Statement by Sanjay Kalra
IMF Resident Representative
Vientiane, November 23, 2012
1. Excellencies, ambassadors, distinguished participants, ladies and gentlemen. It is my great pleasure to represent the International Monetary Fund (IMF) at this Round Table Implementation Meeting for Lao P.D.R. I would like to thank the Government of Lao P.D.R. and the co-organizers of this meeting for the opportunity to speak to you today. Let me also take this opportunity to welcome the recent agreement of the General Council of the World Trade Organization (WTO) for Lao P.D.R. to join the organization.
2. This round table meeting comes at a time when prospects for global growth have deteriorated and downside risks to the global economy are more elevated than they were earlier this year, as noted at the IMF/World Bank Annual Meetings in Tokyo last month. I would like to focus my comments on the opportunities and challenges for Lao P.D.R. against the backdrop of these shifting global prospects. In doing this, I would like to draw on the close engagement that the IMF has with Lao P.D.R., in particular through the annual Article IV Consultation discussions. I would like to note here that, in addition to this policy advice, the IMF provides extensive technical assistance to Government of Lao P.D.R. in several areas within its mandate and offers training opportunities to Lao official at its institutes in Asia, Europe, and the U.S. The recent opening of the Technical Assistance Office for the Lao P.D.R. and the Republic of the Union of Myanmar in Bangkok enhances the possibilities for further deepening of cooperation in these important areas of capacity building.
3. As many of you know, the Executive Board of the IMF concluded the 2012 Article IV Consultation with Lao P.D.R. on August 31, 2012. Overall, at this meeting, the Board commended the Lao P.D.R. authorities for their sound policies, which have contributed to impressive economic growth, reduction in poverty, lower inflation, and improved debt dynamics. Rapid economic growth over the last decade has allowed significant progress towards achieving several of the Millennium Development Goals (MDG) targets. With respect to the external debt sustainability analysis, the Board concluded that Lao P.D.R. now faces a moderate risk of debt distress from a high risk previously. The projected strong performance of the economy, fundamental improvements in institutional capacity, together with recent fiscal consolidation led to this upgrade in the country’s risk rating. The Board also welcomed the authorities’ reform efforts to achieve sustainable and inclusive growth. Structural reforms have been accelerated in some areas in the context of commitments under the ASEAN Economic Community and the prospect of WTO accession. However, while macroeconomic policies have remained generally sound, low reserve coverage and rapid credit growth amid high lending rates have emerged as sources of vulnerability. Mr. Chairman, allow me now to elaborate.
I. Recent Economic Developments and Outlook
4. Real GDP growth in 2011 was strong. At 8 percent, this was a bit higher than the average of 7 percent per annum over the last decade and among the highest in the region. The higher growth was achieved despite policy tightening, global uncertainty, and natural disasters in Lao P.D.R. and its main trading partner, Thailand. Growth is expected to remain at the range of 8–8½ percent in 2012, including on account of substantial activity related to the Asia-Europe meetings. Inflation has moderated to 3¾ percent (12-month) in September 2012, reflecting lower food and fuel price pressures, and favorable base effects. The current account deficit widened to about 21½ percent of GDP in 2011. At the same time, gross international reserves declined by US$51 million to US$677 million (a little over 2 months of imports of goods and services) at end-2011. Recent data suggest that the level of reserves has declined further. Meanwhile, the kip has remained broadly stable against the U.S. dollar and the Thai baht.
5. As regards policies, the fiscal deficit in FY2012 (October-September) is estimated to have moderated to 2½ percent of GDP from 3 percent in FY2011. Meanwhile, on the monetary policy front, policies have loosened recently. Private sector credit growth was over 30 percent (12-month) at end-2011 and rose further to 46 percent in June 2012. In addition, Bank of Lao (BOL) lending to local governments has continued. Rapid private sector credit, together with weak supervision, potentially contains the seeds of problems in the banking system in the years to come.
6. Going forward, growth can be expected to remain strong in 2013 and over the medium term on the back of strong contributions from the mining and hydropower sectors, as a result of which per capita income could rise noticeably over the next five years. With sound policies, inflation can be contained to reasonable levels and the reserve cover can be built to more comfortable levels, reducing the country’s vulnerability to external shocks.
7. This outlook is subject to several risks, mostly from domestic economic management.
- On the external front, the global growth outlook is weak and subject to significant downside risks. For Lao P.D.R., experience from the time of the onset of the global financial crisis suggests that spillovers from global growth have been moderate, although substantial policy stimulus at the time likely contained the fallout. Moderate spillovers from the global economy may well remain the baseline going forward, given limited integration with global markets, continued supportive growth in the main trading partners, and with most hydropower contracts committed for the long term. The main channel of contagion from slower global growth would be through lower gold and copper export prices.
- On the domestic front, there are several important sources of vulnerabilities. First, in the financial sector, rapid expansion of the financial sector in recent years raises concerns about banking sector soundness and a possible emergence of contingent fiscal liabilities in future years. As noted before, despite some slowdown in 2011, credit growth is on the rise again in 2012, putting recent stability gains at risk. Second, the level of international reserve cover currently provides inadequate protection against external and internal risks. Third, the level of public sector debt remains elevated, notwithstanding the recent reduction in the risk of debt distress. Off-budget capital spending remains indicative of weak spending controls that could give rise to additional contingent liabilities.
II. Policy Challenges
8. With this backdrop, the Executive Board suggested that macroeconomic policies be guided by the following considerations:
- There is an urgent need for tightening monetary policy to help address risks stemming from rapid credit growth. Quasi-fiscal lending to local governments should be phased out, and the pace of monetary expansion reduced through sterilization and higher reserve requirements, consistent with our policy advice at the time of the last Article IV consultation. Relatedly, the level of international reserves needs to be built up to more comfortable levels.
- The monetary policy framework can be strengthened, especially by avoiding the pursuit of multiple policy objectives. Tensions that result from the pursuit of multiple objectives may have contributed to the low reserves cushion, and can undermine the main nominal anchor (a stabilized exchange rate). Moving to an explicit inflation target range in the medium term can help improve the effectiveness of monetary policy and anchor inflation expectations.
- Maintaining financial sector stability is contingent on strengthening banking supervision. Enhancing the regulatory and prudential toolkit will help improve the quality of credit while promoting financial deepening.
- Fiscal policy needs to remain prudent, as a backstop to necessary monetary tightening. In particular, increases in current budgetary spending should not be allowed to crowd out higher priority spending. The progress made in improving fiscal and external sustainability must continue. In particular, in light of heightening pressure on international reserves, off-budget capital spending could be reduced more speedily to help contain the current account deficit. Moreover, the contracting of external loans should only be at terms that can help maintain—and improve—Lao P.D.R.’s hard won, upgraded debt distress rating.
- Furthers effort is required to ensure that growth is both sustainable and inclusive. In this context, improvements in the business climate, including those under the umbrella of WTO accession and the ASEAN Free Trade Agreement, are key to enhancing competitiveness in the nonresource sector. At the same time, stepped up efforts to strengthen public financial management can create more space for high impact spending.
It only remains for me to thank once again the Lao P.D.R. authorities and the organizers of this Round Table for the opportunity to participate in this meeting today. On behalf of the IMF, I would also like to reiterate our continued support for Lao P.D.R. on the road ahead.