Issue # 13 53242 Lao PDR Economic Monitor Mid-Year Update Impact of the in Lao PDR Global Financial Crisis and Recent Economic Developments The World Bank Office, Vientiane — JUNE 2009 The Global Economic Outlook Some positive changes took place recently in the global economy, including an unexpected increase in durable and capital goods orders in the US in May, as well as several positive rallies in the stock markets. However, the global outlook and the length of the global recession still remain uncertain at this time. This Monitor bases its country-level projections for Lao PDR's FDI and export demand on the World Bank's projections for the regional and global economic outlook and commodity prices, presented in Table 1. Annex Table 1. The Global Economic Outlook in Summary (percentage change from previous year, unless otherwise specified) 2007 2008 2009e 2010f 2011f Global conditions World trade volume 7.5 3.7 -9.7 3.8 6.9 Consumer prices G-7 countries 1/ 1.7 2.9 0.5 0.8 1.3 United Sates 2.6 3.8 0.3 1.2 2.0 Commodity prices (USD terms) Non-oil commodities 17.1 21.0 -30.2 -2.1 1.4 Agriculture 20.1 27.2 -20.8 -1.0 -0.1 Food 25.7 33.9 -22.9 0.4 0.8 Metals and minerals 12.0 3.7 -40.7 0.5 5.5 Copper 5.9 -2.3 -46.8 8.1 5.0 Oil price 10.6 36.4 -42.7 13.4 4.6 Manufactures unit export value 2/ 5.5 7.5 1.9 1.0 0.0 Interest rates (USD, percent per year) 5.2 3.2 1.5 1.7 2.0 Real GDP growth World 3.8 1.9 -2.9 2.0 3.2 High income 2.6 0.7 -4.2 1.3 2.4 OECD countires 2.5 0.6 -4.2 1.2 2.3 Euro Area 2.7 0.6 -4.5 0.5 1.9 Japan 2.3 -0.7 -6.8 1.0 2.0 United States 2.0 1.1 -3.0 1.8 2.5 Non-OECD countries 5.6 2.4 -4.8 2.2 4.6 Developing countries 8.1 5.9 1.2 4.4 5.7 East Asia and Pacific (EAP) 11.4 8.0 5.0 6.6 7.8 China 13.0 9.0 6.5 7.5 8.5 Indonesia 6.3 6.1 3.5 5.0 6.0 Thailand 4.9 2.7 -3.2 2.2 3.1 Europe and Central Asia 6.9 4.0 -4.7 1.6 3.3 Latin America and Caribbean 5.8 4.2 -2.2 2.0 3.3 Middle East and North Africa 5.4 6.0 3.1 3.8 4.6 Sourth Asia 8.4 6.1 4.6 7.0 7.8 India 9.0 6.1 5.1 8.0 8.5 Sub-Saharan Africa 6.2 4.8 1.0 3.7 5.2 Source: World Bank (Global Development Finance), 2009. Note: 1/ Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. 2/ Unit value index of manufactured exports from major economies, expressed in USD. The Lao PDR Economic Monitor is issued in Lao and English, twice a year (Spring and Autumn) by the World Bank Office in Lao PDR. The Spring issue - Mid-Year Update - reports mainly on recent economic developments and medium-term outlook for the country. The Autumn publication - Main Report - includes reviews of recent economic performance (Part 1), progress in the implementation of the Government’s policy reform agenda (Part II), and donor activities in the relevant reform areas (Part III). This issue of the Monitor was prepared by Somneuk Davading (Country Economist) under the overall supervision of Ekaterina Vostroknutova (Senior Country Economist) and Mathew Verghis (Lead Economist). We are grateful to the Government and donor community for providing inputs and feedback. We would like to thank our World Bank colleagues: Sengxay Phousinghoa for the rapid enterprise survey, Konesawang Nghardsaysone for trade data and graphs, Thalavanh Vongsonephet for cover design, Vattana Singharaj, Boualamphan Phouthavisouk, Souridahak Sakonhninhom and other staff for printing and dissemination of the Monitor. THE WORLD BANK TEAM APPRECIATES FEEDBACK ON THE STRUCTURE AND CONTENT OF THE MONITOR. Lao PDR Economic Monitor - JUNE 2009 1 EXECUTIVE SUMMARY Lao PDR is weathering the global financial crisis better than many of its neighbors. The real sector continued to perform fairly well while fiscal management (especially budget deficit and off-budget spending) became a serious concern. The impacts of the crisis are felt through falling foreign direct investment, prices and demand for exports, especially for resource sectors and agriculture. Tourism and manufacturing (garments) are less affected by the crisis in early 2009 but remain vulnerable. Going forward the challenge is to maintain macroeconomic stability while dealing with crisis impacts. GDP growth, which was at about 7 percent in 2008 is projected to slowdown to 5 percent in 2009 due to the global economic crisis. The relatively sluggish growth of 5 percent this year is mainly due to reduced external demand and tourism receipts and consequently lower contribution from manufacturing and services sector to the overall growth. However, growth in agriculture and mining sector remains strong (at 2.6 percent and 18.6 percent, respectively) and contributes nearly half to the overall growth of 5 percent. Major contribution from services comes from the recent increases in bank lending and public wage spending. Fiscal deficit is posed to increase sharply in FY2009, as expenditure pressures from SEA Games and other infrastructure projects mount against the revenue shortfalls due to the impact of the global financial crisis. The GOL’s revenue collection is expected to drop from 14.2 percent of GDP in FY2008 to 13.2 percent of GDP in FY2009 due to decline in mining and non-resource revenues. At the same time, expenditure increased to about 22.8 percent of GDP in FY2009 from 17.6 percent in FY2008 due to GOL’s plan to stimulate economy and promote domestic consumption, increased public wage spending as well as preparation for the SEA Games and local infrastructure development (including 450 Anniversary Road). Without additional measures, the overall budget deficit is expected to be at around 8 percent of GDP in FY2009. If the proposed at NA Session measures are taken on revenue side and additional measures envisioned on the expenditure side, the Government may be able to contain the deficit at around 6.7 percent of GDP. The headline inflation has been very low in recent months largely due to reduced import prices while kip exchange rates remained fairly stable against major foreign currencies. The year-on-year inflation has declined significantly in recent months (just below zero in June 2009) due to lower energy and food prices. After appreciation by 9.7 percent in 2008, kip nominal exchange rate was steady against US dollar but depreciated slightly by 2.2 percent against baht during the first six months of 2009. The relative movement of these rates suggests market interventions to support the dollar exchange rate. International reserves fell sharply in 2008Q4 and 2009Q1, and are projected to fall significantly in 2009, due to reduced capital inflows and exchange rate interventions. The capital account surplus is expected to decrease to about 14.2 percent of GDP in 2009 from 18.6 percent in 2008 as FDI slumps by about 30 percent. Current account deficit, which was about 16.5 percent of GDP in 2008, is projected to decline marginally to 15.8 percent of GDP in 2009, as imports drop faster than exports due to lower commodity prices and capital imports by large resource projects; this dynamic however does not compensate for the losses on the capital account side. The Government is facing a number of challenges in dealing with the global economic downturn. Major challenges for the GOL to overcome during this difficult time include: (1) financing the significant budget deficit; (2) fiscal and monetary expansionary spending could jeopardize fiscal sustainability and macroeconomic stability in the near future; (3) controlling future NPLs from recent high credit growth, especially for state-owned commercial banks; (4) and finally, the need for accelerating reforms in order to sustain growth and achieve the 2020 goal of graduating from LIC status. Lao PDR Economic Monitor - JUNE 2009 2 TABLE OF CONTENTS EXECUTIVE SUMMARY ……………………………………………………………………………………………………………………………… 1 1. IMPACT OF GLOBAL FINANCIAL CRISIS AND RECENT ECONOMIC DEVELOPMENTS IN LAO PDR …………………………………………………………………………………………………………………………………………3 1.1 GROWTH AND INFLATION ………………………………………………………………………………………………………………… 3 1.2 GOL’S REVENUE AND EXPENDITURE ……………………………………………………………………………………………………5 1.3 EXTERNAL BALANCE………………………………………………………………………………………………………………………… 7 1.4 MONETARY SECTOR………………………………………………………………………………………………………………………… 9 2. THE LAO GOVERNMENT’S RESPONSE TO THE CRISIS ……………………………………………………………………………12 FIGURES: Figure 1. GDP Growth and Inflation, (percent change).................................................................. 3 Figure 2. Contribution to GDP Growth, (percentage points) .......................................................... 3 Figure 3. Medium-term Real GDP Growth and Inflation (percent) ................................................... 4 Figure 4. Real GDP Growth: Contribution by Sector (percentage points).......................................... 4 Figure 5. Monthly CPI Breakdowns (12-month percent change) ..................................................... 4 Figure 6. GOL’s Quarterly Revenue Performance (Billion kip) ......................................................... 5 Figure 7. GOL’s Quarterly Spending (Billion kip) .......................................................................... 5 Figure 8. Summary of the Medium-Term Fiscal Framework (percent of GDP) ................................... 5 Figure 9. Lao PDR: External Public Debt Indicators at End-2008 .................................................... 6 Figure 10. Exports by Sector (US$ m)........................................................................................ 7 Figure 11. Exports by Destination Country (US$ m) ..................................................................... 7 Figure 12. Lao Quarterly Exports (US$ m) .................................................................................. 7 Figure 13. Medium-term Growth of Exports and Imports (US$ m) .................................................. 8 Figure 14. Balance of Payments, 2006-13 (percent of GDP) .......................................................... 8 Figure 15. Expansion in the Monetary Sector (annual percent change)............................................ 8 Figure 16. FDI in Lao PDR, 2006-2013 ....................................................................................... 9 Figure 17. Kip Exchange Rate (Index Dec-2006 =100) ................................................................. 9 Figure 18. Gross Official Reserves ........................................................................................... 10 Figure 19. Broad Money (year-on-year percent change) ............................................................. 10 Figure 20. Contribution to Credit growth (percentage points) ...................................................... 11 Figure 21. Bank Lending (percent of GDP) ................................................................................ 11 TABLES AND ANNEXES Table 1. The Global Economic Outlook in Summary...................................................................... - Annex 1. Rapid Enterprise Survey monitors crisis impacts in the absence of quarterly data................ - Lao PDR Economic Monitor - JUNE 2009 3 1. IMPACT OF THE GLOBAL FINANCIAL CRISIS AND RECENT ECONOMIC DEVELOPMENTS IN LAO PDR GDP growth in Lao PDR is less affected by the jeopardize balance of payments stability. global financial crisis than in many of its After significant appreciation in 2008, kip neighbors. The crisis is transmitted mainly exchange rates remained fairly stable through FDI, and prices and demand for against major foreign currencies, but at a exports. As a result, the real GDP growth is cost of sharp fall in reserves. GOL’s projected to slow to 5 percent in 2009 but budget deficit is expected to rise in remains fairly robust. The inflation has been FY2009 due to the crisis and increased low in recent months due to lower imported spending. The main challenge going commodity prices. SEA Games related forward is to maintain macroeconomic spending and recent high credit growth while stability while dealing with crisis impacts acting as a stimulus have started to and expenditure pressures. 1.1 GROWTH AND INFLATION GROWTH Real GDP growth in 2008 is estimated to Figure 1. GDP Growth and Inflation, have decelerated only slightly, to 7 (percent change) percent from 7.5 percent in 2007 (Figure Inflation, period average (%, right axis) 1). The resource sectors (hydro and mining Real GDP grow th (%, left axis) 10 30 projects) contributed around 2.0 percentage points to this growth (Figure 2), including the 9 8.4 25 construction of four hydro-power dams, an 8 7.5 20 extension of a large copper plant and 7.1 7.0 7 15 increased outputs. The remaining 5 6.4 percentage points came from non-resource 6 10.5 7.2 6.8 7.6 10 sectors: investment in plantations for 5 4.5 5 agricultural crops and industrial forestry, 4 0 manufacturing (including garments), steadily 2004 2005 2006 2007 2008 rising tourism revenues, growing retail and construction, and newly emerging food and Source: Lao PDR authorities (MPI) and staff estimates. nonfood processing industries. GDP growth is projected to slow to Figure 2. Contribution to GDP Growth, around 5 percent in 2009 (see Figure 3). (percentage points) Relatively sluggish growth in 2009 is mainly due to reduced external demand and tourism Resource sectors (hydropow er & mining) receipts and consequently lower contribution Other sectors from manufacturing and services sectors. 9 Nevertheless, growth remains fairly robust 8 and continues to be driven by the increases in 7 0 .3 3 .0 1.0 agricultural output (by 2.6 percent), copper 6 2 .8 2 .0 production (by at least 25 percent) in 2009, 5 and by the service sector (mainly an increase 4 6 .5 in public wage spending, improved retail 3 6 .1 5.4 5.0 2 4 .3 trade, and the consequences of lending 1 growth in 2008 of 85 percent). The Rapid 0 Enterprise Survey conducted recently to 2004 2005 2006 2007 2008 monitor the impacts of the crisis confirms these projections (see Annex 1). Out of an Source: Lao PDR authorities (MPI) and staff estimates. overall 5 percent growth, agriculture Lao PDR Economic Monitor - JUNE 2009 4 contributes 0.8 percentage points, mining - Figure 3. Medium-term Real GDP Growth 1.5, hydropower - 0.4, and services - 1.9 and Inflation (percent) (public wage expenditures 1.4 points, retail Lao PDR: GDP and Inflation trade 0.3 points, and credit growth 0.2 Inflation (%) GDP growth (%) points). The category “other” (primarily net indirect taxes) accounts for the remaining 0.3 10 9 7.6 8 7 percentage points (see Figure 4). 8 7.5 7.0 6.5 7.2 7.4 7.6 6 7 6 5.0 4.5 5 4.5 4.5 Provided reforms continue and global 5 3.5 4.0 4 economic outlook improves (Annex Table 4 3 2.0 3 1), growth is projected to rebound over 2 2 1 the medium term (Figure 3). The projected 1 0 0 growth is driven mainly by the resource sector 2007 2008 2009 2010 2011 2012 2013 (hydropower and mining), agriculture, and Source: Staff estimates and projections. services. The contribution from manufacturing and construction is also expected to climb in the medium term. The power sector, Figure 4. Real GDP Growth: Contribution especially with NT2 coming on stream in early by Sector (percentage points) 2010 and other power projects afterward, is Agriculture Munufacturing Construction expected to increase its contribution to GDP Services Mining Hydropower remarkably in 2010 and onward (Figure 4). Other The medium-term growth prospects are 9 sensitive to changes in global commodity 8 7 prices (mainly metals and agriculture), 6 recovery in regional tourism, implementation 5 of large hydropower projects in the pipeline, 4 3 and changes in demand from neighboring 2 countries (especially Thailand, China and 1 Vietnam) and the EU. 0 -1 2006 2007 2008 2009 2010 2011 2012 2013 Source: Staff estimates and projections. INFLATION Headline inflation has declined rapidly, to Figure 5. Monthly CPI Breakdowns below zero by June 2009, and is (12-month percent change) expected to remain at a low level in the 35 coming months. Lao PDR’s inflation stayed 30 at or below 10 percent throughout the 2008 25 20 food and oil price rises. Average annual 15 10 6.4 7.7 8.7 10.3 10.2 10.0 9.6 8.5 6.5 6.1 inflation (as measured by the Consumer Price 4.5 3.2 5 2.4 1.6 0.7 Index) was recorded at 7.6 percent in 2008 0 -0.2 -5 -1.6 -1.8 and is expected to decline to below 2 percent - 10 - 15 T o tal C P I in 2009 due to recent sharp falls in global -20 Food CP I E ne rgy C P I commodity prices (Figure 3). Among other -25 C o re C P I ( e xc l. f o o d a nd e ne rgy) -30 groups, energy and food prices have declined Nov-08 Jan-08 Jul-08 Jan-09 May-08 Sep-08 May-09 Mar-08 Mar-09 most in recent months from their highs in 2008 (see Figure 5). The core inflation Source: Lao PDR authorities (MPI) and staff calculations. (without food and energy) has also dropped to just below 1 percent by mid-2009 from 4.2 percent in mid-2008. A drop in global commodity prices (especially food and energy) led to overall low inflation in recent months. Lao PDR Economic Monitor - JUNE 2009 5 1.2 GOVERNMENT’S REVENUE AND EXPENDITURE GOL is facing significant revenue shortfalls in FY2009. The GOL’s revenue Figure 6. GOL’s Quarterly Revenue collection is expected to drop from 14.2 Performance (Billion kip) percent of GDP in FY2008 to 13.2 percent in Direct taxes Indirect taxes FY2009 due to decline in mining and other Nontax revenue Total Domestic Revenue non-resource revenues compared to the 2500 approved plan. Revenue collection in the first 2000 six months of this fiscal year was much lower 1500 compared to the same period of last year due to the crisis and delays in payment of mining 1000 profit tax (Figure 6). However, revenue is 500 expected to improve in the second half of the 0 year as GOL has taken a number of measures Q1 FY07 Q2 FY07 Q3 FY07 Q4 FY07 Q1 FY08 Q2 FY08 Q3 FY08 Q4 FY08 Q1 FY09 Q2 FY09 to raise tax revenues including the expected receipt of the deferred mining tax payments as well as introduction of the new excise Source: Lao PDR authorities (MOF) and staff calculations. taxes. Expenditures increased noticeably in the Figure 7. GOL’s Quarterly Spending (Billion kip) first six months of the year due to recent increases in wages and allowances for the Wage and allowances Nonwage recurrent government’s civil servants and expenses Total current spending Total expenditure Total recurrent spending related to the upcoming SEA Games, as well as the upgrading of secondary education 3500 3000 systems (an increase in the number of school 2500 years from 11 to 12, see Figure 7). Much of 2000 the expenditure bill is off-budget this year, 1500 and administered by the BOL, making overall 1000 fiscal policy intransparent. 500 0 FY07/Q1 FY07/Q2 FY07/Q3 FY07/Q4 FY08/Q1 FY08/Q2 FY08/Q3 FY08/Q4 FY09/Q1 FY09/Q2 The budget deficit is projected to be about 7.6 percent of GDP in FY2009 and 5.6 percent in FY2010 (Figure 8.). Source: Lao PDR authorities (MOF) and staff calculations. However, if measures are introduced, the Government may be able to maintain deficit of 6.7 percent of GDP in FY2009 and to 4.4 Figure 8. Summary of the Medium-Term percent of GDP in FY2010. Key measures Fiscal Framework (percent of GDP) (both revenue and expenditure, see Section 2 Revenue for more detail) account for 0.9 percent of Expenditure Budget deficit (with measures) GDP in FY2009 and 1.2 percent in FY2010. Budget deficit (without measures) Off-budget spending Overall, the budget deficit is expected to 25 decline to 3-4 percent of GDP over the 20 medium term given revenue collection to 15 improve as global economy recovers and 10 provided GOL reverts back to a prudent fiscal 5 policy stance. 0 -0.3 -2.0 -2.7 -2.8 -5 A rapid growth in quasi-fiscal activities -4.4 -4.2 -3.2 -4.1 -6.7 - 5.6 conducted by the BOL, including direct - 7.6 -10 2007 2008 2009 2010 2011 2012 2013 lending to infrastructure projects and provinces, is the main source of the Source: Staff estimates and projections. increase in overall budget deficit. The off- budget spending in FY2009 is estimated at Lao PDR Economic Monitor - JUNE 2009 6 about 2.7 percent of GDP. If the quasi- fiscal stability. The direct lending and operations continue, it will undermine the borrowing by the BOL also raise concerns future fiscal sustainability and macroeconomic about soundness of its balance sheet. PUBLIC DEBT According to the recent assessment, Lao Figure 9. Lao PDR: External Public Debt PDR continues to face a high risk of debt Indicators at End-2008 distress.1 External public and publicly- 260 guaranteed (PPG) debt stocks remain at about 240 220 Indicative US$2.9 billion at end-2008 (or about 53 200 Threshholds percent of GDP), but the high level of 180 End-2008 concessionality of official borrowing, which 160 140 comprises most of Lao PDR's debt, keeps debt 120 service ratios relatively contained (Figure 9). 100 Strong economic growth, currency 80 60 appreciation, and prudent debt management 40 contributed to a decline in the debt ratio over 20 0 the past few years. The corresponding net NPV Debt NPV Debt NPV Debt Debt Debt present value (NPV) of debt at end-2008 was to GDP to Exports to Service to Service to Revenue Exports Revenue 35 percent of GDP. Source: Recent joint Bank-Fund debt assessment. In terms of composition, nearly 70 percent of PPG debt is held by multilateral creditors, mainly the Asian Development Bank and World Bank (IDA). About 29 percent is held by bilateral creditors, including a large Soviet-era debt to Although public external debt Russia. Only 2 percent comprises external stocks remain high, key debt debt incurred by public entities on ratios to GDP, exports, and nonconcessional terms, mainly for revenue have improved in hydropower development and electricity recent years and debt service generation. stays below the LIC indicative thresholds. The stock of recorded domestic public debt amounted to 2.1 percent of GDP at end-2008, but is expected to increase remarkably in the short- and medium- term as the Government resorts to domestic borrowing to finance large fiscal deficit. 1.3 EXTERNAL BALANCE LAO EXPORTS AND IMPORTS With exports representing only about 30 average of 29 percent for the five-year percent of GDP in 2008, Lao PDR is a period 2004-2008. The country has been relatively closed economy in comparison exporting mostly metals and hydro- to others in the region. In nominal terms, electricity, but also other products, such Lao exports of goods grew at around 21 as garments, wood and wood products, percent in 2008, compared to an annual and agricultural produce (Figure 10). 1 The last Lao external debt assessment (DSA) was completed in 2008. A new assessment is currently being prepared jointly by the World Bank and the IMF, in collaboration with the Asian Development Bank. Lao PDR Economic Monitor - JUNE 2009 7 Lao PDR exports mostly to the countries Figure 10. Exports by Sector (US$ m) in the region (Thailand, China, Vietnam, Electricity Mining Malaysia, and Australia) as well as Europe Agriculture Garments Wood & Wood Products Other (garments, coffee, and most recently copper 1600 concentrates), see Figure 11. The power 1400 sector’s contribution to exports is expected 1200 to continue growing in the near future, with 1000 800 NT2 and other dams coming on stream in 600 and after 2010. The garment industry, which 400 grew vigorously last year, exports mostly to 200 Europe (about US$150 million in 2008) and 0 recently to the United States and Canada 2005 2006 2007 2008 (around US$31 million in 2008). Lao PDR imported mostly capital goods for large Source: Lao PDR authorities (MOIC) and staff estimates. investments projects, raw materials, and consumer products. Figure 11. Exports by Destination Country (US$ m) The exports are expected to drop on average Thailand Vietnam Malaysia China by 15 percent in 2009 (in value terms) due Australia Europe USA Other to the sharp fall in commodity prices. Compared to Q1 of 2008, Lao exports 1400 dropped by 16.5 percent in Q1 of 2009 due 1200 to lower copper and agricultural prices 1000 (Figure 12). Similar trends are expected for 800 imports due to reduced prices for fuel and for 600 imported capital goods. However, both 400 exports and imports are expected to grow in 200 volume terms in 2009. Among others, copper 0 export volume is expected to increase by 25 2005 2006 2007 2008 percent and fuel imports to go up by about Source: Lao PDR authorities (MOIC) and staff estimates. 15 percent this year. Assuming global economy recovery Figure 12. Lao Quarterly Exports (US$ m) (Annex Table 1), Lao exports are Resource sectors Manufacturing expected to rebound in the medium Agriculture Total exports term, with NT2 and other dams coming on 450 stream in and after 2010 and with the 400 350 recovery of global commodity prices 300 especially for mining and agriculture, see 250 Figure 13. At the same time, imports will 200 surge as major resource projects in pipeline 150 and non-resource FDI resume from 2011 100 50 onward. Projected rapid growth in capital 0 imports by large projects will push up overall 2006 2006 2006 2008 2007 2007 2007 2007 2008 2008 2008 2008 2009 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 imports in the medium term. Source: Lao PDR authorities (MOIC) and staff estimates. Recovery of demand from the East Asia region is the key to Lao exports growth as most of its exports (85 percent) go to this region. Lao PDR Economic Monitor - JUNE 2009 8 Lao PDR’s exports largely depend on Figure 13. Medium-term Growth of demand from the region: Thailand, China, Exports and Imports (US$ m) Vietnam, Australia, Japan, and Korea. Mining exports Electricity exports These countries are already experiencing a Manufacturing exports Agriculture exports slowdown in production and in their own Total exports Total imports exports, which in turn will have an impact on 3000 the Lao PDR. However, many of Lao PDR’s 2500 exports to these countries are food and wood 2000 products, for which no decline in demand is projected so far. European demand for 1500 exports is also projected to decrease as is 1000 European tourism to Lao PDR. After growing 500 by 35 percent in 2007 and nearly 20 percent 0 in 2008, tourist receipts are expected to 2005 2006 2007 2008 2009 2010 2011 2012 2013 decline by around 10 percent in 2009. Garment exports are expected to decline only Source: Lao PDR authorities (MOIC) and staff estimates and projections. slightly in 2009. CURRENT ACCOUNT BALANCE The current account deficit in 2008, Figure 14. Balance of Payments, 2006-13 which was recorded at 16.5 percent of (percent of GDP) GDP, has declined in 2009 (Figure 14). Current Account Balance (CAB) The high current account deficit reflects the Non-resource CAB vulnerability of the Lao economy to external 10 Overall External Balance shocks. However, this deficit stemmed mostly 5 from large capital imports for the construction 0 of big resource sector projects and the high -5 prices of imported fuel. On the other hand, high copper prices have been compensating -10 on the export side. The capital account was in -15 surplus at 18.6 percent of GDP in 2008, -20 driven by resource FDI. The balance of 2006 2007 2008 2009 2010 2011 2012 2013 payments also showed a surplus of 2.1 Source: Lao PDR authorities (BOL) and staff estimates and percent of GDP last year. projections. In 2009, the current account deficit is Figure 15. Expansion in the Monetary projected to drop to 15.8 percent of GDP Sector (annual percent change) from 16.5 percent in 2008 as imports for the construction of large projects are Credit to the economy 100 Total deposits expected to fall faster than export value. Broad money (M2) 85 The non-resource current account deficit is 80 projected at around 10.4 percent. The overall 60 balance is projected to be negative in 2009 36 39 (about 1.6 percent), see Figure 14. Thus, 40 26 30 21 30 18 18 19 17 foreign reserves, which grew rapidly in the 20 7 8 past years, are expected to fall this year 3 0 (Figure 15). The broad money (M2)2, which -9 grew by 18 percent in 2008, is projected to -20 2005 2006 2007 2008 2009 rise by about 17 percent by end-2009. Source: Lao PDR authorities (BOL) and staff projections. 2 M2 is the total amount of money available in an economy at a particular point in time. It includes physical currency in circulation, demand deposits, time deposits, savings deposits, and non-institutional money-market funds. Lao PDR Economic Monitor - JUNE 2009 9 FOREIGN DIRECT INVESTMENT (FDI) In the last few years, Lao PDR economic FDI in Lao PDR is expected to growth has been heavily dependent on decline significantly in 2009-2010 FDI, which is mostly flowing into the due to impact of the global credit natural resource sectors. FDI doubled in constraints. dollar terms between 2006 and 2008 (to about US$850 million); with 80 percent of this FDI in the resource industry. FDI in non- Figure 16. FDI in Lao PDR, 2006-2013 resource sectors (agriculture, light (US$ millions) manufacturing, processing industries, and services) also grew rapidly in recent years but Manufacturing and other industries Agriculture is still small in value terms and in comparison 1200 Services Mining to that in the resource sector. Hydropow er 1000 FDI is expected to fall markedly in 2009 800 (by about 30 percent), through deferred new 600 hydropower and mining projects, as well as 400 sluggish growth in the non-resource sectors during this period (Figure 16). If the global 200 economic outlook improves (Annex Table 1), 0 FDI to the country is expected to rebound in 2006 2007 2008 2009 2010 2011 2012 2013 the medium term as large resource and non- Source: Lao authorities (MPI) and staff estimates and resource projects resume. projections. 1.4 MONETARY SECTOR EXCHANGE RATE After appreciation in 2008, the kip Figure 17. Kip Exchange Rate nominal exchange rate has remained (Index Dec-2006 =100) fairly stable against both the US dollar and baht in 2009, with slight fluctuations. Kip/USD Kip/Baht 110 Before the crisis, BOL allowed the kip to appreciate managing pressures arising from 105 exports of natural resources and commodity 100 price increases. The kip exchange rate 95 appreciated by about 9.7 percent against the US dollar and by 13.4 percent against baht in 90 2008. In contrast, it has depreciated slightly 85 by 0.5 percent against the US dollar and by 80 2.2 percent against baht, during the first six Ap r-07 Ju n -07 Au g -07 O ct-07 Ap r-08 Ju n -08 Au g -08 O ct-08 Ap r-09 Ju n -09 Dec-06 F eb -07 Dec-07 F eb -08 Dec-08 F eb -09 months of 2009 (Figure 17). The relative movement of the exchange rates suggests a market intervention in support of the dollar Source: Lao PDR authorities (BOL) and staff calculations. rate. Reserves fell sharply by about US$50 benefits. At the same time, foreign million (or by about 8 percent, see Figure reserves accumulated to US$ 636 million 18), between September 2008 and March by end-2008 (compared to $530 million 2009. Strong and stable kip exchange rate at end-2007) reaching nearly 6 months of policy in 2008 has served the country well, non-resource imports in 2008. resulting in significant de-dollarization Lao PDR Economic Monitor - JUNE 2009 10 With the change in the external Figure 18. Gross Official Reserves environment, it is important that the exchange rate policy remains (Q-to-Q percent change) competitive, and does not jeopardize long-term growth. If the fall in reserves 30 28 continues, it would significantly limit BOL’s 19 20 ability to control the exchange rate, as well as 17 13 may erode public trust in the stable kip. The 9 10 7 7 8 current fiscal and monetary expansion and 6 2 credit growth create an unusually high 0 demand for imports and thus depreciation -3 pressure. If these continue against the policy -6 -5 -10 of stable kip, reserves would drop Jun-06 Jun-07 Jun-08 M ar-06 S ep-06 Dec-06 M ar-07 S ep-07 Dec-07 M ar-08 S ep-08 Dec-08 M ar-09 significantly. It is currently projected that reserves will fall by US$100 million, to about US$536 million in 2009 from US$636 million (M-to-M percent change) 16 in 2008 (or to about 5 month of non-resource imports). At the same time, broad money 12 (M2), which grew at 18.3 percent in2008 8 (compared to 38.7 percent in 2007), is expected to slow to about 16.7 percent in 4 2009 (Figure 19). 0 -4 BANK LENDING -8 Nov-08 Feb-08 Apr-08 May-08 Aug-08 Dec-08 Feb-09 Jan-08 Mar-08 Jun-08 Jul-08 Sep-08 Oct-08 Jan-09 Mar-09 Credit grew by 85 percent in 2008, including accelerated lending to SOEs. The economy has been historically starved for Source: Lao PDR authorities (BOL). credit against the background of high liquidity in the banking system, and therefore some growth in credit was warranted in 2008. The Figure 19. Broad Money (year-on-year SOCBs increased their loan portfolios in 2008 percent change) by 152 percent (in kip nominal terms) and contributed 19 percentage points to total 45 credit growth (Figure 20). The private and 40 38.7 joint-stock banks increased their loan 35 30.1 portfolios by about 72 percent and 30 contributed 66 percentage points to the credit 25 18.3 20 growth. Over the same period, policy lending 16.7 15 also increased. Total lending as percent of 10 8.3 GDP increased from 7.8 percent in 2007 to 5 12.5 percent in 2008, and is projected at 16 0 percent in 2009 (Figure 21). The lending to 2005 2006 2007 2008 2009 SOEs is likely to climb from 2.8 percent of GDP in 2008 to 3.9 percent in 2009. The Source: Lao PDR authorities (BOL) and staff projections. announced slow down in credit growth in 2009 to about 26 percent is a welcome target in the current circumstances. Nevertheless, the overall banking sector’s loan to deposit ratio, which increased from 40 percent at end-2007 to 62.6 percent by end-2008, is expected to rise to 68.5 by end-2009. Lao PDR Economic Monitor - JUNE 2009 11 Figure 20. Contribution to Credit growth (percentage points) Credit to SOEs Credit to private sector High credit growth (in Total credit to the economy (percent change) 2008) together with weak 85 90 supervision capacity have 80 19 raised concerns about 70 60 future non-performing 50 loans (NPLs). 40 66 30 30 21 8 20 7 3 10 18 22 2 0 6 -7 -2 -10 -9 2005 2006 2007 2008 2009 Source: Lao PDR authorities (BOL) and staff projections. Most recent rapid growth in credit is Figure 21. Bank Lending (percent of GDP) likely to result in a significant increase in Credit to the whole economy (% of GDP) NPLs. The sharp increase in lending against Total deposits (% of GDP) the background of poor capacity to screen Broad money (M2), (% of GDP) Loan/deposit ratio (%, RHS) borrowers raises concerns about growth in 30 80 contingent liabilities, and a possible 62 63 68 70 deterioration of the balance sheets of the 25 60 SOCBs. It is very important that the ongoing 20 45 40 50 reforms in the financial sector and in SOE 15 28 40 25 management continue and accelerate so as to 10 19 20 19 24 20 23 30 deepen the financial sector in order to ensure 16 16 16 12 20 5 10 8 10 its continued resilience to shocks and to make 7 0 0 sure that SOEs are better managed. At the 2005 2006 2007 2008 2009 same time, the supervisory and regulatory role of the BOL should be strengthened in Source: Lao PDR authorities (BOL) and staff projections. order to closely monitor the performance of banks and the banking sector including NPL performance. BOL has started directed lending operations, raising concerns about the soundness of its balance sheet and the Recent rapid increase in banking system as a whole. BOL’s direct lending contributed about 24 percent to the credit to SOEs and total credit growth by March 2009 (on a year- directed lending by BOL to-year basis). It is also evident that BOL has poses further risks for started to borrow in order to finance such the banking sector. operations directly (the latest bond issue in the amount equivalent to about US$60 million was announced in June). To ensure BOL’s performance in its role as a guarantor of macroeconomic stability, it is important that its function as a quasi-fiscal agent and a quasi-commercial bank are phased out in the near future. Lao PDR Economic Monitor - JUNE 2009 12 2. GOVERNMENT’S RESPONSE TO THE CRISIS The impact of the crisis on real GDP Provided the growth rates projected growth is relatively small in the Lao PDR. in this report materialize, additional This is partly due to the relative closeness of measures would be needed on the its economy and partly to the effects of the expenditure side. In this regard the 2008 credit growth and recent SEA Games prioritization of expenditures would be and related infrastructure spending. key for the policies to support future growth. In order to reduce risks Nevertheless, the Government is facing associated with the high credit growth, it significant risks in dealing with the is important that BOL substantially global financial crisis and the increased controls bank lending this year (it should spending, without appropriate fiscal slow to about 26 percent compared to 85 space. The decline in revenues coupled with percent in 2008). expenditure pressures have effectively resulted in abandonment of the recent To be successful, any stimulus should prudent fiscal policy, as off-budget financing be timely, targeted, temporary, and and directed lending by BOL have started and transparent. In this regard, there is a intensified this year. At the same time, an need to strengthen the fiscal and expansionary monetary policy is creating risks monetary policy coordination to maintain in the banking sector. The rapid fall in macroeconomic stability. It is also reserves supported by the decline in net important that the expansionary fiscal capital inflows, is pointing at the vulnerability policy is withdrawn as soon as SEA of the current stable exchange rate policy, if Games expenditures have been the expansionary trends continue on all implemented. Without the fiscal space, fronts. At a minimum, high deficit will put Laos would not be able to maintain high upward pressures on domestic debt and fiscal deficits without a significant increase domestic arrears. A balance of deterioration in stability through an payments crisis and a disorderly adjustment unsustainable increase in domestic of the exchange rate may occur as the worst borrowing, followed by inflation, and case scenario. exchange rate adjustment. The GOL presented some measures to Major challenges for the GOL to deal with the budget deficit, at the NA’s overcome during this difficult time meeting in June 2009. The GOL will rely on include: (1) financing the significant three main sources to finance the deficit: (1) budget deficit (among other policy raising additional revenues through imposition actions, some revenue and expenditure of additional excise taxes, as well as the measures are needed to deal with this restructuring of taxes and fees on luxury issue); (2) fiscal, quasi-fiscal, and goods, and reduction in revenue leakages; (2) monetary expansion could jeopardize mobilization of additional donor funding; and fiscal sustainability and macroeconomic (3) increase of domestic financing (issue of stability in the near future (phasing–out bonds). In addition, the GOL has expressed of quasi-fiscal operations and its strong intention to maintain macro- improvement of fiscal and monetary economic stability; continue economic reforms policy coordination is essential); (3) and make use of opportunities from the global controlling future NPLs from recent high crisis; accelerate regional and global credit growth, especially for state-owned integration; improve investment climate and commercial banks; (4) and finally, the increase private sector competitiveness; and need for accelerating reforms in order to promote equitable growth and reduce poverty sustain growth and achieve the 2020 in the country. vision. Lao PDR, a small country with limited resources and low capacity, cannot easily overcome the impact of the global crisis without a well-designed response plan and a clear financing strategy, for which significant external support will be needed. A balance between the announced measures and short- and medium-term macroeconomic stability is fragile and additional steps will be needed to ensure consistency of policy response. Annex 1. Rapid Enterprise Survey monitors crisis impacts in the absence of quarterly data In order to collect real time information on the possible impact of the global economic crisis on the Lao corporate sector, a Rapid Enterprise Survey was conducted during April 20-24, 2009. In total 140 firms located in four urban districts of Vientiane Capital were interviewed: 53 firms from retail trade, 40 from general manufacturing (11 export-oriented manufacturers) and 47 tourism businesses (33 hotels/guesthouses and 14 travel agencies). Although about 69 percent of firms said that A-Figure 1. Change in firms’ sales level in Q1 their businesses have been affected by the 2009 compared to Q1 2008 global economic crisis, impact on business (percent of total firms interviewed) performance and operations has so far been limited. About 44 percent of all firms surveyed reported higher revenues for the first quarter of 40% 44% 2009, compared to the same period last year (Annex Figure 1). Around 16 percent of firms did not experience change in their first quarter revenues and about 40 percent of firms suffered a decline in their first quarter revenues. Similar sales patterns can be 16% observed across three of the three major sectors Increased in sales covered in the survey. The exception is the retail Remained the same sector, where the percentage of firms reporting a Decreased in sales decline in sales is slightly higher than those reporting increases (Annex Figure 2). A-Figure 2. Change in firms’ sales level in Q1 2009 compared to Q1 2008 by sector Limited impact of the crisis on firms’ (percent of total firms interviewed) operations further confirmed by limited Increase in sales No change in sales adjustment made in employment and working Decrease in sales hours. Findings of the survey indicated that overall 70 only about 14 percent of firms reduced their staff in 60 the past three months (about 10 percent for the 50 tourism sector, 15 percent for retail and 18 percent 40 for manufacturing), see A-Figure 3. Furthermore, the 30 survey revealed that less than 3 percent of firms 20 reduced the number of working hours and number of 10 work shifts; only about 1 percent of all the firms 0 surveyed reduced overtime hours or average wage Genral Mfg Export oriented Mfg Retail Tourism (hotels and during the first quarter of 2009. travel agents) Business confidence across the manufacturing, A-Figure 3. Impact of the crisis on retail, and tourism sectors remains strong. employment during Q1 2009 None of the companies surveyed has plans to reduce the number of work shifts or overtime hours and 20 18 .0 only about 1 percent of firms have plans to reduce 14 .8 their average wage. Fewer than 3 percent plan to 15 12 .8 reduce working hours. Overall, about 6.5 percent of 10 .6 10 firms plan to reduce staff in the next three months. 6 .4 As expected, this number is higher for labor 5 intensive sectors. For example, among 1.9 manufacturers, about 13 percent of firms plan to 0 Manufacturing Retail Tourism reduce staff in the coming months, followed by the tourism sector, where about 6 percent of hotels and Percentage of firm s that reduced staff during Q1 2009 travel agents are expected to reduce the size of their Percentage of firm s planning to reduce staff during Q1 2009 work force (Annex Figure 3). Although the majority of firms interviewed were less affected by the crisis in early months of 2009 they are likely to face more challenging environment during the second half of the year. About 44% of firms are still projecting higher revenues for 2009 compared to 2008 and about 40% are still planning to increase their investment during 2009 as they believed the domestic consumption will continue to be strong in coming months1. Nevertheless, the impact of the crisis on local economy (especially export- oriented and tourism-related activities) is expected to increase during the second half of the year as the global economic recession continues, including recent spread of H1N1 virus. 1 The key findings of this survey are also consistent with the results of the Retail Confidence Survey conducted by Indochina Research Co., Ltd. According to which, most retailers in Indochina Region have been hard hit by the crisis with the exception of Lao PDR, where retailer conditions have actually improved (see details at: http://www.indochinaresearch.com/i-trak/reports.php) THE WORLD BANK OFFICE, VIENTIANE P.O Box UN 345, Patou Xay Nheru Road Vientiane, Lao PDR Tel: (856-21) 450010-11, 414209 Fax: (856-21) 414210 www.worldbank.org/lao Lao PDR Economic Monitor — Mid-Year Update THE WORLD BANK OFFICE 1818 H Street, N.W. Washington, D.C. 20433 Tel: (202) 472-1653 Fax: (202) 522-1560/1557 www.worldbank.org LAO PDR ECONOMIC MONITOR — JUNE 2009 FREE COPY (NOT FOR SALE)