Document of TheWorld Bank FOR OFFICIAL USEONLY ReportNo.31758-LA INTERNATIONAL DEVELOPMENTASSOCIATION COUNTRYASSISTANCE STRATEGY FOR THE LAO PEOPLE'S DEMOCRATICREPUBLIC(LAO PDR) March 10, 2005 Southeast Asia Country Unit East Asia andPacific Region This documenthas a restricteddistributionandmay be usedby recipientsonly inthe performance of their official duties. Its contentsmay not otherwise be disclosedwithout World Bank authorization. CURRENCY EQUIVALENTS (as of March 1,2005) Currency unit = Kip US$1= 10,345 FISCAL YEAR October 1- September 30 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities MDG Millennium DevelopmentGoals ADB Asian Development Bank MIH Ministry of Industry and Handicrafts ADP Agricultural DevelopmentProject M&E Monitoring andEvaluation AFD Agence Franqaisede Dtveloppement MFA MultifibreArrangement AFTA ASEAN Free Trade Area MIGA Multilateral Investment GuaranteeAgency AML Anti-Money Laundering MOF Ministry of Finance ASEAN Association of SoutheastAsian Nations MPDF MekongPrivate Sector DevelopmentFacility CAS Country Assistance Strategy MRC MekongRiver Commission CEM Country Economic Memorandum MTEF Medium-TermExpenditureFramework CFAA Country FinancialAccountability Assessment NGO NongovernmentalOrganization CIDA Canadian Intemational DevelopmentAgency NGPES NationalGrowth andPovertyEradication CPAR Country Procurement Assessment Report Strategy CPI Committee for Planning and Investment NIB Nordic InvestmentBank CPIA Country Policy and InstitutionalAssessment NOSPA NationalOrganizationfor the Study of Policy and CPPR Country Portfolio PerformanceReview Administration DSA Debt Sustainability Analysis NPV Net PresentValue EdL Electricite du Laos NT2 NamTheunI1 EIB EuropeanInvestmentBank NTR Normal Trade Relations ESW Economic and Sector Work NTSEP NamTheun Social andEnvironmentProject EU EuropeanUnion ODA OfficialDevelopmentAssistance FDI ForeignDirect Investment PBA Performance BasedAllocation FMAC Financial ManagementAdjustment Credit PDR People's DemocraticRepublic FIAS Foreign InvestmentAdvisory Service PEMSP Public ExpenditureManagementStrengthening FMCBC Financial ManagementCapacityBuilding Credit Program GDP Gross Domestic Product PER Public ExpenditureReview GEF Global Environment Facility PETS Public ExpenditureTracking Survey GMS Greater Mekong Sub-region PFM Public FinancialManagement GPAR GovemanceandPublic Administration Reform PHRD Policy and HumanResources Development Program PIU Project ImplementationUnit HIPC Highly IndebtedPoor Country PRF Poverty Reduction Fund ICA Investment Climate Assessment PRG Partialhsk Guarantee ICR ImplementationCompletion Report PRGF Poverty Reduction and GrowthFacility IDA InternationalDevelopmentAssociation PRSC Poverty Reduction Support Credit IDF Institutional DevelopmentFund PRSP Poverty Reduction Strategy Paper IFAD Intemational Fund for Agricultural Development PSD Private Sector Development IFC InternationalFinance Corporation RMP RoadMaintenanceProgram IMF InternationalMonetary Fund SEDP Socio-EconomicDevelopmentPlan JICA JapanIntemational CooperationAgency SIDA SwedishIntemational DevelopmentAgency JSAN Joint Staff Advisory Note SME Small andMediumEnterprise JSDF JapanSocialDevelopmentFund SOE State-Owned Enterprise KRLP KhammouaneRural LivelihoodsProject SPRE SouthemProvinces RuralElectrification LBF Lao Business Forum STEA Science, Technology andEnvironment Agency LDC Least DevelopedCountry SWAp Sector-Wide Approach LECS Lao PDR ExpenditureandConsumptionSurvey UN UnitedNations LEnS Lao Environment andSocial Project UNCDF UNCapital DevelopmentFund LPRP Lao People's Revolutionary Party UNDP UnitedNations DevelopmentProgram MBO Mass-basedOrganizations uxo Unexploded Ordnance MCTPC Ministry of Communications,Transport, Post and WBI World Bank Institute Construction WTO World Trade Organization World Bank Vice President: Jemal-ud-dinKassum Country Director: Ian C. Porter Task Team: Enrique Crousillat, Lynne Sherbume-Benz, Zafar Ahmed, Ragini Dalal, ChristopherFinch, Alessandro Magnoli, DeborahNewitter Mikesell FOR OFFICIAL USEONLY COUNTRY ASSISTANCE STRATEGY Table of Contents EXECUTIVESUMMARY ................................................................................................. i I. COUNTRYCONTEXT,..........,.................,............,............,..................................1 A. Political Context................................................................................................ 1 B. Economic TransitionandStrongGrowth ......................................................... C. Poverty Reductionand Social Development ....................................................2 5 D. GovernanceIssues ............................................................................................ 7 E. Capacity ............................................................................................................ 8 11. LAO PDR's DEVELOPMENT PROGRAMAND CHALLENGES .................... 9 B. KeyDevelopmentChallenges......................................................................... 10 A. Country Vision.................................................................................................. 9 D. ExternalDebt.................................................................................................. C. Medium-termEconomic Outlook................................................................... 12 111. THE WORLD BANK INLAO PDR: LESSONS OF EXPERIENCE ................14 15 IV. WORLD BANK GROUP ASSISTANCE STRATEGY...................................... 20 A. Selectivity and Approach................................................................................20 B. WorldBankGroup CAS Objectives andActivities ....................................... 21 D. Portfolio Management....... ..... .......................... .... .. .. ................ .... .. . ....43 C. World Bank AssistanceProgram.................................................................... 38 . . .. . . . . . . . E. ScenariosandTriggers.................................................................................... F. MonitoringCAS Implementation...................................................................44 46 V. MANAGINGRISKS............................................................................................ VI. CONCLUDING REMARKS. . ............................................................................47 . . 49 Text Tables Table 1: Poverty Headcount (1992/93-2002/03) Table 2: Lao PDR: Social Indicators, 1990 and Latest Available Year Table 3: Base Economic Projections Table 4: StrengthenManagement of Key Drivers of FutureGrowth Table 5: StrengthenPublic FinancialManagement, Service Delivery, and Targeted Poverty Programs Table 6: Strengthen Key Capacities and Partnerships Table 7: Support Implementationof NT2 Table 8: Proposed Analytical and Advisory Activities (AAA) Table 9: Proposed Indicative Assistance Program: Base Case Table 10: CAS Triggers Text Figures Figure 1: Economic Performance Figure 2: Progress Towards MDGs, Selected Indicators Figure 3: Lao PDR's CPIA in comparison with IDA Averages Figure 4: Evolution of Lao PDR PRSCs This document has a restricted distribution and may be usedby recipients o d y in the performance of their official duties, I t s contents may not be otherwise disclosed without W o r l d Bank authorization. Text Boxes Box 1: Sources of Growth Box 2. Summary of Baseline Debt Service BurdenIndicators Box 3: Findings from Different Evaluations Box 4: NamTheun 2 (NT2) Hydropower Project as a Driver of Change Box 5: The RoadMaintenance Program- A Success Story Box 6: Major Donor Activities Box 7: Implementationof Lao PDR NamTheun 2 Project: Multilateral and Bilateral Partnership Box 8: IFC inLao PDR Attachments Attachment 1: Lao PDR CAS Results Matrix Attachment 2: Capacity Development Attachment 3: Debt Sustainability Analysis Attachment 4: NGPES - CAS Priorities and Donor Activities Attachment 5: Environmental Sustainability inLao PDR Standard CAS Annexes Annex A2: Lao PDR at a Glance Annex B2: SelectedIndicators of Bank Portfolio Performance and Management Annex B3: IBRD/IDA Program Summary IFC and MIGA Program Annex B4: Summary of Nonlending Services Annex B5: Social Indicators Annex B6: Key Economic Indicators Annex B7: Key Exposure Indicators Annex B8: Operations Portfolio (IBRD/IDAand Grants) Statement of IFC's Portfolio Annex B10: CAS Summary of Development Priorities Map (IBRD 33431) . EXECUTIVESUMMARY Country Context i. LaoPDRhasundertakensignificantreformstomovefromacommandtoamarketeconomy and these reforms have helped stimulate growth and reduce poverty. Growth has averaged 6 percent per year between 1991 and 2003 and the incidence of poverty has fallen from 46 percent in 1992 to 33 percent in 2003. The stabilization programintroduced in the late 1990s has also reduced inflation to single digits. However, the Government's fiscal position has continued to remain fragile and the medium-term debt service is only manageableprovided economic reforms are maintained. ii. Sustaining growth andensuringthat the various sectorscan accelerateproductivity and benefit from linkages to dynamic regional markets will require further liberalization of the trade regime, improvements in other aspects of the business environment, improvements in infrastructure, and better management of forestry, hydro, and miningresources. Sustaining growth will also require significant governance reforms. Lao PDR governance indicators stand below regional and global averages; and while some progress has been made in improving public expenditure management, overall public administration reform has proved much more difficult to implement than the first wave of economic reforms. Capacity constraints also continue to be a significant challenge. iii. LaoPDRisontracktomeetthepovertyMillenniumDevelopmentGoal(MDG)by2015, but will have difficulty in achieving many of the other MDGs. Social indicators for health and education, maternal and child mortality, and access to an improved water source are particularly low. The safety net system in Lao PDR i s underdeveloped and vulnerable groups, such as upland communities and ethnic minorities, are especially susceptible. Bold, innovative steps will have to be taken to truly improve social outcomes and reduce vulnerability, including improving the access, targeting and efficiency of service delivery, developing adequatepay and employment policies inthe social sectors, exploring alternative options for service delivery to remote communities, and taking an integrated approach to improving upland rural livelihoods. The National Growth and Poverty EradicationStrategy iv. In its National Growth and Poverty Eradication Strategy (NGPES-2004), the Government proposes to raise annual growth to 6-7 percent and to eradicate mass poverty by 2010. Developed with an unprecedented level of consultation and participation, the NGPES stresses the Government's commitment to sound macroeconomic policies to sustain growth, and prudent monetary and fiscal policies combined with structural reforms. To convert sustained growth into improved social outcomes, the NGPES also recognizes that strengthened public sector management and capacity development will be critical, as will better service delivery, and better management of natural resources and the environment. Recalibrated World Bank Assistance Strategy v. Dialogue and engagement between Lao PDR and the World Bank have strengthened since the last Country Assistance Strategy (CAS), catalyzed by the NGPES, the NamTheun 2 hydropower project and government interest in regional integration. The present CAS has been designed to support the NGPES and within this framework, key drivers of future growth as well as better targeting of social outcomes and reductions in vulnerability. The World Bank's analytical and advisory activities (AAA) program and Poverty Reduction Support Credit (PRSC) framework will provide strategic support for strengthening the dialogue on the reform agenda. The World Bank has recalibrated its approach for this new CAS, incorporating a stronger emphasis on building capacity. World Bank assistance will focus within each CAS objective on supporting identification, prioritization, and removal of key capacity constraints to achieving poverty reduction and economic and social development goals. The CAS also incorporates a stronger emphasis on partnerships, including developing a consensus among donors and the Government on critical reform issues and how best to address them. CAS Objectivesand Outcomes vi. World Bank assistance will support the implementation of the NGPES in two substantive priority areas: 0 CAS Objective 1: Sustain growth through improved management of key drivers-regional integration and private sector development, rural development, and natural resource management. Expected Outcomes: Strengthened regional integration and private sector development strengthened institutional capacity to support rural development and agricultural productivity; and improved policies and institutional capacities to support more sustainable and participatory management and conservation of natural resources. 0 CAS Objective 2: Improve social outcomes and reduce vulnerability through strengthened public financial management and service delivery capacities and targeted poverty reduction programs. Expected Outcomes: Strengthened public financial management capacities; improved access to and quality of basic health and education services, with an emphasis on vulnerable groups; and improved approachesto reducingpoverty of the most vulnerable. These objectives are complemented by two additional CAS objectives that capture key elements of the approach that the World Bank will use to support these substantive priorities: 0 CAS Objective 3: Adopt a strategic approach to capacity development and partnerships in support of better NGPES results. Expected Outcomes: Strengthened capacities of the Committee for Planning and Investment, the Ministry of Finance, and line ministries to plan, coordinate, and monitor NGPES implementation; strengthened key sectoral and provincial capacities in support of CAS objectives; strengthened capacities of local partner institutions to support capacity development activities; and strengthened donor partnershipsfor better results. 0 CAS Objective 4: Support implementation of Nam Theun 2 (NT2) as an example of an area- based, sustainable natural resource development program that contributes to growth, social outcomes, capacity development, and stronger partnerships. Expected Outcomes: Sustained economic growth, including greater regional integration and more sustainable natural resource management; NT2 mechanisms are put in place to ensure that expected revenues contribute to increases in spending on priority poverty reduction and environmental protection programs, and ultimately to strengthened service delivery and improved social outcomes; NT2 contributes to improved management capacity, coordination and participation, and monitoring; and NT2 involves continued and regular consultationwith local communities as well as effective partnerships among all concerned stakeholders. vii. The World Bank will take an integrated approach to the CAS by combining various instruments, with a particular emphasis on strategic and participatory AAA. A series of PRSCs will support critical public sector reforms to strengthen accountability and efficiency of public expenditure management, and improve allocation of public resources to pro-poor development priorities. Investment operations in selected sectors to support NGPES priorities, and incollaboration with other donors, will complement International Finance Corporation (IFC) and Multilateral Investment Guarantee Agency (MIGA) support to private sector development and will emphasize sector-wide approaches (SWAps) where appropriate. During the first years of the CAS period, International Development Association (IDA) lending/grants will focus on key operations to support the NT2 development framework and associated social and environmental measures. The World Bank will also continue to work closely with the International Monetary Fund (IMF) on issues of macro-economic management and monitoring. viii. The base case IDA allocation currently provides an indicative allocation of US$128 million over the four year period of the CAS. Given Lao PDR's low income and high debt burden, it i s expected that the majority of IDA resources will be available as grants. A low case scenario, characterized by a weak macroeconomic stance, slow pace or serious backtracking on the reform agenda and implementationof the poverty reduction strategy, or a poorly performing portfolio would provide only US$40-60 million and would not include subsequent PRSCs. If there i s substantive non-compliance in the NT2 project, including non-compliance with safeguard and revenue management undertakings, the World Bank would consider even further curtailing lending levels, including the option of not engaging in future financing andor suspension of the entire portfolio, untilit is satisfied that agreements are being met and there is adherenceto commitments. Ifthe pace of reforms and implementation accelerates and significant additional key policy changes are undertaken, it would be expected that the Performance-based Allocation (PBA) exercise could push Lao PDR into a high case lending scenario of about 30 percent more IDA allocation than the base case. These additional resources would be provided mainly through modulated PRSC amounts in support of policy and institutionalreforms, or through one or two additional investment operations. ix. Although IDA resources allocated to Lao PDR are small relative to overall donor support, the World Bank remains a lead agency in supporting Lao PDR's development objectives and policy agenda. The World Bank is making special efforts to work collaboratively with other donors to align programs around common frameworks and strategies. The World Bank will participate actively in newly expanded aid coordination and sector dialogue mechanisms and promote harmonization of project implementationprocesses. Risks x. CAS implementation and results are subject to multiple risks, which fall under four categories: risks arising from the potential for fluctuating political commitment or weaker political will on reforms after NT2 i s approved, as well as weak implementation capacity; risks arising from lack of performance under the NT2 Project; risks relating to the effectiveness of support extended to the country by its external development partners, including the World Bank; and risks arising from external factors over which the Government has no control. The management of these risks will determine the pace and direction of future policy reforms under NGPES as well as implementation performance on the NT2 project. The proposed CAS scenarios and IDA programs are designed to address these issues, including cases of slower or faster reforms and modulating levels of IDA support. SuggestedItemsfor Board Consideration xi. Boardmembersmay wish to discuss, among others, the following aspects of this CAS: 0 Does the CAS adequately support the Government's NGPES? 0 I s the proposed approach to capacity development and partnerships appropriate? 0 I s the proposed approach of combining PRSCs and selectedinvestment lending appropriate? 0 Are the proposed triggers realistic and do they reflect the potential risks? LAOPDR COUNTRY ASSISTANCE STRATEGY -- 1. The last Country Assistance Strategy (CAS) for the Lao People's Democratic Republic (PDR) covering the period FY1999-FY2002 was discussed by the World Bank`s Board of Directors in April 1999 (Report No. 19098-LA). Presentation of this follow-on CAS was delayed so that it could be aligned with the Lao PDR Poverty Reduction Strategy Paper (PRSP), the National Growth and Poverty Eradication Strategy (NGPES), which was discussedby the Board of Directors inDecember 2004. 2. The preparation of the new CAS inLao PDR has been subject to extensive consultations with the Government, donors, and other stakeholders. The consultations began in early 2003 with government representatives, mass-based organizations (MBO), the private sector, and provincial authorities to solicit feedback and strategic inputs. Formal consultations with the Government have been progressive with three inter-ministerial consultations over the last two years. Consultations with other stakeholders including bilateral donors and multilateral organizations continued in 2004, which further strengthened efforts to harmonize assistance among development partners. I. COUNTRYCONTEXT 3. Lao PDR is a small, sparsely populated, landlocked country with extensive natural resources. With a population estimated at 5.7 million in 2004, and growing at a relatively rapid rate of 2.6 percent annually, Lao PDR i s characterized by a rich cultural and ethnic diversity where almost half of the population belongs to minority groups concentrated in the upland areas. Covering an area of 236,800 square kmin the center of the dynamic Mekong region, Lao PDR shares borders with Thailand, Vietnam, China, Cambodia, and Myanmar. Although infrastructure-roads, telecom, water and electricity-is underdeveloped, the country i s rich in water resources, tropical forests and minerals. A large majority of the population relies for its livelihood on agriculture, which accounts for over half of GDP. Urbanization i s relatively low, at 25 percent. Gross National Income (GNI) per capita stands at around US$340. Reliance on external support to the budget remains high, and donor-funded programs account for nearly 40 percent of total public expenditures. A. POLITICAL CONTEXT 4. Lao PDR has maintained a single-party system, similar to China and Vietnam. The Lao PDR People's Revolutionary Party (LPRP) is headed by the Party's Central Committee comprising 53 members elected at the Seventh Party Congress in 2001. The structure of political power remains unchanged since 1975, with a top down decision making process that i s often opaque to outsiders. A relatively small group of Politburo members makes key decisions within the Party and has considerable influence on the Government. While seven out of ten members of the Politburo are current or past military members, the next Party Congress to be held in early 2006 may mark a generation change as several older and conservative members would leave their place to the next generation. The National Assembly, whose members are elected directly by the people from a list of Party candidates as well as some independent candidates, i s increasingly playing a stronger oversight role. In the provinces, governments have a highdegree of autonomy over resources, expenditures, and services. Although there are signals that a political transition is slowly beginning, as reflected in the gradual process of decentralization of decision making, as well as a greater openness in internal processes and a substantial improvement in the dialogue with donors, it i s likely that efforts to accelerate the pace of economic reformwill still beconstrained by the inertia of the political culture. 5. Civil society has a limited but slowly expanding role. InternationalNGOs have been present in Lao PDR for some time. Several international NGOs support knowledge sharing and networking with local civil society groups and a few local independent associations have been formed recently, including education support groups, economic and development support organizations and religious associations. Interest groups (i.e., women, youth, labor, ethnic groups) are formally representedby MBOs linked to the Party. Social accountability i s weak, but there is potential for MBOs to represent constituents in bottom- up policy formulation and decision-making. Although the local media is owned fully by the state, there is open access to foreign media and the internet. B. ECONOMICTRANSITIONAND STRONGGROWTH 6. Lao PDR has undertaken significant economic reforms to move from a command economy towards a market economy. When Lao PDR was established in 1975, a policy of "accelerated socialization" was pursued, including extensive agricultural collectivization. However, by 1982, the use of "market forces" was promoted at the Third Congress of the LPRP and, though halting at times, there has been significant progress towards this goal. In 1986, the Government officially abandoned the central planning system and introduced the New Economic Mechanism. Important steps were taken, such as near total price liberalization and exchange rate unification, the removal of the Government's trade monopoly, and the opening up of foreign and inter-provincial trade. Private firms were allowed to enter the market and family farms were encouraged over collectives. The private sector began to emerge and the number of State-Owned Enterprises (SOEs) was reducedby 75 percent. 7. During the 1990s, structural reforms continued more slowly and intermittently with major setbacks resulting from the economic crisis at the end of the decade. In 1991, the loss of Official Development Assistance (ODA) following the collapse of the Soviet Union stimulated a re-orientation towards Asian and western markets. The Government continued structural reforms in the first half of this period, including further efforts in the banking and SOE sectors, but these and other reforms were only partially implemented. Even so, the Lao PDR economic structure gradually came to be basedprimarily on the private sector, with SOEs accounting for a relatively small share of economic activity; and growth in trade continued, together with an increase in private investment.' Towards the end of the 199Os, the country underwent an acute period of macroeconomic instability due to the Asian financial crisis and a breakdown in monetary and fiscal management in 1997-199tL2In late 1999, the Government responded by launchinga successful stabilizationprogram, tightening monetary and fiscal policies andby early 2001 the currency had stabilized and inflation was reduced to single digits. 8. Annual average real GDP growth rate was 6.3 percent between 1991 and 2000, despite the relatively slow pace of reform and the Asian crisis. This compares favorably with the growth rates of China, Vietnam and other East Asian countries during this period. At its lowest point (1998), growth fell to 4 percent. Manufacturing and services were the main drivers of growth during the early 199Os, with agriculture taking the lead during the later years. Natural resources also contributed significantly to growth duringthe early 1990s,but this dropped off with a decline inforestry sector contributions. Exports grew at an annual rate of 27 percent during 1990-1995, but export growth fell to only 2 percent a year during 1995-2000. 9. During 2001-2004, increased government commitment accelerated the pace of reforms. This commitment is reflected by the phased reforms launched in 2002 in public expenditure management, 'SOEs accountedfor 1percent of employment, 20 percent of manufacturingoutput, and 30 percent of bank credit in 2002, and privateinvestmentrepresented10.1percent of GDP in2003. *Ambitious irrigation investments were implemented without appropriate financing (heavy borrowing from the central bank), resultingintriple digit inflation in 1998anddeep exchangeratedepreciationsof the domestic currency. - 3 - banking and rural finance, SOEs, forestry, trade and the private sector, as well as by the continued stabilizationprogram that has tightened monetary and fiscal policies and reduced inflation to single digits. Nevertheless, the Government's fiscal position has continued to remain fragile with relatively weak revenue performance, weak public sector management, a weak banking sector, and poorly managed remaining SOEs. Some progress has been made in improving public expenditure management, including publication of the State Budget, creation of a central Procurement Monitoring Unit and State Audit Organization. The Government has also implemented an ambitious decentralization policy, intended to bringdecision making closer to the field level, but this has, unfortunately, made fiscal managementmore difficult. Furthermore, there has been little progress in reforming civil service management and pay. Overall, public administrationreformhas provedmuch more difficult to implement than the first wave of economic reforms. 10. Real GDP growth averaged slightly lower but still a robust rate of 5.6percent a year between 2001 and 2004. Annual growth reached 6 percent in 2004. All sectors - agriculture, manufacturing, tourism as well as mining and hydropower - grew during this period, with miningtaking off for the first time. Private investment, especially foreign investment, showed a persistent increase over these five years, albeit from a very low level, but growing to nearly 10percent of GDP in 2004. While there were investments in tourism and garments, most of this increase in 2003 and 2004 came from foreign investment inthe mining sector, especially in copper and gold. Export growth stagnated during the 2000- 2003 period, but jumped in 2004 to a rate of 18 percent, driven mainly by garments, electricity, mining and ~offee,~with most of it going to ASEAN countries and China. 11. The macroeconomic situation has been significantly better during the 2001-2004 period than in the previousfour years. Headline inflation averaged 11 percent a year during the 2001-2004 period compared to an average of nearly 70 percent a year during 1997-2000. There has been a noteworthy improvement in overall macroeconomic performance over the last four years4,although Lao PDR's track record of maintaining single-digitinflation rates over a long period remains weak. Nevertheless, the short- termmacroeconomic situation is satisfactory, as end-of-periodinflation rate reached single digits (Le. 8.6 percent) inDecember 2004. 12. Thisperformance was helped by signifcant fiscal adjustment. In 2002/03 when revenue from timber royalties and other non-tax revenue fell by nearly 2 percent of GDP, the overall fiscal deficit (after grants) jumped (Figure 1). The needed fiscal adjustment took place in 2003/04. Vigorous government efforts to mobilize taxes in 2003/04 combined with the full-year impact of petroleum taxes increased tax revenue (excluding timber royalties) from 8.1 percent of GDP in 2002/03 to 8.9 percent of GDP in 2003/045 highlighting a significant additional tax effort of 0.8 percent of GDP. This led to a modest increase in total revenue of 0.1 percent of GDP @e., from 11.1 to 11.2 percent), because there were offsetting declines in collections from timber royalties, non-tax revenue and import tax revenue (due to AFTA tariff reductions) in that year. Expenditures were reduced by 1.8 percent of GDP, and the fiscal deficit fell accordingly in 2003/04. This helped to keep domestic financing of the deficit low and contributedto bringinginflation down to single digits inDecember 2004. 13. Structural constraints to sustainably increase revenues have begun to be addressed, but progress will be slow. Although the revenue effort inLao PDR i s low relative to many of its neighbors, In the same period, importsgrew 23 percent andconsisted of machinery, equipment, andraw materialfor the garment industry. Large discrepancies exist among estimates of exports and imports providedby different agencies in Lao PDR. Discrepanciesin Lao PDR export and import datawere described in the World BankEconomicMonitor (May 2004 issue). During this period, monetary policy was gearedtowards reducinginflation. Credit growth has thus remained subdued in 2004 with broadmoney growing at around 20 percent.This was madepossibleby the avoidanceof bank financingof the budget. IMF:Lao PDR: Staff Reportfor the 2004Article IV Consultation,November 2004 (page9). - 4 - the difference narrows markedly once revenue i s expressed as a share of non-agricultural GDP, where Lao PDR stands at 18 percent compared to Vietnam's 20 percent and Cambodia's 12 percent. Progressin achieving Lao PDR's revenue potential will be slow due to inadequate technical capacity of revenue administration and a highly decentralized revenue administration in which provinces currently have weak incentives to collect and remit revenue to the national budget. Inearly 2004, the Government took several corrective measures: re-establishing central control over seven main international checkpoints with revenue collected deposited into central government accounts; increasing control over major provincial large tax-payers units, modifying regulations to provide greater control by the center over granting of tax exemptions to investors; and frequent monitoring of provincial revenue collection and remittance to the national budget. But more will need to be done if the revenue share of GDP is to reach its potential. Figure 1: Economic Performance GDP Growth (%) and CPI (%), 1996-2004 FDI in Lao PDR (US$m) +GDP (left axis) +Inflation (rightaxis) O A p p r o v e d QActual - 16C 500 492 503 450 400 350 -- 300 80 -- 60 250 200 150 I 0 0 50 0 96 97 98 99 00 01 02 03 04 2000l01 2001102 2002/03 2003104 Revenue and Expenditure (%of GDP) Current Account Balance (%of GDP) =Revenue, incl.grants -Expenditure +Deficit 0 25 , 215 20 7 -2 -4 -6 -a 10 .I2 onmi -4.6 -4.4 -4.0 -5.8 -3.9 Excludingofficialtransfers 0 hcludingofficialtransfers -10 1 I 14. Lao PDR is increasing its integration, both regionally and globally. Sub-regionally, Lao PDR i s an active partner in the emerging Greater Mekong Subregion (GMS) Economic Cooperation Program (consisting of Thailand, Myanmar, Yunnan province of China, Vietnam, Cambodia and Lao PDR). The GMS programhas strategic importance in terms of potential exports (including hydropower and mineral products) to rapidly industrializing neighboring countries, the development of transport corridors, and sustainable development and management of the Mekong River. Given that most of its trade and foreign investment relations are with these countries, including sale of hydropower, ongoing GMS initiatives are supported strongly by Lao PDR. Lao PDR also participates in the Mekong River Commission (MRC), which explores opportunities for regional cooperation in the Mekong River Basin. On a broader regional and global level, Lao PDRjoined the Association of Southeast Asian Nations (ASEAN) and the ASEAN Free Trade Area (AFTA) in 1998; applied for World Trade Organization (WTO) accession in 1999, and was granted Normal Trade Relations (NTR) status by the United States in November 2004. Implementation of commitments under AFTA, the United States bilateral trade agreement, and WTO are - 5 - opening, and will continue to open, opportunities for further trade in goods and services sectors and investment within the region and globally. The granting of NTR by the United States in November 2004 and the early harvest program from China as well as application of lower Common External Preferential Tariffs on exports to ASEAN countries further expands export opportunities for Lao PDR. Foreign Direct Investment (FDI)trends are significant relative to the size of the economy, although there are year- to-year fluctuations in flows depending on the timing of large hydropower or mining projects. The Government i s working on a decree regarding financing of terrorists, has established an "Anti-Money Laundering (AML) Information Center" to monitor suspicious transactions, and i s preparing an AML law. c. POVERTY REDUCTIONAND SOCIAL DEVELOPMENT 15. Economic progress has resulted in a substantial reduction in poverty over the past decade, although poverty remains high. The incidence of poverty fell from 46 percent in 1992 to 33 percent in 2002-2003 (Table 1). This i s an impressive achievement, which suggests that Lao PDR is on track in terms of meetingthe poverty MillenniumDevelopment Goal (MDG)by 2015 if it is able to maintain the pace of progress. Poverty reduction was more rapid in rural areas than in urban areas, and faster in the north than in the center or south. As consumption increased more in villages than in cities, overall inequality declined. The Gini index of per capita real consumption fell from 34.9 in 1997-1999 to 33 in 2002-2003. Inspite of the progress, poverty inLao PDR remains among the highestinthe region. Poverty in the uplands is 43 percent, compared to only 28 percent inthe lowlands. Poverty in the Government's designated 47 priority districts i s twice as high as in the 70 non-priority districts. A vast majority of the poor are ethnic minorities. Year Lao Area Region Priority District Altitude PDR Urban Rural Vien Nor. Cen. Sou. First Second Other Low Mid Up 2002103 32.9 19.6 37.6 16.4 37.3 34.7 32.4 49.5 40.9 25.7 27.7 36.9 42.7 1997198 39.1 22.1 42.5 13.5 47.3 39.4 39.8 63.0 41.7 30.5 1992193 46.0 26.5 51.8 33.6 51.6 45.0 45.7 16. Social indicators have improved somewhat, but are not commensurate with economic improvements and remain low compared to regional and lower-income country averages. Improvements were achieved between 1990 and 2000 on a number of social indicators including child mortality, gender equality, particularly in primary enrollment, and child malnutrition. However, most social indicators still fall well below the average of East Asian countries (Table 2). Although trends in education showed promise inthe early 1990s, improvements slowed down in 1998 following the financial crisis, are yet to recover fully, and the country risks not reaching the universal completion of primary education goal by 2015 (Figure 2). Ministry of Education data for 2001/02 showed a net enrollment ratio of 81 percent. However, household survey data for the same year showed a much lower net enrollment ratio of 62 percent and of only 45 percent for children in the poorest income quintile. Maternal and child mortality and morbidity are still high by regional standards, as is child malnutrition. Health care utilization is low (less than 30 percent), and quality of services i s poor. Access to an improved water source is available to 37 percent of the population, far below the regional average of 76 percent. The percentageof paved roads inLao PDR (15 percent) is among the lowest inthe region. 17. The reasons behind these poor social outcomes are multiple and inter-related. They include: widespread poverty and highlevels of vulnerability which render many basic services unaffordable to the poor; geographic isolation and inadequate infrastructure which hinder physical access; language and - 6 - cultural barriers; and poor service quality due to low levels of resources and low capacity of providers. Expenditures on education and health in 2001 were 1.9 percent and 1 percent of GDP, respectively. Communities finance 30-40 percent of capital expenditures in education and patients and NGOs pay for most health expenditures (60 percent and 25 percent, respectively). National health spending was only U S $ l l per capita (half the regional average). Inrelative terms, Lao PDR i s the lowest ranking East Asian country on the UNDP Human Development Index (2003), where it places 13lStout of 148 countries. Weaknesses inthe educational and health systems, and in basic service delivery systems, will continue to hamper improvement in the social indicators, unless key structural issues -- low and inefficient use of resources; inadequate incentives for service delivery; low capacity of service providers; and core issues of physical and financial access -- are addressed. Net primary enrollment ratio 61 81 93 (percent) Female (percent) 57 I1 Primary completion rate 74 100 48 Access to safe water (percent o f 39 37 16 58 population) Physicians (per 1,000 people) 0.2 0.2 1.7 Paved roads (percent) 13.8 15 21.2 12.9 18. Vulnerabilityremains high, especiallyfor ethnic minority and upland communities. Forty-eight percent of the population belongs to one of the 49 ethnic minority groups. Most live in the upland areas where livelihood systems are delicately balanced and poor communications exacerbate the challenge of providing social services.Each ethnic group has its own culture and traditions that dictate cropping cycles and patterns, as well as inheritance, health care, and life cycle events. This rich cultural diversity makes service provision complex. The relationship between people and the environment in these fragile, yet resource rich areas, is easily upset. Roads and infrastructure, essential for improving access to services and developing natural resources, also bring threats of logging and unsustainable development and programs that aim to limit opiumproduction or stabilize shiftingcultivation may raise the risk of reducing access of upland communities to the forests and forest products on which they depend. The safety net system in Lao PDR i s underdeveloped and vulnerable groups are especially susceptible to shocks that affect rice yields and livestock. A further complication i s the severe contamination by Unexploded Ordnances (UXO) inten of 18 provinces, which adds costs to infrastructure development and contributes to poverty by limiting agricultural production.With respect to labor conditions, Lao PDR has ratified only one of the fundamental labor standards conventions (No. 29 on Forced Labor), although another five conventions are currently under consideration. While the Lao Labor Law does conform in principle to some basic labor standards, it does not offer adequate enforcement. Anti-discrimination legislation also exists but enforcement is again weak. - 7 - 19. Progress has been made in improving the well-being of women, but significant challenges remain. At 27.3 percent, women's participation in the National Assembly i s one of the highest in the region and the constitution and laws provide for gender equality. A new law on the Development and Protection of Women also provides a legal framework for addressingdomestic violence and trafficking in women and children. Progress has been made in improving social indicators for females and the majority of small businesses in Lao PDR are run by women. However, despite the progress, maternal mortality i s still one of the highest in the region at 650 per 100,000. Lao PDR women work on average one hour a day more than Lao PDR men, and rural women, especially, bear the main responsibility for ensuring food security for the family. Greater gaps and inequalities can be found in rural areas, and especially among ethnic minority women. Within the richdiversity of cultures lie social norms, local beliefs, and marriage and inheritance traditions that discriminate against or marginalize the groups of women they affect.6 Increased migrationhas ledto greater vulnerability of women and childrento traffickers. Figure 2: Progress Toward MDGs,Selected Indicators Primary Completion Rates 1 Child Malnutrition 52P 50 40 -Actual -- dActual --Trend zf E.IF 30 to reach $l 20 Trend to rrE C 10 reach E O MDGs 1990 1995 2000 2005 2010 2015 Under-5 Mortality Rate Maternal Mortalii eUI l- - 7 2007 I -Actual 5 150 t: =%!100 - 4 A c t u a l 0 Trend to O- reach -- Trend to reach r 50 ~~ MDGs ~ 0 4 I I I , I , I 1990 1995 20W 2005 2010 2015 2020 Note: The dataon MDGtrendsreflect householdsurvey datafrom 2000. D. GOVERNANCE ISSUES 20. Lao PDR governance indicatorsstand below regional and global averages. In2003, Lao PDR's Country Policy and InstitutionalAssessment (CPIA) ratings for key governance indicators were below the IDA average (Figure3).' Lao PDR was close to IDA averages for property rightsand governance, and for revenue mobilization, but it was lower on budget and financial management, and seriously lower on transparency and accountability. The IMFranked Lao PDR's public expenditure systems below that of 24 For example, literacyrates for the majority Lao PDR Phutaiare 84 percent for males and 62 percent for females, while among 'Hmong-YaoCPIA ethnic groupsit is 45 percentfor males andonly 8 percent for females. The 2004 exercise is currentlyunderway with anew ratingsmethodologyinplace, but will not be completedbefore April 2005. - 8 - Highly IndebtedPoor Countries (HIPC). With respect to the legal andjudicial framework, a body of law i s slowly being developed and applied in the courts. The lack of a clear distinction between the executive and judiciary hampers enforcement, and transparency remains a key issue. Weak and arbitrary legal enforcement, excessive business license requirements and lack of clarity on property rights continue to affect private sector development. The financial management system and fiscal reporting remain underdeveloped, with minimal reporting, auditing and accounting standards. Tax administration i s improving, but remains weak, especially in customs, where illegal cross-border trade continues with neighboring countries. Civil service reform i s needed to address incentive issues, given the current low salarieshenefits and opportunities for rent-seekingbehavior. Figure 3. Lao PDR's2003 CPIA in comparison with IDA Averages Governance 1. MacroeconomicBalances 20. Transparency&Accountabili Economic Management 19. PublicAdministration 18. RevenueMobilization 4. DevelopmentProgram 17. Budgetand Financial Management 5. Trade and FX 16. PropertyRights and Governance 6. Financial Stability 15. Poverty Analysis and Monitoring 7. Banking Efficiency 14. Social Protection and Labor 8. PrivateSector Environment 12.Equityof Public Reiource Use 10. Environment Social/ Equity 1 - - 11. Gender Structural Lao PDR IDA Averages~ 21. I n April 2003, the Government developed a governance reform program' based on actions in four priority areas: (i) public service reform; (ii)people's participation; (iii) the rule of law; and (iv) sound financial management. Efforts are underway on a pilot basis to improve the management of public administration through increased professionalism and merit-based recruitment. Other efforts to improve public sector management include drafting an anti-corruption decree, increasing transparency in the accounting and audit functions, improving tax administration and establishing checks and balances in the civil service. Work on strengthening participation, encouraging local empowerment and clarifying roles of central and local authorities i s continuing, as i s progress to strengthen judicial reform and public financial management, including fiscal planning, budget preparation, revenue and expenditure managementand financial legislationand regulations. E. CAPACITY 22. Capacity constraintsare a significant challengein Lao PDR and contribute to poor performance on CPIA indicators. While public sector staff are educated,' gaps in incentives, competencies, and skill types and distribution prevent key functions from being performed effectively. Shortages of management and technical skills in finance, accounting and procurement are particularly acute. Organizational Govemment of Lao PDR, Progress Report to the Governance Round Table Meeting, November 2004, following up on the Govemment's earlier report,Priority Areas for Governance Reform: Public Service Reform, People's Participation, Rule of Law, and Sound Financial Management, RoundTable Process,March2003. Over 90 percent of civil servants have some form of post-secondaryqualification and around 10percent have university-level qualifications (Source: Departmentof Public Administration, PrimeMinister'sOffice). - 9 - structures and basic management systems are not aligned with development priorities. Centralized decision-making often discourages local initiatives while low pay levels, delays in payment (especially in rural areas), and lack of performance-based promotions may act as disincentives. Distinctions between legislative, executive, andjudicial functions are blurred. Decision-makers are often isolated from the civil service and conversely, civil servants are often poorly informed about government policy, legislation and even administrative procedures. Government controls on private sector activities include cumbersome investment procedures and annual tax licenses. While the Government has expressed strong preference for local expertise to provide technical assistance, there are few consultants with the requisite skills, often hindering donor efforts to buildcapacity. 23. The Government is taking a number of steps to address capacity constraints. Community development projects and activities are building capacity at the field level to prepare, implement and monitor outcomes of local investments. Recognition of the challenges posed by ASEAN and WTO accession has spurred openness to learning from the experience of China, Malaysia, Vietnam, and Thailand and encouraged growing ties with neighboring countries and an examination of their reform processes. Civil servant training has been expanded and diversified, and modern public sector and economic management concepts have enteredthe curriculumof degree courses. 11. LAOPDR'sDEVELOPMENTPROGRAMAND CHALLENGES A. COUNTRYVISION 24. The National Growth and Poverty Eradication Strategy (NGPES) is a government-owned strategy that lays out Lao PDR's development vision. Lao PDR's NGPES is the first full poverty reduction strategy prepared by the Government and seeks to help the country meet its MDGsby 2015 and graduate from LDC status by 2020. The three pillars of the strategy are to: (i) foster economic growth with equity; (ii)develop and modernize Lao PDR's social and economic infrastructure; and (iii) enhance human resource development. The NGPES stresses the Government's commitment to sound macroeconomic policies to sustain growth, and prudent monetary and fiscal policies combined with broad-based structural reforms to promote private sector-led development. 25. The NGPES was developed in a participatory and consultative manner. The NGPES Committee, formed to oversee the process, drew membership from key ministries and agencies, and representatives from MBOs. A government-implemented Participation Action Plan for NGPES development was supported by the UNDP, the World Bank, and other donors. Intensive consultations were carried out with donor partners inthe context of the 7* and 8" Round Table meetings for the Interim PRSP and NGPES final report, respectively. The consultation process was broadened to include participation by international NGOs and the private sector. In addition to consultations with official MBOs, such as the Lao PDR Front for National Construction and the Lao PDR Women's Union, discussions were held with provincial governments, media and academics. The document was submitted to the National Assembly in October 2003, which approved it after a four-day workshop. 26. The NGPES is a major step forward that builds on the country's potential for growth (Box 1). The strategy: (i) acknowledges the importance of governance challenges; (ii) to articulate solid begins strategies for improving service delivery and infrastructure; (iii)sets appropriate directions for sustaining growth; (iv) seeks to address inequity and vulnerability; and (v) provides a framework for monitoring and implementation. The NGPES also recognizes the importance of improving Lao PDR's international competitiveness, attracting FDI, and undertaking governance reforms. It emphasizes the value of rural infrastructure and the need to enhance human development through a strong agenda for improving - 10- education. However, the NGPES would benefit from stronger prioritization and costing of actions, together with a clear plan for implementing its objectives and a mechanism for monitoring progress. It will also require strong political leadership to overcome the challenges that will arise during implementation. Box 1: Sources of Growth Lao PDR has a number of significant assets and resources to promote strong growth and development. This potential can only be realized, however, if natural resources are well-managed. Legal, regulatory and tax weaknesses, as well as institutional and organizational capacity to manage the benefits from natural resource use must also be addressed inorder to attract and secure domestic and international capital for public andprivate partnerships. Agriculture - There is considerable potential for nearly tripling the area now under cultivation for annual and perennial crops. Growth will come from a transition to greater market orientation (including land registration), improved transport infrastructure, higher productivity, and diversification of crops. Particular attention will need to be paid to managing risks associated with local food security and resource degradation. Manufacturing and services are assuming an increasingly significant role in the economy. Labor i s among the cheapest in the region but productivity is low. Sustaining performance of the sector will require improvements in key building blocks such as the environment for doing business, infrastructure, and market institutions, as well as facilitating regional trade and transport links. Forestry has the potential to contribute more significantly to Lao PDR's development by increasing revenues and improving livelihoods, if the sector i s better managed. Although forests cover nearly half of the country, the contribution to GDP is only 3 percent and deforestation and forest degradation are significant problems in some districts. Improving forest management and utilization and expanding community participation are critical to sustainable development of the sector. Hydropower has impressive potential for both domestic power generation and for electricity exports. Reforms will be needed to clarify governance arrangements in the sector, facilitate private participation, improve sector planning and site-specific preparatory studies, and ensure the good use of the revenues that hydropower exports generate. Mining i s underdeveloped but has excellent geological potential to develop mineral resources such as gold, copper, sapphire and potash. TOdo so, Lao PDR will need to address weaknesses in the existing legal, regulatory, and tax regime. As with other natural resource sectors, the development contribution of the sector will ultimately depend on how the revenue and benefit streams are managed. Source: World Bank, Realizing the Development Potential of Lao PDR, 2004. B. KEY DEVELOPMENT CHALLENGES 27. The NGPES outlines the key challenges that must be overcome in orderfor Lao PDR to reach its economic and social development goals. The analysis in the NGPES, the related Joint Staff Advisory Note (JSAN, Report No. 29966), discussed by the Board in December 2004, and the World Bank's Country Economic Memorandum (CEM) highlights a range of actions necessary to meet the overarching objectives of sustaining Lao PDR's growth and poverty reduction performance while at the same time improving social outcomes. To continue the momentum of the past decade, prudent macroeconomic management will need to be complemented with continued, deepened economic reforms to improve the productivity of agriculture and other sectors, strengthen the enabling environment for trade and the private sector, and ensure a more sustainable and equitable use of natural resources. To convert this growth into improved social outcomes, strengthened public sector management, especially of public finances, will be critical, as will more accountable and well targeted service delivery, and a comprehensive, people-centered approach to reducing poverty in upland areas. In short, inits next phase of development, Lao PDR needs to deepen and broaden sources of growth and increased productivity, tackle the difficult institutional and systemic challenges of public expenditure management for pro-poor service delivery, and develop effective community-based poverty reduction strategies. Reinvigorating efforts to mobilize revenues will be central to the Government's efforts to maintain macroeconomic -11- stability while making progress in addressing the country's pressing development needs. Lasting reform of the state-owned banks and enterprises i s also essentialto ensuring a sustainablefiscal outlook. 28. First, sustaining growth will require a strong economic environment where the various sectors can accelerate productivity and benefit from linkages to dynamic regional markets. The NGPES recognizes that growth will need to be sustained through trade liberalization, higher agricultural productivity, and private sector development. While past agricultural growth rates have been among the highest in the region, further growth in the sector will require increased diversification and management of risks associated with household food security, as well as improvements in property rights and land titling. Improving the performance of the manufacturing and services sectors will require greater efforts in creating a favorable business environment, developing market institutions, facilitating off-farm opportunities and regional linkages, increasing the competitiveness of the private sector, and implementing lasting enterprise and financial sector reforms. Improving exports will also require further liberalization of the trade regime. The delivery of infrastructure services (transport, communication, energy, water and sanitation), including adequate financing to maintain existing stocks and improve access, will be essential and will need to be developed in a concerted effort with GMS partners. The NGPES appropriately sets ambitious growth and macro-fiscal targets, but achieving these goals will require significant structural and governance reforms, disciplined monetary and fiscal policies, a realistic and transparent budgetingprocess, and the effective management of revenues from natural resources. 29. Second, strengthening public financial management, governance and comprehensive community-driven planning processes will be key to improving social outcomes and reducing vulnerability. Successful implementation of the NGPES and progress towards the MDGs will require a shift in resources toward NGPES priorities and improvements in expenditure management, particularly regarding expenditure planning and budgeting, the quality and coverage of financial reporting and predictability in budget execution. The public expenditure management reform agenda should be complemented by reforms in central-local government relations and civil service pay and management. Policy guidance on these issues is expected to emerge from the forthcoming Party Congress. Bold, innovative steps will have to be taken to truly improve social outcomes including improving the access, targeting, and efficiency of service delivery, developing adequate pay and employment policies in the social sectors, exploring alternative options for service delivery to remote communities, and taking an integrated approach to improving upland rural livelihoods. Comprehensive approaches that include community-based participatory planning processes will be needed to make the most effective use of resources allocated for poverty reduction in the poorest areas. More resources will need to be directed to education and health as well as redirecting limited resources to ensure greater access of the poor and vulnerable to quality basic services. 30. Third, management of natural resources and the environment must be strengthenedso that the country's natural endowments can contribute effectively towards growth, poverty reduction, and social improvements.Improved management of forestry, hydropower, and miningresources i s requiredbecause of their potential contribution to revenues that can be used for poverty reduction, growth-related investments and improved social and environmental outcomes and because of the need to protect the naturalenvironment. Issues that need to be addressedinclude strengthening of the framework for private- public partnerships that could bring in the needed investment as well as managerial capacity, strengthening of government capacity at the central and provincial levels to manage complex multi- sectoral activities and promote opportunities for stakeholders to participate in project design and implementation, and strengthening of the public financial management arrangements to ensure proper utilization of revenues. Improvements in the policies and implementation arrangements to manage social and environmental impacts are also essential, including reform of the legal and institutional framework governing the environment, strengthened institutions, better coordination, greater participation and transparency, and stronger law enforcement. - 12- 31, Fourth, building capacity is a key challenge in implementingand monitoring the NGPES. The NGPES sees capacity development as essential to improved governance and public administration and achievement of NGPES priorities. The NGPES recognizes the need for a more comprehensive approach to developing capacity and expresses the Government's intent to: (i) develop an inventory of current capacity building initiatives; (ii) identify and prioritize capacity building requirements at all levels and prepare a framework for implementation of capacity building programs; (iii) create a comprehensive capacity building strategy based on these assessments; and (iv) implement the strategy through an approach that ensures coordination between the various levels of government and development partners. Translating these priorities into concrete actions will be difficult, however, and will require a long-term, systematic approach. An effective monitoring and evaluation (M&E) system for the NGPES will need to be put in place, using participatory processesto update and refine the strategy and action programs on a continuous basis. C. MEDIUM-TERM ECONOMIC OUTLOOK 32. Economic growth is projected to be strong, averaging 6.3percent a year over the CAS-period (Table 3). This i s in line with the medium-termIMFassessment as reported inits November 2004 Article IV Consultationreport. Growth will be driven in large measure by thejump inforeign investment inflows in mining and hydropower sectors, as well as by growth in mineral exports. Improvements in the macroeconomic situation and investment climate over the last two years will also contribute to sustaining rates of domestic private investment and growth in other exports. The latter i s likely to be supported by the projected strong regional expansion and the newly-grantedNTR by the UnitedStates, though garment exports will be hurtby the expiry of the MultifibreArrangement (MFA) in 2005. Table 3: Base Economic Projections Actual Proiected Inflation rate (end-of-period) Private investment/GDP ExportdGDP Current Account DeficiVGDP (including grants) Revenue/GDP 33. Private investment and exports will perform better too. The rising trend in private investment that Lao PDR has experienced over the last two years i s expected to continue, reaching an average of around 12percent of GDP, mainly due to higher foreign investments. The dollar value of exports i s pro- jected to more than double during the next four years, driven by gold and copper exports, raising the ex- port share of GDP from 25.6 percent in2004 to 29.9 percent in 200610. 34. Implementation of AFTA" and commitments under the United States Bilateral Trade Agreement are expected to improve investor perceptions. Continuedintegration of Lao PDR i s expected lo Ongoinginvestmentsby an Australianmining company, Oxiana, in anew copper mine (openingnext year) and expansion of i t s existing gold mine over the next few years, will boost both foreign investmentinflows and exports. Agreements with other mining companies for additional new foreign investments are in process, but they are not factored into the above projection. However, thoughfinal decisionon NT2 is awaited, NT2 investments are factoredinto the aboveprojectionas the base-case. l1 In2005,Lao PDRhas 3,402 tarifflines inthe InclusionList and87 percentof thetariff lines inthat list haveatariff of 0-5 percent. - 1 3 - to drive other reforms that will be neededto face regionalcompetitionand to expand exports successfully. This includes ASEAN and GMS initiatives that are aimed at facilitating regional trade as well as trade of Lao PDR through neighbors' seaports. Those other reforms also include further liberalization of private business registration and of private investment regulations, without which the private sector cannot exploit the new opportunities for agricultural and manufactured exports resulting from increasing integration. Similarly, infrastructure improvements, especially roads and rural electrification, as well as greater openness to private investment in the telecommunications sector, will be key in sustaining regional exports and strong agricultural and manufacturing growth.I2 Unless Lao PDR ensures that implementation of other reforms and improvements in infrastructure accompany increased integration with the region and the world, sustaining GDP growth rates of 6-7 percent a year for the rest of the decade will be difficult. 35. Inflation in December 2004 was in single digits, but only continued vigilance can maintain that over the medium-term. There are significant pressures for increasesinthe civil service wages and given how low the wages are, these pressures are legitimate. However, it i s essential to ensure that the annual increments in the total wage-bill do not outpace the annual increments in revenue so that fiscal sustainability is assured. The 2004105 budget approved by the National Assembly inOctober 2004 sought larger increases in salaries and allowance^'^ than would be appropriate for fiscal sustainability and the revenue performance in the first quarter of 2004/05 confirm that the risk of the proposed increases in wage-bill outpacing revenue increases was real. The Government has thus revised the 2004/05 budget and i s committed to submitting the revisions to the National Assembly at its next session in late April 2005.14 These revisions limit the increases in wages to 20 percent and in allowances to 30 percent with effect from July 1, 2005, with the total salary or wage-bill capped at Kip 1,295 billion for 2004/05; the full-year impact of these increasesin 2005/06 are in line with likely increases inrevenue. The overall fiscal deficit i s expected to be contained at around 4 percent of GDP with domestic financing limited to a very small amount. and adopting new revenue-raising measures if necessary. 36. The Government has committed to continuing its efforts at strengthening revenue collection Recent efforts at improving revenue collection are expected to be enhanced by further actions to centralize customs (including its formalization through a revised Customs Law) and tax administration, greater focus on the large tax- payers as well as medium-sized ones, increased attention to rationalizing and limiting exemptions for investors and timely preparations for implementingthe single-rate Value Added Tax (VAT) in 2007. 37. Lao PDR will now be under the Fund's Surveillance after the Poverty Reduction and Growth Facility (PRGF) expires in April 2005. The I M F ' s November 2004 Article IV Consultation reported robust medium-term growth prospects and low inflation in the single digits. The key short-term risk was the 2004/05 budget approved by the National Assembly in October 2004 that included ambitious revenue targets and large, unsustainable increases in the wage-bill. To mitigate this risk, the 2004/05 budget is being revised in line with the discussions with the Fund and the Bank as noted above. In addition, the PRGF sought `safeguard' actions for the Bank of Lao PDR and several structural measures. Since these are unlikely to be accomplished within the timeframe of the PRGF cycle that expires in April 2005, the ''See ~ World Bank, Realizing the Development Potential of GoPDR, 2004. l3 Proposed increases inwages and allowances were to be effective in the last quarter o f this fiscal year, Le., July 2005 and thus has not yet been implemented. l4 Govemmentisrevisingthe2004/05budgettolimitwageincreasestofiscallysustainablelevels.AletterfromtheFinance The Minister has been received, assuring the World Bank that the agreed revisions to the 2004/05 budget will be submitted to the National Assembly at its next session. The letter also provides assurances, on behalf o f the Govemment, that increases in the wage-bill will not outpace increases in revenue over the medium-term, revenue collection will be strengthened in general, and if necessary, new revenue-raising measures will be adopted to ensure fiscal sustainability, macroeconomic stability and low inflation. - 14- IMF decided not to complete the fourth review. As this situation will continue until the Government requests a successor PRGF, IMF staff will now undertake at least two missions to the country each year, one of which will coincide with Article IV Consultations, and will provide an assessment of the macroeconomic situation to the World Bank after these missions. Fundand Bank staff will continue their close collaboration duringthese missions. 38. The base medium-term outlook is not without downside risks. Thefirst relates to risk of failure to sustain macroeconomic stability and thus to maintain low inflation and stable exchange rates. Economy-wide pressures for increases in the wage-bill, provincial demands for expanding domestically- financed capital spending and the possibility of a slowdown in revenue reforms are key risks that will have to be managed over the medium-term. The Government's adoption of a five-year public expenditure management strengthening program (PEMSP), including a review of center-province fiscal relations, implementation of initial actions to centralize customs and tax administration as well as the recent revision of the 2004/05 budget aimed at reducing wage increases to fiscally sustainable levels, all help to mitigate these risks in the short-term. The second risk arises from the absence of the I M F ' s PRGF program and the resulting reduction in monitoring and dialogue of the IMF with the Government on macroeconomic performance of Lao PDR. The World Bank will work closely with the IMF staff during this period, especially through the semi-annual missions mentioned above, to mitigate this risk.The third risk relates to disruption in the planned inflow of mining and hydropower investments over the next 3-4 years. This risk i s probably low, given the strong commitment of high-level policymakers inLao PDR to these projects. The fourth risk relates to a slowdown in implementation of other reforms and in improvements and investments in infrastructure, both critical for sustaining growth in agricultural and manufacturing sectors and their exports. Given the history of reforms in Lao PDR, and the ambivalence that exists among the top leadership about the pace and content of reforms, this risk i s quite real. While such a slowdown may not affect the planned foreign investments described above, they will certainly weaken the broad-based nature of growth that Lao PDR has experienced in the past and slow down overall growth. D. EXTERNALDEBT 39. The most recent Debt Sustainability Analysis (DSA)" concludesthat in the medium-term Lao PDR's debt service burden is manageable,provided economicreforms-especially on thefiscal front- are maintained. Sensitivity analysis reveals that if the pace of economic reforms falters and export and GDP growth slows, the debt service burden would rise. While the ratio of debt sewice-to exports would still remain below the critical threshold value established for countries like Lao PDR with similar policy and institutional environment, the debt service-to-revenue ratio would rise. 40. The high stock of external debt places Lao PDR in a high-risk category among low income countries. The country could be potentially eligible for HIPC debt relief, although the authorities have stated that they do not intendto avail themselves of such relief. Their view is that the transactions costs of the HIPC procedure and possibly reduced access to bilateral and commercial inflows would outweigh the gains from debt relief in the medium term. Bank and Fund staff concur. However, Lao PDR i s now eligible to receive most and possibly all future IDA financing in the form of grants, thereby reducing public sector borrowing requirements, and this should contribute to easing the debt burdenover time. 41. Public and publicly guaranteed external debt amounts to US$1.9 billion or 92 percent of GDP in 2003. State-owned enterprises (SOEs) account for about 5 percent of the debt stock. Most of Lao PDR's external debt-about 70 percent of the nominal stock at end-2003-is comprised of concessional l5The DSA, completedin November2004 (Attachment3), was conductedjointly with the IMF, World Bank and the Asian DevelopmentBank. - 15 - loans from multilateral creditors, primarily the World Bank and the Asian Development Bank (ADB). The biggest bilateral creditor i s Russia, which accounted for almost 80 percent of the stock of bilateral debt at end-2003. The stock of Russian debt at end-2003, following the agreement, is estimated at US$387 million, after applying a 70 percent upfront discount and an exchange rate of 0.6 rubles to the dollar and this i s part of the base-line scenario. 42. The Lao PDR authorities have approached Russia for more concessional terms. A rescheduling of the stock of Russian debt closer to Naples terms could lower the debt service-to-revenue ratio of Lao PDR by 1-2 percentagepoints per year between 2004 and 2010. 43. The baseline scenario (para. 32) which reflects continuing economic reform and good policy implementation would result in a fall in the public sector borrowing requirement over time. The debt stock indicators would decline continuously over the projection period, though remaining above the threshold value. On the other hand, the debt sewice indicators would remain below the critical thresholds duringthe projection period: the ratio of debt sewice-to-exports remains well below the threshold inboth the short and mediumterm (Box 2), while the ratio of debt sewice-to-revenue (excluding grants) is at the threshold level. The overall impact of the construction and operation of the Nam Theun 2 hydropower project, included inbaseline, on the debt-indicators i s positive. Indicative 2004 2019 Average 2004- Percentages Threshold ' 2019 Debt service-to-exports 15 11.9 9.3 9.5 Debt service-to-revenue 20 19.7 15 19.4 (excluding grants) 44. Sensitivity analysis shows that the effects of a slowdown in reforms accompanied by slower export and GDP growth wouldput priority social expendituresat risk. It would also worsen the ratio of debt service-to exports to 12 percent in some years, but that would still be below the threshold. On the other hand, the ratio of debt service-to-revenue would reach 25 percent in some years. The risk of slower GDP and export growth is mitigated somewhat by the planned mining and hydropower investments provided they remain on track and growth of mineral export receipts remain on trend. 111. THE WORLD BANKINLAO PDR:LESSONSOF EXPERIENCE 45. The present CAS is firmly rooted in the findings and lessons from operational experience during the last CASperiod, as well as an extensive set of evaluations, reviews, and consultations.These have included an Operations Evaluation Department Project Performance Assessment Report (2002). Implementation Completion Reports (ICR), a Bank Quality Assurance Group review of the Lao PDR Analytical and Advisory Activities (AAA) program (2003), and a client survey in 2003 (Box 3). These have been supplemented with more recent client consultations on lessons learned and future directions for the new CAS, and a number of other portfolio reviews. 46. The lending and AAA program under the last CAS has been largely delivered, although with considerable delays in certain cases. Lending, which had averaged about US$42 million in the early 1990s, fell to US$30 million prior to the 1999 CAS, and with the macroeconomic crisis into late 2000, - 16- fell to zero in FYOO.With improved macroeconomic performance and a return to the base case, lending averaged US$32 million per year between FYOl and FY04. During this period, the World Bank provided lending for the Agriculture Development and Road Maintenance projects (both in FYO1); a Poverty Reduction Fund, a Financial Management Adjustment Credit (FMAC) along with a Financial Management Capacity Building Credit (FMCBC) (FY02); SustainableForestry and Land Titling projects (FY03); and Second Education and Second Road Maintenance projects (FY04). This lending was supported by an AAA program that included a Poverty Report, a Country Economic Memorandum, Banking and Financial Sector Report, Production Forestry Policy, Public Expenditure Review and Country Financial Accountability Assessment (CFAA), a Poverty and Environment Nexus Report, a Mining Sector Note, Economic Monitors, a Country Procurement Assessment Report (CPAR) and upport to both the InterimPRSPand full PRSP. Box 3: Findings from Different Evaluations OED - Project Performance Assessment Report and ICRs. There i s a compelling need for the World Bank's project work to be solidly grounded in prior analytic work. In some projects, lack of donor coordination, failure to establish outcome and impact indicators, and high turnover of World Bank task managers hampered project results. Working with decentralized authorities and communities can be an effective option inLao PDR. There needs to be an increased focus on outcomes rather than conditionalities, and on building broader ownership at the highest levels of government. Inprinciple, the potential for policy reform through donor leverage is substantial, with ODA contributing a large share of government budgetary expenditure. Inpractice, donors have not been well coordinated and it has proved extremely difficult to engage the Government inopen discussion on policy. QAG AAA Review. The review suggests that the Bank should strengthen dialogue with Lao PDR on broad development issues; focus more on ownership and capacity issues; develop a stronger mechanismto review and firm up the annual World Bank program and deliverables; and enhance instruments to promote knowledge and build partnerships. It suggests that the new CAS should have a more comprehensive approach to the role of AAA inthe World Bank's assistance strategy. AAA should include greater involvement of the Government and the donor community. I t should seek to exploit synergies with work done by others, and explore use of IDA grants to complement the AAA program. The review also notes areas of success - NT2 partnerships, portfolio management, and successful capacity development in the roads project that should inform design of the new CAS. Client Survey (2003). Financing, donor coordination and building implementation capacity were identified as the World Bank's greatest value. Areas identified as important for World Bank involvement included strengthening infrastructure development, the financial system, the environmental impact of the World Bank's program, developing energy sources, and strengthening the regulatory framework. The World Bank i s perceivedpositively and i s considered effective, but familiarity with the World Bank i s fairly modest. 47. The fundamental objectives of the 1999 CAS-reducing poverty, returning the country to a path of sustained GDP growth of 6-7percent per year, and improving social indicators-were largely met, Poverty has lessenedsignificantly, although absolute levels remain highand urban-rural and regional disparities continue to persist. CAS recommendations for stabilizing the economy and undertaking structural reforms were not achieved during the first two years of CAS implementation, but the macroeconomic stabilization measuresput inplace inlate 1999/2000 were implemented and a programof structural reforms began. Growth remained strong overall during the CAS period. Social indicators have improved, although inmany cases at significantly lower levels than needed to meet MDGs. 48. Dialogue and engagement between Lao PDR and the World Bank have strengthened since the last CAS, catalyzed by preparation of the NGPES, engagement in thepreparation of the Nam Theun 2 (NT2) hydropower project, and government interest in regional integration. During the initial CAS years of macro instability, the World Bank canceled the second tranche of the Third Structural Adjustment Credit and the IMF did not resume a program. The World Bank continued involvement - 17- through AAA and an upgraded field presence. Dialogue and progress on the reform agenda increased, centered on government preparation of an Interim PRSP (FYO1). Renewed interest inthe NT2 project led to a resumption of engagement and the articulation with the Government of a Decision Framework to guide World Bank support. Likewise, government commitment to regional integration with its membership in ASEAN and AFTA provided an additional impetusfor reform. The FMAC supported key public sector, SOE, and financial sector reforms and Lao PDR met all 17 actions for release of the second tranche, establishing a track record of reform. The World Bank-government relationship and trust have continued to improve, with government adoption of an ambitious poverty reduction strategy, the NGPES, and increasing momentumfor implementationof a wide-ranging reformagenda. 49. The experiences gainedfrom the implementation and evaluation of the last CAS haveprovided a number of important lessons: Ownership is essential to ensure sustainability) takes time to develop, and requires an open and well supported dialogue. An informal review of performance under the 1999 CAS found that although the CAS and the Government's National Socio-Economic Development Plan (SEDP) shared a common objective of poverty reduction, the Government and the World Bank (and other ' InternationalFinancial Institutions) differed significantly on development priorities. The Government priority on food security did not match key CAS emphases on macroeconomic stability and deepened structural reforms. This mismatchand ensuing macroeconomic instability underscored the importance of sustained dialogue to discuss reform options and articulate linkages. Government ownership was achieved through a sustained dialogue, supported by good analytical work, plus time. This implies a significant amount of work in the field. The question of timeframe is also essential. While the Government acts quickly when there is strong commitment, capacity constraints continue to hinder effectiveness. Understandingand building on drivers of change have proven important in finding critical levers of reform. The Government's strong commitment to the NT2 project has been a very important driver of change over the last two years that has successfully leveraged reforms in other critical areas (Box 4). The World Bank's participation in supporting the Government has built trust and opened the door to dialogue ina number of new areas. Other opportunities and drivers of change that the World Bank should continue to support include: the Government's growing appreciation of, and commitment to, global and regional opportunities, including its desire to join WTO; the growth of regional markets and investments; Lao PDR's interest in keeping up with its fast-growing neighbors; the Government's commitment to regional cooperation in the MRC and GMS programs; and the Government's desire to graduate from the ranks of LDCs by 2020 and cut poverty in half as outlined inits NGPES. Given capacity constraints, capacity development activities should be undertaken using a comprehensive approach that links capacity to development results. While capacity building objectives were articulated in past projects supported by the World Bank, the links between capacity and development results were unclear. Baselines were rarely identified, making it difficult to measure results. Capacity development needs to be defined in terms of the achievement of specific, measurable results with realistic indicators, timeframes, and baselines defined. This approach should be both opportunistic -- aimed at achieving short-term results, and strategic, gradually addressing structural weaknesses that can only be overcome over the long term. Government and donor resources should be aligned with these desired outcomes. This requires a sound understanding of incentive and governance structures and how these translate into policies, programs, and activities. It also means that capacity building objectives must be embedded in national and sectoral strategic frameworks and interventions at multiple levels-reforms of organizational processes and incentive systems, strengthening of institutions, and individual skill transfer. Attention should also be paid to - 18- local methods; for example, because o f the oral tradition in L a o PDR, written communication and even lecture-style training i s less effective than an approach o f "learning-by-doing" where new concepts, policies, processes, etc. are explained and then applied ineveryday activities. Box 4: Nam T h e m 2 (NT2) Hydropower Project as a Driver of Change Beyond hydropower: Hydropower is, potentially, an important driver of growth and exports, complementing the Government's ongoing efforts to promote private investment in the manufacturing, agriculture and service sectors. NT2 i s the largest and one of the most controversial of these hydropower projects. NT2 is a US$1.2 billion, 1,070 megawatt, private sector project in which the Government of Lao PDRhas a 25 percent shareholding. The World Bank is considering supporting the project through a Partial Risk Guarantee (PRG) of US$50 million and an IDA grant of US$20 million that will support social and environmental mitigation activities to ensure safeguards are met and capacity i s strengthened for managerial aspects of the power project. The revenues generated by NT2 can make an important contribution to the Government's development and poverty reduction agenda if they are well-targeted and applied transparently and accountably. NT2 i s expected to contribute 1.2 percent to GDP growth between 2006 and 2010. The Multilateral Investment Guarantee Agency (MIGA) as well as the ADB and other donors are also considering supporting the project. Policy Reform: The Government is strongly committed to NT2. World Bank participation in project preparation has opened the door to a constructive dialogue on the development framework with different stakeholders. It has also helped build government capacity invarious sectors. This had a catalytic impact on the preparation of a fully government-owned NGPES and has helped increase the degree of convergence between the World Bank and the Government at the policy level. It has also promoted constructive dialogue between the Government and the international financial community on investment opportunities and has strengthened dialogue within the region on the potential for regional cooperation. Cooperation between the World Bank and Lao PDR, and indeed with the international community, has inspired the trust and goodwill needed to broaden the dialogue on key issues of governance, human development and natural resource management. As a result, the World Bank i s supporting these areas in the new CAS. Long-term benefits. The primary benefit from the NT2 project would be the incremental revenues flowing to the Government for several decades starting in 2009, which will be used to finance additional spending on priority poverty reduction and environmental protection programs. Implementation of the NT2 revenue management arrangements will also support the broader public expenditure management and governance reforms, by requiring programs benefiting from NT2 revenues to meet transparency and management standards, including requirements for field level monitoring and stakeholder consultation. Such a large project could also encourage multinational companies to invest in Lao PDR and enlarge the country's access to international financial markets. It also promotes regional cooperation initiatives. The Government has chosen to take on NT2 as a test case, to demonstrate: its long-term commitment to sustainable development in concert with its development partners in the international community; its willingness to engage with the local population in designing and implementing a program of shared benefits at the national, regional and local levels; and its commitment to implement environmental and social safeguards and conserve its natural resources, adopting international standards. Partnership is essential to achieving successful outcomes and to leveraging change. The World Bank contributes only about 10 percent of total donor assistance. It i s thus critical that World Bank assistance be supported by strong AAA and used to leverage other resources within a policy reform framework discussed and agreed with donors and the Government. Partnerships have been critical in presenting a common message to the Government on macro stability and in articulating macro and sector strategies. While partnerships have been steadily improving since 1999, there i s scope for greater cooperation. The World Bank-ADB cooperation o n the NT2 project i s one such example of effective collaboration. Improvedpresence in thefield, analytical work relating toportfolio issues, and more collaborative reviews greatly improvedportfolio performance. The portfolio has improved from the worst in the - 19- East Asia region (1999) to having no problem projects in 2002, 2003, and 2004, and one problem project inearly 2005.16 Four factors were key to portfolio health. First, enhanced field presence with the Country Director based in Bangkok and the upgrading of the Liaison Office to a Country Office allowed for more direct attention and feedback. Second, analytical work, beginning with the Country Portfolio Performance Review (CPPR) in 2000 and followed by the CPAR and CFAA, highlighted some of the major issues facing both the country and project performance. Third, strong field follow- up on portfolio issues and performance, including quarterly reviews with the Government, gradually strengthened the capacity to deal with implementation issues on a daily basis. Fourth, as the Government became more aware of the portfolio issues, there was an improvement in its efforts to monitor donor portfolios (although this still remains weak). While it i s important to continue analytical work and strong collaboration on performance, the focus should now broaden to include outcomes, as well as making sure that the World Bank's program (portfolio and analytical work) i s as effective as possible inhelpingthe Government to achieve its development objectives. 50. Adopting these lessons in the World Bank's new CAS will mean building on recent successes and changing the way the World Bank does business in Lao PDR. Especially important to ensuring the relevance of the World Bank's strategy and portfolio will be building relationships with the senior government leadership to better understand development priorities and internal dynamics. World Bank AAA and dialogue should be sustained and focused on nationalhector strategies in order to build agreement on and commitment to key reform priorities. Instruments will be integrated to facilitate key development results, using strategies that link policy reforms with investments and appropriate mechanisms for capacity building. The World Bank will need to maintain emphasis on communication and coordination with development partners, working towards shared strategies, sector wide approaches (SWAPS),and harmonization(see Box 5 for one example of a success story). Box 5: The Road Maintenance Program A Success Story - Reorienting Strategic Approach. The approval of the Road Maintenance Program (RMP), an eight-year Adaptable Program Loan, marked a major shift in focus from donor-driven investment to one of harmonized preservation and sustainable management of roadassets. Changinghow donors engaged in the road sector, particularly the shift toward a maintenance "culture," took severalyears of active dialogueand analyticalwork. The programis now being successfully implemented by the Ministry of Communications, Transport, Post and Construction (MCTPC) and supports the development and implementation of financing and road management systems; capacity development of public and private road transport and infrastructure services; and the decentralizationof management to provincial and district levels. Harmonizationof Partnerships.The active cooperationof the main donors involved in the sector, mainly Sweden, ADB, the Nordic InvestmentFund and the Bank, was instrumentalfor the success of the project. All ralliedbehind the MCTPC motto, "One Country - One System," supporting the development of harmonized systems in financial management,procurement,reportingandmonitoring. Capacity Building.As part of the RMP, all implementationfunctions for donor-financedprojectsinthe roadsector were intemalizedwithin MCTPC's existingstructures andall adhoc ProjectImplementationUnits(PIU) were dismantled.The second phase of the RMP will implement a comprehensive Human Resource strategy to institutionalize skills and Leadership - Ownership processesthat are linked to projectoutcomes. - Results. A committed government management team led the RMP with substantial participationof the provinces andother stakeholders. Qualified staff were selectedand outstandingoperationalissues are handled efficiently. MCTPC management demonstrates flexibility in implementation yet remains focused on the developmentobjectives. l6 implementationprogressoftheSustainableForestryforRuralDevelopmentProjectwasratedunsatisfactoryinDecember The 2004. The projectis expectedto returnto satisfactorystatus once the Govemment addresses some staffing issues affectingproject management. - 20 - IV. WORLD BANK GROUPASSISTANCE STRATEGY A. SELECTIVITY AND APPROACH 51. Selectivity. The CAS has been designed to support the NGPES and within this framework, to support key areas of future growth and improved social outcomesheductions in vulnerability. The World Bank's AAA program will provide comprehensive but selective support in these two areas based on lessons learned during the last CAS period, new momentum and strong government ownership of the NGPES, growing cooperation among donors, and enhanced dialogue between the Government and the World Bank in recent years. Greater selectivity will be achieved by moving to a AAA cycle approach in which studies are chosen as part of a process leading to more specific advisory work and lending operations. There will also be some areas critical to the successful achievement of CAS objectives where the World Bank will not be taking a leading role (for example, decentralization policy and civil service reform) but will be working closely with other development partners through the Donor Working Group process, and providing AAA support inclose coordinationwith these other partners. 52. In targeting limited IDA resources on priority areas for World Bank assistance, activities will focus on areas where: A strong driver of change exists (such as NT2, government application to join WTO, achieving ASEAN and AFTA commitments, etc.) to provide an opening for dialogue, analytical work, and support to the Government to explore important reform options and build ownership and commitment to a pathof reforms; The World Bank has a demonstrated track record and/or comparative advantage inglobal knowledge and experience that can buildconfidence and create demand for further change; There i s sufficient government commitment to reforms; and an institutional entry point exists, with potential for overcoming capacity constraints that will significantly affect development outcomes; and. e Joint donor resources can be effectively leveraged and by working together each donor can contribute according to its comparative advantage. 53. Many important areas will not be supported by the World Bank during this CAS period due to limited IDA resources, lack of government readiness to take action, and/or other strong donor involvement and comparative advantage, etc. This includes UXO removal where other donors have a comparative advantage. It also includes legal andjudicial reformand development of tourism where other donors andor the private sector are currently working, and large investments in transport infrastructure because of the limited availability of IDA resources. 54. Approach. The World Bank will recalibrate its approach during this CAS period to incorporate a more explicit emphasis on building capacity. Capacity development i s a central element of the CAS approach and each element of the CAS will address it in support of the Government's implementation of the NGPES. Weaknesses in organizational processes and incentive systems as well as in the capacities of specific institutions and in the breadth of individual skills all severely impede both the public and private sector in performing key functions effectively. World Bank assistance will focus within each CAS objective on supporting the identification, prioritization, and removal of key capacity constraints-that are vital for achieving poverty reduction and economic and social goals. - 21 - 55. The CAS will also incorporate a stronger, applied effort to build partnerships with all stakeholders, and especially develop consensus among donors and the Govemment in critical reform areas. The approach will be implemented through involvement in the newly formed Donor Working Groups and ensuring as much as possible that AAA and lending activities are carried out in partnership with government officials, local academics, civil society, and donors. Finally, the CAS will focus particular attention on the implementation of NT2 as a prime example both of the focus on sustaining growth, improving social outcomes and reducing vulnerability and the emphasis on capacity buildingand partnerships. B. WORLDBANKGROUPCAS OBJECTIVESAND ACTIVITIES 56. World Bank assistance will support the implementation of the NGPES in two substantive priority areas: CAS Objective 1: Sustain growth through improved management of key drivers-regional integration and private sector development, rural development, and natural resource management. CAS Objective 2: Improve social outcomes and reduce vulnerability through strengthened public financial management and service delivery capacities and targeted poverty reduction programs. These objectives will be complemented by two further CAS objectives that capture key elements of the approach that the World Bank will use to support these substantive priorities: CAS Objective 3: Adopt a strategic approach to capacity development and partnerships in support of better NGPES results. CAS Objective 4: Support implementation of NT2 as an example of an area-based, sustainable natural resource development program that contributes to growth, social outcomes, capacity development, and stronger partnerships. 57. For its strong growth record to continue, Lao PDR must integrate economically with its regional and global partners, improve the enabling environment for Private Sector Development (PSD) and rural development, and improve management of natural resources. The World Bank will complement other donor activities by applying its global knowledge and local experience to help the Govemment identify critical policy and institutional constraints and options for moving forward. Where there are knowledge gaps and/or lack of consensus on priority reform options, the World Bank will focus on analytical work and development of strategic frameworks. Where there i s greater consensuson development priorities, the World Bank will also support institutional capacity building, and, in a few cases, investments to fill key gaps (Table 4). The World Bank i s working closely with other donors in these areas, complementing and/or jointly undertaking programs with ADB, the European Union (EU), Sweden, Australia, Japan, France and UN agencies, and will support coordination through the Donor Working Group mechanism (including co-leading the working group on macroeconomic and private sector development with the IMF). - 22 - Table :Strengthen Management of Key Drivc s of Future Growth Longer-term/ higher Instruments supporting outcomes order country outcomes Expected CAS outcomes infour years Growth ratesof 6% Strengthenedenabling environment for the OngoingProjects:FMCBC, LandTitling, maintained. private sector andfor trade Agriculture Devt, RMP 2, Provincial Integratedtrade strategyandactionplan Infrastructure Export volumes increase improves trade New Lending:PRSCs, NT2, SPRE-2, from US$340million in Reducedregulatorybarriers to private ProvincialInfrastructure2, GMS Power Trade 2002 to over $550 million sector [number of days to start abusiness AANOthers: IntegratedTrade Framework, by 2007 decreasesfrom 198 to less than 100by Joint ADB-Bank InvestmentClimate 20081 Assessment, GMS PowerTrade Strategy, Increasedprivatesector Improvedsecurity of landtenure leads to InfrastructureStrategy,PER, Govt.-Donor share of GDP increasedinvestment Working Groups, EconomicMonitors, Joint Increasedshare of credit to private sector economicmissions with the IMF Improvedroadandpower infrastructure supportsregionalintegrationandprivate sector development Maintainagricultural Strengthenedrural sector strategy andimproved OngoingProjects: PovertyReductionFund, growthrateof 4 to 5% enablingenvironment for ruralgrowth LandTitling, RMP, ProvincialInfrastructure, Improvednational andprovincial capacity EducationDevelopment2, Agriculture Diversify andmodernize to assess anddevelopparticipatory Development, SustainableForestry the agriculturalsector strategiesto promote ruraleconomic growth New Lending: KhammouaneRural Strengthenedopportunitiesfor farmers and Livelihoods, Provincial Infrastructure2 Increasefood security rural communitiesinselectedprovinces to AANOthers: Khammouanestrategy, Rural increaseproductivity andincreasetrade Sector Strategy, ICA; IntegratedTrade Framework,Donor Working Groups More sustainable andparticipatory management OngoingProiects: SustainableForestry, Land ~Improvegovemanceand environmentalmanagement andconservationof naturalresources Titling of naturalassets Strengthenedgovemanceandmanagement New Lending:NT2, SPRE2, LEnS, NTSEP, of naturalresourceprojects Strengthenthe collection PRSCs Strengthenedcapacity of central, provincial anduse of revenues from anddistrict authorities andcommunities to AANOthers: GEF, EnvironmentMonitors, naturalresourcesto help manage NRM projects by assessing Rural Sector Strategy, MekongResource reducepoverty environmentimpacts, managingprotected Assistance Strategy, Mining Study, Donor areas, implementingenvironmental Working Groups Maintainproductiveforest regulations cover as part of rural More communitiesimplementingforest livelihoods managementfor improvedlivelihoods Strengthenedinstitutional capacity leads to Reduce deforestationrate improvedimplementationof environmental and social safeguards innaturalresource Improverurallivelihoods projects 58. Strengthen regional integration and private sector development. World Bank assistance will focus primarily on analytical work and policy lending. Analytical work will support articulation of strategic frameworks and mechanisms to build synergy between the interventions of multiple actors, while Poverty Reduction Support Credits (PRSC) will support critical policy and institutional reforms. Capacity will be developed through participatory analytical work (including dissemination) and support for policy makers to participate in peer networks and south-south dialogue. Donor coordination in the context of the Macro-PSD Donor Working Group and IFCNekong Private Sector Development Facility (MPDF) support to the Lao Business Forum (LBF) will provide mechanisms to improve coordination of trade and private sector initiatives. a Promote strategicframeworks to improve regional integration andfacilitate trade. The World Bank will conduct with other partners a Diagnostic Trade Integration Study that will develop an integrated strategy and action plan to enhance the global integration of Lao PDR, help boost exports, and - 23 - provide donors with a road map for technical assistance and project support. Key reforms, including the adoption of AFTA tariffs and measures for WTO accession, will be supported by PRSCs, regional knowledge-sharing workshops, and support to integration initiatives (such as GMS, MRC, WTO accession, etc.). These initiatives will complement other donor support from Australia, ADB, UNDP, France, EU, and UNCTAD. The World Bank will also support analysis of the social impacts of regional integration (including issues of migration and spread of HIV/AIDS) and endeavor to ensure that the results of such analysis feed into development of strategies to enhance the benefits and mitigate the negative impacts of greater regional integrationand trade. e Strengthen the enabling environment for the private sector. A joint ADB-World Bank Investment Climate Assessment (ICA) as well as other AAA work on provincial business regulations and the financial sector will assess key constraints and support development of a PSD action plan to coordinate key policy and institutional reforms. Based on this AAA work, the PRSCs and the FMCBC will support implementation of agreed policy actions and programs. IFCNPDF will complement these reforms with technical assistance (Box 7). Strengthened land titling in urban and peri-urban areas will provide security and collateral to encourage private sector development (Land Titling Project supported by the Bank and Australia), and capacity of the land administration institutions will be strengthened. The Economic Monitors and a Country Economic Memorandum (CEM) will provide key economic information and updates on progress being made on economic reform. e Improve infrastructure services that support regional integration and private sector development. The World Bank will support targeted infrastructure investments to maintain the quality of the road network, increase electrification in rural areas, and facilitate participation in regional power trade. The World Bank will provide only a small amount of total investment, but will use this to enhancethe policy environment and leverage more efficient use of government and donor resources. Support will be provided to improve the financing (development of rural electrification fund, tariff restructuring, scaling up of the road maintenance fund) and management of infrastructure assets. Capacity of the MCTPC to support decentralized management of roads, and of Electricite du Laos (EdL) and Ministry of Industry and Handicrafts (MIH) to manage rural electrification at both central and provincial levels, will also be enhanced (second phase of the Road Maintenance Program (RMP-2), Southern Provinces Rural Electrification-2 (SPRE-2), Provincial and Rural Infrastructure). Lao PDR's participation inregional power trade will be facilitated through adoption of regionalprinciples and best practices for power trading through the NT2 project, the GMS initiative, and the establishment of high-voltage cross-border power connections to Thailand, Cambodia and Vietnam, as well as support for preparation of potential hydropower plants under the GMS Power Trade Program. This work will complement work by ADB, China, France, Japan, Sweden and Vietnam and will be coordinated through the Infrastructure Donor Working Group. 59. Strengthen institutional capacity to support a diversified and modernized agricultural sector. World Bank assistance will focus on building capacity of supporting institutions to: (i) analyze key constraints and develop strategies to promote sustained and equitable rural growth; and (ii) design and pilot participatory, market-oriented services that support rural development and agricultural productivity. e Build national and provincial government capacities to develop and implement strategies that facilitate broad-based rural economic growth. World Bank assistance will strengthen capacity for comprehensive, poverty-focusedplanning. A program of AAA work on rural development issues will analyze rural poverty, constraints to long-term rural growth, and policy options. At the provincial level, the Khammouane Development Study and Khammouane Rural Livelihoods Project (KRLP) will work closely with the UNDP-supported Governance and Public Administration Reform Program to build the capacity of provincial, district and village institutions to analyze opportunities and pursue - 24 - activities and investments to improve rural livelihoods. Capacity of village development committees, water user groups, and district staff to provide rural infrastructure (latrines, wells) and agricultural services (including on-farm research, training in monitoring and evaluation (M&E), participatory rural assessment, dry season cropping) will also be developed under the Agricultural Development Project (ADP), the KRLP, and the Poverty Reduction Fund (PRF). Coordination will continue with other donors supporting rural economic growth, such as ADB, Australia, EU, Agence Franqaise de DCveloppement (AFD)and UNagencies, through the Rural Sector Donor Working Group. 0 Improve the ability of farmers and rural communities to respond to an improving business environment and trade opportunities. The ADP, KRLP, and Nam Theun Social and Environment Project (NTSEP) projects, as well as a potentialrural development SWAPwill strengthen production capacity at the farm and village levels through extension, field research, rehabilitation of existing infrastructure as well as community-based production and marketing support investments. Project assistance will include field research, extension, rural tracks and marketing information systems. This will be supported by multipleWorld Bank projects including RMP-2, SPRE-2, PRF, and KRLP, that contain initiatives to improve rural access to roads, electrification, safe water, and sanitation by strengthening the capacity of national and provincial service providers and increasing 0pportunitie.s for both farm and off-farm productive activities. Coordination will continue with other donors supporting overall rural development, such as ADB, Australia, EU,AFD and UNagencies. 60. Support more sustainable and participatory management and conservation of natural resources. World Bank assistance will support improved natural resource management in a number of different sub-sectors - hydropower, mining,and forestry. Support will include assistanceto identify and apply lessons learned from NT2, as well as examples of best practice in other countries, to other projects contemplated by the Government (e.g., other hydropower projects, mining). The World Bank will also provide assistance to increase resources and capacities to promote environmental conservation, involve local communities in natural resource management, and strengthen the application of social and environmental safeguards in development projects. World Bank activities in all these areas will be coordinated with other partners through the EnvironmentNatural Resource Management Donor Working Group. 0 Strengthen overall governance and management arrangements for natural resource management projects. Based on the NT2 experience, the World Bank will encourage the Government to strengthen the framework for private-public partnerships, improve management capacity, and strengthen public financial management of major projects. Interventions in the energy sector, including NT2 and SPRE-2, will support the restructuring of the power sector through the strengthening of the Lao Holdings State Enterprise (new government shareholding enterprise for export hydropower investments) and the strengthening of the framework for small Independent Power Producers, as well as energy efficiency and conservation goals. The Bank will also support improved water management in the Mekong basin by developing Lao PDR's administrative capacities for water resource management through policy advice (in cooperation with ADB and other donors), the Global Environment Facility (GEF)-funded technical assistanceproject for the Commission's Water Utilization Program, and a regional water strategy. In mining and other extractive industries, Bank support will be provided based on the recently completed mining study. Given the growing importance of miningto the Lao PDR economy and the need to ensure good governance and management of revenues streams, the Bank will be discussing with the Government the potential for implementing the Intemational Extractive Industries Transparency Initiative and will be ready to provide technical assistance through grant funds to assist the Government to implement the initiative. - 25 - e Strengthen policies and resources to support better environmental and social outcomes from natural resource management projects. The World Bank will encourage the design of sustainable environmental and social policies, as well as build institutional capacity to support their implementation. The NTSEP and Lao PDR Environment and Social Project (LEnS) will support strengthened capacities at the central, provincial, district and community levels in environmental assessment, monitoring and compliance, resettlement planning and implementation, protected area management, river basin and watershed management, and environmental education and awareness. Through the proposed Lao Environment and Social Project, the Bank i s collaborating with the ADB to establish the Lao Environment and Conservation Fund, and build capacity of STEA, MAF and selected provinces. This pilot environmental fund for protected area management in central Lao PDR will be scaled-up in the long term as a permanent entity eligible to use NT2 revenues for environmental protection activities. To help build government capacity to ensure that mining operations respect the relevant national and international standards with regard to environmental protection and management, the Bank, through trust funds, recently funded a review of the environmental legislation and practices as they pertain to the mining sector. In future, an Institutional Development Fund (IDF) grant i s envisaged to assist the Government to increase its capacities for environmental monitoring and assessment. An integrated GEF ecosystems and wildlife management project i s supporting (with Luxembourg and MacArthur Foundation) biodiversity conservation in Bolikhmsay Province. Attention to biodiversity conservation will. continue to be coordinated with bilaterals, UNDP, and Lao-based international conservation NGOs. e Increase sustainability and contribution to local livelihoods by expanding the involvement of local communities in natural resource management. An integrated package of assistance, based onpriority areas identifiedinsector work, co-financed by the World Bank and the Government of Finland, i s supporting improved forest management. The World Bank contribution will focus on policy and institutional reforms to strengthen support services, implementation of participatory management in selected forest areas, and strengthened forestry sector monitoring and control systems. Capacity development i s embedded in each of these activities, including initiatives to strengthen relevant organizational and individual capacities. The Sustainable Forestry for Rural Development Project i s the primary instrument for World Bank assistance, coordinated with Finland. With respect to watershed development, NTSEP supports participation by the local population inconservation and livelihood activities and i s also focused on the resolution of social issues arising from natural resource projects. The Bank will also work with the Government to access Trust Funds to help reinforce consultative mechanisms with local communities in and around mining areas and to work with the private mining companies to ensure adequate community involvement in spin-off projects. Strengthen institutional capacity to apply social and environmental safeguards to mitigate the impacts of infrastructure and natural resource projects. Projects including the NT2, NTSEP, LEnS, SPRE-2, and GMS Power Trade Program have components to strengthen the capacity of implementing institutions to apply social and environmental safeguards and monitor their outcomes. These are coordinated with ADB, France, and Japan. The Bank will also apply for an IDF to help strengthen government capacities at central and provincial levels to adequately monitor mining sector developments. - 26 - 61. Strengthened public financial management and service delivery will be needed in order to translate sustained growth into improved social indicators. Out of four pillars in Lao PDR's governance program (public service reform, public participation, rule of law, and sound financial management), the World Bank will focus on public financial management and then analytical work to address pay reform within the broader area of public service reform. StrengthenedPublic Financial Management (PFM) will be critical for ensuring that public resources are more efficiently and transparently managed and that increased natural resource revenues are channeled to poverty-reducing services. In addition, strengthened institutional capacities to increase access and quality of key services and implement targeted poverty reduction programs will be required. World Bank activities will build upon its previous support in developing a comprehensive public expenditure management program as well as existing and planned activities to improve service delivery access and quality and reduce vulnerability (Table 5). The World Bank will continue close collaboration with ADB, EU, UNAgencies, Sweden, Japan and other important donors in these areas and work closely with the Donor Working Groups on Education and Gender and Health and HIV/AIDS. Table 5: Strengthen Public Financial Management, Service Delivery, and Targeted Poverty Programs Longer-term/ higher Expected CAS outcomes infour years Instruments supporting order country outcomes outcomes Improvepublic financial Improvedpublic financialmanagement systemand OngoingProjects: FMCBC management to increase capacity New Lending: PRSCs,Public efficiency andtransparency Improvedalignment of expenditureallocations FinancialManagementTA to achievedevelopment with NGPESpriorities (MTEF inplace) AANOthers: PERs, PETS,PEMSP, goals Improvedbudgetarycompliance and Financial Sector Note, sectoral predictability of expenditure expendituremanagement, WBI Increasealignment of Publicationof detailedexpenditureplans, workshops, IDFgrants on public resources with pro- budget, budget executionreports, financial procurement andfinancial poor NGPESgoals statements and audit reports. accountability in SOEs andprivate Reducedlossesfrom state-ownedbanks and enterprises, DonorWorking Groups SOEs (fromKip 200billionby 50%) ReachMDGs andimprove Improvedaccess to andquality of social service, OngoingProiects: Education humandevelopment especiallyfor the poor andvulnerable in selected Development2, PovertyReduction indicators areas Fund,FMCBC Improvedmanagement, allocationand New Lending: HealthServices Improvesocial outcomes monitoring of social sector expenditure ImprovementProject,Provincial Increasedaccess of the poor andvulnerable Rural Infrastructure,PRSCs Improveaccess and quality groups to basichealthandeducationservices AANOthei-s:-SocialProtection of basic social services (800new classrooms,eightupgradedhospitalsin Policy Note, PETS, Poverty targetedpoor areas) Assessment, Social Sector Monitor, Improvedcapacity to trainstaff andconduct educationandhealthESW, policy analysis PERs, Reviewof State Audit Agency, EconomicMonitors, Donor Working Groups Reduce povertyand Developmentandimplementationof policies and OngoingProjects:Poverty vulnerability inpoorest programs for remote, vulnerablegroups ReductionFund, LandTitling, districts Improvedanalysis andcapacity for research and EducationDevelopment2 assessmentsleadto stronger policiesand New Lending: LEnS; Ethnic Group approaches to povertyreductioninpriority areas DevelopmentPlans inprojects Strengtheneddevelopment andimplementationof AANOthers: PovertyAssessment, policies and appropriate community driven Social Sector Monitor, Gender and development for remote and vulnerable communities Ethnic Minority Analysis, to reduce poverty andincreasefood security KhammouaneProvincial Studv - 27 - 62. Strengthenpublic financial management capacities. Together with the ADB and the IMF, the World Bank has supported government efforts to develop a comprehensive Public Expenditure Management Strengthening Program (PEMSP), including a capacity building component that outlines priority government goals and provides a framework for coordinating donor assistance. Within this framework, World Bank assistance will focus on strengthening the core public expenditure management systems, complementing ADB assistance concentrating on audit and accounting systems, strengthening the State Audit Office, and UNDP assistance (with support from Sweden, Switzerland and the EU) on provincial financial management. World Bank support will be provided through the PRSCs, the ongoing FMCBC, the proposed follow-up Public Financial Management TA operation, and a series of Public Expenditure Reviews (with possible support from Sweden) and Public Expenditure Tracking Surveys (PETS) (with support from the EU)as well as through support for sectoral expenditure management. Improve predictability and NGPES alignment of expenditure allocations. World Bank assistance will support expenditure planning, facilitating a gradual shift in resources to NGPES priorities, together with a streamlined budget preparation process. During the CAS period, the proportion of the national budget devoted to health and education, and the share of recurrent expenditures, and expenditures on primary services, are expected to increase in line with NGPES objectives. The World Bank will also support analytical work to provide a basis for a coherent, long-term civil service pay reform policy. Attention will focus initially on the development of an expenditure framework integrating pay policy options. Alongside World Bank support to the Ministry of Finance (MOF) through AAA work and the PRSCs, World Bank projects in key NGPES sectors (for example, education and health), will support improvements in public expenditure management at agency level. Improve expenditure compliance, predictability and transparency. Policy and capacity interventions will support strengthening of the cash management, budgeting, and procurement systems, consolidation of treasury functions, and improved financial reporting and compliance, including provincial revenue and expenditure mechanisms, inter-governmental fiscal transfers, and more timely payment of civil servants. In support of increased financial transparency, the World Bank will support government efforts to publish detailed budgets, execution reports, financial statements, and audit reports. This will entail investments in the definition of appropriate standards, supporting information systems and the training of financial management personnel. This support to be provided through AAA and the PRSCs will be complemented by an ADB-fundedbanking sector reformprogramand a tax project funded by Sweden. Reduce losses from state-owned banks and SOEs. Assistance for state-owned banks and enterprises through AAA and the PRSCs will focus on improving fiscal sustainability-through continuing reforms in the legal framework, supervision, staff capacity to forestall new arrears, further strengthening of credit procedures and other reforms to address underlying causes of persistent non-performing loans. Close coordination will continue with the ADB banking sector reform program. 63. Zmprove social outcomes by increasing access to and quality of basic services, with an emphasis on vulnerable groups. World Bank support for the social sectors follows a three-pronged strategy that focuses on: (i) strengthening the public expenditure management framework (see above) to increase and improve resource allocation to the social sectors; (ii)addressing system-wide structural problems via sector-specific investment loans; and (iii) filling in key knowledge and capacity gaps through a range of advisory and technical assistance activities. World Bank assistance will be provided through the Second Education Development Project, a new Health Services Improvement Project, the PRSCs, and arange of analytical work. - 28 - 0 Improve allocation and management of social sector expenditures to better support poverty reduction and social goals. World Bank assistance will support increased allocations to health and education; improved balance between recurrent and fixed costs; increased share of budget allocated to primary services; and strengthened capacity of education and health ministries to budget, manage, and monitor expenditures (PRSCs, Health Services Improvement and Second Education Projects, and PETS). The World Bank will also support measures to rationalize existing health cost recovery and fee exemption systems to improve access for the poor. 0 Extend access of vulnerable communities to health, education and basic infrastructure services. The World Bank will support improved primary education access in 19 of the poorest districts and access to health care for people living in poor districts of eight central and southern provinces. Projects will support construction of 800 new primary school classrooms, upgrading and equipping of central, provincial, and district hospitals and health centers, and provision of grant funds to districts and communities for priority health and education needs. The projects will be coordinated with other donors (e.g., ADB and Japan) also supporting access to basic education and health care. The World Bank will support increased access of rural communities to safe water and sanitation, strengthening of the Water Supply Authority, and piloting of alternative management models for small towns, including increased involvement of the private sector (Health Services Improvement Project, Second Education Project, PRF, Provincial and Rural Infrastructure Project). The support will be complemented by the ADB Small Towns Program and private sector development projects. Overall coordination with other donors in this area will continue, including through the Donor Working Groups on Infrastructure, Healthand Education. 0 Strengthen health and education institutional capacity to provide pre-sewice and in-service training systemsfor health and education practitioners and to improve policy analysis, strategic planning and monitoring. World Bank assistance will support training for education and health practitioners at the provincial, district and village levels. In education, the World Bank will support in-service training for all teachers in participating villages as well as upgrading of textbooks and teaching guides for primary education. In health, the World Bank will assist in strengthening and provision of short-term training as well as strengthening of the formal medical education system. Assistance will support increased management capacity of both the education and health ministries, including strengthened information management systems, policy and strategy development, and monitoring of outcomes and expenditures (Health Services Improvement Project, Second Education Project, education and health sector strategies, PETS). The assistance will be complemented by other capacity enhancement projects in the health and education sectors, supported by Sweden, EU,ADB, Australia and UNagencies. 64. Support development and implementation of appropriatepolicies and programsfor vulnerable and remote communities. The World Bank will support the Government in the implementation of its strategy for community-driven rural development inpoor upland districts through enhancing analysis and capacity for social and cultural research by the university and other relevant groups (supported by an IDF grant, AAA work, and projects); increasing capacity of MBOs, including the Lao Women's Union and Lao Front for National Construction, to implement policies that represent their constit~encies;'~and improving design of policies and programs and helping intheir implementation. The primary instrument of the Bank's assistance will be the Poverty Reduction Fund (PRF) with additional support from the SustainableForestry and KRLPprojects, and ethnic group development plans. Such as the Law on DevelopmentandProtectionof Women andthe Ethnic Groups Policy (in collaborationwith the UNand other donors). - 29 - Strengthen analysis and the capacity for social and cultural research. Assessments on vulnerability of upland communities, including the impacts of stabilization, relocation, and regional integration policies and programs will be conducted jointly with the Government, MBOs and other donors including Sweden, EU, and UN agencies. These assessments, along with the Rural Sector Strategy, will contribute to dialogue on viable alternative approaches, including in situ development to improve local livelihoods and reduce vulnerability. The LandTitling project, jointly supported by Australia, will include studies of cultural land rights and support dialogue leading to development of appropriate policies for secure access to land for remote upland communities to be included in the National Land Policy. The World Bank will also support the Government to analyze lessons learned from participatory implementation of the PRF, ADP, and other programs18and then support the Government to integrate good practices into other poverty fund initiatives targeting the poorest districts (supported by the PRF, the Poverty Assessment and regional Community DrivenDevelopment monitoring initiatives). Implement policies and programs to increasefood security and reduce poverty and vulnerability in upland communities. The World Bank will continue to support the implementationof the PRF. Through the PRF, upland communities will identify priorities and plan and implement development projects, including infrastructure, health and education facilities, and other services. The Sustainable Forestry Project will help to provide secure access to natural resources for upland communities, and the NTSEP and LEnSprojects will support policy reforms to protect vulnerable upland populations. A more coordinated and participatory approach to ethnic group development plans will be taken to facilitate country-based dialogue and piloting of appropriate options, for example, on language of instruction and on the use of traditional cures and medicinalplants. 65. Successful implementation of the NGPES i s very much dependent on increased capacity and improved partnerships among the Government, the private sector, civil society and the donors. Because of their crucial importance in the current environment in Lao PDR, the focus on capacity building and partnerships will be mainstreamed into the World Bank's assistance strategy (Table 6). A Capacity Development Strategy has been prepared to set the framework for the World Bank's approach to capacity building in Lao PDR (Attachment 2). It focuses on capacity building at the organizational, institutional and individual levels and at emphasizing and mainstreaming capacity development in all the World Bank's support to Lao PDR. Support will focus on the State Audit Office, MOF, Committee for Planning and Investment (CPI), Ministry of Education, the financial sector, and environment and social agencies, among others. The World Bank will also be building on the considerable progress made inrecent years in strengthening donor and other partnerships. 66. Build relationships with policy makers and help strengthen organizational processes and incentive systems. The World Bank will endeavor to continue strengthening relationships and understanding and buildingtrust with policy makers as a basis for a better informed and effective policy dialogue. Inthe first few years of the CAS, and as already highlighted above, the World Bank's highlevel dialogue and support for strengthening the country's organizational processes and incentive systems will focus particularly on improving the public financial management system as well as trade and investment systems and processes. But the World Bank will also be working closely with the Government and other donors, particularly UNDP, on the overall issue of decentralization, in part through AAA work and Projects with similar approaches supportedby the EU,IFAD andUNCDFcouldbe includedinthe analysis, - 30 - lendingdevelopment for Khammouane province, as well as through morebroad-based analytic work. The World Bank also expects to work closely with the Government and UNDP and other donors on the overall issue of public sector reform with a particular focus on civil service pay and will be supporting progress in this area (as well as in the areas of public financial management, decentralization, and trade and investment policy) through the series of PRSCs. In addition, through the overall policy dialogue at the macro and sectoral levels and AAA work, the World Bank will continue to try and deepen its overall understanding of decision making processes in Lao PDR and the evolving roles of the legislature, the executive and the judiciary in order to ensure that policy advice i s grounded in an appreciation of current realities and is responsive to the needs of policy makers. Table 6: Strengthen Key Capacities an( 'artnerships Longer-term/ higher Expected CAS outcomes infour years Instruments supporting order country outcomes outcomes Strengthencapacity to con- Strengthenedrelationshipswith policy makers New Lending PRSCs tribute to sustainedgrowth, andstronger organizationalandincentivesys- AANOthers: KhammouaneProvin- povertyreduction,andim- tems cial DevelopmentStudy, Investment provedsocialindicators Improvedtrust andpolicy dialogue relatingto Climate Assessment, Integrated Bank engagement Trade Framework,Decentralization Study, EconomicMonitors Strengthengovemment Strongernational,sectoralandtraininginstitu- AANOthers: Bank-ADB-SIDA capacitiesfor better NGPES tions with better integratedcapacity development support for poverty survey, Poverty results Stronger cross-sectoralgovemment capacities to Assessment, PETS, Bank-UNDP manageNGPESimplementation support for NGPESimplementation, Emphasizegreaterpartici- NGPES outcomes and actions further prioritized aidcoordinationmechanisms;and pationindefiningandim- andintegratedwith SEDP monitoring WBI support plementingpovertyreduc- Strengthenedmonitoringof NGPES/SEDP (inte- tion strategy gratedwith poverty andMDG monitoring)feed into annualupdates Stronger capacities to develop andimplement priority sector strategies Strengthenedcapacity of local traininginstitu- tions (e.g., NOSPA)to support results-based managementinthe civil service andinNGPES implementation Publicparticipationinandawarenessof NGPES/SEDPimplementationandmonitoring increased Create enablingenviron- Stronger partnershipswith andenhancedcapacity of OngoingProjects:PovertyReduc- mentfor privatesector and the privatesector, civil society, andcommunities tion Fund communities to contribute Improvedunderstandingof constraintsto private AANOthers: InvestmentClimate to growthandpovertyre- sector development Assessment, IntegratedTrade duction Greater outreachwith civil society andMBOs Framework,IFC/MPDF, MIGA, Greater involvementwith communities Bank's outreachprogram, shared AAA andESW, WBI Strengthencoordination Strengtheneddonor partnerships New Lending: SWAP(tbd) amongpartners for more Sharedsector strategiesdevelopedinkey sectors AANOthers: DonorWorking efficient use of donor re- as basis for effectivedonor coordination Groups, donor consultations, Sector sources for povertyreduc- Implementationof Bank assistance strategy Strategies,joint AAA and ESW tion closely alignedwith other major donors Betteralignmentof donor resources with NGPES objectivesand strengthenedaidcoordi- nation - 31 - 67. Help strengthen national, sectoral and training institutions by better integrating capacity development into all World Bank supported activities. All CAS instruments - policy and project loans, sector strategies and AAA - will integrate capacity constraints and political economy issues into the initial thinkingat the concept and preparation stages. Capacity development actions will be firmed up by the appraisaVdecision point stages. And progress in improving capacity against agreed indicators will be monitoredcarefully as part of the implementation process and will be evaluated before any new initiatives covering the same thematic area or institution are undertaken. e Strengthen cross-sectoral government capacities to manage the process of deepening and implementing the NGPES. The World Bank will support capacity development within the CPI and the MOF to monitor and coordinate NGPES implementation. It will also support capacity development workshops for the National Assembly on such issues as NGPES implementation, costing and budget oversight. In collaboration with the UN and other donors, the World Bank will continue to support these counterparts to develop and implement a more results-based management approach to its NGPES program by: (i)strengthening capacities to prioritize and align national development goals (NGPES and MDGs),integrate them into national development plans (NGPES and SEDP), and align sector strategies and expenditure frameworks with them (UNagencies, ADB, and bilateral donors); and (ii) continuing coordination with Sweden and UNDP to strengthen the National Statistical Center's ability to monitor NGPES implementation. Capacity development will also focus on MOF's PEMSPand the State Audit Office. e Strengthen capacities of sectoral institutions at the national, provincial and district levels to develop and effectively implement sound sector strategies and programs. The World Bank has already had considerable success in this respect in Lao PDR, particularly in the infrastructure sector. Going forward, the World Bank intends to build on the progress already made on road management and financing (with the MCTPC) and on energy (with the MIH and EdL). In addition, the World Bank will focus particular attention on capacity building with respect to environmental and social safeguards (building on the NT2 experience and spreading it to other regions); strengthening the capacity of research institutions to monitor social impacts; and strengthening the capacity of the Ministry of Education to target resources to reach vulnerable groups and to monitor education outcomes and to use monitoring information to inform policy decisions. e Strengthen capacities of local training institutions to support capacity development activities. The World Bank will support efforts to incorporate new capacity buildingcontent and methodology in key Lao PDR training institutions, including the National Organization for the Study of Policy and Administration (NOSPA)19 -- the Government's primary training school for civil servants. The World Bank i s assessing the possibility of providing more support to build NOSPA capacities in results-based management and NGPES implementation. Tools to be employed include institutional twinning and other partnership arrangements between senior Lao PDR government officials, their institutions and counterparts in neighboring countries (especially China and the Ho Chi MinhAcademy inVietnam). Partnerships with institutions from Korea and Australia are also foreseen. Support i s also being provided to strengthen in-service and pre- service training institutions inhealthand education. 68. Consult and build partnerships with and help enhance the capacity of the private sector, civil society and communities. Both the NGPES process and the process for preparing this CAS have involved a strong level of consultation with and participation of the private sector, civil society and the public at l9 The NGPESidentifiesNOSPA as a focal point for supportingcapacity development activities supportingNGPES implementation. - 32 - large. During CAS implementation, the World Bank will endeavor to build on this level of consultation and participation and further strengthen contacts with these important groups of stakeholders and, where feasible, help enhance their capacity and effectiveness. e Strengthen partnerships with the private sector. Through the diagnostic trade integration study and the investment climate survey, the World Bank will be working with the Government and other donors to better understand the constraints to private sector development and to help put in place the policies and programs needed to address those constraints. Inundertakingthese studies, the World Bank will be working closely with the Lao Business Forum and complementing the direct capacity buildingsupport to be provided to the Forum and to small businessesin Lao PDR by IFCMPDF. The World Bank as well as IFC and MIGA will also be working directly with the foreign and domestic private sectors on investment projects of importance to the country, building on the very successful NT2 project example. e Consult with civil society and mass-based organizations (MBOs). The World Bank will expand communications with and outreach to civil society - both the international NGOs based in Lao PDR as well as the local organizations that are beginning to be established - as well as the local and foreign media. The World Bank will also strengthen partnerships with organizations such as the Lao Women's Union and the Lao Front for National Construction that have critical roles to play inbringing the voices of their constituencies into the development and implementation of the national economic and social reformagenda. e Work with communities. The World Bank will continue to work directly with communities through the PRF and other ongoing operations to build capacity to plan, prioritize and manage community investments. The World Bank will also build community involvement directly into future operations, particularly in areas of natural resources management and the social sectors. Special emphasis will be placed on building the capacity of women to participate fully in planning and decision making, and more generally in having the skills needed to participate in a market economy. 69. Strengthen donorpartnershipsfor better results. Although IDA resources allocated to Lao PDR are small relative to the size of overall donor support, the World Bank remains a lead agency in supporting Lao PDR's development objectives, and inparticular, its policy agenda. The World Bank will further enhance this role during the next CAS period through its lending and analytical program by actively supporting the Government's aid coordination efforts through the Round Table process and the Donor Working Groups and by seeking co-financing and parallel financing opportunities (Box 6). e Support government and donor efforts to develop and refine shared strategic frameworks in key sectors and build agreement on priority policy and institutional reform as a basisfor more effective donor coordination. The World Bank will continue to work with the Government, the UNDP and other donors to improve the Government's overall capacity for aid coordination and the effectiveness of donor support. During 2003, the Government organized a successful series of thematic Round Table Meetings under the PRSPNGPES process. Following on this, inMarch 2004, donors agreed to establish a new donor coordination mechanism to support the NGPES. This mechanism consists of eight informal sectorauthematic Donor Working Groups consisting of bilateral and multilateral donors and NGO representatives and include active government participation. The groups include: macroeconomic and private sector development; governance; education and gender; health and HIV/AIDS; infrastructure; rural development; environmenthatural resource management; and drug prevention. The objectives of the groups are to: (i) further policy dialogue with the Government on a broad range of sector development issues; (ii) support the respective sectors in the development or strengthening of sector strategies agreed by all stakeholders; (iii) strengthen dialogue and information - 33 - sharing among donors with regard to sector-relevant key issues as well as ongoing and planned projects and programs; and (iv) promote simplification and harmonizationamong donor proceduresin order to lower the transactions costs and burden of the recipient country. These groups are now meetingregularly and are having a positive impact, including inthe development of a Donors' Matrix as an immediate tool for the Government and donors to improve coordination and cooperation (Attachment 4). A widely attended Harmonization Workshop held in February 2005 has also taken positive steps towards agreeing on the establishment of a Harmonization Action Plan. Box 6: Major Donor Activities ADB. ADB i s developingits assistanceprogramfor the comingyears, aligningit with the NGPESpriorities. ADB activitieshave emphasized rural development and market linkages; human resource development; environmental management; and private sector development. The Bank and ADB are working closely together on the NT2 project and more broadly on strengthening environmentalmanagement and social safeguards in the energy sector. The Bank intends to continue close collaboration with ADB in the areas of support to the Government's public expenditure management, banking sector reform, health sector, rural electrification,andSOEreform. Australia. Australia's development cooperation with Lao PDR i s framed by a new country strategy that focuses on access to education,propertyrights in the transitionto a market economy and reducingthe vulnerability of poorer communities to natural disasters. Current key programs include support to the health sector, ASEAN cooperation, preventionof human trafficking, and integration into WTO. Australia and the Bank are co-financing the second Land Titling project to foster the development of efficient landmarkets. European Union. Aligned with the NGPES, the EU has focused its assistance to Lao PDR on rural poverty reduction. Other main areas of cooperation include health care, institutional support, education and the environment (forest conservation). Good governancei s akey element of EU support, inparticular throughits support to the legal sector andpublic administrationsystem. The Bank will work closely with the EU in co-financing PRSC 2 and support to the public expenditure management reform process. France. Franceis primarily supportingelectrificationnetworkimprovements in Vientiane, acapitalizationprogramfor assistance to ruraldevelopment policy implementation,andbasic education.Inadditionto working closely together on andco-financingthe NT2 project,it is expectedthat the Bank andAFD will continue to collaborate closely and agreeon co-financingsupport for rural development andpublic expenditure management capacity building. IMF. The Bank collaborates closely andregularly with the IMF on macroeconomicdevelopments, the fiscal framework and public sector reforms, the financial sector, investment regimes, and poverty. The two institutions co-chair the Donor Working Group for Macroeconomics and Private Sector Development and produced the JSAN for the NGPES in November 2004. Lao PDR will be under the Fund's Surveillancewhen the current PRGFprogramends inApril 2005. Japan. Through the Japan International Cooperation Agency (JICA) grant facility, Japan provides significant support for improvement of transportationinfrastructure; strengtheningof the primary andhigher education system; public health, especially through support for medical technology; human resource development; and the legal sector and public investment plan management. Sweden. Sweden provides key support for strengthening of the legal sector, the public administration reform process and the promotion of human rights. In alignment with the NGPES, other focus areas include support for education, rehabilitation of national roads and strengthening of the national statistical system. The Bank and Sweden are jointly promoting sustainable preservation of the national road network by developing, implementingand co-financing the Road Maintenance Fund facility. The Bank will continue to work closely with Sweden to support amore coherent statistical systemandimprovedgovernance. United Nations. UNDP supports the Government in aid coordinationefforts and, with other UN agencies, providesassistanceto key capacity and institutionalbuilding efforts. The UNsystemi s helping the Government develop and monitor Lao MDGs. The UN agencies also provide support in governance and strengthening of the legal sector, prevention of drug production, UXO operations, healthmanagement, HIVIAIDS preventionand primary education in remote areas. As an active member of the UN Country Team, the Bank works closely with the UN agencies in aid coordination, alignment of support with the NGPES and MDGs and on various aspects of the governance reform program. The Bank also works with the UN Coordinator and UNDP Representative, in particular in aid coordination and major donor-government consultations, governance and financial management. 0 Ensure that the implementation of the Bank's assistance strategy is closely aligned with other major donors in Lao PDR (most notably Japan, ADB and the UN system). Building on the example of the NT2project, which has been a model of cooperation and coordination among five different donors (ADB, AFD, the European Investment Bank (ED), the Nordic Investment Bank (NIB), and the World Bank Group), the World Bank will be endeavoring to leverage the - 34 - relatively modest resources available to it for analytic work and lending by working much more closely with other donors. This will involve doing much more of the AAA work jointly, as i s happening currently for the integrated trade work (which involves the IMF,WTO, and UNCTAD as well as donors under the overall coordination of AusAid) and the investment climate assessment work which i s being led by ADB with support from the World Bank. With respect to policy based lending, a number of donors are already involvedjointly with the World Bank in the policy dialogue and have indicated their interest in co-financing future PRSCs. And inthe case of investment lending, the World Bank will be encouraging the Government and other donors to move as quickly as possible to SWAps to their implementation support in the context of agreed and government-owned sector strategies and programs. As part of these SWAps, the World Bank will be supporting harmonization of project implementation processes, as appropriate. These efforts will require active World Bank involvement in and support for the Round Table process and the sectorallthematic Donor Working Groups at the country level as well as engagement with the headquarters of specific donors, as i s already happening, particularly in the case of Japan and the ADB. 70. NT2 i s a top Lao PDR development priority and a core element of World Bank assistance. The NT2 hydropower project i s a US$1.2 billion (which could increase to US$1.4 billion with contingencies), 1,070 megawatt, private-sector project (in which the Government has a 25 percent shareholding). The project allows Lao PDR to export electricity to the Electricity Generating Authority of Thailand while also producing 75 megawatts of electricity for domestic use. It i s estimated to generate government revenues of an average of US$28 million in the first five years, rising to an average of US$33 million from 2015 to 2019, and rise sharply thereafter to an average of US$73 million from 2020-2024. NT2 could provide significant incremental monies to support Lao PDR's poverty reduction, human development and environmentalmanagementgoals if the additional revenues are well targeted. 71. The preparation of the project has expanded and strengthened the dialogue between Lao PDR and the development community on a wide range of development issues and has served as a catalyst for formulation of the NGPES and progress on a range of development issues. The implementation of the NT2 project will contribute to the attainment of all of the previous three CAS objectives (Table 7).It will contribute to sustained economic growth through further regional integration and more sustainable natural resource management. It will develop government capacity inpublic financial management to ensure that revenues will be targeted inareas that will improve social outcomes. It will strengthen central, provincial, and district management capacities in managing large infrastructure investments, utilizing participatory approaches, and monitoring and build stronger partnerships among all concerned stakeholders. The project does, however, entail development risks that need careful management. It also poses reputational risk for the World Bank, given the expectations it has raised as being a model for sustainable development. To ensure close collaboration during implementation among the five different donors supporting the project, the donors have agreed on a set of Partnership Principles to guide their collaboration (Box 7). - 35 - Box 7: Implementationof LaoPDR NamTheun 2 Project: Multilateral and BilateralPartnership The purposeof the partnership is to improve the quality of donor support for the implementation of NT2 and thereby enhance its contribution to Lao PDR's NGPES. The aim of the partnership is to: 0 support the Government's implementation framework for the NT2 project by strengthening and harmonizing donor support; 0 promote trust and transparency between the Government, stakeholders, and donors involved in the project, and the international community; 0 focus on government and developer implementation performance on the project, particularly on managing project risks; and, 0 strengthen donor dialogue with the Government and other stakeholders by coordinating supervision missions, systematically consulting civil society and project-affected persons, organizing periodic donor meetings, and reporting progress to the Round Table mechanism led by the Government and supported by UNDP. The Partnership will be driven by the following principles: Promoting Donor Synergy: Exploit relative institukonal strengths; work together through dialogue and analytical activities to understand the evolving project context in all its dimensions (e.g., technical, financial, economic, environmental, social, revenue management); share assessments; adopt common project monitoring and evaluation arrangements; avoid duplication in supervision efforts; seek complementarity in financing of future initiatives that expand the development impact of the NT2 project in areas such as energy/hydropower development, river basin management, strengthening of environmental and social safeguards, improving rural livelihoods. Improving Communication with Stakeholders; Build open relationships with the wide range of project stakeholders; show willingness to share appropriate project information with the Government, other donors, civil society and project-affected persons; reinforce government initiatives to listen to the voices of the poor particularly bearing in mindlanguage barriers; and, provide feedback to communities after consultations. Strengthening Assessments of Project Performance: Establish common standards and understanding on assessment of government and other stakeholder performance on the project through effective M&E arrangements; share information with the Government and among the stakeholders, including project- affected persons, concerning project risks as they are handled or emerge, including those caused by deviations from project legal and other arrangements; and work towards a common approach for resolution of the issues. Highlighting the NT2-NGPES Nexus: Monitor closely the impact of NT2 on achieving the Government's NGPES objectives; hold periodic donor meetings; keep the broader donor community and civil society informed on progress inter alia through the Round Table mechanism led by the Government and supported by UNDP; and contribute to a shared view among donors on future dimensions of assistance in support of NGPES. 72. Implementation of NT2 will contribute to sustained economic growth, including greater regional integration and more sustainable natural resource management (CASObjective 1). 0 NT2 demonstrates technically sound and financially viable natural resource development that reflects equitable sharing among international and local stakeholders of the revenues generated and risks posed by natural resource exploitation. The World Bank will support and monitor the project to ensure compliance with international standards and implementation that meets financial and revenue targets. Financing of NT2 and assistance for supervision and monitoring of its implementation will be provided through the NT2 Guarantee, the NTSEP, the KRLP, and the Khammouane Provincial Development Study. The Dam Safety Panel of Experts and the InternationalAdvisory Group will continue to monitor constructionand safeguards. - 36 - Table 7: SupportImplementationof N'. Longer-term/ higher Expected CAS outcomes infour years Instruments supporting order country outcomes outcomes ImplementNT2 as an NT2 implementationcontributesto sustainedgrowth, New Lending:NT2 Guarantees, exampleof sustainable regionalintegration,andsustainablenaturalresource NTSEP,KRLP, LEnS,PRSCs, natural resource management GMS Power development that 0 NT2 demonstrates socially andenvironmentally AANOthers: Khammouane contributes to poverty responsiblenaturalresource management:impacted ProvincialDevelopment Study, reduction villages movedinto developedresettlementsites PETS, PEMSP, PER,Round with plannedinfrastructureandsocial services in TableMeetings,Donor Working place; affected personsand villagescompensated Groups for lost assets;numbers of key wildlife species stableor increased;water quality at acceptable levels Satisfactory progresson constructionreportedby independentmonitoringandevaluationconsultant Strengthenedcapacity of central andprovincial authoritiesto oversee constructionof hydroprojects to intemationalstandards,promote regionaltrade Targetnaturalresource Revenueandexpendituremechanisms inplace to ensure OngoingProjects:FMCBC projectrevenues towards transparent, accountable,well-targeteduse once NT2 New Lending: PRSCs, project social outcomes revenues come on stream componentsto strengthen Eligible programs for NT2 revenues identified in financial managementof key NGPESsuccessor, FYOSbudget andMTEF; key service delivery sectors performanceindicatorsdefinedby 2008. AANOthers: PEMSP, PER, Financialsystems inplaceto ensure that resource PETS,RoundTable Meetings, allocationsto eligibleprograms can be monitored DonorWorking Groups andimpactassessed; public expenditurereviews andtracking surveysconductedandpublishedas scheduled Improvecapacity to Strengthenedinstitutionalcapacities to manage and New Lending:NT2 Guarantees, managecomplex coordinatecomplex naturalresourceprojectsand NTSEP, KRLP, PRSCs,GMS multisectoralprogramin a facilitate participationof all stakeholdersinmonitoring Power, SPRE2 participatorymanner, and andimplementation. AANOthers: RoundTable strengthenpartnerships Continueddialogue andparticipationof local and Meetings,DonorWorking Groups among all concerned internationalstakeholdersinNT2 implementation stakeholders andmonitoring; continuedinvolvementof InternationalAdvisory Group,Panelof EnvironmentalandSocialExperts; regular consultationwith communities inproject area NT2 demonstrates socially and environmentally responsible natural resource development and builds capacities to apply social and environmental safeguards. The World Bank will provide intensive support to build government capacities for applying environmental and social safeguards in support of the NT2 program as well as more broadly in other parts of the country. Capacity development objectives include: (i)institutionalizing the Watershed Management and Protection Authority to improve management of the Nakai Nam Theun Protected Area, with an initial focus on improving capacities in: biodiversity assessment, patrolling and monitoring wildlife poaching and logging, and community participation and livelihoods development; (ii) building the capacity of Khammouane Province to ensure that social and economic impacts are mitigated inNT2 relatedresettlement, including efforts to buildNGO capacity to support village- level planning and delivery of livelihood programs and services; and (iii) improving the capacity of the Science, Technology and Environment Agency to monitor environmental compliance with NT2. The LEnS will complement the NTSEP by addressing capacity and policy issues at the - 37 - national level, including strengthening broader government capacities to apply environmental and social safeguards to other naturalresourceprojects. 0 NT2 contributes to expanded Lao PDR participation in regional economic cooperation and bilateral power trade, increasedforeign investment and effective private-public partnerships for large-scale hydropower projects. The World Bank will continue to encourageregional initiatives, particularly through Mekong mechanisms. It will continue its involvement inthe electricity sector through the Southern Provinces Rural Electrification project, which also supports national-level institution building. 73. NT2 mechanisms are in place to ensure that expected revenues contribute to increases in spending on priority poverty reduction and environmental protection programs, and ultimately to strengthened service delivery and improved social outcomes (CAS Objective 2). The Government's PEMSP will put inplace the key instruments for ensuring that NT2 revenuesare transparently allocated in line with objectives laid out in the NT2 Decision Framework over the longer term (Box 4). The Government has agreed to specific NT2 revenue and expenditure managementarrangementsto be applied from the time of project commissioning (currently estimated as 2009), that will provide additional assurance that revenues specific to NT2 are applied transparently in financing additional spending on poverty reduction and environmental programs. 0 Revenue and expenditure management arrangements will be put in place to ensure transparent, accountable, and well-targeted use of NT2 revenues. The Government has committed to: a set of criteria for selection of poverty reduction and environmental programs to benefit from NT2 revenues; a basis for verifying that NT2 resources provide additional financing for these programs and do not substitute for financing from other sources; the flow of funds through a dedicated Treasury NT2 Revenue Account, so that the transfer of revenues to the central treasury account can be verified and the Ministryof Finance can withhold funds from programs that fail to comply with selection criteria and transparency standards; and a monitoring schedule to assess progress in implementing these arrangements and the impact of NT2 financed spending. These monitoring arrangements will require a significant commitment under the CAS to regular public expenditure reviews, public expenditure tracking surveys and peer reviews of the State Audit Organization. The costs of monitoring NT2 revenue management arrangements will be shared between NT2 project financing partners. 74. NT2 will contribute to improved management capacity at central, provincial, and district levels as well as to more effective partnerships among all concerned stakeholders (CAS Objective3). 0 NT2 implementation supports improved capacities of central, provincial, and district authorities to manage complex infrastructure and natural resource projects, to contribute to local livelihoods, and to mitigate environmental and social impacts. The comprehensive approach to the preparation of NT2 has contributed greatly to strengthening the power sector's capacity to manage large and complex infrastructure projects. The implementation phase of the project will further strengthen the power sector to handle future projects of this nature, and capacity will be developed to conduct and apply the findings of environmental assessments, resettlement action plans, ethnic minority development plans and other relatedinstruments inthe hydropower sector. Continued dialogue and participation of local and international stakeholders in NT2. The preparation of the NT2 project has involved extensive and intensive consultations with local communities. This process will be continued as part of project implementation. In addition, the project is supported by a strong and independent M&E arrangement and close oversight by the - 38 - Panel of Environmental and Social Experts and the Dam Safety Panel of Experts. Multilateral and bilateral co-financiers have entered into a partnership agreement that streamlines support for the Government's implementation framework for the NT2 project. Under this partnership (Box 7), annual meetings of co-financiers are planned, to be followed up by information-sharing meetings under the auspices of the Round Table process with the Government, donors and civil society. These efforts will be complemented by several measures taken by the lenders and partners including: systematic monitoring of the technical and safeguards components of the project and its impacts by one or more professional f i r m s on behalf of the private and public sector financial institutions; regular supervision by staff of the World Bank, the ADB and other development partners; and visits from the International Advisory Group that advises senior World Bank management. c. WORLD BANKASSISTANCEPROGRAM 75. The World Bank will take an integrated approach in its country assistance program in Lao PDR by combining various instruments to effectively support the CAS Objectives based on client priorities and lessons learned. World Bank support during the CAS period will include a mixture of programmatic and investment lending and an important programof analytical and advisory services. Inan effort to maximize limited IDA resources, strategic and participatory economic sector work and technical assistance will be complemented by a series of PRSCs to support cross-sectoral policy reforms. Given Lao PDR's low income and considerable debt burden, the majority of IDA resources will most likely be provided as grants. These resource flows, along with those from other donors and international financial institutions, will help to fill the country's external financing gaps, which are projected to continue in the mediumto longer term, as well as helpfinance priority investments and expenditures. 76. AAA will provide the analytical underpinningsfor policy dialogue, the development of joint government and donorframeworks, the design of the lending program and technical support, and the basis for implementing the CAS Objectives. The AAA program will be closely linked to the CAS Objectives to ensure a coherent and practical set of instruments to promote knowledge and build partnerships. A comprehensive project-cycle type approach that systematically engages the client and development partners throughout the AAA cycle will be instrumental inbuildingcapacity and ownership. Diagnostic work will be undertaken collaboratively with government counterparts, donors, and local researchers to build capacity and consensus around key policy outcomes. The East Asia and Pacific Region's AAA cycle approach will guide these exercises. A balance of core diagnostic Economic and Sector Work (ESW) will be supplemented by analytical work inkey sectors. 77. AAA will focus on four thematic areas (PSD/Regional Integration; Rural Development/Natural Resource Management; Public Financial Management; Service Delivery and Vulnerability) as well as several cross-cutting products which support the CAS Objectives (Table 8). Proposed activities for PSDRegional Integration include the Private Sector Assessmenthvestment Climate Survey, Financial Sector Assessment, CEM, Economic Monitors, Infrastructure Strategy and technical support to the Government's regional integration efforts through updating the IntegratedTrade Framework. Strengthening public expenditure/financial management will benefit from a series of integrated Public Expenditure Reviews (PERs) and PETS, a Contract Value Norms Study, a peer review of the State Audit Organization, and technical assistance on Public Procurement. Rural DevelopmentLNatural Resources Management activities will include sector policies for Rural Development, the Mekong Resources Assistance Strategy, and Environment Monitors. The Khammouane Provincial Development Study will also supplement studies related to the NT2 project, looking at a broader range of institutional, social and economic development issues in the province and feeding into follow-up projects. Improvements in social outcomes from work on service delivery will include a Social Protection Policy Note, Education and Health Sector Strategies, a Poverty Assessment, a Gender and - 39 - Ethnic Minorities Assessment, technical assistance for education and health service delivery, integration of ethnic minorities' concerns in the PRSP, and monitoring and evaluation in education. Cross cutting work such as the studies on decentralization policy and civil service reform have been scheduledto follow up on policy decisions arising from the forthcoming IDF grants will be sought regularly to support the main priorities in the four thematic areas and the World Bank Institute (WBI) will continue to support project preparation in trade and private sector development as well as in local capacity to achieve PRSP priority results. Table 8: L a o PDR: Proposed Analytical and Advisorv Activities (AAA) Private Sector Development and Regional Public Financial Management Integration Expenditure Tracking Surveys (PETS) Assessment of Provincial Business Regulations IntegratedPER-CFAA-CPAR PSNInvestment Climate Assessment and Peer Review of State Audit Organization follow-up Contract Value Norms Study IntegratedTrade Framework Efficiency inPublic Procurement (IDF) CEM Infrastructure Strategy Financial Sector Strategy Economic Monitors Rural Development and Natural Resources Service Delivery and Vulnerability Management Poverty Assessment Rural Sector Strategy Social Protection Policy Note Khammouane Provincial Development Study Education Sector Study Mekong Water Resource Assistance Strategy Health Sector Study Environment Monitors Gender and Ethnic Minorities Assessment Ethnic Minorities concerns in PRSP (tbc- IDF) Monitoring and Evaluation in Education (tbc-IDF) Social Sector Monitors Cross-cutting Lctivities Civil Service Reform Study Decentralization Study 78. A key instrument of the Bank's assistance will be a series of Poverty Reduction Support Credits (PRSCs). As a core Bank instrument, the PRSCs will enable sustained dialogue, coordination and progress on key elements of the Government's reform agenda.20The Government has now adopted an important Public Expenditure Management Support Program, which has been developed over the last several years in close consultation with the World Bank, the IMF, and the ADB, among others. The PRSCs will support institutional incentives that improve organizational capacities, particularly in public expenditure management, financial sector and SOE performance, public spending with NGPES poverty reduction priorities, PSD, regional integration, natural resource management, and monitoring and evaluation. The PRSCs will be single tranche budget-support operations that will become effective and disburse on the ex-ante fulfillment of an agreed set of prior actions. Their design will emphasize alignment with country priorities, simplicity, consultations and participation (including with civil society *'Past dialogue on the preparationand implementation of the FMAC was very important to achieving and developing a track record on reforms. PRSCs provide an instrument to sustain dialogue and progress on these key reform fronts, including public expenditure management andSOEreform, as well as in new areas suchas servicedelivery, the enablingenvironment for regional integration, and private sector development. Although CPIA ratings score low in a number of areas important for policy-based lending, Lao PDR's outcome performance measures (consistent growth and poverty reduction performance) have been strong. PRSCs will provide the main platform for Bank support to incremental policy reforms across sectors that are important for achievingNGPES goals over the CAS period. - 40 - and other stakeholders), partnerships and co-financing, and pay special attention to implementation capacities. The sequencing of the PRSC program i s diagrammed below (Figure 4). It i s expected that PRSCs will be implemented annually during this CAS period (although the components of a PRSC-4 have yet to be discussed and agreed upon), supporting a programmatic series of actions based on three pillars: the first, addressing key reforms scheduled under the Government's PEMSP; the second, addressing sector reforms aimed at shifting resources in support of basic social services and improvements in service delivery management at the sector level; and third, enhancing the environment for revenue generation through a stronger private sector, expanded trade, and greater capacity to manage natural resources. Figure 4: Evolutionof Lao PDRPRSCs -- PRSC-1 PRSC-2 PRSC-3 PEM .1 Strengthened Public 11.1 Public Exp. Management I I1.1 Pdb,ic Exp. Management I Expenditure Management 1.2 Banking Sector 1.2 Banking Sector Capacity -b 1.3 State-Owned Enterpr. 1.3 State-Owned Enterpr. .2 Enhanced Commercialization 1.4 Financial Sustainability 1.4 Financial Sustainability and Transparency of of Utilities of Utilities Banking Sector .3 Restructuring of State- 2.1 Align Spending with 2.1 Align Spending with Owned Enterprises Pro-poor Priorities Pro-poor Priorities .4 Financial Sustainability of (expanded access, pay (A. Health;B. Edu;C. Infrastr.) Utilities through Tariff reform) 2.2 Monitoring 2.1 Restructuring/Efficiencty (A. Health; 6. Edu; C. Infrastr.) Human Improvements 2.2 Monitoring spending and Development enhanced data transparency and 3.2 Liberalization of trade accountability for Regional & Global Growth 79. PRSCs willfocus on critical public sector reforms to strengthen accountability and efficiency of public expenditure management, and improve allocation of public resources to pro-poor developmentpriorities. As such, they will complement other World Bank instruments of support. PRSCs will be particularly important in strengthening the framework within which the NT2 project can have the greatest benefit for Lao PDR through efficient allocation and use of public revenues for priority poverty reduction and development objectives. PRSCs also provide a meaningful tool for strengthening donor coordination. The PRSCs will further contribute to a broad-based approach to capacity enhancement, linkingpolicy and institutional reforms with project-based lending and technical assistance." Until the PRGF i s resumed, World Bank staff will provide an update of the macroeconomic conditions as part of the PRSC documentation in consultation with the IMF. This will be based on Bank staff participation in the two IMFmissions each year, and additional quarterly Bank staff monitoring of revenue performance, revenue measures, as well as bank credit growth. 80. Investment lending, in selected sectors supporting NGPES priorities and in collaboration with other donors, will emphasize Sector Wide Approaches (SWAps) wherever appropriate. SWAps will be particularly useful given the multiplicity of donors and need for harmonization among them, as well as 21 Until the IMF's PRGF i s resumed, World Bank staff will provide explicit macroeconomic assessments as part of its documentationfor the PRSC. This will be based on staff participation in the two IMF missions each year, quarterly staff monitoring and dialogue on revenue collectionin particular, as well as the provision of all macroeconomicinformation from the Government, including quarterlydata on the fiscal, monetary and external accountsof LaoPDR. - 41 - their intention to align support to poverty priorities. SWAps also provide a means for the World Bank to leverage its own resources inpartnership with others. However, a key precondition i s the adoption by the Government and other major stakeholders of shared sector and sub-sector strategies, and the commitment to a multi-year programmatic framework. Recent experience inthe roads sector provides a useful example of how this can be achieved. Year Lending FY05 l l PRSC-1 0 NT2 Social & Environment Project 0 Lao Environment and Social Project 0 NT2 Guarantee FY06 PRSC-2 0 Health Services Improvement-2 Southern Provinces Rural Electrification-2 FY07 PRSC-3 0 Khammouane Rural Livelihoods Project 0 Public Financial Management TA GMS RegionalPower Trade FY08 0 PRSC-4 0 Sectoral SWAP (tbdbasedon progress in different sectors) Provincial and Rural InfrastructureSWAP 81. Znvestment operations will be strategic and results-oriented. New investments will focus on strengthening social and infrastructure services (Health Services Improvement 2, potential Education SWAp, NT2 guarantee, SPRE 2, potential Provincial and Rural Infrastructure SWAp, and investment in the regional GMS program); environmental protection and conservation of Lao PDR's unique biodiversity (NTSEP, LEnS); and rural development and enhancing rural livelihoods (potential Rural DevelopmentlAgriculture SWAp, KRLP). In particular, during the first years of the CAS period, IDA lending/grants will focus on key operations-including the PRSCs-to support the NT2 development framework and the associated social and environmental measures and their implementation. The NTSEP, using an IDA grant, will help fund part of the government equity in the project. A key feature of all operations will be the mainstreaming of capacity development according to the guidelines and framework developed in partnership with WBI. A Technical Assistance Creditlaant will further support the ongoing strengthening of public financial management (Table 9). 82. The World Bank will provide additional support to the NT2 hydropower project through a Partial Risk Guarantee (PRG) in partnership with MZGA and other donors and agencies (ADB, AFD, NIB, and EZB). The PRG will mitigate specific risks relating to political, regulatory and governmental performance, and debt service default resulting from activities and actions under the Government's control: expropriation; the issuance and renewal of permits for construction and operation; changes in laws, taxes and duties; other specific obligations of a sovereign nature defined in the Concession Agreement and other related agreements, and deemed critical for obtaining finance; and force majeure events that are beyond the control of the developers. The private sector developers and financiers have indicated that they are not able to absorb, manage or insure such risks and therefore would need a political risk mitigation package to be able to support the project. The risk coverage under the IDA guarantee - 42 - would mirror that of an IBRD "enclave" guarantee: the lenders and sponsors would take the Thai sovereign risk, including the payment for electricity delivered under the terms of the Power Purchase Agreement. The IDA PRG would not create any additional liabilities for the Government since it backs the commitments already made inconnection with the project. 83. MIGA will support the NT2 project through the provision of a US$50 million political risk insurance instrument and canprovide similar guaranteesfor otherprivate sector investments and FDI. MIGAis also considering providingup to US$lOO milliono f additionalcover for Thai political riskto the project. L i k e the PRG, the MIGA guarantee w i l l mitigate specific risks relating to political, regulatory and governmental performance, and debt service default resulting from activities and actions under the Government's control. MIGA also provides investment marketing services to L a o PDR through its on- line investment promotion services featuring 75 documents on investment opportunities and the related legal and regulatory environment inLao PDR. (FIAS) ,MPDF) will assist in the achievement of the CAS objectives, particularly by strengthening the 84. IFC and other World Bank Group agencies (e.g., the Foreign Investment Advisory Service role of the private sector and the investment and business climate to foster poverty-reducing growth. IFCMPDFactivities are detailed inBox 8. Box 8. IFC inLao PDR MPDF.IFC's primaryengagement inLao PDR hasbeen through the MekongPrivate Sector DevelopmentFacility (MPDF), with selected direct investments in key sectors such as tourism and wood processing. MPDF, a multi- donor funded initiative, managed and supported by IFC, promotes the development of small and medium enterprises in Vietnam, Cambodia and Lao PDR. IFC investments. IFC's willingness to lend to smaller projects has been a catalyst for unlocking local credit, and encouraging co-lending by other development institutions. To date, IFC has extended loans worth US$2.33 million to two hotel projects and US$0.92 million to two small manufacturers. IFC i s considering investments in telecommunications and other key infrastructure areas. Support to individual enterprises. IFC's MPDF started its operations in Lao PDR in 1999, with assistance to individual enterprises. The Facility continues to help local privately-owned small and medium enterprises (SMEs) to upgrade human resources, improve operations, and prepare viable projects to obtain financing, but it i s now focusing particularly on the agribusiness sector and helping NGOs to turn their income generation projects for disadvantaged groups into viable business that can sustain themselves without donor support. Access to finance. To increase access to finance, IFC/MPDF has been working with Lao PDR banks to develop the capacity o f bank credit officers to assess the businesses and proposals of SME borrowers, to restructure non- performing loans, and to improve the profitability of the SMEs whose loans have been restructured. SMEs that are ready for international financing are also being helped to apply for this. Training SME managers. To address the needs of local SME ownedmanagers for managerial training, IFC/MPDF has developed and published Lao language self-study workbooks on marketing and human resources development and has trained local trainers to offer four one- and two-day seminars on caring for customers, motivating people, controlling costs and working with budgets. Improvingthe capacity of business associations. As part of its program to build stronger business associations, IFC/MPDF i s working with the Lao Hotel and Restaurant Association to improve member services. This includes establishing and maintaining an e-commerce Internet portal that enables a number of budget hotels and guest houses to market themselves to the world. IFC/MPDF i s also helping the garment sector to cope with increasing global competition by strengthening the training capacity of the Lao Textile and Garment Industry Group. Improvingthe climate for private enterprise. IFC/MPDF has been supporting the Government's Private Sector Development Strategy, as defined in the NGPES, by addressing key legal and administrative constraints to SME development. As a priority, the Facility is currently implementing three closely related components. These are: serving as the secretariat to the Lao Business Forum (LBF) which will hold its first meeting in 2005; conducting action-oriented research on key private sector issues identified by the LBF's working groups; and collaborating with FIAS inproviding the Government with technical assistanceindrafting key business legislation. - 43 - 85. With thefull support of the Government of Lao PDR, the Bank's assistanceprogram will make use of the new flexible countryfinancingparameters,but carefully and according to pre-specified appli- cation criteria. Individual projects may be financed up to 100 percent, including taxes and duties, based on merit and justification. Bank financing of 100percent i s expected for social sectors and the rural sec- tor, including the environment and biodiversity subsectors. Co-financing will still be encouraged when available. Regardinglimits that would apply to the overall amount of recurrent expenditures that the Bank may finance, there will be no country-level limit, but decision criteria will be applied for each project and line item with due regard to sustainability. The Bank may finance local costs as needed to achieve project objectives more efficiently. The Bank will also be able to finance taxes and duties, as the tax system is considered reasonableinLao PDR. 86. WBZ is working with the country team to mainstream the capacity development strategy that focuses on the design, implementation and monitoring of capacity development in PRSCs, investment projects and non-lending activities. WBI is currently providing knowledge support to public expenditure management, and to new and ongoing projects in the transport and education sectors, with additional support planned in trade, environment, and development of local institutions. D. PORTFOLIO MANAGEMENT 87. Nature and scope of the Lao PDR portfolio. As of January 31, 2005, IDA credits totaling US$723 million equivalent have been approved for Lao PDR with US$586 million disbursed, of which US$37 million has been repaid. These credits have supported development projects in various sectors such as rural development, agriculture, forestry, transport, energy, education, health, land reform, financial management, capacity building, and policy reforms. The current portfolio includes nine active credits amounting to US$153.6 million of which US$122 million i s undisbursed. The fact that half of the portfolio has been replaced by new projects in the last 12 months explains the small disbursed amount. Excluding the Land Titling project which will close next September, the average active life of the remaining eight projects i s only 22 months. Currently there i s only one problem project. Implementation progress of the SustainableForestry for Rural Development Project was rated unsatisfactory inDecember 2004. The project is expected to returnto satisfactory status once the Government addresses some staffing issues affecting project management. The sustainability rating of World Bank-financed operations in Lao PDR has been satisfactory: a review of the last 14 ICRs shows that 11 projects (80 percent of the portfolio) were rated likely or better interms of sustainability. Moreover, the performance of the borrower has been rated satisfactory or better on all but one project, showing a strong commitment from the Government. 88. The current portfolio is well aligned with the CAS with most projects simultaneously supporting several of the objectives, especially rural development. The portfolio also includes 17 grantsz2(PHRD, JSDF, GEF, IDF) amounting to US$17 million in support of increased empowerment of rural communities in uplands areas, efficient procurement systems, improved financial accountability in SOEs and the private sector, and various capacity buildingand project preparation activities. 89. Although implementation and disbursement have been satisfactory over the last four years, improvements are still required. A series of measuresi s being undertaken to address issues at the country and project levels relating to implementation readiness, capacity building, financial management, auditing, implementationarrangements, and project planning, monitoring and evaluation. The CFAA and CPAR identified a series of actions to strengthen the capacity of the Government to manage public expenditures and procurement. Results are already evident in procurement, as evidenced by the endorsement of an effective procurement decree and accompanying rules and regulations, preparation of 22Five grants totaling US$10.2million are pending effectiveness as of February 21,2005. - 44 - harmonized standard bidding documents, and establishment of a Public Procurement Monitoring Office. The CAS will support implementationof other key recommendations. 90. The World Bank will also give priority to improving the quality of the portfolio under supervision. At the project level, the World Bank and the Government will incorporate lessons learned from in-depth fiduciary reviews recently carried out on the World Bank-financed portfolio in several other Asian countries. Detailed and stricter procedures will be incorporated into project documents and agreements: (i) identification of specific anti-corruption measures as part of the project readiness criteria filter; (ii)strengthening of procurement and financial management mechanisms in project design and implementation; (iii)improving disclosure mechanisms; (iv) greater involvement of beneficiaries in project design and implementation; (v) strengthening of the World Bank's own supervision mechanisms; and (vi) systematic follow-up on cases of non-compliance, integrity issues and audit findings, along with appropriate remedial measures. The World Bank also will emphasize capacity development activities in monitoring the portfolio. As appropriate, existing projects will be restructured to match closely capacity development activities with expected project development outcomes. E. SCENARIOS AND TRIGGERS 91. The base-case IDA allocation, which is annually determined by the performance-based allocation system, currently provides an indicative allocation of US$128 millionz3over the four year period of the CAS.24 The Performance-based Allocation (PBA) system that allocates IDA resources among countries each year is strongly linkedto country performance as measured by the CPIA ratings - with strong weights attached to governance - as well as World Bank portfolio performance. This system further underscores the importance of maximizing results and impact, especially for a country like Lao PDR where available IDA resources are limited and are currently lower than during the last CAS. Lao PDR's performance in some key CPIA categories has been lagging in recent years, but with the renewed impetus for reforms and recent measures (particularly inareas such as public financial management, fiscal transparency and accountability) it i s possible that performance ratings could improve and thus generate higher IDA allocations during the years covered by this CAS. Given Lao PDR's low income and high debt burden, it i s expected that a significant portion of IDA resources will be available as grants. 92. A framework for assessing government performance and the adequacy of the policy environment has been developed. It focuses around key reforms in four areas: economic growth, public resource management policy (including government obligations under NT2), poverty reduction, and portfolio performance. The Government has begun reforms in each of these areas and maintaining momentum is important in the base case. A number of indicators, presented in Table 10, will be used to make ajudgment about the overall level of performance and adequacy of the policy environment for base and highcase scenarios. 23 This includes a one-time allocation for the NT2 program in FY05. 24 IDA-14 rules for IDA allocations are likely to change from the IDA-13 rules; however these rules arenot finalized at this point. - 45 - Outcome Areas Economic Growth Macroeconomic Accelerate increaseinrevenue Stability (by raisingrevenue/GDPratios;by limiting wage collections to over 14% of GDP increases to sustainablelevels;: by controlling govemmentborrowing;andlimiting domestic financing) Reduce inflation to and sustainit insingle RegionalIntegration Continue liberalizingAFTA trade and Implementrecommendationsof and PrivateSector reducing time to start a business the trade andinvestment climate Development studies Public Expenditure Strengthenpublicexpenditure management Initiate publicadministration ManagementIPolicy (by implementingthe 5-year Public Expenditure reform inMinistry of Finance ManagementStrengtheningProgram(PEMSP) Enhancetransparency (by publishing expenditureplans, budget,budget execution reports andfinancialstatementsregularly;by applyingrevisedchart of accounts & expanding coverage) Improve StateAudit Office (SAO) Capacity, (by preparingandpublishingpeer reviewreport on SA0 by INTOSAImember;by implementing its recommendations) Center-Province Make provinces accountable(by FiscalRelations ensuringthat expendituresare in line with budget; by eliminatingneb arrears to privatecontractors;by State-owned Continue SOE reforms (by restructuringlarge payingcivil servants salaries on Enterprises SOEs; by appropriatetariff adjustments in time) infrastructureSOEs). State Commercial Improve performance of SCBs (by Banks (SCBs) strengtheninggovemanceandreducingdirected loans;by enhancingregulationsandsupervision). NaturalResource Management Satisfactory implementation of NT2 Environment and social safeguards EducatiodHealth Initiate public administration reform insocial sectors Poverty Reduction Integrate NGPESinto the next Five-Year Plan Accelerateimplementation of and implement I NGPES IP andDOratings Achieve satisfactory IP andDO for 70 percent Achieve satisfactory IPandDO of projects for 80 percent of projects 93. Low case and high case lending scenarios will respond to client performance and the pace of reforms and implementation. A low case lending scenario, which would be characterized by a weak macroeconomic stance, slow pace or serious backtracking on the reform agenda and implementation of the poverty reduction strategy, or a poorly performing portfolio that significantly reduces Lao PDR's score on the PBA, will provide about US$40-80 million over FY05-FY08 and fund directly-poverty- related activities such as income generating and rural development projects, projects inthe social sectors, and capacity development. World Bank support for PRSCs i s not envisaged under the low case. If-therei s substantive non-compliance in the NT2 project, including non-compliance with safeguard and revenue - 46 - management undertakings, the World Bank would consider even further curtailing lending levels, including the option of not engaging in future financing and/or suspension of the entire portfolio, untilit i s satisfied that agreements are being met and there i s adherence to commitments. If the pace of reforms and implementation greatly accelerate and significant additional key policy changes are undertaken, it would be expected that the PBA exercise could pushLao PDR into a high case lending scenario of about 30 percent more IDA allocation than the base case. These additionalresources would be provided mainly through modulated PRSC amounts in support of policy and institutional reforms, such as in PSD, regulatory reforms, financial sector liberalization, the SOE restructuring program, or through one or two additional investment operations. F. MONITORINGCASIMPLEMENTATION 94. The implementation of the results-based CAS will be monitored and evaluated at frequent intervals to enhance effectiveness, determine accountability, and provide feedback for modifcations and corrections. The M&E will be undertaken in a participatory manner in consultation with the Government and other stakeholders. These will include annual CAS M&Eretreats with the World Bank`s Lao PDR Country Team and key stakeholder representatives including the Government, donors, NGOs, and other members of civil society. Independent evaluators may be commissioned to prepare the background material and issues for these retreats. The CAS Results Matrix (Attachment 1) will serve as a checklist of the intermediate and higher level outcomes for which the country team i s accountable. The details of the M&E mechanisms will be developed and agreed with the client and stakeholders. These M&Eexerciseswill becritical for providing the flexibility requiredinafour-year CAS and will feed into the CAS ProgressReport to be prepared and presentedtwo years after the CAS i s discussed. 95. Monitoring the elements of the NT2 project will be particularly important during this CAS period. As indicated in para. 74, a comprehensive M&E program i s being developed and will provide timely feedback to the Government, developers, International Financial Institutions and other interested stakeholders to take corrective action in implementation of the different management programs, and also to track outcomes. The M&Eframework for the project includes: supervision of physical implementation of the hydropower project by professional engineering firms under contract to the developers and the Government; monitoring by the Dam Safety Review Panel and the Panel of Experts (both mandated by the World Bank's safeguard policies); systematic monitoring of the technical and safeguards components of the project and its impacts by one or more professional firms on behalf of the private and public sector financial institutions; monitoring implementation of NT2 revenue management arrangements, including regular public expenditure reviews and public expenditure tracking surveys; an International Advisory Group to advise the World Bank's senior management on the implementation of this highcorporate risk project; and supervision by staff of the World Bank and other InternationalFinancial Institutions 96. A strongfield presence will be essentialfor monitoring CAS implementation. A greater field presence will be needed to ensure results and to help build capacity for implementing more complex infrastructure projects given the NT2 program of activities. The Country Office will need to maintain excellent working relationships and open dialogue with all levels of government. Donor coordination will also be a critical element of field presence, as well as participation in Donor Working Groups. The World Bank's administrative budget will be allocated to reflect the CAS priorities, including the need to fully fund the maintenance of a quality portfolio, the stringent implementation of NT2 and all related safeguard measures and consultations, the multi-year AAA cycle, the design of high quality operations at both the entry and implementation stages, enhancement of local capacity, and the ability to undertake effective partnerships and collaborative efforts. In keeping with recent trends, it is expected that various Trust Funds,usually executedby local counterparts, will continue to provide additional grant resources (such as GEF, IDF,PHRD) for selectedoperations, project preparation, research, and strategy formulation. - 47 - 97. The Bank will continue to expand its capacityfor improved communicationsand outreach with various stakeholders involved in Lao PDR's development. The Bank will build upon the considerable experience gained in its involvement with the NT2 project, where proactive engagement and communica- tions with various stakeholders has been accorded a highpriority, both locally and internationally. These activities have focused on anticipating and mitigating risk, sharing information on project development and the Bank's assistance stance, and updating the international community on Lao PDR's progress with reforms and poverty reduction efforts. Moving forward, the Bank will strengthen its capacity to carry out continuous engagement with various stakeholders. The Bank will work in coordination with donors in creating a multidonor funded public information and development outreach center as a focal point for housing and disseminating development information. This Public Information Center will share informa- tion on development in general as well as sharing research. These efforts -- combined with greater em- phasis on engaging stakeholders, civil society, and local communities in the development, design, and implementation of Bank-supported projects -- as well as increased involvement of local academicians and researchers inthe Bank's AAA work and better dissemination of findings, should help to improve the im- pact of Bank work, as well as familiarity with the Bank and its role inLao PDR's development. V. MANAGINGRISKS 98. The CAS presents an ambitious program supporting selected elements of the broad NGPES agenda and its implementation and achievement of results are subject to multiple risks. The risks fall under the following four categories: first, risks arising from performance by the Government on the NGPES, which is the framework around which the CAS i s designed, caused by fluctuating political commitment and weak implementation capacity; second, risks arising specifically from lack of performance under the NT2 project; third, risks relating to the effectiveness of support extended to the country by its external development partners, including the World Bank; and fourth, risks arising from external factors over which the Government has no control. The management of these risks will determine the pace and direction of future policy reforms under NGPES, as well as implementation performance on the NT2 project. The proposed CAS scenarios and IDA programs are designed to address these issues, including cases of slower or faster reforms and modulatinglevels of IDA support. 99. Country-level NGPES risks revolve around potential for weak political will and commitment to reforms, as well as weak capacity to implement desired reforms in areas such as revenue mobilization, trade reform, SOE restructuring, etc. (see para. 38). There i s also the risk of weaker engagement on broader reform issues after NT2 is approved. However, with the NGPES consultative development process and subsequent approval by the National Assembly, the Government has generatedbroadnational stakeholder commitment to the NGPES program as a whole and to the pushfor regional collaboration and integration in particular. In addition, donors have raised their levels of collaboration andjoint action with the Government in the development, and now implementation, of the NGPES; and regular Round Table and other meetings will focus attention on the measuresneededto sustain reformmomentum. The World Bank program will also provide a strong basis for continued dialogue with the Government on different options for reforms. Although some reversals inprogress on reforms cannot be ruled out and the overall pace of reforms will vary from sector to sector, the internal momentum for reform and the coordinated support of the donor community should help sustain political commitment. Similarly, with regard to weak government capacity, the UNDP, the World Bank, and other donors are working closely on supporting the development of government capacity to turn its NGPES program into prioritized and costed action plans that are implementable by key ministries and many donors are working with the Government to improve key systems that are the backbone to an efficient public administration. The World Bank's planned support for strengthening capacity throughout the CAS, in its AAA, and through its investment support program, highlights concrete capacity development measures to strengthen - 48 - implementation at the institutional level. Progress in these respects will all help alleviate the very real capacity constraints that currently exist. 100. Risks arising from lack of performance under NT2. These risks relate in particular to use of natural resource revenues for non-poverty related activities and failure of the Government to abide by its commitments in implementing the critical safeguard arrangements for NT2. World Bank and other donor assistance in support of Lao PDR's PEMSP and the NT2 revenue management arrangements will be the primary instruments for managing the revenue management risk. NT2 project arrangements include a set of legal agreements and carefully designed enforcement mechanism, while the planned series of PRSCs and accompanying Technical Support will help maintain momentum on the broader program of Public Financial Management reform, helping the Government to systematically address issues as they arise and developing a system that will be more effective and more transparent for all natural resource revenues. Similarly with regard to safeguards, within the context of the NT2 program, the World Bank will provide assistance for supervision and monitoring through the NT2 Guarantee and the NTSEP; while at the national level, the LEnS project will complement NTSEP by addressing capacity and policy issues, including strengthened capacities in environmental assessment, monitoring and compliance, resettlement planning and implementation, protected area management, river basin and watershed management, and environmental education and awareness. Independent technical and environmental experts will also continue to be involved inmonitoring implementationto help guard against safeguard violations. Finally, the partnership agreementamong the donors involved inNT2, that i s being shared with the broader donor community, highlights the need for coordinated donor responses, including with respect to the Government's performance on NT2. IDA assistance also will be influenced during the current CAS period and beyond by government performance on its legal obligations to the World Bank regarding the NT2 project. 101. Risks relating to uncoordinated donor support. The donor community in Lao PDR i s making progress in strengthening its coordination but a potential lack of commitment by donors to align their resources around common frameworks could pose a risk for implementation of the NGPES and achievement of CAS objectives. This risk i s compounded by the World Bank's relatively low level of IDA allocations and administrative budget. These factors call for an approach that coordinates and thus leverages the World Bank's AAA work and small lending program through stronger partnerships with other donors. Fortunately, strong donor coordination exists around the NGPES and will continue to be reinforced through the regularly scheduled Donor Working Groups and increased use of harmonization guidelines. The use of the UNDP supported Round Table Meetings as a platform to deliver messages to all stakeholders and reaffirm commitments to the Government's vision should also help to strengthen coordination and collaboration. 102. External risks. Changes in the trade regime, such as the end of the MFA, or adverse economic developments in Lao PDR's main trading partners could weaken export prospects. Mitigation measures include strong movement forward on the IntegratedTrade Framework where government commitment i s high; analytical work on the Investment Climate Assessment leading to policy changes, improved incentives and increased flexibility in the private sector to respond to shocks; continued support to strengthened dialogue and partnership with neighboring countries to facilitate integration and diversification; support for the private sector through IFC and MPDF; and continued PRSC support for key policy changes. - 49 - VI. CONCLUDINGREMARKS 103. As Lao PDR continues to implement its NGPES program and accelerate the positive trend in reducing poverty, the alignment of the World Bank's CAS to support this effort will be significantly strengthened by more comprehensive capacity development, improved donor coordination and harmonization, and expanded analytical and advisory activities. The proposed framework to evaluate the achievement of the CAS objectives and World Bank performance will validate whether this new approach to operating in Lao PDR will enhance the development impact of IDA resources. Lao PDR will continue to need concessional assistance from its international partners and this CAS provides the foundation for that support over the next four years. 80 b - 'P E 0 0 . 0 . . . . a . 0 . . 3z e.3 a- * * * 0 3 3B L40 0 . 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 Y 3 - B e e a e m e e - 58 - Attachment 2 CAPACITY DEVELOPMENT 1. Capacity development i s the "process by which individuals, groups, organizations, institutions and societies develop abilities to perform functions, solve problems, and set and achieve objectives."' Capacity i s thus critical to achieving specific, measurable development results. In countries where capacity i s weak, achieving specific measurable results requires attention not only to appropriate skills, but to incentive systems, organizational processes, and institutions. This implies a broad country-led approach to capacity development, going beyond the transfer o f skills to an endogenous process o f strengthening institutional and management arrangements and systems. The retention and effective use o f existing capacity are just as important as building capacity. Hence addressing the personnel incentive regime - ensuring adequate base pay and performance rewards -i s also important for buildingeffective capacity. A growing body of evidence suggests that successful donor support for capacity development must respond first and foremost to demand from key stakeholders and be nurtured through appropriate incentives. 2. The Government realizes that overcoming its capacity challenge i s important to achieving its development goals. Although the NGPES does not articulate a comprehensive, integrated strategy to address capacity bottlenecks, capacity needs are featured throughout the strategy. Specific areas where the NGPES notes the need for a greater emphasis on capacity include: strengthening public services, especially at the district level; undertalung administrative reforms to improve the functioning o f the government and civil service; and building capacity infinancial management, decentralization, and development planning. The NGPES notes the importance o f the National Organization for the Study o f Policy and Administration (NOSPA), the primary civil service training institution, in supporting these reforms. The CPI, with responsibility for implementation o f the NGPES, will need to ensure overall coordination o f capacity development activities within the Government. Capacity development at the sectoral level will be managed by line ministries. NOSPA has responsibility for capacity development o f the civil service and at the sub-national level and the Ministry o f Finance's Institute will handle capacity development inthe area o f public financial management. 3. The challenges to overcoming capacity constraints, however, should not be under estimated and emergingopportunities shouldbe supported. Progress will be slow and incremental and the achievement o f a broad capacity enhancement fi-amework may not be fully realized during the timeframe o f this CAS. Shortages o f management and technical skills in finance, accounting and procurement are particularly acute. Organizational structures and basic management systems (such as the budget process and monitoring and evaluation functions) are not aligned with government development priorities. Centralized decision-malung often discourages local initiatives. L o w levels o f pay, delays inpayment o f salaries (especially in rural areas), and lack o f performance-based promotions weaken the motivation for highlevels o fpublic sector performance. The decision-making process i s not well-understood and the distinctions between legislative, executive, and judicial functions are blurred. Decision makers are often isolated from the civil service and conversely civil servants are often poorly informed about government policy, legislation and even administrative procedures. The Government continues to control the activities o f the private sector through cumbersome investment procedures and annual 'UNDP, CapacityDevelopment, 1997. - 59 - tax licenses. The Government indicates a strong preference for local expertise to provide technical assistance, but few consultants with the requisite s h l l s exist. 4. Nevertheless, opportunities are emerging. Accountability and transparency are increasing in some areas with elections now held for the National Assembly and village leaders (albeit usually from party lists only). National Assembly debates are now televised, budgets are published, and community development projects allow broader involvement in decision-makmg at the field level to design, implement, and monitor outcomes o f local investments. Efforts are also being made to clarify the role o f the legislature and judiciary, and responsibility for the administration o f the civil service has been restored to the Prime Minister's office, evidence of the importance that the Government gives to improving civil service performance. Recognition o f the challenges posed by ASEAN and WTO accession has also spurred openness to learning from the experience o f China, Malaysia, Vietnam, and Thailand and has encouraged growing ties with neighboring countries and an examination o f their reform processes. Training o f civil servants i s now delivered by a range o f institutions, and also by making greater use o f the university and training events sponsored by external partners. Modern public sector and economic management concepts have entered the curriculum o f degree courses, and NOSPA i s exploring institutional partnerships with institutions inThailand as well as with WBI. 5. Two studies o f the political economy o f reform undertaken inparallel to CAS preparation provide important insights into designing the Bank's assistance strategy. The first study assessed the social and political factors that influenced the reform agenda, focusing on decentralization, governance, and the private sector.* The second was an informal comparative analysis o f reform inChina and Vietnam and the implications itmay have for the trajectory for the reformprogram in Lao PDR. These reports highlighted that reform will be made according to Lao timetables, which may be slower than donors would like (and likely slower untilthe 8' Party Congress meets in 2006); that many government and party officials remain suspicious o f western ways; that personal relationships are critical and broadening our scope o f contacts within government, both formally and informally, will be important; that presenting strong rational options based on good research data in face-to-face encounters in relaxed and informal settings i s more effective than written communication; that comparators from ASEAN countries and other neighbors i s effective; that even ifradical reform i s unlikely, incremental improvements are possible and are very important for improving governance and buildingcapacity; and that working at the level o f local government (following the example o f China) and supporting the building o f its capacity i s also important. LESSONS LEARNED BANKPROGRAMIMPLEMENTATION FROM 6. A number o f reviews have been undertaken to assess lessons learned fi-om Bank- supported capacity building in Lao PDR. These included a Capacity Development Portfolio Retrospective that analyzed the capacity focus and impact o f technical assistance (TA) and training in 10 recent Bank projects in Lao PDR; a Capacity Development Concept Note articulating an approach to mainstreaming capacity development in the new CAS; a capacity analysis o f the local administrative training institute, NOSPA, and a WBI-designed CE framework and methodology to address capacity issues at the institutional, organizational, and Stuart-Fox, Martin, "Politics and Reform inthe Lao People's Democratic Republic", Working Paper No. 1, Political Economy of Development series, Programon Civil Society and Governance, The College of William and Mary, M a y 2004. - 60 - individual levelse3Together this work highlights the need for a more integrated approach to capacity development in the CAS by combining long-term efforts to address structural weaknesses with opportunistic interventions aimed at short-term results. 7. Although capacity buildingwas considered a priority inthe last CAS, no explicit capacity framework or strategy was articulated. As a result, capacity development efforts have been fragmented. The Bank's work has tended to focus on addressing its own fiduciary and reporting requirements rather than on the long-term needs o f the client. Inadequate attention has been given to broader developmental goals or effectiveness. 8. W B I ' s review o f the Bank's project portfolio in Lao PDR indicates that most Bank interventions have included capacity development activities. However, the Bank's capacity development interventions have rarely been supported by a systematic assessment o f capacity constraints and requirements and have generally lacked clearly defined capacity development objectives and indicators. Consequently, it has proved difficult to monitor and evaluate the impact o f Bank interventions on capacity building. 9. There have been some notable exceptions. One example o f effective capacity development i s the Road Maintenance Program (RMP), an eight-year Adaptable Program Loan (APL), approved in 2001 after considerable dialogue and after agreement on clear roles for donors and other stakeholders. The project marked a major shift in focus from ad hoc donor- driven investment to one o f harmonized preservation and sustainable management o f road assets. Previously, donor-supported Project Implementation Units (PIUs), staffed by expatriates or nationals, paid significantly higher salaries, increased transaction costs and seriously compromised the development o f existing institutions and the effectiveness o f development programs. Narrowly focusing capacity building on training and technical assistance failed to address fundamental issues o f institutional incentives and organizational accountabilities. Roads were being built, but not well maintained. As part o f the RMP, all implementation functions for donor-financed projects in the road sector were internalized within the Ministry's existing structures and all ad hoc PIUs were dismantled. Absent PIUs, projects continued to be well implemented by the Ministry and harmonized systems in financial management, procurement, reporting and monitoring further increased efficiency. Building on this experience, the second phase of the RMP will support a comprehensive human resources strategy. The Ministry will track progress through the systematic monitoring o f pre-agreed indicators. This note builds on the considerable work that the Bank has done over the past year-and-a-half to review capacity building activities, identify the key lessons leamed, and apply them to develop a more systematic and integrated approach to capacity development. Contributing reviews and discussion pieces include: CE Portfolio Retrosuective; Cauacity Development Conceut Note for Lao PDR CAS by WBI and the CT that was complemented by a Studv of the Political Economv, which cautioned against an overly ambitious time line for effecting institutional change. E/ Results Framework powerpoint that lays out the 3-level (institutional, organizational and individual) framework and the concem with linking improved skills and processes as intermediate outcomes leading to higher order operational or development outcomes. Validating the Auuroach: Cauacitv Develoument Pilot in the Transuort Sector: WBI participated in both pre-appraisal and appraisal missions for FWP2 helping to design a process to prioritize, baseline and monitor critical capacity issues constraining the decentralization o f the maintenance fund management and procurement functions supporting rural road maintenance. Institutional Analvsis of the National Organization for the Studv of Policv and Administration (NOSPA), which i s the main training institute (strongly tied to the Party) for the civil service. - 61 - 10. Additional key lessons from experience inLao PDR include: Capacity building components within projects have been most effective when applied within an integrated program-based approach linked into national and sector strategies that prioritize specific capacity results. Skills building efforts combined with policy reforms and donor alignment with country-led strategies have also had stronger results. At all levels (national and sector strategies, as well as in projects and analytical work), capacity development should be linked to specific, measurable results and broader development objectives. Ensuringthe existence o f baseline information on capacity levels, defining appropriate indicators, monitoring interventions based on outcomes, and realistic timetables are all important. Approaches should be both opportunistic-aimed at achieving short-term results- and strategic-gradually addressing structural weaknesses that can only be overcome over the long-term. Capacity development requires a sound understanding o f incentive and governance structures. Clearly understanding organizational processes at different levels (central, provincial, and district) i s also required for developing strong institutional and organizational capacity. Capacity development activities should be matched with broader development outcomes. Effective upstream communication with stakeholders, identification o f champions, and deeper understanding o f incentive structures and change processes are critical inproject design and implementation. Because o f the oral tradition in Lao PDR, written communication, and even lecture- style training i s less effective than "learning-by-doing" where new concepts, policies and processes are explained and then applied ineveryday activities. CAPACITYDEVELOPMENTLAO IN PDR:APPROACH 11. These challenges and opportunities, as well as lessons learned from previous experience, have implications for the approach the Bank takes to support the Government's capacity development strategy. Because capacity development encompasses the behaviors and performance o f institutions, organizations and individuals, it requires a better understanding o f the governance structures and weaknesses that determine a country's development potential. It also requires a better understanding of institutional and organizational incentives and processes, so that weaknesses can be addressed. Mainstreaming capacity development also means that external interventions need to be closely aligned with sector strategies, supporting the development o f these strategies so that they are realistic and operational. 12. Progress against both development and capacity enhancement objectives will have to be monitored. Capacity development objectives should be mainstreamed in the design and implementation o f individual operations (projects and analytical work) within a results-based framework, This begins with a diagnosis o f capacity constraints, defining desired results, articulating step-by-step strateges and defining ways o f measuring and monitoring progress. Partnerships with local institutions are critical for designing and monitoring appropriate capacity - 62 - development initiatives, and to delivering key inputs such as training. Because the challenge i s much larger than the resources available for addressing it, closer coordination will be needed among development partners. Donor collaborationthrough sector programs will also be important to ensure consistency and efficiency. 13. In light of the above elements, the following will be important to incorporate into the Bank's approach: 0 Explicitly and systematically assess capacity constraints as national (NGPES and SEDP) and sectoral strategies are further developed. As the government moves towards developing action plans for the implementation o f the NGPES, as well as incorporating the NGPES into the next SEDP, capacity constraints should be explicitly analyzed and actions prioritized. Indeveloping programs to address these gaps, clear objectives should be set, measurable indicators defined, and monitoring systems put inplace. This approach applies equally to analytical work and should guide donor coordination efforts. 0 Ensure that capacity development strategies and interventions are informed by an understanding of political economy and institutional incentives. Ineach area o f proposed reform and at both central and local levels, a better understanding o f the decision-malung process will improve the effectiveness o f the design and implementation o f our support to government. At the level o f institutions that we work with, the Bank should seek to understand how governance structures impact policies, programs, and activities. This will better ensure that our policy advice i s more responsive to the needs o fpolicy makers and i s grounded in a better appreciation o f current institutional and organizational realities. 0 Strengthen local training institutions to incorporate new material and expertise into their curricula. Further support should include the universities, ministry-specific training institutions such as the Ministry o f Finance Training Schools, the Customs Training Facility, the National Audit Office Training Schools, and the 29 training institutions o f the Ministry o f Education (of which two have capacity for accounting and finance training), as well as NOSPA. The Second Education Development Project, for example, i s supporting the MOE's capacity building strategy to buildup in-country capacity for the delivery o f training in education administration and management through the establishment o f a Department for Education Administration and Management within the Faculty o f Education at the National University o f Lao (a US$1 million project component). Training o f trainers i s another area where donors have had some impact and more could be done. 0 Ensure capacity development is mainstreamed into the Bank's country program. Capacity development should be embedded in the routines o f program and project development, implementation and monitoring o f the Bank's portfolio, as well as in the design, implementation, and follow-up o f analytical work. Client feedback should be encouraged. All projects, programs, and analytical work - including on-going projects - should develop a capacity development strategy, including monitorable performance indicators, within the first year o f CAS implementation. Activities should be aligned within the broader sectoral strategies and action plans and should systematically baseline, build,and monitor key capacities. Activities shouldplace greater emphasis on learningby doing, ensuring that training i s sequenced with policy and institutional reforms that will improve potential for new skills to be used and institutionalized. Bank teams and their government counterparts will require guidance on how to apply the broad capacity - 63 - development fi-amework operationally, and simple tools and guidelines will be developed to help them to: (i)diagnose capacity constraints; (ii)develop a coherent capacity development strategy; and (iii) design monitoring mechanisms. CAPACITYDEVELOPMENTLAO IN PDR:Focus 14. Given scarce resources, Bank support will focus on achieving NGPESKAS results in areas where: (i)the Bank has a demonstrated track record, comparative advantage, or global knowledge and experience to build confidence and create demand for change, (ii)there i s sufficient government commitment to building capacity to achieve priority results, (iii)an institutional entry point has been identified where overcoming capacity constraints will significantly affect development outcomes, and (iv) other stakeholders, including donors, have a shared commitment to common results and coordination o f efforts andresources. 15. Insupporting the achievement of NGPES results, during this CAS period the Bank will focus its capacity building efforts in three main areas: (i) building relationships with policy makers and helping to strengthen organizational processes and incentive systems; (ii) helping to strengthen national, sectoral, and training institutions by better integrating capacity development into all World Bank activities; and (iii) buildingpartnerships, consulting, and helping to enhance the capacity o f the private sector, civil society and mass based organizations, and communities. While this Appendix does not attempt to be comprehensive, it outlines below some o f key areas of plannedBank involvement. 1. Buildrelationships and strengthenorganizational processesandincentivesystems. 16. Continuing to strengthen relationships at different levels o f government and with different institutions will be important during the CAS period for stronger and better informed policy dialogue. Duringthe first few years o f CAS implementation, there will be a strong focus on public financial management as a core backbone to stronger public administration as well as good governance. The Bank program will also support analytical work on the trade and investment environment to strengthen government understanding of various policy options for strengthening policies to enhance regional and global integration. Other parts o f the work program will focus on decentralization in a pilot province, Khammouane, through both analytical work and lending. Other aspects o f public sector reform, such as civil service pay, will be addressed through PRSCs. Outlined here, as an example of some o f this work, i s our approach to supporting the development o f capacity o f government inpublic financial management. 17. Strengthen corepublicfinancial management capacities. InApril 2003, the Government developed a governance reformprogram based on actions infour priority areas: (i) public service reform; (ii)people's participation; (iii) rule o f law; and (iv) sound financial management. The the UNDP's Governance and Public Administration Reform Program (GPAR) i s supporting this improvement in governance by targeting civil service reforms and redefining central-local relationships (decentralization). Efforts are underway on a pilot basis to improve the management o f public administrationthrough increased professionalismand merit-based recruitment.Work on strengthening participation and decentralization i s being supported by a group o f donors to encourage local empowerment and clarify roles o f central and local authorities. Japan and Norway are helping to strengthenjudicial reform activities and the World Bank, ADB and UNDP are focusing support on public financial management to improve fiscal planning, budget preparation, revenue and expenditure management and financial legislation and regulations. Buildingon ajoint World Bank, IMF, ADB Public Expenditure Review, the recently completed - 64 - Financial Management Adjustment Credit, and a strong dialogue on the management o f natural resource revenues catalyzed by Nam Theun 2 preparation, the Bank has worked with the government to develop a Public Expenditure Management Strengthening Program (PEMSP) with a significant capacity development component. 18. The main objective o f the PEMSP is to increase Ministry of Finance capacity to more effectively and transparently utilize public financial resources in line with NGPES/MDG results. It will ensure that key staff have the technical skills needed to fulfill their assigned expenditure management functions through targeted training and gradually develop a cadre o f accredited financial management personnel. 0 Articulation and implementation of a strategicframework for public expenditure reforms with an explicit emphasis on capacity. Inclose coordinationwith other donors (especially ADB and IMF), the Bank worked with the Government to develop a comprehensive public expenditure management strengthening program that integrates activities (and donor support) around a common framework. Capacity development i s a key component o f the PEMS, built around two government objectives: (1) to raise national public sector skills for improved budget preparation and execution; and (2) to improve quality and transparency o f public financial management including enabling it to meet intemational accounting and auditing standards. This will be supported by the N T 2 Loan Guarantee, Financial Management Capacity BuildingCredit (FMCBC), proposed PRSCs, and PHRD grants. 0 Support for specijk institutional, organization, and individual capacity building measures highlighted in the PEMSP. Discussions are underway to determine specific areas and modalities for World Bank support for PEMSP capacity. At the organizational level (both nationally and at the provincial and district administrationlevels) the program will develop appropriate systems for expenditure planning and budgeting to allocate public resources more effectively according to the Government's development and poverty reduction policy objectives and will improve procedures and skills for better budget execution, accounting, and financial reporting. These activities will include an initial needs assessment and capacity buildingstrategy (FY04-05), revised organizational roles and responsibilities; upgrading and development o f financial training institutions; and training o f critical staff. This will be supported by the FMCBC, PRSCs, and activities supportedjointly with UNDP. 2. Strengthen national and sectoral institutions, as well as training institutions 19. The Bank program will strengthen local capacity in every area o f Bank involvement, supporting country capacity development goals through all CAS instruments - policy and project loans, sector strategies, and analytical and advisory work. Box 1 outlines how capacity development will be integrated with Bank product cycles to support the development o f country capacities, ensuring that capacity constraints and political economy issues will be considered at the concept stages, firmed up during decision point stages, and evaluated duringimplementation. The program will support cross-sectoral government capacities to manage the process o f deepening and implementing the NGPES, including workshops for the National Assembly on NGPES implementation, costing, and budgetary oversight. It will also strengthen capacities o f sectoral institutions at the national, provincial, and district levels to develop and effectively implement sound sector strateges and programs. It will strengthen capacities o f local training institutions to support capacity development activities. A few other examples o f how Bank instruments will strengthennational and sectoral institutions are presented. - 65 - CAPACITYDEVELOPMENT BANKPRODUCTCYCLES AND Capacity development objectives, strategies and performance indicators will be integrated into each stage o f the product cycle. It will be made explicit inthe concept note for projects and policy and analytical work. At this stage task teams can identify financing requirements to address capacity issues in project preparation, such as diagnostic studies, and the national andregional partners that can support development o f the capacity development strategy. During preparation capacity constraints will be taken into account and addressed when formulating objectives, performance indicators and targets. This will entail the formulation o f specific capacity development Monitoring Project / Policy &Anal- . .-' - \ strategies, identification o f specific ( Preparation capacity development inputs and results, Particular attention will be given to how analytical and policy work can be integrated into the Government's policy making process, the identification o f target audiences and appropriate communication strategies. Key performance indicators should consist o f the extent to which policy recommendations are adopted, implemented and their impact assessed. At decisionmeetingdappraisalthe adequacy o f the project or AAA capacity development framework will be assessed. National institutions should take the lead in project implementation,with particular emphasis on learning by doing. Where specific inputs are provided- consulting and training services - there should be a strong preference for partnerships with local institutions. For policy and analytical work, the implementation stage extends beyond the analytical work to cover its adoption and application as policy. This is likely to increase the cost and timeframe o f policy and analytical work. Routine monitoringand follow-up should regularly review progress to help project teams and clients assess whether capacity development strategies are having the desired results and make appropriate adjustments. Retrofittingexisting projects may also be needed. Evaluation at the project and program level should focus on the impact o f interventions on institutional capacity and lessons-learned: these assessments are likely to have a greater impact when national institutions are directly involved. 20 Strengthen Committee on Planning and Investment (CPI) capacity to implement the NGPES. The CPI has overall responsibility to support and manage implementation o f the NGPES. CPI will need to work in collaboration with the technical ministries and organizations that actually implement the Government's programs -- prioritizing, costing, and monitoring the NGPES. Developingmonitoring systems i s a critical element o f successful implementation o f the NGPES, as they are an important way to foster a culture o f learning and innovation in the public sector, providing feedback on strengths and weaknesses, successes and failures. Jointly with other donors (the UN, ADB, WHO, SIDA, etc.), the Bank will assist CPI and other targeted institutions (Ministries o f Health, Education, Agriculture, and Infrastructure in the initial round) to set priorities and monitor progress as follows: 0 Workshops. A series o fjoint Bank/UNDP-supported workshops and technical assistance are helping CPI and line ministries (with NOSPA as an observer) to prioritize actions under the NGPES in light o f budget constraints. This includes articulating and sequencing action plans in key sectors; reconciling needed expenditures with financing - 66 - constraints; and preparing sector programs and supporting matrices. The action plans will identify key capacity constraints, select specific capacity interventions and develop indicators to monitor progress. Instruments would include UNDP-Bankjoint support for NGPES implementation, NGPES updates, donor theme group, and the UNDP monitoring project. Studies. Incollaboration with donors, CPI will undertake a study to assess capacity gaps and take inventory o f existing capacity initiatives and the resources assigned to them. This has been suggested to the Government (in the JSAN, among others) and dialogue needs to continue among donors and with the Government to determine the best modalities for helping the Government to undertake such a complex task. Data Collection and Analysis. Assist the National Statistical Center to build a poverty monitoring and evaluation system and to link it with NGPESMDGmonitoring. This will be supported by the Poverty Assessment, Lao PDR participation in regional WBI initiatives, sectoral interventions, and activities supported by SIDA and other donors. 21, Strengthen government capacity to apply environmental and social safeguards, building on the NT2project experienceas well as extending to other regions. Duringthe CAS period the Bank will provide intensive support to the Government to build its capacity to apply environmental and social safeguards both in support to the N T 2 program, as well as more broadly inother parts o fthe country. This will be supportedbythe followinginstruments: NTSEP, LEnS, GEF, and the ongoing forestry project. The environmental and social capacity development objectives around N T 2 include: Institutionalize the WatershedManagement and Protection Authority. This agency will improve management o f the Nakai Nam Theun Protected Area. The initial focus will be on improving capacity for: biodiversity assessment, patrolling and monitoring wildlife poaching and logging, and community participation and livelihoods development. Activities will include developing operational processes and rules for the Authority and i t s engagement with stakeholders, staff training and study tours, partnership with NGOs and other national parks, village facilitation teams, education and awareness programs. Build the capacity of the Khammouane Province to undertake responsible, accountable and effective resettlement. A decentralized government unit will coordinate resettlement efforts in the province and the program will be implemented through a public-private partnership that will build capacity on both sides. NGO capacity will be developed to support village-level planning and delivery o f livelihood programs and services and village facilitation teams will be trained to facilitate detailed village-level planning with districts. Visits will also be made to other dam projects to learn good practices. Improve the capacity of the Science, Technology and Environment Agency (STEA) to monitor environmental compliance with NT2. Monitoring protocols and education and awareness programs will be developed for STEA staff. STEA staff will also be trained both formally, as well as on the job through resident experts, to monitor compliance with the Concession Agreement and to ensure adequate water quality. Encourage the design of sustainable environmental and social policies and build institutional capacity to implement those policies in Lao PDR beyond the NT2 project urea. The Lao Environment and Social Project (LEnS) will support: (i)strengthened capacities o f government institutions, including STEA and MAF, at the central and - 67 - provincial levels, in environmental assessment, resettlement planning, monitoring and enforcement, protected area management and raising environmental awareness; (ii) establishment and operation o f a pilot financing vehicle for protected area management in Central Lao, to be scaled-up inthe long term as a permanent entity that will be eligible to use N T 2 revenues for environmental protectionactivities inthe country. 22. Strengthen key sectoral and provincial capacities where the Bank has a comparative advantage. Bank project and analytical work at the sectoral level - education, health, roads, electricity, forestry, etc. - will support capacity development. Efforts include those in the Ministry o f Education; Ministry of Communications, Transport, Post, and Construction (MCTPC); and Ministry o f Agriculture. Examples o f activities inthe Ministryo f Education and MTCPC are described below. Strengthen the capacity of the Ministry of Education to target resources to reach vulnerable groups and to track education outcomes. Support will be provided to build Ministry o f Education capabilities to: (1) target education resources to the most vulnerable groups and better monitor expenditures; and (2) monitor education outcomes and use monitoring information to informpolicy decisions. With a particular focus on the 47 poorest districts as identified inthe NGPES, the activities would include: establishing a monitoring and evaluation system to strengthen organizational processes and assess education outcomes; supporting the development and implementation o f a public expenditure trackmg survey (PETS) that will enable the Ministry o f Education to better track allocations and expenditures (and would also linkwith the cross-cutting work o f the Ministry of Finance and with CPI in implementing the NGPES); baselining existing functions and staff capabilities; and implementing training on program budgeting, costing, and priority setting. These activities would be supported by any needed retro- fitting o f the monitoring framework o f the Second Education Project (EDP2) to include capacity indicators related to project outcomes; and the PETS study to assess education expenditures and identify key actions to improve transparency, accountability, and effectiveness. A project coordination division focusing specifically on M&E has been established under the Ministry o f Education. Given the strong focus on M&E for capacity buildingby the MoE, consultants have been hired to work alongside the unit and provide TA to help guide the unit's staff intraining other agencies within the MoE on designing a monitoring framework in all aspects o f their work. An Education Sector Study i s also planned. Continue to improve the capacity of the MCTPC to manage the road network. Building on successful pilot projects inthe first Road Maintenanceproject (RMPl), the RMP2 will support increasing capacity for road management and financing through increased central and provincial capacity for planning, budgeting, implementing maintenance work programs; increased capacity for road transport management and safety; and building organizational capacity o f MCTPC and provincial departments o f MCTPC to upgrade key business functions, including safeguards, for effective performance under a decentralized structure; promote results-oriented human resources development, information technology and communications; strengthen transport business sector; and improve environmental and social safeguards capacity. The RMP2 will also help to decentralize road maintenance functions to the provincial level and build managerial s h l l s to effectively manage and distribute the road maintenance funds to local communities; and build the systems and capacity necessary for improved procurement leading to the issuing o f small contracts for work undertaken at the provincial level. Based on decentralization o f road maintenance in two pilot provinces under RMP1, in - 68 - RMP2 a comprehensive HR strategy was developed for the Ministryto standardize skills and processes required for decentralization in all provinces. The process of base-lining capacity, tailoring capacity development interventions and agreeing on monitoring indicators was undertaken during appraisal o f W 2 . A PHRD grant i s currently supporting a consultancy study, based on detailed capacity building TORSin the RMP2 PAD, to determine baseline capacities and monitor progress at both national and sub- national levels. 23. Strengthen capacity of local partner institutions to support capacity development activities. Local institutions will play a critical role in helping to scale up the implementation o f capacity development initiatives in Lao PDR. NOSPA i s the Government's primary training school for civil servants and i s identified inthe NGPES as the focal point for supporting capacity development activities. In partnership with other donors (including GTZ and UNDP), WBI and the country team are working with NOSPA to strengthen NOSPA's capacity to support NGPES implementation. Tools include revised curriculum design and learning methodologies; research and policy analysis; institutional twinningand other partnership arrangements between senior Lao PDR government officials, their institutions and counterparts inneighboringcountries (especially China and the Ho-Chi MinhAcademy inVietnam). Partnerships with institutions from Korea and Australia are also foreseen as a starting point for their international networks. WBI thematic programs are poised to partner with NOSPA in the design and delivery of skill and policy based courses, to be the basis for enhancing the autonomy o f NOSPA in design, delivery as well as related research in the second and third years. Instruments include: WBI thematic programs in Trade, Investment Climate and PRSP; WBI PHRD funding for preliminary assessment and design of full program proposal for institutional strengthening to prepare it for NGPES implementation; PHRD and IDF grants, partnership programs with GTZ, Melbourne Institute of Technology, UNDP, and the Korean Institute for Development Finance. 3. Buildpartnershipsand capacity of the private sector and civil society 24. During implementation of the CAS, the Bank will build on the consultative process of both the NGPES and the development o f the CAS, by continuing a strong level o f dialogue and participation with the private sector and broadly with civil society. It will do this by strengthening partnerships with the private sector, consulting with civil society and mass-based organizations, and by working with communities. Several activities are underway to work with both the Government and the private sector to strengthen regional integration and private sector development. The Poverty Reduction Fund Project i s also identified below as an example of capacity development at the community level. 25. Strengthening partnership and capacity in theprivate sector. One example o f the way the Bank will support partnerships and capacity in the private sector i s its support to the development of a pro-poor, pro-growth trade strategy. A Diagnostics Trade Integration Study (DTIS) will serve as a road map for technical assistance and project support that enables Lao PDR to improve its trade performance. Through a collaborative approach with a range of stakeholders, the study will build capacity, especially o f Ministry o f Commerce staff, to enable them to access and analyze international trade data, better understand implications of commitments in trade, and identify key constraints to Lao PDR's export competitiveness. The study will better inform negotiations with the WTO and raise broader awareness among policymakers and other stakeholders on trade policies and pro-poor growth. This complements the IFC/MPDF support to the Lao Business Forum, which facilitates capacity development inthe private sector and provides an ongoing mechanism for improving coordination o f trade and private sector initiatives. T o increase access to finance, IFC/MPDF has been workmg with the - 69 - Lao PDR banks and private SMEs on skills for credit assessments and loan performance. Managerial training for SMEs i s being provided by the Facility as i s training for business associations such as the Hotel and Restaurant Associations and Lao Textile and Garment Industry Group, Collaborative work through the Donor Working Groups and through PRSCs will also align donor assistance for south-south dialogue and other networks. A World Bank-ADB Investment Climate Assessment undertaken in a collaborative manner will assess key constraints and support development o f a private sector development actionplan to coordinate key policy and institutionalreforms. 26. Support capacity development of civil society. The Bank will support community empowerment and civil society capacity development through a number of its projects, grants, and AAA. The ongoing Poverty Reduction Fund Project, as one example, applies a strong participatory process at the village level to buildcommunity capacities to identify needs, develop solutions, and participate in implementation and monitoring o f sub-projects. A primary objective i s to build capacity and empower villages to manage their own public investment planning and sub-project implementation in a transparent manner as well as to strengthen local institutions to undertake participatory decision-making and conflict resolution processes at the village, inter- khet, and district levels. Capacity building interventions include the establishment o f provincial technical support teams to provide technical advice to project teams and training to District Facilitators to work directly with communities participating in the project (overseeing project implementation and coordinatingwith district officials). - 70 - Guidelines: UpstreamIntegrationof Capacity DevelopmentinLao PDR CASInstruments The overall goal o f the CAS program i s to support the development o f Lao capacity to achieve its development objectives as articulated in the NGPES. A framework to integrate capacity considerations into lending and non-lending CAS instruments has been developed. The framework integrates capacity concems at the strategic level through NGPES implementation workshops, policy dialogue and the PRSC. Annual CAS reviews, multi-donor roundtables and other annual fora provide opportunities to reconfirm priorities and adjust programs as needed based on progress indicators. Within the Bank CAS program, project loans, sector strategies and AAA integrate consideration of capacity constraints, outline capacity development actions and monitor progress inimproving capacity against agreed indicators. NGPESWorkshops. A series of joint World Bank, WBI, UNDP workshops hosted by CPI are aimed at supporting NGPES implementation in four key sectors: education, health, infrastructure and agriculture. These workshops constitute an opportunity to strengthen cross-cutting planning and management s h l l s at the sectoral level. The workshops will cover program prioritization, costing and budgeting and one module will be dedicated to identifying and monitoring critical capacity gaps. This will enable the Government to improve coordination of donor assistance for capacity development. The PRSC supports improvement o f public administration functions to better achieve the NGPES targets. The program calls for a combination o f studies, advisory services, training and organizational reforms, supported by the Bank and other donors, which will allow the support the achievement o f PRSC objectives. The matrix below (Table A) i s an example o f the application o f the capacity development framework to one result area in the PRSC (transport). The capacity matrix was developed to articulate specific capacity constraints, outline possible interventions, and define outcomes and monitoring indicators to assess whether capacity has improved. AnnualFora CAS Reviews: These should be an occasion for the Bank team to get a cross-cutting view of progress in the implementation o f project and ESW-specific capacity development work as it relates to broad CAS goals. Round Table Meetings: The Bank could propose to Round Table members that an assessment o f capacity development efforts be captured in an annual review o f the Government's NGPES implementation. LearningActivities: Leaming events such as NGPES, PEMand trade workshops can be used as opportunities to introduce the notion o f capacity constraints associated with implementing the specific elements and targets o fNGPES. Ownership: The underlying critical success factor for implementing this approach to capacity development i s to ensure ownership by the client. Periodic stakeholder workshops or meetings designed to secure and reinforce client demand will be valuable. - 71 - Tat e A. SamDle PRSC CaDac v DeveloDment Framework (Tra Organizational Individual (Norms. incentives, rules) (businessprocesses and systems) (Skills) Capacity Lack of clarity ofroles and Low management capacity at the Low levels o f technical, Constraint weak accountability of provincial level in: procurement, administrative andmanagerial provinces for managingRoad monitoring, financial management, skills (planning, reporting, Maintenance Fund private sector capacity and village procurement, M&E) Continued dependence on participation donors to finance maintenance Weakness inmeasuremento f performance CE Year 2: Country-to-country Year 2: MCTPC trains staffin Interventions dialogue to share and Year 1: Intemational consultancyreport above key functions demonstrate altemative assessingneeds and baseline capacities Year 3: MCTPC implements approachesto promoting a o f core and support functions series o f formal events and "maintenance culture" Year 2: Workshop to disseminate informal teaming activities for Year 3: Public information results and develop plan o f action to multiple stakeholders strategy throughperiodic implement performancemeasurement (govemment and contractors) reporting to broaden awareness systemacross provinces inkey support functions o f Rh4F status Year 3: Study completed on functional benchmarking to improve performance (financial management, procurement, andM&E) Intermediate Increased clarity by MCTPC Improved competencein Outcome and other stakeholders on roles MCTPC using standardizedindicators performing technical and responsibilities for to benchmark and measureperformance administrative andmanagerial managing the RMF of core and support functions Indicators Increasein share o f RMF Increasein number o f staff covered by nationalbudget Increasein performancein X number o f meeting benchmarks for core from x to y provinces using performanceindicators Increasein the number o f Provinces and support functions autonomously managing core and support processes ' HighlightingCapacitv Developmentat the ProiectLevel The review o f the Bank's lending portfolio for the Lao PDR revealedthat the focus was often on building capacity for project implementation rather than broader institutional functions; capacity components are not always well linked to overall development objectives or even project objectives; a baseline o f existing capacity i s often lacking; and indicators o f progress in strengthening capacity are not identified. To remedy past weaknesses, the Country Team supports integration o f capacity considerations into each phase o f the project cycle. The matrix below (Table B) provides an illustration o f how this can be done, with reference to the education project. New Projects To integrate capacity considerations into the project cycle, the following steps are suggested: 1.Concept Note: Review experience ofpast projects and sectoral analysis a. Bank team to identify capacity constraints at that are likely to affect achievement o f project objectives. b. Bank team to assess which capacity development interventionsworked well or not in past projects (by reviewing ICRs, OED, QAG, and supervision reports, for example), with the goal o f identifying effective (and non-effective) approaches, as well as possible future partners. - 72 - Table B. Sample CD Framework (Second EducationDevelopmc t Project) Obj tive: Getting the most vu11 rable into primary schools in the 1 poorest provinces Institutional Organizational Individual (Norms, incentives, rules) (Business processes and systems) (Skills) Capacity Lack o f agreed strategy to Weak information base on out-of-school Little knowledge, at the national, Constraints convert NGPES targets into children provincial and local level of the actions MOET, o f `what works' Insufficient budget allocation intemationally and regionally to education programs Lack o f trained personnel [nterventions Establishnationalgoals for MOEeducationpolicy division to collect Awareness raisingworkshops reading, writing, math, taking and analyze data on out-of-school drawing on cross-country into account variations across children experience ethnic groups Establish"policy" unit within MOET, Training programs, curriculum Focus PRSC on social sector under EDP I1 development expenditures MOEto develop and implement testing protocols Indicators Social sector budget Education Sector Development Program X number ofprofessors at NUOL allocations increasedto xx first stage completed, with focus on Education Faculty trained level central, provincial and district outcomes Increasedaccuracy in data collection and analysis o f factors leading to schoolnon- enrollment, non-attendance Policy unit established within MOET, andproducing quality work to be measured against comparators inthe region Education management department established within Education Faculty o f 2. PreparatiodPre-appraisal: In discussionswith client and other important donors a. Bank team to agree on project objectives with client while highlighting and prioritizing capacity constraints where appropriate. b. Bank team to detemine whether client has access to data in order to assess baseline capacity. c. Client (alone or with consultant funded by preparation grant or other donor) to prepare baseline o f capacities for priority result areas. d. Client, in consultation with Bank team, to develop indicators to monitor progress in , developingcapacity needed to achieve project objectives. e. Bank team /WBI and client to jointly design and develop interventions to mobilize grant funding, involve institutional partners and share best practice from countries addressing similar issues to address constraints. 3. AppraisaVNegotiations/ProjectDocumentation a. Bank team to ensure that documents include reference to actions needed to develop capacity, committing the team and client to monitor and make progress in key capacity outcome areas. b. Bank team and client to determine the role o f local institutions and other learning partners in supporting project objectives and monitoring capacity development progress. 4. Project SupervisionLImplementation a. Bank team to incorporate capacity development into SupervisionFramework. - 73 - 5. Monitoring and Follow-Up a. Review progress on capacity building indicators during supervision missions, mid- term review, and ICRs. b. Seek suggestions from client on additionalperformance indicators. c. Provide feedbacldguidance, make necessary adjustments, and mobilize additional resources as required. Retrofitting Ongoing Projects Following Board approval, several entry points exist during implementation to incorporate the capacity framework into ongoing lending. 1. Bank team and government to assess capacity bottlenecks that have emerged during project implementation, assess experience o f other donors active inthe sector. 2. Bank team to review project components (e.g. TA component) to see whether capacity development objectives are clearly stated and relate to project objectives. 3. Confirm that indicators relating to capacity development component have been identified. If not, develop indicators, include inmonitoring system. 4. Bank team to incorporate capacity development indicators into results matrix for Project Supervision Report, and Bank team should report on progress. AAA Developing capacity should become a goal o f AAA activities. This would imply joint preparation and dissemination o f AAA in most cases, Important analytical work for Lao PDR in this CAS period will include development o f sector strategies, for example inrural development and education, and diagnostic tools such as the IntegratedPERs (includes CPARs and CFAAs). The poverty analysis such as PETS and LECS are outputs that are central to the implementation of the NGPES. Each o f these activities presents an opportunity to strengthen client analytical skills and ownership o f the emerging recommendations. If capacity development i s one o f the explicit goals o f AAA, time, quality and cost implications o f a more participatory approach would need to be built into the planning. This approach would require the Bank team at the concept note stage to: 1. Incorporate retrospective assessments o f client capacity from previous related analytical work. 2. For the task at hand, break down the main functions and tasks involved, such as data gathering, analysis, writindsynthesis, and use o f data in policy design and recommendations. 3. Determine the incentives and assess the ability o f the client to be able to undertake/ leam to perform each task. 4. Review available data and options to be able to baseline and benchmark plans for progress in the client's own objectives for increased autonomy in analysis and policy formulation. - 74 - Attachment 3 Lao PDR:Debt SustainabilityAnalysis November2004 (IMP, World Bank andAsianDevelopmentBankjoint report) 1. Lao PDR has an elevated debt burden that places it in the high risk category among low-income countries. Debt stock ratios are well above the indicative thresholds for countries with comparable policies and institutions. Although the debt service schedule looks manageable on the external side, the country's poor revenue generation indicates that debt service requirements over the next few years will put pressure on the government budget, with the risk that priority social expenditures will be crowded out. 2. At end-2003Lao PDR's stock of public and publiclyguaranteed(PPG) external debt, in NPV terms, was US$1.9 billion.This is highin comparison to standard macroeconomic indicators, representing 92 percent o f GDP, 218 percent o f exports, and 534 percent o fpublic revenues. Basedon this debt stock, staff calculations suggest that Lao PDRis eligible for HIPC debt relief(Box 1). 3. Most of Lao PDR's debt - about 70 percent of the nominal stock at end-2003 - comprises concessional loans from multilateral creditors, primarily the World Bank and the AsDB. The biggest bilateral creditor is Russia, which accounted for almost 80 percent o fthe stock o f bilateral debt at end-2003. State-owned enterprises (SOEs) account for just under 5 percent o f the debt-stock. 4. The stock of Russian debt at end-2003 is estimated at US$387million, after applying a 70 percent upfront discount and an exchangerateof 0.6 roublesto the dollar.An agreement was reached between Lao PDR and Russia in December 2003, which granted an NPV reduction o f about 20 percent on the consolidated debt stock. [The Lao authorities have subsequently approached Russia for more concessional terms, which would help them in meeting the high debt service payments forecast for the near future.] 5. The debt sustainability analysis indicates that in order for Lao PDR to lower its high debt stock ratios and debt service-to-revenue ratio over the medium term, three important conditions need to be satisfied. First, exports and GDP must continue to grow robustly. Second, fiscal revenues as a percentage o f GDP must continue to rise. Third, public borrowing as a percentage of GDP must decrease over the medium-term, and care must be taken to maintain a relatively high average level o f concessionality innew borrowing. Box 1. Lao PDR's HIPC Eligibility Lao PDR currently meets the eligibility criteria and fulfills all the conditions necessary to benefit from the enhanced HIPC Initiative. It i s a PRGF-eligibleand IDA-only country, with a GDP per capita of US320 in 2003. The NPV of public and publicly guaranteed(PPG) extemal debt at end-2003, after the application of a stock-of-debt reduction on Naples terms on Pans Club debt and assuming comparable treatment by all other official bilateral and commercial creditors, would amount to about $1 billion, corresponding to an NPV of debt-to-exportsratio of 198 percent Thus the countryi s well above the 150percentthresholdrequiredfor HIPC under the exports criterion '. '. The Lao authoritieshave emphasized that they do not intend to avail themselves of HIPC debt relief. Their view i s that the transactions costs o f the HIPC procedure and possiblyreduced access to bilateral and commercial inflows would outweighthe gains from debt relief inthe medium-term. 1, This figure is based upon the applicationof the HIPC DSA methodology.It differs from the debt-to-exports ratio shown in Table 1, for three main reasons First, insteadof a common discountrate of 5 percent on all debt; the HIPC framework utilizes currency-specific discount rates. Second, it uses a three year backward-lookingaverage of exports inthe denominator, rather than current year exports. Third, it assumes an application of traditionaldebt relief (Naples terms). 2. Lao PDR does not qualify for HIPC debt relief under the fiscal criterion, since its revenue-to-GDP ratio i s well beneaththe 15 percent threshold. - 75 - I.BaselineExternalSustainabilityAnalysis 6. The baseline scenario reflects continuing economic reform and good policy implementation, allowing fairly rapid growth of GDP and exports, and continued fiscal reforms, leading to a fall in the public sector borrowing requirement over time. The main macroeconomic assumptions include (i) increases in real GDP averaging about 6 percent over the 2004-2019 period driven in part by increases in electricity and mineral exports; (ii)increases in exports in US$ terms averaging over 9 percent, driven in part by increases in electricity and mineral exports; (iii) a gradual reduction in the public sector borrowing requirement (including SOEs) from 6.6 percent o f GDP in2004 to 5 percent o f GDP by 2019; and (iv) a grant element o f between 40 and 50 percent for future public sector borrowing. 7. The debt stock indicators remain above indicative thresholds throughout the projection period, despite improving substantially over time (Table 1 and Figure 1). The NPV o f debt-to- GDP declines from 58.6 percent at end-2003 to 37.8 percent in 2019. The NPV o f debt-to-exports follows a similar path, declining from well above 200 percent in2003 to just under 150 percent by the end o f the projection period.' Once the construction phase o f the Nam Theun 2 (NT2) dam i s completed in2009, debt ratios are projected to improve, on account o f falling current account deficits, and robust GDP and export growth (Table 3a). 8. Debt service indicators suggest a more modest and manageable debt burden both in the short- and medium-terms. Public external debt service i s projected to average about 9.5 percent o f exports duringthe 2004-2019 period with the projected trajectory remainingrelatively flat duringthis period (Table 1 and Figure 1). Generally the relatively low debt service to exports indicators reflect: (i)stableandrelativelyhighgrant elementonthe debt stockresultinginarelativelylowdebt a service requirement, and (ii) high export growth during the period when debt service requirements increase as a result o f the end o f grace periods. 11.Baseline FiscalSustainability Analysis 9. The baseline macroeconomic scenario (Table 2 and Figure 2) is premised on steadily increasing government expenditure in the social sectors, thus making the MDGs more attainable? Hence the scenario depends crucially on fiscal reforms to enable greater revenue- generation. This would allow the public sector borrowing requirement to fall over time, as described in the previous section, while keeping expenditures consistent with the Govemment's poverty reduction strategy. Inparticular, it i s assumed that tax revenues as a percentage o f GDP rise from 11.3 percent o f GDP in2004 to 14.5 percent o f GDP in2019. 10. Similar to the external analysis, the debt-stock ratios3 start at a very high level and remain above indicative thresholds throughout, despite falling substantially over the period. The downward path o f these ratios i s due mainly to improving revenue performance on a steadily risingGDPbase, and a falling public sector borrowing requirement. Box 2 compares these debt stock indicators, and debt service indicators, to their indicative thresholds. Non-interest expenditures rise by 2 percentage points o f GDP over the projectionperiod, from about 16 percent in2004 to 18 percent in2019. Assumingthat population grows at 2 percent per annum, this i s equivalent to an increase indollar expenditures per person of about 7 percent per annum over the entire period. As notedinTable 2, onthe fiscal side public debt includes domestic debt (which is relatively small), and the analysis uses the Lao PDR fiscal year rather than calendar years. - 76 - 11. The debt service-to-revenue ratio remains high for the next few years, putting priority social expenditures at risk. Although grants will ease the servicing requirements to some extent4, any slippage in revenue reforms could lead to an unsustainable debt-service burden, requiring the authorities to choose between compressing development expenditures and accumulating arrears. The debt service-to-revenue ratio also underscores the importance o f SOEs borrowing prudently to finance only commercially viable projects. Inthe near-term the debt service-to-revenue ratio i s higher by 4-5 percentage points when SOE debt i s included. If any o f the SOEs were to have difficulty servicing their debt, it would add to the already highburdenon the Government's budget. Box 2: Summary of Baseline Debt Sustainability Indicators Note: Figures initalics are under the indicative thresholds. " Threshold over which countries with similar evaluations of policies and institutions would have an at least 25 percent chance of having a prolonged incident of debt distress in the coming year. Lao PDR lies within the bottom quintile of countriesrankedby the World Bank's Country Policy and Institutional Assessment Index (CPIA). 12. The baseline scenario assumes that the Russian debt i s paid down according to the schedule agreed in December 2003. T o the extent that the Lao authorities are successful in obtaining more concessional terms, that would reduce the pressure on the Government budget and either (i) increase the envelope for social spending or (ii) the amount o f new loans required over the reduce near term5,primarily from multilateral donors. 13. In the medium-term the debt-to-revenue ratio falls to a more sustainable level, averaging about 17.5 percent between 2010 and 2019. This trajectory i s due to steady improvements in revenue as a percentage of GDP. The N T 2 project will boost GDP significantly when it becomes operational, and this, combined with prudent new borrowing, would lower the debt service burden considerably on the fiscal side. As Table 2 shows, the debt-service-to-revenue ratio including grants remains at or just above the indicative threshold throughout the period. Although the public sector borrowing requirement falls over time inthe baseline scenario, new loans indollar terms increase due to rapid GDP growth, averaging about US$lSO millionper annum through the end o f the decade. - 77 - Box 3: The Effect of NT2 onDebt Indicators The NT2 project will have a substantialpositiveimpacton external public debt indicators. In2010, US$ exports and real GDP are projected to grow at 27 percent and 11percent respectively, with the commencement of electricity exports from the project. The relatively small increase in the public debt burden arising from financing the Government's participation inN T 2 is more than offset by the increases inexports and GDP. The impact o f N T 2 causes the NFV o f debt-to-exports ratio to fall by about 25 percent, from 181 percent without the N T 2 project to 156 percent in2010, and from 162 percent to 146 percent in2019. The impact on the fiscal side i s less pronounced, although still positive, because o f the small impact o f N T 2 o n both public sector debt and fiscal revenues. The NPV o f debt-to-revenue ratio falls from 364 percent to 355 percent in 2010 and from 242 percent to 233 percent in2019. 111.SensitivityAnalysis: Alternative MacroeconomicScenario 14. Sensitivity analysis is undertaken on the basis of an alternative macroeconomic scenario which corresponds to a slowdown in economic reforms (Tables 1 and 2, and Figures 1and 2). This scenario is chosen for its plausibility; despite the NT2 project and the Oxiana mines, a slackening pace o f structural reforms could lead to lower growth rates o f GDP and exports in the medium term, and insufficient fiscal reform could lead to lower revenue generation compared to the baselineU6 15. The alternative macroeconomic scenario assumes lower export and GDP growth, and poor revenue generation. The growth rate o f exports i s 2 percentage points lower than in the baseline scenario, beginning in 2006. GDP growth i s similarly kept below the baseline fiom 2006 onwards, and flattens out at 5 percent per annum over the mediumterm. VAT i s not introduced, and that administrative reforms such as the centralization o f customs revenue falter over the medium- term. Hence, tax revenues as a percentage o f GDP stay at their 2004 level o f 11.3 percent of GDP. 16. Onthe external side there is not muchqualitative difference fromthe baseline.The NPV o f debt-to-GDP ratio remains above the indicative threshold throughout, following the same declining path as in the baseline, but only reaching 41 percent in 2019 instead o f 37.8 percent inthe baseline. Similarly, the NPV o f debt to exports declines after 2005 but falls to a ratio o f 190 percent in 2019 instead o f the 146 percent projected under the baseline scenario. The debt service burden remains manageable throughout under the alternative scenario. 17. Onthe fiscal side, the alternative scenario emphasizes the riskto the government budget due to debt servicing requirements in the near term. The NPV o f debt-to-revenue ratio again remains above the indicative threshold throughout, but now it does not fall below 300 percent. The debt-service burden as a percentage o f revenues i s considerably higher in the medium-term. In particular, over the next few years the debt service-to-revenue ratio i s 2-3 percentage points higher than the already elevated ratio of the baseline scenario, and the ratio does not fall below 20 percent even by the end o f the projection period. If this scenario were to transpire, the fiscal envelope for social expenditures would be squeezed, greatly impeding the Government's poverty-reduction strategy and adversely affecting the attainability o f the MDGs. Consequently, the risk o f debt-distress would increase markedly. The alternative scenario considered here is likely to be o f more actual relevance than the standardized alternative scenarios o f the low-income DSA template, which are premised entirely o n historicalpatterns. - 78 - IV. SensitivityAnalysis:BoundTests 18. The standardized shocks o f the low-income DSA template may not be well suited for analyzing risks to Lao PDR's debt sustainability. For example, on the external side, a very large negative shock to exports in the first two periods only (as assumed in the template's stress tests) seems implausible, because in 2005 the scheduled expansion o f the gold mine and the opening o f a new copper mine would add US$lOO million to exports. It would seem more plausible and therefore more interesting to examine the effect o f a gradual slowdown in the growth rate o f exports in the medium term. However, for completeness, we also include tables showing the effects o f standardized shocks (Tables 3a, 3b, 4a and 4b). These tables support the view that the mainrisk to the baseline on the external side i s lower-than-projected exports, while the mainrisk on the fiscal side i s poor revenue effort, leading to a deteriorating primary balance. IV. Conclusion 19. Lao PDR currently has an extremely high stock of debt, placing it in the high risk category among low-income countries. The NF'V of debt in relation to GDP, exports and government revenues are all at elevated levels. The analysis undertaken here indicates a high debt service-to-revenue ratio over the next few years even with improved revenue generation. In the medium-term the debt service burden i s manageable, but only if the political will to continue with economic reforms - especially on the fiscal front - i s maintained. 20. Sensitivity analysisrevealsthat ifthe paceof economicreforms falters, the debt burden, high even inthe baseline case, couldbecomeunsustainable.The NPV o f debt-to exports and debt- to-revenue would rise from the already elevated levels o f the baseline scenario. The debt service-to- revenue ratio would also rise further, making it difficult to maintain or increase the envelope for social expenditures and puttingat riskthe Government's poverty reduction efforts. - 79 - Figure 1. Lao P.D.R.: External Sustainability of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2003-2019 (Inpercent) 60 NPVof debt-to-GDP ratio 55 50 45 40 -Baseline 35 -Alternative Macroeconomic Scenario 1/ 30 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 NPVof debt-to-exports ratio 215 195 175 1 155 115 135 -Baseline 95 - -Alternative Macroeconomic Scenario 1/ 1 1 li 12 Debt service-to-exports ratio 11 10 9 8 7 6 -Baseline 5 -Alternative Macroeconomic Scenario 1/ ~~ 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Staff projections and simulations. 1/Export growthi s lower by 2 percent per annumfrom 2006. Real GDPgrowth falls to 5 percent by 2009 and stays at that level. - 80 - 60 55 - '---- NPVof debt-to-GDP ratio . 1 1 - . . - - m a 50 - 45 - 40 - -Baseline 35 - - - - -Alternative Macroeconomic Scenario 1/ IncludingSOEdebt 30 - 600 NPVof debt-to-revenue ratio 550 500 450 400 350 -Baseline 300 - - - IncludingSOE debt 250 -Alternative Macroeconomic Scenario 1/ 200 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 - 2018 2019 Debt service-to-revenue ratio - -Baseline '- I . 30 I = = IncludingSOEdebt L *. - 25 t- I -Alternative Macroeconomic Scenario 1/ u 1 - 1 I.I 20 - - - - " - - - I - - I 15 - I 10 II 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Staff projections and simulations. 1/Fiscalrevenues are assumedto remain at 11.3percent of GDP. - 81 - 2 6 3 3! '? x r- 1 09 U U oc 3 h 00 '" p: 0 2v 3 vi m w 3 @ x 09 x x 3 vi vi CQ + - m 22 2 2 8. 9 2 1 3 z vi vi s!2 6 3 2 2 2 v i v i v i 2 . . . 3 3 3 - 82 - 9 i ; ; '? ? '? D '9 ? r- c 9 D 9 D q 3 m M - 83 - :' * o 0 0 - 84 - Table 3b. Lao P.D.R.:Sensitivity Analyses for K e y Indicators of Public and Publicly Guaranteed Extemal Debt, 2003-19 (Inpercent) Estimate Projections 2003 2004 2005 2006 2001 2008 2009 2010 2011 2012 2013 2019 NPV ofdebt-to.GDP ratio Baseline 59 54 53 52 52 52 51 41 46 45 44 38 Bound Tests 8I,Real GDP growth at historical averageminusone standarddeviationin2004-05 59 55 54 53 53 53 52 48 47 46 45 39 82 Exportvalue growh at historical average minus one standarddeviation in 2004.05 I1 59 57 61 60 59 59 58 54 52 51 49 41 83 USdollar GDP deflator at historical averageminus one standarddeviationin2004-05 59 69 79 78 78 77 76 71 69 68 66 57 84 Net non-debt creating flows st historical average minus one standarddeviation in 2004-05 21 59 57 56 55 55 54 53 50 48 47 46 39 85 Combinationof 8 1-84 usingone-half standard deviationshock 59 64 73 72 12 71 70 65 64 62 61 51 86 One-ti= 30 percentnominaldepreciation relativeto the baseline in 2004 31 59 75 73 72 72 71 70 65 64 62 61 52 NPV ofdebt-to-exportsratio Baseline 218 213 187 175 180 185 188 156 158 159 160 146 BoundTests 81 RealGDP growth81historical averageminusonestandarddeviation in2004-05 218 213 187 175 180 185 188 156 158 159 160 146 82 Exportvalue growth81historical averageminus onestandard deviationin 2004-05 11 218 269 351 327 336 344 348 289 291 291 290 256 83. USdollar GDP deflator at historical averageminus one standard deviation in2004-05 218 213 187 175 180 185 188 156 158 159 160 146 84 Net "on-debt creating flaws at historical averagendnur one standard deviationin 2004-0521 218 223 197 184 190 195 198 164 166 166 166 150 85 Combinationof B1-84 usingone-half standard deviation shocks 218 226 245 229 236 242 246 204 206 201 207 187 86 One-tin30 percent nominal depreciation relative to the baseline in2004 31 218 213 187 175 180 185 188 156 158 159 160 146 Debt service ratio Baseline 7.2 119 103 9 5 93 9 5 10.0 8.5 85 8 7 9.0 9.3 BoundTests 81 RealGDP growthat historicalaverageminus onestandarddeviationin2004.05 7 1 2 1 0 9 9 9 1 0 8 8 9 9 9 82. Exportvitiuegrowth at historical average minus One standarddeviationin 2004-05 I/ 7 14 17 16 16 16 17 14 I 5 16 17 17 83 USdollar GDP deflator at historical averageminus onestandard deviationin 2004-05 7 1 2 1 0 9 9 9 1 0 8 8 9 9 9 B4 Net "on-debt creating flows at historical averageminus one standarddeviation in 2004-0521 7 I 2 10 10 9 10 10 9 9 9 10 10 85 Combinationof 61-84 usingone-half standard deviation shocks 7 13 13 12 I2 12 13 II 11 II 12 12 86 One-ti= 30 percentnominal depreciation relative to the baseline in2004 31 7 1 2 1 0 9 9 9 1 0 8 8 9 9 9 Memorondurn rlem: Grant e l m " assunledon residual financing (i e, financingrequired above baseline) 48 48 48 48 48 48 48 48 48 48 4 48 Source. Staff projectiorv and simulations I 1Exportsvalues are a s s u d to remainpcrmnently at the lower level. but the current account 8s a share of GDP is assunul lo rstum to illbaseline Isvd sRsr the shock (implicitly assuming an offsetting adjustnnt inimpart levels) 21Includesofficial and privatetransfers and FDI. 31Depreciationis defined as percentagedecline indollarnocal currencyrate. such h a t it never exceedi 100percent - 85 - i o*PLOZLO ? ? ? ? ? 3:: : ' ? w q w w 'LOPQ'ZLO COW " i oL?O? +r ? - - : 8 % -- O N W - 86 - Table 4b. Counuy: Sensitivity Analysesfor Key Indicators of Public Sector Debt, 2003-2019 Estimate Projections 2003 2004 2005 2006 2007 2008 2009 2015 2019 NPV of Debt-to.GDP Ratio Baseline 59 55 53 53 53 52 51 39 34 B.Bound tests B1. Real GDP growth i s at historical averageminus one standarddeviations in2004-2005 58 54 53 53 52 52 51 41 38 B2. Primary balanceis at historical averageininus one standard deviations in 2004-2005 58 62 68 67 66 65 63 49 43 B3. Combination of 2-3 using one half standarddeviation shocks 58 60 65 64 63 62 60 47 41 B4 One time 30 percentreal depreciation in 2004 58 74 70 69 67 65 63 48 41 B5. 10percent of GDP increase inother debt-creating flows in 2004 58 60 58 57 57 56 54 43 38 NPV of Debt-to-Revenue Ratio Baseline 532 482 458 446 429 407 392 285 237 B. Bound tests B1.Real GDP growthis at historical averageminus one standarddeviations in2004-2005 527 476 456 444 427 407 392 298 260 B2. Primarybalanceis at historical averageininus one standard deviations in 2004-2005 527 549 586 561 535 506 485 356 297 B3. Combination of 2-3 using one half standarddeviauon shocks 527 531 557 535 511 483 463 340 285 84. One time 30 percentreal depreciation in 2004 527 653 604 577 546 513 489 343 286 B5. 10percent of GDP increase in other debt-creating flows in 2004 527 533 499 483 463 438 421 312 265 Debt Service-to-RevenueRatio Baseline 14 20 24 24 23 22 22 18 15 B.Bound tests B1. Real GDP growth is at historical averageminus one standarddeviations in2004-2005 14 20 25 25 25 24 24 22 22 B2. Primary balanceis at historical averageminus one standarddeviations in2004-2005 14 20 28 29 28 27 26 30 28 B3. Combination of 2-3 using one half standarddeviation shocks 14 20 27 28 21 26 25 28 26 B4. One time 30percentreal depreciation in 2004 14 22 29 29 28 27 26 25 24 B5. 10percent of GDP increase inotherdebt-creatingflows in 2004 14 20 27 26 26 25 24 25 24 Sources:Lao P.D.R. authorities, and staff estimates and projections. - 87 - - 88 - - 89 - E& E m - 90 - - 91 - - 92 - - 93 - - 94- Attachment 5 EnvironmentalSustainabilityinLaoPDR State ofthe Environment Lao PDR i s well endowed with natural resources including forests, freshwater and wildlife, Table 1compares Lao PDR with some o f its neighbors. Key indicators are presented in Table 3. The Govemment o f Lao PDR has made important strides in partnership with local communities and international organizations in instituting changes that could slow the pace o f natural resources degradation. Recent institutional achievements include: enacting an environmental impact assessment decree; strengthening the regulation for wildlife trade in endangered species; creating a specialized agency to protect and manage the Nakai Nam Theun Watershed; decentralizing environmental functions to provinces; improving water and air quality monitoring; and establishing a third-party monitoring protocol to report on environmental impacts o f development projects. Furthermore, sustainable management o f the country's natural resources and responsible governance o f the benefits accrued from their use have beenidentified as integral parts o f the Government's recently approved National Growth and Poverty Eradication Strategy (NGPES). Table 1: Comparisonof EnvironmentalIndicators amongMekongCountries IIIPopulation(million persons) 5.5 13.3 64.8 82.7 Land area (sq.km.) I1 236,800 II 181,040 I1 515,113.6 II 331,114 II Forest (1,000 sq.km.1 126 93 148 98 Deforestation (average annual % change 1I 0.4 1I 0.6 II 0.7 11 -0.5 II 1990-2000) 1I Landunderprotection(% oftotalland) 14 18 18 Water use (% of total resources) 1I 0.3 1I 0.1 I1 8 I1 6 II C02 emissions (metric tons per capita) 0.1 0.1 3.2 0.6 Access to an improved water source (% 35 30 80 56 of POP.) Access to improved sanitation facilities 29 58 97 86 (% o furbanpop.) Environmentalexpenditure (% o f total d a I 1.2-14 I 0.8-1 I expenditure I Recognizing that the country's natural resource base i s important for the country's future prospects, the Government o f Lao PDR has invested inimproving environmental management by adopting (1999) and implementing (2002) the Environmental Protection Law. Regulations have been introduced for conducting impact assessments o f development projects and sector-specific Environmental Assessment regulations have been developed for hydropower and electricity as well as road development. The Forest Law o f 1996 and its various enabling implementation decrees and regulations support measures to improve the protection o f forests and protectedareas. - 9 5 - The Government is currently finalizing its National Environment Strategy (NES), which includes a new National Environmental Action Plan for 2006-2010. The key components will focus on: (i) sustainable management o f renewable natural resources; (ii)improved environmental management o f industrial and infrastructure sectors, and (iii) strengthening o f the institutional framework for environmental management and capacity building. The NES will be accompanied by 18 Provincial Environment Strategies and Action Plans. Over the past five years, many sector specific strategies and action plans have also been prepared focusing on Water, Biodiversity, Agriculture and Forestry. Despite this progress, environmental conditions in the country remain threatened - deforestation has increased, threats to protected areas are rising, and urban environmental problems are now emerging. Highlighted below are some o f the key environmental challenges in Lao PDR that continue to hinder the progress made to date and the future of natural resource preservation over the short to medium-term. Forest and land resources are under pressure Nearly 90 percent o f the country i s occupied by forest lands (twice the average forest cover for EAP countries). Despite the introduction o f protected areas, land shifting to agriculture and illegal logging have led to a decline inforest cover (from 70 percent to 47 percent over the last 50 years) and therefore to the destruction o f natural habitats. Ina number o f upland forest areas, deforestation i s mainly a result o f logging and unregulated commercial exploitation. In addition, local pressures include unsustainable exploitation practices, shifting agriculture, and poverty, all o f which are puttingpressure on the remaining forests. Commercial logging i s permitted only in areas with forest management plans, and logged areas must be replanted and well-maintained. Since logging i s prohibited inprotected areas the pressure on production forests i s enormous, often leading to clear-cutting and forest degradation. The Government has identified and will soon formalize the creation o f a system o f National Production Forest Areas (NPFA) covering an initial eight regions, totaling 500,000 hectares. This system will include formal arrangements with local communities that prescribe benefit sharing, increased participation, and empower communities to use forest revenues for local development efforts. In an effort to conserve its forest resources and biodiversity, a National Protected Area system has also been established covering almost 3.4 million hectares, or more than 14 percent of the country. It would be useful for the Govemment to consider applying this approach to the commercially valuable forest outside o f the protected areas which would benefit an additional 1.5 million people. Participatory forestry, through which local people are enabled to manage and directly benefit from the sale o f timber and other forest resources, has had a remarkable and demonstrated success in Lao PDR. This, and other improved commercial forest management approaches, if applied, will deter illegal and uncontrolled logging, and form the core o f a viable forestry reform program. Despite having a low population,density, with an annual population growth o f 2.8 percent, the pressure on land resources for cultivation i s rapidly increasing. The Government's long-term goal i s to establish a nationwide land administration system and provide secure tenure to all eligible landholdings. To achieve this goal, the government needs to accelerate land titling activities. The pressure on suitable land for agriculture i s further aggravated by the fact that Lao PDR was subjected to heavy bombing during the Indochina war, resulting in large areas o f dangerous unexploded ordnance-ridden land throughout many parts o f the country. - 96- Water resources andpotential of hydropower 0 Lao PDR's freshwater resources are the most abundant in Asia on a per capita basis, with total renewable water resources estimated at 190 million m3per year. Currently there i s relatively little competition between the various users o f water because o f the relative abundance o f water and the small population. Total water usage i s relatively limited, estimated at 1 billion m3per year in 20001. An estimated 90 percent i s used for agriculture purposes, while domestic and industrial sources use 4 and 6 percent, respectively. However, development emphasis on expanding land cultivation and increasing exploitation o f hydropower development i s puttingadditionalpressure on the resource base. 0 The hydropower potential o f Lao PDR i s high compared to other countries in the lower Mekong River Basin, providing the Government with an opportunity to eam foreign income to support socio-economic development. Hydropower generation has increased five-fold in the last 25 years, and i s expected to expand by three-fold in the next five years. Over the next 25 years, Lao PDR has the potential to generate 18 percent o f the 23,000 megawatts o f hydropower that can be generated in the Mekong River Basin. Nevertheless, the exploitation o f this hydropower potential needs to be carefully balanced with environmental and social pressures so as to derive the necessary benefits. The NGPES recognizes the importance o f the hydropower sector in economic growth and poverty reduction and the Government acknowledges that hydropower development must be sustainable if its development potential to deliver lasting benefits to Lao PDR i s to be fully realized. Environmental performance o f this sector has been somewhat lackluster to date, and some hydropower projects have contributed to significant ecological damage and social issues. Biodiveristy is threatened Lao PDR i s one o f the most biodiversity-rich countries in Southeast Asia. Of the 1140 animal and plant species reviewed in 1999', 319 are considered o f national or global conservation significance (based on their limited numbers and limited range). In recent years a number o f genera and species o f mammals that are new to science (e.g. the Saola and Giant-Antlered Muntjac), birds, reptiles, amphibians and fish have been identified in Lao PDR. Commercialization and trade in wildlife products have also increased with improved access to previously remote areas. Although much wild meat i s consumed within the country, there i s also a massive illegal trade o f live animals and animal parts from and into neighboring countries. Having signed the Convention on International Trade in Endangered Species in May 2004, and due largely to the efforts o f the Ministry o f Agriculture and Forestry and the Wildlife Conservation Society, as well as a national gun amnesty, the wildlife trade has become less visible nationwide. As part o f its efforts to conserve its biodiversity, more than a fifth o f its land area is under protection through a network o f 20 National Protected Areas, two Corridors, and several provincial and district level protected areas supported by laws and decrees. Despite this designation and the enabling legislation, the allocated budgets and subsequently the levels o f protection in all o f the protected areas are very low, with reports o f widespread logging and poaching. Institutional capacity remains weak 0 The GOL has enacted a wide array o f legislation and regulations for environmental conservation and protection, and i s party to key global environmental conventions; however, the capacity to implement and enforce them on the ground remains weak. Environmental legislation has evolved quickly in Lao PDR leading to inconsistencies `Source: FA0 Review of World Water Resources by Country (2003)(www.fao.org) Duckworth et al, Wildlife in Lao PDR: 1999Status Report - 9 7 - including conflicting provisions, overlapping mandates given to different Ministries, and lack o f implementingregulations and supporting environmental standards. 0 Inadequate human resources (2 percent o f public sector staff) and very low government budgets (less that 1 percent o f government budget) significantly constrain the implementation and enforcement o f ambitious legislation and policies that have been enacted to protect the country's vast naturalresources fkom environmental degradation. Urbanization challenges 0 While only 20 percent o f the population live in urban areas (about half the average percentage in EAP countries), population in those areas are already experiencing environmental health risks. Although Lao PDR has the largest per capita volume o f renewable water resources in Asia, access to safe drinking water i s still insufficient. Only about 61 percent o f its urban population has access to piped water supply. In 2000, an estimated 67 percent o f the urban population in Lao PDR had access to satisfactory sanitation facilities. EnvironmentalLinkagesto CAS Objectives Long-term economic growth and poverty reduction can be significantly undermined by the over-exploitation and degradation o f the natural resource base. The CAS process recognized this from the outset and set about mainstreaming environment in the key priority areas that are important for pursuingsustainable growth and poverty reduction. The CAS embeds environment and natural resource management as a cross-cutting theme across the four objectives. The expected outcomes and the instruments supporting their achievement are synthesized below (Table 2). Among the main international partners supporting the Government are the Agence Franqaise de Developpement, Asian Development Bank, Swedish International Development Agency, and the World Bank. Support i s provided in environmental protection, capacity building, forest management, biodiversity conservation and watershed management through activities aimed at strengthening institutions at the national and provincial levels and financing infrastructure and services. - 9 8 - Table 2: Environmental Outcomes and B a n k Instruments ~~ Outcomes Instruments 1. Strengthenedenvironmental institutions and Lending instruments through: 1. Sustainable Forestry for Rural Development e building capacity of central andprovincial authorities Proiect (FY03) The objective o f the project is to assess and monitor environment impacts, and to assist in sustainable management o f improving compliance with environmental and social production forests to alleviate rural poverty in safeguards. selected provinces by implementing the building capacities in protected area management, Government's forest policy reformactions river basin and watershed management eLao Environment Conservation Fund (LECF) 2. Nam Theun 2 Hvdrouower Proiect and Nam becomingfully operational and geared to receive NT2 Theun 2 Social and Environment Proiect. This revenuesfor use in priority environmental programs project will build and operate an e improved natural resources management in poverty environmentally and socially sustainable reductionprograms hydropower plant in Central Lao, and generate revenues that can be used for poverty reduction and environmental protection. 2. N T 2 demonstrates socially and environmentally responsible natural resource management through: 3. Lao Environment and Social Proiect (FY05): a improved management of 400,000 hectares of This project aims to improve the environmental protected areas; management o f natural assets in Lao PDR to resettledpopulation of 6200people in the Nakai alleviate poverty and boost economic growth. plateau have access to safe water and sanitation and Specifically, the project aims to: (a) strengthen adapt to environmentally appropriate livelihood and institutions and instruments for assessment, farming practices (community forest management, monitoring and compliance for environmental integrated pest management, etc.) and social sustainability; (b) investing in local- e divers$ed livelihood opportunities designed, piloted level environmental and livelihoods and mainstreamed for those living in the downstream improvement areas to compensatefor poor water quality e strengthened capacity of WMPA, E M U and NTPC to 4. Other Proiects: Rural Development, monitor and reduce social and environmental impacts Infrastructure and Human Development o f natural resource projects projects will be designed to improve their environmental outcomes. 3. Increasedarea under sustainable forest management - AAA through: 1. Lao Environment Monitors (FY05, 07, 09): e approving and applying key regulations and The Monitors will undertake diagnostic work improving revenue generation and analytical studies to assess the state o f the e broad-based participation and equitable sharing of environment and establish priorities benefits e reducing illegal land conversions and logging 2. Povertv-Environment Nexus (FY05). This operations TA will improve the environmental and natural e expanding overage of sustainable forest management resources management coverage o f poverty plans to 528,000 hectares reduction efforts 3. Safeguards Thematic Suuervision (FY06). This will asses the status o f compliance o f the Bank Dortfolio. - 99- Table 3: Key Environmental and Natural Resources Indicators Environmentalstrategy/ action planprepared in 1995 Group Data Country Data East Asia &Pacific Low Income Population(millions) 5.5 1,838.50 2,494.60 Urbanpopulation (% of total) 20 38.2 30.6 GDP (S billions) 1.65 1,833 1,124 GNIper capita, Atlas method ($) 340 960 430 Agriculture Land area (1,000 sq km) 236.8 15,885 32,424 Agricultural land (% o f land area) 8 50 43 Irrigated land (% o f crop land) 18.3 34.7 26.3 Fertilizer consumption (100 gramdha arable land) 140 2,077 710 Foodproduction index (1989-91 = 100) ' 188 171 136 Population density, rural (peopldsq kmarable land) 495 568 510 Forests Forest area (1,000 sq km) 126 4,238 9,031 Forest area (% o f total land area) 41.5 27.2 27.1 Annual deforestation (% change, 1990-2000) 0.4 0.2 0.8 Biodiversity Mammal species, total known 247 Mammal species, threatened 36 Bird species, total breeding 700 Bird species, threatened 27 Nationally protected area (% of land area) 14 9.2 8.4 Energy GDP per unit of energy use (PPPUkg oil equiv) 3.6 Energy use per capita (kg oil equiv) 854 518 Energy imports net (% energy use) -3 -8 Electric power consumption per capita (kWh) 816 317 Share of electricity generatedby coal (%) 65.1 49.2 Emissionsand pollution C02 emissions per unit o f GDP (kg/PPP$ GDP) 0.1 0.6 0.5 C02 emissions per capita (mt) 0.1 2.1 0.9 Consumption of CFCs (ODP metric tons) 42,259 14,561 Particulatematter (popweighted averagepgim3) 47 69 64 Passenger cars (per 1,000 people) 3 10 6 Water and sanitation Freshwater resourcesper capita (m3) 50,000 6,020 6,416 - total (% total water resources) 0.3 7.2 6.5 - agriculture (% total freshwater withdrawal) 82 81 92 Access to an improved water source (% total pop) 64 76 76 - rural (% rural pop) 60 67 70 - urban (% urban pop) 75 93 90 Access to sanitation (% total pop) 44 47 43 - rural (% rural pop) 36 36 31 - urban (% urban pop) 70' 72 71 Under-5 mortality rate (per 1,000 live births) 106 42 121 - 100- Group Data Country Data East Asia & Pacific Low Income National accounting aggregates 2002 - Gross nationalsavings (% GNI) 38.8 21.5 Consumption of fixed capital (% GNI) 8 9.2 8.4 Educationexpenditure (% GNI) 1.8 2.2 2.6 Energy depletion("YOGNI) 0 3.4 5.9 Mineral depletion (% GNI) 0 0.3 0.4 Net forest depletion(% GNI) 0 0.1 0.8 C 0 2 damage (% GNI) 0.2 1.8 1.3 Particulateemission damage (% GNI) 0.2 0.8 0.6 Adjustednet savings (% GNI) 25.5 6.7 Source:The Little Green Databook (2004) and Lao Environment Monitor 2005 (draft) - 101- Lao PDR at a dance 3110/05 East POVERTYand SOCIAL Lao Asia & Low- PDR Pacific income Developmentdiamond' 2003 Population,mid-year (millions) 5.7 1,855 2,310 GNI per capita (Atlas method, US$) Life expectancy 340 1,080 450 GNI (Atlas method, US$billions) 1.9 2,011 1,038 T Average annual growth, 1997-03 I Population (%) 2.6 1.o 1.9 Labor force ("A) 2.4 1.1 2.3 1 GNI Gross Per primary Most recent estimate (latest year available, 1997-03) 1capita w enrollment Poverty (% of populationbelownationalpovertyline) 33 Urban population (% of total population) 25 40 30 Life expectancy at birth (years) 55 69 58 I 1 Infant mortality (per 1,000live births) 82 32 82 Child malnutrition (% of children under51 15 44 Access to improvedwater source ~ Access to an improved water source ('A ofpopulation) 37 76 75 Illiteracy ("h of populationage i5+) 47 10 39 , Gross primary enrollment (% of school-age population) 111 92 I ".--*-* Lao PDR Male 112 99 Low-incomegroup Female 111 85 I KEY ECONOMICRATIOS and LONG-TERM TRENDS 1983 1993 2002 2003 I Economic ratios" GDP (US$ billions) 1.3 1.8 2.1 Gross domestic investmentlGDP 19.5 22.0 Exportsof goods and servicesiGDP 21.5 28.4 26.5 I Trade Gross domestic savingsiGDP - Gross national savings/GDP 14.1 16.5 Current account balance/GDP -7.8 -5.2 -5.4 interest paymentslGDP 0.3 1.6 1.7 Total debtlGDP 149.5 88.8 104.0 Total debt serviceiexports 8.4 14.6 16.2 Present value of debtlGDP 58.6 Presentvalue of debtlexports 218.7 I Indebtedness 1983-93 1993-03 2002 2003 2003-07 (averageannualgrowth) GDP 4.8 6.2 5.8 5.3 6.4 .vrr yylLao PDR GDP per capita 2.3 3.5 2.9 2.5 3.6 Low-incomegroup Exportsof goods and services STRUCTUREof the ECONOMY 1983 1993 2002 2003 I ("A of GDP) I Agriculture .. 57.5 50.4 48.8 Industry 17.7 24.7 25.7 ' Manufacturing 13.1 19.1 Services ...... 24.7 25.0 Privateconsumption 58 55 00 01 02 03 General governmentconsumption 9.2 4.9 -- I Imports of goods and services .. 31.2 33.9 ^^ 4 9 - *GDI - O ' G D P ~ 1983-93 1993-03 2002 2003 (averageannualgrowth) Agriculture 3.7 4.8 4.0 2.2 Industry 9.9 10.2 10.1 10.0 Manufacturing 12.7 10.7 13.0 6.3 Services 3.8 6.6 5.8 6.9 Privateconsumption General governmentconsumption Gross domestic investment Importsof goods and services Note: 2003 data are preliminary estimates The diamonds show four key indicators in the country (in bold) compared with Its income-group average. If data are missing, the diamond will be incomDlete. - 102- Lao PDR PRICES and GOVERNMENT FINANCE 1983 1993 2002 2003 Inflation (%) Domestic prices (% change) 150 7 Consumer prices 10.6 15.5 Implicit GDP deflator 11.2 10.6 13.9 Government finance ("h of GDP,includes current grants) Current revenue 14.4 13.2 Q8 99 00 01 02 03 Current budget balance 6.3 5.7 ...................... GDP deflator -CPI Overallsurplusideficit -4.0 -5.8 TRADE 1983 1993 2002 2003 (US$ millions) Export and Import levels (US$ mill.) Total exports (fob) 241 341 401 700 Wood products 66 94 94 Agriculture 9 27 28 Manufactures 87 105 105 Total imports (ci9 432 570 618 Food 93 100 Fuel and energy 29 0 0 Capital goods 99 210 231 97 98 99 00 01 02 03 Export price index (1995=100) 102 118 Import price index (7995=100) 105 108 Evorts mlmports Terms of trade (7995=100) 97 109 I BALANCEof PAYMENTS 1983 1993 2002 2003 Current account balanceto GDP (%) (US$ millions) Exportsof goods and services 332 517 554 Imports of goods and services 490 613 673 Resource balance -158 -96 -119 Net income 3 -70 -81 Net current transfers 0 51 71 87 Current account balance -121 -104 -95 -113 Financing items (net) 133 118 150 133 Changes in net reserves -12 -14 -55 -20 I Memo: Reserves including gold (US$millions) 196 216 Conversion rate (DEC, local/US$) 35.0 716.3 10,116.0 10,572.0 EXTERNAL DEBT and RESOURCEFLOWS 1983 1993 2002 2003 (US$ millions) Total debt outstanding and disbursed 451 1,985 1,614 2,171 IBRD 0 0 0 0 IDA 19 217 435 485 I F 2 5 7 " Total debtservice 4 29 76 91 IBRD 0 0 0 0 IDA 0 2 9 11 Composition of net resource flows Official grants 11 69 115 123 Official creditors 58 54 60 75 Privatecreditors 0 0 0 0 Foreign direct investment 0 30 60 69 Portfolio equity 0 0 0 0 I D 8% World Bank program Commitments 0 19 45 25 A - IBRD E . Bilateral Disbursements 5 38 33 48 B IDA D Other multilateral . F - Private Principal repayments 0 1 6 7 C IMF .. G -Short-term Net flows 5 38 27 42 Interestpayments 0 1 3 4 Net transfers 4 36 24 38 ~~ Development Economics 3110105 - 103 - Annex B2 CAS Annex B2 Lao People'sDemocratic Republic - Selected indicators** of Bank Portfolio Performance and Management As of 03/10/2005 Indicator 2002 2003 2004 2005 Portfolio Assessment Number of Projects Under Implementation a 12 12 12 12 Average Implementation Period (years) * 3.4 3.1 3.5 3.2 Percent of Problem Projects by Number a, 0.0 0.0 0.0 11.1 Percent of Problem Projects by Amount a, 0.0 0.0 0.0 6.5 Percent of Projects at Risk by Number a, 0.0 8.3 0.0 11.1 Percent of Projects at Risk by Amount a, 0.0 16.1 0.0 6.5 Disbursement Ratio (%) * 24.0 25.8 25.9 10.0 Portfolio Management CPPR during the year (yedno)' No No No No Supervision Resources (totat US$ millions) 0.65 1.006 1.061 1.208 Average Supervision (US$/project) 50,000 71,857 75,786 80,533 Memorandum Item Since FY 80 Last Five FYs Proj Eva1by OED by Number 23 6 Proj Eva1by OED by Amt (US$ millions) 442.3 105.3 % of OED Projects Rated U or HU by Number 34.8 16.7 % of OED Projects Rated U or HU by Amt 19.3 2.4 a. As shown in the Annual Report on Portfolio Performance (except for current FY). FY2005 includes nine projects under implementation and three projects to be delivered in FY2005. b. Average age of projects in the Bank`s country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank'sportfolio at the beginning of the year: Investment projects only. f. The supervision resources include supervision costs charged to the projects (including GEF projects) and COSU staff working on supervison not directly charged to the proejcts. They exclude the resources spent on portfolio management. g. For FY05, they are planned resources (including GEF projects); also include resources for ICRs. * Informal quarterly CPPRs (QPPRs) were conducted each year. ** All indicators are for projects active in the portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. - 104 - Annex 63 CAS Annex B3 Lao People's Democratic Republic - IBRDhDA Program Summary As of 03/10/2005 Proposed IBRDADA Base-Case Lending Program Fiscal year Project US$(M) Strategic Rewards Implementation (H/M/L) Risks (H/M/L) 2005 PRSC 1 10.0 H L Nam Theun Social & Environment 20.0 H H Lao Environment and Social Project 4.0 H H Nam Theun 2 Guarantee 13.0 H H 2006 H H Health Services Improvement Project 15.0 H M H M 2007 PRSC 3 8.0 H H Public Financial Management TA 3.0 H M Khammouane Rural Livelihoods 7.0 M M GMS Regional Power Trade 5.0 H H 2008 PRSC 4 8.0 H H Sectoral SWAP 6.0 M M Rural Provincial Infrastructure 2 6.0 H M Overall Total 128.0 Note:The program is merely indicative. Actual size of projects (IDA Credits and Grants), timing, and overall annual commitments will depend on the availability of IDA resources through the continuing Lending Strategy Review (LSR) exercises (in particular,in light of IDA-14 outcomes), the status of project preparation, and the definition of the project and components to be financed by IDA to be agreed with the government and other cofinancing partners. H : High M : Medium L : Low - 105 - Annex B3 CAS Annex B3 Lao People's Democratic Republic - IFC and MlGA Program FY 2002 2005 - As of 03/10/2005 2002 2003 2004 2005 IFC approvals (US$m) 16.00 0.00 0.00 4.00 Sector (%) Information 100 Oil, Gas and Mining 100 Total 100 0 0 100 Investment instrument (%) Loans 69 100 Equity Quasi-Equity 25 Other 6 Total 100 0 0 100 ~ MIGA guarantees (US$" 0.00 0.00 0.00 0.00 - 106 - Annex B4 CAS Annex B4 Lao People's Democratic Republic - Summary of Nonlending Services As Of 0311012005 Product Completion FY Audience a Objective Recent completions Economic Monitors FY03 GOV, Bank, PD BSP, KG, M, PS Private Sector NoteKonference FY03 GOV, Bank, Donor, PD DP, BSP, KG, M Mining Sector FY03 GOV, Bank, Donor, PD DP, BSP, KG, M, PD IDF-Public Expenditure and Debt Management FY04 GOV, Bank, Donor, PD GOV, KG, M, PD SSR/CEM FY04 GOV, Bank, Donor, PD DP, BSP, KG, PD, PS Economic Monitor (1st Issue) FY04 GOV, Bank, Donor, PD KG, M, P Economic Monitor (2nd Issue) FY04 GOV, Bank, Donor, PD KG, M, P Dialogueon Mining Sector FY04 GOV, Bank, Donor DP, BSP, KG, M PRSP - JSA FY05 GOV, Bank, Donor BSP, M, Underway ExpenditureTracking/Poverty Assessment FY05 GOV, Bank, Donor, PD BSP, B, KG, M Rural Sector Issues Note FY05 GOV, Bank, Donor, PD BSP, B, KG Financial Sector Issues Note FY05 GOV, Bank, Donor BSP, B, KG IDF-Efficiencyin Public Procurement FY05 GOV, Bank GOV, DP, M Economic Monitors FY05 GOV, Bank, Donor, PD KG, M, P Environment Monitor FY05 GOV, Bank, Donor, PD KG, M, P Contract Value Norms Study FY05 GOV, Bank, Donor, PD BSP, KG, P Planned PSNInvestment Climate Survey FY06 GOV, Bank, Donor, PD BSP, B, KG Khammouane Provincial Dev. Study FY06 GOV, Bank, PD BSP, DP, KG, SD IntegratedTrade Framework FY06 GOV, Bank, Donor, PD BSP, KG Integrated PER (with CFAA, CPAR) FY06 GOV, Bank, Donor, PD BSP, KG, M Social Protection Policy Note FY06 GOV, Bank, Donor BSP, DP, SD EducationSector Study FY06 GOV, Bank, Donor, PD BSP, KG, P, SD Economic Monitors FY06 GOV, Bank, Donor, PD KG, M, P Peer Review of State Audit Organization FY06 GOV, Bank, Donor, PD PS, DP, PS IDF-Ethnic Minorities concerns in PRSP FY06 GOV, Bank, PD GOV, KG, P, PD IDF-Monitoringand Evaluation in Education FY06 GOV, Bank GOV, KG, M CEM FY07 GOV, Bank, Donor BSP, DP, KG Civil Service Reform Study FY07 GOV, Bank, Donor BSP, KG RD Sector Strategy FY07 GOV, Bank, Donor BSP, KG, SD Infrastructure Strategy FY07 GOV, Bank, Donor BSP, KG, SD, PP, PS DecentralizationStudy FY07 GOV, Bank, Donor BSP, KG FinancialSector Assessment FY07 GOV, Bank, Donor BSP, DP, KG Economic Monitors FY07 GOV, Bank, Donor, PD KG, M, P Environment Monitor FY07 GOV, Bank, Donor, PD KG, M, P ExpenditureTracking Survey FY07 GOV, Bank, Donor, PD BSP, DP, M, KG HD Sector Strategy FY08 GOV, Bank, Donor DP, KG Gender & Ethnic Minorities Assessment FY08 GOV, Bank, Donor DP, KG Investment Climate Follow-up FY08 GOV, Bank, Donor, PD DP, PD Poverty Assessment FY08 GOV, Bank, Donor, PD BSP, B, KG, M Integrated PER FY08 GOV, Bank, Donor, PD BSP, KG, M Social Sector Monitor FY08 GOV, Bank, Donor, PD KG, M, P Economic Monitors FY08 GOV, Bank, Donor, PD KG, M, P a. Government (GOV), Donor, Bank, Public Dissemination (PD) b. Government (GOV); Bank Group (B); Bank Group Strategy Preparation (BSP); Public, including civil society (P); Policy Discussion (DP); Monitoring (M); Knowledge Generation (KG); Public Debate (PD); Problem Sovling (PS); Project Preparation (PP);Stakeholder Discussin (SD). - 107 - Annex B5 CAS Annex B5 Lao People'sDemocratic Republic - Social Indicators As of 0311012005 Latestsingle year Same regionlincomegroup East Asia & Low- 1970-75 1980-85 1997-2003 Pacific income POPULATION Total population, mid-year (millions) 3.0 3.6 5.7 1,854.5 2,310.3 Growth rate (% annual averagefor period) 2.2 2.4 2.6 1.o 1.9 Urban population (% of population) 11.4 15.6 25.2 39.7 30.3 Total fertility rate (births per woman) 6.5 6.5 4.8 2.1 3.7 POVERTY ("7of population) National headcount index 33.0 Urban headcount index 20.0 Rural headcount index 38.0 INCOME GNI per capita (US$) 340 1,080 450 Consumer price index (1995=100) 1,083 Food price index (1995=100) INCOMWCONSUMPTION DISTRIBUTION Gini index 33.0 Lowestquintile (% of income or consumption) 7.6 Highestquintile (% of income or consumption) 45.0 SOCIAL INDICATORS Publicexpenditure Health (% of GDP) 1.o 1.9 1.2 Education (%of GDP) 0.4 1.9 3.2 2.7 Social securityand welfare (% of GDP) Net primary school enrollment rate (`7of agegroup) Total 81 92 78 Male 84 92 84 Female 77 92 72 Access to an improvedwater source (% of population) Total 37 76 75 Urban 61 93 90 Rural 29 67 69 Immunization rate ("7of childrenages 12-23months) Measles 6 71 70 64 DPT 4 56 78 64 Child malnutrition (% under 5 years) 40 15 44 Life expectancy at birth (years) Total 42 47 55 69 58 Male 41 46 54 68 57 Female 44 49 57 71 59 Mortality Infant (per 1,000live births) 145 135 82 32 82 Under 5 (per 1,000live births) 218 200 115 42 126 Adult (15-59) Male (per 1,000 population) 610 531 355 184 319 Female (per 1,000population) 510 439 299 129 268 Maternal (modeled,per 100,000live births) 650 Births attended by skilled healthstaff (%) 19 68 38 Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998due to changefrom ISCED76 to ISCED97.Immunization:refers to children ages 12-23months who receivedvaccinations before one year of age. World DevelopmentIndicatorsdatabaseAugust 2004, World Bank -108 - Annex B6 CAS Annex B6 Lao People's Democratic Republic - Key Economic Indicators As of 03/10/2005 Actual Estimate Projection Indicator 2000 2001 2002 2003 2004 2005 2006 2007 2008 National accounts (as % GDP at current market prices) Gross domestic product 100 100 100 100 100 100 100 100 100 Agriculture' 52.1 50.8 50.4 48.8 Indust$ 22.7 23.5 24.7 25.7 Services` 24.4 24.8 25.0 25.5 Total Consumption Gross domestic fixed investment 20.9 20.9 19.5 22 18.9 19 7 20.7 20.7 20.8 Government investment 14 13.5 10.9 11.9 8.8 8.7 8.5 8.7 9.0 Private investment 6.9 7.4 8.6 10.1 10.1 11.1 12.1 12.0 11.8 (includes increase in stocks) ~xports(GNFS)~ 29.9 28.3 28.4 26.5 25.6 28.3 29.9 28.8 27 8 Imports (GNFS) 34.8 33.3 33.9 32.2 33.6 32.2 34.5 33.9 33.3 Gross domestic savings Gross national savings' 19.4 17.1 14.1 16.5 10.4 12.1 10.5 10.3 10 3 Memorandumitems Gross domestic product 1,740 1,762 1,818 2.088 2,412 2.665 2,895 3,125 3.375 (US$ million at current prices) Gross national product per capita 310 320 340 380 400 420 (US$,Atlas method) Real annual growth rates ("h,calculated from 1990 prices) Gross domestic product at 5.8 5.8 5.8 5 3 6.0 7.0 6.5 5.8 5 8 market prices Gross Domestic Income Real annual per capita growth rates ("h,calculated from 1990prices) Gross domestic product at 2.7 2.9 2 5 3.4 4.4 3.9 3.2 market prices Total consumption Private consumption Balance of Payments (US$m) ~xports(GNFS)~ 520.4 499.5 516.7 554 0 617.3 753.9 865.3 900.4 938 7 Merchandise FOB 344.8 333.6 340.5 401 0 437.3 563.1 663.0 683.0 705 0 Imports (GNFS)~ 608.4 586.2 616.6 673 2 810.1 857.9 998.6 1058.4 11235 Merchandise CIF 562.4 542.2 570.1 618 2 752.2 764.1 864.2 921.O 982 9 Resource balance -86.0 -86.7 -99.9 -1192 -192.8 -104.0 -133.3 -158.0 -184 8 Net current transfers 136.2 64.9 71.1 86 9 96.9 102.7 110.7 117.5 I24 9 (including official current transfers) Current account balance -25.2 -66 -99 -1133 -204.3 -209.2 -304.4 -335.1 -366 8 (after official capital grants) Net private foreign direct investment 31.3 23.9 60.4 69 4 186.3 105.5 86.1 88.1 90 3 Long-termloans (net) 62.8 65.8 126.9 88 9 72.2 184.9 324.4 337.9 342 4 Official Private Other capital (net, inciudlng -49.9 -52.8 -26.9 -1 6 -8.7 -40.8 -43.4 -18.1 -5 4 errors and omissions) Change in reserves -43.9 0.8 -55.4 -19 8 -29.9 -21.o -27.6 -37.8 -35 5 Memorandum items Resource balance (77 of 0.0 0.0 -0.1 -0 1 -0.1 0.0 0.0 -0.1 -0 1 GDP at current market prices) (continued) - 109 - Annex I36 Lao People's Democratic Republic Key Economic Indicators - (Continued) Actual Estimate Projection Indicator 2000 2001 2002 2003 2004 2005 2006 2007 2008 Real annual growth rates (1995 prices) Merchandise exports (FOB) 0.8 -3.2 2.1 17.8 9.0 28.8 17.8 3.0 3.2 Primary Manufactures Merchandise imports (CIF) 1.5 -3.6 5.1 8.4 21.7 1.6 13.1 6.6 6.7 Public finance (as %of GDP at current market prices)' Current revenues 13.2 13.2 13.1 11.1 11.2 11.4 11.8 12.3 12.8 Current expenditures 7.7 7.8 8.1 7.5 7.9 8.5 8.7 9.3 9.4 Current account surplus (+) or deficit (-) -1.4 -3.7 -5.4 -5.4 -8.5 -7.9 -10.5 -10.7 -10.9 Capital expenditure 13.3 12.6 10.1 11.2 7.6 8.7 8.6 8.5 8.8 Foreign financing 5.7 3.1 3.3 5.2 3.7 4.1 3.8 3.7 3.6 Monetary indicators MUGDP (at current market prices) 15.6 16.9 17.6 17.6 17.9 17.8 Growth of M2 (YO) 7.8 12.9 24.1 28.7 11.7 Private sector credit growth / 27.6 -5.2 5.4 6.6 14.4 total credit growth (%) Price indices( 1995 =loo) Merchandise export price index Merchandise import price index Merchandise terms of trade index Real exchange rate (LCU/US$)' Real interest rates Consumer price index (% growth rate) 23.2 7.8 10.6 15.5 10.5 6.2 5 5.0 5.0 GDP deflator (% growth rate) 25.1 8.5 10.6 13.9 7.7 7.0 5.7 5.0 5.0 a. GDP estimated at factor cost. b. "GNFS" denotes "goods and nonfactor services." c. includes net unrequited transfers excluding official capital grants. d. Includes use of IMF resources. e. Central Government, f. "LCU" denotes "local currency units."An increase in US$/LCU denotes appreciation - 110- Annex B6 Lao People's Democratic Republic Selected Indicators Table - Actual Estimate Projection 2000 2001 2002 2003 2004 2005 2006 2007 2008 Part A: Main Macro Aggregates Annual growth rates, calculated from constant 1995price data GDP (mp) per capita Total consumption per capita GDP at market prices 5.8 5.8 5.8 5.3 6.0 7.0 6.5 5.8 5.8 Total consumption Private consumption Gross domestic investment (GDI) Gross dom. fixed investment (GDFI) Exports (GNFS) -4.4 0.3 6.1 -0.7 1.2 18.2 12.6 1.9 2.1 of which Goods -9.7 1.1 4.7 8.0 0.1 24.7 15.5 0.9 1.1 Imports (GNFS) -9.7 1.o 7.2 0.3 10.9 2.5 14.2 3.8 3.9 of which Goods -9.1 0.7 7.9 -0.6 11.7 -1.7 10.9 4.4 4.5 Savings-investment balances, as percentage of GDP Gross Domestic investment of which Government investment Foreign savings 3.7 5.4 5.5 8.5 7.9 10.5 10.7 10.9 Gross national savings 17.1 14.1 16.5 10.4 11.9 10.2 10.0 10.0 Government savings 8.2 6.1 5.4 4.8 4.6 4.7 4.9 5.3 Non government savings 8.9 8.0 11.o 5.6 7.3 5.5 5.1 4.7 Gross domestic savings Other GDP inflation Annual average exchange rate (LCWUSS) 7,012 7,878 8,913 10,115 10,572 Index real average exchange rate ( =loo) 100 102 97 98 102 Terms of trade index ( =loo) NA Incremental capital-output ratio (GDI based) NA Importelasticity with respect to GDP NA Money growth 7.8 12.9 24.1 19.5 18.0 Part 8:Government Finance Indicators Percentage of GDP Total revenues, of which 13.2 13.2 13.1 11.1 11.2 11.4 11.8 12.3 12.8 Tax revenues 10.6 10.7 10.6 9.1 9.3 9.5 9.8 10.5 11.0 Total expenditures, of which 21.5 20.7 18.4 19.0 15.9 17.4 17.6 18.0 18.4 Consumption 7.7 7.4 7.2 7.2 7.8 8.4 8.6 9.3 9.4 Deficit(-)/Surplus(+) -4.1 -3.7 -2.8 -5.8 -3.9 -4.1 -3.9 -3.8 -3.7 Financing: 4.6 4.4 2.8 6.4 3.9 5.1 4.7 4.6 3.7 Foreign 5.7 3.1 3.3 5.2 4.1 4.1 3.8 3.7 3.6 Monetary sector -0.8 1.6 -1.3 1.1 0.2 1.o 1.o 0.9 0.1 Other domestic 0.1 0.0 1.8 0.0 0.0 0.0 0.0 0.0 0.0 Other Total DebVGDPmp Total interest paymentsflax revenues Part C: Debt & Liquidity Indicators Total DOD and TDS DOD (US$ millions) DOD / GDPmp ratio TDS (US$ millions) 84 76 91 117 122 125 121 198 (continued) - 111- Annex B6 Lao People's DemocraticRepublic Selected Indicators Table - (Continued) Actual Estimate Projection 2000 2001 2002 2003 2004 2005 2006 2007 2008 TDS / exports (XGS) ratio 16.7 14.6 16.2 19.0 16.2 14.4 13.4 21.o Total gross reserves (months' imports G&S) 2.6 3.5 3.2 3.9 4.2 4.3 4.5 4.5 Part D: External Financing Plan (US$, millions) Official capital grants Private investment (net) Net Long term borrowing excl IMF Adjustmentsto scheduled debt service Ail other capital flows Financing Requirements (incl IMF) of which current account deficit - 112 - Annex B7 CAS Annex B7 Lao People's Democratic Republic - Key Exposure Indicators As of 0311012005 Actual Estimate Projected lndlcator 2000 2001 2002 2003" 2004 2005 2006 2007 2008 Total debt outstanding and disbursed (TDO) (US$m)a 1,447 1,458 1,614 2,171 2,244 2,418 2,710 3,031 3,356 Net disbursements (US$m)a 24 59 203 145 147 251 377 403 413 Total debt service (TDS) 81 84 76 91 117 122 125 121 198 (US$"" Debt and debt service indicators (%) TDO~XGS~ 278.3 291.6 312.2 387.7 363.5 320.7 313.2 336.6 357.5 TDOlGDP 83.2 82.7 88.8 104.0 93.0 90.7 93.6 97.0 99.4 TDS/XGS 15.5 16.7 14.6 16.2 19.0 16.2 14.4 13.4 21.o ConcessionalflDO 59.0 62.6 60.2 72.8 75.1 71.4 61.5 53.2 46.6 IDA exposure indicators (%) IDA DS/public DS 21.4 18.0 24.9 29.8 215 0 16.50 16.90 18.40 19.30 Preferred creditor DS/public DS (%) 77.0 71.6 79.4 85.1 61.1 48.8 49.7 55.5 57.8 IDA DSMGS 1.3 1.3 1.8 2.1 2.4 1.7 1.6 1.7 1.8 IDA TDO (us$mld 393.6 406.6 435 484.8 515.4 556.5 607.1 660.7 721.1 Of which present value of guarantees (US$m) 0 0 0 0 0 0 0 0 0 Share of IBRD portfolio (%) 0 0 0 0 0 0 0 0 0 IBRDTDO (us$mld 0 0 0 0 0 0 0 0 0 IFC (US$m) Loans Equity and quasi-equity MlGA MlGA guarantees (US$m) l/. Soviet-eraRussiandebtofUS$387millionforthefirsttimeunderoutstandingdebt. Databefore2003areunreliable. Includes a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMFcredits and net short-term capital. b. "XGS denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank for International Settlements. d. Includes present value of guarantees. e. Includes equity and quasi-equity types of both loan and equity instruments. - 113 - x m a x (0 d (D d X 4 C - 114- Annex 88 Lao People's Democratic Republic Statement of IFC'sCommitted and Outstanding Portfolio Amounts in US Dollar Millions As Of 03110/2005 Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1998 SEF Endeavor 0.15 0 0 0 0.15 0 0 0 1998/2000 SEF Settha 0.86 0 0 0 0.86 0 0 0 2001 SEF Villa Santi 1.15 0 0 0 1.15 0 0 0 Total Portfolio: 2.16 0 0 0 2.16 0 0 0 Approvals Pending Commitment Loan - Equity Quasi - - Partic 2005 Millicom Lao 4 0 0 0 Total PendingCommitment: 4 0 0 0 - 115 - Annex 810 CAS Annex B10 Lao People's Democratic Republic - CAS Summary of Development Priorities As of 0311QI2QQS Country Major issue Country Bank Reconciliation of Network area performance priority priority country and Bank priorities Poverty Reduction & Economic Management Poverty reduction Excellent Rural poverty; rising urban inequality High High Economic policy Good Pace of reform; fiscal decentralization; fiscal High High deficits; external debt; institutional capacity Public sector Fair Weak capacity; pace of PEM and SOE reforms; Moderate High PRSCs administrative decentralization Gender Good Education and employment gaps; maternal Moderate Moderate mortality Human Development Education Fair Low literacy rate; gender and regional gaps; low High High completion rates; lack of trained teachers; teachers' salaries (low and in arrears); female secondary education; Health, nutrition & Fair Low utilization rates; poor quality of services; High High population health workers' salaries (low and in arrears); high child mortality rate Social protection Poor Limited services Low Moderate Other donors providing support; Social Protection Policy Note Environmentally & Socially Sustainable Development Rural development Good Rural infrastructure; diversification High High Environment Good Sustainable natural resource management; High High forestry; hydropower Social development Fair Regional and urban/rural disparities; limited Moderate Moderate participation; weak civil society Finance, Private Sector & Infrastructure Financial sector Fair/Poor Access to services; access to credit; banking Low High PRSCs; FMCBC supervision; regulations projects; Financial Sector Strategy Private sector Fair Regulatory/licensing environment;export High High competitiveness Energy & mining Good Hydropower development; revenue High High management; environmental safeguards Infrastructure Good Inadequate maintenance; weak management High Moderate Other donors capacity; rural accessibility providing substantial support; Infrastructure strategy MAP SECTION IBRD 33431 100°E 102°E 104°E 106°E 108°E This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. C H I N A LAO P.D.R. To Lincang To Gejiu To Daluo Gnot-Ou 22°N Ou 22°N Phongsaly Boun-Nua PHONGSALY MYANMAR VIETNAM LUANG NAMTHA Muang Luang Khoa To Namtha Hanoi Meung Muang Xiangkho MekongBOKEO Xai Nambak Ou Sam-Neva Ban Beng LUANG Viangxai Huaisai Ta OUDOMSAI PHRABANG HOUAPHAN Rai Xiangkhoang Plateau 20°N Pakbeng Luang ChiangoT Phrabang SAYABOURY Plain of Jars Kham Nan Phokhoun Xiang Khoang XIANG Sayaboury Kasi KHOANG Phou Bia Gulf of Vangviang (2,817 m) Ban Nalé Nalé Xaisomboun Tonkin VIENTIANE Nam Ngum Reservoir Pone BOLIKHAMSAI Paksane Khamkeut Paklay Me kong Hong Mekong 18°N Xanakham VIENTIANE Kading 18°N PREFECTURE OF KHAMMOUANE VIENTIANE MUN. Cammon Plateau Ban Na Phan Thakhek To Vinh To Khon Kaen Noy XeBangfai To Khon Kaen Xebangfai 0 50 100 Kilometers SAVANNAKHET Xéno Xéno Xepon 0 25 50 75 100 Miles THAILAND Savannakhet Phin To Qui Nhon Se Banghiong Samouay LAO PEOPLE'S 16°N 16°N DEMOCRATIC SARAVANE Don Saravane REPUBLIC Khongxedon SEKONG Sekong SELECTED CITIES AND TOWNS Pakxong To PROVINCE CAPITALS Ubon RatchathaniCHAMPASSAK Bolovens NATIONAL CAPITAL Champassak Plateau Attapeu Sanamxai RIVERS ATTAPEU TT MAIN ROADS RAILROADS Khong PROVINCE BOUNDARIES 14°N 14°N CAMBODIA INTERNATIONAL BOUNDARIES 104°E 106°E NOVEMBER 2004