices (copper, gold) due to sustained global demand, coming from China in particular. Imports are expected to rise by about 12 percent driven by consumer goods (+17 percent), raw materials (+ 13 percent) and slower capital investment imports (+ 8 percent) because of reduced demand for equipment and machinery imports in 2010. 11 Figure 11. Current Account Balance and Overall Balance of Payments, 2007-2008 and Projections for 2009-2012 (percent of GDP) L Current account balance (CAB) DNon-resource CAB Exports $* &"Capitalaccount balance Overall Balance 35 1 2007 2008 2009 2010 2011 2012 Source: staff estimates andprojections. 28. The budget deficit is expected to remain moderate in the medium term (FY2009/10- 2010/11). This is based on revenue and expenditures projections that take into account the global recovery, deployment of new VAT and a prudent expenditure policy. The budget deficit is projected at 3.5 percent in FY2009/10, down from 4.6 percent in 2008/09. The expected decrease in the deficit is due to: (i) the phasing out of BOL quasi-fiscal activities in FY2009-10, as explained in the PRSO-5 Letter of Development Policy and reiterated publicly by the Government and BOL; (ii) reduction in one-off 2008/09 capital spending related to the SEA games; and (iii) improvements in tax revenue collection and the introduction of VAT in January 2010. Figure 12. GOL's Revenue Performance, FY07-FY11 h Revenue L Tax - Resource Revenue 16 14 12 10 8 6 4 7 2 0 FY07 FYO8 FYO9 FYlO FYll FYl2 Source staff estimates and projections 29. FY2009/10 revenue collection for Q1 (Oct-Dec 2009) was fairly on track, reaching about 95.5 percent of the plan. The GOL has been confident that the revenue target will be achieved for this fiscal year as the fundamentals for 2010 are expected to remain strong including recovery in regional and global demand, foreign direct investment, and natural resource exports. In 20 10, the government will receive 15.6 million of revenues from NT2. It is expected that these revenues will increase to US$26 million in 201 1-2015, US$50 million in 2016-2020, and US$120 million in 2021-2035. 12 30. Both revenues and expenditures record an artificial increase in FY2009/10 due to the new inclusion in the budget of foreign financed projects not executed through the budget (so called "non- project grants in Table 3). Including these externally-financed projects into the budget mechanically increases both 20 10 revenues (grants) and expenditures (externally-financed capital spending) by the amount of 1456 billion kip or 2.6 percent of GDP). Excluding them, the total revenue is expected to be 15.8 percent of GDP while total expenditure is 19.3 percent of GDP (about 1 percent decline compared to FY2009 of 20.3 percent of GDP), and overall budget deficit remains unchanged at 3.5 percent of GDP 3 1. Excluding the "non-project grants and expenditures", public spending is expected to decline to 19.3 percent mostly on the account of reduced capital spending. Current spending remains stable at the previous year's level of 10.3 percent of GDP. The planned budget does not propose any significant increase in the public wage bill, to the exception of transfers, which mainly covers operational spending for SEA Games and 450 anniversary events. Domestic capital spending is planned to increase moderately from 2.3 to 2.5 percent of GDP, while external capital spending will decrease slightly by 0.2 percent of GDP (excluding non-project grants). As a response to Ketsana natural disaster, 110 billion kip (USD13 million) have been allocated from the State Accumulation Fund to finance recovery costs. The Government is also planning to finance the That Luang expansion at the occasion of Vientiane Capital 450 anniversary, of around 100 billion kip (USD12 million). 32. The projected budget deficit of 3.5 percent of GDP is expected to be financed externally by 1.9 percent and domestically by 1.6 percent. Domestic financing will cover 200 billion kip of this deficit, through new issuance of Treasury bills. It is expected that Treasury will stop previous practice of rolling-over existing T-bills, which will be paid back the following year through the budget via appropriate allocations. Budget support from development partners is expected to contribute to finance the budget deficit. Lao PDR is an ODA-dependent country that benefits mostly from project-related foreign assistance in the form of concessional loans and relatively modest budget support. Apart from IDA'S PRSO series (co-financed by EC, Australia and Japan), ADB provides other budget support. It is expected that the European Commission and Australia will continue to provide additional yearly support through the PRSO vehicle, while Japan will resume its budget support. It is estimated that budget support will be about US$20 million per year. Figure 13. Summary of the Medium-Term Fiscal Framework (percent of GDP) " .... " ....... " " " kd Revenue and grants Ld Expenditure @Overall balance (incl grants) QOff-budget spending (BOL lending) ~ 21 7 21 9 21 9 20 15 I 10 5 l o I -5 I -10 J FY07 FY08 FYO9 FYlO FYll FY12 , Source: Staff estimates andprojections. 33. The 2009 decline in net foreign assets combined with rapid credit growth calls for enhanced government efforts to rein in credit and decrease the downward pressure on net foreign assets of the banking system and ultimately the exchange rate. Although early to say, preliminary indications suggest that the Government and BOL are true to their word not permitting any new direct lending by the 13 central bank and slowing down credit expansion. The Government committed in the PRSO-5 Letter of Development Policy and in public statements to slow down credit growth and phase out any new quasi- fiscal activities by end-2009. Credit growth has started slowing down, although at a slow pace, and that BOL has stopped issuing any new bonds, except roll-over in 20 10 (cf. Table below). 34. The rapid expansion of credit against the backdrop of relatively weak banking supervision also raises concerns on banking sector stability. Total lending as percent of GDP amounted 20 percent of GDP in December 2009 while reported non-performing loans (NPL) dropped from approximately 10 percent at the end 2006, to approximately 3.7 percent in December 2009. In the context of rapid credit growth, it is not clear however whether these NPL reductions are coming from an improvement in the loan portfolios of banks or from a mechanic impact from new loans expansion. These risks are highlighted by a history of a lack of appropriate capacity for screening of borrowers. It will be important in the future to strengthen banking supervision and improve credit screening capacity in banks to prevent potential risks of defaulting in the banking sector. BOL Bond Issuance 2009 Kip currency (billion kip) 450 USD currency (million USD) 140 BOL Bond rollover 2010 Kip currency (billion kip) 140 USD currency (million USD) 110 DEBT SUSTAINABILITY 35. According to the most recent debt sustainability analysis @SA), Lao PDR continues to face a high risk of debt distress.' External public and publicly-guaranteed (PPG) debt stocks remain elevated, but the high level of concessionality of official borrowing, which comprises most of Lao's debt, keeps debt service ratios relatively contained. Public external debt stock indicators are expected to remain at or above policy-dependant indicative thresholds throughout half of the projection period under the baseline scenario, and could increase further in the event of weaker macroeconomic performance or greater accumulation of non-concessional debt. Debt servicing ratios, however, remain below the relevant thresholds even under alternative assumptions. 36. The debt profile has improved in recent years, in part because the government has generally followed a prudent strategy of avoiding the accumulation of non-concessional debt. Strong economic growth, currency appreciation, and prudent debt management contributed to a decline in the debt ratio over the past few years-the stock of external PPG debt in nominal terms was US$2.9 billion at end-2008, or 53 percent of GDP, down from 81 percent at end-2005. MOF reports that the nominal debt stock increased by US$230 million in 2009. All the new debt is contracted at concessional terms, and most of the increase (82 percent) is accounted by disbursements from non-Paris Club bilateral creditors, primarily Thailand. The corresponding net present value (NPV) of debt at end-2008 was 35 percent of GDP or 91 percent of exports of goods and non-factor services. In terms of composition, nearly 70 percent of PPG debt is held by multilateral creditors, mainly the Asian Development Bank and IDA. 9 The most recent DSA has been completed jointly by the World Bank and the IMF, in collaboration with the Asian Development Bank in June 2009. 14 About 29 percent is held by bilateral creditors, including a large Soviet-era debt to Russia that is currently under negotiation. Only 2 percent comprises external debt incurred by public entities on non-concessional terms, mainly for hydropower development and electricity generation. 37. The size of domestic public debt has increased significantly in 2009, although from a very low base. At end-2008, the stock of recorded domestic public debt amounted to 2.1 percent of GDP and comprised mainly treasury bills and bank recapitalization bonds. In 2009, increasing off-budget public investments by lower levels of government backed up by BOL issuance of bonds have led to a significant increase in the domestic debt. Total bond BOL issuance amountedUS$193 million in 2009 or 2.7 percent of GDP, comprising 140 million of USD-denominated bonds and 450 billion of kip-denominated bonds. The BOL has committed to stop issuing new bonds in 2010 and will only roll-over some of the existing bonds for a total amount of 140 billion kip and 110 million USD. Table 4. Lao PDR.: External Public Debt Indicators at End-2008 Indicative Thresholds End-2008 NPV of debt, as a percent of: GDP 30 35 Exports 100 91 Revenue 200 255 Debt service, as a percent of: Exports 15 4 Revenue 25 12 I Source: WB and IMF staffestimates. I 38. Under the baseline scenario, external debt stock indicators remain at elevated levels over the medium term, but decline below the relevant indicative thresholds toward the middle of the projection period. The net present value (NPV) of public external debt increases slightly over the short- term as the pipeline of IDA and ADB move from grants to credits, before declining steadily to 20 percent of GDP over the longer term. Debt service ratios (both as a share of exports and government revenues) fall continually and remain below indicative thresholds throughout, despite falling concessionality as Lao PDR is assumed to assess more commercial borrowing as the country develops. 39. External debt sustainability is most vulnerable to a depreciation of the nominal exchange rate." In the same way that the sustained strong appreciation of the kip over the past couple of years served to bring the debt ratio down considerably, a 30 percent depreciation kip would lead to a sharp jump in the NPV of debt-to-GDP and debt-to-revenue ratios which would remain above the respective debt stock thresholds through most or all of the projection period. Under this shock, debt levels (both related to GDP and revenue) would only decline below the thresholds over the very long term. Lower export growth (by one standard deviation in 2010-11) would push the NPV of debt-to-exports up to double its baseline level over the first half of the projection period and in excess of indicative thresholds throughout. 40. External borrowing should be obtained on concessional terms and fiscal and quasi-fiscal liabilities should be carefully managed, to guard against external vulnerabilities and to ensure debt lo The most extreme stress test is defined as the bound test resulting in the most extreme deterioration of the debt burden indicator after 10 years. 15 ratios remain on a declining path. Continued prudent debt management as well as cautious assessment and monitoring of large-scale projects will be required to mitigate the risks posed to external and public debt sustainability. Given the number of potentially profitable projects in the resource sector, availability of non-concessional finance is likely to increase once the financial crisis subsides, and fiscal risks could arise if these projects fail to generate the expected returns, including to the government's own equity stakes. This highlights the importance of improving debt management capacity and developing a medium-term borrowing strategy for the government, including for resource sector activity, as well as greater disclosure of borrowing plans. Figure 14. Projected External Public Debt Service, 2007-2013, (US%mand percent) e t e r n a l Publlc Debt Servlce 600 7 - 30 26 20 I6 IO 6 - 0 2007 2008 2008 2010 2011 2012 2013 : :Debt sewice (rnllions of US dollar, left axis) : :I -- .. ..... PPG debt service-to-exports ratio (in percent) PPG debt service-to-revenue ratio (in percent) Indicativethreshold (25%) Source: Joint Bank-Fund Debt Sustainability Assessment, 2009 41. Lao PDR chose not to avail itself of debt relief under the Heavily Indebted Poor Country (HIPC) Initiative or the Multilateral Debt Relief Initiative (MDRI).Because Lao PDR is classified as having a high risk of debt distress, under the debt sustainability framework Lao PDR receives all IDA assistance on grant terms (PRSO 2-5, and the proposed PRS06 are IDA grants). Lao PDR is also eligible for up to 50 percent of grants within its performance based allocation from the ADB. 42. In conclusion, the current macroeconomic policy framework is appropriate for a budget support operation. The macroeconomic outlook is positive, but it will be important to slow down credit growth in 2010 so as to relieve the downward pressure on net foreign assets. Steps are being taken to re- establish the sustainability of fiscal and monetary policies, after injecting into the economy in 2009 a large fiscal stimulus which has been instrumental in weathering the global crisis and sustaining one of the highest growth rate in the region. Going forward, the government has committed to a more sustainable macroeconomic path. Credit growth is slowing down, although at a slow pace, and there is commitment to phase out BOL credit. It will be important to further rein in credit growth in 2010 down to a rate consistent with macroeconomic stability, and which allows banks thorough screening of borrowers. Finally, it will be important in the medium term to put in place appropriate macroeconomic and fiscal management policies to enable the country to benefit the most from the structural increase in natural resources revenues. 16 PROGRESS WITH POVERTY REDUCTION 43. Lao PDR has achieved significant progress in poverty reduction, while the effect of the global financial crisis of poverty and social outcomes has been small. The poverty headcount l 1 has declined from almost half the population to below one quarter within a decade. In 1992/93, basic needs were not met for 46 percent of people, but this number fell to 39 percent in 1997/78, to 33 percent by 2002/03 and to 28 percent by 2007/8. The share of poverty was reduced by 30 percent in one decade, lifting one eighth of the total population out of poverty. Even though the population grew by more than one million between 1992/93 and 200718, the absolute number of the poor declined to just over 1.5 million. 44. However, significant challenges remain. Urban areas and districts along the Thai border have experienced rapid growth and poverty reduction, but other groups continue to lag behind. The northern part of the country remains poorer than the southern and central regions, and uplands are poorer than lowlands. Poverty rates vary according to ethnicity, with the Lao-Tai displaying lower poverty incidence. The priority districts remain much poorer than non-priority districts, which have been the focus of the intervention by the Government and development partners. Despite the efforts to targeting of government expenditures at these areas, poverty reduction in these areas has been relatively slow. The reason for this finding remains to be further clarified. It should be also be noted that, due to the small population share in the priority districts, 43 percent of the poor live in areas with higher population density, including in urban centers and the provinces along the Mekong. 45. Liberalization of private sector, trade and expansion of the road network (financed by the public sector) were major drivers of poverty reduction during the period of 1997/98-2002/03.'* Other major entry points for poverty reduction include road access to market, farming productivity, lack of ownership of land and livestock, limited access to credit and weak marketing chains. In addition to the geographical factors, major causes of poverty include the legacy of physical devastation during the Vietnam War, with unexploded ordnance (UXO) still affecting half of the country's territory; weak public service delivery, especially in the health and education sectors; inadequate communications infrastructure; and shortcomings and weaknesses in the management of public resources. 46. Household vulnerability to shocks remains high, but so far the impact of the crisis seems small. First, Lao households are highly vulnerable to natural disasters and shocks. Second, the food and financial crises have highlighted new forms of vulnerability which while still limited, will grow in significance over the years, as Lao economy becomes more open to global markets and increasingly marketized. At this point nevertheless, the impact of increased food prices appears to be relatively muted. Similarly, although there have been some impacts of the financial crisis on trade, the natural resource sector and tourism, most of the Lao households still rely on subsistence agriculture. As a result, the impacts on social and poverty outcomes have been small. TOWARDS ACHIEVING MDGs 47. Lao PDR faces multiple challenges in meeting the Millennium Development Goals (MDGs) by 2015, which are expected to be further challenged by economic growth being increasingly driven by capital intensive (hydro and mining) industries in the years ahead. The second national report on the implementation of the MDGs in the Lao PDR has been prepared by the Government and UNDP. The I1 The poverty headcount shows the share of the poor in the total population. This is the share of population whose per capita consumption is below the national poverty line. This line is designed to approximate the expenditure needed to cover basic food and non-food needs, and is lower than theUS$1.25 a day poverty line. 12 Lao PDR Poverty Assessment, ibid. 17 MDG report sets the goals to be met by 2015, in accordance with the national priorities and through the implementation of the NGPES. Lao PDR lags behind the regional and low-income country's averages on many key social indicators (Table 5). Overall, the Lao PDR's mixed record on social indicators reflects a difficult transition process in the 1990s, a low tax collection effort at less than 11-12 percent of GDP until the last 2 years and significant decentralization with lack of adequate central oversight. Available data suggest that the Lao PDR is off track on a number of the MDGs, including malnutrition, measles immunization, skilled birth attendance, and some dimensions of gender equality (girl's equal enrollment in tertiary education). 48. Education is among the better performing sectors in Laos, at about the halfway point between the 1990 benchmark and the 2015 target date. The literacy rate for young adults (15 to 24 year-olds) is roughly on target (showing progress from the 71 percent in 1995 to 84 percent in 2005). Although this represents good progress, literacy rates are well below regional averages: an adult literacy rate at 84 percent continues to represent a considerable distance with the regional average at 98 percent. Enrolment rates data also show a steady progress, from 58 percent in 1991 to 84 percent in 2005, but still behind Cambodia and Thailand. Finally, the primary school completion rate shows an increase from 48 percent in 2001 to 60 percent in 2004, and the most recent figures from 2008 indicate a survival rate until Grade 5 of 68 percent, which is a good rate of progress. However, even with planned increasing in financial resources from the Government and Development Partner for the education sector, it appears that the MDG target of 90 percent primary completion is at risk of not being achieved. 49. Progress towards the health MDGs has been mixed. The under-5 mortality rate has declined from 170 to 98 between 1995 and 2005. While child mortality is still high, the MDG target is within reach. There has been less progress on other health indicators, in particular malnutrition, skilled birth attendance, and immunization coverage. The need for progress in these areas represents a considerable challenge for the coming years. 18 Table 5. Selected Social Indicators for Lao PDR Life expectancy at birth (years) Maternal mortality Child malnutrition, weight for age (YOof under 5) Low income countries 39 (2004) East Asia & Pacific 79 (2004) 79 (2005) I Access to improved water source (YOof population) I Low income countries I 75 (2004) I 75 (2005) I East Asia & Pacific I 51 (2004) I 51 (2005) Access to improved sanitation facilities -I - PT)R 1,ao - - - - I 3-n n n n ~ 1 ,I - \--- -I 4~~2006) .- . A Literacy (YO population age 15+) of Children reaching grade 5 Source: World Bank data, and Population and Housing Censusfor 2005 (NSC) Note: Latest year available. Maternal mortality rates for East Asia & Pacijic and Low Income Countries are adiusted. Primary completion rate is the total number of students successfilly completing the last year ofprimary school in a given year, divided by the total number of children o ofjcial graduation age in the population. f 19 111. THE GOVERNMENT'S PROGRAM 50. The NGPES and NSEDP were developed through an increasingly participatory process, established a framework for future reforms and made Government development priorities more explicit and transparent. These priorities are consistent with the multi-dimensional nature of poverty alleviation and seek, in particular, to: (i) deepen structural reforms in areas including public expenditure management, financial sector, SOEs, private sector development, trade and legal development; (ii) maintain macroeconomic stability by increasing revenue and ensuring appropriate monetary and fiscal policy; (iii) invest in the social sectors to expand access and improve social sector outcomes; (iv) invest in infrastructure such as roads, power and water supply, and expand access to these services; (v) invest in rural development and natural resource management - including support for agricultural, mining, forestry and hydropower development; and (vi) strengthen national capacity and institutions. The Poverty Reduction Strategy underpins both the Country Assistance Strategy (CAS) and the PRSO program. 51. The Sixth NSEDP 2006-10 and the Progress Report are viewed as a Poverty Reduction Strategy that fulfills the main criteria: poverty focus, broad participation, results orientation, and donor harmonization. The NSEDP 2006-10 integrates the NGPES and builds on its participatory approach, poverty focus and to some extent results orientation. It complies with the key features of a successful Poverty Reduction Strategy. In particular, it is more poverty and result-focused than the NGPES, also setting out more realistic targets and objectives than in the past plans. The NSEDP consultation process was also broader than in previous plans, with inclusion of development partners and private sector for the first time. It contains a small but functional monitoring and evaluation framework. It also discusses donor harmonization issues. At the same time, the NSEDP would have benefited from greater analysis of resources implications of policy actions and reforms, from a stronger monitoring and evaluation framework and from the development of a comprehensive macroeconomic framework. International non-governmental organizations (NGOs) and development partners active in the Lao PDR endorsed the final NSEDP at the 9th Round Table Meeting (RTM) on November 28*, 2006, and reconfirmed their commitment at the two subsequent Round Table Implementation Meetings in November 2007 and 2008. 52. The NSEDP envisages the reduction of poverty through a combination of broad-based economic growth and focused and policy interventions. The four strategic intervention areas of the plan are i) human development and private sector driven economic growth; ii) competitiveness, trade and regional integration; iii) social development and targeted poverty reduction interventions; and iv) good governance. Through these key priority intervention areas, the NSEDP enables the evolution of the Lao PDR's economy towards a private sector led system with modern governance, while keeping a strong focus on human and social development. The geographical targeting of NSEDP's interventions reflects the empirical evidence provided by the most recent household survey and the Lao PDR Poverty Assessment. The PRSO considers focused interventions on the first two pillars under Component 1 and the last two pillars under Component 2 of the Policy Action Matrix. 53. While at an early stage, preliminary orientations of the seventh NSEDP (2011-2015) continues to focus on achieving the MDGs in 2015 and transitioning out the Least Developed Country (LDC) status by 2020. The next plan five overarching goals are: (i) improving livelihoods, human development and poverty reduction; (ii) macroeconomic stability with rapid economic growth that benefits the most; (iii) social development and environmental protection; (iv) improved governance, capacity and transparency; and (v) strengthened international cooperation and regional integration. Extensive consultations with key stakeholders are underway, and several consultations with development partners through the sectoral working groups have already taken place. 20 REVIEW OF KEY POLICY REFORMS UNDER THE FIRST FIVE PRSOs 54. With promulgation of the Enterprise law in 2005, several important steps have been taken to simplify business entry, including elimination of minimum capital requirement for starting a business, introduction of simplified business registration system in August 2008, abolishment of establishment license for general manufacturing firms. With the intention to further improve the overall investment climate in the country, the National Assembly approved a new Unified Investment Promotion Law to replace two existing investment laws (July 2009). Among others, the new law has abolished very lengthy and cumbersome licensing approval procedures for general investment activities, and created a level- playing field for both domestic and foreign investors by harmonizing business entry procedures and investment incentives. In order to ensure effective implementation of the new unified Investment Promotion Law upon its promulgation, various ministries and agencies are currently reviewing relevant laws and regulations under their jurisdictions to identify and resolve any possible inconsistencies between the Investment Promotion Law and other existing laws and regulations. The Government and the National Chamber of Commerce and Industry have recently institutionalized regular dialogue mechanism at both central and provincial level to identify and address impediments to business creation and expansion. The Government has also committed to an SME strategy encompassing reform measures in many investment climate components, such as regulatory environment for businesses operations, access to finance, and business support services. In the financial sector, several laws and regulations have been developed in order to level the playing field between private and state-owned banks, and between domestic and foreign owned banks, and provide services for domestic and foreign, small and large businesses; these include adoption of Law on Commercial Banks, Secure Transactions Law, revision of Presidential Decree on precious metals and foreign exchange, regulations on deposit taking and non- deposit taking micro-finance institutions, and effort to improve credit information system, and establish collateral registry for movable assets. 5 5. The government has entered regional and international agreements that require increased transparency and commitments to specific economic policies by member states. Lao PDR has joined ASEAN/AFTA, has and is also a member of the World Customs Organization (WCO). Lao PDR is committed to acceding to the WTO and progress towards this goal has now accelerated with the completion of the 5' Working Party negotiations in Geneva in July 2009. As part of the accession process, the country is introducing a number of reforms to the legal and policy environment for trade in order to improve transparency and align the legal framework with international norms. Legislation to provide for automatic import licenses in all products except for those on a "negative" controlled list was introduced in mid 2009 - a key requirement of WTO Working Party members. In 2005/6, Lao PDR undertook a Diagnostic Trade Integration Study (DTIS) in order to identify the main constraints to improved trade performance. Based on the DTIS "Action Matrix", the Government is now working to systematically address these constraints, build institutional capacity and to simplify and streamline the regulatory environment for trade. Lao PDR has also made progress on its commitments to reduce tariffs under regional agreements and other related reforms. 56. Government is also introducing policy and institutional reforms to enhance sustainable management of investments in natural resources. As a whole, the natural resource sector (hydropower and mining) have become a significant contributor to the national economy: (a) mineral exports represent 40 to 50 percent of total national exports, and current power exports contribute an additional 10 percent; '~ (b) direct government revenue from t a ~ a t i o n of mining and hydro operations combined has represented 20 to 25 percent of total tax collection since 2007; and (c) localized economic impacts are significant from service industries, direct employment, and alluvial and small-scale mining. The Government has 13 Profit tax royalties, and other fees, but excluding dividend payments. 21 been working toward improving environmental and social management of hydropower facilities, including strengthening the regulatory environment, institutional setup, and building the resources and capacity to improve enforcement over time. The recent approval of a Prime Minister's decree on environmental impact assessment is a key step forward in this area. These actions are taking place within the broad directions of the National Policy on Environmental and Social Sustainability of the Hydropower Sector. In the mining sector, the approval of the Minerals Law by the National Assembly is a decisive policy step towards sector strengthening. The law seeks to improve transparency and predictability in grating exploratiodmining licenses to investors, clarify regulations regarding the transfer of mining rights, clarify government's equity rights in mining projects, clarify and improve the competitiveness of the fiscal regime, and to propose standard mineral exploration and mining agreements. 57. The Government implemented measures aimed at improving the financial performance of SOEs, including supporting SOEs corporatization and cost-recovery for state-owned utilities. Reforms implemented in the early 1990s reduced the number of SOE sector substantially. The SOEs sector is relatively small with less than 15,000 employees. The performance of the sector has continuously improved since 2006 as indicated by the decline in total losses of central SOEs. Total losses of central SOEs went down to 14 billion kip in 2008 (0.2 percent of total Government revenue) from about 56 billion kip in 2006. Nevertheless, many SOEs, especially the smaller ones continue to make losses and their corporatization remains an unfinished agenda. Since 2002, international audits were undertaken by GOL for the largest loss-making SOEs and for`SOCBs, restructuring plans for the four largest loss-making SOEs were also developed and started implementation. The Government is now finalizing restructuring plans for additional four SOEs (Phase 11) and has recently started to develop restructuring plans for remaining 4 SOEs (Phase 111). The Government has also established regular monitoring of the progress against the restructuring plans of SOEs and against financial targets established for the SOCBs. 58. Progress has been slower on implementation of restructuring plans for SOEs. The implementation of restructuring plans has been slower than anticipated, due to partly unclear division of responsibilities between National Committee for Business Development (NCBD - former Business Promotion Office), Ministry of Finance and line ministries over implementation of restructuring plans, and lack of strong ownership from senior managers of the SOEs. However, ongoing effort of the Government to develop the first medium term strategy for SOE reform is expected to provide concrete measures to improve corporate governance of strategic SOEs, define Government's role in non-strategic SOEs, and clarify the role of NCBD and other relevant agencies in SOE reform process.. 59. The Government has achieved progress in bringing state-owned utilities towards cost recovery levels, especially Electricity du Laos (EDL). Regular and on-schedule electricity and water tariff increases took place during PRSOs 1-5, moving state-owned utilities to cost recovery levels. The Government is following the Power Sector Action Plan to ensure financial viability of EDL. Financial viability of the power sector has four key aspects: (i) settle electricity arrears of Government for the year ending September 2005; (ii) implement an arrangement for ensuring that future government bills for electricity consumption are paid in full, and on time, so that the receivables from government departments do not exceed 90 days; (iii) annual tariff adjustment for EDL to achieve financial performance targets; and (iv) reduction of technical and commercial losses by EDL. EDL reported profit for the first time in 2007 due to the tariff adjustments since 2005 in line with the agreed tariff reform over 2005 to 201 1, reduction of distribution system losses from more than 20 percent in 2005 to about 13 percent in June 2009; and reduction of arrears owned by the Government agencies after settlement. The Government has managed to reduce electricity arrears to EDL, however budgetary outlays continue to be less than projected consumption, and therefore new arrears emerge annually. 22 60. The Lao financial sector is gradually moving toward commercialization, transparency and sustainability. The banking sector development is still limited. Government ownership is still dominant, but with a declining share, with privately-owned banks now holding 40 percent of total banking sector assets. Banking sector lending accounted for around 16.3 percent by the end of June 2009. The sector is highly liquid, with a low share of loans to deposits ratio (50.4 percent at end 2008). At the same time, physical penetration of bank branches, although on an improving trend, is among the lowest in the world, with approximately 1 branch per 80,000 people at the end of March 2009. The NPL figure of Laos banking system dropped from 10.5 percent at the end of 2006 to 4.4 percent in December 2008. Also, NPL to total loans of SOCBs declined from 13.0 percent in 2006 to 1.7 percent in 2008. However it remains unclear whether this reduction comes from portfolio improvement or fast credit increase. 61. During PRSOs 1-5, the financial sector reforms concentrated on the restructuring of the state- owned commercial banks (SOCBs), strengthening the supervisory role of the central bank and improving legislation. Independent international auditors have regularly performed audits based on International Financial Reporting Standards (IFRS) and provide an impartial assessment of the financial and performance situation of SOCBs. The performance of two SOCBs (BCEL and LDB) met the operational and financial target set in the ADB -BOL agreed Governance Agreement (GA) and thus both were eligible to be recapitalized by MOF in 2006-2009. The Accounting Law supporting the International Accounting Standards (IAS) and Regulation for deposit taking and non-deposit taking Microfinance and Law on Commercial Banks were enacted and implemented within PRSO 1-5. In addition, as of January 1, 2009, BOL fully enforced the new Accounting Law (chart of account) on every commercial banks. However, due to some technical problem related to the new accounting standard, BOL experiences disruptions in the reporting system. In addition, BOL, acting on behalf of Government, finalized the first Financial Sector Strategy (FSS) which aims at developing a strong, efficient, well-recognized and competitive financial system. Box 1. Lao PDR Financial Sector Strategy The Lao PDR Financial Sector Strategy was approved by Government in October 2009. It reflects the vision of the Lao authorities for the long term development of the financial sector by laying out the main directions of reforms, investments and capacity building to be implemented over the period 2009-2020 in six sub-sectors: 1. Banks. The respective roles of the central bank and commercial banks have been clarified following the adoption of the two-tier banking system in 1989. The following priorities have been identified to strengthen the central bank functions of the Bank of Lao PDR: k Improve a comprehensive, accurate and timely data collection system; (ii) Develop a standardized reporting system; (ii) Increase the efficiency of monetary and exchange rate policies; (iii) Strengthen the supervision of commercial banks and other financial institutions; (iv) Strengthen internal administration and governance. To promote fair competition in the commercial banking industry, the priorities strategies will be followed: k Promote internal corporate governance; (ii) Comply with the prudential regulations; (iii) Strengthen the reporting system; (iv) Privatize the SOCBs; (v) Reduce barrier to entry into the banking industry; (vi) Promote modem technology. 2. Non-Bank Financial Institutions. Insurance companies, social security funds, provident funds, leasing companies, fmance companies, securities companies are classified as Non-Bank Financial Institutions (NBFIs). Well functioning NBFIs promote fund mobilization, access to financial services and credit extension. There are only a few NBFIs in Lao and most of them are not officially regulated. BOL supervises and regulates only the deposit-taking NBFIs. To improve the sub-sector performance, the following strategies have been identified: > (i) Establish a formal regulating agency to supervise Non-Deposit Taking NBFIs; (ii) Strengthen the legal framework; (iii) Develop supervisory, monitoring and auditing standards; (iv) Promote new technology. 3. Micro-Finance Institutions (MFIs). Government encourages Micro-Finance Institutions (MFIs) as an alternative 23 to provide financial services for poor, low-income households and rural people. Like the NBFIs, only the deposit taking MFIs are supervised by BOL. The following strategies have been identified to strengthen the sub-sector: > (i) Establish a formal regulating agencies to supervise Non-Deposit Taking MFIs and (ii) a basic legal framework. 4. Monev Markets. Fully functioning money and inter-bank markets will be instrumental to better manage liquidity in the financial system and enhance the efficiency of monetary and exchange rate policies through indirect instruments. The strategies to improve both markets are summarized as follows: > (i) Establish and enforce regulatory framework; (ii) Promote modem technology and equipments; and (iii) Adopt International Accounting Standards. 5 . Capital Market. The Government plans to establish an electronic bidding stock market in 2010. The development of a stock market is aimed to create favorable conditions for long-term investment and allow greater mobilization of funds. The following steps are identified to prepare for stock market establishment: > Create the basic conditions for the establishment of stock market operations and enhance its efficiency over time in order to be fully integrated with the region and the world. 6 . Financial Sector Infrastructure. The improvement of infrastructure is essential to support the future expansion of the sector. The following strategies are identified to improve the infrastructure of the sector: P (i) Establish an effective legal framework; (ii) Improve accounting standards; (iii) Develop the efficient paymentlsettlement system; (iv) Establish a confident safety net for depositors; and (v) Strengthen human resources. 62. Substantial progress is being made in the overall public financial management reform program. Within the Government's Public Finance Management Strengthening Program (PFMSP), the PRSO series has concentrated on assisting the Government in putting in place an appropriate legislative framework for managing budgetary resources and starting implementation of the Budget Law of 2007 which focuses on centralization of the Treasury Department, Customs Department, and the Tax Department, along with development of a new revenue sharing framework. Some of the key PFM reforms implemented to-date by the government are: (i) establishing centralized control over all provincial and ministerial spending accounts, representing about 80 percent of total budgetary resources; (ii) revising the budget classification system to be consistent the IMF GFS statistics, and implementing it for FY2008/09 budget (iii) published, with expanding coverage and improved timeliness, the annual budget and outturn reports; (iv) mandated minimum spending on health and education sectors by provincial governments starting FY2008/09; and (v) improved the legislative framework governing public financial management and external audit. The PRSO program has been instrumental in supporting the government's policy reform framework in these areas. 63. Revenue collection effort has been increasing. The Government has succeeded in improving revenue forecasting and collections, as demonstrated by the achievement of its revenue target for the past three years.14 The domestic revenue to GDP ratio increased from 12.6 percent in 2005/06 to 13.8 by 2008/09. This increase in revenue effort is a combination of public financial management reforms as well as high commodity prices. However the global financial crisis has caused a revenue shortfall of about 8 percent compared to initially planned in FY2008/09. This shortfall has come mostly from the resource sector. Improvements in revenue collection and enhanced expenditure controls have allowed the Government to fully fund budget expenditures and to start settling arrears on utilities, and these controls will be an important tool for managing expenditures appropriately as the financial crisis unfolds further. The Government has also started presenting budget reports and consolidated financial statements to the 14 The Lao PDR Public Expenditure Review and Integrated Fiduciary Assessment (2007) highlighted shortfalls in revenue collection a central issue and the main reason for cash rationing and arrear accumulation. 24 Parliament's June session. The new Budget Law brought forward the time for budget submission to the National Assembly from October to June so as to allow more time for deliberations on the overall budget strategy and for sector ministries and provinces to prepare detailed budgets proposals and allocate them to spending units earlier in the budget year, thereby improving budget planning and execution. Although for each of the last three years, the budget for the following year has been approved by the National Assembly before the start of the fiscal year, the budget calendar needs to be followed more rigorously and formal rules and ceilings need to be issued to guide the annually budget process to provide realistic budget discussion between MOF and spending agencies. 64. The PFMSP also supports the improvement of public financial management in time for the coming on stream of the NT2 revenues in 2010. The Government has identified eligible expenditures in four sectors: education, health, rural transport and environment against NT2 resources and the National Assembly has approved the allocation of 50 billion kips for these expenditures in the FY2009/2010 budget. Progress with putting in place the core systems to manage NT2 revenues has been on-track. Government has made efforts to improve the monitoring and evaluation framework through the Public Expenditure Review (PER) and Public Expenditures Tracking Survey (PETS), and international advisory services have been engaged to assist the Government improve the results framework for PFMSP and work on the Public Expenditure and Financial Accountability assessment is underway. 65. Notwithstanding the progress achieved, some areas within the PFM reforms have experienced delays due to technical capacity constraints, difficult institutional change management, and the political context: (i) The development of the new intergovernmental fiscal transfer mechanism has been slower than anticipated because of technical capacity constraints at MOF to devise the transfer mechanism, significant institutional changes needed in establishing a transparent and rules based central- local resource allocation framework to replace the established ad-hoc bargaining process, and political support needed to transfer resource allocation powers from provinces to the center. However, the Government has been moving in the right direction, with significant consultations with provinces and the political establishment, and in this regard has managed to mandate minimum spending by provinces on social sectors, agreeing to sharing rates for shared taxes, as well as MOF developing a phased strategy for implementing the budget norms. (ii) The legislative framework for public procurement has been improved over the recent years through the passage of a new procurement decree, implementing rules & regulations, a standard procurement manual and standard bidding documents, but implementation needs to be improved and immediate priorities are to ensure country-wide usage of the recently approved standard procurement documents by all procuring agencies and strengthening their capacity through establishment of an institutionalized procurement capacity building program, as well putting in place a system for monitoring procurement performance and outcomes. (iii) Another area where limited progress has been achieved is on developing sectoral medium term expenditure frameworks. This is again due to a lack of implementation capacity, coordination between sectors and MOF, and more fundamentally, due to the still weak annual budget process that can support the move to MTEF. The ADB leads efforts on developing the MTEFs over the medium term, while focusing immediate efforts on strengthening the medium term fiscal framework to support annual budget process. 66. Several steps were taken in the PRSP priority sectors (health, education, and infrastructure). During PRSOs 1-5, the Government improved monitoring and timeliness of payment of salaries to teachers and health workers. In addition, it launched pilots of school grants program and equity fundsspilots for hospitals. The Education Sector Development Framework (ESDF) has paved the way for implementing the aid effectiveness agenda and the Education Management Information System (EMIS) has been set up to provide timely and reliable information about the results in the education sector. In the health sector, prioritization for public interventions has been strengthened towards improved health outcomes. Several strategies and action have been developed and are starting implementation, albeit slowly because of capacity and resource constraints (Maternal, Neonatal, and Child Health Strategy 25 and Action Plan, Skilled Birth Attendance Plan Nutrition Strategy and Action Plan). In infrastructure, revenues from the Road Maintenance Fund (RMF) established in 2002 have increased up from US$2 to US$20 million between 2002 and 2008, covering 60 percent of total need for the maintenance of national road network. Nevertheless, the financing gap is still large for adequately maintaining provincial, district and rural roads. The new transport sector strategy aims at improving connectivity within the country and with the region to support cross-border trade and is the basis for aid effectiveness and sector wide approach. Rural electrification has shown steady progress, with 69 percent of households having access in 2009, against 44 percent in 2004. IV. BANK SUPPORT TO THE GOVERNMENT'S PROGRAM LINK TO CAS 67. The PRSO program is an integral component of the CAS, supporting its pillars, achieving the outcomes, and contributing to its risk management strategy. The CAS Progress Report discussed in May 2007 includes a provision of US$10 million for each of the PRSOs 4-7 operations. Component 1 of PRSO and its subcomponents support the first pillar of the Bank's CAS objective - to sustain growth through managing key growth drivers. Component 2 of PRSO and its subcomponents support the second pillar of the CAS, especially where it concerns strengthening public financial management to improve the social outcomes. PRSO also helps to manage risks identified in the CAS, especially those related to weak implementation capacity and to fluctuating political environment. The second series of PRSOs continues to contribute to the third pillar of the CAS by supporting the establishment and implementation of a capacity building strategy and partnerships, through identifying capacity constraints in all sectors of operation, addressing them through TA and an extensive PRSO dialogue, and through attracting strong partnerships under PRSO umbrella. The latter reflects the recent co-financing of the PRSOs by the European Commission, Japan, and Australia. 68. Preparations of a new CAS are underway, in order to align the Bank strategy with the upcoming seventh NSEDP (2011-2015). While it is too early to determine what the focus will be, it is very likely that it will stay the course with the directions established by the current CAS and look at new opportunities presented by next five-year plan as well as changing global and regional context. RELATIONSHIP TO OTHER BANK OPERATIONS 69. The PRSO program plays a focal role in supporting the policy reform dimensions of other Bank operations, both ongoing and as envisaged in the CAS, and is in turn supported by other Bank operations. The PRSO framework provides a platform for policy reforms that complements interventions within other sectoral investment operations. Inter alia, this means that PRSO supports key policy reforms that are then implemented with support from other Bank operations. Over time, a satisfactory policy-based operation aims to provide IDA with convincing evidence that the country's policies and institutions are improving and thus allow more resources to be made available for both sectoral investment operations and budget support. 70. PRSOs are a critical element of the Bank's support for NT2. The World Bank support for the NT2 project was based on a decision framework with three key elements: (i) Lao PDR establishing and implementing viable development policies, characterized by concrete performance, and national programs for poverty reduction and social and environmental protection; (ii) sound technical, financial, economic and implementation aspects of the proposed project, as well as the design and implementation of safeguards policies; and (iii) wider understanding and broader support from the international donor community and global and local civil society for Lao PDR's development framework and the proposed 26 project. The PRSOs support the implementation of development policies, and national programs for poverty reduction and social and environmental protection, as referenced in the first element of the NT2 decision framework. The links to NT2 entail a high degree of scrutiny of the reform program, including the PRSO program, through annual consultations with NT2 partners, the International Advisory Group and ultimately through dissemination of information to the donor community and the wider public. 71. A key component of the series supports the Government?s program for improvement in transparency and effectiveness in public expenditure management, as laid out in its Public Finance Management Strengthening Program (PFMSP). The PFMSP inter alia supports the implementation of the NT2 revenues management arrangements which are aimed at providing additional resources in support of poverty reduction and environmental protection programs, to be selected according to an agreed set of eligibility criteria. 72. The Financial Management Capacity Building Project (FMCBP) is designed to finance technical assistance and capacity building needs to support the implementation of the Government?s structural reform programs in public financial management, SOCB reform, SOE reform and enterprise development. FMCBP has already been used to finance various PRSO-related activities, including independent audits of SOEs and SOCBs under PRSOs 1 to 4; provision of technical assistance for revising the chart of accounts and realigning the budget nomenclature, training of staff, procurement of hardware to improve management of state assets, and the recruitment of technical assistance under the PEMSP. FMCBP has recently been restructured to provide additional financing on grant terms, to assist the Government in scaling up the capacity building needs for the PFMSP, implementation of the revised Budget Law, and reforms envisaged under the PRSOs. The FMCBP is also supporting capacity strengthening at the SAO, in close coordination with on-going TA from ADB. 73. AusAID, the EC, SIDA, and SDC have also established a multi-donor trust fund managed by the World Bank to support the implementation of the PFMSP. This multi-donor trust fund will be an important vehicle for providing untied additional resources to the Government for implementation of the PFMSP, including support for implementation of the new Budget Law. The MDTF will also be an appropriate vehicle for improving donor coordination and harmonization. 74. The MOF and the World Bank are also preparing the Treasury Modernization Project which aims to deploy an integrated Treasury Information Management System at Treasury Departments across the country. This proposed project, expected to be presented to the Executive Board in FY 11, builds on the support provided by the FMCBP and the PFMSP multi-donor trust fund towards modernization of the Government budget execution system and put in place procedures on budget execution that would further tighten fiduciary controls and increase speed of budget execution. 75. The Multi-Donor Trust Fund for a Trade Development Facility and the Lao Customs and Trade Facilitation Project (LCTFP) both contribute to improving trade competitiveness. The custom project facilitates trade by improving the efficiency and effectiveness of customs administration. It will simplify customs procedures, eliminate duplication and redundancy, reduce transaction costs and time to clear goods, and increase transparency and accountability. The project was built on the results of AAA work including DTIS and ICA and supports the reform agenda to sustain fast export-driven growth in the medium- and long- term. The major reforms in trade facilitation and other trade-related areas are supported through the PRSO program, Component 1. The Multi-Donor Trust Fund for a Trade Development Facility managed by the World Bank with contributions from EC and Australia is also supporting this program and provides technical assistance to improve competitiveness, business environment, standards, information technology for border operations and inter-agency coordination, and implementation support for a sector-wide approach in trade. 27 76. The recently approved Technical Assistance for Capacity Development in Hydropower and Mining Sector Project provides a platform to increase human capacity and improve the performance of Government oversight institutions for the two sectors. It aims at building critically needed capacity and generating public awareness across the hydropower and mining sectors. The provision of adequate skills and training to government staff and the next generation of leaders for the two sectors would remove critical bottlenecks to the development of both sectors. The hydropower component focuses on capacity building in support of sustainable hydropower development in Lao PDR. Activities will cover the entire value chain, from planning, concessioning, construction, and operation to revenue management, including facilitating the implementation of the NPSH. The mining component supports: (i) the completion and dissemination of the new mining legislation; (ii) the development of a national mining development policy; (iii) preparation of a standard mineral development agreement; and (iv) promote models for corporate social responsibility, risk mitigation and community benefit-sharing approaches. 77. The Lao Environmental and Social Project is supporting the development of the regulatory framework for the hydropower sector, and in relation to other large development projects. Sub-grants to support implementation of the National Policy on the Environmental and Social Sustainability of the Hydropower Sector, including the strengthening of Environment and Social Impact Assessment (ESIA) Practice and new ESIA regulation in Lao PDR. LESSONS LEARNED 78. The World Bank has a long track record in policy lending to the Lao PDR since 1989. For the period of 1989 to 2001 however, the experience was uneven. The outcome of the first three Structural Adjustment Credits (SAC) l 5 was rated by the Bank's Operations Evaluation Department (OED) - now renamed Independent Evaluation Group (IEG) - as unsatisfactory, mainly due to feeble Government commitment to the reform program and weak implementation capacity. OED recommended that future policy-based operations in the Lao PDR incorporate key lessons from these operations. 79. These lessons were taken into account in the design of the programmatic PRSO program for the first series (PRSOs Nos. 1-3) and the current second programmatic series (PRSOs Nos. 4-7) as follows: Greater inter-ministerial coordination needs to be fostered. The Government has made special effort to institute and ensure inter-ministerial coordination through the PRSO Steering Committee and its Technical Secretariat, with representation across ministries and frequent meetings to align implementation strategies and discuss cross-cutting issues. This process is led by the Ministry of Finance, and the operations processing schedule is determined by the Ministry of Finance. In order to ensure appropriate coordination of monetary and fiscal policy during the financial crisis, the PRSO Steering Committee also includes the Deputy Governor of the Bank of Lao PDR. Adequate and appropriate technical assistance and implementation support should be provided. In order to assist in effective implementation of the policy reforms, complementary technical assistance is being provided through the FMCBP and other resources such as the PHRD, the MDTF for PEMSP, the Trade Development Facility, and coordinated technical support by other development partners. l5 The three operations are: SAC I (approved in 1989), SAC I1 (approved in 1991) and SAC 111 (approved in 1996). 28 Take into consideration capacity limitations. The PRSO program was designed as a programmatic series to take into account the need to manage reforms in a series of steps with focus on medium-term outcomes and monitorable impacts. 80. These efforts have contributed to the successful implementation of the first PRSO series and a promising beginning of the second series. Inter-ministerial agency coordination has been vastly improved through the PRSO process and related dialogues; resulting in real ownership among agencies and ministries and efficiency in coordination. The impact of technical assistance provision in selected areas has been clearly noted. l6 The PRSO program was built upon the Government's own poverty reduction strategy rather than on an externally imposed framework. 81. Capacity constraints remain, however. The Government's ability to implement reforms may have been overestimated during the design of the first programmatic series. Structural reforms during transition from a planned to a market economy, such as SOE reform and banking sector reform, need to be accompanied by several parallel processes before they can be implemented. These require building understanding of the meaning of these reforms, and creating support blocks within the Government. This suggests the following necessary sequence: improved monitoring, setting targets and monitoring achievements of such targets, building incentives system to achieve targets within the public sector, and finally implementable actions. Building capacity to perform in such complex reforms during this sequence is key to success of these reforms. 82. Other concerns about the coverage of PRSO had emerged from the implementation of the first series. 17 They include: (i) recognizing benefits of greater focus; (ii) identifying and addressing critical capacity constraints; (iii) fostering ownership by aligning reforms with national development objectives; (iv) shifting the focus to outcomes; (v) maintaining flexibility in order to achieve these outcomes; and (vi) aligning the Bank's AAA work with PRSO objectives. 83. Based on these lessons, the following criteria for triggers and actions have been incorporated in the current second PRSO series. Acceptable triggers should meet the following criteria that are consistent with good practice on conditionality (see Box 2). (a) Reinforce ownership and be consistent with NSEDPPRS and cover four years (PRSOS 4-7); (b) Not attempt to fully cover all NSEDP agenda; on the contrary, PRSOs shall help the Government to prioritize the reform agenda in NSEDP; (c) Be flexibly formulated and be leading to achievement of monitorable outcomes based on programmatic approach. Focus should be more on a four-year program deliverables rather than on particular year-by-year actions; (d) Be critical to the achievement of the series outcomes (growth, poverty reduction, and macro stability); (e) Have lasting effect in improving mechanisms and incentive systems; (f) Be accompanied by TA on a principle of mutual accountability. l6 For example the public financial management component has showed faster and more profound progress in comparison to others areas that did not have or have little of such support, i t . , banking reform. 17 The World Bank and the Government teams have taken stock of the lessons learned from the implementation of the first series of operations, PRSOs Nos. 1-3, during the dialogue on PRSO Nos. 1-3 and during the retreat in Houayxay, Bokeo province. 29 Box 2. Good Practice Principles on Conditionality Applied in Lao PDR Principle 1: Reinforce Ownership Ownership of the PRSO series is reinforced through program design and participatory and transparent PRS process. Recent track record of Lao PDR indicates continued commitment and ownership of the program supported by PRSOs. The analytical work is being undertaken by the GOL in close collaboration with development partners and is used in policy and decision making process. In order to adjust to a more realistic assessment of the political commitment to SOE and banking sector agenda, the focus of PRSO.5 was shifted in direction of monitoring these sectors while still trying to push forward reforms. Principle 2: Agree up front with the government and other jinancial partners on a coordinated accountability framework Under PRSO series, there is an agreed accountability framework including a well-defined policy matrix for measuring progress under the program. This framework however is not yet harmonized across the donor community, but significant steps are being taken to improve aid coordination and harmonization across the board, reflected in signing the Vientiane declaration on aid effectiveness (by GOL and 22 development partners). Importantly, cooperation of the donor community behind the current PRS04-7 series has intensified during PRS06, including joint missions, monitoring and evaluation, and strategic planning for PRS07. Principle 3: Customize the accountabilityframework and modalities of Bank support to country circumstances The modalities of the operation are meeting country needs and encourage public financial management reform. However, some adjustments need to be made in the hture on the timing of reforms, particularly in sectors related to structural adjustment to a market economy, such as SOEs and banking sector. 0 Ownership of some sensitive policy reforms has been strong (like on trade and public financial management), however it was weaker on other issues (such as SOE reform and state-owned banks reform). 0 The evidence amounts that policies supported under PRSOs reflect Government's expressed policy intentions and are aligned with the NSEDP. Principle 4: Choose only actions critical for achieving results as conditionsfor disbursement and supported with Technical Assistance Prior actions and conditions chosen from the agreed accountability framework are focused on critical actions for achieving the objectives of the program. Country circumstances and advancement of structural reforms however dictate specific approach to achieving the objectives of the program. Ensure that corresponding technical assistance is identified up-front where development partners commit to providing assistance to implement the reforms, and mechanisms exist for reinforcing the principle of mutual accountability. Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based financial support 0 The PRSOs support is aligned with the budget cycle and is disbursed prior to the end of the Government's fiscal year in September. Regular reviews are done through frequent assessment missions and RTM and annual plan processes are incorporated into the routine monitoring of progress on actions and triggers. Result focus of these reviews should however be strengthened in the future. 0 For the proposed PRS06, the size and coverage of the policy matrix has been set ensuring that the interventions are at the reform frontier, whilst ensuring that implementation capacity is there It is hoped that for PRS07, analytic work will be fed more upstream into the policy dialogue, building on the achievements of the analytical work during recent years that has been participatory and increasingly owned by the Government. 30 ANALYTICAL UNDERPINNINGS 84. R The analytical under innings the PRSO series were extensively reviewed in the Program Document for the PRSO-4. The review discussed the series of AAA completed and ongoing, including the Budget Law Implementation Plan (2007), the first Public Expenditure Tracking Survey (PETS, 2007), a Public Expenditure Review and Integrated Fiduciary Assessment (PER-IFA 2007), Lao Financial Sector Study (2006), Country Economic Memorandum (2004), a Poverty-Environment Nexus Study (2002), Lao Poverty Assessment Country Procurement Assessment Review (2002), a Poverty Study (2002), a Country Financial Accountability Assessment (2002), and a Public Expenditure Review (2002). More recently, the analytical work includes the Lao Poverty Assessment, PSIA; the Diagnostic Trade Integration Study (DTIS); and an Investment Climate Assessment (ICA). As part of the NT2 revenue management arrangements, the Government has undertaken to conduct a PER every two years. These studies have been prepared by Bank staff in collaboration with the Government. 85. As noted in the Program Document for PRSO-4, the strategy underpinning the Bank's AAA program is to identify and fill key knowledge-gaps with an emphasis on joint work with the Government and other development agencies to bring about a buy-in on the diagnosis from all stakeholders. The results of this AAA process were used to build consensus on policy reform, sector investments, and harmonization of donor assistance in key areas. These are reflected in the NSEDP as well as its implementation. Several of these studies have been prepared in collaboration with other development partners including the IMF, ADB, UN, and EC, as well as other agencies. 86. The World Bank has been providing significant technical support to the Government for implementation of the public finance management strengthening program and the NT2 Revenue Management Arrangements (RMA). This support has permitted policy dialogue and close collaboration on central-local fiscal relations and the revenue sharing framework as well as on revision of the chart of accounts along with budget nomenclatures. This activity has been instrumental in ensuring appropriate implementation support be provided to the Government on complex public finance management reforms. 87. The Government and development partners have commenced the PER for FY2009, and conducting the PEFA Assessment. The results from this analytical work will provide further insight into the design of the upcoming PRSO operations. This will include focus on the fiduciary framework of the Government. This PER will provide an assessment of progress on the PFM reform program since 2004, including implementation of the NT2 M A , and considers the challenges and priorities for the reform program looking ahead. In this regard, the PER would recommend any re-prioritization within the reform program. The PEFA assessment will present a snap shot of the status of the PFM system in Lao PDR and will help refine the Government's PFMSP program accordingly. 88. A Report on the Observance of Standards and Codes (ROSC) has been finalized and an IDF grant is in place to fund the implementation of some of the key recommendations. It provides findings and recommendations to strengthen enterprises accounting and auditing practices, in order to foster the quality and reliability of enterprises financial reporting, thereby contributing to improved business environment and investment climate in the country. The ROSC addresses the systemic and governance requirements that are necessary for improved competitiveness in world markets, an enhanced financial sector, and a strengthened enterprise accounting and auditing practice in the country. It provides policy recommendations for necessary actions towards implementation of international corporate accounting and auditing standards; strengthening the profession and improving the capacity of professional bodies; 18 World Bank, Program Document for PRSO-4, May 15,2008, pp. 26-29. 31 introducing appropriate mechanisms for ensuring compliance with enterprises accounting and auditing requirements; and developing arrangements for high quality accounting and auditing education and training. Looking forward, there is the need to for developing a unified framework for accounting and auditing covering the private and public sector. 89. The upcoming GAA work will help to refine the design of subsequent operations. In particular, the PRSOs will build upon findings of the Country Economic Memorandum (CEM) on natural resource management (scheduled for delivery in FY2010), Financial Sector Strategy (FY2010), Health Financing Policy Note (FY2010), Teachers Study (FY08), Education for All Assessment (FY09), Civil Service Pay and Compensation Review (FY2010), Study on Trade in Services (FY09), Uplands Livelihood Typology and ICA (FY20 lo), subsequent PER (FY20 lo), the Public Expenditure and Financial Accountability Assessment (FY20 lo), the update of the Investment Climate Assessment (FY2010), next Poverty Profile (2010), next PETS (FY201 l), and other studies. Regular policy notes and small AAAs will also contribute to the overall program and allow for mid-term corrections where needed, including Environmental Monitors and Economic Monitors. COLLABORATION WITH THE IMF AND OTHER DEVELOPMENT PARTNERS 90. Since April 2005, the Fund has conducted an annual Article IV consultation as well as prepared half-yearly macroeconomic assessment letters. The Bank and the Fund staff collaborate closely during these annual consultations in the context of the PRSO program. The IMF's last Article IV consultation was completed in June 2009. The next consultations activity is scheduled for June 2010. Findings of the latest mission have been reflected in the Program Document. The IMF will provide an assessment letter for PRS06 by end April 20 10. 91. PRSOs in Lao PDR are characterized by a framework of evolving partnership between Government and development partners, and have become an important new aid modality and a vehicle for donor harmonization and policy coordination. During the preparation of PRSC-1 through PRSO-5, and the current PRSO-6, discussions were held with major development partners including the IMF, EC, Japan, and the ADB. For PRSOs 4-7, the matrix was appraised jointly by the three development partners co-financing the program: Japan, European Commission, and Australia. The World Bank and donor team inform the donor community on the progress with PRSOs and encourage other development partners' participation. 92. Australia, represented by AusAID, has decided to co-finance PRSOs and is also providing complementary TA support via two World Bank-managed multi-donor trust funds for public finance management strengthening program and the Trade Development Fa~i1ity.l~ Australia has been actively participating in the PRSO series, as well as in the PFMSP and trade development. Australia's special focus is on ensuring that PFM reforms lead to enhanced resources for social sectors, delivered in a timely manner to service delivery units, as well as in implementation of the trade facilitation action plan. Australia is involved in the social sectors, especially in education, where it is supporting the Government in implementing its sector plan, the Education Sector Development Framework, and corresponding annual prioritized and costed action plan. Australia is proposing to co-finance the upcoming World Bank Technical Assistance Project for Capacity Development in Hydropower and Mining sector. The Policy Action Matrix (Annex 2) incorporates AusAID's focus areas. 93. The European Commission's participation in the joint PRSO-6 focuses on the dialogue in the following sectors: public finance management and civil service reform (i.e. pro-poor budgeting, control and transparency of budget execution, external scrutiny of the budget, PEFA assessment), private 19 Australia'sestimated budget for PRS06 is 2.5 million Australian dollars. 32 sector development and trade sectors (i.e., enabling business environment and investment, regional and international trade integration, trade facilitation and macroeconomic stability) with a special attention to the education and health sectors (i.e,, budget allocation, sector management and service access). The Financing Agreement with the Government of Lao PDR to support the PRS04 to 7 implementation of Euro13 million, was signed at end-2008. It includes a Euro3 million commitment to support PRSO-6 achievements. The support comprises a fixed tranche of Euro2 million and a variable tranche of Euro1 million which is subject to achievement of three variable tranche indicators targets that are assessed during the joint PRSO appraisal mission. The use of indicators to measure Government's performance in the health and education sectors was introduced in this four-year agreement for PRSO-5, 6 and 7. The set of three indicators per sector for the variable tranche are incorporated into the Policy Action Matrix (under both PRSO-6 and indicators columns). A support of Euro3 million to PRSO-4 was disbursed at the end of 2009 and PRSO-5 payment has not been processed yet. The EC is also providing complementary TA support to enterprise development (Le. SME programme), to strengthening MOH and MOE and via the two multi-donor trust funds (public finance management strengthening program and the Trade Development Facility). 94. The Government of Japan has decided to co-finance PRSOs through the scheme of Japanese ODA loans. The Japanese Government agreed to provide a loan up to 1.5 billion yen as the Budget Strengthening Support Loan using the same PRSO policy matrix in November, 2009. Japan also provides some complementary TA supports via the JICA's Technical Cooperation scheme for improving public finance management and investment environment. Japan's interests in policy dialogue lie in the following areas. In Component 1 (Investment Climate, Competitiveness, and Business Development): Improving Investment Environment, including legislative consistency, institutional building and simplification of procedures; Promotion of Trade and Transport, including institutional building and human resource development on custom and custom clearance and simplification of procedures; SOEs Reform, including preparation of restructuring plans; Financial Sustainability of the Public Electricity Utility, including settlement of arrears, preparation and implementation of action plans; and Financial Sector Reform, including improvement of the management of state-owned commercial banks. In Component 2: Strengthening Public Finance Management; including management of Public Investment Program (PIP), capacity building towards MOF officers through conducting trainings on Treasury Cash Management and Public Accountings and supporting to establish Human Resource Development(HRD) system by formulation of HRD Strategy and its implementation plan. Japan's interests also include Improving Service Delivery (Education and Health) as another important sector. These interests have been included in the Policy Action Matrix, as reflected in Annex 2. 95. Other development partners provide grants for technical assistance in support of policy reforms and capacity building. The PRSO program has an ambitious agenda, and grant-based technical assistance plays an important role. Several development partners have already provided this assistance. JBIC financed consulting services to the Business Promotion Office (BPO) in the Prime Minister's Office (PMO) to support the development of SOE restructuring plans under the PRSO-2 and PRSO-4, and will provide similar support under PRSO-5. The Government of Japan provided a PHRD grant for technical assistance to the Lao PDR under PRSO-3, and an application is being made for a similar grant for PRSO- 5. The EC, ADB and Swedish International Development Agency (SIDA) financed technical assistance to support the PRSO-linked Public Expenditure Review (PER) and are supporting the Public Expenditure Management Strengthening Program (PEMSP). The PRSO process has involved close collaboration with many other donor-supported initiatives - notably, the ADB's work on banking reform, SIDA's work on tax reform and the United Nations Development Program's work on governance and public administration reform. 33 V. THE PROPOSED OPERATION OPERATION DESCRIPTION 96. The PRS06 -- which is jointly prepared by the Government and IDA and in collaboration with co-financing development partners -- is the third operation of the second PRSO series (PRSOs 4-7) in support of the implementation of Lao PDR's Poverty Reduction Strategy which is articulated in the Sixth NSEDP. The PRSO-6 assists the government to continue cross-cutting reforms in a consistent framework, while the financial support provided will contribute to reduce the gap between the costs of implementing key elements of this strategy and the resources available from the Government's own revenues and other development partners' support. 97. The PRS06 seeks to support policies that ensure sustained growth and improved revenue mobilization in the medium term, thereby increasing resources available to be used for implementing the poverty reduction strategy. PRS06 focuses on two broad policy areas consistent with the goals and strategies identified by the Government in its PRS, and reflected in the World Bank's CAS in the following way: (1) sustainable growth; and (2) public resource and expenditure management. Increased growth and improved management of public resources will ensure that additional resources are available for implementing the poverty reduction strategy, and that these resources are deployed more effectively and efficiently towards improving social outcomes. 98. Progress in these policy areas enables a continuation of the good macroeconomic performance, continued progress with poverty reduction, as well as managing the impact of the global financial crisis. As programmatic budget support, the PRSO program will contribute to funding predictability, and the associated dialogue between the Government and donors to ensure policy prioritization and donor coordination. At the same time the reforms supported by the PRSO will ensures that scarce available resources, which have been declining due to the onset of the global financial crisis, are deployed more strategically and effectively. 99. Building on the track record of the PRSOs 1-5 and increased implementation capacity, the PRS06 and PRS07 focus on implementation of the laws and institutional restructuring, while starting assessing desired outcomes of the series. PRSOs 1-5 have put in place a strong platform for programmatic policy reform, an appropriate legislative and institutional framework (especially in the public finance management framework), strengthened capacity of government, and helped put in place a robust foundation of these reforms. The collaboration between the Government and development partners has also been significantly strengthened. COMPONENT 1: INVESTMENT CLIMATE, COMPETITIVENESS, AND BUSINESS DEVELOPMENT 100. Both the current and upcoming NSEDPs call for a high level of investment to achieve targeted growth. The upcoming NSEDP calls for a level of total investment of 32 percent of GDP, out of which 23 percentage points are expected to be mobilized from the private sector, including FDI. It also emphasizes the need to support SMEs development to create jobs and diversify economic growth. Currently, the country enjoys similar volumes of investment (28 percent of GDP in 2008), but most of it (80 percent) goes to the natural resource sector. Domestic private investment remains low. There is a need to support private investment in other sectors, in order for Laos to sustain a balanced and job-creating economic growth. 101, Private sector faces significant constraints to doing business, including lack of access to good infrastructure, cumbersome regulations, limited access to finance. The WB/ADB Investment climate 34 assessment concluded that the priorities in improving the investment climate on the policy and institutional front should be streamlining regulations, improve access to formal sources of finance, eliminated discretion in taxation, and improve regulations and process specific to importing and exporting goods. 102. The triggers and policy actions are designed to foster productive long-term investment through an enabling environment for regional integration and private sector development, based on findings of a range of AAA work done by the World Bank and other development partners during the past several years, as described above. To support private sector development, the programs focus on the following eIements: (i) creating an enabling business environment and attracting quality investment in the non-resource and natural resource sector (hydropower and mining); (ii) reducing trade barriers and proceeding with implementation of international and regional agreements; (iii) improving performance and monitoring and SOEs; and (iv) enhancing the commercialization and transparency of SOCBs. 103. First, PRSO 4-7 contributes to create and sustain an enabling business environment and attract quality investment in the non-resource (general) and resource private sector. In the non- resource private sector, the series specifically supports the formulation and implementation of the Enterprise and Investment Laws. The Enterprise Law, supported by PRS04 and PRSOS, has successfully introduced simplified enterprise registration procedures. The investment law, supported by PRS06, proposes among other measures to abolish lengthy and cumbersome licensing procedures for both domestic and foreign investors seeking to make investment outside a Negative List, which could before take 3 to 5 months for approval.*' The new investment law also enhances level playing field between foreign and domestic investors by harmonizing the investment incentive regime. The expected outcomes which PRS04-7 directly influences are the simplification of regulations for business entry. The number of days to start a business for manufacturing sector has decreased from 183 (163) in 2006 to 145 (100) in 2009 [staff estimate (doing business)] and is expected to drop by another 60 days once the investment law is implemented. 104. In the resource sector, the PRSO series support the development of a regulatory framework which attracts quality and responsible investments. The PRSO series specifically supports: The implementation of the Mineral law. The Mineral law addresses some of the key issues facing the industry, including introduction of more transparency and predictability in granting exploration and mining licenses to investors, clearer regulations regarding operations, transfer of mining rights and clarification of government's equity rights in mining projects. The World Bank technical assistance project will support sector agencies prepare the first stages of the listed actions as well as sector promotion, while the PRSO supports the key policy and institutional aspects of the reforms. The implementation of the National Policy on Environmental and Social Sustainability in Hydropower Development (NPSH). Specifically, it supports the strengthening of environmental and social impact assessment process through the issuing of Prime Minister's decree 112 as well as the public disclosure of report on the implementation of the policy to date. The EIA Decree represents a significant strengthening of the environmental impact assessment process by replacing ministerial regulations with a Decree issued by the Prime Minister, and clarifying the range of procedures and responsibilities involved. It also provides for a grievance process, in line 2o A negative list approach requires that discriminatory measures affecting all included sectors be liberalized unless specific measures are set out in the list of reservations (the negative list). 35 with the NPSH. Following the issuing of the new decree, the series will support the updating of the policy, as well as the development of an action plan to guide its implementation. These actions will be supported by the Hydro Mining Technical Assistance project, as well as the Lao Environment and Social Project. 105. Second, the PRSO series is supporting government efforts to reduce trade barriers and proceeding with implementation of international and regional agreements. It supports reforming trade facilitation legislation and procedures in order to support increased private sector investment, streamlined cross-border trade, and the introduction of a more transparent rules-based system compliant with the WTO principles. The specific actions that the series has been supporting are: 0 Developing relevant implementing regulations and guidelines of the Customs Law; developing and implementing a national trade facilitation action plan to promote simplification, harmonization, transparency and automation in customs and other border procedures; implementing customs modernization through the adoption of a new single administrative document and streamlining customs procedures; preparing for the introduction of the national single window; increasing compatibility with ASEAN and WTO standards. On the latter, three key pieces of trade facilitation legislation need to be revised and are supported by the PRSO series: (i) PM Decree on Import Licensing (successfully revised as a completed policy action under PRSO5); (ii) PM Decree on Import-Export Management; and (iii) PM Decree on Rules-of- Origin. Revisions to this third Decree will ensure that Rules of Origin applied under Lao law are transparent, non-restrictive and non-distorting; administered in a consistent and uniform manner; and based on a positive standard (and hence consistent with the WTO Rules of Origin Agreement)? It was initially foreseen that PRS06 would support PM Decree on Import-Export Management. Because more time was needed for consultations around this important decree, it was decided that it will be supported by PRS07, while the rules or origin Decree which had made more headway was selected instead. The expected outcomes which PRS04-7 intends to directly influence are cross border streamlining of procedures. The numbers of days to export and import have decreased from respectively 66 and 78 to 50 and 50 are is expected to decrease further by the end of the series. 106. Third, PRSO 4-7 contributes to improve the performance and monitoring of state-owned enterprises (SOEs) and supports the SOE restructuring process. It assists the government's effort in improving SOEs efficiency, strengthening Government's capacity to monitor them, improving the regulatory environment in which they operate, and develop and implement a strategic plan for reform including corporatization of key SOEs. In order to make significant progress in SOE reform, it is essential to adopt far-reaching policy decisions to improve performance of SOE sector through defining strategic and non-strategic SOEs; withdrawing from non-strategic ones; clarifying the role of NCBD; corporatizing strategic SOEs; strengthening state-assets value management; and enhancing shareholder functions of the MOF . 21 Rules of origin are used to determine the country of origin of a product in international trade for certain purposes. These purposes may be for quotas, anti-dumping,anti-circumvention,'statistics origin labeling. or 36 107. Specific actions that the PRSO series supports includes: 0 (i) NCBD under the PMO conducted independent financial audits for FY2005 and FY2006 for ~~ 4 Phase I1 SOEs and 3 Phase I S O E S ; (ii) NCBD is developing restructuring plans for Phase I1 and I11 SOEs, which are expected to be completed by the end of 2009. 23 The main reasons for the delay in completing the restructuring plans for both Phase I1 and Phase I11 SOEs are lengthy processes for recruiting international consulting firms and poor financial information of the SOEs. 0 (ii) The sustainable settlement of electricity arrears between government agencies and Electricite' du Laos (EDL) and the setting up of a system that would preclude future arrears, including compliance with the Sustainability Action Plan. In the past, major arrears from the Government budget have built up to the utilities. 108. The expected outcomes which PRS04-7 intends to directly influence are greater transparency and commercial viability of major SOEs being restructured, and to reduce their financial losses. The ratio of losses over profits in the SOE sector has declined from 4.8 percent in 2006 to 0.001 percent in 2008. Government electricity arrears have declined, from LAK 133 billion in 2004/05 to LAK 34.5 billion in 2008/09, these arrears are expected be fully settled by 201 1. However, budgetary outlays continue to remain below projected electricity usage, and thus it is expected that new arrears will accrue for FY2009/10. The Government is now considering establishing an effective responsibility matrix for government agencies to conserve electricity and to be responsible for settling their electricity bills in a timely manner. Supporting such a responsibility framework will be the focus of the PRS07 operation. 109. Fourth, PRS04-7 series seeks to improve the depth and outreach of the financial sector by: (i) taking an integrated approach to financial sector reform through developing and implementing comprehensive financial sector strategy; (ii) enhancing banking supervision and regulation by strengthening SOCBs supervision, which account for 60 percent of total banking sector assets; and (iii) developing sustainable microfinance regulatory and institutional framework. The specific actions which PRS06 supports are (i) the strengthening of the Bank of Lao PDR supervisory functions and (ii) the development of an action plan to implement the approved Financial Sector Strategy. 110. The expected outcomes which the series seeks to directly influence is a better performing banking sector, with declining non-performing loans. Non-performing loans declined from 8.1 percent in 2006 to 3 percent at the end of 2009. 22 Analysis of available financial information indicated that 7 out of 12 SOEs under restructuring generated profit during 2006, with profit margin ranging from 0.68 - 16.95 percent of total sales. Key findings of the independent audits include: (i) weak control over fixed assets, cash, purchases, trade and other payables; (ii) absence or inadequate documentary support for the cost and revaluation of fixed assets, trade payables; (iii) lack of comprehensive accounting policies and procedural manuals; lack of proper budget plans and projected cash flow; and (iv) some of the audited SOEs had negative equity and high liquidity risk 23 SOE restructuring is divided into 3 phases: Phase I started in 2004 and consists of 4 large SOEs (BPKP, Lao Airline, Nam Papa Nakhoneluang and Pharmaceutical Factory No.3 (PF3)); Phase I1 started in 2005 of 4 medium SOEs (Agriculture Industry Development Import-Export State Owned Enterprise, Lao State Fuel Company, Societe Lao Import-Export, and Road Construction Company); and Phase I11 started in 2006 for 5 SOEs (DAFI, LXP, LVSVT and LVKK). 37 COMPONENT 2: PUBLIC FINANCE MANAGEMENT AND IMPROVING SERVICE DELIVERY Public Finance Management 111. The PFM component of the PRSOs 4-7 focuses on key cross-cutting PFM reforms, and balances policy reforms momentum with implementation capacity. The thrust of the public financial management reforms continues on deepening them whilst focusing on implementation of policy reforms undertaken by the Government to strengthen the central-local fiscal framework, improving budget planning and execution, implementation of the legislative acts adopted under PRSOs 1-5, and focus on improving service delivery in health and education. 112. First, the PRSOs 4-7 supports the improvement of the credibility of budget planning and enhancement of transparency and comprehensiveness of budget reporting by: 0 Strengthening and regular updating of the public finance management strengthening program (PFMSP). The PFMSP comprehensively lays out the PFM agenda, including the implementation of the NT-2 RMAs, where the Bank is providing significant staff time support and financial resources. In this regard the Bank and development partners have established a multi-donor trust fund to support PFMSP implementation. 0 Clarification of central-local relations and respective responsibilities related to revenue- sharing, expenditure assignment, and service delivery. Since the promulgation of the Budget Law 2007, the Government has been taking steps towards making the budget allocation system more transparent and rules based. In this regard, the MOF's Budget Department has been leading the work on developing a new revenue sharing model and a system of budget norms for the education and health sectors. Since FY2008/09 the Government has managed to mandate minimum spending on health and education sector by provinces. Additionally, the revenue sharing model has been developed, widely consulted within government and with the National Assembly's Economy, Planning and Finance Committee. The methodology has been endorsed in principle by the Government. It is expected that the revenue sharing formula will be implemented together with the budget allocation norms starting from the FY2010/11. MOF is also developing a strategy for implementation of the budget norms from FY2010/11. This work will entail: (i) clarification and completion of expenditure assignments between central and local government levels in education sector; (ii) development and issuance of a decision on expenditure assignment in the health sector covering all four aspects of the assignment, namely responsibilities for (a) actually producing the service, (b) providing or administering the service, (c) financing the service and (d) setting standards, regulations or policies guiding the provision of government health service; and (iii) data and scenario analysis for the introduction of budget allocation norms for education and health and an "all other categories of expenditure" for budget formulation and for design of an equalization grant for less well-off provinces. 0 Timely publication of budgetary information with increasing coverage and improving classification. The intention is to ensure that there is enhanced dissemination of timely information on budget execution and plans. The specific supported actions are the timely as publication of planned and actual budgets and in-year budget execution reports with increasing coverage. The MOF has implemented an up-graded GFIS from October, 1, 2009 with a new common chart of accounts and centralized system architecture. Once the system is stabilizes and all payment vouchers and revenue receipts are processed through the GFIS, the GFIS will be able to provide report on budget execution on a real-time basis. 38 113. Second, the PRSOs 4-7 supports the improvement of the transparency of intergovernmental fiscal relations and faster budget execution, through the implementation of the Budget Law, centralization of Treasury, customs and tax functions, and debt management strengthening. Specific policy measures are: 0 MOF adopted and commenced implementation of the Treasury Single Account framework, by consolidating all revenue accounts into Treasury-managed accounts. Since the promulgation of the Budget Law in 2007, the Government has put in place the necessary legislative framework for centralizing the Treasury Department, including transferring the control of bank accounts from ministries and provincial finance departments to MOF, within a Treasury Single Account framework. The implementation of this policy has been progressing steadily. To date, MOF has managed to gain control over all provincial treasury accounts, extra-budgetary funds like the road fund, and bank accounts of line ministries. Revenues collected by the tax and customs departments are deposited into these bank accounts. Approximately 80 percent of total public finances flow through these accounts. The remaining 20 percent represent bank accounts held by spending agencies collecting technical revenues. While this is already a major achievement in terms of establishing centralized control and oversight over public monies, the Ministry of Finance is taking further steps to bring them into the budget. Under PRS06, the MOF will issue instructions for all spending agencies to put their technical revenue into the Treasury. To this end, the MOF in collaboration with the Bank of Lao has completed an inventory of spending unit accounts that are being held in the banking system. Currently the MOF is reviewing and classifying accounts to decide which ones should be transferred to the Treasury. Based on the classification results, instructions will be issued to transfer the relevant spending unit accounts from the commercial banks to the Treasury. It is expected that the transfer process will take some months to be fully completed. Debt management strengthening. The main objectives are: (i) to strengthen the debt recording and reporting capabilities of the debt management unit of the External Finance Department, by putting in place an external debt recording systems with formats consistent with international standards; and (ii) to increase the strategic management of debt and improve capacity to identify appropriate sources of financing for government's medium-term development plans. Procurement capacity and transparency strengthening. The main objective is to ensure effective implementation of the public procurement legislation through strengthened monitoring and evaluation of performance and outcomes, increased access to procurement information and improved procurement capacities. The specific measures which are supported include effective use of the standard bidding procurement, operationalization of the procurement website, and development and implementation of an institutionalized capacity building program, and establishment of a system for monitoring and reporting procurement performance and outcomes. Besides the enactment of the improved procurement legislation in 2004 and finalization of standard bidding documents and standard procurement documents in 2009, progress on implementation of the improved procurement framework has been slow. The main constraint has been the prevailing weak capacity of the Procurement Monitoring Office (PrMO) of MOF which has still not been provided the staffing and resources set out in its 2005 Charter to enable it to carry out its functions effectively. Another reason is that enhanced high level government attention to procurement reform would bring the much needed support which is required for PrMO to perform its monitoring role and exercise the legislated authority vested in it under the Procurement Sub-decree and Implementing Rules and Regulations. There has recently also been a hesitated delay in engaging international consultants to assist with procurement reform activities that require specialized expertise which are not readily available in the country. . 39 114. Third, the PRSO-6 supports the State Audit Organization (SAO) in implementing the action plan for capacity strengthening which was approved as part of PRSO-5. SA0 completed an Audit Peer Review with SA0 New Zealand and approved the corresponding action plan for strengthening capacity for improving the quality and timeliness of financial audits. In order to ensure that capacity building support is provided in a consistent and coherent manner, the PRSO program is supporting the implementation of findings of the Audit Peer Review report. The World Bank, ADB and other development partners will provide support to the SA0 to implement this plan, with the aim of improving the quality and timeliness of financial audits in the first instance, and developing capacity for conducting performance audits in the future. Improving financial audit is also a key aspect of the NT2 RMA. 115. The expected outcomes which PRS04-7 intends to directly influence are the credibility of the budget; comprehensiveness and transparency predictability in budget execution; timeliness and quality of budget execution report; and scope, nature and follow up of external audit. For monitoring and assessment of progress, 7 PEFA indicators (PI-1, PI-6, PI-8, PI-10, PI-16, PI-24 and PI- 26) have been selected and for them baselines and targets have been jointly assessed and agreed with the Government as part of the on-going 2009 PEFA assessment and endorsed by the Development Partners. Policy actions and triggers implemented by this series directly contribute to the improved performance in the selected elements of the PFM system. For example, the implementation of the budget law and centralization of treasury, custom and tax administration functions allow the central government to take control of the major sources of revenue collection, making cash more timely available to the National Treasury to meet the expenditure needs of the spending units. As a result, the budget would become more credible. The work on clarifying the expenditure assignment, and development and application of the budget allocation norms would improve the transparency of intergovernmental fiscal relations. Given variations in complexity and status of the reform in different elements of the PFM system, the progress measured by improvement in the scores of PEFA high-level indicators is expected to be uneven among them. In some areas such as external audit where the reform program has just recently launched, improvement in the scoring of the performance indicator may take some years. Where possible, sub- dimensions of the indicators are expected to be used to monitor and assess progress as per the table below. 40 Table 6. Monitoring Indicators for Public Finance Management Component of PRS04-7 PEFA Target Baseline* Dnr-l:-.-* Performance Indicator Description of the IIIUI&IILUI L U G Indicator I1 I (2007) \rvvr' I 2009** Lv09** (201 1) (PI) PI-1 Aggregate expenditure out-turn compared to original approved budget C B B PI-6 Comprehensiveness of information included in budget documentation B B A PI-8 Transparency of Inter-Governmental Fiscal Relations D D D+ PI-10 Public Access to key fiscal information C C B PI-16 Predictability in the availability of funds for commitment of B B B+ expenditures 0) B (OB (ii)B (iijA (iii) B (iii)B (iii)B PI-24 Quality and timeliness of in-year budget reports C+ C+ C+ (0 c (i)C (i)C (ii) B (ii)A (ii)A (iii) C (iii)C (iii)B PI-26 I Scope, nature and follow-up of external audit D I D+ I D+I Note: * Baselines are joint MOF's and Bank Staff retroactive assessment; ** Tentative results of 2009 PEFA assessment. Improving Service Delivery 116. The specific actions that the PRSO 4-7 support to improve service delivery are: (i) the design and implementation of a civil service reform strategy; education strategy and health strategy, (ii) the production through information systems and publication of health and education service delivery data; (iii) strengthening budget planning at the service delivery unit level. ii C v l sewice 117. The government is developing a civil service reform strategy that will discuss issues aimed at strengthening delivery of public services.24 In addition, the Public Administration and Civil Service Authority (PACSA) has revised the Decree on benefits for officials working in remote areas. This decree aims at incentivizing civil servants to move to underserved rural areas by providing additional benefits to those posted to rural areas (additional cash benefits, housing, clothing, travel benefits, possibility of accelerated promotion). The PRSO series supports these two set of actions. The Government is expected to consider and approve the civil service reform strategy in 2010. The P R S 0 7 will aim to support policy critical aspects of the approved strategy, in order to ensure improvement in performance of the civil service. 24 The Public Administration and Civil Service Authority (PACSA) presented a draft Civil Service Management Strategy (CSMS) to the Government in November 2009. The overall objective of the CSMS is to institute processes for improving civil service human resource management and development in order to support the GOL's socio-economic development goals through high public service delivery standards. A supporting goal is the building of a modem civil service in line with regional and international benchmark models and practices. The nine identified strategic reform areas over the period 20 10-2020 are : (i) Improvements in human resources (HR) policies and regulation; (ii) HR planning; (iii) Salary reform, (iv) Performance management; (v) HR development; (vi) Service, information and communication technologV (ICT) and e-Governance; (vii) Gender, equity and equal opportunities; (viii) Occupational safety and health; and (xi) International and regional cooperation.. 41 Education 118. Lao PDR has seen substantial growth in primary and secondary enrollment in the last 10years. Recent data indicate that net primary school enrollment now stands at around 83 percent. Improvements in net enrollment in recent years have to a significant degree been driven by growth in female enrollment. Notwithstanding these achievements, enrollment is often late, a low proportion of students complete the full cycle of primary and secondary school, repetition rates remain high, and there are concerns about the quality of education. Moreover, the poorest districts in Lao PDR are experiencing systematic disadvantages in a range of educational indicators. While public expenditure on education has recovered from the financial crisis of the late 1990s, the level of spending remains low and heavily reliant on external financing. 119. The Government's education policy focuses on primary education and is set out in the NGPES, the NSEDP, and the Education Sector Development Framework. The Government has established the achievement of universal primary education by 2015 as a primary goal, with reductions in gender and geographic disparities in access, improvement in the quality and relevance of education, and improved education management as key strategies for achieving this goal. While the policy framework for the education sector emphasizes primary education, it also establishes priorities in lower secondary education, non-formal and adult education, teacher training, upper secondary, preschool, tertiary education, and technical education and vocational training. Taken together, the Government's policy priorities in education signify a substantial financing gap relative to current financing levels. 120. The actions in the education sector envisioned under PRSOs 4-7 aim to create conditions for improved strategic prioritization in the allocation of resources and more effective performance management. The PRSO actions include the following: Identify strategic direction and resource requirements. The completion of the Education for All Mid-Decade Assessment (EFA MDA) -- in the context of the Education Sector Development Framework -- provides an opportunity for the Ministry of Education (MOE) to take stock of achievements and challenges in the sector and to identify future strategic direction and resource needs. In addition, MOE is preparing a annual sector plan that reflects the priorities of the ESDF. Ensure that strategic priorities are reflected in the annual budget process (and eventual budget allocations), and that key components of recurrent spending are increasingly financed from domestic sources, including through introducing school grants pilots. 0 Improve the comprehensiveness and reliability of education information and integrate it into the planning and budgeting process. A second set of actions focus on the Education Management Information System (EMIS) and publication of Yearbooks. Improvement of the EMIS is a fundamental step to improve performance monitoring and management in the sector, and one of the requirements for the MOE to have access to NT2 revenues from FY2009/10. 121. The expected outcome which PRS04-7 intends to directly influence is an improved management of allocation and monitoring of education expenditures, with increased allocation of recurrent spending to education, and increased EMIS coverage. Health 122. Health outcomes in Lao PDR are improving, but significant challenges remain. According to available data, under-five mortality fell from 170 per 1,000 live births in 1995 to 98 in 2005, suggesting that Lao PDR is on track to meet the MDG target related to child mortality. However, 42 important health challenges remain. Mortality and morbidity remain very high, especially among the rural population. At least in part, this reflects low levels of utilization of health services (including of key preventive services such as immunization), Financial barriers and a lack of qualified personnel in rural and remote areas comprise key constraints to increasing utilization. 123. The Government's policy framework for the health sector emphasizes equity and improved access to primary care. NSEDP endorses the MDGs, establishing improved health outcomes and enhanced equity in access to basic curative and preventive health services (in terms of gender, economic situation, religion, ethnicity, and geography) as key goals for the sector. The Plan recognizes that a growing reliance on external financing and user fees entails risks in terms of sustainability and equity. NSEDP calls for increased government spending, but also for more diversified health financing arrangements, including piloting and expansion of, inter alia, compulsory health insurance, equity funds, and community based health insurance. The NSEDP also emphasizes the need to strengthen human resource management and target attention to priority districts. These goals and priorities resonate well with the CAS outcomes, which concern government spending on health and access to health services. 124. The PRSOs 4-7 support the Government's policy framework by focusing on key constraints to improving the performance of the health system. A first set of actions focus on health financing arrangements, including the establishment of a forum and process for developing a health financing strategy; piloting of equity funds to promote access for the poor; routine monitoring of key performance indicators in the main health financing schemes; and strengthened evaluation of health financing reforms to support policy making. These actions are expected to contribute to a consensus among key stakeholders about the merits and demerits of different health financing reform options, and, in the longer term, to a health financing system that effectively promotes equitable access and financial protection. A second set of actions focus on the Health Management Information System (HMIS), with the aim of establishing an institutionalized process for routine reporting on key health indicators by 20 11. Box 3. Health Financing Strategy in Laos The Health Financing Strategy (HFS) 20 10-20 15 is the first strategy to provide a frame work for health financing in Lao PDR. It is based on an extensive review of MOH health financing documents, consultative meeting within the health sector, line ministries concerns as well as Development Partners. The strategy is a joint production of Health FinancingIPlanning Task Force (HFP), Department of Planning and Finance, MOH, with technical support from Development Partners. The discussion of HFS began in early November, 2009 and the first draft was submitted to MOH Steering committee in the middle of March, 2010. The vision of HFS is "to free health services from the state of underdevelopment and to ensure full health service coverage, justice and equity in order to increase the quality of life for all Lao ethnic groups" it mission is "to achieve universal coverage by reducing out-of -pocket spending, increasing access to quality needed health services for all Lao people without them facing catastrophic fmancial expenses and to contribute to attainment of the five health MDGs" There are four strategic objectives that contribute to realization of this vision and mission of the HFS in Lao PDR. These include: (1) Increase investment and public health spending especially from domestic sources; ( 2 ) Rationalize expenditures to Improve health and nutrition outcomes, especially at PHC level and among the poor; (3) Strengthen access to good quality, affordable and sustainable health services by expanding social health protection towards achieving universal coverage; and (4) Strengthen the management capacity and evidence & information for policy-making. Under each of these 4 Strategic Objectives, there are thirteen Sub-objectives contribute to support the achievement of health financing strategy. The strategy also includes detailed priority strategic interventions that specifies the main activities to support each of the thirteen sub-objectives which can produce the immediate produce, time frame, responsibilities, and the essential resources estimation that will be required to implement each of the strategic intervention. 43 125. The expected outcomes which PRS04-7 intends to directly influence is an improved access to health care and health financial protection and an improved management and monitoring of health expenditures with increased allocation of recurrent spending to health and an increased HMIS coverage. 126. The Table below summarizes the prior actions and rationale for PRSO-6: Table 7. Summary of Prior Actions for PRS06 Prior Action 1: The MPI abolishes the reauirement for an investment license for Peneral investment activities outside the Nepative List as part of the implementation of the Law on Investment Promotion. Rationale: Available studies on business regulations, including ICA, DTIS, Enterprise Survey and Doing Business Report indicate that existing investment licensing regime is prominent barrier to starting a business in Lao PDR because the current regime lacks transparent licensing qualifications or procedures, furthermore, approval of the investment license requires to have very cumbersome consultation process between planning and investment agency and all other relevant agencies, which could take up to 2- 3 months to complete. To address this issue the Ministry of Planning and Investment (MPI) has developed new Investment Promotion Law, which among others, has proposed to abolish investment licensing requirement for all general investment activities outside the negative list developed as part of the implementation of the Enterprise Law and introduces an harmonized investment incentive regime for both domestic and foreign investors. Prior Action 2: Government amroves P M decree on Import-Export manapement and MOIC issues implementiw regulations based on this decree. Rationale: The revised decree will extend the principle of "national treatment" to all firms wishing to import, export or transit goods across Lao borders. It is an essential part of steps to improve transparency and bringing the Lao legal framework for trade in line with the principles of the WTO Agreement, and as such is a required step for the 6* WTO Working Party negotiations. Status: Delayed - Moved to PRS07 and replaced by new prior action on Rules of origins. The drafting of the revised Decree is completed. However, before submitting for approval by the Prime Minister's Office, MOIC intends to have the text reviewed by legal staff in the UNCTAD Trade Negotiations and Commercial Diplomacy Branch, Division on International Trade in Goods, Services and Commodities. This is an important, and initially unforeseen, step which is being taken to ensure that the new Decree complies with WTO principles and the expectations of the WTO Working Party. As such the Decree is unlikely to be formally approved by the Government by the PRS06 deadline of March 2010. A revised target date of September 2010 was agreed. It was agreed that this trigger is moved to PRS07. New Prior Action 2: The Recipient approves P M Decree on Rules-of-Oripin and the MOIC submits to the Minister of MOIC the implementinp regulation under said Decree on Mav 17,2010. Prior Action 3: The MOF (a) remains current on settlement of arrears for the period commencing FY 2004/05 and includinp FY2007/08, and reconcile arrears for FY2008/09; /b) provides adeauate budpetam allocations to government apencies for current electricitv consumption for FY2009/10; and /c) together with EDL, clarifv the financial arranpements for electricitv provision to the irrigation sector in a letter sent bv EDL to MOF on April 30, 2010 and at a followinp workshop held in Vientiane on May 4,2010. Rationale: The purpose of this prior action is to; (i) reduce arrears on utilities; and (ii) ensure financial sustainability of EDL. The "Action Plan for Financial Sustainability of the Power Sector" (Action Plan) 44 - comprises four main actions: (a) settle electricity arrears of government for the year ending September ., 200j; (b) implement an arrangement for ensuring that future government bills f& elkctricity consumption are paid in full, and on time, so that the receivables from government departments do not exceed 90 days; (c) regular tariff adjustment for EDL to achieve financial performance targets; and (d) reduction of technical and commercial losses by EDL. Prior Action 4: The Bank of Lao PDR (BOL) approves the Action Plan for the Financial Sector Stratew WSS) on Auril20,2010. Rationale: The rationale is to support the government in its effort to obtain a comprehensive strategic view on future financial sector development. The FSS aims to develop a strong, sophisticated and efficient entire financial system including banking, capital market, insurance, micro-finance and financial sector infrastructure. While the existing strategy is broad based, the action plan will identify priorities and appropriate actions of each related agency. It is expected that implementation of the action plan will commence immediately after approval. Prior Action 5: The Bank of Lao PDR (BOL) submits to the MOF the Annual On-Site Reports and the Quarterly Off-Site Examination Reports of the Banaue pour le Commerce Exterieur Lao JBCEL), the Lao Development Bank (LDB) and the Amicultural Promotion Bank (APB). Rationale: The rationale for this prior action is to support BOL supervisory function which has been strengthened during the PRSO 1-5. These three state-owned commercial banks (SOCBs) represent 60 percent of total banking sector's assets. Prior Action 6: MOF completes centralization of the National Treasurv and consolidates spending unit accounts into Treasury Manaped account Re-formulated: The MOF completes centralization of the National Treasurv on December 31, 2009, and the Minister of Finance issues Instruction No.734MOF on April 21, 2010 to the National Treasurv to transfer spending unit accounts to the National Treasury Rationale: Completion of the centralization of the treasury will help ensure consistent application of budget execution rules and regulations throughout the country, improve timeliness of cash flows and cash management, ensure more timely reporting on budget execution, facilitate performance monitoring and professional skill development of treasury staff. The consolidation of spending unit accounts into Treasury managed accounts will ensure more efficient cash management and utilization, broaden the budget coverage and enhance fiscal transparency. Rationale for reformulation: the centralization of treasury operations in all provinces is completed. Consolidation of spending unit accounts will start immediately upon the issuance of the Ministry of Finance instruction, in March 20 10, and is expected to take some time, hence the reformulation. Prior Action 7: MOH finalizes Health Strategy for submission to Government after due consultation with Ministrv of Labor and Social Welfare. Ministrv of Finance, Ministry of Planning and Investment and other stakeholders Re-formulated: The MOH submits the Health Financinp Stratew to the MOH Steering Committee for consideration after due consultation on said stratew with Ministrv of Labor and Social Welfare, Ministrv of Finance, Ministrv of Planning and Investment and other concerned line ministries and apencies, and development partners on March 22,2010. Rationale: Health care in Lao PDR is predominantly financed through direct out-of-pocket payments by households. This includes payment of user fees in public facilities as well as expenditures on health care and drugs from private providers and abroad. The government channels budgetary resources to facilities in the form of line-item budgets to cover salaries and other recurrent expenditures, but government spending on health is insufficient to cover the full cost of services. Despite efforts to expand both health 45 insurance programs (mandatory and voluntary) and health equity funds for the poor, coverage of these schemes remains low. The heavy reliance on out-of-pocket payments results in considerable financial barriers to utilization of health services, contributing to low levels of utilization and significant health- related financial risk. Progress towards addressing these challenges will depend on how the system for financing health care in Lao PDR evolves over the coming years. In order to facilitate a consultation on these strategic choices, the MOH, in consultation with other concerned ministries, will develop a health financing strategy. This strategy will be submitted to MOH steering Committee for approval, and will inform subsequent decisions concerning budget financing, regulatory reform, and so forth. Rationale for reformulation: The rationale is that more time than initially expected is required for MOH to complete the preparatory work, the required consultation, and internal approval before the strategy could be submitted to government. 127. In addition, preliminary discussions with Government have allowed identifying the following candidate for PRS07 prior-actions (triggers). Table 8. Prior Actions (Triggers) For PRSO-7 46 VI. OPERATION IMPLEMENTATION POVERTY AND SOCIAL IMPACT 128. The links between the decrease in poverty and government programs and expenditure are complex, and the subject of ongoing analytical work. However, it is clear that the substantial improvements in access to social services and infrastructure over the most recent period have played an important role in reducing consumption poverty and increasing welfare. The improvements in access to roads, clean water and sanitation are particularly impressive. Education opportunities have expanded and more than eight in ten children between the ages of six and ten are enrolled in primary school. In addition, a swift expansion in ownership of assets has occurred, including motorbikes and mobile phones, even in the most remote areas. This is increasingly linking previously remote communities to infrastructure and information. 47 129. At the same time, lack of access to infrastructure, services and markets is strongly correlated to poverty progress. Enrollment rates among ethnic minorities and those living in remote rural areas remain far below the national average. Furthermore, improvements in access to healthcare over the past 5 years have been slow. Many households still need to travel long distances on poor roads in order to access healthcare. Although the causal relationships are complex, it appears that lack of access to infrastructure and markets are closely associated with barriers to growth and poverty reduction and require further investment. 130. The PRSO series supports and is fully consistent with the Government poverty reduction strategy, embedded in the NSEDP, which provides a comprehensive strategy for development, with a range of medium-term policies aimed at sustained growth and poverty reduction. The NSEDP addresses poverty in Lao PDR through several thematic and cross-cutting issues, aiming to further its reduction through sectoral and regional development. The poverty reduction strategy seeks to expand economic activity, improve access to basic services, increase health security, and empower decision-making of the poor. It recognizes the role of good governance and legal reforms will play in this strategy, as well as how private sector development and natural resource management interplay to better ensure opportunities and funding in fighting poverty. 13 1. Policy actions supported under PRSO-6 are expected to have positive social impacts, and no significantly negative impacts are envisaged. On the business development and investment climate component, the proposed operation supports greater clarity and consistency in the legislative framework relating to investment and doing business climate, and together with supporting the development of the trade facilitation action plan, aims to improve coordination across different agencies so that citizens can engage more easily in trade and commerce. These reforms are expected to have a positive impact on employment and incomes generally. 132. With regards to SOEs, the operation supports measures aimed at improving the financial management of SOE?s so that the quality of their services improves and leakage of resources is curtailed. While SOE restructuring may potentially have an adverse social impact, given that SOE sector is small, impacts will be very low (the program only covers nine enterprises directly, and no massive lay-offs). 133. By supporting policies to reduce government arrears to EDL, it is envisaged that EDL will be able to invest more resources in improving services and maintain its countrywide electricity system better. In addition, clarity in the financial arrangements for electricity provision in the agriculture sector would enhance transparency in roles and responsibilities of MOF and EDL, improvement in coordination between these two entities to serve users better. This would mean that all users would benefit from better service provision. Although PRSO is not supporting directly the adjustment in electricity tariffs, it is useful to note that these adjustments are been made in such way that they remain affordable for the poorest (Box 4). 134. Public financial management reforms aim to improve fiduciary controls and enhance quality of service delivery. By supporting the development of rules based and transparent budget norms, the operation aims to assist the government in addressing the horizontal inequities between rich and poor provinces on spending on health and education. The operation is also supporting the government?s efforts at centralizing the Treasury department. This reform will significantly: (i) reduce fiduciary risks associated with fragmentation of government bank accounts across the country; and (ii) ensure that funds are transferred to service delivery units in a timelier manner. The operation is also supporting the publication of budget execution reports as well as budget plans. 48 Box 4. Electricity tariff adjustment: Increasing cost recovery while protecting the poor As part of the implementation of the Sustainability Action Plan of the Power sector, the government is implementing a tariff adjustment schedule, approved on June 24, 2005. In designing tariffs, Government expressed 2 main priorities: (i) that the utility (EDL) be commercially strong; and (ii) that the power be affordable, particularly to the poor. The first of these concerns is addressed by the tariff adjustments schedule aiming at increasing the cost recovery level. The second concern may be seen as conflicting with the first one. The usual way for resolving this conflict is to provide a lifeline tariff, which may be applied in 2 ways: (1) Design a low tariff available for the poorest; (2) Design a low tariff available to all domestic consumers, but only for a small level of consumption. The former approach is difficult to implement and costly to manage, as it requires the utility to track the income status of consumers. The latter approach is easier to manage and justify: The poor are presumed to have the need and resources only for a small amount of electricity. The larger consumers will be charged for the remainder of their consumption at a rate sufficiently high to cover losses on the sale of the lifeline amount as less than cost-recovery. With this approach, the issue is the defmition of the number of kilowatt-hours per month that should be included in the lifeline component. EDL currently uses 25kw per month as the first block of consumption in the domestic tariff. The average tariff is based on weighted average of all the three blocks of tariff levels. Twelve percent of household falls into in the fast block, 84 percent in the second block and 4 percent in the third block. Residential consumers and agriculture are below cost- recovery, and so are rural areas where the vast majority of the poor is. A new tariff update was launched in 2009 which will provide recommendations for hrther tariff adjustment. The Government remains committed to carefully assess tariff structure against affordability by the poorest. Tariff Adiustment (2005-2010) Average cost in Lao Kip 2005 2006 2007 2008 2009 2010 annual recovery increase (2007) Residential consumers First Block (0-25 k W m o n t h ) 115 132 154 177 203 234 15% Second Block (26-150 k W m o n t h ) 265 273 284 293 301 310 3yo 36% Third Block (>150 k W m o n t h ) 765 765 773 773 773 773 0% Non-residential consumers Agriculture 295 310 329 345 362 3 80 5% 40% Government 706 696 686 677 667 665 -1.4% 89% Industry 636 627 618 610 601 599 -1.4% 84% Commercial 826 826 835 835 835 835 0% 102% International organizations 1066 1066 077 1077 1077 1077 0% 107% Entertainment 1095 1095 106 1106 1106 1106 0% 122% Medium Voltage Agriculture 251 263 279 293 308 323 43% Government 600 592 590 581 573 563 92% Industry 541 533 526 518 511 509 103% Commercial 702 702 709 709 709 709 112% Total average 543 546 550 552 556 560 61% Jote: all figures are in real terms at 2 0 0 ~ rice levels. Source: EDL website. The adjustment of tariffs has greatly improved EDL financial performance which has turned into a profit in 2007, and 2008, and allowed greater investment in electricity access in rural areas where the majority of the poor are. Access to electricity yields positive social benefits to the rural population, as improved access to electricity in rural areas leads to improved living standards and greater opportunity for income generation. Access to electricity has gone up from 44 percent in 2004 to 69 percent in 2009. 49 ENVIRONMENTAL ASPECTS 135. This operation is not likely to have significant negative effects on environment, natural resources, and forestry. Nevertheless, certain environmental impacts might arise since the PRSO series supports a wide range of policy areas and interventions. While PRSO supports SOE restructuring and ma have potential environmental implications, given that SOE sector is small, impacts will be low (the program only covers nine enterprises directly, and no constructioddestruction are envisioned). While trade liberalization may potentially have an impact on the environment, this operation covers only first steps and regulatory reform aimed directly at easing cross-border movements of goods, rather than at major trade reforms. In fact, the investment climate improvement program would not touch upon environmentally-sensitive sectors, such as forestry or mining since these sectors are regulated by separate legislation. The impacts therefore are expected to be low or minimal. 136. PRSO-6 continues to support policy and institutional reform in natural resources management. Regarding infrastructure, the PRSO program provides support to EDL to implement the Action Plan for the Financial Sustainability of the Power Sector. Since the major source of power comes from hydropower with potentially high environment and social impacts, the Government is working toward ensuring compliance with environmental and social safeguards. Support from international partners is available through the Nam Theun 2 Hydroelectric Project, Nam Theun Social and Environment Project, and the Lao Environment and Social Project. In the context of NT2, the Government has enacted the National Policy on Environmental and Social Sustainability of the Hydropower Sector to ensure that future development of the hydropower projects complies with environment and social safeguards. In the mining sector, the PRSO supports the completion of the new mining legislation, including the development of complementary regulations which comprise standards and detailed regulations for environmental protection. The PRSO program is supported by the Lao Environmental and Social (LEnS) project; NT2 environmental, economic and social work; the Poverty and Environment Nexus study series and the Lao Environment Monitor. 137. The Lao Environmental and Social Project is supporting the development of the regulatory framework for the hydropower sector, and in relation to other large development projects. Sub-grants to support implementation of the National Policy on the Environmental and Social Sustainability of the Hydropower Sector and the Resettlement Policy have been implemented and their phase I reports are ready. Based on the findings and stakeholders dialogues, the Environment and Social Impact Assessment (ESIA) Practice and Proposed New ESIA regulation in Lao PDR has been revised and has been sent to the Minister for signature. Similarly, the Technical Guidelines on Compensation and Resettlement has been updated and is expected to be disseminated in coming months. A sub-grant to develop a river basin organization to manage water resources in the Nam Theun/Nam Kading basin, has contributed to the development of a national river basin management model, alongside ABD/AFD efforts in the Nam Ngum basin. 138. The recently approved Technical Assistance Project for Capacity Development in Hydropower and Mining Sector will enhance the awareness and technical knowledge of Ministry of Energy and Mines (MEM) agencies, especially the Department of Electricity (DOE), the Department of Mines (DOM), and the provincial departments of MEM (PDEM), to address environment and social safeguard issues. Environmental and social capacity building and awareness is an integral part of the design of each of the project components. 139. The Nam Theun 2 Project remains the primary vehicle for on-the-ground implementation of social and environmental safeguards related to hydropower development, and is providing considerable practical experience and potential for capacity building in relation to a broad range of social and environmental activities, including detailed and long-term village consultations, protected area 50 management, community forestry, community fisheries, development of market-based agriculture, and development of links between micro-credit schemes and the formal financial sector. IMPLEMENTATION, MONITORING AND EVALUATION 140. The progress in NSEDP implementation is monitored annually by the Government (Ministry of Planning and Investment-MF'I). Each year, government agencies report to MPI progress on implementation through a bottom-up process which follows administrative levels (from districts to provinces to Central administrations). Regular discussions also take place with the donor community within the Macroeconomic, Private Sector Development and Trade Working Group as part of the Round Table Meeting (RTM) process, as well as separate and more detailed discussions on each part of the PRSO in other RTM working groups. The IMF conducts supervision through annual Article IV missions Development partners, especially co-financing development partners, participate in missions and retreats. The Bank is supporting the progress in strengthening the M&E framework for the NSEDP, by providing capacity building to the MPI, key line ministries, pilot provinces, and to the National Assembly staff. An essential part of these capacity-building activities includes support for the sector monitoring plans under the NSEDP. As far as possible, outcome indicators listed in the PRSO matrix are identical with the outcome indicators of the NSEDP monitoring plans drafted by the line ministries, including ministries of Health and Education. 141. The implementation of the PRSO program is led by the PRSO Steering Committee. The Steering Committee has been established by Order of the Prime Minister, is chaired by the Minister of Finance and supported by a PRSO Secretariat chaired by the Vice Minister of Finance; both bodies include senior level representation from relevant ministries. In particular, the Ministry of Foreign Affairs, the Ministry for Planning and Investment and its National Statistics Center, Ministries of Education and Health, Energy and Mining, Industry and Commerce, Agriculture and Forestry, MTCPC, BOL, Prime Minister's Office and its Business Promotion Office, PACSA, and other agencies are represented. The PRSO Secretariat covers the program implementation and coordinates with all relevant ministries and agencies. 142. Stakeholder consultations on reforms take place regularly, are government-led, and mainstreamed into PRSO policy actions. Consultations are an integral part of the consensus building efforts towards reform in Laos and a key element of success. It is standard practice for the Government to set up working groups, task forces, steering committees and organize workshops with key agencies and stakeholders to discuss strategic orientations, including design of sectoral strategies, legislative and regulatory framework, and implementation modalities of policies. Development Partners support consultation initiatives where appropriate through financial means and technical assistance. . 143. Progress with the PRSO program implementation is monitored by the PRSO Secretariat with reference to the PRSO Program Matrix, updated annually as part of PRSO negotiations. The PRSO secretariat meets regularly to take stock of progress and discuss next steps for policy reform implementation. The World Bank and development partners monitor progress via continuous dialogue throughout the year, including periodic missions. Accordingly, this Program Document for the second series of four PRSOs includes a policy reform matrix designed and updated jointly by the Government, the World Bank and co-financing development partners to reflect evolving policies and the pace of implementation of the NSEDP and the current status of progress. 144. In addition to monitoring of progress against policy actions, the PRSO results indicators have been updated to track the impact of this PRSO series. This is the usual Monitoring and Evaluation (M&E) framework which covers all four operations in the series. The end-of-series outcomes expected under each sub-component of the PRSO program are recorded in the PRSO matrix (Annex 3). 51 Indicators for general monitoring of development impact, including the European Union Variable Tranche Indicators is also presented in Annex 4. In addition, macroeconomic developments and poverty and social indicators are closely monitored (see above). FIDUCIARY ASPECTS 145. The government has been improving the overall fiduciary arrangements around budget execution, however, weaknesses remain. The overall fiduciary risk is considered to be significant due to weakness in the financial management systems and slow implementation of the improved public procurement framework. The government has started publishing quarterly budget execution reports to increase transparency in budget execution. However the accuracy and comprehensiveness of these reports need to be further improved. At the same time implementation of the Consolidated Treasury Account framework has helped the National Treasury take direct control over revenue accounts across the country. This has allowed the National Treasury to conduct daily reconciliation of bank accounts. From FY2008/09 the SA0 has started submitting to the Parliament audit report for the consolidated government accounts in the June session, although this report is not publically published. The accounting and auditing profession and related institutions need to be developed. 146. Despite the significant fiduciary weaknesses, significant progress in improving the PFM system and the reforms has taken place through PRSO and other instruments which warrant continuing support through to a budget support operation. Actions planned under PRSOs 6-7 are contributing to reducing the fiduciary risk. Major recommendations aimed at further improving the public financial management systems, including the efficiency and transparency of use of public resources, are reflected in the PFMSP and supported by the PRSO program, and other instruments in place such as the MDTF and FMCBP. The challenge is to effectively implement the PFMSP, and monitor the strengthening program initiatives by the Government. Strengthening external audit functions and public financial management systems is a medium- to long-term process monitored under this series. The legislative framework for public procurement has been improved over the recent years through the passage of a new procurement decree, implementing rules & regulations, a standard procurement manual and standard bidding documents, but implementation needs to be improved and immediate priorities are to ensure country-wide usage of the recently approved standard procurement documents by all procuring agencies and strengthening their capacity through establishment of an institutionalized procurement capacity building program as well putting in place a system for monitoring procurement performance and outcomes. 147. The last IMF Safeguard Assessment of the BOL, conducted in 2003, classified the risk as being medium-high in the five categories on which the assessment was based (external audit mechanism, legal structure and independence, financial reporting framework, internal audit mechanism and internal control system). Progress on the safeguard recommendations has been mixed, and the agreed joint audit of the BOL 2003 and 2004 accounts by the State Auditor and an international audit firm have not been done. However, the State Audit Organization has conducted compliance and financial audits on BOL annually since 2007/08. These audit reports have been submitted to the Parliament, but are not available to the public. 148. It is recommended that the Recipient will maintain a dedicated deposit account for the proceeds of the Grant, and will report on the funds flow of the dedicated deposit account. The Government will, if considered necessary by IDA, allow an independent external audit of the dedicated foreign currency deposit account. 52 DISBURSEMENT AND AUDITING 149. A single tranche grant of SDR 13.3 million (US$20 million equivalent) including SDR 6.65 million (US$lO million equivalent) in pilot crisis window resources will be made available upon grant effectiveness, anticipated for June 2010. The recipient is the Lao PDR. The closing date of the operation will be April 30, 201 1. 150. The Grant proceeds will be disbursed against satisfactory implementation of the development policy program and the stipulated release conditions of PRSO-6. The grant proceeds will not be tied to any specific purchases. However, such proceeds will not be used for ineligible expenditures. As was practice under PRSOs 1-5, the Recipient will maintain a dedicated Deposit Account in US dollars at the BOL (which is the Central Bank of the Government), as part of the general foreign currency reserves of the Government, and the Grant proceeds will be deposited by IDA into that Deposit Account. An equivalent amount will be converted into local currency and credited to a Central Treasury account that is used to finance budget expenditures. 151. Through the MOF, the Government will report to IDA the amount received into the US Dollar Deposit Account at the BOL, and the amounts withdrawn from the Deposit Account and the equivalent amounts credited in local currency to the Central Treasury Account available to finance budgeted expenditures. The report on the amounts withdrawn will include the date and namehumber of the Government's bank account into which the local currency amounts have been deposited. The report on receipts and disbursements from the Deposit Accounts is to be submitted to IDA within 45 days of the final disbursement of the grant proceeds from the Deposit Account. 152. The Government will ensure that the grant proceeds are used for budgeted public expenditures except for purposes or items on IDA'S "negative list" as agreed during negotiations and specified in the Financing Agreement. If the proceeds of the Grant or any part of the Grant proceeds are used for ineligible purposes, as defined in the Financing Agreement, the Bank will require the Government, upon notification from IDA, to refund the amount directly to IDA. Amounts refunded to IDA upon such requests shall be cancelled. Upon request by IDA, the dedicated account and related fund flows to and from this account will be audited by independent auditors acceptable to IDA and in accordance with terms of reference acceptable to IDA, and the audit report will be provided to IDA within four months after IDA'Srequest for such an audit. The processes and controls described above reflect the findings of the IMF's safeguard assessment as regards the central bank control environment in making use of a dedicated deposit account for the foreign exchange proceeds of the Bank`s disbursement. RISKS AND RISK MITIGATION 153. The Lao PDR PRSO series remains a relatively high risk program warranted by a substantial potential payoff - Lao PDR remaining on its current growth and poverty reduction trajectory and making progress towards the MDGs. Over time the nature of risks has changed. Risks initially identified as binding such as commitment to reform and inter-agency coordination have declined, while capacity risks have increased and become a possible binding constraint. More recently, the global crisis has challenged macroeconomic policy coordination'and brought macroeconomic management risks at the forefront. Significant risk mitigation remains necessary. Three main risks have been identified which could affect the impact of the proposed operation and PRSO program. These are set out below together with mitigating factors: (a) Potential deterioration of the macroeconomic outlook may come from: (1) delays in the start of operation of hydropower projects, and/or construction of new power plants, and/or weaker regional demand for Laos key exports and leading to a decline in exports earnings and FDI; (2) a 53 continued loss in net foreign assets in the banking sector, leading to loss of confidence in the banking sector in the context of rapidly growing credit and limited bank supervision, and pressures on the exchange rate; and (3) a reversal of the current policy to contain fiscal deficit, quasi-fiscal activities and credit growth. These factors may put at risk macroeconomic stability by leading to an increase in contingent liabilities in the state-owned financial sector, arrears to utility companies and private contractors, pressures on international reserves, expenditures and public debt, as well eventually on the exchange rate. The PRSO operation and the Lao PDR country program mitigate this risk by the following avenues: (i) through strengthened macroeconomic monitoring providing inputs to what would constitute a flexible macroeconomic policy response allowing the economy to adjust to a temporary lower balance of payment equilibrium through lower than anticipated export earnings; (ii) by providing direct general budget support which eases the constraint of financing reforms in the context of multiple and competing needs, and facilitate the Government exit out of the fiscal stimulus; (iii) by assisting Government to put in place appropriate policies and institutional mechanism for improved expenditure and SOEs management; (iv) policy actions that limit the accumulation of arrears to electricity company; and (v) a financial sector component that includes SOCBs monitoring and strengthens bank supervision. Most importantly, the Government is committed to a sustainable macroeconomic path.and a phasing out of quasi-fiscal activities. (b) The weak public financial management system does not allow for timely reconciliation and reporting of public finances indicates a high fiduciary risk of possible leakages of funds. This risk is heightened by provincial autonomy without adequate monitoring and accountability mechanisms This risk is mitigated by the fact that the Government is now in the process of recentralizing budget execution at the National Treasury and established the Treasury Single Account, and revenue administration functions (Customs and Tax Departments), and the PRSO is supporting this program frontally. Continuing fiscal risks could result in the diversion of PRSO funds away from PRS priorities, and to cover losses of SOCBs and SOEs. This risk is partially mitigated by a program of monitoring of SOE and SOCB performance embedded in PRSO program matrix and closer implementation support by Bank staff on PFM issues. To date the PRSOs 1-4 have contributed to the following: (i) the National Treasury centralization process has already resulted in the MOF taking control of provincial government bank accounts; (ii) deployment of e-Revenue facilities at the Vientiane Capital Tax office; (iii) EDL has stopped making losses; and (iv) budget monitoring system being strengthened. Therefore, over the course of the PRSOs 1-4, these risks have been reduced. PRSO-5 and beyond are further proposing to mitigate this risk by assisting BOL to establish a real time payment settlement system across the country. (c) Severe capacity constraints in the civil service are due to the lack of adequate qualified personnel, and low pay and incentives. This risk is partially mitigated by working with the Government to outsource non-core functions like ICT connectivity for GFIS, supporting the Government in formulating an appropriate pay and compensation policy, and provision of additional resources for PRSOs 5-7 implementation through a World Bank project (FMCBP), Mining and Energy Sectoral TA, and TA provided by other development partners. Consistent with the lessons learned from the previous series, the team ensures that TA be available for each sub-component and action in the action matrix, and development partners work together to identify capacity building needs: additional resources made available to PRSO include bilateral aid from Japan, Australia, and EC, and aligned TA provided through multi-donor trust hnds administered by the World Bank on behalf of other development partners. The CAS includes a pillar on capacity building and the World Bank is leading donor efforts in this area. 54 ANNEX 1: LETTER OF DEVELOPMENT POLICY ' LET?'ER OF DI+:VELOP>IENT POLICY h 11.. Robert B. Zoellick 1'1-csident l'lie World Bank \l'ashington, D.C. l)car Mr. Zoellick. I On behalf' of tlic (io\eriiiiieiit of I.no PDK. I aiii writing to requcst the i ~ i ~ t i d Association's cotitiriiied Iinnticid and tccliiiical support for the I ! ~ ~ ~ ~ * ~ iDe\ telvj~inent itiiple~neiitationol'our National Growth and Poverty Eradication Strategy through a Sixth I'overfy Reduction Support Operation (PRS06), the third of the second programmatic wries PRS04-7. - Poverty Reduction Strategy 7 Our intentiori is ti3 achieve rqiid ecoiioiiiic grou-tli in order to improve tlie living i oiiclitioiis of the poor population. We tire conimitted to Iial\41ig poverty by 2015 and gixiuating from the status of Icast-devcloped country by 2020. Our commitment to reforms atid the tlevelopnient strategy to achicve these goals lists been articulated hi the titre-year Natioiial Socio-Economic Developinelit Plan for 2006-201 0 (NSEDP 2006-10), wliich was approlied by tlie National Assembly in 2006, and that is a siiccessor of the National Growth and Poi erty Eradication Stratcp (NGI'ES). : 'I'he goveriunent luis rnatfc strides in recelit years to\vartls more participatory and 11,iiisparent .development planning. The NCrf'liS'PRSP and NSEDP 2006- 10 were also ~l tlctvcloped through cxtetisive consultations at c e n ~ as well as local levels, with financial stippoit fiom the IJNDP, the World Bank, ADB and other donors. The consultative process was broadened to increase pai-ticipatjon by civil society and the private sector, In ntltlition to consultations \vith niilss organizations. such as the Lao Women's Union, . discussions were tirlcl t4.i t h the privatc sector, acildeinics, and tlie provinces. as well as at I ~ I village level. Consultations \vith donor partners were carried out in the coiitext of the C 4"' liouiirltable h4txting in N'oiuiiber 2006, as \vel1 as during aniiual updates in 2007, 2i)OY, allti 2009. 55 4. The NSEDP establishes a frainc\vork for future clevelopntent and tuakes our de\~elopniciit priorit ics iiioi.e csplicit ritid [ransparent. These priorities take into accou~it iille\iation. mid are detailed in the concrete tlie iiiitlti-dimensiottal nature of j i o \ ~ r L ! ~ ;ic.tiuns detailed iii this ctocumen(: ( 9 '. Maintain niacrocconomic stability by increasing reveriuc atid ensuritig appropriate fiscal and inonetary policy; L , (ii) (iii) In\est in the social sectors to expand acccss to basic educatioii and health services and itiipro\pe Lao's social sector outcomes; (ha) Invest iii iiifrnstixctiire siich RS roads, po\ver, aiitl water s~tpply, and espaiiil access to tlicsc scrvices; (VI Immt in rural dwelopiiient a n d natural resource management-including s iippor t f'o r agr icu 1t i Ira I. 111i ti i ng. 11 [ry atit1 ti yclropo wer developnient; 1res and (vi) Strcngtlicn capacity 5. the D~iring Itoutid 'I'able Implementation Meeting of November 2009 tlie progress iii implementing [lie NSEDP tvas presented to dc\~elopmcntpartners aiicl summarized in tlic Itound Tablc Implciiiei~ts~ioti Report and in the Background Document. The iiicidence of poverty Iias been reduced to 26.9%) iii 2008 and specific service dclivery jwgrcss include: increase 01' net primaiy eiirolniciit ratc (h4L)Cs 2) to 9 I .6% in 2009; sicady iniprovemcnt of gender p;ii*ily in enimlnients (h4DGs 3 ) reaching 88.4% in 2009; txisc of tlie vaccination coxrage to 71% following the efforts to intensifjr the imtiiunization programmc for niotlier i l d child and iniproi-ed ~ C C C S Sto safe water with 74% of total population in 2007. 0. The NSEDP implemeiitation has entailctl important acliievemetits in reforms in economic areas, socid sectors miuiageinent as well as in Public Finance Manageiiient ( IJFh4)\\.it11 key rcfoi~iis bciiig supported by the PRSO. It is i~iipoitantto highlight .speciiic progress in enliaricing the inanagetnent of Public Fiiiaiices which are critical to Iiinintaining fiscal sustainability. Ministry of Finance efforts to imple~nenttlie Public Finalice Management Strengthening Programme have resulted i n a fill1 centralization of the Tax and Custoins fimctions, tlie creation of a National 'I'rcasury, the preparation o f Smdard Bidding Docuiiieiits and the production of atitoinatecl budget execution reports sincc the launch 01' nn upgraded GFlS. This progress is retlected in tlie recent PEFA assessnient showing improved rates 01 era11 i'roiii the situetion in 2007 wiien PRSO 4 s t iirted. 56 - t h l'o\'ci*tv Rrduc t ioii Sui)riort Opera( ion Si\ 7, The PRSO-6 will assist the Governtiient iii implenicntation of the National Social aiid Ecoiiortiic Developmcnt Plan by focusing on two broad policy areas: (i) protecting [lie poor and iiiipm-iiig social outcoiiies throiigli better public financial management s~ stciii aiict service lie liver^,: and (ii) sustaining gtnwtli through improvement of the track niicl management of nalural resources. i l l \ cstmeii[ climate. I'i~cilita~iiig 8. -1hc sixth I'RSO conliniies to ~mderpitioiir oll.jective of' maintaining a sound iiiacroecoiioIiiic environment aiiti accelcratiiig growtli, as we esit from thc global crisis. 'Tliis operation Ey ILIA will provide extertial rcsoiirccs for the esecution of 01' 11 I. \'2009/10 budget. iricliiditig supporting oiir el'hrts to exit a liscal stimulus piit i n place it1 3UO9 and maititaiii a I1tmd-bascd ccononiic gronth. 11, Diiritig tlic last year. tlic Govcrnnieiil liiis iiiiplemeutcd the policy reform limic\\,ork agreed during (lie PRS04-7 preparations. The iiiipleiiientatioii of all prior itctions aiid policy actioiis has been described in Prograin Ilociitnent for the PRSOG.'['he p i o r actions impleriieiited by different agencies are prescnted below to denionstrate the Iiiulli-sector nature of thc operation that brings togctliei. different agencies and . tlcvt.lopment patqncrs to iinplcnicnt ii consistent policy rcfortii fimiework so well. We i.~-.allyappreciate this assistance. MPI abolislictl itii,estnient license for gcneral in\*estiiientactivitics outside the Negatiife 1,ist as part of tlic iiiiplcnicntatioti of the Ini~estmctitPronrotioii Law. Goveniment appro\'ed Phl Decree o i i Rules-of-Origin and MOIC has submitted to the Mitiister of MOIC' the iiiiplcnienting regulations undei*said Decrec cui May 1 7. 20 10. MOF and EDL. reniainecl currelit on scttlciiient of arrears for 2004/05 - 2007/08. ant1 reconciled any arrears for FY2008/09; MOF provided adequate budgetary allocations for currcnt electricity consumption for FY2009A 0: MOF and E I l L clari t i d fiiiniicial arraiigciiieiitc for electricity provision to the irrigation hecmr. Bank of Lao PDR (BOL) approved the Action Plan for the Financial Sector Strategy (FSS) Bank of Lao PDR (BOL)colnpletcd and stibiiiitted to Ministry of Finance the Quarterly Off-Site Esamination Reports and the Annual On-Site esamination reports of Ihnque pour le C'otiimcrce Exterieiir Lao (BCEL), Lao Develvpiiieiit Briiik (LDl3). atid tlic Apricultui.al I'rotiiotioti Bank (APB). MOF complctecl centralization of the Nationitl 'Treasury aiid coniiiienced consolidation of spending unit accounts into 'Treasury Managed account. MOH siibiiiitted Health Financing Strategy to MOH Steering Committee for consideratioti after due consultation with Ministry of Labor arid Social We1fare. h4 ini st ry of Fi tia me. h.1i tii s t r!' of PI ai111in g and I nves tine t i t arid other st a keho 1d c r s. . 57 IO, In additioii t u ttir prior actions. tlic governinelit . also iinplenicntcd 22 p l i c y ions t h a t wcrc ;i i 111c d , ilt i 111pro vi tig 111e i ti \`cs t nicn t cl iiii ate. coni pe t i t ivcness, and i j t'i tu isiticss dwelopineiit (C`otiiponcnt 1 ) and strenptlienitig the public finance management I`ixitcwork and iiqxwiiig service ciclitrry t C`onipoiieiit 2). l'RSO-7 Prior Actions (`omponctit 1 prior actions for PI c d d d 3 c .m E 2s EP > c d e 0 c 0 Q Sa o m m a m 0 0 m b b mm m OIOZ 6001 0 m gz E: E: 3 , a- " "_" .""__ 8002 m m E: E: 3 m- 0 LOOZ m m m E: E: 9 0- am m m m 2 9002 2 2 4 3 m m d m ! I e m c! I h c 0 cl 0102 I I____.." " ..I" ..._ ..... . _ . . I .... ..""._I_..._".."._I...." ..... " s 1002 1 c? 0 d >-- 9002 M E 8 6 u I / I w 3 m 2 - m h 0 .I 2 + z 0 $m o 3 rAm am a 0102 ; .I..I ... ... .." ........ $ 1 y u n 6002 j &- d u m Y 8002 n i P, : LOO2 : t n P, u 9002 I 1 - ru i o h . m c 8 E 8 6 Y W E m L 0 A m m < a I 0102 I 6002 m m a s n ................... 1 ............. --. ~ o w 8002 zE?i=n O 0 LOOZ I 9002 I ' I - m .- C M E 8 6 c) U a al m .. ..... 0102 00 00 ................ ........................... ,......... . . . . . -- .. l. ............ .... * l . ..l I l ..l ... .. , 6002 "-- .......................... ._ I. ..... .... ,. ...... __............. 8002 LOO2 9002 I I l.l". .......... ................ ....... .... ""... " ....." " ......... .I."".1... ....... .............. ............... "l........... . ..... ""..l.." " ". ... .".l. ....................... ."... " " z f 8 U 6 ......................................... ................ I ............................................ :.. .................. ..... ......... c 0 M 5a o m rAm OTOZ 6002 8002 LOOZ . ...... ,.._ .... . .... .. . W 0 9002 m 0 ?S m V h M B B * 0 8 B c) m C m c* 0 a 53 o m m u 0102 6002 0 8002 ". c1 12 d z- m rD LOO2 m 9002 U 9 .. Y v x W g E W OTOZ -?g I Y ~ - s 6002 9 v) Iz 8002: c: 3 LOOZ 9002 I 0 00 - m d t 3 ....11.._...-._l_..1.1..1..1~.... .111......_......i....._.....~... i _. . . . . . . I . . . _ I . . I . . . . _ ... . . . . . . .J . . . . . . _ . I . . . . _ _ . . . . . _ l .... . . . . . . . . . i OIOZ -- ";F! m 6002 8002 LOOZ I ~ 9002 I I I I 3 OQ I. . ........ I I ....... . . . .... ...... ... ... m ? i! a - c . B I ..... I ..................... .............. _."I._.. .__-_.. ....... ....................... ................................. OIOZ 6002 8002 LOOZ I 9002 I I I I ".. ". ANNEX 5: LAO PDR AT A GLANCE Lao PDR a t a glance 3/5/a East Key Development Indicators Lao Asia & Low Age distribution, 2007 PDR Pacific income Male Female 72008) 75-79 8044 Population, mid-year (millions) 6.0 19Q 1296 4549 Surface area (thousand sq. km) 237 16,299 21846 30-34 Population growth (Oh) 2.4 0.8 2.2 15-19 Urban population (%of total population) 31 43 32 04 GNI (Atlas method, US$ billions) GNIpercapita (Atlas method, US$) GNIpercapita (PPP, international $) 4.7 740 2,080 4,73 2,182 4,969 744 574 1489 I lo 5 per& 0 5 of tdal poprlation 10 GDP growth (%) GDP percapita growth (Oh) 7.3 4.7 114 a.5 6.4 4.2 I Under-Smortality rate (per 1,000) 180 ( m o s t r e c e n t e s t i m a t e , 2003-2008) 180 140 120 Poverty headcount ratio at $1.25 aday(PPP, %) 44 I7 100 Povertyheadcount ratio at $Z.OOaday(PPP,%) 77 39 80 60 Life expectancy at birth (years) 63 72 57 40 Infant mortality(per 1000 live births) 62 22 80 20 0 Child malnutrition (%of children under 5) U 28 1990 1995 2000 2007 Adult literacy, male (%of ages is and older) 96 72 OLao PDR OEast Asia 8 Pacific Adult literacy,female (%of ages is and older) 90 55 Gross primaryenrollment,male (%of age group) 11 1 a0 *Inflation -GDPgrowh Gross primaryenrollment,female(%of age group) a9 89 140 I Access to an improved water source (%of population) 87 68 Access to improved sanitation facilities (%of population) 66 39 1980 1990 2000 Long-Term E c o n o m i c Trends Consumer prices (annual Ohchange) 35.9 23.1 GDP implicit deflator (annuai %change) 25.1 Exchange rate (annual average, local per US$) a 708 7,888 Terms o f trade index(2000 = no) 1980-90 1990-2000 2001-08 (average annualgrowth Sa) Population, mid-year (miliio ns) 3.2 4.1 5.2 6.0 2.5 2.4 2.1 GDP (US$millions) 2733 5,545 6.2 6.9 (%of GDP) Agriculture 54.9 43.0 33.0 3.9 3.4 Industry P.6 19.1 26.3 113 112 Manufacturing 5.5 8.0 xl.1 115 a.0 Services 32.6 37.8 40.7 6.9 7.8 Household final consumption expenditure 79.4 79.1 74.1 4 12 6.2 General gov't final consumption ewenditure 19.2 6.7 9.7 29.3 22.8 Gross capital formation 22.1 u.0 27.7 3 14 30.1 Exports o f goods and services P 30 33 19.4 17.6 Imports o f goods and services 25 44 44 t3.4 li.0 Gross National savings 3 18 is Note: Figures in italics are for years otherthan those specified. 2008 data are preliminary. ..indicatesdata are not available. a.Aid data arefor2007. Development Economics, Development Data Group (DECDG) 83 Lao PDR Balance o f Payments and Trade 2000 2008 current account balance (CAB) (US$millions) DNon-Resource CAB Total merchandise exports (fob) 342 1429 11 Capital account balance Total merchandise imports (cif) 718 2,267 .Overall Balance Net trade in goods and services -244 -632 *O 1 15 7 15 Current account balance -l79 -696 as a %of GDP -m.5 -P.6 10 5 Reserves, including gold a7 636 0 Central Government Finance -5 -10 (%of GDP) Current revenue (including grants) 16.9 15.2 -15 Tax revenue m.6 t3.9 -20 Total expenditure 215 l7.0 I 2006 2007 2008 2009 Overall surpiusldeficit -4.6 -18 External Debt and Resource Flows 0 Revenue and Grants I Totalexpenditure (US$millions) uOverall balance (including grants) Total debt outstanding and disbursed 2,459 5,145 Total debt service 11.1 183 Debt relief (HIPC, M DRI) - - 17.6 11n Total debt (%of GDP) I . P2.7 94.3 Total debt service (%of exports) 117 n.3 Foreign direct investment (net inflows) 31 914 Portfolio equity(net inflows) 1 15 85 World Bank Group portfollo 2000 2007 (US$millions) IBRD -10 Total debt outstanding and disbursed 0 0 Disbursements - - FY04 FY05 FY06 FY07 FY08 Principal repayments - - interest payments 3 5 Composition oftotal external debt, 2007 (US$miliim) IDA Total debt outstanding and disbursed 403 686 Disbursements 20 27 Total debt service 12 27 IFC (fiscalpar) Total disbursed and outstanding portfolio 2 5 of which IFC own account 2 5 Disbursements for iFC own account 1 2 Portfolio sales, prepayments and repayments for IFC own account 0 1 Private, 2,032 M IGA Gross exposure 0 89 New guarantees 0 0 \Si lateral, 668 P rivate Sector Development 2000 2008 Time requiredto start a business (days) - 145 Cost to start a business (%of GNI percapita) - 141 Time requiredto register pmperty(days) - t35 Note: Figures in italics are for years otherthan those specified. 2008 data are preliminary. 3/5/ll ..indicatesdata are not available. -indicates observation is not applicable. Development Economics, Development Data Group (DECDG) 84 MAP SECTION IBRD 33431 100°E 102°E 104°E 106°E 108°E This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. CHINA LAO P.D.R. To Lincang To Gejiu To Daluo Gnot-Ou Ou 22°N 22°N Phongsaly Boun-Nua PHONGSALY PHONGSALY MYANMAR VIET NA M LUANG Muang NAMTHA Khoa Luang To Namtha Hanoi g kon Meung Muang Xiangkho BOKEO Me Xai Nambak u ng Sam-Neva O Ban Ta Be LUANG Viangxai Huaisai OUDOMSAI PHRABANG HOUAPHAN To Chiang Rai Xiangkhoang Plateau 20°N Pakbeng Luang Phrabang SAYABOURY SAYABOURY SAYABOURY Kham Nan Plain of Jars Phokhoun Xiang Khoang Sayaboury Kasi XIANG KHOANG Phou Bia Gulf of Vangviang (2,817 m) Ban Nalé Nalé Xaisomboun Nam Ngum Tonkin VIENTIANE Reservoir BOLIKHAMSAI Pone g Hong Paksane n o ek Khamkeut Paklay M Kadi VIENTIANE ng Me 18°N Xanakham 18°N ko ng PREFECTURE OF KHAMMOUANE VIENTIANE MUN. Cammon Plateau Ban Na Phan To Xe Thakhek e e Vinh Ba ng a a To fai Khon Kaen N oy To Khon Kaen Xebangfai 0 50 100 Kilometers SAV SAVANNAKHETXepon SAVANNAKHET Xéno Xéno 0 25 50 75 100 Miles T HA ILA ND Savannakhet Phin To Qui Nhon g S e B a n g hio n Samouay LAO PEOPLE'S 16°N 16°N SARAV Saravane SARAVANE SARAVANE DEMOCRATIC on D REPUBLIC Khongxedon SEKONG Sekong SELECTED CITIES AND TOWNS Pakxong To Ubon PROVINCE CAPITALS Ratchathani CHAMPASSAK Bolovens CHAMPASSAK Champassak Plateau NATIONAL CAPITAL Attapeu Sanamxai RIVERS ATTAPEU TTAPEU ATTAPEU MAIN ROADS RAILROADS Khong 14°N 14°N PROVINCE BOUNDARIES CA MBO DIA INTERNATIONAL BOUNDARIES 104°E 106°E NOVEMBER 2004