95669 Lao Economic Monitor – April 2015 3 Currency Equivalents (Exchange Rate Effective as of March 11, 2015) Currency Unit = LAK (Lao Kip) LAK8,105 = US$1.00 Fiscal Year = October to September Acronyms and Abbreviations ATIGA ASEAN Trade in Goods MCH Mother and Child Health Agreement MOF Ministry of Finance AEC ASEAN Economic Community MOIC Ministry of Industry and AFAS ASEAN Framework Agreement Commerce on Services NA National Assembly ASEAN Association of Southeast Asian NEER Nominal Term Effective Nations Exchange Rate BOL Bank of Lao PDR NFA Net Foreign Assets BOP Balance of Payment NPL Non-Performing Loan CLMV Cambodia, Lao PDR, Myanmar NSEDP National Socio-Economic and Vietnam Development Plan COD Commercial Operation Date OPEC Organization of the Petroleum CPI Consumer Price Index Exporting Countries DMFAS Debt Management and PIP Public Investment Projects Financial Analysis System PPG Public and Public Guaranteed EAP East Asia & Pacific Debt EDL Electricité du Lao PV Net Present Value FDI Foreign Direct Investment REER Real Effective Exchange Rate FY Fiscal Year SOCBs State-Owned Commercial GDP Gross Domestic Product Banks GFIS Government Financial SOE State-Owned Enterprise Information System TSA Treasury Single Account GOL The Government of Lao PDR VAT Value Added Tax HC Health Centre WBG World Bank Group IMF International Monetary Fund WEO World Economic Outlook IPP Independent Power Producers WTO World Trade Organization LDC Least Developed Country YOY Year on year LSX Lao Securities Exchange Regional Vice President : Axel van Trotsenburg Country Director : Ulrich Zachau Senior Practice Director : Marcelo Guigale Country Manager : Sally Burningham Sector Manager : Mathew A. Verghis Primary Author : Keomanivone Phimmahasay 4 Lao Economic Monitor – April 2015 Acknowledgements Lao PDR Economic Monitor - April 2015 was prepared by the country team under the guidance of Mathew Verghis (Practice Manager, Macroeconomics and Fiscal Management Global Practice) and Sally Burningham (Country Manager). The Team comprises of Alain D’Hoore (Senior Country Economist), Somneuk Davading (Senior Economist), and Keomanivone Phimmahasay (Economist) with helpful inputs on the two selected issues in Part II from Konesawang Nghardsaysone (Trade Economist) and Richard Record (Senior Economist) on the “ASEAN Economic Community 2015 – Implications for Lao PDR” and Lars Sondergaard (Program Leader) on the “Creating Productive Jobs for Inclusive Growth”. Administrative and report production assistance from Souksavanh Sombounkhanh (Program Assistant) and Toomkham Luanglath (Communications Associate) and Maniphet Phengsavatdy is gratefully acknowledged. The team would like to express gratitude to the Government officials from Ministry of Finance, Ministry of Planning and Investment, Ministry of Industry and Commerce, Ministry of Energy and Mines, the Bank of Lao PDR, and representatives from the Lao National Chamber of Commerce and a number of businesses for sharing valuable views and inputs. The findings and interpretations expressed here are those of the authors and do not necessarily reflect the views of the World Bank Group, its Executive Directors, or the countries they represent. Lao Economic Monitor – April 2015 5 Table Of Contents Executive Summary 10   Part I: Recent Economic Developments 16     Key Regional Economic Developments 17     Recent Economic Developments In Lao PDR 18     Growth 18     Inflation 19     Government Revenue And Expenditure 20     Public Debt 23     External Sector 25     Exchange Rate 28     Monetary Developments 29   Part II: Selected Issues 31     Asean Economic Community 2015 – Implications For Lao PDR 32     Trade in Goods 32     Trade in Services 33     Investment 34     Trade Facilitation 35     Creating Productive Jobs For Inclusive Growth 37 Annex 1: Lao PDR At A Glance 43 Annex 2: East Asia And Pacific: GDP Growth Projections 45 List Of Figures Figure 1: GDP Growth and Inflation 18 Figure 2: Contribution by sectors to real GDP growth 18 Figure 3: Monthly Inflation 19 Figure 4: Contribution to Food Inflation 19 Figure 5: Government Fiscal Performance 20 Figure 6: Government Expenditures 20 Figure 7: Social sectors expenditures 20 Figure 8: Government Revenue 21 Figure 9: Public spending on education 22 Figure 10: Public spending on health 22 Figure 11: Average crude oil price 25 Figure 12: Balance of Payments 26 Figure 13: Merchandise Exports 27 Figure 14: Merchandise Imports 27 6 Lao Economic Monitor – April 2015 Figure 15: Foreign Direct Investment 27 Figure 16: Net foreign assets and foreign reserves 28 Figure 17: Reserves coverage 28 Figure 18: Lao kip exchange rate 28 Figure 19: Real effective exchange rate 28 Figure 20: Domestic credit growth in EAP region 29 Figure 21: Banking sector assets 29 Figure 22: Contribution to credit growth 29 Figure 23: Sectoral contribution to credit growth 30 Figure 24: Composition of credit by sectors 30 Figure 25: Trading costs remain high 35 Figure 26: Percentage of firms in Lao PDR, Vietnam, and Yunnan province (China) complaining that there were no or few applicants to a job, by skill level 37 Figure 27: Sectoral breakdown of output and labor in the overall economy of Lao PDR 39 Figure 28: Early Grade Reading Assessment for Lao PDR 39 Figure 29: Comparison of adult literacy by education level in Lao PDR and Vietnam 40 List Of Boxes Box 1: Public Spending on education and health sectors 22 Box 2: The oil price decline should benefit the economy, but also has some downside risks 26 List Of Tables Table 1: External PPG Debt Composition 24 Table 2: External PPG Debt Burden Indicators 24 Photo by Remy Rossi / World Bank, 2013 Photo by Bart Verweij / World Bank, 2014 10 Lao Economic Monitor – April 2015 Executive Summary Recent Economic upwards closer to the government’s target. The projected reduction in the fiscal deficit Developments as recent fiscal consolidation measures take effect will slightly dampen domestic demand. 1. Based on preliminary estimates, the The external current account deficit should Lao PDR economy grew by 7.5 percent in continue to reflect high FDI-funded imports, 2014, compared to an average of 8 percent and only gradually improve in the medium over 2011-13. Construction, some of which term as power projects come on stream and is related to foreign investment in the start to export electricity. hydropower sector and spillovers, forestry (wood exports) and services were the main 3. Average annual inflation in 2014 contributors to this growth. The direct output decelerated to 4.2 percent from 6.4 percent contribution from the resource sector lowered a year earlier, driven primarily by slower last year due to a fall in total gold output, in growth in food prices and a decline in fuel part associated with the lower gold price, and prices. Food prices in 2014 were, on average, flat electricity output from the existing power plants. In addition, fiscal tightening measures higher by 7 percent compared to 2013; a through budget cuts and, to a certain extent, significant deceleration from 12.6 percent a a slowdown in bank credit growth also had year ago. After falling by 5.4 percent during some impact on domestic activity. 2013, fuel prices fell by an additional 0.8 percent in 2014 reflecting developments on 2. Looking forward, real GDP growth is world markets. Inflation is projected to be projected to slow further in 2015 before around 4-5 percent this year. accelerating in the medium term. Growth is projected to slow to 6.4 percent in 4. In response to a widened fiscal deficit 2015 assuming a high, but stable, level of in FY12/13, the Government embarked on investment in new large power projects much needed fiscal corrective measures in and fiscal consolidation effects. Given FY13/14 and FY14/15. Total revenues as a the adoption of expansionary economic share of GDP remained stable at 23 percent policies in the past few years and resultant in FY13/14, supported by robust receipts from macroeconomic vulnerabilities, a slowdown non-resource sectors and improvements in associated with policy corrections (such as administration that in part offset the effects fiscal consolidation and slower credit growth) of lower commodity prices and lower gold are expected to help restore macroeconomic output and grants. On the expenditure side, stability. This outlook is subject to both the decision to suspend public benefits that downside and upward risks. Further more than offset the wage increase took place instability in Thailand, a sharper correction at the beginning of the fiscal year. A second in economic activity in China or materializing round of spending cuts was approved late in risks in the financial sector could hurt growth. the FY13/14, totaling around 1 percent of GDP On the other hand, lower oil prices, faster in full year terms. Close to 40 percent of the completion of some hydropower projects cuts came from adjustments to the public as well as better performance of the non- investment plan with the remaining affecting resource sectors could push growth rates administration spending. As a result, the Lao Economic Monitor – April 2015 11 fiscal deficit narrowed to 4.3 percent of GDP on the Lao balance of payments, given that in FY13/14, from 6 percent the previous year. petroleum products constitute nearly 20 However, the Government’s financial position percent of total imports. continued to be tight as arrears incurred in previous years were being repaid. Further 6. While the nominal exchange rate containment of the deficit is expected in remained relatively stable within the band FY14/15 with the deficit projected to stabilize set by the Bank of Laos (BOL), the real at 4.2 percent of GDP. The Government exchange rate continued to appreciate. plans to limit growth in total public spending During 2014, the kip depreciated by 2.7 to about 7 percent in nominal terms, to percent against US Dollar and appreciated by be supported by lower recruitment in the 2.3 percent against the Thai baht. However, public service and a wage freeze for most of with inflation in Lao PDR exceeding inflation the civil service. At the same time, revenue in some of the main trading partners, the administration is expected to be further real effective exchange rate continued to strengthened, and there are excise increases appreciate. The appreciation of the Kip planned for vehicles and luxury goods. over the last five years reached more than 30 percent, which has undermined the 5. Foreign exchange reserves coverage competitiveness for Lao PDR’s tradable remains low as compared with prudential exports and cheapened consumer imports, benchmarks. Reserves stood at US$ 815 and therefore contributes to the pressure on million in December 2014, 23 percent higher the external balance. than in December 2013, due to strong investment inflows and foreign borrowing. 7. Indications in 2014 are that bank credit Nevertheless, the reserve cover remains low growth is slowing down sharply compared less than 2 months of goods and services to its previous rapid pace over several years. imports, and about 28 percent of foreign After having averaged more than 50 percent currency deposits. These indicators imply annually during 2008-13, credit growth significant vulnerability to shocks. The slowed down to 14 percent in December 2014. international prudential benchmark for Despite slower credit growth during 2014, foreign exchange reserve cover is between the overall health of the banking system 3-6 months of imports of goods and services. continues to be a concern. Rapid sustained Therefore, building up reserves to increase growth of credit over several years has buffers against shocks remains critical to continued to stretch supervisory capacity. macroeconomic stability. The recent trends The non-performing loans (NPL) ratio rose in fiscal consolidation and credit growth sharply in the first half of 2014. The NPL slowdown as well as signs of depreciation will ratio of state-owned commercial banks rose help in curbing domestic demand for imports from below 3 percent at end 2013 to about and therefore lessen the pressure on reserves. 8 percent in June 2014, while their capital- Moreover, the recent sharp fall in global oil to-asset ratio declined to about 3 percent, prices, with annual average crude prices raising concerns about health of the sector down by 8 percent during 2014 compared to and possible contingent liabilities. a year ago, should have a favorable impact 12 Lao Economic Monitor – April 2015 Selected Issues of trade facilitation and non-tariff measures in order to lower trading costs; iii) providing mutual recognition of qualifications for I. Asean Economic professional services; iv) improving labor Community 2015 – skills; v) establishing a transparent and non- Implications For Lao PDR discriminatory investment regime; and vi) promoting quality investment. Immediate 8. The commencement of the ASEAN reforms are needed to replace manual Economic Community by 2015 is expected processes for business start-up and sectoral to present new opportunities for Lao PDR; business licensing with a modern automated however, further trade and investment system that is streamlined, time-efficient, policy reforms and strong implementation of transparent and predictable. Such deeper commitments by the authorities are needed. reforms are critical in moving toward a rule- The country’s export performance continues based business model on the ground and to skew towards hydropower and mining aiming at improving the competitiveness of exports as non-resource sectors still operate the private sector in Lao PDR. in a relatively high-cost business environment with low labor productivity. In the near term, II. Creating Productive Jobs Lao PDR’s goods and services exports and For Inclusive Growth investment inflows to non-resource sectors are not expected to suddenly significantly 10. In order to achieve broad-based, rise due to supply side constraints and inclusive growth and poverty reduction the hindrance on competitiveness of the in Lao PDR, channeling greater resources private sector (lack of skilled labor and labor toward tackling key workforce skills and availability, and relatively high trade costs productivity challenges is of significant and costs of doing business). A short-term importance. The majority of labor is in the impact could potentially be increased imports agriculture sector, where productivity is low. of consumer goods when import prices As a result, the movement of labor from the become cheaper. Lao PDR may expect to see agriculture sector to other non-farm jobs has new opportunities for foreign investment and been slow. Labor movement is also deterred some benefits through lower costs of imports by limited opportunities for higher-paid and future inflows of some professional and higher-productivity non-farm jobs, in services1 that Lao PDR lacks. part due to constraints on business startup and doing business. Despite the impressive 9. In order to grasp new opportunities and growth in the past decade, in part driven enjoy the benefits of regional integration, by the development of the resource sector, it is necessary for Lao PDR to take steps to job creation in this sector has been limited. create a conducive business environment. The skills problems are not only limited to These steps include: i) continuing regulatory vocational skills, but stem from a lack of and policy reforms; ii) ensuring effective basic reading and numeracy skills from early implementation of commitments in the areas childhood. Boosting agricultural productivity 1 Professional services in the AEC context covers nurses, architects, engineers, medical practitioners, dental practitioners, accountants and surveyors only. Lao Economic Monitor – April 2015 13 is a top priority for improving livelihoods and reducing poverty, as it will help raise farm incomes and will eventually free some workers to look for higher paying non-farm jobs. In the meantime, this should be coupled with investing in productivity improvement in existing non-agriculture sectors as well as streamlining processes for business establishment and operations in order to enable a diversified private sector that will help generate employment opportunities. On the supply side, strengthening early childhood education and literacy skills and building job- relevant technical skills will be critical. 14 Lao Economic Monitor – April 2015 Recent Economic Developments In Brief Growth moderated in 2014 but remained Inflation decelerated driven by slower strong… growth in food prices and declining oil prices Change from the previous year, percent Change from the previous year, percent Source: Government, LNCCI data and staff estimates Source: LSB and WB staff calculations Fiscal consolidation started since FY13/14 Most effects expected from expenditure (percent of GDP) measures (percent of GDP) Source: MOF and WB staff estimates Source: Government, LNCCI data and staff estimates Lao Economic Monitor – April 2015 15 Reserve coverage remains low Despite credit growth deceleration, risks to the banking sector remain Source: BOL and WB staff calculations Source: BOL and staff calculations Lao PDR’s trade is more integrated, but most …and the trading costs remain high exports are from natural resources… Trade cost per container# (US$ per container) (percent of GDP) Source: Lao PDR Authorities, trading partners and WB Source: Doing Business 2013, 2014, 2015 staff calculations Trade cost includes both import and export costs per container …and the lack of skilled labor and generally The issue may be extended to the need for low productivity, including agriculture sec- improving overall literacy skills from early tor where most people work in… childhood education as well Composition of economy by amount of hours worked in Scores on basic literacy test (from 0-8 points) for adults each sector (in % of total) with different education levels Source: Lao Development Report 2014 Source: Lao Development Report 2014 Part I: Recent Economic Developments Photo by Remy Rossi / World Bank, 2013 Lao Economic Monitor – April 2015 17 Key Regional Economic Developments The global economy is showing signs of Significant uncertainties remain about the recovery, but at an uneven pace; global growth strength and sustainability of the recovery rose modestly by estimated 2.6 percent in in high-income economies, as well as about 2014 and is projected to further rise to 3 the timing of policy actions by central banks percent in 2015. The gradual strengthening in these countries. A key risk to the regional of activity in high-income economies will outlook is that the global recovery, and the boost demand for exports from developing associated pickup in demand for regional East Asia and Pacific (EAP), helping the region exports from the developed economies, may to sustain its growth performance. Growth in be slower than anticipated. In addition, global developing EAP moderated to 6.9 percent in financial conditions are likely to tighten, and 2014 and is expected to slightly slow further financial volatility may also rise, especially due to slight moderation in China. Despite if geopolitical tensions escalate; this may such trend, the EAP region will remain the create debt-service challenges for some fastest-growing developing region (See economies. Relatedly, real estate prices Annex 2 for projections). in some countries are likely to come under pressure. In the near term outlook, projected growth Source: EAP Economic Update October 2014, Global moderation in China will offset projected Economic Prospects January 2015 pickups in other economies in the region. In China, growth has moderated to 7.4 percent in 2014 and is projected at 7.1 percent in 2015, reflecting intensified policy efforts to address financial vulnerabilities and structural constraints, and to place the economy on a more sustainable growth path. Measures to contain local government debt; curb shadow banking; and tackle excess supply capacity, high energy demand, and high pollution will reduce investment and manufacturing output. Excluding China, the regional growth bottomed out at 4.6 percent in 2014, reflecting the slowdown in Indonesia and Thailand, before recovering to 5.2 percent in 2015. Growth, excluding China, will gradually pick up, as exports firm and the impact of domestic adjustment in the large ASEAN countries eases. However, the capacity to benefit from the global recovery will vary significantly across countries, reflecting structural constraints to investment and export competitiveness, and weak export prices for commodity producers. 18 Lao Economic Monitor – April 2015 Recent Economic Developments In Lao PDR Growth by about 60 percent reaching about US$ 1.5 billion to neighboring countries5. Services were also estimated to have stable growth last 1. Preliminary estimates put the growth year driven by wholesale and retail, banking, rate of the Lao PDR economy at 7.5 percent transportation, storage, and communication, in 2014; slightly below the 8 percent average some of which were spillovers from the over 2011-2013 due to slowdown in some resource sector construction. real sectors and fiscal tightening (Figure 1). On the supply side, key growth drivers in 2014 came from robust activity in the construction Figure 1: GDP Growth and Inflation and construction-related industry some of (percent yoy) which was related to the resource sector and spillovers, forestry (wood export), and services (Figure 2). In the resource sectors, despite lower direct output contribution2, the construction of hydropower projects provided considerable indirect contribution through construction and services sectors3. The hydropower output was estimated to have a slow increase in 2014 from existing plants and other smaller projects. The mining sector contribution lowered due to a declining overall gold output and effects of lower Source: Government, LNCCI data and staff estimates commodity prices. However, the development of several large-scale hydropower projects4 Figure 2: Contribution by sectors to real GDP boosted the construction and construction- growth related industries, as well as spillovers. (percentage points) Overall, the construction and construction- related sectors, particularly related to large hydropower projects, continue to show solid growth driven by FDI in the resource sectors, which more than offset a decline in public investment spending in real term last year due to fiscal consolidation. Forestry (mostly wood exports) contribution is estimated to have risen significantly in 2014, reflecting a significant increase in wood exports in 2014 Source: Government, LNCCI data and staff estimates 2 Direct output contribution refers to the change (increase or decrease) in output (for example, GWH increase after power projects start operation; mineral output change due to expansion plan). Indirect contribution is mostly the spillovers to other sectors (e.g. services, construction) mostly during the construction phase of the resource projects. 3 Resource sectors cover hydropower and mining sectors. 4 Projects under construction include Hongsa Lignite power plant, Xayaboury, Nam Ngiep 2, Nam Ou 2,5,6, and Xepian Xenam Noi projects. 5 According to trading partners’ customs websites: www.customs-info.com/Trade/Commodity.aspx; www.customs. gov.vn Lao Economic Monitor – April 2015 19 2. Going forward, real GDP growth is significant deceleration from 12.6 percent a projected to slow to 6.4 percent in 2015. The year ago (Figure 4). After falling by 5.4 percent forecast assumes a high but stable level of during 2013, fuel prices fell by addition 0.8 investment in large power projects as well as percent in 2014 reflecting developments on further fiscal consolidation effects. Real GDP world markets. Inflation is projected around is projected to ease to 6.4 percent in 20156, 5 percent next year. before accelerating again in the medium term. Given the adoption of expansionary economic policies in the past few years and emerged Figure 3: Monthly Inflation macroeconomic vulnerabilities, a slowdown (percent yoy) associated with policy adjustments (such as fiscal consolidation and slower credit growth) are expected to help restore macroeconomic stability. This outlook is subject to both downside and upward risks. Further instability in Thailand, a sharper correction in economic activity in China or materializing risks in the financial sector could hurt growth. On the other hand, lower oil prices, faster coming on stream of some hydropower projects as well as better performance of the non-resource sectors could push growth rates upwards Source: LSB and WB staff calculations closer to the government’s target. The fiscal deficit should narrow to about 4.2 percent as recent fiscal consolidation measures take effect, with stable revenues to GDP despite Figure 4: Contribution to Food Inflation lower resource-sector revenues, and a (percentage points) moderate degree of expenditure containment. The external current account deficit should continue to reflect high FDI-funded imports, and only gradually improve in the medium term, beyond 2015, as power projects come on stream and start to export electricity. Inflation 3. Average annual inflation in 2014 decelerated to 4.2 percent from 6.4 percent Source: LSB and WB staff calculations a year earlier, driven primarily by slower growth in food prices and a decline in fuel prices. Food prices in 2014 were, on average, higher by 7 percent compared to 2013; a 6 This projection is at the lower range taking into account some down side risks. If upside risks materialize, growth prospects could be revised upward. 20 Lao Economic Monitor – April 2015 Government Revenue And repaid. The overall non-resource fiscal deficit including grants also narrowed as a result, Expenditure from about 10 percent in FY12/13 back to 7 percent in FY13/14. Under the implementation 4. The fiscal deficit for FY13/14 is of the budget cuts, availability of updated estimated to decline as result of fiscal outturn information will enable further consolidation measures. Early measures analysis of the impacts on the social sector in FY13/14 included a cut in public sector spending especially health and education benefits that offset the second 40 percent sectors (Box 1: Public Spending on education wage increase. Total revenue remained stable and health sectors). at about 23 percent of GDP as improved non- resource revenue performance (VAT, excise, import duties) compensated for the lower Figure 6: Government Expenditures mining revenues and grants. With revenue (percent of GDP) growth falling short of the ambitious revenue target, and arrears repayment bearing on Government cash flows, the financial position remained tight in FY13/14. A new round of fiscal corrective actions was announced in mid-2014, with spending cuts equivalent to about 1 percent of GDP in full-year terms7. As a result, the fiscal deficit for FY13/14 is estimated to decline from 6 percent to 4.3 percent (Figure 5) though the financial position of the Government continued to be Figure 7: Social sectors expenditures tight as arrears incurred in FY12/13 (close to (percent of total public expenditure excl. debt payment) an estimated 2 percent of GDP) were largely Figure 5: Government Fiscal Performance (percent of GDP) Source: MOF and WB staff estimates Note: numbers were revised to include on-budget grant- Source: MOF and WB staff calculations financed investment spending ‘* Original Budget Plan 7 The Government proposed to the National Assembly cuts to public spending in the amount of kip 659 billion, of which kip 250 billion to be cut from the public investment plan, while kip 409 billion to be cut from the recurrent spending plan (Vientiane Times Newspaper, July 8th, 2014, http://www.vientianetimes.org.la/FreeContent/freeCont_Govt%20 seeks%20parliament.htm) . Lao Economic Monitor – April 2015 21 5. On the revenue side, total revenue as a Figure 8: Government Revenue ratio to GDP is estimated to remain stable (percent of GDP) as non-resource revenues compensated for the decline in grants and mining revenues. The Government attempted to strengthen revenue administration, which contributed to revenue growth making it stayed around 23 to GDP in FY13/14 (Figure 7). Mining related revenue fell due to lower commodity prices and associated lower overall gold output. Non-resource revenues performed well, particularly import duties, excise tax and value added tax (VAT), making non-resource revenues’ share to GDP increased to 14.8 Source: MOF and WB staff estimates percent. Grants declined from 5.3 to about 5 Note: numbers were revised to include on-budget grant- percent. financed investment spending 22 Lao Economic Monitor – April 2015 Box 1: Public Spending on education and health sectors Figure 9: Public spending on education Figure 10: Public spending on health (percent of total government spending#) (percent of total government spending#) Source: MOF and WB staff calculations Note: # total government spending, excluding debt payment ‘* Original Budget Plan Public spending on priority social (about US$ 490 million in FY13/14 sectors, education and health, has plan). However, non-wage recurrent expanded under the FY12/13 – FY13/14 expenditures, which are important to the original budget plans, though mostly efficiency and quality of public services, due to the rise of the wage bill. Public remain a small share of less than 2 spending on health was set to rise to percent of the total public expenditure about US$ 220 million or 7 percent of (about US$ 45 million). The lack of non- total public expenditure, excluding debt wage recurrent spending in proportion to payment, in FY13/14 from the sharp drop public investment and wage bills increase in FY11/12 implementation. The increase in these two sectors can undermine is allocated to recurrent spending (Figure the quality of public services. With the 10). The non-wage recurrent spending implementation of wage increase in on health, which covers the spending FY12/13 and the aforementioned budget for operation and maintenance of public cut in FY13/14, the outturn information assets and consumables, as a share is not yet available to allow assessment of total spending was planned to rise of the impacts on these sectors. To help to about 2.4 percent in FY13/14 plan ensure development outcomes, strategic (about US$ 76 million) from 0.7 percent resource allocation and improvement in FY11/12 budget implementation (about in absorptive capacity in these two US$ 13 million). Public spending on sectors would be equally important going education was also planned to increase forward. in the last two fiscal years, driven by the increase in wage bills and benefits Lao Economic Monitor – April 2015 23 6. Overall the fiscal deficit in FY14/15 is guaranteed (PPG) external debt stock and expected to remain stable at 4.2 percent the rest is private external debt. The nominal as fiscal consolidation takes effect. Total stock of PPG external debt is estimated to spending growth will be contained, coupled rise from US$4.5 billion in 2012 (47.7 percent with much slower recruitment rate. The of GDP) to about US$5.1 billion at end-2013 Government has given a priority to completing (48.3 percent of GDP), mainly the result of the existing projects, repaying eligible past higher borrowing from China and Thailand public investment project arrears and has in part driven by public investment in equity restricted new public investment projects holding in power generation projects. The that are not related to poverty reduction corresponding net present value of PPG objective. Under the FY14/15 development external debt at end-2013 was estimated at plan, key measures include the instruction to 39.8 percent of GDP, significantly increased spending units to allocate at least 35 percent from 32.5 percent of GDP in 2012. of the annual capital spending budget for clearing past PIP arrears and stop any off- 8. Lao PDR’s risk of debt distress budget spending without approval from the remains moderate, but with heightened national assembly. Relevant sectors are risk compared to last year’s assessment. advised to periodically update the unit cost Under the baseline case, the PV of external for construction related to their sectors and PPG debt to GDP ratio is projected to breach made known to the public as a reference the debt burden thresholds for PPG external for proper project costing. The revenue debt for the next few years before declining measures will focus on strengthening in the medium term. The breach means that revenue administration. These measures, if the PPG external debt stock and future implemented strictly, should go a long way repayment flows increase compared to the to improving the Government’s financial thresholds that indicate the sustainable level position and restoring fiscal sustainability. of public external debt. This indicates higher Nevertheless, the falling of fuel prices might debt burden and limited cushions for the have some impact on the Government budget in the case of adverse shocks. Other revenue and is being monitored closely. debt and debt service indicators remain low due to the high level of concessionality in Public Debt official borrowing. Most of the PPG external debt is denominated in foreign currencies, 7. Preliminary assessment of the Lao making it vulnerable to a risk of significant PDR total external debt indicates increased sudden exchange rate depreciation. external debt stock at end 2013 compared to 2012. Nominal total external debt (public 9. Bilateral creditors have accounted and private debt) is estimated to increase for a larger share in total external public from about 80 percent of GDP at end 2012 to debt in 2013. Bilateral creditors, mainly about 84 percent at end 20138, out of which China, Russia, Thailand, Japan and Korea – slightly more than half is public and publically accounted for 64 percent of total external PPG at end 20139. Multilateral creditors 8 This is among the high external debt ratios in the region, compared to some ASEAN countries such as Cambodia (33 percent of GDP), Myanmar (25 percent), China (1.5 percent), Indonesia (31 percent), Philippines (28 percent) and Malaysia (31 percent). 9 This includes a 50-million USD bond that was issued in May 2013, two bonds totaling about 100 million USD have been issued in December 2013 in the Thai capital market. In 2014, about 170 million of bonds were issued. These are for financing the general budget deficit. 24 Lao Economic Monitor – April 2015 accounted for the remaining, of which mostly 11. The Government is taking steps to Asian Development Bank and followed by strengthen the framework for public debt the International Development Association management. Enhancing capacity in debt (the World Bank). The share of bilateral management, debt sustainability analysis creditors has increased significantly vis-à-vis and project viability appraisal is of crucial multilateral creditors, reflecting both higher importance in Lao PDR. A debt monitoring levels of borrowing and harder average terms. system (DMFAS) is now fully deployed and Table 1: External PPG Debt Composition US$ Share of total PPG In percent of GDP billion external debt Total 5.1 100 48  Multilateral 1.8 36 17  Bilateral 3.3 64 31    Commercial 0.1 3 1 Source: IMF and WB’s Debt Sustainability Analysis 2014 Table 2: External PPG Debt Burden Indicators Debt Burden End 2013 Indicative thresholds Present value of debt, in percent of   GDP 40 40   Exports 150 92   Revenue 250 221 Debt service, in percent of   Exports 20 5   Revenue 20 12 Source: IMF and WB’s Debt Sustainability Analysis 2014 10. Total public sector (domestic and capacity building for debt management unit external) debt is estimated at 59 percent has continued. This system has helped the of GDP at end-2013. Domestic public debt authority to monitor and analyze external stood at about 11 percent of GDP at end-2013 public debt portfolio of Lao PDR. Lao PDR consisting of commercial bank lending and start to report detailed debt information bond holdings as well as the Bank of Lao PDR to the Debt Report System as per its (BOL) direct lending to local Government’s international obligation. New presidential off-budget infrastructure projects. Given ordinance on public debt management has higher costs of domestic borrowing, the share been in principle approved. The Ordinance of domestic PPG debt remains relatively defines the responsibility and authority of small. Going forward, however, as domestic the Government agency to borrow and to financial markets deepen, the share of issue new debt (including public, publically domestic public debt is likely to increase. guaranteed debt and contingent liabilities), invest and undertake transactions on the Lao Economic Monitor – April 2015 25 Government’s behalf, and provides for deficit is estimated to slightly decline debt management objectives as well as relative to GDP, from 11.5 percent to GDP requirements to publish information on to 11.2 percent in 2014 due to estimated public debt on a timely basis. The authorities significant increase in wood exports this are taking steps to encourage a transparent year that will partly compensate for the fall public debate over debt and investment in commodity prices and overall gold output projects by publishing information in media decline (Figure 12, Figure 13). Nevertheless, and on the National Assembly website, other non-resource exports still experienced but these efforts are starting from a very relatively slower growth last year partly low base. All these efforts underscore the related to the constraints on the supply side. authorities’ commitment to strengthening Imports growth was driven by capital and debt management. consumption goods imports some of which are related to the investment in hydropower 12. Reforms to strengthen cash projects10 (Figure 14, Figure 15). External management in the National Treasury have factors such as the sharp recent fall in global also been initiated. The MoF has established oil prices is expected to have a favorable a National Treasury subordinating local impact on the Lao balance of payments, given treasury offices to central management. that petroleum products imports constitute The Government cash accounts are being nearly 20 percent of total imports (See Box progressively consolidated on the Treasury 2). Single Account (TSA) comprising a system of arrangements with the BoL and three Figure 12: Balance of Payments state-owned commercial banks reporting (percent of GDP) their treasury balances daily to the National Treasury based on the zero-balance account arrangement initiated with the banks. Cash management will be further strengthened through setting up a cash management unit in the National Treasury, developing cash-flow projections, and establishing clear responsibility for the National Treasury to engage into financial asset and liability management transactions to achieve the targeted balance of the TSA at the lowest cost. Source: Staff estimates based on data from Lao External Sector authorities (MOIC) and partner countries 13. Preliminary estimates indicated a slight improvement in the external balance supported by non-resource exports and still strong inflows of foreign investment in the resource sectors. The current account 10 These include Hongsa Lignite power plant, Xayaboury, Nam Ngiep 2, Nam Ou 2,5,6, Xepian Xenam Noi, etc. 26 Lao Economic Monitor – April 2015 Box 2: The oil price decline should benefit the economy, but also has some downside risks Figure 11: Average crude oil price Source: World Bank Commodity Price, March 2015 The average crude oil price plunged sharply Also, lower fuel prices are expected to in the second half of 2014. Nevertheless, the bring some benefits to consumers as lower annual average price fell by about 8 percent prices boost purchasing power. Already in yoy in 2014. This resulted from sluggish global December 2014, retail energy prices were 6 demand and a supply glut due to increased percent lower compared to a year ago. Fuel supply from US shale production and the consumption accounts for about 8 percent in reluctance to cut output by the Organization the Consumer Price Index basket. Lower fuel of the Petroleum Exporting Countries (OPEC). prices are also expected to be translated in Cheaper oil is expected to boost global GDP reduced prices of other goods and services by around 0.1 percentage point and GDP of due to lower costs for producers. oil importing developing economies, including in the East Asia and Pacific region, by around However, there are also downside risks. The 0.2 percentage points. decline is expected to affect government revenue, where oil revenue (from excise tax With Lao PDR being a net importer of oil, and VAT) accounts for about 10 percent of the lower oil prices are expected to have a domestic revenue, or about 2 percent of GDP. favourable impact on the external balance. However, the existing mechanism of fuel Oil import accounts for about 20 percent of price regulation may help soften the impact total Lao PDR imports, or about 9 percent on revenue. In addition, the recent slide in oil of GDP. The fall in annual average oil price prices comes also in response to moderating in 2014 is expected to offset the demand, growth in China. Further slowdown in China or which rises by about 10 percent annually on other key trading partners of Lao PDR might average, and therefore to keep oil import bills affect their demand for Lao PDR exports. stable compared to the previous year and help contain the current account deficit from largely expanding. Lao Economic Monitor – April 2015 27 Figure 13: Merchandise Exports (US$ million) 14. Foreign exchange reserves coverage remains low as compared with prudential benchmarks. Reserves stood at US$ 815 million in December 201411, an increase of 23 percent compared to a year ago (Figure 16). However, net foreign assets fell notably by about 20 percent yoy in December 2014 due to a sharp increase in foreign liabilities of commercial banks. To help reduce the pressure on reserves, the BOL has instructed commercial banks since mid-2013 to limit Source: Staff estimates based on data from Lao exposure to lending in foreign currency authorities (MOIC) and partner countries to borrowers with insufficient foreign currency earnings. Nevertheless, exchange Figure 14: Merchandise Imports management also has contributed to (US$ million) fluctuations of reserves. The ratio of reserves to foreign currency deposits has gradually dropped to slightly less than 30 percent in December 2014 and still less than 2 months of imports of goods and services12 (Figure 17). These indicators still imply the remaining vulnerability in the external balances. Therefore, building more reserves to increase the cushion against shocks is critical to macroeconomic stability. The recent Source: Staff estimates based on data from Lao trends in credit growth slowdown and fiscal authorities (MOIC) and partner countries consolidation will have an important role in curbing domestic demand for imports as Figure 15: Foreign Direct Investment (US$ Million) well as lower pressure from falling oil prices therefore are expected to lessen the pressure on reserves. Source: Staff estimates based on data from Lao authorities (MOIC) and partner countries 11 Reserves can cover only the estimated cash flow on public external debt (interest and repayment) over 2015-16, of about US$500 million. 12 This is WB staff estimates based on the trade data from Lao authorities and trading partners. BOL estimates more than 4 months based on Lao authority’s trade data. Both agencies use the same nominal foreign reserves data but different measures of imports 28 Lao Economic Monitor – April 2015 Figure 16: Net foreign assets and foreign Figure 17: Reserves coverage reserves (percent) (percent) Source: BOL and staff calculations Source: BOL and staff calculations Exchange Rate Figure 18: Lao kip exchange rate 15. While the Bank of Lao PDR maintains nominal exchange rate stability of the Lao kip against major currencies, foreign exchange policy should give more consideration to reserve management and competitiveness. In nominal terms, the kip depreciated by 2.7 percent against the U.S. dollar during 2014 while it appreciated against Thai Baht by about 2.3 percent (Figure 18). However, with inflation in Lao PDR exceeding inflation in some of the main trading partners, the Source: BOL real effective exchange rate continued to appreciate. The real appreciation of the Kip over the past five years reached more than Figure 19: Real effective exchange rate 30 percent (Figure 19), which has undermined the competitiveness for Lao PDR’s tradable exports and cheapened consumer imports, and therefore contributes to the pressure on the external balance. Source: IMF Lao Economic Monitor – April 2015 29 Monetary Developments the past few years, the non-performing loans ratio (NPLs) started to rise where the 16. Credit growth slowed down by aggregate NPL for SOCBs rose from below December 2014. Domestic credit grew at 3 percent at end 2013 to about 8 percent about 14 percent yoy in December compared by June 2014 and the capital-to-asset ratio to 35 percent yoy a year earlier due to dropped to an average of 3 percent in the decelerated credit growth to the private period. This might have an implication on the sector across all sectors (Figure 22, Figure contingent liabilities for the Government. The 23). This is party related to the recent fiscal BOL recently issued a notice to suspend the difficulty and fiscal consolidation efforts. approval of new private bank applications Despite such deceleration, overall credit and reassess the performance of the banking growth in Lao PDR was still among the sector. At the same time, it also plans to highest in the region (Figure 20). Industry, strengthen prudential regulations and Figure 20: Domestic credit growth in EAP Figure 21: Banking sector assets region (kip billion) (percent yoy) Source: BOL and EAP Update October 2014 Source: BOL and staff estimates construction and commerce sectors account Figure 22: Contribution to credit growth for more than half of the total private sector (percent and percentage points) credits (Figure 24). 17. Despite recently deceleration credit growth, the overall health of the banking system continues to be a concern. The banking sector has notably grew with the total assets expanded to more than 70 percent of GDP compared to slightly less than 50 percent four years ago (Figure 21). State- owned banks (SOCBs) account for about half of that. The rate of sectoral and credit expansion has stretched the bank supervision Source: BOL and staff estimates capacity. After sustained credit growth in 30 Lao Economic Monitor – April 2015 introduce financial soundness risk indicators. In addition, performing relevant stress tests periodically can also help the BOL to test the strengths and weaknesses and therefore focus the support and reform in the needed areas. Figure 23: Sectoral contribution to credit growth (percentage points) Source: BOL and staff estimates Figure 24: Composition of credit by sectors (percent to GDP) Source: BOL and staff estimates Part II: Selected Issues Photo by Bart Verweij / World Bank, 2014 32 Lao Economic Monitor – April 2015 Asean Economic Community 2015 – Implications For Lao PDR13 1. The ASEAN Economic Community progressively removed more than 80 percent (AEC), which is set to come into force at of all import tariffs, with the remaining the end of 2015, represents a key first tariffs still applied on sensitive goods, such step towards the establishment of a single as unprocessed agricultural commodities. market among ASEAN member states. In Vietnam reduced all import tariffs for this context, what does it really mean for agricultural products to between 0 and 5 Lao PDR? The country is already closely percent in 2013, Lao PDR and Myanmar will integrated with the ASEAN region. In fact, need to do the same by 2015, and Cambodia the 2015 AEC milestone should really only be by 2017. The CLMV countries are committed viewed as a first and important step towards to eliminating all remaining tariffs, including establishing a single market, but many more on sensitive goods, by 2018. In theory, lower steps will be required in the years afterwards tariffs should see lower cost imported goods if ASEAN member states are to truly benefit across the region. This will benefit consumers from an economic community. This brief note and firms requiring imported materials to presents four key aspects of the AEC that process into other products, but will also most affect Lao PDR: trade in goods; trade in expose businesses to more intense price services; cross-border investment; and trade competition. Governments which receive a facilitation. notable share of tax revenues from tariffs on imports (about 10 percent of domestic Trade in Goods revenue) will also see a loss in revenue. v What will happen in 2015? 3. At the same time, under the AEC countries are also committed to the 2. The ASEAN Trade in Goods Agreement elimination of non-tariff barriers (these (ATIGA) provides the rules and regulations include, for example, quotas, unreasonable for the import and export of physical standards, licenses or restrictions at the merchandise within ASEAN member states. border). All ASEAN member states were The key AEC commitment is that all trade required to meet this commitment by 2010, within ASEAN will be duty free by 2015. In with the exception of the Philippines in 2013 fact, all tariffs including those on sensitive, and the CLMV countries in 2015. In fact, unprocessed agricultural imports were progress has been rather slower and as eliminated in 2010 by the six original member tariffs have moved closer to zero, countries countries (Brunei, Indonesia, Malaysia, the have increasingly started to apply non-tariff Philippines, Singapore and Thailand). The measures as an alternate control measure on remaining, and less developed, countries imports. Many are formulated without clear CLMV (Cambodia, Lao PDR, Myanmar and and legitimate policy objectives. Vietnam) have more time to comply and have 13 This note was prepared by Konesawang Nghardsaysone, Trade Economist, and Richard Record, Senior Country Economist Lao Economic Monitor – April 2015 33 v What does it mean for Lao PDR? competitiveness of the Lao private sector, rather than through the effect of tariffs. 4. Lao PDR will see lower cost imports Similarly, many Lao exporters struggle to coming into its economy when most comply with non-tariff measures, such as remaining import tariffs are eliminated Sanitary and Phytosanitary requirements in actual terms during 2015-18. This will and technical standards, applied in export help improve the efficiency of firms that use markets. These challenges take much longer imported materials and benefit consumers of to be addressed. imports. Domestic producers who compete with imported products will, however, face Trade in Services tougher competition. v What will happen in 2015? 5. In 2015, Lao PDR expects to eliminate all import tariffs except for around 900 7. Rules regarding trade in services sensitive tariff lines (about 10 percent of within ASEAN countries are provided in total tariff lines) which will remain at 0-5 the ASEAN Framework Agreement on percent tariff rates and 63 highly sensitive Services (AFAS). This governs the supply of tariff lines (about 1 percent of tariff lines) services across borders, foreign investment which will remain above 5 percent. These in services and migration of persons across remaining tariffs will need to be eliminated by borders to provide services. ASEAN member 2018. As of February 2014, some 79 percent of states have been progressively attempting all Lao tariff lines are at zero, 17 percent are at to reduce barriers to services trade in line 0-5 percent, and the remaining 4 percent are with AEC objectives, but in reality actual above 5 percent. These remaining tariffs are implementation lags behind commitments. mostly applied to unprocessed agricultural While there are now very few restrictions on commodities, including rice. As these supplying services across border, there are remaining tariff reductions are phased in, still limits on the maximum amounts that the Government is likely to lose considerable foreigners can invest in services within many customs revenue, most notably on imported ASEAN countries. Contrary to expectations, vehicles from within ASEAN. In expectation of ASEAN is also still a long way from having tariff reductions, the Government is therefore free movement of labour across the region. increasingly shifting taxes of vehicles from The key AEC 2015 commitments on the tariffs (which are applied on imports) to excise movement of labour are for the temporary taxes (which are applied on sales of vehicles). entry of business visitors, intra-company staff transfers and for the free movement 6. On exports, Lao PDR already gained of persons providing some professional duty free access to the original six ASEAN services only. Professional services in the AEC members in 2010, and will progressively see context covers nurses, architects, engineers, remaining tariffs on Lao exports applied by medical practitioners, dental practitioners, Cambodia, Vietnam and Myanmar reduced accountants and surveyors only. For example, during 2015-18. Given that Lao exports to from 2015 a Lao engineer can temporarily ASEAN did not jump substantially when travel to provide his/her services in Thailand tariffs were reduced in 2010, it is likely that upon the mutual recognition of her/his the most significant constraints are actually qualifications and experiences by the Thai associated with supply side capacity and the authorities. The movement of unskilled labor 34 Lao Economic Monitor – April 2015 within ASEAN is still restricted by domestic within Lao PDR. laws of member states, and there are no AEC commitments on unskilled labor. Investment v What does it mean for Lao PDR? v What will happen in 2015? 8. Lao PDR is committed under the AEC, as 10. Under the ASEAN Comprehensive well as under other obligations such as at the Investment Agreement, member states WTO, to progressively increase the number are committing to putting in place an of service sectors where foreign firms can investment regime that is free, open with invest. By 2015, the country is committed no restrictive or discriminatory measures to raising the cap on the maximum share imposed on flows of investment across the that foreigners can invest in services to 70 region. Foreign investment is to be facilitated percent across all sectors. In many sectors through more transparent, consistent, and there are no limits at all, meaning that 100 predictable rules, regulations and procedures. percent foreign investment is permitted. Investment applications and approvals are However, like with trade in goods, the expected to be streamlined, simplified and most significant constraints to attracting transparent in order to attract and facilitate increased foreign investment in diversified foreign investment across ASEAN. Outside of sectors are associated with a Lao PDR the services trade, this covers manufacturing, being a small market and having a high cost agriculture, fishery, forestry, mining and business environment. Increasing the volume quarrying. Investors are to be properly and quality of foreign services investment protected through transparently established into Lao PDR can be best seen as a means of conflict settlement procedures and improving the competitiveness of other firms mechanisms that conform to international in Lao PDR, including manufacturers which standards and practices. depend on the availability of support services. v What does it mean for Lao PDR? 9. AEC commitments on the movement of skilled professionals are unlikely to have 11. Lao PDR is committed to establishing a major impact in Lao PDR as the country a free and open investment regime has significant skills shortages in all of the conforming to AEC requirements, and (limited) areas where free movement will efforts have been made to put in place a be allowed. In theory, it may be somewhat revised investment promotion law, removing easier, and lower cost, for firms to import all discriminatory measures, abolishing the these professional services after 2015 need for investment license and ensuring helping to boost competitiveness, but it is that foreign and domestic investors are unlikely that Lao PDR will be exporting such treated in the same way. However, in professional services in the immediate future. practice there are still significant gaps and However, implementation will involve not only a generalized lack of transparency that simplification and streamlining of visa and affects the quality of foreign investment that work permit approval processes, but also Lao PDR receives. Numerous licenses and reforms to domestic laws and regulations permits are required at the sector level, often to allow for the mutual recognition of taking considerable time for the necessary qualifications gained from across ASEAN paperwork to be completed. Few processes Lao Economic Monitor – April 2015 35 are yet automated. Investor protection and Figure 25: Trading costs remain high dispute resolution mechanisms remain weak Cost to export and import (US$ per container) due to lack of transparency, and procedures for insolvency are still very basic. Trade Facilitation v What will happen in 2015? 12. Under the AEC, countries are committed to the free flow of trade through single, harmonized and standardized trade and customs processes and procedures that aim to lower the transaction costs Source: Doing Business 2013, 2014, 2015 of trade. At the country level, customs clearance and declaration processes are to be streamlined and automated with the use electronic trade portal, the Lao PDR Trade of risk management systems and integrated Information Portal in 2012 as a national with simplified and harmonized processing trade repository. The portal provides of regulatory requirements, including information to the public on all trade related customs clearance and the issuance of laws, regulations, procedures and processes. licenses and permits via a National Single Lao PDR is also progressively introducing Window. However, in practice it is unlikely automated customs systems to streamline that all member states will be able to have border management, and has commenced fully functioning systems prior to AEC work on the design for a national single establishment in 2015. Similarly, countries window. However, much still needs to be are committed to establishing electronic done to bring costs down and performance trade portals or repositories containing all standards up to those seen elsewhere in the trade laws, regulations, procedures governing ASEAN region. and process maps for imports and exports. At the regional level, all National Single Windows 14. In order to grasp the new opportunities will eventually be integrated into an ASEAN and enjoy the benefits of such regional Single Window. integration, it is necessary for Lao PDR to depend reforms in various areas critical v What does it mean for Lao PDR? for improving the competitiveness of the private sector. Priority areas include 13. Lao PDR has made some good progress continuing regulatory and policy reforms and on trade facilitation, but the country’s effective implementation of commitments landlocked status keep trade costs high in the areas of (i) trade facilitation and non- (Figure 25). Most of the benefits from tariff measures to lower trading costs; (ii) better trade facilitation, such as faster and providing mutual recognition agreements simpler border procedures, are beneficial in for professional services and labor skills themselves, although AEC commitments help improvements; (iii) establishing a transparent to some extent. Lao PDR was actually one and non-discriminatory investment regime; of the first ASEAN countries to establish an and (iv) promoting quality investment. Photo by Stanislas Fradelizi / World Bank, 2011 Lao Economic Monitor – April 2015 37 Creating Productive Jobs For Inclusive Growth 1. Recent media confirms the above a much higher percentage than in neighboring findings and reports of a perceived countries. This phenomenon points to “skills problem” in Lao PDR have spurred troubling workforce issues. Why are people an intense focus on skills development not moving to fill vacancies in manufacturing initiatives. Media coverage of rising wages that offer potentially better opportunities? and complaints among firms of a shortage Does Lao PDR lack enough workers, and/or of skilled workers has raised concerns over is it a problem of workers lacking the right whether Lao workers are equipped with the skills? Or the lack of more attractive, higher- skills sought by firms. According to the recent paid job opportunities outside the agriculture Investment Climate Assessmen14, inadequate sector? workforce skills have emerged as the top constraint to private sector expansion in Figure 26: Percentage of firms in Lao PDR, Vietnam, and Yunnan province (China) Lao PDR instead of the lack of physical complaining that there were no or few infrastructure as cited by firms in the past applicants to a job, by skill level enterprise surveys. In addition, productivity in Lao PDR is estimated to be about half what would be expected for a country at this level of development. In addition, there has been almost no observable growth in labor productivity during the last decade. 2. However, the Lao Development Report 201415 argues that the workforce problems, which Lao PDR faces do not only stem from problems in the education sector. Looking only to skills development as a solution would not address the fundamental problems Source: World Bank Enterprise Surveys in Lao PDR, constraining economic growth, employment Vietnam, and Yunnan province (China) (2012) creation, and poverty reduction. Creating an environment conducive for farm and non- 4. Tackling key workforce and farm businesses to make investments and productivity issues is particularly pressing grow remains an essential first step for skills given that Lao PDR is undergoing a major development. demographic transition. The population is projected to increase by 38 percent from 6.4 3. One indication of bigger underlying million in 2010 to 8.8 million in 2030, with structural problems is that firms complain approximately 96,000 additional people that not enough workers are applying for reaching working age every year in the jobs, even the low-skilled jobs. Nearly half of coming decade compared to 63,000 in the firms in Lao PDR indicated that they had no or 1990s. Expansion of the labor force and a few applicants to an unskilled job (Figure 26), decrease in the number of dependents present 14 Record, R. et al. (2014) “Investment Climate Assessment 2014: Policy uncertainty in the midst of a natural resources boom”, Washington, DC: The World Bank. 15 Sondergaard, L. et al. (2014) “Lao Development Report 2014: Expanding Productive Employment for Broad-based Growth”, Washington, DC: The World Bank. 38 Lao Economic Monitor – April 2015 an opportunity for growth, particularly if is currently engaged in agriculture, Lao PDR can tap the potential of young improving livelihoods for those in the workers through productive employment sector is critical to reducing poverty in opportunities. Without sufficient prospects Lao PDR. However, an estimated 7 in 10 for employment for these labor force Lao workers are still mainly employed in entrants, poverty reduction and stability low-productivity agricultural jobs that could be undermined. keep them on the farm despite lower living standards. This is particularly Key Challenges troubling considering that about 1 million children under the age of 10 live 5. It is critical for Lao PDR to address a on farms and face dim prospects for number of key workforce-related challenges breaking out of poverty. in order to manage its demographic transition successfully and advance to the —— Limited opportunities for higher-paying, next stage of development. These challenges higher-productivity jobs. Countries include: develop by moving workers from low- productivity jobs in agriculture to —— Overreliance on the natural resources higher-paying, higher-productivity sector. While there has been a heavy jobs in manufacturing and services. reliance on the natural resources sector However, the Lao manufacturing sector as an engine of growth, it does not appears to struggle to attract workers, create shared growth and employment. and numerous factors discourage the Because the sector has a high ratio of investment necessary to help boost capital to labor, it was able to produce productivity (and therefore wages) in approximately 18 percent of Lao PDR’s the sector. As illustrated by Figure 27, GDP in 2013 with only 22,000 people. the share of the manufacturing sector Furthermore, the boom in the natural in terms of both output and labor in the resources sector makes it relatively more overall economy has remained very low difficult for the nascent manufacturing relative to the natural resources sector sector to grow, including by putting and the construction and services upward pressure on the exchange rate sector in recent years. which makes manufacturing exports less competitive and by fueling a —— Very low levels of literacy. The skills consumption and investment boom problem in Lao PDR is deeper and more which can put upward pressure on severe than is generally recognized, wages. Such upward pressure on being a problem not simply of vocational wages is one possible reason why skills but of even basic reading and manufacturing workers have seen their numeracy skills. An Early Grade Reading wages rise by approximately 12 percent Assessment showed that over 30 per year in the past 5 years, well above percent of 2nd graders could not read a labor productivity growth. single word, and among those who could —— Low productivity in the agricultural read, 57 percent did not understand what sector. Because most of the labor force they had just read (Figure 28). In an adult Lao Economic Monitor – April 2015 39 literacy assessment carried out in six (Figure 29). Given how important countries around the world—including reading ability is for learning more Vietnam, Yunnan Province (China), and advanced skills, the low level of basic Lao PDR—adults in Lao had the poorest literacy has serious implications for literacy skills among the adults tested. the country’s productivity, growth, and Post-secondary graduates in Lao PDR competitiveness. performed almost on par with people with only primary schooling in Vietnam Figure 27: Sectoral breakdown of output and labor in the overall economy of Lao PDR Composition of economy by amount of output produced Composition of economy by amount of hours worked in by each sector (measured as value-added and expressed each sector (in % of total) in % of total value-added) Source: National Statistical Center of Lao PDR Source: Authors’ calculations based on LECS III, IV, and V Figure 28: Early Grade Reading Assessment for Lao PDR Source: World Bank (2014). “2012 Lao PDR EGRA Survey Report” [draft]. 40 Lao Economic Monitor – April 2015 Figure 29: Comparison of adult literacy by education level in Lao PDR and Vietnam Lao PDR Vietnam Source: STEP Household survey 2011/2012. Within the survey, there is a literacy assessment designed by Educational Testing Service (ETS) Note: Graphs show scores on basic literacy test (from 0-8 points) for adults with different education levels in Lao PDR and Vietnam The Way Forward 7. As agricultural productivity increases and more workers are able leave farming, 6. Given that the majority of the the Lao economy will need to generate more country’s workforce is currently engaged in attractive off-farm jobs to absorb these agriculture, raising agricultural productivity workers. Contrary to what media reports is arguably the top development priority might suggest, Lao PDR is not facing a labor for Lao PDR. In the shorter term, higher shortage, as it has a very large “reservoir” of agricultural productivity will help generate farm workers that could potentially move to better livelihoods for the 4.5 million Lao the non-agricultural sectors; rather, Lao PDR people living on farms. Over the longer term, has a shortage of attractive job opportunities increased productivity on the farms would that make it worthwhile for a farmer to give eventually lower the need for labor, freeing up farming. To help create more attractive up agricultural workers to move to more off-farm employment opportunities, barriers productive jobs in other sectors. In particular, to doing business in Lao PDR must be greater attention is needed in two areas: removed to encourage investment and spur productivity growth in diversified sectors. In —— Facilitating trade in paddy and rice to particular, action is needed on three fronts: encourage private investment in milling, which would help reduce milling costs —— Streamlining and simplifying the and give farmers greater incentive to business compliance and transaction increase production for export; costs associated with dealing with Government to create a more business- —— Making better use of public resources friendly environment; supporting rice farmers, with a more balanced approach in allocating —— Improving transparency in the provision resources for extension activities, of public sector services to business technology development and transfer through measures such as publication of (including good seed), and irrigation. all fee schedules, permits, and licensing requirements; and Lao Economic Monitor – April 2015 41 —— Establishing a more predictable 9. In the process of planning specific playing field for the private sector, reforms in these areas, it will be critical for with consistent implementation of policies to be grounded in better information. publicly available legislation, rules, For example, policies affecting the workforce and regulation and with reduced should be based on a complete and accurate bureaucratic discretion. picture of labor market dynamics—what is happening, who is affected, what the 8. As greater diversification generates implications of potential policies might be. more productive employment opportunities, However, crucial information on sectoral it will be critical to ensure that the Lao employment, migration, and other labor workforce is equipped with the knowledge market indicators are lacking. Instruments and skills to be able to take up these such as a labor force survey could help provide jobs. Greater priority should be placed on essential information for policymakers to cultivating a workforce that possesses understand the key challenges and design the basic foundational skills needed to be appropriate solutions. Further work is also productive. Resources need to be focused needed to understand the array of factors more effectively on the critical windows of affecting the workforce-related challenges opportunity when skills are built by: discussed above, including determining why manufacturing wages have been rising faster —— Expanding and strengthening early than labor productivity and identifying other childhood development and education barriers to worker mobility between jobs and to help develop school readiness skills sectors. and basic cognitive and behavioral skills, which also includes efforts to reduce chronic malnutrition which threatens cognitive development; —— Ensuring that all children can read by the end of grade 2, making reading a national obsession so Lao PDR can build a skilled and productive workforce; and —— Building job-relevant technical skills, with the Government taking on a more strategic role in vocational skills development by developing policies, setting standards, investing in training materials and instructors, improving public information about the training system, and carrying out training evaluations. 42 Lao Economic Monitor – April 2015 Annex 1: Lao PDR At A Glance Photo by Remy Rossi / World Bank, 2013 44 Lao Economic Monitor – April 2015 2011 2012 2013 2014 2015 Est Proj Output and prices (percent change, unless otherwise indicated)   Real GDP 8.0 8.0 8.5 7.5 6.4    (excluding resources, percentage points) 4.4 4.8 6.0 6.6 4.4   GNI per capita (in US dollars) 1100 1260 1460 1570 ..   Consumer prices (% change, period-average) 7.6 4.3 6.4 4.2 5.0 Public finances (in percent of GDP) 1/ FY10/11 FY11/12 FY12/13 FY13/14 FY14/15   Total revenue 22.1 23.9 23.0 23.2 22.8   Domestic Revenue 16.4 17.3 17.4 17.9 17.9    Domestic Revenue (non-resource) 13.0 13.0 13.7 14.8 15.4     Domestic Revenue (excl. mining) 13.6 14.0 14.6 15.9 16.4   Grants 5.7 6.6 5.7 5.3 4.9 Expenditure 24.9 25.2 29.1 27.5 27.1  Expenditure 24.9 25.2 29.1 27.5 27.1   Current 10.4 11.0 16.3 14.8 15.2    Capital and on-lending 12.9 13.4 12.2 12.1 11.3 Overall budget balance (deficit) -2.7 -1.3 -6.0 -4.3 -4.2   Overall budget balance (deficit, excl. mining) -5.6 -4.6 -8.8 -6.3 -5.7   Overall budget balance (deficit, excl. hydro and mining) -6.2 -5.6 -9.8 -7.4 -6.8 Balance of payments   Current account balance (% of GDP) -9.8 -12.7 -11.5 -11.2 -11.5   Capital account balance (% of GDP) 9.2 13.4 10.8 12.5 12.0   Overall balance (% of GDP) -0.6 0.6 -0.7 1.3 0.5 Gross official reserves   In millions of US dollars 679 740 662 815 884   In months of imports of goods and services 2.3 1.9 1.5 1.7 1.7 External public debt stock /2   In millions of US dollars (end period) 3,769 4,500 5,092 5,601 6,118   In percent of GDP (end period) 46.7 47.7 48.3 48.5 48.7   External public debt service    PPG debt service-to-exports ratio (in percent) 2.7 4.1 5.1 4.8 5.2    PPG debt service-to-revenue ratio (in percent) 7.4 9.8 12.4 11.2 12.3 Monetary Sector   Credit growth 48.1 26.6 34.5 14.2 15.0   Broad money growth 29.0 31.0 17.0 20.0 20.0 Memorandum items: Nominal GDP (millions of US dollars) 8,234 9,390 11,187 11,837 13,030 Exchange rate (kip/US$, average) 8,058 7,982 7,862 8,035 8,035 Sources: Staff estimates and projections based on data provided by the Lao authorities. 1/ Fiscal year basis (October to September). 2/ DSA 2014 data Annex 2: East Asia And Pacific: GDP Growth Projections Photo by Remy Rossi / World Bank, 2013 46 Lao Economic Monitor – April 2015 2012 2013 2014 2015 Est. Forecast World 2.4 2.5 2.6 3.0   High income 1.4 1.4 1.8 2.2   Developing countries 4.8 4.9 4.4 4.8    East Asia and Pacific 7.4 7.2 6.9 6.7      China 7.7 7.7 7.4 7.1      Indonesia 6.3 5.8 5.1 5.2      Malaysia 5.6 4.7 5.7 4.9      Philippines 6.8 7.2 6.4 6.7      Thailand 6.5 2.9 0.5 3.5      Vietnam 5.2 5.4 5.4 5.5      Cambodia 7.3 7.4 7.2 7.5      Lao PDR 8.0 8.5 7.5 6.4      Myanmar 7.3 8.3 8.5 8.5      Timor Leste    East Asia - exclude 6.3 5.3 4.6 5.2 China    ASEAN 5.7 5.0 4.5 5.0 Source: EAP Economic Update October 2014, Global Economic Prospects January 2015