Statement by Mr. Benedict Bingham, IMF Senior Resident Representative
Vientiane, November 03, 2009
1. Once again, it is my pleasure to represent the IMF at this Round Table Implementation Meeting. This meeting is particularly timely given the incipient signs that the global economy is turning the corner, and I would like to thank the Government for the opportunity to discuss the outlook for the Lao economy. I will focus my comments today on an overview of the global economic outlook as well as the opportunities and challenges it may present for Lao P.D.R.
Global Economic Developments and Outlook
2. I start with our latest assessment of global economic developments. There are increasing signs that the global recession has bottomed out, in large part as a result of unprecedented policy actions. Emerging economies appear to be somewhat ahead on the road to recovery, led by a resurgence in Asia, especially China with its front-loaded fiscal stimulus, and supported by stabilization or modest recovery elsewhere. The pick up is being led by a rebound in manufacturing and turn in the inventory cycle, and there have been some signs of gradually stabilizing retail sales, returning consumer confidence and firmer housing markets. As prospects have improved, commodity prices have staged a comeback from lows reached earlier this year, and world trade is beginning to pick up.
3. However, the global economy is far from out of the woods yet. Financial markets remain under strain, and are likely to remain impaired for considerable time to come. Support from public policies will eventually have to be withdrawn, and households in economies that suffered asset price busts will continue to rebuild savings while struggling with high unemployment. As such, the recovery is expected to be slow, with possible setbacks along the way given the global economy’s reduced capacity to absorb new shocks. Moreover, medium-term growth is unlikely to return to the high levels experienced pre-crisis, with implications for emerging and developing economies’ external demand and growth.
4. In our latest projections, world output is projected to expand by about 3 percent in 2010, following a contraction of around 1 percent in 2009. Advanced economies are projected to expand sluggishly (1¼ percent) throughout much of 2010 with unemployment continuing to rise until later in the year. In emerging economies, real GDP growth is forecast to reach almost 5 percent in 2010, driven mostly by China, India and other emerging Asian economies. Stronger global prospects and the turn in the inventory cycle is expected to lift commodity prices, raising income and growth prospects in commodity exporting economies such as Lao P.D.R. and underlying a tick up in inflation.
Lao P.D.R.’s Economic Outlook
5. The impact of the global slowdown on Lao P.D.R. has been somewhat smaller than in neighboring countries. This is not only due to low exposure to global financial markets, but also the boost provided by a sizable fiscal expansion and by one-off events such as the SEA Games. While growth is expected to remain robust, coming in among the highest in the region, after China, India and Bangladesh, it is still expected to slow due to the impact of lower foreign currency inflows, softer tourism and falling commodity prices on economic activity. Projects already in train and strong public investment are expected to support growth in the range of 4½–5 percent in 2009–2010.
6. Given recent positive global developments, especially in the Asia region, risks to growth which were previously to the downside are probably coming into balance. On the one hand, the support provided by one-off public investment projects and the SEA Games will gradually wind down and will need to be supplanted by private investment. Continued strains in global financial markets could hold back investment, especially in capital intensive resource sector projects, leading growth lower. On the other hand, strengthening global demand and rising commodity prices could bring a return of foreign investment, boosting growth.
7. Let me pause here and emphasize a key point: while risks to growth are somewhat balanced, risks to macroeconomic stability as a result of excessively loose policies remain. Public investment has soared, fueling credit growth through July of nearly 100 percent year-on-year. In a dollarized economy such as Lao P.D.R., spending of such a magnitude may ultimately weaken the external position through placing downward pressure on the exchange rate. In such a case, the government can either allow the exchange rate to depreciate, or intervene, selling dollars, to keep the exchange rate from depreciating. However, both policy options entail significant risks, as rapid depreciation could lead to a swift re-dollarization and further pressure on the exchange rate, while intervention would deplete precious foreign reserves which could be used to shield the economy in the case of an external shock. The fact that both policy options have significant risks attached to them is what lies behind our recommendation to rein in policies to a level which preserves macroeconomic stability.
Navigating Unsettled Waters with Low Visibility
8. It goes almost without saying that policy making in a highly uncertain global environment is much more difficult than during boom times. In our view, as noted in the recent Article IV Staff Report, policies over the past 12 months or so have been somewhat overly expansionary, skewed toward maintaining growth despite heightened risks and vulnerabilities. While fully supporting the government of the Lao P.D.R.’s commendable long-term goals of poverty reduction and graduating from low-income status, it is important to remind ourselves that attaining these goals requires that macroeconomic stability be maintained.
9. Against this background, the key near-term priority is to put in place a set of well-coordinated and realistic policies which ensure that macroeconomic stability is preserved. This will not only protect the gains which have been achieved in recent years, but also set the stage for continued growth and poverty reduction over the years to come. The still-unsettled global environment implies that policy making will need to remain flexible, and vulnerabilities both present and potential will need to be carefully assessed and managed.
10. To this end, we would suggest that policies be guided by the following considerations:
• Fiscal policy: The official budget for FY2009/10 may need to be reviewed, as revenue targets appear ambitious, while expenditure plans may not fully cover stated commitments. While the intention to tighten to fiscal stance is fully in line with our recommendation, the budget deficit target may not be achievable without additional measures. Specifically, tax revenues could be about 1 percent of GDP lower than budgeted, while domestically financed expenditure (including identified off-budget operations) is likely to be some 2 percent of GDP higher. In such an event, domestic financing in excess of 2 percentage points of GDP would be required.
• Monetary and exchange rate policy: Notwithstanding the welcome announcement to curtail new BoL direct lending, renewed efforts are needed to contain the current pace of credit expansion. Excessive growth of credit—which reached 95 percent in July and in large part reflects the loose fiscal position—could put downward pressure on the exchange rate and weaken the external position, especially if deposit mobilization or foreign currency inflows slow. Lending by state-owned commercial banks is particularly high, especially in view of their still-weak balance sheets and need for recapitalization.
• Banking sector: In light of very high credit growth, tightening liquidity and slower economic activity, the banking sector warrants close monitoring. While SOCBs have increased their exposure to the construction sector and public-sector related activities, some smaller new entrants are also expanding their loan books rapidly, entering into the low-collateral retail and SME lending segments which are more vulnerable to dips in economic activity. A sudden reversal of deposits could heighten liquidity risks, especially given limited instruments for managing liquidity, and possibly reverse recent gains in deepening banking sector intermediation.
11. So far I have focused on near-term challenges, which is probably appropriate given that the global economy is struggling to emerge from the most significant slowdown in many decades. However, it is equally appropriate to remind ourselves of the importance of the broader structural reform agenda to achieving sustained growth and poverty reduction. Maintaining momentum on key reforms, especially those aimed at improving the overall business climate, will not only foster greater private-sector participation, but also improve competitiveness and bolster investor confidence.
12. Let me thank you once again for this opportunity to participate in these discussions. On behalf of the IMF, let me reiterate our continued commitment to providing Lao P.D.R. with the best possible policy advice and support in these still-unsettled times.