proposed programmatic approach and policy- based loan for ...peer reviewer yuji miyaki, public...

Report and Recommendation of the President to the Board of Directors

Project Number: 52146-001 September 2019

Proposed Programmatic Approach and Policy-Based Loan for Subprogram 1 Lao People’s Democratic Republic: Strengthening Public Finance Management Program Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB's Access to Information Policy.

CURRENCY EQUIVALENTS (as of 3 September 2019)

Currency unit = kip (KN)

KN1.00 = $0.0001140 $1.00 = KN8, 771.08

ABBREVIATIONS

ADB – Asian Development Bank GDP – gross domestic product IMF – International Monetary Fund Lao PDR – Lao People’s Democratic Republic LDC – least-developed country MOF – Ministry of Finance NSEDP – National Socio-Economic Development Plan PFM – public finance management PPG – public and publicly guaranteed PPPF – post-program partnership framework SDG – Sustainable Development Goal TA – technical assistance

NOTES (i) The fiscal year (FY) of the Government of the Lao People’s Democratic Republic

ends on 30 September.

(ii) In this report, “$” refers to United States dollars. Vice-President Ahmed M. Saeed, Vice-President, Operations 2 Director General Ramesh Subramaniam, Southeast Asia Department (SERD) Directors Jose Antonio Tan III, Director, Public Management, Financial Sector

and Trade Division, SERD Yasushi Negishi, Country Director, Lao Resident Mission, SERD

Team leaders Jhelum Thomas, Senior Public Management Specialist, SERD

Aekapol Chongvilaivan, Economist (Public Finance), SERD Team members Florissa Barot, Associate Project Analyst, SERD Robert Boothe, Public Management Specialist, SERD Jennalyn Delos Santos, Operations Assistant, SERD Soulinthone Leuangkhamsing, Senior Economics Officer, SERD

Laurence Levaque, Senior Social Development Specialist (Gender and Development), SERD Heekyung Katie Nam, Counsel, Office of the General Counsel

Peer reviewer Yuji Miyaki, Public Finance Specialist (Taxation), Central and West Asia Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

PROGRAM AT A GLANCE

I. THE PROPOSAL 1

II. PROGRAM AND RATIONALE 1

A. Background and Development Constraints 1

B. Policy Reform and ADB’s Value Addition 4

C. Impacts of the Reform 8

D. Development Financing Needs and Budget Support 9

E. Implementation Arrangements 9

III. DUE DILIGENCE 9

IV. ASSURANCES 10

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 14

3. Development Policy Letter 15

4. Policy Matrix 19

Project Classification Information Status: Complete

PROGRAM AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 20052019143956521369 Generated Date: 03-Sep-2019 14:51:46 PM

1. Basic Data Project Number: 52146-001Project Name Strengthening Public Finance

Management Program (Subprogram 1)

Department/Division SERD/SEPF

Country Lao People's Democratic Republic

Executing Agency Ministry of Finance

Borrower Lao People's Democratic Republic

2. Sector Subsector(s) ADB Financing ($ million)Public sector management Public expenditure and fiscal management 45.00

Total 45.00

3. Strategic Agenda Subcomponents Climate Change InformationInclusive economic growth (IEG)

Pillar 2: Access to economic opportunities, including jobs, made more inclusive

Environmentally sustainable growth (ESG)

Environmental policy and legislation

Climate Change impact on the Project Low

4. Drivers of Change Components Gender Equity and MainstreamingGovernance and capacitydevelopment (GCD)

Public financial governance Effective gender mainstreaming (EGM)

5. Poverty and SDG Targeting Location ImpactGeographic TargetingHousehold TargetingGeneral Intervention on PovertySDG Targeting

NoNoYesYes

Nation-wide High

SDG Goals SDG5, SDG16, SDG17

6. Risk Categorization: Low .

7. Safeguard Categorization Environment: C Involuntary Resettlement: C Indigenous Peoples: C.

8. Financing

Modality and Sources Amount ($ million)

ADB 45.00 Sovereign Program (Concessional Loan): Ordinary capital resources 45.00

Cofinancing 0.00 None 0.00

Counterpart 0.00 None 0.00

Total 45.00

Currency of ADB Financing: USD

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on (i) a proposed programmatic approach for the Strengthening Public Finance Management Program and (ii) a proposed policy-based loan to the Lao People’s Democratic Republic (Lao PDR) for subprogram 1 of the Strengthening Public Finance Management Program. 2. The program will help the Government of the Lao PDR achieve fiscal consolidation and advance public finance management (PFM) by (i) strengthening public debt management and reforming tax administration, (ii) improving medium-term fiscal planning and budgeting, and (iii) enhancing governance and budget credibility. The program will support the government’s Vision to 2030 and Public Finance Development Strategy to 2025 (Strategy 2025), 1 and help the government realize its development priorities in the Eighth National Socio-Economic Development Plan (NSEDP) 2016–2020.2 The program has been classified as effective gender mainstreaming and contributes to gender equality (operational priority 2) under Strategy 2030 of the Asian Development Bank (ADB). It will build the foundations for gender-responsive budgeting, including gender capacity assessments to strengthen organizational structures and ensure greater representation of gender stakeholders in key PFM reform structures. The program also contributes to Strategy 2030 by strengthening governance and institutional capacity (operational priority 6).3 The program addresses Sustainable Development Goal (SDG) 16 by strengthening governance and inclusive institutions, and SDG 17 by enhancing domestic revenue mobilization and building capacity. The program is aligned with ADB’s country partnership strategy, 2017–2020,4 and is included in the country operations business plan, 2019–2021 for the Lao PDR.5 The design and monitoring framework is in Appendix 1.

II. PROGRAM AND RATIONALE A. Background and Development Constraints 3. The Lao PDR is currently one of the fastest-growing economies in Southeast Asia and has made substantial progress towards graduating from least-developed country (LDC) status by 2020. A resource boom and strong foreign direct investment in resource sectors resulted in robust growth in gross domestic product (GDP), which averaged 7.4% during 2010–2018. Gross national income per capita reached $2,599 in 2018. Strong growth has alleviated poverty, and the Lao PDR’s poverty rate declined from 27.6% in 2008 to 23.2% in 2013. The Lao PDR met the criteria for graduation from LDC status for the first time in 2018.6

1 Government of the Lao PDR. 2018. Vision to 2030 and Public Finance Development Strategy to 2025. Vientiane. 2 Government of the Lao PDR. 2016. The Eighth National Socio-Economic Development Plan (NSEDP) 2016–2020.

Vientiane. 3 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific.

Manila. The program will support operational priority 6 by addressing reform priorities in public expenditures, revenue collection, and building resilience to respond to economic shocks in a timely manner.

4 ADB. 2017. Country Partnership Strategy: Lao People’s Democratic Republic, 2017–2020—More Inclusive and Sustainable Economic Growth. Manila.

5 ADB. 2018. Country Operations Business Plan: Lao People’s Democratic Republic, 2019–2021. Manila. 6 The Lao PDR met the thresholds for gross national income per capita and Human Assets Index for the first time

during the March 2018 review. If progress continues until the subsequent 2021 review, the Lao PDR will graduate from LDC status in 2024, following a 3-year implementation period. Further information can be found at: http://www.la.undp.org/content/lao_pdr/en/home/presscenter/pressreleases/2018/3/19/lao-pdr_s-eligibility-for-grad-from-least-developed-countr/.

http://www.la.undp.org/content/lao_pdr/en/home/presscenter/pressreleases/2018/3/19/lao-pdr_s-eligibility-for-graduation-from-least-developed-countr/

http://www.la.undp.org/content/lao_pdr/en/home/presscenter/pressreleases/2018/3/19/lao-pdr_s-eligibility-for-graduation-from-least-developed-countr/

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16.1 16.1

15.515.2

15.4

15.6

15.8

16.0

16.2

2010-2016 (average) 2017 2018

Figure 1: Tax and Non-tax Revenue (% of GDP)

3.2

1.7

0.5

4.3

2.8

5.65.1 5.5

4.4

0123456

Figure 2: Fiscal Deficit (% of GDP)

56.2 57.9 57.7 58.5 55.8 57.245.8 45.6 45.4 46.2 49.6 51.4

0

50

100

2013 2014 2015 2016 2017 2018

Figure 3: Public and Publicly Guaranteed Debt (% of GDP)

Total External

4. Despite strong economic performance, the Lao PDR’s social development indicators have fallen well behind regional averages; inequality widened between 1993 and 2013, and the Gini coefficient increased from 0.31 to 0.36. The Lao PDR is also increasingly vulnerable to revenue volatility resulting from its dependence on natural resources with fluctuating commodity prices and exacerbated by weak tax administration. This has led to a growing fiscal deficit and high public debt levels, which have increased the Lao PDR’s exposure to macroeconomic shocks. This could undermine sustainable financing of services and derail the country’s poverty reduction and development goals under the Vision to 2030 (footnote 1).7 In addition, the Lao PDR’s susceptibility to disasters triggered by natural hazards, such as drought and landslides, can also have a devastating impact on an agrarian economy and hinder long-term growth prospects.8 To reduce the Lao PDR’s vulnerability to economic shocks, and to maintain growth and improve social outcomes, more must be done to strengthen PFM. The government has identified three primary development constraints: (i) lack of comprehensive debt management and tax reform strategies; (ii) absence of medium-term fiscal planning and budgeting; and (iii) weak governance and budget oversight.9

GDP = gross domestic product. Sources: Asian Development Bank and International Monetary Fund.

5. Lack of comprehensive debt management and tax reform strategies. Government debt has increased because of rising government expenditures and investments in large public projects, amplified by declining tax and nontax revenues. The tax base is narrow, compliance is low, tax administration is inefficient, and revenues are reliant on natural resources. Ineffective tax administration has resulted in the Lao PDR ranking 155th out of 190 economies for paying taxes

7 IMF. 2019. Lao People’s Democratic Republic: 2019 Article IV Consultation. Washington, D.C; and Sector

Assessment (Summary): Public Sector Management (accessible from the list of linked documents in Appendix 2). 8 In 2018, floods caused by heavy monsoon rain affected 15 provinces and Vientiane (the capital). 9 These three development constraints are consolidated from the eight challenges of PFM reforms recognized in the

Vision to 2030 and Public Finance Development Strategy to 2025 (footnote 1).

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in the 2019 Doing Business Indicators.10 Tax and nontax revenues declined from an average of 16.1% in 2010–2016 and 16.1% in 2017 to 15.5% of GDP in 2018 (Figure 1).11 These factors increased the fiscal deficit to 4.4% of GDP in 2018 from 3.0% in 2010–2016 (Figure 2), which is one of the highest levels among the Lao PDR’s regional and structural peers.12 The absence of a comprehensive legal framework for effective debt management leaves the government lacking the necessary tools to systematically address its deteriorating debt situation including its increasing risk from contingent liabilities.13 Outdated debt reporting systems and the absence of an integrated external and domestic debt framework contribute to a fragmented approach to debt management practices, and public and publicly guaranteed (PPG) debt remains high at 57.2% of GDP in 2018 (Figure 3)―a high level by frontier market standards.14 The external PPG debt, which accounted for 51.4% of GDP in 2018, is increasingly from bilateral creditors.15 As a result, the 2019 debt sustainability analysis of the International Monetary Fund (IMF) assessed the Lao PDR at high risk for external debt distress (unchanged from the previous ratings in 2018).16 It also underlines the country’s high exposure to contingent liability risks, especially those related to state-owned enterprises in the power sector.17 6. Absence of medium-term fiscal planning and budgeting. The weak strategic link between policy, planning, and budgeting undermines overall fiscal discipline in the budget process. This contributes to large budget deficits and ineffective financing of development priorities, placing the achievement of the NSEDP priorities at risk.18 The Ministry of Finance (MOF) does not provide indicative budget ceilings to line ministries to guide their budget preparation process. The absence of a medium-term framework weakens the link between budget allocation and estimated funding needs at the line ministry level, causing budget unpredictability and weak budget preparation and execution, and ultimately hampering public service delivery and poverty reduction objectives. Finally, the Lao PDR also attained low scores in the 2018 Public Expenditure and Financial Accountability Assessment for key PFM indicators, such as a multiyear perspective in expenditure budgeting (rated D), and orderliness in the budget preparation process (rated C+).19 7. Weak governance and oversight of budget. This constraint relates to the government’s efforts to effectively implement its PFM reform strategy and improve oversight. The State Budget Law, revised in 2015, provides the legal and institutional framework for a budget preparation process and gives the MOF a strengthened mandate for negotiating budget allocations with line ministries. However, much of the existing legislation has yet to be fully implemented because of the lack of relevant regulations and the limited oversight of implementing agencies. In addition,

10 World Bank. Doing Business 2019: Training for Reform. Washington, D.C. 11 The low tax revenue-to-GDP ratio of about 13.2% during 2010–2018 exposes the Lao LDR’s tax and nontax revenues

to global mining and hydropower market price volatility. 12 ADB. 2019. Asian Development Outlook 2019. Manila. 13 Contingent liabilities are public and publicly guaranteed debt that will be realized upon due to state-owned enterprise

debts and operating losses of public private partnerships. 14 World Bank. 2018. Lao People’s Democratic Republic Economic Monitor. Washington, D.C. 15 Bilateral creditors accounted for 63.7% of total external PPG debt in 2016, up from 50% in 2011. Interest payments

increased to 6% of total fiscal revenues in 2013–2017 and are expected to rise further to 9.5% in 2018–2022. 16 IMF. 2019. Lao People’s Democratic Republic: the 2019 Article IV Consultation―Debt Sustainability Analysis.

Washington, D.C. Official foreign exchange reserves were equivalent to only about 1.3 months of import cover for goods and services as of December 2018, significantly lower than IMF’s minimum requirement of 3 months.

17 In some cases, security over state owned enterprises’ assets in the power sector may trigger ADB’s negative pledge provision. Staff are working closely with the authorities to identify the assets that have been pledged and will discuss remedial measures for them.

18 ADB. 2016. Lao People’s Democratic Republic: Governance Risk Assessment. Manila. 19 World Bank. 2018. The Lao People’s Democratic Republic Public Expenditure and Financial Accountability: Public

Financial Management Assessment. Washington, D.C.

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there are currently no regulations to mandate the timely disclosure of budget documents for budget oversight. Coupled with weak capacity at the National Assembly, there is little meaningful oversight of the annual budget. The core budget documents, such as the annual approved budget, quarterly fiscal reports, and public finance annual reports, are not accessible to the public. B. Policy Reform and ADB’s Value Addition 8. Government reform program. In June 2016, the government launched the Eighth NSEDP 2016–2020 (footnote 2), which aims to pursue continued economic growth and macroeconomic stability, while reducing the poverty rate and economic vulnerability, and improving service delivery in health and education. The NSEDP focuses on the need for a macroeconomic framework to provide information in a responsive, timely, and accurate manner. The NSEDP also aims to improve revenue and expenditure management by strengthening revenue collection and ensuring that expenditure management is in line with a financial plan approved by the National Assembly. Strategy 2025 (footnote 1) further articulates the need for a strong, transparent, and modern public finance system in line with international standards. The strategy includes goals and priorities in four areas: (i) maintaining macroeconomic stability, including control of the budget deficit; (ii) maximizing revenue collection; (iii) developing a sound expenditure policy in line with rationalizing spending; and (iv) prudent debt management. To implement this, the government has developed the Implementation Plan for Public Finance Management Reform, Step 1 (2018–2020) of Phase II (2018–2025) (PFM implementation plan) under direct responsibility of the MOF and relevant line ministries.20 The government’s fiscal consolidation efforts are expected to gradually lower fiscal deficit from 4.4% of GDP in 2018 to 4.3% of GDP in 2019, and 3.7% in 2020 (footnote 12). 9. Programmatic Approach. The program employs a programmatic approach, which recognizes the need for long-term engagement and strategic sequencing of policy actions to strengthen PFM. A programmatic approach also enables ADB to align its support with the government’s PFM reform priorities over a medium- to long-term horizon. Strengthened PFM systems, together with carefully managed fiscal policy, will support macroeconomic stability and ensure that public resources are efficiently transformed into public investments and social services. The program includes two subprograms to be implemented over 2018–2021, covered by a medium-term results framework to ensure the long-term engagement necessary for PFM reforms. The program will focus on three key reform areas: (i) public debt management and tax reform, (ii) medium-term fiscal planning and budgeting, and (iii) budget governance and credibility (Appendix 4). Subprogram 1 consists of eight policy actions, all of which have been accomplished, and three of which are pertinent to gender mainstreaming. They are closely aligned with the government’s PFM reform implementation plan (footnote 18). This will provide the foundation for the ensuing, more targeted policy actions to push forward the three program reform areas in subprogram 2. It will deepen the reforms further through support in the implementation phases of the reform areas, including development of regulations and institutional strengthening. 10. Strengthening public debt management and tax reform. This reform area will improve public debt management and revenue collections. It addresses the widening fiscal deficits without compromising sound public spending to achieve the NSEDP goals, and ensures that financing constraints do not lead to sharp reversals in fiscal policy. Under subprogram 1, there are three policy actions. First, the MOF adopted the 2018 Public Debt Management Law to rationalize the use of debt instruments and to cap the rise in public debts. The law, which became effective from

20 Government of the Lao PDR. 2018. Implementation Plan for Public Finance Management Reform, Step 1

(2018–2020) of Phase II (2018–2025). Vientiane.

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August 2018, requires the National Assembly to approve all investment projects that exceed $50 million. It also sets out provisions on the public debt management strategic plan, establishes direct borrowing procedures, defines criteria for government borrowing, and provides the guidelines for government bond issuance. Moreover, the law aims to optimize debt management and gradually reduce the debt burden to 50% of GDP by 2025, and guide prudent spending decisions in the medium term. The law also better defines the criteria and approval procedures for infrastructure investments to ensure that future investments have high social returns and are closely aligned to NSEDP objectives.21 Debt reporting and consolidation of domestic and external debt have been further strengthened through an integrated approach. Under subprogram 2, the MOF will implement the Public Debt Management Law by establishing a fully functioning public debt management unit, with a 30% female staff requirement and a clear regulatory framework. The Debt Management Unit will be strengthened to monitor potential fiscal risks and impacts of contingent liabilities. 11. Second, the tax system has been strengthened and modernized through both tax policy and administrative measures. The government has finalized the drafts of new laws on tax administration, income tax, and excise tax. Together, they will considerably strengthen tax policy and administration by addressing the need for a broader tax base and modernized tax system. An organizational restructuring has placed local tax authorities under the MOF’s Tax Department to improve revenue collection coordination and oversight between central and provincial levels and ensure that all revenues collected at the local level are returned to the consolidated fund. The Tax Department has also established a Revenue Collection Division (responsible for large taxpayers, who account for 40% of total tax revenues) to improve tax compliance by large businesses. Third, the government has completed the Tax Sector Development Plan for 2018–2020 to reform the tax system by strengthening the legislative framework, improving revenue collection, and enhancing institutional capacity. It has also incorporated a gender action plan to address priorities under its strategic goal to build staff and institutional capacity in the Tax Department.22 Under subprogram 2, the government will enact tax laws on tax administration, excise taxes, and income taxes for improved transparency and compliance. The MOF will also conduct a social impact assessment of the new laws with an emphasis on impacts on small and medium-sized enterprises (including those headed by women), and low-income families. The post-program partnership framework (PPPF) may include ADB support to deepen reforms in public debt management by improving coordination with subnational governments for effective public debt management and strengthening the capacity of relevant agencies to implement the new tax laws. 12. Improving medium-term fiscal planning and budgeting. This reform area will enable the government to finance its priorities and contain its fiscal deficit by effectively managing expenditures and revenues over the medium term. With its PFM reform implementation plan, the government has included a target for fiscal deficits of between 3–5% in 2020 and less than 3% by 2025 (footnote 18). Under subprogram 1, there are two policy actions. First, with support from the Domestic Resource Mobilization Trust Fund administered by ADB, the government implemented medium-term fiscal planning, which determines the overall envelopes for expenditures in line with a fiscally sustainable budget and greater predictability and transparency. This policy action has improved the budget process and development outcomes through greater clarity of policy objectives, predictability in budget allocations, and transparency in the use of

21 The new projects need to have clear links to poverty reduction and/or disaster risk reduction. Infrastructure projects

that exceed $50 million will need to be presented to and approved by the National Assembly. A project approval manual has been developed to streamline project submissions by line ministries.

22 Government of the Lao PDR. Ministry of Finance, Tax Department. 2019. Gender Action Plan for Staff and Institutional Capacity Building. Vientiane.

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resources. The MOF strengthened its guidance to line ministries in the budget process by providing a budget ceiling to ensure that overall fiscal deficit targets are met. A series of capacity building programs on gender-responsive budgeting have been provided to high-level and technical government officials in the MOF and relevant line ministries to foster gender considerations in budget planning. Second, the MOF implemented tax and nontax revenue planning to establish clear revenue targets and improve tax and nontax revenue administration. The revenue planning was also integrated into the medium-term fiscal planning. Under subprogram 2, the government will align fiscal policy with the NSEDP goals by establishing a fiscal policy and budget statement to line ministries. This will provide fiscal and contingent liability risk assessments and detailed budget ceilings to individual line ministries for the following budget year, plus indicative ceilings for two additional years to enable line ministries to prioritize expenditures to maintain overall targets. The government will ensure public expenditures are efficiently allocated to priority NSEDP sectors (especially health and education) within the overall budget ceilings to enable the government’s long-term fiscal deficit target (reducing the budget deficit to 2.5% by 2022) to be met. The PPPF may include ADB support on improving medium-term expenditure planning and budget submissions among line ministries. 13. Enhancing governance and budget credibility. This reform area will foster governance, transparency, and credibility of the government’s PFM reform agenda and budgeting processes to ensure that public resources are effectively overseen and channeled towards realization of the NSEDP goals. Under subprogram 1, there are three policy actions. First, in March 2018, the government operationalized its Strategy 2025 through the PFM implementation plan (footnote 18) to implement the six priority programs.23 This includes priority areas for (i) improving fiscal policy, (ii) developing a legal framework for the finance sector, (iii) reforming revenue management, (iv) strengthening expenditure management, (v) modernizing PFM, and (vi) improving the organizational structure and human resource development. Second, a national steering committee was appointed to ensure continuity and oversight of the PFM reform agenda in line with Strategy 2025, with representatives from the Lao Women’s Union and the National Committee for Advancement of Women included in the implementation committee. Third, to improve transparency, the MOF adopted standards in line with the International Budget Partnership and published core budget documents, 24 particularly the Government Finance Statistics Annual Reports for Fiscal Years 2015, 2016, 2017, and mid 2018 on revenues, expenditures, and revenue collection. Under subprogram 2, the MOF will strengthen budget planning, preparation, and execution in compliance with the State Budget Law by establishing relevant budget regulations and legal frameworks. The PPPF may include ADB support to the next generation of the PFM reform agenda, including fiscal transparency and credibility. 14. ADB experience. ADB has been a key long-term reform partner in the Lao PDR, providing loans, grants, and technical assistance (TA) to support PFM reforms since the Public Finance Management Strengthening Program was approved in 2005 (Figure 4). In 2005–2014, ADB focused on selected areas of public expenditure management, including efficiency, planning and budgeting, and accountability, to enable the government to successfully integrate national poverty reduction strategies into budgetary priorities and implementation. 25 This support helped the

23 The government in July 2017 approved the Vision to 2030 and Public Finance Development Strategy to 2025

(footnote 1), which assigns the MOF to coordinate with line agencies for implementation of the comprehensive PFM reform. It also provides the road map for the second generation of PFM reforms and defines the government’s priorities for strengthening its PFM systems.

24 International Budget Partnership. 2010. Guide to Transparency in Government Budget Report. Washington, D.C. 25 ADB. 2005. Technical Assistance to the Lao People’s Democratic Republic for Public Expenditure Planning for

National Growth and Poverty Eradication Strategy. Manila; ADB. 2008. Technical Assistance to the Lao People’s

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government improve PFM in terms of governance, transparency, and capacity of the MOF and relevant agencies under the Governance and Capacity Development in Public Sector Management Program.26 The progress enabled ADB to support PFM reform in the health sector in 2013–2018 under the health sector governance programs.27 ADB’s experience has provided three key lessons that have been incorporated into the program design. First, long-term engagement is essential to push through complex public finance reforms in a weak capacity environment. The crosscutting nature of PFM reform programs requires a programmatic approach and policy sequencing to enable flexibility and responsiveness to the government’s PFM reform agenda. Second, the leading role of the MOF in driving the PFM reform agenda and embedding key planning processes as part of the core budget process is key. Previous ADB support developed the necessary tools for the reforms, but may have underestimated the need for strong leadership and ownership by MOF of these reforms. This will be important for the Lao PDR to achieve fiscal consolidation. Finally, the program will benefit from strong coordination with ADB sector teams, such as health and education, to ensure that efficiency gains in PFM strengthen implementation at the sector level. Figure 4: ADB Engagement with Public Finance Management Reform Agenda in the Lao

People’s Democratic Republic

MDG = Millennium Development Goal; MOF = Ministry of Finance; PFM = public finance management; SDG = Sustainable Development Goal; TA = technical assistance. Source: Asian Development Bank.

Democratic Republic for Strengthening Public Financial Management. Manila; and ADB. 2011. Technical Assistance to the Lao People’s Democratic Republic for Strengthening the Capacity of the State Audit Organization. Manila.

26 ADB. 2012. Report and Recommendation of the President to the Board of Directors: Proposed Programmatic Approach, Policy-Based Loan and Grant, and Grant Assistance for Subprogram 1 to the Lao People’s Democratic Republic for the Governance and Capacity Development in Public Sector Management Program. Manila; and ADB. 2014. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loan for Subprogram 2 to the Lao People’s Democratic Republic for the Governance and Capacity Development in Public Sector Management Program. Manila.

27 ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Programmatic Approach, Policy-Based Loan, and Technical Assistance Loan for Subprogram 1 to the Lao People’s Democratic Republic: Health Sector Governance Program. Manila; and ADB. 2018. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Grant for Subprogram 2 to the Lao People’s Democratic Republic: Health Sector Development Program. Manila.

2005–2008: Initial efforts to improve fiscal planning and budgeting through TA

2010–2014: Governance and Capacity Development in Public Sector Management Subprograms 1–2 (footnote 24) focused on PFM reforms targeting at governance, transparency, and capacity of MOF and relevant agencies

2013–2018:

Health Sector Governance Program Subprograms 1–2 (footnote 25) improved efficiency of budget allocations to the health sectors and achievements of health outcomes under MDGs and SDGs

2018–2021: Strengthening Public Finance Managament Subprograms 1–2 to support the government’s PFM reform agendas and implementation strategies aligned with the Vision to 2030 and Public Finance Development Strategy to 2025 (footnote 1)

2015–2019: TA to bring in the medium-term budget and public expenditure planning

2012–2014: TA supported the state audit agencies for greater governance, transparency, and accountability

2008–2011: TA continued to foster efficiency and accountability of budgeting and public expenditures

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15. ADB value addition. ADB experience underlines that successful PFM reforms in the Lao PDR require a long-term, multipronged approach to developing sequenced and demand-driven reform agendas in line with government priorities. ADB engagement in the sector has prepared the way for reforms and generated important lessons. The recent TA has strengthened planning by establishing a comprehensive revenue and fiscal planning tool to generate overall budget ceilings and better use limited fiscal resources, consistent with a sustainable macroeconomic framework.28 This program will offer value addition to the Lao PDR’s PFM reforms in two ways. First, the programmatic approach will enable ADB to both deepen its engagement in these PFM agendas and provide more comprehensive and systematic support that (i) builds on past ADB assistance and (ii) is aligned with the government’s Strategy 2025 and the PFM implementation plan (footnote 18). More importantly, the program recognizes that successful PFM reforms require sustained efforts by the MOF to lead the complex reform process and coordinate with relevant ministries and stakeholders. Therefore, through ADB’s long-term engagement, the program is designed to foster leadership and ownership by the MOF of the reform agendas. This will help sustain the momentum of the reform process, thereby achieving more meaningful, sustainable reform outcomes. 16. Development partner coordination. The development partner coordination mechanism is well institutionalized and led by the government. It is embedded in the government-owned reform program, as articulated in Strategy 2025. The government leads development partner coordination through the recently established PFM steering committee group. Development partners in the sector also meet on a quarterly basis to share progress in ongoing PFM reform areas. Close policy coordination and dialogue with the government and development partners will continue through participation in government-led coordination platforms. ADB has coordinated with key development partners active in PFM reforms in the Lao PDR throughout the program design, including the European Union, the Japan International Cooperation Agency, the IMF, and the World Bank.29 ADB also coordinated with the IMF to assess fiscal outlook and risks and continued to monitor the public debt situation. The policy actions in the program are consistent with IMF’s 2019 Article IV Consultation assessment and recommendations for the Lao PDR. IMF has provided guidance to the Lao PDR, under which the Lao PDR is expected to initiate fiscal reforms and expenditure rationalization. IMF is also providing technical assistance support, which focuses on medium-term revenue strategy, customs reforms, and development of a unified chart of accounts for improved expenditure tracking. C. Impacts of the Reform 17. Economic impacts of the program. The impact of the program is sustainable financing of public services for achieving the NSEDP goals (footnote 1). The effect of the program is PFM and fiscal position strengthened. The program supports the Lao PDR’s capability to develop and implement a clear fiscal strategy, grounded in a macroeconomic framework and closely aligned to its NSEDP priorities, in order to meet its fiscal deficit targets in the medium term. The program impact assessment estimates the gross benefits from the policy actions in the three reform areas at approximately $4.5 billion accrued over a 10-year period.30 A significant proportion of the gross benefits stem from efficiency gains from improved fiscal planning and governance of the budget

28 ADB. 2015. Technical Assistance to the Lao People’s Democratic Republic for Support for Governance and Capacity

Development. Manila. 29 Development Coordination (accessible from the list of linked documents in Appendix 2). 30 Program Impact Assessment (accessible from the list of linked documents in Appendix 2).

9

process, as well as benefits from the lower interest payments associated with reduced public debt levels. D. Development Financing Needs and Budget Support 18. The Government of the Lao PDR has requested a programmatic approach, comprising two subprograms and a concessional loan of $45 million from ADB’s ordinary capital resources to finance subprogram 1.31 The loan will have a 24-year term, including a grace period of 8 years; an interest rate of 1.0% per year during the grace period and 1.5% per year thereafter; and such other terms and conditions set forth in the draft loan agreement. There is no maturity premium payable to ADB. The indicative amount of the loan under subprogram 2 is $40 million. The loan size is based on the Lao PDR’s financing needs, the development impact of the policy actions, and development spending in conjunction with the reform. In 2019, the government’s gross financing need is $811.65 million, equivalent to a projected budget deficit of 4.2% of GDP. To finance the deficit, the government plans to raise $591.3 million from foreign financing including borrowings and grants. E. Implementation Arrangements 19. The MOF is both the executing and implementing agency for the program and is responsible for coordinating program-related reforms and driving reforms at the line ministry level. The implementation period is from March 2018 to June 2019 for subprogram 1 and from July 2019 to March 2021 for subprogram 2. The proceeds of the policy-based loan will be withdrawn in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time).

III. DUE DILIGENCE 20. Safeguards. Following evaluation of the policy actions, subprogram 1 is classified as category C for the environment, involuntary resettlement, and indigenous peoples. Subprogram 2 is also anticipated to be classified category C, which will be confirmed at a later stage. 21. Poverty and social. This program will help maintain macroeconomic stability, support prudent fiscal management, and help improve fiscal predictability through medium-term budgeting in key social and economic sectors. This will allow the government to gradually achieve a more focused approach to budgeting for the social sectors, the SDGs, and its targeted poverty programs, such as the Poverty Reduction Fund, to directly benefit the poor and vulnerable. This will support the government’s focus on poverty reduction by channeling resources into policy priorities, as reflected in the NSEDP and the Vision to 2030. Subprogram 1 is categorized as effective gender mainstreaming. The program has helped the government address the need to build a foundation for gender-responsive budgeting, undertake gender capacity assessments in strengthening organizational structures, and ensure greater representation of gender stakeholders in key PFM reform structures. Improved PFM will ultimately improve service delivery and access, and thereby benefit the poor, women, children, and small and medium-sized enterprises. Implementation of medium-term fiscal planning and budgeting will also allow the MOF to more systematically integrate gender concerns into their budget process.32 22. Governance. The government has made gradual, consistent progress in improving the regulatory environment for developing PFM. Since the enactment of the 2006 State Budget Law,

31 Subprogram 3 may be added during processing of subprogram 2, subject to further discussion with the government. 32 Summary Poverty Reduction and Social Strategy (accessible from the list of linked documents in Appendix 2).

10

which was revised in 2015, PFM policies and reforms have focused on enhancing budget transparency, developing a framework for medium-term planning, increasing the authority of the MOF in public finance and budget, and increasing budget stability. While more strengthening is needed, ADB has reinforced this momentum with continuing support to improve governance, accountability, and predictability of fiscal and budget planning.33 ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and the MOF. 23. Risk and mitigation measures. Major risks and mitigating measures are described in detail in the risk assessment and risk management plan.34 The expected net benefits and impacts of the program are expected to outweigh the risks. Political resistance to the reform initiatives may retard progress on policy actions or full realization of the program benefits. However, the risks are moderate because of the government’s strong commitment to and ownership of the reform actions. The risks are also mitigated by ADB’s TA, which targeted MOF’s implementation of medium-term fiscal planning and budgeting (footnote 32).

IV. ASSURANCES 24. The government has assured ADB that implementation of the program shall conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the loan agreement.

V. RECOMMENDATION 25. I am satisfied that the proposed programmatic approach and policy-based loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve

(i) the programmatic approach for the Strengthening Public Finance Management Program, and

(ii) the loan of $45,000,000 to the Lao People’s Democratic Republic for subprogram 1 of the Strengthening Public Finance Management Program, from ADB’s ordinary capital resources, in concessional terms, with an interest charge at the rate of 1.0% per year during the grace period and 1.5% per year thereafter; for a term of 24 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan agreement presented to the Board.

Takehiko Nakao President

3 September 2019

33 Sector Assessment (Summary): Public Sector Management (accessible from the list of linked documents in

Appendix 2). 34 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK

Country’s Overarching Development Objective Public services for achieving the NSEDP goals sustainably financed (The Eighth National Socio-Economic Development Plan 2016–2020).a

Results Chain Performance Indicators with

Targets and Baselines

Data Sources and Reporting

Mechanisms Risks

Effect of the Reform PFM and fiscal position strengthened

By March 2022 : a. Ability to develop and implement

a clear fiscal strategy improved (2018 baseline: Public expenditure and financial accountability report rating of D+; no clear fiscal strategy in FPBS)

b. Fiscal deficit maintained between 2.5% and 3.5% of gross domestic product (2018 baseline: 4.9%)

a. Public expenditure

and financial accountability report and/or MOF FPBS

b. National statistics

reports, Lao Statistics Bureau

Changes in political priorities prevent the implementation of identified reform areas.

Reform Areas 1. Public debt management and tax reform

Key Policy Actions Subprogram 1 (by 2019): 1.a Public debt management law

enacted (2018 baseline: No public debt management law in place )

1.b Tax sector development plan approved by MOF with a strategy to address organizational capacity gaps, including gender considerations (2018 baseline: No comprehensive tax sector development plan)

Subprogram 2 (by 2022): 1.a Ministerial instructions and

regulations for public debt management approved (2018 baseline: No regulations for debt management law)

1.b Debt management unit in MOF operationalized, with women making up 30% of staff (2018 baseline: Debt management unit established, but not fully functioning, with limited capacity)

1.c Social impact analysis of tax administration, excise, and income tax laws circulated to key stakeholders to inform impact of tax policies (2018 baseline: No social impact analysis of the new tax laws)

1.a Official gazette 1.b Tax sector

development plan

1.a Ministerial

instructions

1.b MOF annual report 1.c MOF social impact

analysis report

Tax reform legislation is hampered by vested interests, leading to delays and revenue shortfall.

12 Appendix 1




Mechanisms Risks

2. Revenue and expenditure framework 3. Governance and budget credibility

1.d Tax administration, excise, and income tax law approved (2018 baseline: Draft tax administration, excise, and income tax law)

Subprogram 1 (by 2019): 2.a Medium-term fiscal planning

implemented in the budget process (2018 baseline: No medium-term planning processes)

2.b Tax and nontax revenues for the

following budget year and 2 additional years forecasted (2018 baseline: No tax and nontax revenue planning implemented)

Subprogram 2 (by 2020): 2.a Budget allocations to health,

education, and social protection maintained at or above 2017 levels (2017 baseline: KN2.23 trillion or $259.3 million)b

2.b Fiscal policy and budget

statement, which includes medium-term outlook and gender-responsive budgeting guidelines, published by MOF (2018 baseline: FBPS does not include medium-term guidelines or gender considerations)

2.c 3-year rolling expenditure plans for the NSEDP implemented to enhance efficiency of public expenditure management and public service delivery (2018 baseline: No expenditure plans for NSEDP)

Subprogram 1 (by 2019): 3.a PFM reform implementation

strategy, the plan to guide implementation of PFM reforms, approved (First Quarter 2018 baseline: No PFM reform implementation plan)

3.b PFM Reform Steering

Committee established, with

1.d Official gazette 2.a Budget circulars 2.b MOF progress report

on the revenue model

2.a Budget circulars

2.b MOF FPBS

2.c MOF budget

preparation guidelines

3.a PFM Reform

Implementation Plan, Step 1 (2018–2020) of Phase II (2018–2025)

3.b Prime ministerial decision establishing

Institutional coordination challenges interfere with PFM reforms Insufficient implementation of medium-term planning results in weak fiscal consolidation efforts. Changes in political priorities shift resources away from the implementation of PFM reforms.

Appendix 1 13




Mechanisms Risks

gender stakeholders, Lao Women Union and National Commission for Advancement of Women, participated in the implementation committee (2018 baseline: No gender stakeholders included in the PFM reform process )

3.c Core budget documents and fiscal reports published in line with International Budget Partnership standards (2018 baseline: No key budget documents published)

Subprogram 2 (by 2020): 3.a Budget regulations for Articles

29, 52, 53, and 55 of the State Budget Law implemented for the core budget principles, including medium-term budget and debt management frameworks and effective legislative oversight and financial reporting (2018 baseline: No budget regulations)

national PFM committee/ Appointment letter of the Implementation Committee for the PFM reform

3.c Government Finance

Statistics Annual Reports for Fiscal Years 2015–mid 2018 published in MOF website

3.a MOF budget regulations

Budget Support

Asian Development Bank Subprogram 1: $45,000,000 (concessional loan) Subprogram 2: $40,000,000 (indicative)c

FPBS = fiscal policy and budget statement, MOF = Ministry of Finance, NSEDP = National Socio-Economic Development Plan, PFM = public finance management. a Government of the Lao People’s Democratic Republic. 2016. The Eighth National Socio-Economic Development Plan

2016–2020. Vientiane. Officially approved at the Eighth National Assembly’s Inaugural Session, 20–23 April 2016, Vientiane.

b Budget allocations to the Ministry of Education and Sports, the Ministry of Health, and the Ministry of Labour and Social Welfare.

c The loan amount for subprogram 2 is indicative and subject to the government’s request and approval by the Asian Development Bank.

Source: Asian Development Bank.

14 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=52146-001-3

1. Loan Agreement

2. Sector Assessment (Summary): Public Sector Management (Public Finance Management)

3. Contribution to the ADB Results Framework

4. Development Coordination

5. Country Economic Indicators

6. International Monetary Fund Assessment Letter

7. Summary Poverty Reduction and Social Strategy

8. Risk Assessment and Risk Management Plan

9. List of Ineligible Items

Supplementary Document

10. Program Impact Assessment

Appendix 3 15

DEVELOPMENT POLICY LETTER

16 Appendix 3

Appendix 3 17

18 Appendix 3

Appendix 4 19

POLICY MATRIX Implementing

Agency Subprogram 1

March 2018 to June 2019 Accomplishments (Policy triggers in bold)

Subprogram 2 July 2019 to March 2021

Indicative (Policy triggers in bold)

Post Program Partnership Framework1

Reform Area 1 – Public Debt Management and Tax Reform

Ministry of Finance Ministry of Finance Tax Department, Ministry of Finance

To address the weak external position and high level of the public debt and declining revenues, the government implemented reforms to effectively manage its debt position and strengthen tax policy and administration. Accomplishments include:

1. The Ministry of Finance submitted the

final draft of the Public Debt Management Law to the government. The law became effective following its publication in the official gazette.

2. The Ministry of Finance finalized the drafts of the new tax administration law, excise law and income tax law, to strengthen income and excise tax policies and modernize tax administration including tax dispute resolutions, tax incentives for multinational enterprises, and transfer pricing, in consultation with small and medium enterprises (including those headed by women) and other stakeholders.

3. The Ministry of Finance approved the Tax Sector Development Plan―a master plan of tax system reform over the medium term―as part of its public finance development strategy. It also developed a strategy to

The government deepens reforms on public debt management thereby reducing the risk of debt distress, and takes additional steps to further strengthen revenue mobilization. Accomplishments include: 1. The Ministry of Finance approved the

ministerial instructions and regulations for public debt management establishing a formal regulatory framework for the implementation of the Public Debt Management Law.

2. To strengthen the institutional framework

for public debt management, the Ministry of Finance established and operationalized the Debt Management Unit in the External Finance and Debt Management Department, with 30% female staff.

3. The Ministry of Finance completes an social impact analysis of the proposed tax laws for their impacts on small and medium enterprises and low-income families, including women.

The government continues to improve public debt management in coordination with subnational government. The development of regulations and implementation capacity for the tax laws continue to improve revenue mobilization through better tax policy and administration

1 A third subprogram may be considered following further discussions with the government.

20 Appendix 4

Implementing Agency

Subprogram 1 March 2018 to June 2019

Accomplishments (Policy triggers in bold)




address organizational capacity gaps including gender considerations.

4. The government endorsed the tax administration, excise, and income tax laws for submission to the National Assembly for consideration and approval

Reform Area 2 – Medium term fiscal planning and budgeting

Ministry of Finance Ministry of Finance Ministry of Finance

The government has taken steps to contain fiscal deficit and put in place systematic and efficient medium term fiscal planning and management to balance NSEDP goals with fiscal feasibility. Accomplishments include: 4. The Ministry of Finance (i) implemented

medium-term fiscal planning for budget preparation with an overall budget ceiling, to maintain fiscal discipline through improved budget management and rationalized spending, and (ii) conducted capacity building and awareness raising programs for gender responsive budgeting for key stakeholders in MOF and relevant line ministries.

5. The Ministry of Finance improved tax and non-tax revenue planning through implementation of a revenue model and its integration into the medium-term fiscal planning to establish credible revenue targets, and effective revenue administration.

The government has taken steps to maintain a sound fiscal position and ensured sustainable financing for achieving the SDGs especially those relating to poverty, gender and vulnerable people. Accomplishments include: 5. To protect social sector spending, the Ministry

of Finance maintained budget allocations to health, education, and social protection within an overall budget ceiling, to ensure sufficient allocations of public expenditures to priority areas.

6. The government published a Fiscal Policy and

Budget Statement (FPBS) using the medium- term planning framework that includes gender responsive budgeting guidelines. The FPBS provides a medium-term economic outlook, context of fiscal policy, sources of revenues and budget ceilings at the line ministry level.

7. To enhance prudent expenditure

management and efficiently channel resources for public service delivery, the Ministry of Finance adopted the guidelines

The medium-term fiscal planning maintains fiscal discipline evidenced by lower budget deficits. The spending plans of individual line ministries stays within the medium-term framework, as stipulated by the 2015 State Budget Law. More efficient revenue and expenditure planning enables strategic allocations of

Appendix 4 21

Implementing Agency






for three-year rolling expenditure plans aligned with the NSEDP.

resources towards NSEDP priorities

Reform Area 3 – Governance and Budget Credibility

Ministry of Finance Ministry of Finance

The government advances the Public Finance Management (PFM) reform agenda establishing mechanisms for effective implementation and enhancing transparency through publication of key budget documents, to foster transparent governance and inclusive growth. Accomplishments include: 6. To implement the Vision to 2030 and

Public Finance Development Strategy to 2025, the Ministry of Finance identified six key reform programs2 to support the implementation of PFM reforms and developed a detailed workplan for relevant departments and sectors.

7. To ensure continuity of PFM reforms, the Prime Minister appointed the PFM Reform Steering Committee, to oversee the PFM reform agenda across the government. The PFM Reform Steering Committee included the Lao Women’s Union and the National Commission for Advancement of Women in the implementation committee for public finance management reform.

The government deepens PFM reforms by strengthening the regulatory framework to effectively channel the country resources for development and equitable growth. Accomplishments include: 8. To provide strong legal and policy basis for

budget reforms, the Ministry of Finance approved budget regulations for Article 29 of the State Budget Law to adopt the core fiscal principles such as a balanced budget, a medium-term framework, and a debt management framework.

9. The Ministry of Finance approved the budget regulations for implementing Article 52 and Article 53 of the State Budget Law to establish rigorous processes for controls over budget preparation, and execution consistent with the applicable legal and fiduciary frameworks,

The government continues PFM reforms and initiatives as identified in the PEFA self-assessment. The provisions of the 2015 State Budget Law are fully complied implemented, and the established legislative frameworks pave the way toward the next phase of the PFM reform strategies

2 The Action Plan for the Public Finance Management Reform, Step 1 (2018–2020) of Phase 2 (2018–2025) identifies six key areas for reform to strengthen public

finance in the Lao PDR. These are: (i) fiscal policy improvement, (ii) legal framework development and improvement to the finance sector, (iii) Revenue management reform, (iv) expenditure management reform, (iv) modernization of public finance sector; and (vi) organizational structure and human resource development.

22 Appendix 4

Implementing Agency






Ministry of Finance

8. To enhance fiscal transparency, the Ministry of Finance disclosed the Government Finance Statistics Annual Fiscal Reports for Fiscal Years 2015, 2016, 2017 and June 2018.

10. To strengthen legislative oversight of the budget and financial reporting, the Ministry of Finance approved budget regulations to support the implementation of Article 55 of the State Budget Law.

Fiscal transparency is further strengthened; and legislative-executive dialogues continue to foster public trust, and stakeholder confidence.