IMF Sees Laos Return to Steady Growth, Warns of Debt Risk

IMF Executive Board Concludes 2023 Article IV Consultation with Lao People’s Democratic Republic
Local market in Laos during sunrise. (Photo: Freepik )

This year’s conversation with Laos saw the IMF focused on how to support steady economic growth in 2023, considering the high public debt that still poses a risk for the country.

Marked exchange rate depreciation following the global terms of trade shocks at the start of 2022 brought high inflation and deteriorating living standards. Public debt has increased further, largely driven by currency depreciation, but also by additional government arrears, domestic bond issuances to recapitalize banks, and SOE debts.

The government has enacted measures intended to improve the public finances and to ease
FX pressures. These include substantial fiscal consolidation, driven by expenditure cuts, a
recovery in revenue collection, and by debt servicing deferrals. The central bank has tightened monetary conditions by issuing bonds and increased the policy rate and reserve requirements, and has also tightened exchange controls and prioritized access to FX.

The prospect is for a return to steady growth in 2023, supported by higher regional growth,
particularly through tourism, exports of goods, and resource extraction. Falling global
commodity prices would allow inflation to gradually fall. But even with higher growth and
despite eliminating the primary fiscal deficit, public debt would remain at high levels for an
extended period.

The scale of public and external debt poses substantial risks to the outlook, including from significant financing needs, low foreign exchange liquidity and reserves, and the prospect of tight global financial conditions limiting external market access. The external environment remains uncertain; It is possible that net trade improves further, given the potential for a faster pick-up in services (e.g., logistics and tourism) and remittances, which would bring valuable foreign exchange earnings, but the external environment could be more adverse than expected in 2023.

Executive Board Assessment
Executive Directors noted that the post-pandemic recovery has been challenging, marked by the acceleration in exchange rate pressures, substantial increase in inflation rates, and a
worsening public debt ratio. While the near-term growth outlook appears positive, large public financing needs and liquidity pressures pose significant downside risks. Against this
background, Directors encouraged the authorities to press ahead with adjustment policies and governance reforms, supported by Fund technical assistance, to address macroeconomic imbalances and promote sustainable, inclusive and more broad-based growth. Looking ahead, Directors encouraged the authorities to strengthen Fund engagement.

Directors emphasized the urgency of strengthening public finances and ensuring debt
sustainability, given significant financing needs, difficult financing conditions, and large
contingent liabilities. They welcomed the authorities’ recent progress at balancing the primary budget, and called for further efforts toward a sustained, growth friendly, and revenue based consolidation, with spending prioritizing critical development and social needs. Directors considered that revenue measures should be focused on eliminating tax exemptions and reversing recent tax cuts, while paying particular attention to consistent application of taxes. Expenditure policies should be supported by comprehensive public financial management reforms, including for state Directors agreed o owned enterprises, to prevent further accumulation of arrears.

Directors agree on the importance of continuing to tighten monetary conditions, given
negative real rates and foreign exchange shortages. They noted the authorities’ efforts to
contain exchange market pressures, but cautioned against excessive reliance on
administrative measures. Directors emphasized the need to strengthen the operational
independence of the central bank and refrain from monetizing sovereign obligations.

They also called for vigilance in light of risks and vulnerabilities in the financial sector. The directors advised strengthening banking regulation and supervision and building capital buffers to help address the solvency strains in the banking sector while calling for heightened monitoring of liquidity levels and contingency planning. They noted the injections of capital into two state owned banks and welcomed the authorities’ intention to end forbearance policies and implement corrective action measures in 2023.

Directors agreed that structural reforms are crucial to boost private sector development and durably sustain high growth rates. They called for measures to improve education and skills training and emphasized the urgency of improving governance and transparency. Directors welcomed progress on the AML/CFT regime and encouraged swift implementation
of the Financial Action Task Force’s mutual evaluation recommendations when published. They also urged progress on improving the quality, coverage, and timeliness of economic data.