84807 MANAGING RISKS FOR MACROECONOMIC STABILITY LAO PDR ECONOMIC MONITOR January 2014 Sector Focus School Based Management in Lao PDR: Current Conditions and Recommendations for the Future THE WORLD BANK The World Bank © All rights reserved This publication is a product of the staff of the World Bank. The findings, interpretations, and conclusions expressed herein do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. Lao PDR Economic Monitor – January 2014 was prepared by the World Bank country team under the guidance of the Sector Manager and Lead Economist for South-East Asia Region, Mathew Verghis and Senior Country Economists, Alain W. D’Hoore and Richard Record. The team comprises of Keomanivone Phimmahasay, Alain W. D’Hoore and Somneuk Davading (recent economic developments and overall report), Saysanith Vongviengkham and Leah April (public finance), Ratchada Anantavrasilpa (financial sector), Konesawang Nghardsaysone and Richard Record (private sector and trade facilitation) and Lucrecia Santibanez from RAND and Omporn Regel (school based management). The team would like to express its gratitude to the Government of Lao PDR (especially BOL, MOF, MPI/LSB, MEM, MOIC, MoICT, MAF and other ministries) and the Lao National Chamber of Commerce and Industry and its members for providing essential inputs. We would like to also thank our World Bank colleagues: Vattana Singharaj, Meriem Gray and Toomkham Luanglath, for administrative support and dissemination of the Monitor. “THE WORLD BANK TEAM APPRECIATES FEEDBACK ON STRUCTURE AND CONTENT OF THE MONITOR” For further information please contact World Bank Lao PDR Country Office. • Ms. Keomanivone Phimmahasay on data and content (kphimmahasay@worldbank.org) • External Affairs and Communications Team on communications, copy rights, distribution list (worldbanklaos@worldbank.org) The World Bank Lao PDR Country Office Patouxay Nehru Road P.O Box 345 Vientiane, Lao PDR Phone: (856-21) 266200 Fax: (856-21) 266299 EXECUTIVE SUMMARY 4 EXECUTIVE SUMMARY Recent Macroeconomic Update The Lao economy is estimated to grow at 8.1 meat prices earlier in the year first, and lately a percent in 2013, fueled by a vibrant resource pick-up in rice prices, food price inflation has sector, continued FDI-financed investment in driven the inflation process through most of 2013. hydropower, and accommodative macro economic policies. The hydropower sector (both In FY12/13, the fiscal deficit widened markedly completed projects in operation and projects in due to a combination of a large increase in public the construction/development phase), sector wages and benefits, and a decline in grants construction, food processing and services sectors and mining revenues. Total expenditure is remain the major contributors to this growth. This estimated to have risen fast in FY12/13 driven by is aided in part by accommodative macroeconomic the more-than-two folds rise in the wage bill, policies. Domestic credit growth has remained including salaries and benefits. This large increase high at about 31 percent (year-on-year) in reflected three main factors: a 40 percent increase September 2013 driven by private sector credit. in the base wage; a large 760,000 kip monthly In addition, public spending has also expanded allowance to all public employees; and about 10 through a substantial base wages increase and the percent increase in new public recruitments. This provision of monthly benefits of 760,000 kip per total wage and benefits increase was equivalent person to all public employees. to almost 5 percent of GDP compared to FY11/12, which was the major contributor to a higher fiscal Growth is projected to moderate to 7.2 percent deficit, followed by lower mining revenues and in 2014, reflecting a small projected slowdown grants. As a result, the fiscal deficit is estimated to in some real sectors, mainly mining and have widened sharply to 5.8 percent of GDP, from construction. Key growth drivers are expected to 1.3 percent in FY11/12 and non-mining fiscal come from services (wholesale and retail, balance to 8.6 from 4.6 percent in the same period. transportation and telecommunication), and food The rapid widening in the deficit appears to have processing and beverages, supported by continued strained the cash position of the government in strong domestic demand and construction and recent months, leading to payment delays (or construction-related industry. The resource sector arrears) on wages and non-wage items to be is expected to provide a smaller direct contribution carried on to the next fiscal year. to growth in 2014 as new commercial operations of major power projects are not expected and the The FY13/14 budget plan indicates a narrower halt in Sepone’s gold production is likely to offset fiscal deficit of about 4.3 percent. Overall some gains in expected higher copper production. spending remains high because a combination of a further 40 percent increase in wage index and Inflationary pressures, mainly through food new recruitment despite the cut in benefits to civil prices, are not showing signs of dissipating by servants and some capital spending. However, the end 2013. The headline inflation reached about 7 deficit (cash basis) could be higher of up to about percent in November 2013. With fast growing 6 percent of GDP if arrears such as payments for EXECUTIVE SUMMARY 5 EXECUTIVE SUMMARY wages arrears from FY12/13 were included. On While the Bank of Lao PDR maintains nominal the revenue side, the focus has been placed on exchange rate stability of the Lao kip against strengthening revenue administration. However, major currencies, foreign exchange policy should mining revenue contribution remains uncertain probably give more consideration to reserve due to projected lower commodity prices and management and competitiveness. In nominal expected lower total gold production in 2013-2014 terms, the kip depreciated only slightly against that will partly offset the expected copper output USD during January-November 2013 while it increase in the same period. Therefore, the path appreciated against the Thai Baht by about 3.8 of the fiscal deficit in FY13/14 will critically percent in the same period, as Baht has weakened depends on the authorities’ ability to achieve an against USD in the wake of political turmoil unusually strong performance in revenue Thailand. The effective exchange rate appreciated collection and to maintain tight control over by 2 percent in nominal terms and by 5.5 percent spending across categories. in real terms during January-November 2013. The continued real appreciation of the exchange rate The risk of debt distress remains moderate, implies a deterioration of competitiveness for Lao according to the recent Joint IMF-World Bank PDR’s tradeables exports, which exacerbates the Debt Sustainability Analysis (DSA) 2013. Although pressure on the external balance. all external debt distress indicators remain below the policy dependent indicative thresholds during Foreign exchange reserves and net foreign assets the projection period under the baseline scenario, continued to fall in the third quarter of 2013. the thresholds are breached under certain shocks. Reserves are expected to reach about $600 million The ratios of external public and publically by end 2013 which would make the level lowest guaranteed debt and its net present value to GDP in a decade with only 1.3 months of goods and have risen in 2012, particularly from an increase services imports. This trend has been fueled by a from bilateral sources. Non-concessional widening current account deficit. While a borrowing has also risen, from a low base, due to significant portion of the current account deficit SOEs and the government to finance equity stake is accounted for by increased investment in the in hydropower projects. This commercial resource sector, strong domestic demand, fueled borrowing also includes the first bond issuance on in part by accommodative fiscal and monetary the Thai bond market in May 2013 in an amount policies and a continued real appreciation of the of US$50 million (about 0.5 percent of 2013 GDP) exchange rate have contributed to the pressures to finance the general public investment program. on the overall external balance and foreign Debt service ratios remain within the policy- reserves. The declining reserve buffers raise dependent indicative thresholds mainly due to the concerns over the country’s resilience in absorbing high level of concessionality of official borrowing, any adverse shock. In response, the Bank of Lao although the share of concessional loans is PDR recently issued an instruction to discourage expected to decline in the future. Therefore, lending in foreign currencies to businesses that strengthening fiscal and debt management have insufficient foreign currencies earnings and capacity is of crucial importance. to limit cash withdrawals from foreign currency EXECUTIVE SUMMARY 6 accounts. Although the effect of these measures capacity building, improving of timeliness of fund has yet to be fully realized, such a step signals the delivery, and improving accountability move by the monetary authority to addressing mechanisms. The summary section provides more forcefully the issue of low foreign reserves. further details. Sector Focus School Based Management in Lao PDR Lao PDR’s education system faces challenges in meeting its goals of providing all students with access to education and improving learning outcomes. The government has increased spending on education aiming to improve student outcomes. Nevertheless, it has faced challenges, for example, non-wage, public recurrent expenditure, which serves to pay for school materials, equipment, teacher training, etc., is still relatively low. Private household financial contribution has remained a contributing part of funding for schooling. The lack of resources constitutes a constraint learning resources and quality of facilities. The study presents a framework explaining how school based management can help improve education quality. In order to help address challenges on education quality, in 2011 the government instituted a School Block Grant (SBG) program, which is a form of School Based Management (SBM), that provides financial contribution for schools as non-wage expenditure per student and gives provinces, districts and schools greater administrative control with a view to improve effective educational administration and schooling quality. As this initiative is at its early stage, challenges encountered include, among others, the limited local capacity. The study then provides possible suggestions in areas such as local ACRONYMS AND ABBREVIATIONS 7 ACRONYMS AND ABBREVIATIONS ASEM Asia-Europe Meeting PBM Phu Bia Mining BOL Bank of Lao PDR PPG Public and Public Guaranteed Debt BOP Balance of Payment QOQ Quarter on Quarter CB Commercial Bank REER Real Effective Exchange Rate COD Commercial Operation Date RO Right Offering CPI Consumer Price Index SBG School Block Grants DEBs District Education Bureaus SBM School Based Management EAP East Asia & Pacific SOCBs State-Owned Commercial Banks EQS Education Quality Standards SOE State-Owned Enterprise ESDF Education Sector Development Framework UHC Universal Health Coverage EU European Union VAT Value Added Tax FDI Foreign Direct Investment WB World Bank FY Fiscal Year WEO World Economic Outlook GDP Gross Domestic Product YOY Year on Year GOL Government of Lao PDR IMF International Monetary Fund IPP Independent Power Producers LDC Least Developed Country LNCCI Lao National Chamber of Commerce and Industry LSB Lao Statistics Bureau LSX Lao Securities Exchange LXML Lane Xang Mineral’s Limited MAF Ministry of Agriculture and Forestry MDG Millennium Development Goals MEM Ministry of Energy and Mines MOES Ministry of Education and Sports MOF Ministry of Finance MOIC Ministry of Industry and Commerce MPI Ministry of Planning and Investment NA National Assembly NEER Nominal Term Effective Exchange Rate NFA Net Foreign Assets NPL Non-Performing Loan NSEDP National Socio-Economic Development Plan TABLE OF CONTENTS 8 TABLE OF CONTENTS PART I. RECENT ECONOMIC DEVELOPMENTS 10 GROWTH AND INFLATION 10 GOVERNMENT’S REVENUE AND EXPENDITURE 12 EXTERNAL SECTOR 17 MONETARY DEVELOPMENTS 20 PART II: SECTOR FOCUS 21 SCHOOL BASED MANAGEMENT IN LAO PDR: CURRENT CONDITIONS 22 AND RECOMMENDATIONS FOR THE FUTURE ANNEXES 27 Annex 1 – Lao PDR At A Glance 27 FIGURES Figure 1. Growth and Inflation (percent change) 11 Figure 2. Real GDP Growth (at factor cost): Contribution by sector (percentage points) 11 Figure 3. Monthly Inflation (YOY percent change) 11 Figure 4. Contributions to Food Inflation 12 Figure 5. Thai and Lao glutineous rice price (USD/Tonne) 12 Figure 6. Government’s Fiscal Performance 14 Figure 7. Government Revenues (percent of GDP) 14 Figure 8. Wage Index Increase 14 Figure 9. Government Expenditures (percent of GDP) 14 Figure 10. Figure 10. Balance of Payments (percent of GDP), 2009-14 18 Figure 11. Merchandise Exports (US$ million) 18 Figure 12. Gold and Copper exports 18 Figure 13. Merchandise Imports (US$ million) 18 Figure 14. NFA and International Reserves 18 Figure 15. Reserves Coverage (percent of total FOREX deposits) 18 Figure 16. Kip Exchange Rate (Index Dec-2006 =100) 19 Figure 17. Nominal and Real Effective Exchange Rate (Index Dec-2006 =100) 19 Figure 18. Contribution to Bank Credit Growth (percent and percentage points) 20 TABLES 15 Table 1: Ratios of Wages and Benefits to other fiscal variables (percent) 15 Table 2: Lao PDR: External Public Debt, Indicative Thresholds and End-2012 Outcomes 15 Table 3: Lao PDR: Stock of external PPG at end 2012 15 PART I RECENT ECONOMIC DEVELOPMENTS Lao PDR Economic Monitor – January 2014 10 RECENT ECONOMIC DEVELOPMENTS GROWTH AND INFLATION The Lao economy is estimated to grow at year, saving an estimated 2 percent of GDP. On 8.1 percent in 2013, fueled by a vibrant the supply side, key growth drivers are expected resource sector, continued FDI-financed to come from services (wholesale and retail, investment in hydropower, and accommodative transportation and telecommunication), and macroeconomic policies. The hydropower sector food processing and beverages, supported by (both completed projects in operation and continued strong domestic demand. Construction projects in the construction/development phase), and construction-related industry are expected to construction, food processing and services sectors still grow fast, albeit at a slower pace compared to remain the major contributors to this growth. the high base in recent years. The resource sector Furthermore, the hydropower contribution is expected to provide a smaller direct contribution to GDP will benefit from the completion1 and to growth in 2014. On the hydropower side, development of several large hydropower projects the sector’s output will be broadly flat, as new including Hongsa Lignite, Sayaboury, Nam Ou, and commercial operations of major power projects Xepian Xe Namnoi projects, with large spillovers are not expected to come on stream in 2014. to the construction, food and services sectors. The contribution from the mining sector will Growth in the services sector is strong across benefit from increased copper production, which main sub-sectors, in wholesale and retail trade, will compensate for the halt in Sepone’s gold tourism, transportation and telecommunication, production from end 20132. and banking. The growth was also supported in part by accommodative monetary and fiscal policies. Domestic credit growth has remained high at about 31 percent (year-on-year) in September 2013 driven by private sector credit. In addition, public spending also expanded through a substantial base wages increase and provision of monthly benefits of 760,000 kip per person to all public employees. For 2014, growth is projected to moderate to 7.2 percent, reflecting a small projected slowdown in some real sectors, mainly mining and construction. The forecast does not assume that macroeconomic policy will be markedly less expansionary. Fiscal policy, in particular, will only be moderately less so, since the authorities decided to retain a large wage increase even as allowances were canceled for the current fiscal 1 Completed projects expected to commence full operations in 2013 include Nam Ngum 5 and the Theun Hinboun expansion project. 2 In November 2013, MMG Limited (Sepone mine) announced a decision to cease gold operations at its Sepon mine in Laos effective December 2013 due to depleting ore reserves and lower margins. See more detail at http://www.mmg.com/en/Investors-and-Media/News/2013/11/18/Sepon-to-cease-gold-pro duction.aspx Lao PDR Economic Monitor – January 2014 11 Figure 1. Growth and Inflation (percent change) Figure 2. Real GDP Growth (at factor cost): Contribution by Sector (percentage points) Source: Government, LNCCI data and staff estimates and projections Source: Government, LNCCI data and staff estimates and projections INFLATION Inflationary pressures, mainly through food said, accommodative macroeconomic policies are prices, are not showing signs of dissipating by also a factor behind the continued momentum end 2013. With fast growing meat prices earlier in inflation, and they raise the risk that higher in the year first, and lately a pick-up in rice prices, inflation expectations could become entrenched food price inflation has driven the inflation process even if supply/demand factors dissipate. in Laos through most of 2013. Overall inflation has doubled since early 2013, and the headline inflation is projected at 6.5 percent for 2013, Figure 3. Monthly Inflation (YOY percent change) compared to 4.3 percent in 2012. Overall inflation accelerated from 3.5 percent YOY in late 2012, to 5.5 percent YOY by April 2013, and almost 7 percent in November, off only somewhat from its peak in July (at 7.4 percent) (Figure 3). Headline inflation has since leveled off at around 7 percent in the past few months. Food price inflation has decelerated slightly since July but remained above 14 percent (Figure 4). The increase in meat and vegetable prices that drove sharply higher food price inflation earlier in the year has slowed down somewhat but remains high, while rice consumer prices have accelerated in the last three months, registering around 17 percent increase, broadly in line with a recent strengthening of glutinous rice prices in Thailand (Figure 5). This Source: MPI (LSB) and staff calculations Lao PDR Economic Monitor – January 2014 12 Figure 4. Contributions to Food Inflation Figure 5. Thai and Lao glutineous rice price (USD/Tonne) Source: MPI (LSB) and staff calculations Source: www.fao.org GOVERNMENT’S REVENUE AND EXPENDITURE In FY12/13, the fiscal deficit widened markedly Total public expenditure for FY12/13 rose sharply, due to a combination of a large increase in public mainly as a result of a large increase in the wage sector wages and benefits, and a decline in grants bill. Total expenditure is estimated to have risen and mining revenues. Total revenues and grants by 37 percent in FY12/13 driven by the more- declined from 19.7 percent of GDP in FY11/12 than-doubling (125 percent increase) in the wage to about 19.1 percent in FY12/13 due mainly to bill, including salaries and benefits. The ratio of lower grants (Figure 7). Overall domestic revenues the wage bill to GDP rose from about 5 percent eased to 17.1 percent of GDP in FY12/13, from in FY11/12 to 9.5 percent in FY12/13 (Figure 9). 17.2 the previous year, as strong non-resource This large increase reflected three main factors: tax performance almost offset lower mining a 40 percent increase in the base wage (in the revenue. Mining revenues fell by 4 percent, as a same proportion for all wages) (Figure 8); a large fall in copper prices and higher mining production 760,000 kip monthly allowance to all public costs that partly offset the volume and gold price employees—estimated to cost about 2 percent of gains in 2012—as a share of total revenues, mining GDP; and new recruitments, adding an estimated revenues dropped from their high of 19 percent 10 percent to the numbers of employees. in 2012, to 16 percent in 2013 (hydro revenues remained at 5.5 percent of total domestic Wages in FY12/13 accounted for about 70 percent revenue). At the same time, non-resource taxes, of the non-resource domestic revenue—one particularly VAT and excise taxes, registered a measure of stable sources of revenue on which to strong performance, growing by 21 percent in fund stable, hard-to-compress spending (Table 1). nominal terms, and from 11.8 percent of GDP in The vulnerability of budget execution to negative 2012 to 12.3 percent of GDP in 2013 (Figure 7). shocks on the revenue side is heightened. As a result also, the share of domestic revenue that Lao PDR Economic Monitor – January 2014 13 financed non-wage recurrent spending (including to achieve an unusually strong performance equipment, operations and maintenance, and in revenue collection and to maintain tight important material, such as textbooks in public control over spending across categories. On schools and medication in public health centers) current plans, the fiscal deficit on a commitment decreased to its smaller share in recent years. basis—that is, based on current year’s authorized spending plans—is projected to narrow to about Further fiscal pressure has also emanated from 4.3 percent of GDP this fiscal year, with slightly a growing trend of local government reported higher revenues to GDP, broadly stable (relative encouragement of private pre-financing and to GDP) current spending, including on wages, execution of public infrastructure projects. These and a decline in capital spending. At the same projects are pre-financed by private contractors time, the fiscal deficit on a cash basis— that is, citing development priorities of concerned including the full payment of FY12/13’s budget regional authorities despite limited prior items in arrears—should widen to about 6 percent budget allocations, with related risks of creating of GDP (cash basis), well above the level reached contingent liabilities and intensifying pressure last year. on the budget and the fiscal stance. While the current number and size of active and planned Overall spending will remain high, despite the cut pre-financing arrangements remains unclear, the in benefits to civil servants. This cut, however, is authorities will need to develop clear regulations almost fully offset by a substantial rise in the wage and policies to manage these projects. index by about 40 percent, with the index value increasing from 4800 to 6700) (Figure 8), as well Overall, with lower revenues and sharply higher as continued recruitment, including the full-year total spending, the fiscal deficit is estimated to effect this year of last year’s recruitment3. An even have widened sharply to 5.8 percent of GDP, from larger concern is the continuation of the wage 1.3 percent in FY11/12 (Figure 6). The overall non- increase policy into next fiscal year (FY14/15). resource fiscal deficit is estimated at 9.5 percent On current trends, the pursuit of this policy in FY12/13 (from 5.5 percent in FY11/12) while implies a further sizeable increase in the wage the non-mining fiscal deficit is estimated at 8.6 bill (in absolute and relative terms), unlikely to percent, from 4.6 percent in the previous year. be offset by new revenue measures, or spending The increased deficit was mainly due to the wage cuts in other categories. A rapid revision of civil and benefits increase (equivalent to almost 5 service wage policy appears to have become a percent of GDP increase compared to FY11/12), new priority for Lao PDR. followed by lower mining revenues and grants. The rapid widening in the deficit appears to have On the revenue side, the focus has been placed strained the cash position of the government on strengthening revenue administration in recent months, leading to payment delays particularly related to the valuation of equipment (“arrears”) on both wages and non-wage items. It and vehicles imports. However, mining revenue also encouraged the authorities to take corrective contribution remains uncertain due to projected measures on short-term spending as the new fiscal lower commodity prices and expected lower total year started. gold production in 2013-2014, despite expected copper output increase in the same period. The path of the fiscal deficit in FY13/14 will Achieving the needed 20 percent increase in critically depends on the authorities’ ability nominal revenues in the non-resource sectors will 3 For example, new staff that has been recruited at mid-year in FY13/14 only impacted the budget for half a year, while they will affect the budget for all 12 months this year. Since recruitment levels exceed 10 percent per year, this financial effect of recruitments is large, as it implies a 5 percent growth in the wage bill next year even if there are no new recruitments or no wage increases. Lao PDR Economic Monitor – January 2014 14 be a significant challenge, even as the revenue be expected to put continued strain on the base expands with nominal GDP by about 11 government’s cash position, and require careful percent over the year. The large outlays on wages, monitoring and control of all expenditure, across to be paid every month over the year, should also government levels and agencies. Figure 6. Government’s Fiscal Performance Figure 7. Government Revenues (percent of GDP) (percent of GDP) Source: MOF and staff estimate and projection Source: MOF and staff estimate and projection Figure 8. Wage Index Increase Figure 9. Government Expenditures (percent of GDP) Source: MOF and staff estimate and projection Source: MOF and staff estimate and projection Lao PDR Economic Monitor – January 2014 15 Table 1: Ratios of Wages and Benefits to other fiscal variables (percent) FY11/12 FY12/13 FY13/14 FY14/15 Est. Proj. Proj. Wage and benefits as % of total expenditure 23.2 38.1 39.8 48.2 Wage and benefits as % of total recurrent 44.5 61.5 61.9 68.3 Wage and benefits as % of domestic revenue 28.3 55.4 54.2 66.6 Wage and benefits as % of non-resource domestic revenue 37.6 70.6 65.0 78.5 Wages, benefits and compensations as % of non-resource 49.3 80.1 73.7 86.6 domestic revenue Source: MOF and staff estimate and projection PUBLIC DEBT4 The recent Joint IMF-World Bank Debt Sustainabil- The DSA 2013 showed that the present value of ity Analysis (DSA) 2013 concluded that Lao PDR’s external debt to GDP ratio is moving closer to the risk of debt distress remains moderate. Although thresholds in the near term due to higher projected all external debt distress indicators remain below new borrowing to support projected fiscal expendi- the policy dependent indicative thresholds during ture. This trend of the net present value indicates the projection period under the baseline scenario, a smaller room for adjusting in case of any adverse the thresholds are breached under certain shocks. shocks. Table 2: Lao PDR: External Public Debt, Indicative Thresholds and End-2012 Outcomes Indicative thresholds End 2012 Present value of debt, as % of GDP 40 32.5 Exports 150 73.8 Revenue 250 184.9 Debt Service, as % of Exports 20 4.1 Revenue 20 10.1 Source: Lao authorities; IMF and WB Debt Sustainability Analysis 2013 Table 3: Lao PDR: Stock of external PPG at end 2012 Billion USD Indicative thresholds End 2012 Total 4.2 100 46.0 Multilateral 1.9v 45.9 21.1 Bilateral 2.0 47.3 21.8 Commercial 1/ 0.3 6.7 3.1 Source: Lao authorities; IMF and WB Debt Sustainability Analysis 2013 1/ Includes direct borrowing by state-owned enterprises on non-concessional terms 4 Lao PDR Debt Sustainability Analysis and Article IV Consultation 2013 prepared by IMF and World Bank staff in consultation with Lao PDR authorities. Lao PDR Economic Monitor – January 2014 16 The external public and publicly-guaranteed debt and the ratio of debt service to revenue could (PPG) level has been increasing in 2012. The exceed the 20 percent threshold in 2021. The risk nominal stock of external PPG debt rose from US$ to debt sustainability could be dependent on the 3.7 billion in 2011 to US$ 4.2 billion in 2012, return in the medium to long run from resource mainly due to rapid increase in borrowing from projects that have been partly financed by external China and Thailand. As a result, the ratio of PPG PPG borrowing. Cautious assessment and external debt to GDP increased from 44.8 percent monitoring of large scale projects and private to 46.1 percent in 2012 while the net present external debt will be essential to mitigate risks on value of PPG rose from 29.8 percent of GDP to external and public debt sustainability, particularly 32.5 percent in the same period (Table 2, 3). Debt if some projects are financed from commercial service ratios remain within the policy-dependent borrowing such as bonds backed by future indicative thresholds mainly due to the high level revenue. of concessionality of official borrowing, although the share of concessional loans is expected to Recorded domestic public debt also rose notably. decline in the future. The share of bilateral Recorded domestic public debt to GDP rose to creditors has been increasing, mainly from China, 15.8 percent in 2012 from 8.9 percent in 2011 half India, Japan, Korea, Malaysia, Russia and Thailand. of which comes from continued disbursements Commercial borrowing share has also risen due from BOL to local government off-budget to higher borrowing by SOEs and the government infrastructure projects. The remaining includes to finance the equity stakes hydro projects. This government bonds to recapitalize state-owned commercial borrowing also includes the first bond banks (SOCBs). Total domestic and external PPG issuance on the Thai bond market in May 2013 in debt was recorded climbed to 61.8 percent of GDP an amount of US$50 million (about 0.5 percent of in 2012 from 56.2 percent in 2011 as a result of 2013 GDP) to finance the general public expansionary fiscal policy in 2012. investment program. This initiative contributed to create a market in Lao sovereign bonds, part of the country’s efforts to prepare for an eventual exit from eligibility for concessional sources of finance. This trend also underscores the importance of strengthening debt management framework and capacity. Higher debt to GDP ratio underscores the need to strengthen debt management capacity. Considering debt sustainability would be one key criterion before new debt creation. Additional external borrowing to finance mega infrastructure projects could jeopardize debt sustainability by bringing the debt-to-GDP ratios well above the indicative debt distress thresholds. For example, an illustrative scenario of a high speed railway project could push the overall external PPG debt to the peak at around 80 percent of GDP in 2022 Lao PDR Economic Monitor – January 2014 17 EXTERNAL SECTOR The external current account deficit has of dwindling buffers raises concerns over the continued to widen, rising from 15 percent of country’s resilience in absorbing any adverse GDP in 2012 to about 21 percent this year (Figure shock. In an attempt to address the issue, the BOL 10). Much of the widening reflects strong import recently issued an instruction to commercial banks growth particularly associated with capital imports to tighten foreign currency lending to businesses to support the construction of large resource that have insufficient foreign currencies earnings projects, such as the Hongsa Lignite, Nam Ou, and and to limit cash withdrawals from foreign Sayaboury power projects. In addition, mining currency accounts. Commercial banks also have export earnings came out lower than projected to exercise their due diligence in knowing their (Figure 12), and they are expected to fall further customers. Although the effect of these measures due to lower prices despite higher output. With has yet to be fully realized, such a step signals the loose fiscal and monetary policies, and a sustained move by the monetary authority to addressing appreciation of the real exchange rate in recent more forcefully the issue of low foreign reserves. years (which makes imports relatively cheaper and Pursuing this policy, as well as embarking on a exports more expensive and thus harder to sell), gradual reconstitution of their gross reserves non-resource imports growth has likely outpaced position by outright sterilized purchases if needed, the non-resource exports increase. is clearly an important undertaking for policy makers, even if entails some modest temporary The overall balance of payments is projected to pressure on bilateral exchange rates. come out in a small deficit in 2013 as the widening current account deficit is partly offset The outlook for 2014 calls for a slight by higher investment inflows. The capital account improvement in the overall balance of payment surplus, that mostly finances capital imports, is as strong capital inflows are expected to continue estimated to have risen from about 15.7 percent to compensate the current account deficit. The to 19.5 percent of GDP, mainly driven by current account deficit is expected to remain high investment in hydropower projects, while that in due in part to the large need for capital goods the non-resource sector is estimated to slow in imports supporting the on-going construction of 2013 after a robust acceleration in 2012. large scale hydropower projects. Additionally, non- resource imports growth is likely to continue Reflecting this overall balance, foreign exchange outpacing non-resource exports growth. At the reserves are projected to decline in 2013. Foreign same time, the uncertainty in the global economy exchange reserves and net foreign assets and possible moderation of growth in some continued to fall in the third quarter of 2013 emerging markets could have further implications (Figure 14). Reserves were recorded at $580 for Laos, including through lower FDI and lower million5 in September and are expected to reach mining export prices, with a possible negative about $600 million by end 2013 which would make impact on Lao export earnings and government the level lowest in a decade with only 1.3 months revenues. of goods and services imports. The ratio of reserve to foreign currency deposits fell progressively from about 60 percent two years ago to around 27 percent in September 2013 (Figure 15). This trend 5 The stock of foreign reserves in September was roughly equivalent to the projected debt repayments (interest and principal) due over two years, 2014-15 (of US$490 million). Lao PDR Economic Monitor – January 2014 18 Figure 10. Balance of Payments Figure 11. Merchandise Exports (US$ million) (percent of GDP), 2009-14 Source: BOL and staff estimates and projections Source: Staff estimates and projections based on data from MOIC, LNCCI and partner countries Figure 12. Gold and Copper exports Figure 13. Merchandise Imports (US$ million) Source: Lane Xang Minerals Limited and Phu Bia Mining Companies, 2012 Source: Staff estimates and projections based on data from MOIC, LNCCI and partner countries and staff calculations Figure 14. NFA and International Reserves Figure 15. Reserves Coverage (percent of total FOREX deposits) Source: BOL and staff estimates Source: BOL and staff estimates Lao PDR Economic Monitor – January 2014 19 EXCHANGE RATE While the Bank of Lao PDR maintains nominal to appreciate steadily for the fourth continuous exchange rate stability of the Lao kip against year. The effective exchange rate appreciated by major currencies, the onus of foreign exchange 2 percent in nominal terms and by 5.5 percent policy should probably shift toward giving in real terms during January-November 2013 more weight to reserve management and (Figure 17). The continued real appreciation of the competitiveness. In nominal terms, the kip exchange rate implies a loss of competitiveness for depreciated only slightly against USD during Lao PDR’s tradeables (discouraging exports and January-November 2013 while it appreciated encouraging imports that compete with locally- against the Thai Baht by about 3.8 percent in the produced goods), which exacerbates the impact same period, as Baht has weakened against USD of the continued increase in domestic labor costs. in the wake of political turmoil Thailand (Figure In addition, better balancing the goal of nominal 16). With inflation well in excess of the rates in exchange rate stability and the need for reserves partner countries, real exchange rates continued is also important. Figure 16. Kip Exchange Rate Figure 17. Nominal and Real Effective Exchange (Index Dec-2006 =100) Rates Source: BOL and Bank of Thailand and staff calculations Source: IMF Lao PDR Economic Monitor – January 2014 20 MONETARY DEVELOPMENTS6 Domestic banking credit growth has slowed to asset (CAR) ratio requirement while some state- down but remained high in September 2013 owned banks still face difficulties in that respect. (Figure 18). This growth was driven mainly by Non-performing loans have reportedly remained private sector credit, which grew by about 37 below 4 percent by end 2012 partly on the account percent YOY at end-September 2013. This trend of growing credits. The growth of banking also has primarily come about from broadly reflects physical expansion and improvement in accommodative policy—both monetary and availability of, and access to, financial services, structural banking policy—in the face of buoyant with an expanded network of branches and credit demand growth in the construction, services units (from 340 units in 2011 to 383 units commerce and service sectors. Credit to state- across the country in 2012) while the number of owned enterprises (also including BOL direct ATMs has increased by 22 percent from 442 units lending to local infrastructure projects) still grew to 540 units in the same period. An important on- at 13 percent YOY in that same period despite the going effort is the improvement of the Anti-Money fall QOQ in recent quarters. The BOL has reportedly Laundering/Combatting the Financing of Terrorism committed to cease lending to finance new (AML/CFT) draft law. In this context, strengthening government projects (off-budget) outside the bank supervision capacity is also crucial to oversee approval from the National Assembly. In addition, and support implementation and enforcement of the BOL recently issued a notice to discourage the regulations. commercial banks from lending to businesses with inadequate foreign currency earnings and do not allow withdrawals of foreign currencies intended Figure 18: Contribution to Bank Credit Growth for transaction settlement with foreign suppliers. (percent and percentage points) Broad money growth was slightly slower at 23 percent YOY in September 2013 compared to about 26 percent in March due to slower growth in the money and quasi-money in the same period. As the banking sector expands and credit growth is strong, the authorities should continue efforts to strengthen supervision and enforcement of prudential norms. In the context of a rapidly growing banking sector and growing bank lending, the BOL continues to strengthen enforcement of compliance with prudential obligations of commercial banks to publish their financial reports. However, some banks are still facing difficulties in complying in a timely manner. In Source: BOL and staff estimates terms of financial soundness, BOL issued a regulation for commercial banks to increase their registered capital which is to be completed by 2014. Most banks have met the minimum capital 6 The most recent monetary data after September to enable an assessment of the government’s recent monetary policy stance is not yet available. PART II SECTOR FOCUS SCHOOL BASED MANAGEMENT IN LAO PDR: CURRENT CONDITIONS AND RECOMMENDATIONS FOR THE FUTURE Lao PDR Economic Monitor – January 2014 22 SCHOOL BASED MANAGEMENT IN LAO PDR: CURRENT CONDITIONS AND RECOMMENDATIONS FOR THE FUTURE7 Despite sustained economic growth since the Overview of Education Sector and Outcomes in mid-1980s, Lao PDR’s education system faces Lao PDR challenges in meeting its goals of providing all students with access to education and improving Recent measures by the GoL to increase spending learning outcomes. To further the country’s on education and thereby improve student economic development, the Government of Lao outcomes have faced challenges, but are beginning PDR (GoL) has placed a priority on improving its to produce modest results. To formalize its education sector. However, as of 2012, Lao PDR commitment to improving education, the GoL was not on track to achieve its Millennium developed the Education Sector Development Development Goal (MDG) of universal primary Framework (ESDF), which documents the education. There are concerns about education education policy objectives in Lao PDR. It called quality as well, particularly whether students are for increasing public expenditures on education completing primary school with sufficient from 11 percent in 2010/11 to around 18 percent mathematics and literacy skills. To help address by 2015. According to data from the Ministry of these challenges, the GoL instituted in 2011 a Finance, educational expenditure as a percent of School Block Grant (SBG) program that gives total government spending was 13 percent in provinces, districts and schools greater 2011-2012. However, non-wage recurrent administrative control than they have ever had. expenditure in education in the country remains The program is a form of School Based low (Ministry of Finance, 2012). Non-wage, public Management (SBM) that was designed to make recurrent expenditure is that which serves to pay educational administration more effective and for school materials, equipment, teacher training, improve the quality of schooling. etc. It currently represents about 20 percent of recurrent expenditure, but only between three The report presents a framework that explains and seven percent of total education expenditure how SBGs can improve education quality. The over the past four years. As a result, households framework draws lessons from international have to pay non-mandatory fees for schooling in experience that may be particularly useful for the order to make up for the shortfalls, and this could GoL, and identify challenges and potential risks to negatively affect access to education for children successful implementation of the program. It uses from poor families. Low levels of non-wage public information from published data and reports, as spending on education also limit learning well as a baseline survey that was administered resources and quality of facilities in classrooms during the first year of the SBG program operation and schools. Although learning outcomes have by a local survey firm to a sample of schools. This improved in recent years, only about half of fifth was carried out as part of the SBG impact grade students can demonstrate Lao language evaluation effort. The discussion is also informed skills beyond the basic level. In mathematics, by qualitative data gathered by RAND in October learning outcomes are particularly poor, and 2012 from six schools in the Southern region of results from 2006 and 2009 suggest a declining the country. Our findings provide a framework for trend. Repetition and dropout rates are high in policy makers in Lao PDR to consider strengths, first, and to a lesser extent second grade, but weaknesses, and other challenges that they might improve thereafter. face as they continue to introduce SBM in Lao PDR. 7 Santibanez, Lucrecia. 2014. School based management in Lao P.D.R. : current conditions and recommendations for the future. Washington DC ; World Bank Group. http://documents.worldbank.org/curated/en/2014/01/18745470/school-based-management-lao-pdr-current-conditions-recommendations-future Lao PDR Economic Monitor – January 2014 23 The “School Operating Cost” or Government SBG school fees from parents, many parents continue Program to make voluntary financial and in-kind contributions to schools. This signals that they are The SBGs seek to increase school enrollment, invested and committed to improving their reduce education costs for parents, address children’s education. pressing quality issues and involve the broader community in school-based management and • Lastly, there have been efforts in Lao PDR, by oversight. The SBG program introduced a EFA-FTI and CIED, to develop and disseminate guaranteed, predictable stream of funding for all training materials to help schools craft a School schools to help them meet their most pressing Development Plan and to train them on the operational needs. This is a key feature of the SBG Education Quality Standards (EQS) framework. program and novel in the Lao PDR context. In the These efforts can help principals and school program’s first year (2011), the SBG amounted to committees make effective spending decisions. 20,000 LAK per student, which was roughly equal However, dissemination of these materials has to the non-wage expenditure per student (Ministry been limited and only a few hundred schools have of Finance data). In addition, provincial and district received training on their usage. level authorities received some initial training on SBGs from the Ministry of Education and Sports Challenges and risks to successful implementation (MoES). A SBG manual was also produced and of SBM programs in Lao PDR distributed among provincial and district level authorities for training purposes. The year 2012- The “School Operating Cost” program, also 13 was the second year of the program, and the referred in this report as the Government’s SBG GoL plans to keep the program in place for 2013- program, was launched for the first time in 2011- 14, with a few modifications that could include 2012 at a national scale. The massive size of the increasing the amount of the block grant. reform effort probably contributed to limitations in some features of implementation. Our review SBM in Lao PDR: Foundations to build from identified several challenges and risks to a successful implementation of the SBG program in The report finds that, although still in its early Lao PDR. stages, the GoL’s SBG program appears to be a solid step toward establishing School Based • Schools are not always receiving the grants on Management efforts in the country. Lao PDR time, which makes it difficult for them to plan already has some of the institutional foundations effectively. This is to be expected given that the to build from. program is just getting started, but it is important that education officials should pay close attention • VEDCs have been established in most schools, to in the coming years. and school decision-making is already highly decentralized. In fact, principals report already • SBM implementation is hindered by insufficient having high degrees of influence over most school local capacity and limited support and monitoring matters. efforts; for example, some local school staffs are not receiving training, and student record keeping • Although after SBG program was implemented is faulty in some schools. Although the MoES has most schools no longer collect non-mandatory initiated training efforts, a larger-scale effort is Lao PDR Economic Monitor – January 2014 24 needed to build local capacity and provide by education officials in the coming years. adequate monitoring and support for SBG implementation. Recommendations • Although most schools continue to solicit As the Government SBG program evolves and voluntary contributions from parents to make up education officials gain better knowledge and for resource shortfalls, the SBG program could experience with its implementation, more time lead some parents to reduce their financial and resources can be devoted to ensuring that contributions to schools. Evidence from grant key program implementation elements are programs in other countries suggests households adequately addressed. If properly implemented, reduce their own spending on education when better school administration and higher schools receive grants that pay, among other community involvement could have long-term things, for school supplies. If this were to happen, impact. Based on this review of documents and it would lower the amount of total resources survey data, and limited information gathered schools receive and make schools worse-off from interviews with principals, teachers, parents financially. Moreover, beyond making financial and other school actors, the following is contributions to schools and having some recommended. influence on construction of school facilities, parents do not perceive to have an influence over 1. Deliver funds on time. Since 2011-12 was the most school decisions. This could hamper the first year of the SBG program, it is understandable SBG’s program ability to engage a wider base of that there were issues with timely delivery of the parents and community members in schoolwide funds to schools. However, in future editions of decision making. the program, concerted efforts should be placed on ensuring that funds are delivered on time, so • In the first year of the program, reporting on that schools can effectively plan. If possible, the use of funds has been erratic. Part of this is schools should receive the whole SBG at once, to the result of the GoL releasing the first tranche of allow for the purchase of bigger-ticket items that the funds unconditionally. However, reporting on might be needed earlier in the year (i.e., classroom the second tranche was still uneven across equipment, teacher training). districts. This might have been due to the absence of training given to district officials as well as 2. Train school leaders and community members. principals and VEDC members on reporting and Training of principals, VEDCs and even District general management of the SBG. Erratic reporting Education Bureaus (DEBs) during this first year of could hamper monitoring efforts by officials at implementation was limited. To effectively districts and provinces. Thus, in the future, closer participate in school affairs, principals and VEDC attention should be paid to the issue of reporting. members should receive training that increases Another potential issue that could increase the their ability to understand the purpose of SBG, risk of misuse or waste of the SBG funds is related and their role in the program. Principals in to improper safeguarding of these funds—such as particular need to be given basic leadership and school treasurers keeping the funds in unlocked management training on how to conduct containers at home. This could be the result of meetings, develop a school vision, and engage in lack of banking facilities in the villages or high participatory planning and budgeting. Parents transaction costs, but should also be addressed should be trained and supported so they can be Lao PDR Economic Monitor – January 2014 25 better informed about how to promote higher publishes reports of these and other school data student learning and how to make better use of for all schools, and aggregated by province and school funds. As the SBG program continues into district. Principals and VEDCs could be trained to the future, the goal of principal and VDEC training use those indicators to set student outcome should be to enhance their management and targets and gauge progress. In addition, there are planning capacity thus systematic training is the EDQ standards which can also be used to set needed on an ongoing basis. The SBG program can targets. reap the benefits of the financial and administrative empowerment it confers to schools, 5. Train school leaders on how to manage SBG only if all school actors have the capacity to take funds. Training for school leaders should also full advantage of the resources, collaboration and address the importance of adequate reporting and planning processes the SBG is intended to offer. safeguarding of SBG funds. In an environment where the authorities delegate autonomy over 3. Increase parent empowerment through spending decisions to schools, adequate reporting targeted training and mechanisms for school is important to prevent misuse of funds and to participation that encourage wide representation ensure that resources are spent as effectively as from the community might be needed. Principals possible. The review also identified issues related report having a lot of influence over most school to adequate safeguarding of leftover SBG funds. matters, but the influence of parents appears to Many villages in Lao PDR lack adequate banking be more limited. SBM programs can confer both facilities. In villages with banks, transaction and financial and administrative empowerment. other costs might become too high for schools to However, to reap the full benefit of both, parents bear. Nevertheless, some attention could be paid must be well-informed, engaged and capable of to devise mechanisms or provide resources to making decisions that best address school needs. adequately safeguard funds that are not In addition, SBM requires strong parental immediately spent. participation and oversight to counter the diminished role of central authorities. Thus, to 6. Provide more implementation support and increase parent empowerment, targeted efforts consider making funding formula more and investments in training and other mechanisms progressive. Some funds should be earmarked for might be needed. Parents should receive training provinces and districts to provide needed support that allows them to engage and participate in for SBG implementation. Consider soliciting school decision making. technical assistance services and funds from donors to enhance local capacity, and 4. Establish a system to collect and use school infrastructure (including IT infrastructure) and in data for decision making. Principals and VEDC turn, aid monitoring and support efforts. District members should have the required information Education Bureaus (DEBs) should receive to set learning and other school quality targets. additional human and financial resources to This includes keeping accurate attendance records enable them to fulfill their tasks under the SBG so they can receive the right amount of the SBG. program. The funding formula could also be made Lao PDR does not have a national, standardized to be more progressive. First, to compensate small student assessment system. Principals do have and remote districts for the added cost associated access to student-level data on repetition rates with collecting the grant. And second, to consider and enrollment for their own schools. The MoES that it could cost more to deliver comparable Lao PDR Economic Monitor – January 2014 26 quality education services in some area, and that sustained funding stream that provides certainty some schools face greater challenges improving over some expenditures over the long run. But student outcomes and thus might need additional unforeseeable expenditures will continue to arise. support. Parents might also be encouraged to make in-kind contributions. Schools should register the 7. Leverage existing resources. Training manuals reception of these funds and integrate them and materials developed for other initiatives (i.e. within their school budgets so they can better plan the Community Initiatives for Primary Education for their use. Development project (CIED), EQS, etc.) should be adapted for this program where relevant. These 10. Take further steps to strengthen school previous efforts could be useful inputs to design autonomy and accountability and signal stronger training that is intended to support effective policy intent in this area. While the country has planning and school management. made important progress and demonstrated strong policy intent in one indicator of school 8. Establish financial accountability. The GoL autonomy and accountability (school autonomy should take additional steps to ensure in budget planning and approval), the SABER study accountability from schools, districts and rated all other indicators as only “emerging.” provinces in the use of SBG funds. Since 2011-12 There is still more work to be done on the other was the first year of operation of the SBG, the first indicators, such as personnel management, school tranche of the funds was delivered to schools and student assessment and school accountability unconditionally. In addition, training of principals to stakeholders to move further toward greater and district officials on reporting and other SBG accountability and school autonomy. management has been limited. As the SBG program evolves, schools should be required to report to DEBs in a timely fashion on the use of the SBG, and to submit their school development plans. DEBs should report back to provincial education authorities and provincial authorities to the MoES on the implementation of the SBG. District and provincial reports should detail when and how funds were transferred to the schools, use of funds at the school level (expenditure analysis), the work of the VEDCs, supervision (inspector visits, etc.), and trainings delivered. 9. Encourage parents to continue to donate funds to schools. Parents should be encouraged to continue to contribute to their school to the extent that they are able to. Schools in Lao are in need of more resources for infrastructure, classroom materials and equipment, teacher training and other items. Parents can be encouraged to see the SBG as a complementary, Lao PDR Economic Monitor – January 2014 27 ANNEX 1 – LAO PDR AT A GLANCE Lao PDR Economic Monitor – January 2014 28 Source: Lao PDR Authorities, IMF-WB DSA 2013, WB staff estimates and projections. Note: * for January-November 2013 THE WORLD BANK LAO PDR COUNTRY OFFICE Patouxay, Nehru Road Vientiane, Lao PDR Tel: (856-21) 266 200 Fax: (856-21) 266 299 www.worldbank.org/lao THE WORLD BANK OFFICE 1818 H Street, N.W. Washington, D.C. 20433 Tel: (202) 472-1653 THE WORLD BANK Fax: (202) 522-1560/1557 www.worldbank.org