Lao People's Democratic Republic: Staff Report for the 2013 Article IV Consultation

KEY ISSUESEconomic context. Growth was strong in 2012, and the economy is overheating fromexpansionary macroeconomic policies. The current account deficit has deterioratedsignificantly, a product of a currency appreciation in real effective terms, a growing fiscaldeficit, and strong domestic demand. International reserves are inadequate forprecautionary needs. Credit growth has declined, but remains excessive, raising financialstability concerns. Inflation is accelerating, and could become more broad-based.Outlook and risks. Growth is projected at 8¼ percent in 2013 before reverting towardpotential of about 7½ percent in the medium-term. Inflation is projected to remainelevated, a result of excess demand. A recent tightening of public wages should reducethe headline fiscal deficit to 4 percent of GDP in 2014, although the current accountdeficit is expected to remain high. FDI inflows should be vigorous, but reserve levelswould remain inadequate. The economy is vulnerable to trading partners' growth andterms-of-trade shocks, and policy slippage. Banks' asset quality could also deteriorate.Policy focus. There was broad agreement that policies should be tightened to replenishinternational reserves and manage a soft landing while building the foundations forbroader-based growth. Restoring economic stability is a key priority.Fiscal policy. A comprehensive medium-term budget strategy anchored around anonmining fiscal deficit target of no more than 5 percent of GDP beginning this fiscalyear would ensure debt sustainability and reduce existing vulnerabilities. Furthertightening through revenue administration, public employee compensation restraintalong with civil service reform, and possibly a VAT rate hike, will be needed.Monetary, exchange rate, and financial sector policies. The USD/kip exchange rateshould move more flexibly in line with market conditions with a view toward graduallybuilding up international reserves. Domestic monetary conditions should be tightened tomoderate credit growth and inflation. Financial supervision requires strengthening, withprudential measures to reduce leverage and balance sheet mismatches.Building broader-based growth. Efforts to improve the business climate and acceleratelegal compliance with the WTO will bolster trade integration and private-sector growth,enhance productivity in the nonresource sector, thereby improving economic resiliency.Public sector financial management reform will improve the quality of public spending.Upgrading health and education infrastructure will help reduce inequality.