world bank document country procurement assessment report ... nao national audit office ... * lao...
TRANSCRIPT
Document of
The World Bank
FOR OFFICIAL USE ONLY
Report No: P7526-LA
REPORT AND RECOMMENDATION
OF THE
PRESIDENT OF THE
INTERNATIONAL DEVELOPMENT ASSOCIATION
TO THE EXECUTIVE DIRECTORS
ON A PROPOSED FINANCIAL MANAGEMENT ADJUSTMENT CREDIT
IN THE AMOUNT OF SDR 13.5 MILLION
(US$ 17.0 MILLION EQUIVALENT)
TO THE LAO PEOPLE'S DEMOCRATIC REPUBLIC
May 28,2002
Poverty Reduction and Economic Management UnitEast Asia and Pacific Region
This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
Pub
lic D
iscl
osur
e A
utho
rized
GOVERNM[ENT FISCAL YEAR: October 1 - September 30
CURRENCY EQUIVALENTS: Currency Unit = Kip (as of May 2002)US$1 = K 9,540
ACR )NYMS AND ABBREVIATIONSADB Asian Development BankAPB Agricultural Promotion BankASEAN Association of Southeast Asian NationsBCEL Banque pour le Commerce Exterieur LaoBIO Business Improvement OfficeBOL Blank of Lao People's Democratic RepublicHPKP Bolisat Phattana Khet Phoudoi (SOE)BRC Ilank Restructuring CommitteeCAS Country Assistance StrategyCFAA Country Financial Accountability AssessmentCPAR Country Procurement Assessment ReportCPC Committee for Planning and CooperationDAFI Development, Agriculture Forestry Industry Group (SOE)EdL Electricite du LaosEPL Enterprise of Post LaoEPTL Enterprise of Post and Telecommunications LaoETL Enterprise of Telecommunications LaoESAF Enhanced Structural Adjustment FacilityEU luropean UnionFMAC Financial Management Adjustment CreditFMCBC Financial Management Capaciy Building CreditIFC Intemational Finance CorporationIFI Intemational Financial InstitutionIMF Intemational Monetary FundJBIC Japan Bank for Intemational CooperationJICA Japan Intemational Cooperation AgencyLST Lao Shinawatra Telecom Company LtdMAF Ministry of Agrictilture and ForestryMCTPC Ministry of Construction, Transport, Post, and CommunicationMIH Ministry of Industry and HandicraftMOF Ministry of FinanceMOJ Ministry of JusticeMOUR Memorandum of Understanding for RestructuringNAO National Audit OfficeNBCA National Biodiversity Conservation AreaNEM New Economic MechanismNGO Non-Govemment OrganizationNPEP National Poverty Eradication ProgramNPL Non-Performing LOanNT2 Nam Theun 2ODA Official Development AssistancePHRD Policy & Human Resources Development FundPIP Public Investment PlanPMO Prime Minister's OfficePPIAF Public Private Infrastructure Advisory FacilityPPTA Project Preparation Technical AssistancePRGF Poverty Reduction and Growth FacilityPrMO Procurement Monitoring OfficePRSP Poverty Reduction Strategy PaperSCB State-owned Commercial BankSIDA Swedish Intemational Development AgencySOE State-owned EnterpriseUNDP United Nations Development ProgrammeUNICEF United Nations Intemational Children's FundWASA Water Supply AuthorityWHO World Health Organization
Vice President: Jemal-ud-din Kassum, EAPVPCountry Director: Ian C. Porter, EACTFChief Economist and Sector Director: Homi Kharas, EASPRTask Team Leader: Ijaz Nabi, EASPR
FOR OFFICIAL USE ONLY
THE LAO PEOPLE'S DEMOCRATIC REPUBLIC
PROPOSED FINANCIAL MANAGEMENT ADJUSTMENT CREDIT'
TABLE OF CONTENTS
Credit and Program Summary .................................. vi
I. INTRODUCT]ION ................................... 1
II. THE MACROECONOMIC FRAMEWORK ................................ . 4A. Macroeconomic and Growth Performance ................................... 4B. Medium-Term Framework ................................... 6C. Structural Reform ................................... 7
III. STRUCTURAL WEAKNESSES . . 7A. Problems in the Public Sector .7B. The State-Owned Enterprise Sector .11C. The Financial Sector .14D. Consequences of Structural Weaknesses for Growth and
Poverty Reduction .16
IV. GOVERNMENT'S REFORM PROGRAM AND POVERTYREDUCTION .18
A. Public Sector Management .18B. The State-Owned Enterprise Sector .23C. The Financial Sector .31
V. WORLD BANK GROUP STRATEGY . .............................. 36A. Bank Assistance Strategy .................................. 36B. Partnerships with Other Donors and Agencies .................................. 39
VI. THE PROPOSED FINANCIAL MANAGEMENT ADJUSTMENTCREDIT .................................. 40
A. Rationale for the Proposed Program .............. .................... 40B. The FMAC Program .. ................................ 41C. Implementalion and Monitoring . ................................. 48D. Credit Administration .. ................................ 48E. Environmental Assessment .................................. 50F. Benefits and Risks .................................. 51
VII. RECOMMENIDATION .53
The World Bank core team for this operation was led by Ijaz Nabi (EASPR) and consisted of: Magdi Amin (EASPS), EnriqueCrousillat (eEASEC), Nina Eejima (LEGEA), Ron Hood (EASPR), Abha Joshi-Ghani (PFG), Olivier Lambert (E4SFS), WilliamMagrath (EASRD), Keiko Miwa (YPP), Behdad N. H. Nowroozi (EAPCO), Sethaput Suthivart-Narueput (EASPR), LindaSchneider (EACSQ), Malarak Souk;avat (EACLF), Thang-Long Ton (RASPR), Mara T. Baranson (EACSQ), Soudalath Silaphet(EACLF), and Hedwig Abbey (EASPR). The Peer Reviewers were. Habib Fetini (MNSED), Patrick Honohan (FSP), WilliamMako (EASPS), Anand Rajaram (PPMPS). and Peter Winglee (IMF).
This document has a restricl:ed distribution and may be used by recipients only in theperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.
THE LAO PEOPLE'S DEMOCRATIC REPUBLIC
PROPOSED FINANCIAL MANAGEMENT ADJUSTMENT CREDIT
TABLE OF CONTENTS (Continued)
ANNEXES
Annex 1: The Lao Banking and Financial SectorAnnex 2: Financial Management Capacity Building CreditAnnex 3: IMF's Poverty Reduction and Growth Facility - Program SummaryAnnex 4: Longer-Term Reform Actions beyond the Timeframe of FMACAnnex 5: Decision Framework for Processing the Proposed NT2 ProjectAnnex 6: Poverty Reduction Fund Project
LETTER OF DEVELOPMENT POLICY
REFORM POLICY MATRIX
STATISTICAL APPENDIX
iv
BOXES IN TEXT
Box 1: I-PRSP Policy Agen,ia 2001- 2003 ........................................ ................ 3Box 2: Chronology of Econf;mic Developments ....................................................... 4Box 3: Macroeconomic Periormance Indicators ...................................................... 46Box 4: FMAC Program Perlormance Indicators ...................................................... 47
TABLE IN TEXT
Table 1. Financing Requirements, 2001-2004 ....................................................... 40
FIGURES IN TEXT
Figure 1: Lao PDR: Poverty and Gini Coefficient ................................................... 2Figure 2: Lao PDR: GDP Growth and CPI ........................................................ 5Figure 3: Lao PDR: Composition of Investment ...................................................... 6Figure 4: Lao PDR: Main Exports .................... ................................... 6Figure 5: Lao PDR: SOE E,mployment Share, Industrial Value, and NPLs .......... 11Figure 6: Lao PDR: The Sbuctural Problem: ....................................................... 17Figure 7: Lao PDR: Reform Program ........................... 35
v
THE LAO PEOPLE'S DEMOCRATIC REPUBLIC
PROPOSED FINALNCIAL MANAGEMENT ADJUSTMENT CREDIT
Credit and Program Summary
Borrower: The Lao People's Democratic Republic
Amount: SDR 13.5 million (US$ 17 million equivalent)
Terms: Standardl IDA terms: 40-year maturity with a 1 0-year grace period
Description: The proposed Credit of SDR 13.5 million (US$ 17 million equivalent), to bedisbursed in two tranches, is a Financial Management Adjustment Credit(FMAC) that would build on and support the implementation of Lao PDR'scurrent reform program. The components of the reform program lo be supportedby FMAC are as follows:
* The public sector reform component supports improved budget planning,streamlined budget execution and control as well as a transparent budgetprocess, and natural resources management;
* The state-owned enterprise (SOE) component focuses on strengtheningovergight of financial and operational performance of SC)Es, enterpriserestructuring, and rationalizing the regulatory framework. Relevant issues inthe power sector are also addressed in this component;
* The financial sector component seeks to stabilize the financial conditions ofthe banks, to strengthen them, and to launch micro/rural finance for povertyreduc:tion.
Benefits: The expected result of the FMAC is strengthening of the structures of theeconomy such that:
* Greater fiscal transparency and accountability is achieved, with betterbalance in budget spending;
* Increased budgetary resources are available for poverty reduction;
* SOEs (including Electricite du Laos [EdL] in the power sector) are moreaccountable within a stronger regulatory framework and manage financialrisks prudently, which would prepare them for privatization down the road;
* State-owned commercial banks (SCBs) meet prudential regulations andtherefore do not threaten macro-stability and future economic growth;
* Micro/rural finance supports poverty reduction in the rural areas where mostof the population lives; and,
* Incentives are in place for participatory management of forestry resources;improved monitoring and rationalization of the "cut rate" contribute togovernment revenues and enhance income at the village level.
vi
The structural improvements collectively will contribute to additional benefits,as reforms are pursued in the medium term:
* Lao PDR will avoid the accumulation of contingent liabilities that result inperiodic crises leading to a severe loss of investor confidence and curtailmentof social services and safety nets.
* Lao PDR's system of financial flows will have been streamlined and will bemore transparent, giving confidence that large potential investments in theenergy sector will yield economy-wide benefits in terms of income growthand poverty reduction.
Risks: The key risks are:
* Insufficient political will to complete reforms;
* Lack of capacity and weak legal/administrative incentives to improveperformance;
* Possible political backlash from electricity tariff and other SOE priceliberalizations; and,
* Abandonment of reforms as difficulties accumulate.
Efforts to mitigate the risks.
- Recent government actions reflect a new commitment to reform. Theseinclude the removal of the top management of an SCB for poor performance,the agreement to hire external advisors in SCBs to prepare for restructuring,and significantly, the resale of Lao Beer back to the private sector.
- Disparate SOEs are being collected under the umbrella of the PrimeMinister's Office. A dynamic, reform-minded minister has been appointedto champion reform. The largest SOE, Bolisat Phattana Khet Phoudoi(BPKP), is under restructuring and will have a significant demonstrationeffect for restructuring other large problem SOEs.
- The technical assistance operation, Financial Management Capacity BuildingCredit (FMCBC) that will be presented to the Board at the same time withFMAC, is expected to build capacity by aiming to change the mindset at theworking level, which will generate support for reform within the system.The government's willingness to borrow for technical assistance, givenextreme reluctance in the past, is a good indication of a more proactivestance on capacity building.
- FMAC requires the government to implement tough legislative, regulatoryand institutional measures in a number of key commanding heights of theeconomy. This momentum will be difficult to reverse given the PRSPprocess to which the authorities are committed that will ensure continuedmonitoring and engagement to stay the reform course.
vii
- Key players within the government (i.e., the Prime Minister, the Minister ofFinance and others heading the key line ministries) have been engaged in along process of dialogue and have fully endorsed the reformn program. Onanother level, a series of workshops and seminars have been held for mid-level civil servants to explain reform objectives and their benefits, to garnerwider support.
- Thc operation has been prepared in close cooperation with the IMF, theADB, and major bilateral donors which has helped avoid conflicts that createthe room for reform slippage.
* Des;pite these mitigating factors, risks of poor performance are substantialandl need to be monitored.
Poverty Category: Not applicable
EstimatedDisbursements: The credit would be disbursed in two tranches. The first tranche would amount
to SDR 5.6 million (US$ 7.0 million equivalent) and the second one SDR 7.9million (US$ 10.0 million equivalent).
Project ID Number: PE-P068069
viii
]REPORT AND RECOMMENDATION
OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON
A PROPOSED F][NANCIAL MANAGEMENT ADJUSTMENT CREDIT
FOR THIE LAO PEOPLE'S DEMOCRATIC REPUBLIC
I. INTRODUCTION
1. I submit for your approval the following report and recommendation on a proposedFinancial Management Adjustment Credit of SDR 13.5 million ($17 million equivalent) to the LaoPeople's Democratic Republic (Lao PDR) to provide support for the implementation of thecountry's current reform program.
2. The Lao PDR is one of the poorest countries in the world, with a per capita gross nationalincome of $310 in 2001 ($290 in 2000). The percentage of the Lao population in poverty was 39.1percent (or 1.9 million people) for 1997/98, down from 46.0 percent in 1992/93 (Figure 1).' Thisis an annual rate of reduction of 3.3 percent.
3. Poverty rates are uneven across regions, and across urban and rural areas. The rural pooraccount for more than 90 percent of all poor. In the Northern Region of the country, with thehighest percentage of poor, the poverty rate was 47.3 percent in 1997/98, down from 51.6 percentin 1992/93. The Vientiane Municipality had the lowest poverty rate (13.5 percent in 1997/98; itwas 33.6 percent in 1992/93). The regions and provinces in the country with the highest povertyincidence rate were also the ones with the slowest rate of poverty reduction.
4. Income inequality in Lao PDR has increased in recent years. The Gini index was 0.35 in1997/98, up from 0.31 in 1992/93 (Figure 1). Consumption shares of the bottom four quintileshave declined. This has significantly eroded the gains from growth for those at the bottom end ofthe distribution. Region-wide moderation in economic growth and contraction in employment isone reason for these inequities. Another is macroeconomic difficulties of the recent pastoriginating in structural rigidities in public sector management, the SOEs and the banking sector.
5. With its vast natural resources of forestry and hydroelectric power, the Lao PDR is wellpositioned to redress poverty effectively, provided there is sound macro-economic managementand improved resource allocation. Macroeconomic stability is being restored with the support of aPRGF negotiated with the IMF in April 2001, but it is still fragile. To consolidate macroeconomicstability and improve the overall flow of resources in the economy, a program of structural reformsis being implemented in public sector management, state-owned enterprises, and the bankingsector with technical assistance from multilateral and bilateral donors. The proposed FinancialManagement Adjustment Credit (FMAC) that supports the deepening of the program of structural
N. Kakwani, Gaurav Datt, Bounthavy Sisouphanhthong, Phonely Souksavath, and Limin Wang, "Poverty in LaoPDR: 1992/93-1997/98," World Bank, March 30, 2002.
reform has been prepared in this context of increased engagement of the Lao PDR withinternational financial institutions. It is designed to reduce the risk of poverty reversals as in 1997-98 when the macro and structural reform program went off-track.
Figure 1
Lao PDR: Poverty and Gini Coefficient
50
40
30
20
10
01992/93 1997/98
=Poor - Gini coefficient
Source: Kakwani, Datt, Sisouphanhthong, Souksavath, and Wang (2002).
6. The proposed FMAC program is consistent with the government's National Socio-Economic Development Plan (NSEDP) for 2001-05 focusing on poverty reduction by promotingsustainable growth with equity. The Interim Poverty Reduction Strategy Paper 2 (I-PRSP),prepared by the authorities in March 2001 and discussed at the Boards of the IMF and the WorldBank, established the official approach to poverty reduction and is the first step in developing afull Poverty Reduction Strategy Paper. The I-PRSP sets out the government's poverty reductionstrategy in the context of macro-economic stability and sustainable growth. It lists sixteen areas(Box 1) where policy and institutional reform are needed to achieve broad-based, participatoryeconomic growth. Of these 16 items, the proposed FMAC supports four items fully and anothertwo items partially. Other areas are being covered either by other donors, or through investmentoperations. The areas covered by the proposed FMAC have been kept to key public financialmanagement issues to focus the operation on where well-defined policy reforms have beenidentified and where government's implementation capacity is adequate. The full PRSP, currentlyunder preparation and to be completed by March 2003, will expand on each of the policy areas anddevelop a comprehensive medium-term program to deepen reform. The reform of structuralweaknesses discussed in Chapter III are consistent with the approach being taken in the full PRSP.A direct approach to poverty reduction by the government is discussed in the Poverty ReductionFund Project (PRFP, Annex 6) to be presented to the Board with FMAC.
2 Lao PDR, Interim Poverty Reduction Strategy Paper, IDA/SecM2001-0246), was discussed at the Board on April 24,2001..
2
Box 1: I-PRSP Policy Agenda 2001-2003Policy Area Objectives
MACROECONOMIC AND RE LATED Maintain macroeconomic stability, improve resource allocation, andSTRUCTURAL POLICIES raise sustainable economic growth1. Fiscal Policies
Overall Budget Maintain and strengthen prudent fiscal managementDecentralize budget management, while strengthening budgetexecutionImprove fiscal transparency and budget preparation procedures
Revenue Strengthen revenue collectionModernize tax system and broaden revenue base
Expenditure Improve balance of current and capital expenditure and increaseshare of social expenditureImprove management of external debt and foreign aid
2. Enterprise Development Strengthen commercial behavior of SOEs and promote private sectordevelopment
3. Financial SectorMonetary and Exchange Rate Maintain strict monetary policyPolicyBanking Reform Create sound and viable banking system and improve financial
intermediation4. Trade Policy Promote growth through increased trade and foreign direct
investmentSECTORAL POLICIES5. Forestry Policy Establish a sound policy framework providing for viable and
sustainable forest development and management6. Agricultural and Rural Ensure food security and promote market-based farming. Reduce
Development disparities between lowland and sloping-land farming7. Infrastructure Maintain and develop an enabling infrastructure framework
Road InfrastructureEnergy
HUMAN RESOURCE Strengthen Lao PDR's human capital and increase efficiencyDEVELOPMENT8. Education Improve budget for education; increase access of most vulnerable to
education and reduce regional disparities; strengthen non-formaleducation; and, improve teacher education
9. Health Strengthen delivery of health care services at grass root level --particularly in underserved areas -- and improve quality of services
10. Water, Sanitation, and Nutrition Increase access to safe drinking water and sanitation system andimprove nutrition
STRATEGIC SUPPORT POLICIES Strengthen poverty reduction actions11. Governance and Public Establish sound governance behavior in public administration and
Administration Reform consolidate the decentralization processLand Administration and Establish sound policy and legal framework for land administration,Management Policy allocation and management
12. Drug Control and HIV/AID,S Curtail opium production and minimize social and economicconsequences of HIV/AIDS
13. UXO Decontamination Clear unexploded ordnance (UXO) to improve safety and reclaimland contaminated with UXOs.
14. Gender Equity Promote the role of women in socio-economic development,planning, and the public decision-making process
15. Environment Ensure environmental sustainability of development actions16. Statistics Improve coverage, timeliness and quality of statistical databases, and
expand use of international standards in compilation of data
3
II. THE MACROECONOMIC FRAMEWORK
A. Macroeconomic and Growth Performance
7. In the second half of the 1980s and the first half of the 1990s, the Lao PDR implemented its"New Economic Mechanism" (NEM) to make the transition to a market economy. This reformeffort was supported by the Bank through three adjustment operations that helped to stimulateeconomic growth as the economy moved from a centrally-planned system towards a market-oriented one (Box 2).
8. In 1997, at the height of the regional crisis, the authorities pursued an expansionary fiscalpolicy with ambitious investrnents in irrigation to attain rice self-sufficiency. But this was donewithout appropriate financing arrangements. Heavy borrowing from the Bank of Lao PDR (BOL),the central bank, caused triple-digit inflation in 1998. As a consequence, the kip depreciated to7,600 kips per US dollar in 1999 from 2,135 in 1997.
Box 2: Chronology of Economic Developments1986 New Economic Mechanism launched1988 New foreign investment law, with liberal regime1989 IMF's Structural Adjustment Facility (1991-93)
Bank's first Structural Adjustment Credit1991 Announcement of privatization plan of some large state-owned enterprises
Bank's second Structural Adjustment Credit1993 IMF's Enhanced Structural Adjustment Facility (1993-96)1994 New foreign investment law (with legal 100 percent foreign ventures)1996 Bank's third Structural Adjustment Credit1997 Ambitious investment plans implemented without appropriate financing1998 Inflation soared to triple digits1999 Collapse of the national currency
New Minister of Finance and new Governor of the Central Bank, BOL.The govemment embarked on a strong stabilization program with tight fiscal and
monetary policies2001 Govemment prepared the I-PRSP
IMF resumed its program to Lao PDR with a $40 million equivalent PRGF;Release of the first tranche under the program
2002 Satisfactory review of the PRGF program by the IMF Board;Release of the second tranche under the program.
9. In mid-1999, the authorities embarked on a strong stabilization program addressing fiscal,monetary and the current account imbalance, and economic conditions improved in 2001. Theexchange rate stabilized and inflation fell to 7.5 percent. Despite weaker external demand, realGDP growth was recorded at 5.7 percent in 2000 and 5.2 percent in 2001 (Figure 2). 3
3 There is, however, some concem regarding reliability of GDP estimates because of poor data quality.
4
Figure 2
GDP Growth (right scale) andCPI (left scale) (percent)
50 i 2
O O1997 1998 1999 2000 2001 2002
CPI --+ GDP Growth Rate]
Source: IMF and Lao PDR authorities.
10. Improved fiscal manatgement was re-instituted with the FY2000 budget. Strong effortswere made to improve tax administration. Capital spending was reduced with the scaling down ofconstruction projects. This allowed for more current spending. Additional external assistancesupported the budget deficit and borrowing from BOL declined further. The budget deficit isprojected to stay at 5 percent of GDP, of which only 0.3 percent of GDP is bank financing.Additional revenues are expected from improved tax collection.
11. Monetary policy played a key role in the stabilization program by reducing the excess kipliquidity and sharply limiting central bank financing -- especially for irrigation projects -- and theissuance of central bank securities. Inflation was brought under control following a cautionarymonetary policy.
12. The current account balance was estimated at -4.9 percent of GDP in 2001 (compared with-1.4 percent of GDP in 2000, and -4 percent in 1999). In 2002, the current account deficit isprojected to improve to -3.4 percent. 4 The authorities have maintained a flexible exchange ratewhich has been stable vis-as-vis the US$ and the Thai baht since end-1999.
13. At end-2001, gross international reserves were estimated at 2.5 months of imports, or $134million. Exports, at $350 million, were virtually unchanged from the level attained in 2000.Electricity exports, valued at ',114 million, have overtaken timber6 as the largest foreign exchangeeamer. Garments were the second largest export category at $100 million in 2001. However, dueto the weaker external demand, total merchandise exports stayed at the same level as in 2000.Exports are expected to perform better in 2002, with growth projected at 6.2 percent (Figure 4).
4 Excluding the proposed Nam Theun 2 (NT2) project. The current account balance is projected to stabilize at below-3 percent of GDP subsequently and can be readily financed, even without the proposed Narn Theun 2 hydropower5roject.
Excluding the proposed Namn Themn 2 (NT2) project. The current account balance is projected to stabilize at below-3 percent of GDP subsequently and can be readily financed, even without the proposed Nam Thewi 2 hydropowerproject.
Timber exports account for $81 million.
5
14. Imports, at US$558 million, declined slightly in 2001 (-2 percent). Consumer goodsaccount for the largest category of imports at $280 million. Investment goods follow at $166million (including machinery and equipment, vehicles, fuel, and construction and electricalequipment). Imports are expected to recover in 2002.
Figure 3 Figure 4
Lao PDR: Composition of Investment (%) Lao PDR: Main Exports (US$ million)
35 - 140 -9 17 8 9 030 120-25 100 v20 FB80-1 5 _ _ _ _ _
10 -4020
5 2~~~~~~~~~~~~~~0
1998 1999 2000 Proj Proj Proj 1995 1996 1997 1998 1999 20002001 2002 2003
U Hydropower Invest/GDPElPrivate (non-hydro) Invest/GDP El Timber El Electricity 0 Garments 0 CoffreEl Public Invest/GDP _
Source: IMF and Lao PDR authorities. Source: IMF and Lao PDR authorities.
15. With the restoration of economic stability since 2000, and the PRGF program in place forover a year, the Lao authorities have established a track record of satisfactory macroeconomicmanagement. The government is also committed to broad-based economic growth and povertyreduction, as outlined in the I-PRSP of 2001. This is being solidified with the on-goingpreparation of the full PRSP.
B. Medium-Term Framework
16. In the medium term, the government will continue to maintain a macro-economicframework to attain a growth rate of about 5.5-6.5 percent, inflation of about 5-7 percent, and astable exchange rate. This will contribute to achieving the poverty reduction objectives outlined inthe I-PRSP and the NSEDP.
17. On the external side, the current account deficit is projected to improve to below 3 percentof GDP for FY04 period (excluding investment imports requirements for the proposed Nam Theun2 Project (NT2). Exports are expected to grow at an average annual rate of about 6.7 percent for2002-2004. Imports are projected to grow at similar export rate of about 6.7 percent per year in2002-2004 (excluding imports related to the NT 2 Project).
18. Fiscal policies are expected to support macroeconomic stability objectives whileaccommodating pressures for additional social spending. The authorities envisage a fiscal deficitof about 5 percent of GDP, with a modest increase in revenue that will allow additional currentspending, including expenditures in the social sectors. Domestic bank financing of the budget willbe limited to l/2 percent of GDP. Improvements in administration and compliance will help toimprove revenue performance with a projected modest growth of about 0.4 percent of GDP. Thecomposition of expenditures is expected to shift toward current spending, in line with the PRGF
6
program. The increase in cturrent expenditure would accommodate the increase in governmentwages and additional spendin- for maintenance and arrears payments. Overall public expendituremanagement will be strengthened to meet fiscal targets and to support the decentralization efforts.
19. The objective of the government's monetary and exchange rate policy continues to berestraining inflation and maintaining a stable exchange rate. The BOL is expected to continue itsdiscipline in budget financing and active sales of government securities with more attractiveyields. The authorities will continue to maintain a flexible exchange rate system.
C. Structural Reform
20. While a sound macroeconomic framework is central to stable economic growth andpoverty reduction, it can be sustained only if the underlying structural weaknesses that impede theflow of resources in the economy to their best uses can be addressed. These weaknesses and theirimpact on macroeconomic stability, economic growth and poverty reduction objectives arediscussed in Chapter III.
21. Structural rigidities need to be addressed also in view of the planned large investment in theenergy sector associated with Nam Theun 2. The investment will generate substantial revenuesthat should be intermediated in the economy efficiently to ensure that the I-PRSP and NESDPobjectives are achieved.
22. The government has started to implement a credible reform program to address thestructural weaknesses. This program, the actions already taken, and the medium-term agenda arepresented in Chapter IV. Thle program of actions supported by the proposed FMAC and theassociated performance indicators are presented in Chapter VI.
HI. STRUCTURAL WEAKNESSES
A. Problems in the Public Sector
The Budget
23. Basic Challenges. Lao PDR faces many challenges in planning and managing publicresources to establish sustainable economic growth and reduce poverty. It has a relatively sparsepopulation of just 22 persons per square kilometer as compared with 121 in Thailand and 238 inViet Nam. The economy is overwhelmingly agricultural (53 percent of GDP) and rural (77percent of the population). Nluch of the rural population is widely scattered. Ethnic minoritiesinhabit remote areas that are regularly cut off from the rest of the country by seasonal rains. Somegroups move periodically as they practice slash-and-bum agriculture.
24. The cost of delivering services such as health and education is high in this demographicand geographic context. The climate and terrain make transportation services costly to build andmaintain over long distances that connect relatively small numbers of people. Being land-locked,
7
the country has no coastal waterway and the Mekong river is navigable only during certainseasons.
25. Budget Execution and ControL While geography is unalterable, the I-PRSP has argued thatsome of Lao PDR's problems stem from weaknesses in the basic systems for budget execution andcontrol, and these can be addressed.
26. There has been a persistent tendency towards loss of fiscal stability created by poor budgetmanagement practices. A serious bout of inflation and exchange rate depreciation in the late 1990sresulted from a series of large and unplanned investment expenditures in irrigation projects.Macroeconomic stability was eventually restored but at substantial cost due to cut-backs for healthand education. While the central government ministries have since by and large managed to avoidmajor unplanned expenditures, the provincial governments are prone to making commitments thatare not provided for in the budget. Moreover the provinces, which collect the bulk of revenues,do not consistently remit collections to the center as required, undercutting the centralgovernment's ability to redress the regional imbalances. To accommodate these items, ad hocexpenditure cuts have to be made or recourse made to central bank financing.
27. These problems arise from a lack of fiscal discipline in which the budget plan is notadhered to, and they are made more complicated by a weak system of accounting and control aswell as a fragmented network of treasury accounts. While there remains a unitary budget system,the rapid pace of implementation of decentralization is placing additional strains on thegovernment's ability to monitor and control its public resources.
28. Plannin Consistently, evidence from the various sectors shows a pattern of inadequatespending for wages, maintenance and other recurrent items, and heavy emphasis on economicsectors over social sectors that retards the achievement of poverty reduction objectives. For thelast several years, capital spending in Lao PDR has accounted for 60 percent or more of thebudget. This compares with 36 percent in Thailand and 29 percent in Viet Nam. These outcomesare not simply a result of local preferences. They reflect the fact that in the Lao PDR the futurerecurrent costs of capital projects are not estimated and are therefore not adequately taken intoaccount when decisions are made. They also reflect the fact that revenues are persistentlyoverestimated, and since donors cover as much as 80 percent of the capital budget, the only placewhere ad hoc cuts can fall is on recurrent spending, and this tends to be concentrated in the socialsectors. Public sector wages have fallen by half and have remained that way for almost four years.Teachers and hospital workers are paid far less than regional averages and are leaving their jobs.These were not planned outcomes. They are the result of flawed systems.
29. The budget planning process is both bottom-up and top-down. Detailed submissions aremade by lower levels of government and consolidated for presentation to the National Assembly.This is a positive feature that allows considerable scope for the incorporation of local input into thebudget plan; however, the budget passed by the National Assembly is of highly aggregated form,and the details of cuts or changes made at this level are not spelled out when it is passed. Hagglingover line-item interpretation of the budget drags on several months into the fiscal year. This
' One recent exception to central government adherence to the budget plan was the unplanned purchase of Thaiinterests in Lao Beer.
8
unusual feature of the planning part of the budget cycle results in delay of publication of thedetailed budget plan and makces for an uncertain environment for budget execution.
30. Transparency and Gjovernance. The government ceased publishing the budget andexpenditure outcomes after the Asian crisis, and when it did resume with FY01 data, the figuresemerged with a long lag and in a highly aggregated form that did not show spending by sector.Without adequate information, judging the impact of public expenditures is hard, and theeffectiveness of expenditure planning is undermined. For recent years it has not been possible todetermine from the budget figures how spending lines up with the sector spending targets laid outin the government's own I-PRSP. This problem is made more complicated by the fact that theBudget Nomenclature and the Chart of Accounts are not consistent, and this separates the planningfunction from the accounting and control functions. At the end of the day it may be possible todetermine if the government spent as much as it planned but not whether it spent this the way itplanned. Moreover, there are a number of special funds, many of which are associated with donorprograms, and the resources. flowing through these funds are not included in the budget. Theseproblems have prevented reg;ular assessment of poverty-related expenditures.
31. The procurement process is in need of improvement to ensure that it is efficient, transparentand fair. There is a general need for greater openness, but problems are particularly important withrespect to contracting by state-owned enterprises.
Natural Resources Managenment
32. Rural and natural resources management remains a concem for the government and itsrevenue contribution remains crucial to the budget. A source of structural weaknesses originates inthe country's management cf its forestry sector, with impact on the budget, the SOEs related tothis sector, and ultimately to the banking sector.
33. Forestry. Growth and poverty reduction prospects for the Lao PDR are heavily dependenton its natural resources. 'Yet, forestry, a substantial natural resource of the country, does notcontribute adequately to national development nor to poverty reduction. Incentives facing resourceusers do not reflect the real scarcity of forest resources, leading to excessive demands andoverexploitation. The way in which resources -- including land, investment, and revenues fromtimber harvests -- are mobilized in the sector are distorted and result in misallocations and,especially important, inadequate impacts on poverty and ineffective protection of biodiversity.Forestry royalties, as a share: of government revenue, have increased from 20 percent in the mid-1990s to 6 percent of tax revenues and 5 percent of all revenues in 2001. Collection rates are low,around 50 percent, and royalty revenues have been declining since the mid-1990s. Over the lastfive years, the Treasury has realized only about one third of the estimated market value of thetimber harvested.
34. Deforestation and forest degradation, loss of biodiversity, soil erosion, and degradation ofagricultural lands are also serious environmental challenges that are directly related to thelivelihood security of the predominantly poor rural population. There is an urgent priority toundertake measures to protect the fragile watershed environment associated with developed andpotential hydroelectric projects. With natural resources, especially forests, as one of the few
9
sources of growth, rent-seeking and corruption are critical aspects of the management of naturalresources in Lao PDR.
35. A fundamental strategic weakness in the forestry sector has been the government's attempt,in the face of overwhelming capacity constraints and limitations, to directly manage the resourcethrough public agencies. Recent experience has shown that development approaches that activelyinvolve local communities in decision making and resource management lead to dramaticallybetter development outcomes. Local communities are more acutely aware of the potential andcondition of the resource, are in a strong position to provide protection and control against outsidethreats and abuse, and will -- with technical assistance and reasonable benefit-sharingarrangements -- mobilize to plan and develop sustainable resource management. Redirecting therole and performance of the public forestry agencies from efforts at direct management to asupporting and facilitating approach will require considerable effort and discipline in controllingand managing entrenched interests and privileged elites, which benefit from the rents generatedunder existing policies and institutional arrangements.
36. An additional key concern in the forestry sector is the management and protection of thecountry's biodiversity resources. A large proportion of the forest resource has been allocated to asystem of National Biodiversity Conservation Areas (NBCAs) that presently totals nearly threemillion hectares. The regulatory framework for NBCA management is currently weak and isinconsistent with international standards and nomenclature. This leaves the protection of NBCAsuncertain and puts at risk associated investments in infrastructure, such as the proposed NamTheun 2 Hydropower Project. Government has tightened its approach to forest law enforcementand control, but is severely handicapped by capacity constraints, confused institutionalresponsibilities, and lack of local participation in all aspects of forest law enforcement.
37. Energy. Lao PDR has only a few industries in which it enjoys a comparative advantage inthe region; the most important of these is the generation of electricity. The country has large andalmost untapped energy reserves, principally hydropower, and a central location in a regioncharacterized by expanding electricity demand. The Lao power sector is, however, still in a veryearly stage of development. Institutions are weak and the power grid serves only 18 percent of thepopulation. Furthermore, only 450 MW of an estimated 18,000 MW of exploitable hydro potentialhas been hamessed. The sector has the potential to play a pivotal role in achieving the social andeconomic development objectives of the government of the Lao PDR by expanding the availabilityof low cost, reliable electricity within the country and by earning foreign exchange from exportsales to the region.
38. For over a decade, a program of on-going legislative reform has been in progress, the aimof which is to create a legal enviromnent that encourages optimal, responsible and sustainableinvestment in the power sector. 8 These legislative changes reflect the government's wish toattract private capital to power projects. They create an environment that is sympathetic to thereasonable requirements of international investors and lenders. The Electricity Law introduced a
8 Overhaul of the legal environment includes: Contract Law (1990); Commercial Bank and Financial InstitutionsLaw (1992); Customs Law (1994); Labor Law (1994); Business Law (1994); Law on the Promotion and Managementof Foreign Investment (1994); Secured Transaction Law (1994); Water & Water Resources Law (1996); ElectricityLaw (1997); and, Environmental Protection Law (1999).
10
licensing system that sets out the steps and conditions to be observed by private investors seeking amandate to develop independent power producer projects; however, regulations for key legislationhave yet to be drafted to establish the conditions for issue of licenses and to define the proceduresto be followed and the rights and obligations that attach to such a license.
39. Measures have been introduced to commercialize the state-owned national power utility,Electricite du Laos (EdL) and improve its financial situation; however, in recent years thegovernment's inability to adjust tariffs at the pace of inflation has resulted in an acute financialcrisis of the power sector. Specifically, EdL has been unable to meet the financial covenantsagreed with IDA and ADB during the last two years. However, new tariffs, approved in April2002, will pernit these targets to be met (Para. 107).
B. The State-Owned Enterprise Sector
Context and Rationale
40. The State-Owned Eniterprise (SOE) reform program must be viewed in the context ofsubstantial progress made uander the New Economic Mechanism. Through privatization andcommercialization of state enterprises, liberalization of foreign direct investment and tariffregimes, increased financial controls, and improved management practices, both the scope and roleof state enterprises in the economy were dramatically reduced from 1987 to 1997. Of 640commercial and industrial S'OBs which existed in 1989, only 93 remained as 100 percent state-owned firms in 1997, including 24 enterprises deemed strategic.9 SOEs now constitute less than 1percent of total employment (Figure 5). Yet progress has been uneven. The 1997 regionalfinancial crisis, policy reversals, and subsequent macroeconomic instability dramatically reducedforeign direct investment (FDI) and private job creation - both integral to SOE reform. FDIapprovals declined from 17'0 percent of GDP in 1994 to 10 percent of GDP in 1998. Theauthorities thought it prudent to delay SOE reform in light of the harsh macroeconomicenvironment. Ownership diversification continued, including joint ventures being formed withLao Telecom, Lao Beer, and Lao Tobacco.
Figure 5
SOE. h-ve small .b.re of employment an... ... d asnil sha of industri lalu e ...but -ecooot for the .jonity of NPLt
added (bilon kip)
AgRicuturie
900 - ____r
500- 400 -rvt
300 l1
300 frl 63E
SOE Public Privote 100 Ih
5% S Privete
Source: Lao PDR authorities and UNIDO (1 999).
9 This figure treats SOE conglomerates, such as BPKP and DAFI (Development, Agriculture Forestry IndustryGroup), as single enterprises and does not include eight joint ventures or seven new SOEs. The actual number ofSOEs is therefore larger.
Dimensions of the Problem
41. Non-performing loans. While SOEs make a relatively small contribution to national outputand employment, they contribute a disproportionately large share of non-performing loans (NPLs)[Figure 5]. As of September 2001, loans to state enterprises constituted 69 percent of the totalvolume of the top twenty non-performing accounts in each of the three commercial banks prior toJanuary 1, 2000, and 29 percent of non-performing loans since January 1, 2001. Of these largernon-performing accounts, which exceeded $94 million in aggregate, SOEs comprised over $47million.'0 The underlying causes of non-performing loans are several. Key among these is a legalframework for insolvency that does not provide sufficient incentive for banks to resolve theproblem of non-performing loans due to structural defects in the code of Civil Procedure, as wellas limited judicial capacity. The ADB is providing technical assistance to the Lao authorities inorder to strengthen the insolvency framework and provide judicial training. The weak legal andjudicial regime for addressing enterprise insolvency is combined with historically weak regulatorypressure from the BOL to enforce loan quality, effectively softening the budget constraint SOEsface. This is being addressed within FMAC, as well as by the IMF and ADB, and indicates theintegrated nature of the operation. Management of most SOEs, which is assigned by lineministries, usually consists of ministry staff with little direct commercial management experience.Policy lending is still largely accepted as a means to achieve national economic objectives.
42. SOE policy and regulation. For several years, SOE policy has been fragmented among lineagencies and the Ministry of Finance (MOF), with no mechanism to establish and enforce policydirection across ministries and with provincial governors, aside from the Cabinet itself. InSeptember 2000, a new minister, under the Prime Minister's Office (PMO), was named to head theBusiness Improvement Office (BIO). This Minister's mandate, yet to be formally approved by thePrime Minister, includes defining the future role of the state, legal reforms, regulatory reforms,enterprise restructuring, corporate governance, social, labor and environment concerns as well aspublic information. This is a well-developed agenda, but will require substantial technical capacitybuilding within BIO to enable it to both develop and guide on behalf of the government.
43. SOE governance. Under the 1994 Business Law, SOEs must report to MOF, whichexercises fiduciary responsibility as caretaker of the state's investrnent capital. Despite the law,the government has an incomplete view of the operational and financial performance of SOEs.Reporting requirements are unclear, particularly at the provincial and district levels, and SOEs inthe defense sector do not currently report to MOF. Mechanisms which provide direct oversight ofstate enterprises in order to hold them accountable to the state's performance objectives, such asSOE Executive Councils, have been ineffective. Not all SOEs have boards in place, and few of theboards that exist meet as frequently as required. Directors, frequently civil servants who have full-time functions within line ministries, have insufficient time or capacity to exercise their fiduciaryresponsibility. There is little clear definition of the roles and responsibility of board directors; theboards' understanding of accounting, business management or financial management is weak.While a National Audit Office (NAO) was created, few SOEs have regular annual audits. Thiscombination of factors limits the state's ability to manage risk and execute SOE reform policy.
10 This figure includes $12 million owed by Lao Beer in relation to its buy-back of shares prior to resale to a new jointventure partner.
12
44. New SOE creation. Notwithstanding the gains made under the New EconomicMechanism, the government's official stand remains that SOEs are a major pillar of the economy.This was articulated most recently in the 7h Party Congress in March 2002: "State Economy is themost important sector in leading the transformation from a subsistence economy to commodityproduction ... " This policy context, combined with the policy of economic decentralizationannounced by the Prime Minister in March 2000 (Advisory No. 01/PM), has given provincial anddistrict governments substantial autonomy which is being used, among other things, to create newSOEs. While the rapid creation of new SOEs to achieve political or economic objectives haslargely passed, at least seven SOEs have reportedly been created recently to support provision ofagricultural inputs and rice sl:orage.
45. Lack of competition. The policy and institutional environment for enterprises, both stateand non-state, limits the competitiveness of enterprises and the stable development of the industrialsector. Obstacles to compelitiveness include policy, regulatory and legal framework, inadequategovernance and transparency, and bureaucratic impediments to the operation and establishment ofenterprises. For example, in3Frastructure enterprises such as water, energy, telecommunications andaviation are incurring operating losses due to lack of cost recovery and political interference intariff setting. Tariff levels are kept low and this contributes to financial losses, lack ofmaintenance of assets, inadequate investment in new facilities, and low service levels. The playingfield with the private sector is not level." In addition to unattractively low tariffs, this maypartially explain why a sector like telecommunications, which was opened to competition, stillremains monopolized.
46. Utility tariff reform and sector regulation Infrastructure enterprises such as water, energy,telecommunications and aviation are incurring operating losses due to lack of cost recovery. Thedominance of political objectives in tariff setting has led to financial losses, a lack of maintenanceof assets, inadequate investrnent in new facilities, and consequently poor service levels. Whilepoverty is a major concern, this does not make a case for across-the-board restraint on tariffs. Ingeneral, affordability issues should be addressed by means other than general tariff interventions.SOE pricing strategy is a ccmplex mix of cross-subsidies designed to maximize revenues whilelimiting the price impact of commercial autonomy on the majority of the population. For example,the water tariff for Lao citizens in Vientiane is l/76h the tariff for foreign offices; however, waterconsumption is a poor indicator of poverty. Many poor people have no piped water connectionsand indeed pay a huge premium for vendor and bottled water supplies. For Lao Aviation, NamPapa Lao, Lao Telecom and EdL, weighted-average tariffs are currently below full cost recoveryfor the services provided. While the objective of ensuring affordable service to lower incomesegments of the population is well-intentioned, directing the subsidy through the enterprise: (i)limits the ability to target the subsidy to the most needy; (ii) causes the government to subsidizeenterprise losses and causes NPLs; and, (iii) limits the accountability of the enterprise for bothefficiency and profitability. B3ecause the tariffs are low, the scope for new investment in the sectoris limited, severely restricting potential competition which could serve to establish low priceswhile increasing service quality delivery. Among utility SOEs, the policy of commercialautonomy has not been supported by mechanisms, such as sector regulatory capacity and targetedand transparent subsidies, to allow competition and full price liberalization.
" See Country Procurement Assessment Report, World Bank, 2002.
13
47. A coherent regulatory framework in each of the infrastructure sectors is required to attractprivate investment. For example, while great strides have been made in the decentralization of thewater supply sector with the creation of provincial "Nam Papas", these decentralized organizationsare operating in a regulatory vacuum. There is little or no clear guidance as to the long-termstrategy and intentions of the government and policy is being driven by local political forces. Theambiguity is adversely affecting levels of service.
C. The Financial Sector
48. The Lao banking sector is small in absolute terms, with total assets of approximatelyUS$400 million. It is also relatively small when compared with the size of the Lao economy: theratio of the banking system's total assets to GDP is about one fourth. State-owned commercialbanks (SCBs) dominate, holding more than two thirds of the banking system's total assets. Thethree largest banks (Banque pour le Commerce Exterieur Lao - BCEL, Lao May, and Lane Xang)are fully owned by the government. BCEL maintains a dominant position, accounting forapproximately half of total deposits and almost 40 percent of total loans in the system. (Annex Iprovides a detailed description of the financial sector.)
Inadequate Policies
49. Directed, non-commercial credit accounts for a substantial share of total credit and appearsto be responsible, to a great extent, for a high level of NPLs in the system. The analysis of SCBs'portfolios shows that about 80 percent of loans to the state sector are non-performing and it is notunreasonable to assume that SCBs' loans to the state sector are directed. This situation has alsoresulted in weak governance in the banks, as managers cannot be held responsible for theperformance of the institutions.
50. Low repayment rates are encountered in the private sector, where NPLs stand at 60 percentof loans. Years of state-managed economy have contributed to create a culture of non-repayment,as evidenced by the low NPL recovery rate -- around 18 percent according to some unofficialestimates -- during the first recapitalization of the banking system in 1994. 12
51. Price signals are distorted, hence capital cannot flow to its best use. Commercial banks aretheoretically free to set their interest rates on loans since the elimination of the guidelines onmaximum lending rates in June 1995, and there is no official restriction on the maximum spread.In practice, however, SCBs behave in identical ways by not pricing loans according to risks andmaturity but rather by seeking compliance with government policies.
52. Subsidized interest rates prevent the development of a sustainable microfinance industry(MFI). Currently, it is estimated that an MFI should charge an interest rate between 3-4 percentflat per month. But the Agricultural Promotion Bank (APB), which has the largest outreach,charges less than 0.5 percent flat per month. On the other hand, money lenders charge 20 percentflat per month on average. The government left the MFI pricing policies relatively free for the last
12 According to the ADB's internal evaluation department, the low recovery rate was the result of poorly designedrecovery structure.
14
five years but recently have exerted pressure to lower the interest rates to unsustainable levels,discouraging new initiatives and putting at risk the few on-going microfinance projects.
Weak Framework
53. The Central Bank Law does not provide the BOL with a clear mandate and a well-definedhierarchy of priorities. Thus, the BOL has pursued conflicting multiple objectives simultaneously.Even if BOL had been able to follow one course, such as price stability and low inflation, itseffectiveness in monetary poliicy was limited by the following factors:
* The economy is 80 percent dollarized;' 3
* The BOL lacks adequate autonomy, having to consult with, and obtain approval from,the executive power for most of its activities;
* Policy or directed lending accounts for a significant share of overall lending; and,* The BOL's financial resources are limited.
54. Since January 1997, a new and better chart of accounts was introduced to modernize Laobank accounting and bring it closer to international accounting standards. However, enforcementand compliance have lagged.
55. The regulatory framework for banks departs from international best practices in someaspects. A major weakness appears to be the specific SCB governance structure that reduces SCBautonomy and limits the Managing Director's accountability. For all practical purposes, the lackof enforcement of existing prudential rules leaves SCBs unregulated.
56. There are some gaps and inconsistencies in the laws. Inportant laws such as theBankruptcy Law or the Secured Transaction Law depart from evolving international best practicesto a certain extent. More danaging, however, is the fact that laws are not always fully andsystematically applied, and judgments are not always enforced.
57. With regard to microfiniance, the BOL regulation really allows only one model -- which isthe savings and credit cooperalives. Restriction on institutional models, with private or diversifiedownership, deters pilot projects.
Weak Institutions: Lack of Skilled Human Resources
58. MOF does not have a c onsistent financing program, providing low risk and liquid assets,for the budget deficit. MOF ordy recently has unambiguously allowed adequate tax deductions forloan loss provisions. The ministry has not effectively administered accounting laws, regulations,and procedures, and has not established financial disclosure requirements adequate to ensure thatfinancial information is reliable and available. In BOL, the bank's supervision department isstaffed with relatively young people with little experience who have yet to build the necessarycredibility and respect that are necessary to ensure banks' compliance to the regulatory framework.
13 The word "dollarized" used here means currencies other than the kip - i.e., U.S. dollar and the Thai baht.
15
59. Narrow and restricted dissemination by the Ministry of Justice (MOJ), of legislative actsand regulations, is responsible in part for the lack of compliance and uncertain outcomes whenrights are to be protected; however, the major reason appears to be that the judiciary remains tooweak to implement the laws. In addition, seeking justice through the legal and judicial system isstill somewhat at odds with Lao culture.
60. The SCBs do not have sufficient skilled management and staff, resulting in SCBs providingloans in foreign currencies to borrowers without foreign exchange revenues. SCBs do not have aresearch and development unit to help make decisions and evaluate business opportunities. Creditofficers lack the skills needed to analyze credit risk, project risk, market risk, and foreign currencyrisk. SCBs do not have formal lending policies or credit limits and do not use any standard creditappraisal document. Extemal legal opinions on loan contracts are not sought. SCBs do not have apolicy stating when to take legal action against a particular borrower or a policy of obtainingregular financial statements from all of their borrowers. Site visit reports are not prepared. Creditfiles are not properly kept. Internal auditors do not carry out a regular review of banks' loans toensure that they comply with internal and BOL's regulations. The classification of loans is notregularly carried out. These are significant deficiencies that need short and long-term remedies,and improving the "Loan Cycle" will be a long-term endeavor.
D. Consequences of Structural Weaknesses for Growth and Poverty Reduction
61. A counter-factual illustrates the crisis dynamics associated with structural weaknesses andinforms the design of the proposed reform program. According to IMF estimates in the PRGF, afiscal deficit of 5 percent is sustainable even though its structure (as discussed above) isundesirable. The SOE structural problems could potentially add I to 2 percentage points of GDPto the deficit. With proper accounting, provisioning and fiscal accounting of capital injections, anadditional 1 to 2 percentage points of GDP could be added to the deficit due to weaknesses in thebanking sector. Thus in the absence of structural reform, a sustainable fiscal deficit of 5 percentcould deteriorate to around 9 percent of GDP which would be fiscally untenable and would lead toa crisis and severe macro-economic difficulties as experienced in 1997/98. The cumulative impactof the structural weaknesses (outlined above) on macro-economic instability is presented in Figure6.
16
Figure 6
Lao PDR: The Structural Problem:Unsustainable Public Finances that Retard
Growth and Poverty Reduction
Development Problem The Budget Fiscal Problem
* Inadequate or no rectuTentbudget -. Fiscal deficit currently about
• Large donor funded investment 5 percent of GDPprojects with implementation more or less sustainableproblems t
* Corruption and waste SOES* Equity objectives not niet
/ Low price due tosocialPotentially add 1-2* Low prices due to social I >^ t_t A percentage points additional
objective deficit due to directed credit* High cost due to enterprise and other contingent
inefficiency liability* Corruption BA t
Banki q Sector* NPLs* Corruption* Not meeting future Add 1-2 percentage
growth need . points more* Not meeting the equity :9
objective
* Recurrent crises as in f 4 1997/99, disrupting Total deficit could reachgrowth and poverty Crisis that 8-10 percent of GDP which
alleviation Retards Growth would be explosive* triple digit inflation* Collapse of currency and Poverty
value Reduction* Loss of confidence
17
IV. GOVERNMENT'S REFORM PROGRAM AND POVERTY REDUCTION
A. Public Sector Management:
62. The govemment of the Lao PDR remains firmly committed to achieving rapid reduction inpoverty. Its growth and poverty reduction strategy, as articulated in the I-PRSP and the NSEDP,highlights the importance of stable and sustainable growth to help reduce poverty. There is arecognition that the extent to which growth will result in poverty reduction depends on structuralpolicies that improve economic efficiency and govemance while reducing the vulnerability toeconomic crises that adversely affect the poor. The government's reform program focuses on a setof structural problems at the stage of budget formulation and execution, inefficiencies and losses inthe state-owned enterprises and the cumulative effect of these on the shallow and fragile bankingsector. It is designed to increase growth by promoting stability and a clearer role of the publicsector and to reduce poverty directly through improved allocation of public funds.
The Budget
63. Improved public spending is an important instrument to offset the incipient trends towardsincreased inequality in Lao PDR and to reach marginalized groups who do not directly benefitfrom overall economic growth. The government is seeking to strengthen budget execution andcontrol by improving the basic cash management, reporting, auditing and control systems thatgovern public expenditures. With these reforms, budgeted expenditure shares for health andeducation should increase in line with the PRSP and unauthorized accounts should be identifiedand closed.
Prior Reform Measures
64. Budget planning. The government has already undertaken significant steps to improve themeasurement of poverty and to enhance the poverty focus of public expenditures. The first LaoExpenditure and Consumption Survey, conducted by the National Statistical Center in 1993, wassubstantially improved and updated in 1998. The basic poverty measurement initiatives haveenabled the government to complete the I-PRSP in April 2001 and it will complete the full PRSPin FY 2003.
65. To better achieve its development objectives, as outlined in the I-PRSP, and raise the shareof recurrent spending, the government has been reducing capital expenditures which peaked atover 70 percent of total expenditures in 1998/99, and have fallen to less than 60 percent in2001/02. Further rebalancing of public expenditures was achieved through a 25 percent increase inbasic civil servant wages from the start of 2002 to compensate for past inflation. Given that a largeportion of civil servants are teachers, this is helping to reach the I-PRSP target of lifting theeducation's share of the budget to 13 percent.
66. With the assistance of the Asian Development Bank (ADB), the Lao PDR is better able toplan and manage public investments. A Public Investment Plan (PIP) monitoring project thattracks donor-funded investment expenditures has been established and the results are publishedannually. This is now being extended to domestically funded public investments. Decree No.
18
58/PM, dated May 22, 2002, on Management of Public Investment and the associated guidelinesprovide a rationalized framework for project selection that involves streamlining by size and atwo-stage process of evaluation against set qualification criteria, followed by a separate budgetresource availability hurdle. This system is being applied now as the FY2002/03 investmentproposals are received.
67. Budget accounting and control. Decree 20/PM of 1993 on Public Accounting is nowbeing more fully and effectively implemented with the establishment of an information andbudgetary system in four pilot Ministries (Agriculture and Forestry, Education, Finance, andHealth) with assistance from the ADB. This system allows the systematic computerized recordingand processing of expendittres by administrative units. It includes budgetary and accountingreferences, committed current and capital expenditures at the central level, and it specifies budgetallocations, payment orders and the value of budget allocations available after payment ordershave been deducted.
68. To tighten the control of public resource flows, a Ministerial Decision was issued in 1999requiring MOF's Treasury Department to exercise prior commitinent controls on expenditures. Toensure that commitments are consistent with the budget, responsibility for the commitment controlfunction now rests with the Budget Department (Ministerial Decision No. 1706/MOF, datedOctober 22, 2001).
69. Transparency. With assistance from the ADB, the NAO was established by Decree No.174/PM in 1998 and began producing audits of central government ministries, provinces, andindividual projects. The NAO has been reporting annually to the President, the Prime Minister andthe National Assembly. The quality of its audits has been improving as the capacity of NAO staffis enhanced through continued ADB support
70. In line with the requirements of the PRGF, the Treasury Department has begun aninventory of Treasury accounts at all levels. This inventory, which is now almost complete, willallow MOF, working in conjunction with BOL, to identify and close all unauthorized Treasuryaccounts which facilitate the proliferation of off-budget revenues and expenditures.
Reform Measures Supported by FMAC
71. With the support of the proposed FMAC, the Lao PDR is taking several additional steps tofurther stabilize the budgetary process and budget planning.
72. To promote transparency in fiscal management, the 2000/01 budget outcome and the2001/02 budget plan with classification by ministry/province and service 1 were published in theOfficial Gazette on March 25, 2002. The detail of the presentation has been substantiallyexpanded, including breakdow:ns by sector at both central and provincial levels.
73. Decree No. 58/PM, dated May 22, 2002, on the Management of Public Investment requiresthat PIP submissions for new public projects in excess of 1 billion kips in the FY 2002/03 budget
14 Classifications are by ministry/province and service, so that it is possible to identify separately the central ministryand provincial spending on health, education, etc.
19
include estimates of associated recurrent costs during the operating period. Guidelines forestimates of the recurring costs have been prepared for presentation at the provincial budgetconferences in May 2002. A workshop on the subject for the Committee for Planning andCooperation (CPC) and MOF staff, held at the CPC with the assistance of the World Bank in Aprilthis year, was very useful in disseminating information on these topics. The CPC will present theresults of this work for the FY 2002/03 PIP to the donors in October 2002. A consultant has beenengaged to assist CPC with recurrent cost estimates under terms of reference agreed with the Bank.As part of the second phase of the FMAC-supported program, the CPC will complete anassessment of recurrent cost estimates associated with new projects in excess of 1 billion kips.
74. Following the January 17, 2002 letter sent jointly by the World Bank and the IMF to theMinister of Finance concerning the draft Accounting Regulations and Procedures, and consistentwith discussions held between the World Bank and the Accounting Department in February 2002,revisions are being prepared. This process is at an advanced stage and the government expects toadopt a Regulation of the Minister of Finance on Public Accounting and Procedures for theimplementation of Decree No. 20/PM on the General Regulation of Public Accounting, datedFebruary 18, 1993, and prepare a strategy for reform of the Department of Treasury. TheRegulations and Procedures are expected to be issued by end-June 2002. These accountingreforms set the stage for the medium-term reforms for Treasury operations which will bedeveloped in close collaboration with the International Financial Institutions (IFIs).
75. The enabling legislation for the establishment of a Procurement Monitoring Office (PrMO)is already in place. The government is moving forward with establishment of the PrMO, withinMOF, headed by a qualified and experienced Director and assigned with adequate staff andresources. In addition, the Implementing Rules and Regulations will be revised in line with therecommendations of the World Bank's draft Country Procurement Assessment Review which thegovernment received on May 3, 2002. A candidate has been identified for the position of PrMODirector.
Reform Measures in the Medium Term
76. A series of medium-term reforms of Treasury operations will be launched under theguidance of a recently formed Standing Committee headed by the Vice Minister of Finance. Keyreforrns will include establishment of Treasury offices in line ministries, closure of unauthorizedTreasury accounts, consolidation of the network of Treasury accounts, revision of Treasuryregulations including sanctions, and publication of a manual of consolidated laws, decrees andregulations for government-wide Treasury operations. Following the revision of PublicAccounting regulations and refinements of the chart of accounts and budget nomenclature, thepilot computerized accounting systems will be extended to cover all central ministries andprovinces. These initiatives will serve to improve both expenditure management and revenuemobilization objectives by restricting the scope for unauthorized off-budget transactions andbringing about a closer integration of treasury, accounting and budget operations. In addition, thegovernment plans to introduce intemal audit and accounting processes, to adopt internationalpublic accounting and auditing standards and to revise accounting decrees and regulations toclarify financial control responsibilities among the central government and the provinces.
20
77. Further steps to improve the transparency of budget processes will include continuedpublication of the budget plan and budget outcome and steps to reduce the publication lag. In themedium term, the government intends to adopt legislation to provide greater autonomy for theNAO and to establish an effective parliamentary oversight over public finances, and to make theaudited annual accounts and audit reports of the NAO fully accessible to the public. A review willbe undertaken to assess the scope for rationalizing the roles and responsibilities of the oversightagencies including the NAC), the State Inspection Agency, MOF's Inspection Department, thePermanent Economic Committee of the National Assembly, and the BIO within the PMO. Thegovernment also intends to introduce by appropriate legal instrument the principle that allsubsidies and other quasi-fiscal expenditures be reflected explicitly in the national budget. Thiswill be reinforced by the program to enhance Treasury operations and closure of unauthorizedaccounts, thereby enabling the Lao authorities to progressively eliminate all off-budget revenuesand expenditures.
78. Financial reporting in the private sector will benefit from the introduction of measures toimprove the institutional framework for setting its accounting and auditing standards. Theseinclude efforts to streamline various laws and regulations related to accounting and auditingpractices in the private seclor, as well as adoption of international accounting and auditingstandards for this sector.
79. To enhance budget planning, the government will improve revenue estimation methods andbegin to reverse the persistent pattern of revenue shortfalls and subsequent ad hoc expenditurecuts. It will develop better unit cost measures for major expenditure programs, including healthand education, to support mole realistic bottom-up estimation of the costs of achieving plan goals.The classification used by the CPC in the PIP monitoring system will be aligned with the budgetclassification system, and the latter will be extended to allow identification of expenditures byprogram. These steps will zdlow the government to reflect the results of poverty monitoring,expenditure tracking and PRS"? work in public expenditure plans and expenditure outcomes.
Forestry
80. The performance of the forestry sector has not been as satisfactory as expected. Thegovernment believes that the contribution of forest resources to the incomes and livelihoods ofrural people would be increased under a better forest management system. This includesaddressing, among others, the iissue of unplanned and uncontrolled logging.
Prior Reform Measures
81. A number of steps has been taken toward reforming the policy and institutional constraintschallenging forestry and the government is working with a number of partners to build the capacityneeded to improve management of the resource. These steps include reducing excess capacity inwood processing sector, mandating that timber production be restricted to areas targeted forinfrastructure development or covered by sustainable forest management plans, introducingmarket-oriented timber sales methods, achieving successful trials of participatory forestrymanagement, and successfully controlling illegal and unauthorized logging in targeted areas.
21
82. The government recognizes the full range of environmental, economic and social benefitsthat a well managed forestry sector will provide. The Lao PDR is well endowed with forestbiodiversity and is recognized as the host of unique and globally endangered species of plants andanimals. A system of NBCAs has been established and the government is introducingmanagement and protection of these areas. In the future, the authorities expect to improve thequality of management of these areas by, among other things, employing participatory approachesthat combine conservation with tangible contributions to the livelihoods of local people.
Reform Measures Supported by FA4C
83. The Ministry of Agriculture and Forestry (MAF) has formally approved the key Principlesfor Village Participation in Sustainable Management of Production Forests and the PMO hasissued a Decree on Sustainable Management of Production Forest Area that supercedes relevantarticles of existing orders.
84. Under the FMAC program, the government will strengthen the regulatory framework forprotected areas management and will issue, through MAF, Regulations amending theImplementing Regulations on National Biodiversity Conservation Areas, Regulation No.0524/AF.2001, dated June 7, 2001, inter alia, to clarify the definitions and procedures governingzoning and land use within said Conservation Areas, and eliminate inconsistencies in respect ofprotected species listings. Furthermore, Implementing Regulations on Sustainable ForestryManagement will be adopted which include specific provisions to enable the involvement of localcommunities in production forest management.
85. The government's top priorities under the period of the FMAC program focus on bringingorder and discipline to the exploitation of the country's production forest resources. Until now,these areas have not been adequately mapped, inventoried, or their harvest properly planned andorganized. Harvesting is considered by international norms to be of lower efficiency thanexpected. If proper forest management is not undertaken, pressures from mismanagement of theproduction resources would increase and the result would negatively affect the goals for sustainedrevenue mobilization and biodiversity conservation, and would require urgent attention andcorrection.
86. Recognizing that the capacity of government forestry agencies at all levels is limited, theofficial strategy is to involve local communities in forest management by providing a frameworkfor the rapid expansion of the area under sustainable scientific forest management conducted incooperation with Village Forestry Organizations. Decree No. 59/PM, dated May 22, 2002, andImplementing Regulations on Sustainable Forestry Management which include specific provisionsto enable the involvement of local communities in production forest management, will provideguidance to the national, provincial and local agencies responsible for working with communitiesand Village Forestry Organizations on the basis of voluntary Village Forestry Agreements andwritten management plans. This regulatory framnework will implement the "Principles for villageparticipation and other key principles in sustainable management of production forests."
87. implementation of this program, expected to be supported by international partners, isaimed at rapidly bringing a large portion of the production forest resource under sustainable
22
management. This will involve mapping, demarcation and registration of a network of productionforest areas and the preparai[ion, approval and implementation of management plans.
88. The government will initiate a forestry sector monitoring program to routinely assembleand analyze information on policy implementation and development results. A comprehensivesectoral monitoring program, which will enable the government to monitor and report on theimplementation of this program, will be initiated with the FMAC program.
Reform Measures in the Medium Term
89. Looking beyond the FMAC program, the government intends for the forestry sector tocontinue to develop as a sustainable source of growth and public revenue and a means for povertyreduction. To support this, the Lao PDR will continue its efforts to introduce more market-oriented timber sales methods, will develop policies to reduce excess capacity in the woodprocessing sector, and will complete the regulatory framework for forestry envisioned under theForestry Law with well firmulated Implementing Regulations covering all forest types andmanagement systems under the law.
90. Investments are expected to continue in reforestation, plantation development andwatershed management. These efforts are vital to the development of alternative sources of rawmaterial, and to the protection of existing and planned downstream infrastructure. As with themanagement of natural production forests and conservation areas, the government intends toemploy participatory methods and will consult with a range of stakeholders to ensure broad-basedsupport for sustainable development.
B. State-Owned Enterjprise Sector
91. The government recognizes that a well-functioning, financially-sustainable enterprisesector is important to improving the delivery of services to the poor, creating meaningfulproductive employment, as well as supporting the transformation of the economy from an agrarianto an industrial and service-based economy. Many of the enterprises have, in the past, supported amix of social, political and economic objectives. With social and political stability in place, thegovernment's focus is now on enhancing the economic contribution of state-owned enterprises.The Lao PDR's objectives are to improve the oversight and management of those SOEs whichshall remain under state jurisdiction, in order to make them more commercially oriented, efficientand able to compete with other enterprises. For several non-perforrning enterprises, this willrequire deep internal reform to strengthen management and eliminate non-productive activities.For infrastructure SOEs, this will require regulatory and tariff reform.
92. Reform of SOEs should contribute to poverty reduction by permitting a better allocation ofpublic funds. WNhile there iis some danger that the poor could be adversely affected by highertariffs, this risk has been rnitigated by careful design of the tariff structures to permit moreeffective poverty targeting while meeting efficiency of reduced internal costs, and closer alignmentof prices and marginal costs.
23
Prior Reform Measures
93. Commercialization The Lao PDR's SOE reform policy must be viewed in light of gainsmade in implementing the NEM, which dramatically reduced the number of SOEs throughliquidation and privatization, hardened budget constraints, and removed the monopoly status whichmany SOEs previously enjoyed. Under the 1994 Enterprise Law and implementing regulations,the framework for commercial autonomy and self-sufficiency of SOEs was introduced. All SOEshave introduced Executive Councils which govern SOEs, replacing the previous direct municipalor central government control and ownership mechanism. The Office of State Assets within MOFwas assigned to execute the fiduciary responsibility of the state as shareholder.
94. Privatization. From 1988 to 1997, the government undertook a substantial program ofprivatization. Of over 600 central and provincial SOEs which existed in 1988, only 91 remainedas 100 percent state-owned enterprises by 1995. In 1996, plans were developed to privatize anadditional 58 enterprises. Unfortunately, the disruptions of the economic crisis delayed the SOEreform process, as it was difficult to force further adjustments in the midst of a harshmacroeconomic climate. By impacting macroeconomic stability -- which is a prerequisite toforeign investor interest in transformed assets -- as well as domestic purchasing power, the crisismade further progress on privatization very difficult. However, several enterprises, including LaoTobacco and Lao Telecom, continued to be privatized during this period.
95. Restructuring A number of larger SOEs, including those in infrastructure sectors, havebeen unable to achieve financial sustainability, which in turn contributed substantially to both thenon-performing loans problem in the banking system and a fiscal drain on the budget. Theperformance of enterprises which remained in state control during the crisis and through 2001revealed weaknesses in the management and oversight of SOEs. Policy Decision No 368/PMO inOctober 2000, provided the context for intervention to restructure non-performing SOEs. InDecember 2001, Bolisat Phattana Khet Phoudoi (BPKP), the enterprise responsible for the largestnon-performing loans in the banking system, was transferred to MOF, and the process ofrestructuring was initiated. Audits of Lao Aviation and BPKP further strengthened thegovernment's commitment to finding a comprehensive solution.
96. SOE reform policy. In this broad context, the government began to engage with the Bankin September 2001, through the FMAC program, to improve the financial performance of state-owned enterprises and consolidate the gains previously made in transforming SOE management.A new Minister was named to head the BIO in order to lead enterprise reform policy, particularlywith respect to SOEs. A target list of enterprises has been identified for restructuring by thisoffice.
97. With respect to infrastructure SOEs, financial sustainability is a particularly difficultchallenge in light of the need to undertake substantial investment programs to provide essentialservices to the poor. Integral to the financial sustainability of several of these enterprises is acombination of internal restructuring to reduce costs with tariff reforms and introduction ofappropriate regulatory frameworks.
98. Water sector. The Water Supply Authority (WASA) was established as the centralregulatory authority for the water and sanitation sector of the country in the Ministry of
24
Communication, Transport, Post and Construction. This was followed by the water sector policystatement in 1999. The new policy changed the role of the central government from serviceprovider to facilitator and coordinator in the development process for water supply and wastewatermanagement systems in urban and rural areas throughout the country, including sector investmentsupport. Work is underway with donor support (ADB's Project Preparation Technical Assistance,PPTA) to develop a legal and regulatory framework for the water supply and sanitation sectorunder the auspices of WASA. The national water policy is described in the Prime MinisterialDecision No 37/PM of 1999 on Management and Development of the Water Supply Sector. Thisdocument establishes the principles for a tariff policy and for the Provincial Nam Papa operationson commercial principles in lirLe with the national policy on working toward full cost recovery forurban water supply and centralized wastewater systems, with progressive block rate tariffstructures.
99. In accordance with the Decision 37/PM, the tariffs shall be set within the constraints ofaffordability and willingness to pay, adopting a uniform province-wide tariff system withpossibilities for cross subsidizing. Average tariff has increased from 195 Kip/m3 in 2000 to 550Kip/m3 in September 2001. WVASA has authorized an increase to 650 Kip/m3 from July 2002.Nam Papa Vientiane has proposed a tariff of 750 Kip/m3. However, further reforms are envisagedas tariffs still remain well below cost recovery and do not take into consideration new capitalinvestment costs.
100. In a context of developing regulatory instruments for the sector, WASA has agreed toreview the water tariff principles and elaborate a comprehensive water and sanitation tariff policyin consultation with key stakeholders of the sector. The review is expected to be done in light ofpossible future private sector participation in the water supply and sanitation sector.
101. Telecommunications. T he government has made a number of changes to the structure ofthe telecommunication sector over the last decade. These include introducing private investmentthrough a joint venture (1994') as well as separating post from telecommunication (1995). Atelecommunication law was passed in April 2001 and lays the framework for telecom regulationsand entry into the sector. The sector has been open to competition since the beginning ofNovember 2001. The government issued a mobile license in early 2001 for Millicom IntemationalCellular SA, a Luxembourg-headquartered international mobile investor.
102. Until 1993, the Enterprise of Post and Telecommunications Lao (EPTL) was the 100percent government-owned organization responsible for operating telecommunications in thecountry. In 1994; a joint venture was established between the government and a Thai company,Shinawatra International Public Company Limited -- Lao Shinawatra Telecom Company Ltd.(LST) -- to operate telecom services (Telecom Project Phase III). This was not the first example ofprivate investment in the telecorn sector. In 1995, ETPL was divided into Enterprise of Post Lao --responsible for postal services - and Enterprise of Telecommunication Lao (ETL) -- responsiblefor telecommunications. In 1996, ETL and LST were merged to form Lao TelecommunicationsCompany Limited (LaoTel) with the government owning 51 per cent and Shinawatra owning 49per cent. LaoTel was granted a concession of 25 years with five-year exclusivity (through October2001). ETL was resurrected in August 2000 to hold grant-financed government assets. As aresult, LaoTel ended up leasing certain network elements needed for its service provision such as
25
the international gateway. With the expiration of LaoTel's exclusivity in October 2001, the way isnow open for ETL to enter the sector as a telecom service provider. ETL plans to provide fixedtelephone lines, mobile Global System for Mobile Communications, and Voice Over InternetProtocol services in 2002.
103. While a tariff structure exists in this sector, the government recognizes that domestic tariffsare highly subsidized and the need to develop a firmer policy for tariff determination. TheTelecom Department, as the regulatory body, is putting in place a tariff policy study and hasrequested assistance for the development of a regulatory framework including tariff rebalancingand interconnection charges as well as a framework for private sector participation and licensingarrangements.
104. Transport. Three tariff increases for Lao Aviation were approved over the last year. Whilethe government recognizes that tariffs are not yet at cost recovery levels, it is considering a recentrequest from Lao Aviation to increase tariffs from 8 cents/seat/km to 20 cents/seat/km for domesticflights - bringing tariffs to cost recovery levels (at 65 percent capacity utilization) in the firstquarter of 2003.
105. Electricity. Since 1997, there have been several activities for restructuring tariffs andregulation in this sector, upon the preparation of parallel projects of the World Bank and ADB.The Ministry of Industry and Handicraft (MIH) issued in March 2001 a Power Sector PolicyStatement (with World Bank support) that established the following two main objectives for thePower sector: (i) to maintain and expand an affordable, reliable and sustainable electricity supplywithin the country to promote economic and social development; and (ii) to promote powergeneration for export to provide revenues to meet the government's development objectives. Itwas agreed that the achievement of these twin goals depends on continuing progress in thefollowing two areas:
* Development and enhancement of the legal and regulatory framework to effectively directand facilitate power sector development; and
* Reform of institutions and institutional structures to clarify responsibilities and streamlineadministration.
106. Prior to the Policy Statement, the Lao PDR's National Assembly enacted the ElectricityLaw (1977), an important advance in the development of a legal framework to attract, direct andcontrol optimal investment in power projects. Currently, consideration is being made for theseparation of Electricite du Laos (EdL) from its off-grid and independent power producerresponsibilities, and to establish an independent regulator. Resources are being mobilized insupport of an open debate on sector reform. The government has also approved a proposal for aPublic-Private Infrastructure Advisory Facility (PPIAF) supported workshop on sector reform(scheduled to be held around November 2002) which would be followed by the formulation of anaction plan.
107. The government's efforts to commercialize EdL started in the mid-1990s under technicalassistance support of the World Bank and ADB. Since then, EdL has been established as aseparate juridical entity with a functioning Board of Directors. Also, EdL has strengthened its
26
financial management capability (with World Bank support), has been reorganized on the basis ofcost centers that facilitate accountability of each operation, and the utility has divested from somenon-core activities (e.g. concrete pole plants). This process was supported by the enactment of theElectricity Law which supports the commercialization of the sector. Following the 1997 regionalfinancial crisis, EdL's financial situation was seriously affected by exchange losses. In response tothis situation, in December 2000 a Financial Recovery Plan, satisfactory to the Bank, was proposedfor EdL. This plan called for: (i) conversion of some debt to equity; (ii) temporary relaxation ofonlending conditions to EdL, particularly for debt associated to social-oriented investments; (iii)undertaking a tariffs study and the subsequent implementation of a new tariff policy; (iv)revaluation of fixed assets; (v) signing of a performance agreement between EdL and thegovernment; and, (vi) review of EdL's investment plan. In spite of the slow implementation ofthis Plan at the onset, almost all of the measures have been implemented at this stage. New tariffsapproved in early April 2002 will allow EdL to comply with financial covenants for the first timein more than three years.
Reform Measures Supported by FMAC
108. The SOE reform program in FMAC, paralleling the objectives of the PRGF, is expected tocontribute to a strengthened financial management of existing SOEs, enterprise restructuring, andtariff reforms.
109. In recognition that the monitoring of the operational and financial performance of SOEs,particularly at the Provincial and District levels and among some ministries, is insufficient tosupport management of financial risks and execution of SOE reform policy, the government hasissued a Decree: (i) requiring that financial and operational performance of all SOEs at theministerial, provincial and district levels be reported to MOF; (ii) specifying regular reportingrequirements; and, (iii) stating that new SOEs to be established are those which are specificallyapproved by the Prime Minister, and which will provide essential services which cannot becurrently provided by the private sector or by budgetary means; (iv) requiring MOF to publish inthe Official Gazette the financial performance of SOEs on a quarterly basis; and (v) requiring theprivatization or liquidation of those SOEs which have produced the greatest operating losses, orwhich otherwise fail to comply with this Decree. To contain the growth of non-performing loanscontributed by SOEs, the government prohibits non-commercial policy lending to SOEs, and alllending to SOEs with outstanding non-performing loans.
110. Recognizing that a limSited number of SOEs have contributed disproportionately to non-performing loans in the banking system, the government has signed Memoranda of Understandingto initiate the restructuring process for BPKP, Lao Aviation, Nam Papa Lao and PharmaceuticalFactory No. 3. These Memoranda define the contribution of the enterprise, the PMO, and theOffice of State Assets of MOF with respect to the preparation of time-bound restructuring plans foreach enterprise and the first stages of their implementation.
111. To better manage the utilities with a view toward cost recovery, reforms have been initiatedin the tariff policy for electricity, water, transport, and telecommunications. For electricity, thegovernment has implemented a new electricity tariff policy, to be applied from May I for a periodof 36 months. It consists of an average monthly increase of 2.3 percent which will take the
27
average tariff to Kip 665/Kwh by the end of the period (US cents 7 at the current exchange rate,between US cents 5 to 6 under the government's set of assumptions). Following the proposal ofthe tariff study, the schedule will move towards a marginal cost structure while keeping a lifelinetariff to protect low-income consuners.
112. For water, a draft tariff policy outline was prepared for the water sector and was submittedto the Bank for review. Policy objectives and principles have been laid out. These will bedeveloped and firmed up after consultation with the stakeholders (consumers and operators,national and local Treasury and international development agencies). Gradual increase of watertariffs is being implemented. The most recent set of tariff increases was authorized by WASA onApril 23, 2002.
113. The Ministry of Construction, Transport, Post and Communication (MCTPC) and LaoAviation have requested a tariff study to support the achievement of full cost recovery tariffs bythe second tranche. An increase has been agreed between the MCTPC and Lao Aviation fordomestic tariffs. It is agreed that the domestic tariffs for Lao Aviation would be the higher of$0.20/seat/kilometer or the tariff required to achieve full recovery of all operating maintenance anddepreciation costs.
114. A study on tariff structure and tariff policy for telecommunications has been launched withgrant assistance from JICA. A JICA-financed consultant is attached to the TelecommunicationsDepartment at MCTPC. The telecommunications departrnent is preparing a telecom policystatement, and Kreditanstalt ftr Wiederaufbau of Germany has agreed to provide assistance.
115. In order to clarify the policy on management of SOEs, the government will issue, throughMOF, Implementing Regulations to Decree No. 54/PM, dated May 9, 2002, on Management ofState-Invested Enterprises.
116. By end-March 2003, the government expects to begin to realize some results of the Decreestrengthening the performance monitoring of SOEs. An assessment of the financial performanceof SOEs will be prepared and, under criteria consistent with technical audit standards, will identifynon-performing SOEs that require: (i) performance improvement; (ii) strengthening of financialreporting; or, (iii) bringing them to the point of sale or liquidation, as the case may be. Gradually,this will be expanded to all state-owned enterprises. 'The government will adopt a time-boundrestructuring plan for BPKP, Nam Papa Lao, Pharmaceutical Factory No. 3, and Lao Aviation, andimplement all of the actions under said restructuring plan, which in accordance with such time-bound restructuring plan. Substantial progress is being made by each enterprise in defining itsrestructuring plan.
117. In SOE restructuring, MOF will execute memoranda of understanding for the developmentand execution of time-bound restructuring plans with DAFI and four loss-making SOEs whichhave outstanding, non-performing loans in excess of one billion kip.
118. The government expects to complete the financial restructuring of EdL, includingrevaluation of assets, amendment of selected subsidiary loan agreements, and debt-to-equityconversions.
28
119. Tariff reforms will be continued. For water, transport and telecommunications, thegovernment will adopt and publish tariff policies and structures incorporating: (i) cost recoveryprinciples; and (ii) directed and transparent subsidies, if any, for the potable water supply andtelecommunications sector, Lao Aviation, and telecommunications sector; and will adopt a time-bound action plan for the implementation of said tariff policies. The implementation of tariffpolicy will be through appropriate legal instruments such as Ministerial Regulations. Thegovernment has commissioned studies to formulate tariff policy and tariff structure to include costrecovery. These are expected to be ready by November 2002. Appropriate stakeholderdiscussions will be held and social impact studies will be carried out on the tariff policy for eachsector. The Terms of Reference for Social Impact Assessment Studies for the water sector havebeen drafted. Similar work for electricity and telecommunications will be addressed.
120. Going forward, the government will clarify the role and strengthen the functions ofregulatory bodies/departments. This will be accomplished through providing and developingadequate resources and capacilty in water, telecommunication, energy and transport sectors.
121. In the water sector, the Water Supply Authority -- the water sector central regulatoryauthority for the water and sanitation sector of the country -- is being assisted by ADB indeveloping its mandate, including a better definition of its role, functions and jurisdiction.
122. In telecommunications., the government will seek to define and strengthen the capacity ofthe Department of Telecommumications in MCTPC as the designated regulator for this sector. Inaddition, the government will work to identify resource requirements for this agency under thegrant from PPIAF. The regulatory framework will also be developed under the PPIAF Grant.
123. Transport. The government's pian is to develop a regulatory framework for this sector.
124. Energy. The govermnent will continue to implement the commercialization of EdL thatwas started in the mid-1990s, with strengthened management capacity and a firmer financialfooting through the Financial Recovery Plan.
Reform Measures in the Medium-Term
125. While the policies proposed for support under the FMAC represent a substantial effort bythe government to address some of the most urgent deficiencies in the enterprise sector, the reformprogram will clearly require a mnedium-term effort. The Office of State Assets will require furtherstrengthening in order to take a proactive stance through early detection and intervention ofenterprises which may cause financial damage to the state budget or to the banking system. Thecapacity of the NAO will also require strengthening in order to execute more regular audits of keyenterprises. The Boards of Directors of state enterprises will need to become more effective infinancial control and strategic management, both through training and through expansion of theuse of independent, experienced directors from outside the civil service.
126. Through the enterprise restructuring process, the government hopes to identify and addressmany of the key obstacles to financial sustainability of state-owned enterprises, including removal
29
of non-commercial mandates on pricing and service delivery, strengthening of the social safety netto alleviate the impact of SOE reform on workers, reducing the cost and improving the function oforganizational structures, and institutionalization of effective management controls. To strengthenthe incentives for all enterprises to achieve financial sustainability, the government expects to havemade substantial progress, with ADB support, on strengthening the legal framework forinsolvency, secured lending and civil procedures.
127. Beyond FMAC, the government's medium-term vision for the enterprise sector is one inwhich all enterprises, irrespective of the nature of ownership, are able to contribute substantially toincreased employment generation and poverty reduction, improved service delivery, andmacroeconomic stability. Realization of this vision rests on five pillars:
* establishment of a sound and stable investment environment for the development of allenterprises leading to the resumption of foreign and domestic direct investment flows;
* creation of a market-oriented regulatory framework and tariff regime for key infrastructuresectors which enables the private sector to contribute to essential service delivery on acompetitive basis;
* leveling of the playing field between SOEs and the private sector, including in the areas oftaxation and public procurement, to introduce greater competition between SOEs and theprivate sector and to facilitate the flow of resources to areas of greatest demand;
* creation of a judicial system which is able to provide strong incentives to improve financialperformance and facilitate commercial transactions, including credit; and,
* achieving a simple, manageable trade regime that promotes integration of Lao PDR firstwithin Asian Free Trade Agreement and then within the global economy.
128. This will require a substantial and cross-ministerial reform agenda, developed inconsultation with the private sector, SOE managers, and the foreign investment community. Tobuild ownership and commitment to the reforms among all concerned stakeholders, thegovernment will establish a public-private consultative mechanism led by the CPC, with thesupport of the World Bank, IMF, ADB, and the Mekong Project Development Facility. Thegovernment's immediate priorities are to increase the attractiveness of Lao PDR as a destinationfor foreign direct investment, to simplify business registration procedures for foreign and domesticentrepreneurs, and to continue to reform the trade regime. Longer-term reform priorities of theenterprise sector are expected to emerge from the consultations with domestic and foreignbusinesses.
129. With more progress on governance of state enterprises, improvement of the domesticbusiness and regulatory environment, and a resumption of foreign investor interest in Lao PDR,the conditions will be in place for a resumption of the previous policy of ownership transformationon a more sound footing. Meanwhile, the government will continue to take a pragmatic approachto the question of ownership transfortnation, including the potential use of joint ventures toimprove the performance of SOEs.
130. In the medium term, the issue of transparency and financial accountability in the SOEsector will be addressed though implementation of the following measures designed to improve itsfinancial reporting and corporate governance: (i) requiring large SOEs to prepare financial
30
statements in accordance wilh adopted standards and be annually audited by independent auditors;and, (ii) publishing their audited financial statements and making them accessible to the public.
131. The government shall consider additional measures to achieve a more effective level offinancial management. These include: (i) introducing an internal audit function in large SOEs; (ii)establishing audit committees of the board; and (iii) strengthening the accounting professionalorganizations to become fully professional bodies.
C. The Financial Sector
132. Financial sector reform is critical to reducing the risk of a financial crisis which couldhave a devastating impact on the poor. The government is finalizing a comprehensive reformprogram in the financial sector, with the support of the three key international financial institutions(IMF, ADB and the Bank) wrorking in close partnership. The financial sector components helpsreduce poverty in three main ways: (i) macroeconomic stability in banking reforms; (ii) broad-based growth via a financial sector oriented towards credit to the private sector; and, (iii) directpoverty reduction though support for micro and rural finance. Progress on the financial sectorreform agenda is expected to take several years. In the medium term, the flow of resources tobetter uses and the development of direct access by the poor to financial services will be importantingredients of the overall poverty reduction effort.
133. Working closely withl the World Bank, IMF and ADB, the government has started toimplement a comprehensive reform program in the financial sector. The program includes threemain themes: ensuring macroeconomic stability via banking reform, promoting broad-basedgrowth via a strengthened fulancial sector, and unleashing the power of micro-finance to reducepoverty.
Prior Reform Measures
134. The government has taken a number of actions recently to stabilize the balance sheets ofSCBs that include credit ceilings, adherence to stricter classification of loans and provisioning,prohibition of lending to deftiulting borrowers, suspension of accrual of interest on all NPLs andrestrictions of the distribution of dividends by the SCBs. Tax Law has been clarified to allowloan-loss provisions as a normal deduction against taxable income. Last year, disciplinary measurewas taken to remove top execuitives of Lao May Bank to send a signal that mismanagement will nolonger be tolerated.
135. With the assistance of international financial institutions and bilateral donors, thegovernment has taken a number of steps to improve the overall climate for the financial sector.The government has establisihed a technical committee, the Working Committee for FinancialSector Development (whose miembership includes MOF, BOL, MOJ, and CPC) with the mandateto oversee the preparation of policy reforms in-the financial sector. A vision of the Lao FinancialSector was formulated after discussions among senior policy makers to build understanding,consensus, and ownership. A Bank Restructuring Committee (BRC) was established forrestructuring of SCBs. The BRC prepared draft Memoranda of Understanding with the IFIs statingthe restructuring principles and strategy. To address the NPL problem and its resolution, an
31
analysis was launched to identify how to strengthen the legal and judicial underpinnings of theinvoluntary process. A Steering Committee and External Committee for NPLs resolutions wasestablished. The government is also developing a voluntary process for NPLs resolution and hasagreed to initial outcome targets by setting specific numbers on NPLs to be resolved and in theprocess of resolution within the specific timeframe of FMAC.
136. In order to assess accurately the financial situation of the SCBs, the government hascommissioned audits of SCBs accounts for three years (1998, 1999 and 2000) with assistance fromAusAid. To bring the SCBs up to date in terms of banking technology in the future, thegovernment has initiated a World Bank-supported study to analyze the information technologyrequirements for SCBs. Similarly, with World Bank support, the government has launched thestudy of the social impact of SCB restructuring in order to design an adequate social safety net forredundant workers.
137. Rural and micro-finance are important for a country such as the Lao PDR where themajority of the population and the poor live in the countryside. The needs for micro-finance, aseffective means for poverty alleviation, are most acute in these areas. In 1997, the governmentundertook a survey of the sector with UNDP support. Based on the results evidencing a largeunmet demand for micro-financial services, the government piloted an ambitious project toimprove awareness, sensitization, and access of the people for micro-finance. With donor support,the government has built this capacity through exposure visits to various rural and micro financeinitiatives in the region. The activities in this area have been given a new momentum with theestablishment of the Rural and Microfinance Committee to oversee government activities in thisarea and to prepare policy recommendations. With ADB support, the government has agreed tolaunch an operational diagnostic and a financial audit of the APB with a view to gamer experienceand infornation on rural banking services and to restructure APB.
Reform Measures Supported by FMAC
138. As part of FMAC preparation, the government is continuing to deepen reforms in thefinancial sector. By the end of March 2003, measures undertaken will be assessed to (i) avoid thedeterioration of the SCBs' risk portfolio; (ii) implement its risk diversification rules; and (iii)effectuate the autonomy of SCBs. This regime shall remain in place until banks are activelyengaged in their restructuring program. Furthermore, the BOL has issued (i) a set of Instructionsto centralize credit decisions in SCBs' headquarters and limit individual and group exposures; and(ii) a time-bound action plan. BOL will ensure compliance with these measures.
139. The government is committed to establishing SCB autonomy. To this end, MOF has issueda Notice to SCBs that all future lending (including policy lending) be subject to commercialcriteria. The Minister of Finance delegated to the SCBs' Boards of Directors to appoint DeputyManaging Directors and Branch Managers upon proposal of the Managing Directors and to allowSCBs to freely set interest rates on loans and deposits. The BOL is to prepare a time-bound actionplan for implementation, monitor and ensure full implementation of this measure.
* In addition, the BOL is considering an amendment to the Decree Law on CommercialBanks. This alleviates the concerns related to the permanence of Notice 0566/MOF,
32
dated March 31, 2002, on commitment to the autonomy of SCBs, as one area to beamended will precisely be on governance of SCBs to ensure consistency with theBusiness Law.Concerning SC]3's institutional restructuring, the government has signed aMemorandum of Understanding of Restructuring (MOUR) for each SCB whichincludes (i) phased capital build-up based on improved operational performance; (ii)temporary management support to SCBs in the form of international advisors; and (iii)an action plan in case SCBs do not reach performnance indicators.
140. The government is pledging to undertake several additional measures by end-March 2003under FMAC as follow-up to the steps noted above to consolidate the reform effort. Thegovernment intends to audit the calendar year 2001 accounts of SCBs, and for the AgriculturalPromotion Bank the calendar years 2000 balance sheet and 2001 accounts.
141. The government is committed to have the SCB's institutional restructuring programslaunched and by March 2003 will procure the professional services of at least two bankingadvisors, to provide advisory services for the management of SCBs, with qualifications andexperience adequate to carry out their services according to detailed terms of reference agreed.
142. Regarding non-performing loan resolution, the government requires that by end-March2003, SCBs resolve an aggregate amount of Kip 100 billion equivalent of SCBs non-performingloans of at least ten accounts through: (i) the liquidation of non-viable companies; (ii) therestructuring of viable companies such that their debts can be fuilly serviced by their cashflows;(iii) the seizure and sale of assets to recover cash; or (iv) the exchange of the loan for cash ormarketable assets. The government will also prepare an assessment that identifies ten non-performing loan accounts undergoing resolution.
143. The Lao PDR strategy is to increase access to financial services for the poor people. Inconsultation with MOF, BOL, and the relevant provincial authorities, and microfinance entitiesincluding Cooperative de Credit de Soutien aux Producteurs, Microfinance Project and Project deDeveloppement Decentralise de Phongsaly, will prepare a policy statement, an assessment and atime-bound action plan to address the implementation of a rural and microfinance reform program.
Reform Measures in the Medium Term
144. Financial sector reform will continue to be pursued well beyond the current phasesupported by FMAC and ADB's planned Financial Sector Program Loan III (FSPL III) to ensurethat the financial services needs of a growing economy are met and also adequate attention is paidto the less well-off segments of the society.
145. The government objective is a Lao banking system with modern, sound, robust, efficient,and sustainable institutions meeting prudential standards. Banks will be cost-efficient andcustomer-oriented. The government envisages a competitive environment in which banks unableto comply with the law and regulations are removed, and the better banks -- whether private orstate-owned -- will be allowed to thrive.
33
146. To improve further the framework for sound commercial banking and the bankingenvironment in general, The govermnent is conunitted to implementing several measures. It willcontinue to build and strengthen the capacity in the supervision department of the BOL. Thisincludes providing, in the next two years, training in accounting, regulations, on-site inspectiontechniques and off-site analysis with support from the IMF and the EU. To support off-siteanalysis, the government intends to establish adequate MIS for the supervision department toenable BOL staff to monitor the process.
147. Legal reforms for the financial sector are also on the anvil. The government plans toconduct a review of the Banking Law (Decree) in order to: (i) make it consistent with the BusinessLaw (on corporate governance) for SCBs, (ii) increase competition outside the Vientiane area, and(iii) review capital requirements of banks. The government intends to review banking regulationswith a view to bringing them into conformity with international banking standards. Thegovernment is also committed to enhancing transparency in the banking system. To this end, thegovernment will modify Lao accounting standards to better conform with international accountingstandards and will implement a program of dissemination of banking laws. The govermnent willalso improve enforcement of laws governing (i) secured lending ; (ii) bankruptcy; (iii) disputeresolution; and (iv) debt recovery by enhancing the capacity of judges.
148. The planned measures for improving legal capacity of judges outlined above, inconjunction with appropriate modification of the judicial procedures, including the setting up ofspecialized courts for commercial dispute, will help in the recovery of NPLs. A voluntary debtresolution process will also be put in place to promote NPL resolution. To that end, a fullyfunctional Credit Bureau will be established to improve access to creditor and debtor records.
149. In the area of rural and microfinance, the specific policy measures to create an enablingenvironment will be articulated under FMAC and the planned FSPL III and the governmentintends to implement those according to the action plan to be defined. However, the authoritieshave already decided that APB should become a viable market-oriented rural financial institution.
150. To ensure smooth implementation of the credit, the government intends to establish aProject Implementation Unit at MOF for the implementation of FMAC by May 2002, under theproposed Financial Management Capacity Building Credit (FMCBC).
151. To conclude, the government's impressive reform agenda and its prior actions andmeasures attack the triad of inefficiency (e.g., budget, SOEs, and banking sector; Figure 7) thathas retarded Lao PDR's efforts at stable growth and steady poverty reduction. It addresses keystructural weaknesses and thereby reduces macroeconomic vulnerability, strengthens the enablingenvironment for growth, and reduces poverty.
34
Figure 7
Lao PDR Reform Program:Attacking the Triad of Inefficiency
Reform Objective The Budget Reform Measure
* Planning * Balance recurrent and capital* Accounting & control - spending• Transparency -* Approve regulations to the
Public Accounting Law*Publish the budget, off-budget
SOEs expenditures
* Strengthening * Prohibit new SOE's non-oversight | -. commercial lending, consolidate
* Enterprise reporting, strengthen boardsrestructuring * Transfer ownership to MOF and
* Tariff reform restructure (including EdL)* Prepare and implement tariff
policies with cost recovery andtransparent subsidy; rationalizeregulatory bodies
Banking Sector
* Check risky lending
* Stabilize banks * Strengthen management,* Restructure banks t~o encourage commercial credit
suppor futur g h policies and improve accountingsupport future grovmth - sE
* / L-- \ practices*Promote micro/rural practicePromote mic a -. * Achieve NPL recovery targetsfinance . - , .'-> . *^ .Prepare sector vision after
dialogue and announce a timebound action plan to realizethat vision
35
V. WORLD BANK GROUP STRATEGY
A. Bank Assistance Strategy
152. The FMAC comes to the Board at the tail end of the implementation period of the current
CAS (FY2000-02). As such, the FMAC involves actions that will take place during the next CAS
period. The participatory phase of preparing the next CAS covering FY2003-05 is about to start.
The CAS is expected to be presented to the Board, which will also discuss the government's full
PRSP and the Bank-Fund Joint Staff Assessment, towards the end of FY2003. The full PRSP is an
important input to the FY2003-05 CAS, and therefore the timing of the latter has been driven by
the timetable for the full PRSP.
153. Summary of the FY2000-02 CAS. The last CAS (Report No.19098-LA, March 30, 1999)
was prepared at a time of deteriorating macroeconomic conditions triggered by the regional
economic crisis and exacerbated by mishandling of macroeconomic policy by the government. It
was designed to serve as a critical instrurnent of dialogue with the government by articulating
issues and outlining measures needed to restore balance and resume sustainable growth. The
fundamental objective of the CAS was poverty reduction with the goal of helping the country to
return to a path of sustained 6-7 percent GDP growth, improving social indicators, and graduating
from the ranks of the Least Developed Countries by 2020.
154. The CAS focused on helping Lao PDR in:* Stabilizing the economy (in close collaboration with the IMF);
* Deepening structural reforms in the financial sector and SOEs, improving the regulatory
environment for the private sector and other sectors such as agriculture and forestry, and
supporting capacity building;* Investing in the social sector, health and education;* Investing in rural development and natural resource management - including support for
rural and national infrastructure and hydropower development; and,
* Strengthening portfolio management.
155. To achieve the FY2000-02 CAS objectives, a program of assistance, including investment
and sector adjustment operations, technical assistance credits and grants, learning and innovation
loans, and adaptable program loans, and policy advice and dialogue, was proposed. Supporting
analytical work and capacity building were also identified. The strengthening of portfolio
management and project supervision was envisaged.
156. CAS FY2000-02 triggers. The CAS provided for three (Low-, Base-, and High-Case)
lending scenarios. In 1999, Lao PDR was in the Low Case (US$50-$75 million for the three-year
IDA lending). It was, however, agreed that restoration and maintenance of macroeconomic
stability -- evidenced by agreement on an ESAF program (later replaced by the PRGF), for
example -- along with progress on financial and legal sector reforms as well as increased per capita
expenditures (in real terms) in the social sectors, would trigger a Base Case Scenario (US$125-150
million of three-year IDA lending). A High Case (with three-year IDA lending of $150-200
million) would be triggered by a deeper and more rapid pace of reforms compared to the Base
36
Case, inter alia characterized by offering some SCBs to strategic investors, privatizing SOEs, andreforrning logging arrangements.
157. Progress since the CAS FY2000-02. The government highlighted the progress made andits strategy going forward in the I-PRSP which was discussed at the Bank and Fund Boards inApril 2001. The full PRSP (also known as the National Poverty Eradication Program or NPEP) isunder preparation. In April 2001, the IMF approved a three-year arrangement under the PRGF. Astrong stabilization program was launched to address fiscal, monetary and current accountimbalances, and economic conditions have steadily improved (including the lowering of inflationfrom the triple-digit levels reached earlier and the stabilization of the domestic currency) over theCAS period. In February 200:2, the first performance review under the PRGF was presented to theIMF Board and release of a second tranche was approved. The economy is now growing at over 5percent, and inflation has been contained at around 6-7 percent. Furthertnore, financialmanagement reforms will be supported through the FMAC and required strengthening of capacityis being developed under the iFMCBC. Also, public expenditure allocations for the social sectorshave been raised, signifying greater comnmitment to human development. Overall, significantprogress has been made since the CAS was approved by the Board, and Lao PDR has met thetriggers identified in the CAS for movement from the Low Case to the Base Case scenario. Duringthe three year period FY2000-02, IDA lending operations are expected to total $85 million,reflecting this transition from ihe Low Case to the Base Case.
158. However, the macroeconomic stability attained remains somewhat fragile and many of theunderlying causes of previous imbalances still need to be further addressed. The pace of reforrnhas also often faltered. The proposed FMAC, FMCBC, and the PRFP operations, along with theIMF's PRGF program, will support the government's continuing effort and also strengthen thecapacity for economic management and policy-making. The government is moving forward at astepped-up pace with more comprehensive policy and institutional reforms supported by moreintensive dialogue, analytical work, and support for preparation of a range of projects by the Bank,in addition to intensive supervision of its portfolio. The measures included in the FMAC relatingto budgetary and public expenditure reforms, SCBs, SOEs, and the willingness of the governmentfor the first time to accept an IDA credit for technical assistance, are demonstrations of politicalwill on the one hand and, on the other, a recognition of the importance of strengthening capacity todesign and implement reforms speedily.
159. The government has expressed its eagerness to create the conditions in which the proposedNam Theun 2 (NT2) hydropower project could be successfully implemented. Preparation of thisone billion dollar, thousand megawatt, private sector hydroelectric project, regained momentum inAugust 2000 with the signing of a tariff MOU between the developers and Thailand's ElectricityGenerating Authority of Thailand (EGAT). This momentum has been reinforced by the recentinitialing of the key Concession and Power Purchase Agreements and the prospects of signing offormal agreements in July 2002, leading to delivery of power to Thailand in 2008. A frameworkfor possible Bank Assistance for the Planned NT2 Project is found in Annex 5. Bank managementhas indicated that the Lao PDR needs to further articulate an overall development framework forpoverty reduction along with clear and monitorable performance benchmark, establish a trackrecord of performance against such benchmarks, and improve its communications with theinternational community, in addition to undertaking due diligence on safeguard and project quality
37
issues, before it could be in a position to consider proposing to the Board possible Bank support tothe project . The government has responded positively to this challenge.
160. In addition to working on enhancing the design and implementation of its poverty reduction
strategy, the government is strengthening its relationships with other partners in the international
donor community, other countries in the sub-region (stemming from positive ASEAN
developments), and with the international private sector (evidenced in the working relationshipestablished between the government and Nam Theun 2 Electricity Consortium (NTEC), the
developer for NT2, and with the Sepon Mining Project supported by the IFC). The government is
also adopting new approaches supporting empowerment, participation and decentralization. A
good example is the government's support for and ownership of the proposed IDA-financedPoverty Reduction Fund Project, which would provide a mechanism for targeting revenues to
poverty-reduction activities with many decisions being made directly at the village level.
161. Progress is also being registered in the challenging area of environmentally sustainable
natural resource management. The recent Bank logging survey mission in the NT2 project area
found that there has been progress in more effectively controlling logging; the government is
adopting measures needed to further village forestry reforms, and concrete steps (such as theestablishment of the Nam Theun Watershed Management and Protection Authority) are being
taken to promote conservation and sustainable environmental management.
162. Finally, the governmentfs greater attention to implementation issues is also reflected in the
improved performance of the IDA portfolio. The disbursement ratio improved from 12 percent in
FY2000 to 25 percent in FY2001 and is currently running at close to the same rate for FY2002. Of
the nine active projects currently in the portfolio, only one still remains in problem status and the
number of "at risk flags" have also diminished. The number of overdue audits have also declined.Portfolio issues are regularly reviewed and discussed with the government in the field with other
donors often participating as observers and generic issues are addressed and procedures
streamlined as early as possible.
163. Preview of the proposed FY2003-05 CAS. While the next CAS is being formulated in a
more positive environment than the last CAS, it would be a mistake to underestimate the
challenges ahead. Lao PDR is governed by a single political party with tight control over political
and economic activities. The political consensus supporting the direction and pace of reforms,though strengthening, is still fragile. Capacity, both in the public and the private sector, is
extremely weak. Civil society organizations of the type seen elsewhere (such as multiple politicalparties, local NGOs, nongovernmental media) are conspicuous by their absence or have little
voice. Beginnings have been made on issues such as empowerment and participation, but these
policy objectives have yet to develop deep roots. The risks of weak economic management,
reluctance to address structural problems frontally, inadequate capacity at both the policy and
implementation levels, and shortcomings in governance, are significant risks that need to be
addressed.
164. In the context described above, it is important that the government articulates a medium-
term development vision, designs and implements a comprehensive reform program that underpinssuch a vision, and establishes clear and monitorable performance indicators that enable
38
measurement of progress. The government proposes to use the NPEP, now under preparation, toserve this purpose. The NPEP, which would be reviewed by the National Assembly, would alsoserve as the basis for dialogue and communication with the international community. This wouldalso be the program with which the Bank would align its own assistance strategy in the CAS incoordination with other donors. As done previously, the next CAS will couch the Bank'sassistance program within various scenarios. Details, including explicit triggers and lendinglevels, will be formulated at that time after a participatory and consultative process.
B. Partnerships with Other Donors and Agencies
165. International Monetary Fund. After a hiatus of almost five years, the Lao authoritiesrequested IMF assistance. On April 23, 2001, the IMF approved in principle a three-yeararrangement for Lao PDR under the PRGF for about US$40.2 million equivalent to support thegovernment's strategy to strerLgthen macroeconomic stability and reduce poverty through growthwith equity (Annex 3). The IMF also approved and released the first tranche of $5.7 millionequivalent under the PRGF at the same time. Also in April 2001, the IMF and the Bank issued theJoint Staff Assessment of the government's I-PRSP.
166. The first review of the performance of the Lao economy under the PRGF was presented tothe IMF Board in February 2002 following some delay. The IMF Board approved the release of asecond tranche of $5.6 million equivalent, signaling its continuing support for the government'ssteady effort in strengthening macroeconomic stability and laying the basis for further structuralreforms. IDA will continue 1o collaborate closely and coordinate activities with the IMF staff.Staff of the two institutions prepared joint assessments of the PRSP. IDA has been coordinatingwith the IMF on the content of the FMAC and PRGF to ensure that these instruments complementone another. The proposed FNMAC has to be seen in this conducive setting.
167. Asian Development Bank. The ADB has formulated its new Country Strategy andProgram with considerable consultations with stakeholders in 2001. This CSP will provideguidance for ADB activities in Lao PDR for the next five years. Continuing its theme of a shift inassistance toward poverty reduction, ADB will support the Lao PDR's efforts to address povertyand to undertake poverty reduction measures with broadened community participation andopportunities. ADB focus in ]Lao PDR will be on four priorities: rural development and marketlinkages, human resource development, sustainable environmental management, and private sectordevelopment and regional integration.
168. Current and future ADB lending and technical assistance programs will focus on efforts toreduce poverty, including direct poverty intervention projects and pro-poor growth projects. In2001, ADB commitments for Lao PDR amounted to $65 million in 2001 ($60.5 million in 2000),and $39.8 million ($51 million in 2000) was disbursed from 18 on-going projects.
169. The Bank is coordinat:ing with the ADB in activities to support the financial sector,education, health, rural development strategy, forestry, energy and transport sectors. Specifically,in the financial sector, ADB and the Bank are coordinating to ensure complementarity ofinstruments between the proposed FMAC and ADB's up-coming Financial Sector Program Loan.Technical assistance and capaciity building instruments currently include ADB's PPTA grants.
39
170. Japan Bank for International Cooperation (JBIC) has been supporting Lao PDR in thepower sector. JBIC has provided ODA loans to tap hydroelectric power projects that could helputilize the abundant hydroelectric power resources of the country. Total accumulatedcommitments from three ODA loans amounted to 9.1 billion yen. The Bank is coordinating effortson project financing in the energy sector. Japan also provides the largest support through JICA.Currently, JICA is finalizing a macro-economic intellectual support project and the IFIs arecoordinating with JICA in this project.
171. Bilateral donors and other international organizations. The Bank is maintaining closeworking relationships with bilateral donors: Australia (Land Titling, Audit of the SCBs), Norwayand Switzerland (education); Belgium (health), and Finland and Sweden (forestry). The Bank alsocoordinates with other international organizations: UNICEF, UJNDP, and WHO, as well as EU.
VI. THE PROPOSED FINANCIAL MANAGEMENT ADJUSTMENT CREDIT
A. Rationale for the Proposed Program
Financing Needs
172. The Lao PDR's financing requirements for 2002-04 are currently estimated to be $75million. It is expected that this financing gap will be met by disbursements under the IMF's PRGFand support from the Bank with the proposed operation and commitments from other donors(Table 1).
Table 1. Financing Requirements, 2001-2004 (US$ million)Prel. Projected2001 2002 2003 2004
Financing needs 200 222 268 368- Current account deficit 108 115 123 233- Medium and long terrn amortization 39 43 50 52- Others 48 34 48 43- Reserve requirements 5 30 47 40
Financing resources 200 222 268 368- Grants 23 54 70 82- Long-term borrowing 104 106 125 118- Direct foreign investment 33 41 60 168- Other inflows 40 1 -22 -20- Additionalfinancing needs 20 35 20
Source: Derived from IMF data, May 2002.
A Robust Reform Agenda Consistent with I-PRSP
173. The government has sought the advice of the Bank, the ADB, and the IMF for designing acomprehensive reform program to address the various dimensions of the structural imbalance.This strategy was spelled out in the I-PRSP discussed at the Boards of the Bank and the IMF inApril 2001. The government intends to undertake a comprehensive restructuring of the economy
40
to address sources of financial imbalances, in the budget, in the SOE sector and in the bankingsystem. Such restructuring will give confidence to investors that Lao PDR will be able to utilizethe substantial financial flows associated with the planned NT2 investments and the expectedincrease in revenues following implementation of a rational forestry policy.
Capacity Building/Technicai' Assistance Support
174. With critical needs in economic and financial sector management and a relativelyunderdeveloped human capital base and weak institutions, the Lao PDR priority is to buildcapacity and to support instiitutional capacity building for the successful implementation of thegovernment's reform program. The required technical assistance project is being provided tosupport the government in implementing reforms (Annex 2).
Consistency with the CAS
175. Until early 2001, the CAS for the Lao PDR was in the Low Case scenario (out of threewhich were envisaged for FY2000-02). These three scenarios were based on the pace ofmacroeconomic stabilization measures; pace, depth, and coverage of structural reforms andinstitutional development; progress on project implementation and improving the quality of theportfolio; and, the absorptive: capacity of the economy. The Base Case scenario has been triggeredby the restoration and maintenance of macroeconomic stability. Now that macroeconomic stabilityhas been restored and a PRGF with the IMF is in place, the Bank program, as stipulated in theCAS, can move to the Base Case scenario.
B. The FMAC Prograinn
176. The proposed FMAC is a two-tranche operation supporting the following policy actions bythe government.
177. Actions Taken by the Lao PDR
Public Sector Reform
Budget planning:* Issued a Decree on Public Investment Management requiring that PIP' submissions for
new public projects in excess of 1 billion kip in the FY2002/03 budget includeestimates of associated recurrent costs during operating period;
Budget transparency* Published in the Official Gazette the FY2000/01 outcome and the FY2001/02 budget
with classification by ministry/province and service with a separate identification of thedistinct central ministry and provincial expenditures by sector and expenditurecategory;
41
Natural resources management* MAF approved the key Principles of Village Participation in Sustainable Management
of Production Forests: PMO issued a Decree on Sustainable Management ofProduction Forest Area and superceding relevant articles of existing orders;
SOE Reform
Strengthen oversight of financial and operational performance of SOEs* Issued a Decree: (i) requiring that financial and operational performance of all SOEs at
the ministerial, provincial and district levels be reported to MOF; (ii) specifying regularreporting requirements; (iii) stating that new SOEs to be established are those whichare specifically approved by the Prime Minister, and which will provide essentialservices which cannot currently be provided by the private sector or by budgetarymeans; (iv) requiring MOF to publish in the Official Gazette the financial performanceof SOEs on a quarterly basis; and (v) requiring the privatization or liquidation of thoseSOEs which have produced the greatest operating losses, or which otherwise fail tocomply with this Decree;
* The MOF and BOL prohibited non-commercial policy lending to SOEs, and all lendingto SOEs with outstanding non-performing loans;
Enterprise Restructuring* Transferred ownership of the largest loss-making SOE, BPKP, to the Ministry of
Finance for corporate restructuring in cooperation with the Office of the PrimeMinister;
Tariff Reform* Electricity: implemented a new electricity tariff policy;
* Water: prepared a white paper on tariff policy for the water sector;
* Transport and Telecommunication: launched studies on tariff structure and started thepreparation of tariff policies for Lao Aviation and Lao Telecommunication;
Financial Sector Reform
Financial sector reform to promote macroeconomic stability* BOL issued (i) an Instruction to stop the growth of SCBs' risk portfolio if the ratio of
NPLs to credit risk portfolio (net of provisions) exceeds 15 percent of loans made afterDecember 31, 1999 and (ii) a time-bound action plan for implementation;
42
* BOL issued (i) an Instruction to centralize credit decisions in SCBs headquarters andlimit individual and group exposures and (ii) a time-bound action plan forimplementation;
Banking reforms to su)port broad-based economic growthFramework for Sound Banking* Borrower committed to the autonomy of SCBs: Minister of Finance issued a Notice to
SCBs requiring that all future lending (including policy lending) be subject tocommercial criteria; Minister of Finance issued a delegation of his powers to appointdeputy Managing I)irectors and Branch Managers, to the SCBs Board of Directors, sothat those managers are appointed by the Boards upon proposal of the ManagingDirectors;
* Minister of Finance issued a Notice to SCBs to allow them to set freely interest rates onloans and deposits and BOL prepared a time-bound action plan for implementation;
Institutional restructuring* MOF/BOL/SCBs sSigned MOUR for each SCB which includes (i) phased capital build-
up based on improved operational performance; (ii) temporary management support toSCBs in the form of international advisors; and, (iii) an action plan in case SCBs do notreach performance indicators;
178. BOARD CONDITIOTN (met)
Project Implementation UnitProiect management* Establishment of a Project Implementation Unit at the Ministry of Finance, satisfactory
to the Association, :for implementation of the FMAC and the FMCBC in May 2002;
179. EFFECTIVENESS CONDITION
Public Sector ReformBudzet accounting and control* Adopt a Regulatiorn of the Minister of Finance on Public Accounting and Procedures
for the implementation of Decree No. 20/PM on the General Regulation of PublicAccounting, dated February 18, 1993, satisfactory to the Association.
43
180. Actions for the Release of the Second Tranche
181. By the release date of the second tranche of the FMAC, the Lao PDR will need to haveaccomplished the following:
Public Sector ReformBudget planning1. completed, through CPC, an assessment, in a manner and substance satisfactory to theAssociation, recurrent cost estimates associated with new projects in excess of 1 billionkip;
Budget accounting and control2. prepared, through the Ministry of Finance, in a manner and substance satisfactory to theAssociation, a strategy for the reform of the Department of Treasury;
Budget transparency3. established a Procurement Monitoring Office within the Ministry of Finance, headed bya qualified and experienced Director and assigned with adequate staff and resources in amanner and substance satisfactory to the Association;
Natural resources management4. issued, through the Ministry of Agriculture and Forestry, in a manner and substancesatisfactory to the Association, Regulations amending the Implementing Regulations onNational Biodiversity Conservation Areas, Regulation No. 0524/AF.2001, (June 7, 2001),inter alia, to clarify the definitions and procedures governing zoning and land use withinsaid Conservation Areas, and eliminate inconsistencies in respect of protected specieslistings;
5. adopted, through the Ministry of Agriculture and Forestry, Implementing Regulationson Sustainable Forestry Management, satisfactory to the Association, which includesspecific provisions to enable the involvement of local communities in production forestmanagement;
SOE ReformStrengthen oversight of financial and operational performance of SOEs6. issued, through MOF, Implementing Regulations to the Decree on Management ofState-Invested Enterprises, Decree No.54/PM, dated May 9, 2002, satisfactory to theAssociation.
7. prepared and furnished to the Association in a manner and substance satisfactory to theAssociation, through the Ministry of Finance, an assessment of the financial performanceof SOEs, and under criteria consistent with technical audit standards satisfactory to theAssociation, identified non-performing SOEs requiring: (i) performance improvement; (ii)strengthening of financial reporting; or (iii) bringing them to the point of sale orliquidation, as the case may be;
44
Enterprise restructurilig8. adopted a timebound restructuring plan, satisfactory to the Association, for BPKP, NamPapa Lao, Pharmaceuitical Factory No. 3, and Lao Aviation, and implemented all of theactions under said restructuring plan, which in accordance with such time-boundrestructuring plan are due within seven (7) calendar days prior to the exchange of viewsunder Section 2.02(d) of the Development Credit Agreement;
9. executed, through MOF, memoranda of understanding for the development andexecution of time-bound restructuring plans with DAFI and four loss-making SOEs whichhave outstanding, non-performing loans in excess of one billion, in a manner and substancesatisfactory to the Association;
10. completed the financial restructuring of EdL, in a manner and substance satisfactory tothe Association, including the revaluation of assets, amendment of selected subsidiary loanagreements, and debt 1:o equity conversions;
Tariff reform11. adopted and published tariff policies and structures incorporating: (i) cost recoveryprinciples; and (ii) directed and transparent subsidies, if any, for the potable water supply,telecommunications sector and Lao Aviation; and adopted a timebound action plan for theimplementation of sai.d tariff policies, all in a manner and substance satisfactory to theAssociation;
Financial Sector ReformStabilization of financial institutions to support macroeconomic stability12. prepared an assessment, in a manner and substance satisfactory to the Association, thatassesses the measures undertaken by the Borrower to: (i) avoid the deterioration of theSCBs' risk portfolio; (ii) implement its risk diversification rules; and (iii) effectuate theautonomy of SCBs;
13. audited, in a manner and substance satisfactory to the Association, the calendar year2001 accounts of SCBs, and for the Agricultural Promotion Bank the calendar year 2000balance sheet and 2001 accounts;
Strengthening financial institutions to support economic growthSCBs Institutional Restructuring14. procured the professional services of at least two banking advisors, to provide advisoryservices for the management of SCBs, with qualifications and experience adequate to carryout their services detailed in terms of reference satisfactory to the Association;
Non Performing Loan Resolution15. resolved an aggregate amount of Kip 100 billion equivalent of SCBs non-performingloans of at least ten accounts, in a manner and substance satisfactory to the Association,through: (i) the liquidation of non-viable companies; (ii) the restructuring of viablecompanies such that their debts can be fully serviced by their cashflows; (iii) the seizureand sale of assets to recover cash; or (iv) the exchange of the loan for cash or marketableassets;
45
16. prepared an assessment, in a manner and substance satisfactory to the Association, thatidentifies ten non-performing loan accounts undergoing resolution; and,
Increasing access to financial services by the poor17. prepared, in consultation with MOF, BOL, and the relevant provincial authorities andmicrofmance entities including Cooperative de Credit de Soutien aux Producteurs,Microfinance Project and Project de Developpement Decentralise de Phongsaly, a policystatement, an assessment, and a timebound action plan to address the implementation of arural and microfinance reform program, all in a manner and substance satisfactory to theAssociation.
182. Performance Indicators. The macroeconomic and FMAC program performanceindicators are presented in Box 3 and Box 4, respectively.
Box 3: Macroeconomic Performance Indicators
1. Inflation has been in single digit levels for twelve months prior to exchange of views.
2. A stable foreign exchange rate has been maintained.
3. The fiscal deficit for 2001/02 was less than five percent of GDP and the fiscal deficit for2002/03 has been programmed at about five percent of GDP.
4. Domestic bank financing of the fiscal deficit has been less than 0.5 percent of GDP in thetwelve months prior to the exchange of views.
5. Education expenditure for 2001/02 was at least 10 percent of the total budget andeducation expenditure programmed for 2002/03 was at least 12 percent of the totalbudget.
6. Extemal financing program for the balance of payments for 2002/03 has been put inplace.
7. The budgeted expenditures on power projects in 2002/03 were in line with the medium-term Power Development Plan.
46
Box 4: FMAC Program Performance Indicators
Public Sector Perfor ance Indicators
A. Expenditure shares for health and education meet or exceeded in FY 2001/02 budgetoutturn, and shares in budget plan for FY 2002/03 are increased in line with the PRSP.
B. Unauthorized treasury accounts are identified and closed.
C. The FY 2002/03 budget plan and the FY 2001/02 outcome are published with full sectordetail.
II. SOE Reform Indicators
A. At least 60 percent of all SOEs have provided quarterly reports to MOF, consistent withguidelines issued by MOF, for quarters ending December 31, 2002 and March 30, 2003.
B. As of March 30, 2003 ihe total number of state-owned enterprises is no greater than thetotal number as of March 30, 2002.
C. The number of business units in the BPKP has been reduced no greater than 9 throughliquidation, merger and/or consolidation by March 30, 2003.
D. Domestic tariffs for Lao Aviation are the higher of $0.20/seat/kilometer or the tariffrequired to achieve full recovery of all operating, maintenance and depreciation costs.
HI. Financial Sector Performance Indicators
A. The level of non-performing loans (NPLs) in state-owned commercial banks must be kepbelow the level as of December 31, 2001:1. BCEL - below 23 percent;2. Lane Xang Bank - lbelow 30 percent; and3. Lao May Bank - below 73 percent.
(Loans signed after January 1, 2000. NPL classified as per Regulation BOL No. 8.)
B. No new non-commercial loans. Non-commercial loans are defined as loans made (i)without ensuring that the borrower's cashflow is sufficient to repay; (ii) pricing at belowmarket interest rate; or (iii) by-passing recently improved credit procedures.
C. Kip 100 billion equivalent of SCBs' NPLs will be resolved.
47
183. Medium-Term Follow-up Actions. The proposed FMAC helps launch the reform programin the right direction to meet the objectives listed under the program actions above. Theseobjectives are consistent with the I-PRSP. However, government commitment and donor supportbeyond the time frame of FMAC will be critical to consolidate and deepen reform in the mediumterm. Such medium term reform program will be reflected in the full PRSP expected to becompleted by March 2003. The CAS (under-preparation) will spell out the continuity of Bank'sengagement in the medium term reform program via both technical assistance as well as possiblePoverty Reduction Credits to support further deepening of the reform program. The medium termactions in each of the FMAC supported areas are listed in Annex 4.
C. Implementation and Monitoring
184. The government is planning to establish a high level inter-ministerial coordinationcommittee to monitor progress and implementation of reforms to ensure that there is adequateparticipation from all relevant quarters.
185. Monitoring arrangements. The government, with the assistance of the Bank's countryoffice, will strengthen management information systems for SOEs and for all public spending, andfor the banking system to ensure adequate monitoring of the activities supported by the project.
186. Monitoring and supervision of this proposed operation will take place in closecollaboration with the IMF. In order to facilitate this task, the government is to provide formalperiodic reports to the Bank on the progress made in each component of the program. In addition,joint periodic review meetings are proposed to assess progress more frequently and take specialactions where necessary.
D. Credit Administration
Borrower and Credit Amount
187. The Borrower is the Lao People's Democratic Republic. This operation is a two-trancheCredit of US$ 17 million equivalent. The first tranche of SDR 5.6 million (US$ 7.0 millionequivalent) would be made available upon credit effectiveness. The second tranche of SDR 7.9million (US $ 10.0 million equivalent) would be available for disbursement upon fulfillment of theMilestones end-March 2003 conditions. The closing date of the Credit is May 31, 2003.
188. The project will be managed by the MOF under the direct supervision of the Minister ofFinance. To assist the Minister, a day-by-day project implementation unit has been set up underthe proposed FMCBC and included officials from MOF's specific units, the Budget Department,the Department of Treasury, and the State Asset Department, as well as representatives from theMinistry of Agriculture and Forestry. The project will be under the overall guidance of the PrimeMinister's Office, the Committee for Planning and Cooperation, and the Bank of Lao PDR.
48
Disbursement, Reporting and Auditing Arrangements
189. The Credit will folllow IDA's simplified disbursement procedures for adjustmentoperations, '5 and the Credit proceeds will be disbursed in compliance with the stipulated releaseconditions. Various measures have been taken to ensure that the overall fiduciary policies andinstitutions are adequate to proceed with support from IDA and other development partners.Disbursement will not be linked to any specific purchases and no procurement requirements willhave to be satisfied.
Deposit Account
190. The Borrower will open and maintain a dedicated Deposit Account in US dollars in theBOL into which the proceeds of the Credit will be disbursed for the Borrower's use once theCredit is approved by the Board. Disbursements from the Deposit Account will follow normalgovernment policies and procedures. If after deposit in the Deposit Account the proceeds of theCredit or any part thereof are used for ineligible purposes, as defined in the Development CreditAgreement, the Bank will requtire the Borrower to either return that amount to the Deposit Accountto be used for eligible purposes, or refund the amount directly to IDA. The BOL, on behalf of thegovernment, will maintain an appropriate accounting system in accordance with generallyacceptable accounting principles. The Deposit Account of BOL will be independently auditedeach year on terms of reference already agreed with IDA.
191. All US dollar disbursemnents out of the Deposit Account will be executed by the Lao PDRin accordance with its existing rules and should be monitorable by the World Bank. Since BOLdoes not import directly, it will: sell this foreign currency to commercial banks that will execute theimports. These banks in turn, would open separate deposit accounts from which they will financethe eligible imports and maintain those accounts for review by the BOL.
192. Through the BOL the Borrower will: (i) report the exact sum received illto the DepositAccount; (ii) ensure that all withdrawals are for "eligible" expenditures; (iii) indicate to IDAdetails of the account of the M/[OF which is part of the consolidated fund of the treasury to whichthe kip equivalent of the Crediit proceeds will be credited; and, (iv) submit a report on receipts anddisbursements for the Deposit Account.
193. The processes and controls described above are intended to provide assurance that IDAfunds have arrived at their intended destination and are being used for their intended purposes, andare subject to the Borrowers' rules and regulations.
Country Financial Accountability Assessment (CFAA)
194. The CFAA has been prepared by the Bank and the draft was shared with the authorities inearly 2002. Its findings also serve as input into the draft Public Expenditure Review which wasdiscussed with the government in February-March 2002.
15 Operational Memorandum: Simpliifying Disbursements under Structural and Sectoral Adjustment Loans, February8, 1996.
49
195. The overall fiduciary risk in Lao PDR is considered to be high despite the fact that there areelaborate built-in controls within the government financial management system. There isinsufficient transparency related to public finances and the general attitude towards fiscaldiscipline is not strong. 16 These weaknesses are compounded by an inadequate awareness ofmodem practices of internal control in the public sector. While an elaborate control system is inplace, involving many pre-approval and checking processes, it needs to be made more effective.The government's decentralization initiative needs to be supported with a sufficiently robustinstitutional framework that clearly defines the new responsibilities at lower levels. Technicalcapacity of staff at these levels needs to be strengthened. The oversight functions and the NationalAuditor's Office need improvement. To address these deficiencies, the government has agreed toimplement several recommendations of the Public Expenditure Review and CFAA. The proposedFMCBC as well as the government initiative supported by ADB are expected to bring the fiduciaryrisk to an acceptable level.
Procurement
196. The draft Country Procurement Assessment Report (CPAR), prepared in March 2002,reviews the overall efficiency of procurement processes in the Lao PDR and specifically theefficiency of procurement on Bank-assisted projects. It also develops an action plan to addressareas that need to be strengthened. The draft CPAR made a series of recommendations for thecountry's procurement system, the most critical of which are highlighted as follows. Thegovernment's PrMO needs to be made functional as soon as possible to play the pivotal role inprocurement reforms, providing monitoring of country-wide procurement activities and playing animportant role in delivering training programs. The PrMO, once functional, will serve as aprocurement resource center to promote an improved dialogue between the government andprivate project developers to assist in removing bureaucratic bottlenecks to promoting thecontinued development of the private sector. To improve the transparency of procurement, thegovernment will need to reflect best international practice in its procurement policies.
E. Environmental Assessment
197. The proposed FMAC is a structural adjustment credit in support of a collection of reformand policy support activities. In accordance with Bank's environment policies (OP/BP 4.01), thisoperation is classified as Category C. With its low level of economic development and one of thelowest population densities in the East Asia region, environment concerns in the Lao PDR centermainly on rural and natural resources management issues.
198. The government is developing a regulatory framework for environmental assessment, andstandards and compliance monitoring, but additional work will still be needed to improve thisframework and to strengthen implementation capacity. The government of the Lao PDR iscommitted to undertaking a broad program of environmental capacity building, institutionalstrengthening, environmental and land use planning as well as physical investment projectsaddressing environmental issues. Progress in these matters is also coming through preparation for
16 Based on the set of standards for assessment of transparency as a component of public financial accountability inthe IMF Code of Good Practices on Fiscal Transparency (March 2001).
50
the proposed Sustainable Forestry, Nam Theun 2 and Nam Theun Social and Environmentoperations.
199. A high national priority has been reduction of shifting cultivation practices as part ofefforts to reduce deforestation and forest degradation. The government's priority has been thedevelopment of irrigated alteniatives to slash-and-bum practices, but there may be greater promisein developing sustainable rainfed upland fanming practice, more in line with traditional practicesand technology. The government is working with both the Bank and other donors on alternativeagricultural development projects and strategies aimed at reducing environmental degradationrelated to agricultural production.
F. Benefits and Risks
Benefits
200. The expected result of the FMAC is the strengthening of the structures of the economysuch that:
* Greater fiscal transparency and accountability is achieved, with better balance in budgetspending;
* Increased budgetary resources are available for poverty reduction;
* SOEs (including EdL in the power sector) are more accountable within a strongerregulatory framework and manage financial risks prudently, which would prepare themfor privatization down the road;
* SCBs meet prudential regulations and therefore do not threaten to macro-stability andfuture economic growth;
* Rural and microfinance support poverty reduction in the rural areas where most of thepopulation lives; and,
* Incentives are in place for participatory management of forestry resources, improvedmonitoring, and rationalization of the "cut" rate contribute to government revenues andenhance income at the village level.
201. The structural improvements collectively will contribute to additional benefits as reformsare pursued in the mediuim term:
- Lao PDR will avoid the accumulation of contingent liabilities that result in periodiccrises leading to a severe loss of investor confidence and curtailment of social servicesand safety nets.
- Lao PDR's system of financial flows will have been streamlined and will be moretransparent, giving confidence that large potential investments in the energy sector willyield economy-wide benefits in terms of income growth and poverty reduction.
51
Risks
202. The key risks are:
* Insufficient political will to complete reforms;
* Lack of capacity and weak legal/administrative incentives to improve performance;
* Possible political backlash from electricity tariff and other SOE price liberalization; and
* Abandonment of reforms as difficulties accumulate.
203. Efforts to mitigate the risks:
- Recent government actions reflect a new commitment to reform. These include theremoval of top management of an SCB for poor performance, the agreement to hireexternal advisors in SCBs to prepare for restructuring, and significantly, the resale ofLao Beer back to the private sector.
- Disparate SOEs are being collected under the umbrella of the Prime Minister's Office.A dynamic, reform-minded minister has been appointed to champion reform. Thelargest SOE, BPKP, is under restructuring and will have a significant demonstrationeffect for restructuring other large problem SOEs.
- The technical assistance operation, Financial Management Capacity Building Credit(FMCBC) that will be presented to the Board at the same time with FMAC, is expectedto build capacity by aiming to change the mindset at the working level, which willgenerate support for reform within the system. Government's willingness to borrow fortechnical assistance, given extreme reluctance in the past, is a good indication of a moreproactive stance on capacity building.
- FMAC requires the government to implement tough legislative, regulatory andinstitutional measures in a number of key commanding heights of the economy. Thismomentum will be difficult to reverse given the PRSP process to which the authoritiesare committed that will ensure continued monitoring and engagement to stay the reformcourse.
- Key players within the government, (i.e., the Prime Minister, the Minister of Financeand others heading the key line ministries), have been engaged in a long process ofdialogue and they have fully endorsed the reform program. On another level, a seriesof workshops and seminars have been held for mid-level civil servants to explainreform objectives and their benefits, to gamer wider support.
- The operation has been prepared in close cooperation with the IMF, the ADB, andmajor bilateral donors, which has helped avoid conflicts that create the room for reformslippage.
* Despite these mitigating factors, risks of poor performance are substantial and need tobe monitored.
52
VII. RECOMMENDATION
204. I am satisfied that the proposed credit would comply with the Articles of Agreements of theAssociation and I recommend that the Executive Directors approve it.
James D. WolfensohnPresident
by Shengman Zhang
Washington, D.C.May 28, 2002
Attachments
53
ANNEX 1 - LAO PDR -- FMACThe Lao Banking and Financial Sector
The Lao banking sector is small in absolute terms, with total assets of approximatelyUS$400 million. It is also relatively small when compared with the size of the Laoeconomy: the ratio of the banking system's total assets to GDP is about one-fourth. 'Thisratio is particularly low for an economy with a non-diversified financial system and isevidence of a system in an early stage of development.
State-owned commercial banks (SCBs) dominate the market, holding more than two-thirds of the banking system's total assets. The three largest banks (Banque pour leCommerce Exterieur Lao- BCEL, Lao May, and Lane Xang) are fully owned by thegovernment. BCEL maintains a dominant position, accounting for approximately half oftotal deposits and almost 40 percent of total loans in the system.
The main characteristics of deposits (Kip 1.5 trillion or US$193 million equivalent2 ) arethe following: overwhelmingly (a) from urban areas, (b) in foreign currencies and (c) inState-Owned Banks. Deposits represented 14 percent of GDP.
As of September 1999, loans constituted the main item in the consolidated balance sheetbut only accounting for only 33 percent of total banks' assets. The consolidated SCBsloan-to-deposit ratio stood at a low 20 percent at year end 1999. The share of privatesector was about 53 percent of total loans while the public sector3 was 47 percent. Atyear-end 1999, 75 percent of bank loans were denominated in foreign currencies.
The Agricultural Promotion Bank (APB) is the only formal institution providing financialservices of any significance to the rural households4 . APB channels subsidies throughreduced interest rates. But APB is also an agriculture promoting agency and serves as a"super-coop" for agricultural inputs and equipment by importing and providingfertilizers, hand tractors and equipment to borrowers through lending in kind.
The Lao banking system enjoys a certain degree of openness. There are three joint-venture banks (one private, one mixed and one jointly owned by Lao PDR and Vietnam),seven branches of foreign banks (six Thai and one Malaysian), and a foreign private bankrepresentative office. Major clients of foreign banks are foreign companies orsubsidiaries and affiliates of foreign companies. Given the current economicenvironment, foreign branch activities have essentially been funding the working capitalof Thai and Malaysian manufacturing and trading firms operating in the Lao PDR.
l This summary is based on the paper, "The Banking and Financial Sector of Lao PDR: Financial Sector Note," byBank of Lao PDR, World Bank, and ADB, May 2002.2 End of December 1999 at Kip/US$ rate of 7,600.3Public sector comprises of Government entities at the national, provincial and municipal levels, companies that arestate-owned, joint ventures with the Govemment and state-connected enterprises (including those closely identifiedwith the Govemment and undertaking projects for the Government). There appears to be some inconsistencies betweenthe banking accounting procedures and the above definition of public sector enterprises as the monetary surveyindicates that only 1/3 of credit goes to public enterprises.4 APB remains a very little known institution which claims to hold about 100,000 accounts.
ANNEX 1Page 2 of 2
There are only a few formal non-bank financial institutions in Lao PDR. There is onefull fledged insurance company and recently a second one entered the market in selectedsegments; the social security system is still in its infancy, with no accumulated financialsurpluses.
The microfinance system comprises five types of suppliers. The APB is the largestsupplier of micro-loans and charges low (highly subsidized) interest rates. There are anestimated 1,600 donor fuinded Village Revolving Funds (VRFs) providing microfinanceservices, mostly on a subsidized basis; institutional sustainability is almost never anobjective. The Lane Xang Bank, one of the three SCBs, also started to provide micro-loans (under 30 million kips). Only three emerging MFIs (still projects), which target thepoor, seek financial sustainability. Money lenders lend at rates averaging 20% permonth.
Assessment of The Current State of the Lao Financial System
The formal banking and financial sector has a limited outreach. The Lao banking systemis characterized by a marked geographical concentration in banking services in Vientiane(capital city) and in the five "larger" cities. It is estimated that less than 10 percent of thepopulation has access to ihe banking system. Banking services provided are poor; forexample, statements of individual accounts are not provided readily and regularly.
The microfinance industry's outreach is also limited as it only started to develop in thelast four years. Estimates show that only 25 percent of potential micro-borrowers andpotential micro-depositors have access to micro-financial services.
The formal system is insolvent to a large extent. Four major banks holding two-thirds ofthe system's assets are inm,olvent (but generally liquid) since 60 percent of loans, onaverage, are nonperforming. These institutions hold almost 80 percent of total deposits.The SCBs capital requirements stood at approximately Kip 700 Billion5 (US$80 million)to strictly meet the Lao regulation (8 percent Capital Adequacy Ratio). In a small andconcentrated economy such as the Lao PDR, the capital adequacy ratio should be higherthan 8 percent to ensure that the banking system would not be wiped out after the firsteconomic downturn.
5Source: KPMG Audit Report datcd November 2001. Figures as June 30, 2001 and I US$ = 8,750 Kip.
ANNEX 2 - LAO PDR -- FMACFinancial Management Capacity Building Credit
The proposed credit will focus on strengthening the government capacity in undertaking thereform program under the Bank's proposed FMAC. Capacity building activities would draw onrecommendations from donors including ADB and IMF. Output will be a detailed capacitybuilding partnership program between the government and donors. The proposed credit wouldsupport the reform objectives and long-term development of institutional capacity, throughtechnical assistance, training programs and system development in selected governmentagencies., aiming for a comprehensive framework for consolidating, and providing a strategicfocus in, capacity building activities in the Lao PDR.
Objective
The central objective of the project is to provide technical assistance and training programs tosupport the development of institutional capacity to assist in the successful implementation of thegovernments reform program. The project also aims to provide a medium-term framework forBank's assistance. The time frame of the proposed Credit would provide continuity to the reformprogram particularly in institutional strengthening. At the same time, the proposed Credit isenvisaged to provide timely and flexible support to facilitate the implementation of the reformprogram.
Components
The credit will focus on capacity building activities in the following areas:
* Financial Sector Reform: (i) stabilize the financial condition of the state-ownedcommercial banks (SOCBs); (ii) strengthen the SOCBs to support broad-based economic growth;and (iii) enhance micro/rural finance for poverty alleviation;
* Public Expenditure Reform: (i) improve budget planning, (ii) streamline budgetexecution and control, and (iii) make the budget process more transparent; increase awareness inpublic sector of internal control measures both at federal and provincial levels through adoptionof international public sector accounting and auditing standards and establishing internal auditfunctions in line ministries; Strengthen oversight function of National Audit Office to mitigatefiduciary risk in government through conducting comprehensive review of oversight bodies.
* State-owned Enterprises Development: (i) strengthen oversight of financial andoperational performance of SOEs, (ii) restructure selected enterprises, and (iii) establish tariffpolicies reflecting cost recovery; establish regulatory framework in infrastructure sectors.
Implementation
The project design calls for a centrally located implementation unit which would have a broadoverview and mandate. The implementation responsibility will be located within the MOF in theform of a Project Implementation Unit (PIU). The monitoring and evaluation will be carried outjointly with the government and the participating donors.
ANNEX 3 - LAO PDR -- FMACIMF's Poverty Reduction and Growth Facility - Program Summary.
In April 2001, the IMF approved in principle a three-year arrangement for Lao PDR under thePRGF for about US$40.2 million equivalent to support the government to strengthenmacroeconomic stability and reducing poverty. The IMF released the first tranche under thePRGF of $5.7 million equivalent in April 2001. The second tranche of $5.6 million equivalentwas approved by the IMF Board in February 2002, following a satisfactory review ofperformance in the first year o0f the PRGF arrangement.
The PRGF is helping the Lao E'DR to build on recent gains in macroeconomic stabilization.Sustained macroeconomic stability and higher growth with equity are to be the basis for povertyreduction program. GDP growth in 2002 is projected at 5 percent (5.2 percent in 2001). Creditrestraints by the central bank a%nd state-owned commercial banks (SOCBs) and a prudent fiscalstance are being pursued by the authorities so as to maintain the downward pressure on inflation.Credit growth of the SOCBs will be sharply reduced to 18 percent in 2002, concurrentlysupporting better loan quality. The authorities will manage a flexible exchange rate regime withthe margin between the banks and the parallel markets rates to be kept under 2 percent. Exchangesystem controls would continue to be eased.
On thefiscal side, the overall budget deficit will be kept at about 5 percent of GDP for the period2000/01-2002/03. External concessional financing will be relied upon to finance this deficitwhile avoiding domestic bank 1inancing. To increase revenue, reforms of the tax administrationincluded focusing on large tax lpayers in preparation for the VAT to be introduced in 2003.Additional revenues would be lfor social spending, including rural development. Improvement ofthe treasury system, fiscal reporting, and accountability would be expected to render publicexpenditure management more efficient.
For the banking sector, PRGF provide for reforms in recapitalizing the weak SOCBs conditionedupon improved performance. Other features include enhanced governance, implementation of astandard accounting framework, loan classification, and provisioning requirements. SOCB-directed lending is to be phased out.
In the enterprise sector, the authorities will initially focus on avoiding losses in key large SOEsthrough price adjustments and develop more comprehensive reforms during the first year of theprogram. Measures to promote private sector development will also be formulated.
Trade reforms will focus on the implementation of AFTA commitments, including removal ofquantitative restrictions and lowering of tariffs for AFTA members.
The IMF review rated the performance of the Lao economy during the first year of the PRGF assatisfactory. There was some rmoderate slowing of the GDP growth to about 5 percent butinflation remained at about 7 percent in 2001. The authorities have undertaken actions toimprove revenue administration.
ANNEX 4 - LAO PDR -- FMACLonger Term Reform Actions
beyond the Timeframe of FMAC
Public Sector Component
Budget Planning* Improve the systems for revenue estimation and establish track record that
reverses the currently persistent pattern of revenue shortfalls and subsequent adhoc expenditure cuts.
* Develop better unit cost measures for major expenditure programs includinghealth and education to support more realistic bottom-up estimation of the costs ofachieving plan goals.
* Develop mechanisms for judging individual investment proposals on their meritsin the budget preparation process (including competing against recurrent spendingproposals).
* Improve the systems for monitoring PIP expenditures and align the PIPexpenditure classification systems at CPC with those of MOF.
Budget Accounting and Control* Revise the budget classification to allow identification of expenditures by
ministry/province, service, program and item.* Refine COA through eliminating redundant spending items, and adopt a
simplified COA for provinces/districts.* Harmonize and unify coding for budget classification and COA.* Extend MOF/ADB pilot computer system to all line ministries and major
provinces following revision of budget classification.* Improve the systems of monitoring of PIP expenditures and align the system of
classification of PIP expenditures with that of MOF for better expendituremonitoring.
* Extend budget classification to program level.* Rationalize treasury accounts in banking system; reduce number and establish
single account for each autonomous administrative unit.* Complete the closure of all unauthorized treasury accounts continue with a
sustained effort to eliminate all off-budget revenues and expenditures.* Undertake a sustained program of training under Budget Department of MOF to
support extension of expenditure control system to district levels as thedecentralization program is unfolded though 2004.
* Reform the system of tax assignments and intergovernmental transfers to addressincentive and equity considerations.
ANNEX 4Page 2 of 4
Budget Transparence* Continue the publication of the budget plan and budget outcome with full sector
detail, eventually including program level expenditures. Include greater detail inthe budget passed by the National Assembly to eliminate post-budget line itemnegotiations and reduce the lag in publication.
* Issue a decree to make audited annual accounts, audit reports of the NationalAudit Office and results of parliamentary discussion on audit reports fullyaccessible to the public.
* Adopt a modem internal control framework for the government as a whole.* Conduct a comprehensive review to rationalize the roles and responsibilities of
the oversight agencies including the National Audit Office, The State InspectionAgency, MOF's Inspection Department, the Permanent Economic Committee ofthe National Assembly, and the Business Improvement Group within the PrimeMinister's Office.
* Adopt international public accounting standards and internationally acceptedauditing standards and establish an internal audit function in line ministries.
* Conduct a comprehensive training program on application of new standards.* Define the role of the external audit function in the Constitution to strengthen the
independence and role of the National Audit Office as well as establish aneffective parliamentary oversight over public finances.
SOE Reform Component
Oversight of Financial and Operational Performance of SOEs* Strengthen capacity of MOF's Office of State Assets to evaluate financial
performance and manage contingent liabilities arising from guarantees of SOEdebt.
* Build capacity and awareness of corporate governance principles.* Build audit capacity both at National Audit Office and at board level in larger
enterprises.* Strengthen SOE autonomy by replacing majority of ministry-appointed board
officials and managers with board members and managers selected on basis ofbusiness competence.
ANNEX 4Page 3 of 4
Enterprise Restructuring* Full separation of commercial and policy roles of SOEs, with removal of all non-
commercial mandates (pricing, labor, service delivery).* Strengthening legal framework for insolvency including both bankruptcy, secured
lending and civil procedures with respect to appeals.* Removal of barriers to competition with private sector, including, inter alia,
development of competition policy framework, reform of public procurement, andliberalization of import licensing.
* Improving investment regime including FDI approval, business licensing andregistration.
* Strengthening and funding of social safety net.* Full commercialization with targeted privatisation and private sector provision of
infrastructure.
Tariff Reform* Regulatory capacity building and training.* Capacity building on targeted subsidies.
Financial Sector
Stabilization of Financial Institutions to Support Macroeconomic Stability* Strengthening of BOL Supervision Department to implement adequate prudential
regulations* Implementation of institutional restructuring of SCBs
Strengthening Financial Institutions to Support Economic Growth
Framework for Sound Banking* Phasing out of directed and policy lending* Similar governance structure in private banks and in SCBs to hold management
accountable for results* Market determined interest rates on loans and deposits* Adequate accounting and auditing frameworks* Adequate disclosure requirements* Functional Credit Bureau.
SCBs Institutional Restructuring* Operational restructuring (adequate policies and procedures, rightsizing with
Social Safety Net; adequate investments in information technology...)* Financial restructuring
ANNEX 4Page 4 of 4
Non Performing Loan ResolutionThe creditors have a credible threat against defaulting debtors.
* Adequate legal instruments: bankruptcy law, secured transaction law* Adequate judicial system which is able to implement laws and enforce decisions
in a timely and efficient manner.* Adequate dissemination of laws including official translations.
Increasing Access to Financial Services by the Poor* Implementation of the Action Plan* Institutional restructuring of the Agricultural Promotion Bank* Establishment of transparent subsidy mechanisms
Forestry Reform Componenat
Production Forestry Poliicy* Reduce wood industry over capacity* Removal of quota harvest system with management plan based harvests* Royalty calculation rationalization
Forest Biodiversity Conservation* Clarification and stanldardization of regulatory framework
Plantation Forestry* Eliminate policies that restrict private sector plantation investment (land access,
transport)
ANNEX 5 - LAO PDR -- FMAC
Decision Framework for Processing the Proposed NT2 Project
Proposed NT2 Project
1. The proposed private sector investment project includes the development, construction, andoperation of a thousand Megawatt trans-basin diversion power plant on the Nam Theun river, atributary of the Mekong, in the central region of the country, about 250 kilometers east ofVientiane. The main features of the project are a 48-meter high gravity dam on the Nam Theunriver, a 450 sq. km. reservoir, the powerhouse, and a 130 km long double-circuit 500 kVtransmission line to deliver the electricity produced to the Thai grid. A 70 km. long single-circuit 115 kV transmission line will also be included to carry the small portion of total electricaloutput that will be dedicated to domestic uses.
2. The project is structured as a BOOT (Build-Own-Operate-Transfer) arrangement. TheGovernment asked a foreign consortium, Nam Theun 2 Electricity Consortium (NTEC),comprised of EdF (France) in a head-contractor partnership with Montgomery Watson Harza ofUSA (35 percent), EGCO of Thailand (25 percent) and Ital-Thai Development also of Thailand(15 percent), to assist in constructing and operating the project. NTEC, currently representingthe private sector interests, will shortly be incorporated with the Lao Government's investmententity (Electricite du Laos, with 25 percent of equity) to formn the operating company, NamTheun 2 Electricity Company (NTECO), for a concession period of 25 years. The developer hasinformed the Bank that it expects to sign, in July 2002, a Power Purchase Agreement (PPA) withEGAT (the Thai public-sector power entity) for export of over 90 percent of the energygenerated by NT2 and also sign a Concession Agreement (CA) with the Government of LaoPDR in the same month.
3. Estimated project cost is US$1.075 billion (about 65 percent of GDP in Lao PDR) and isexpected to be funded using loan facilities of $752 million and shareholders' equity of $323million. Export credits to the tune of $270 million, commercial loans from Thai banksamounting to $375 million and commercial loans from developed countries' banks to the extentof $107 million, make up the loan financing ($752 million) for the project.
Decision Framework for Processing the NT2 Project
4. A broad decision framework was shared with the Government of the Lao PDR during aManagement mission led by the Country Director in August 2001. Project processing would belinked to progress shown by the Government on: (a) implementation of a developmentframework characterized by concrete performance that aims at poverty reduction andenvironmental protection; (b) ensuring that the technical, financial and economic aspects of theproject and the design and implementation of safeguard policies were of a standard acceptable tothe Bank; and, (c) obtaining broad support from international donors and civil society for thecountry's development strategy and the NT2 project itself. The three elements of the decisionframework are elaborated upon below.
ANNEX 5Page 2 of 5
5. Policy and Institutional Reforms. Less than ten percent of the power produced by NT2will be used in Lao PDR; the rest is to be sold to Thailand. Therefore, the major benefit fromthe NT2 project would be sizable incremental revenues (through royalties, taxes and return onequity) flowing to the Government of the Lao PDR for several decades starting from 2008 -- notthe direct benefits of power pioduction. Global experience has clearly shown that suchadditional revenues can be pul: to the most productive uses when governance improvements andhuman capital development go hand in hand with project initiatives. Currently, the policy andgovernance framework in Lao PDR is flawed and capacity in the public sector is woefully weak.Substantial sustainable improvements to these policy and institutional areas are needed toachieve macro-economic stability and pave the way for sustainable broad-based growth. Whileit is appreciated that such reforms take time to complete, a serious start and demonstratedprogress is necessary before sufficient confidence can be gained that these reforms will indeed beaccomplished. Such demonsbtation is all the more important to assuage lingering doubts in thecommunity of international financial institutions and donors, dating back to the macroeconomicmissteps taken in 1997-1999 tlhat exacerbated the effects of the regional crisis.
6. The IMF-backed Poverty Reduction and Growth Facility (PRGF) and the government-driven Interim Poverty Reduclion Strategy Paper (I-PRSP) lay the foundations of such policyand institutional reforms. An overall poverty reduction framework (PRSP) is needed to lay outthe strategy for the sustainable and environmentally responsible use of revenues derived fromnatural resources such as hydropower, forestry, and mining. The full PRSP, that will bediscussed at the Bank Board in FY 2003, is expected to set the agenda for further Bank supportthrough a series of Poverty Reduction Support Credits (PRSCs) to strengthen governance andpromote human development in Lao PDR. Furthermore, expected annual budgetary revenuesfrom NT2 would be, in part, channeled directly to initiatives aimed at poverty reduction and aportion of the proceeds would also partially fund long-term conservation efforts (for severaldecades) in designated consenration areas.
7. Meanwhile, building on the efforts of the past SACs and the recently-completed PublicExpenditure Review (PER), the FMAC and its companion Financial Management C'apacityBuilding Credit (FMCBC) seekc to strengthen GOL's capabilities through financial and publicsector reforms. Key areas being addressed include: i)financial sector -- stabilize financialcondition of the banks (SCBs), strengthen banks to support broad-based economic growth, andlaunch micro/rural finance for poverty reduction; ii) public sector -- improve budget planning,streamline budget execution and control, make the budget process more transparent and launchparticipatory forestry framework which has significant budgetary implications; and, iii) SOEs --strengthen oversight of financial and operational performance of SOEs, restructure enterprises,rationalize the regulatory framework (power sector SOEs are addressed here as well -- especiallyEdL, the entity that would carry GOL's equity share in the NT2 project). A Poverty ReductionFund (PRF) Project would corrmplement these efforts through direct targeting of funds forpoverty-reducing investments at the village level. A separate forestry operation will also addressimprovements in forestry management at the regional level. Improvements in public expendituremanagement would lead to betler poverty targeting.
ANNEX 5
Page 3 of 5
8. The health of the overall IDA portfolio in Lao PDR must also be addressed. There are nineactive IDA projects in the portfolio at this time. In recent years, performance of the portfolio hasbeen mixed, but with an improving trend.
9. Success on the policy and institutional reform front will be measured through progress onthe development and implementation of a comprehensive government-driven reform program,articulated in the PRSP and other policy statements and supported by the Bank, IMF and otherdonors through instruments such as the PRGF, FMAC, PRSCs and various investment operationsas well as maintenance of good standing on the overall project portfolio. Therefore, a sine quanon for Bank support to the project is an agreement upfront on a set of policy and institutionalreforms and demonstrated progress on the implementation of these reforms. Progress on allthese operations will be guided and measured by a set of performance benchmarks. This pre-requisite for Bank support for NT2 has been accepted by the Lao PDR Government.
10. Project Standards and Safeguards. The NT2 project is being designed and will beimplemented by NTEC (or NTECO). The head contractor -- EDF/Montgomery Watson Harza --is strong and each is highly rated as a leader in the field. Therefore, unlike public sector energyprojects, cost overruns or completion delays are not serious risks. The project sponsors haveamassed substantial analysis affirming that NT2 is technically sound in terms of hydrology anddam design and also economically and financially viable. The Bank is in the process of re-confirming these findings through ongoing due diligence. The project is well-managed to dateand the Developer is capable and responsive to Bank suggestions. NT2 is a priority for theGovernment while also being financially attractive to the Developer. This provides incentive forall parties to find workable solutions when problems arise. With this said, the Bank must still,inter alia, perforn due diligence on the PPA and other legal agreements covering the project, thecase for additional power purchase by Thailand, the design of the dam and associatedconstruction (a Bank supported Dam Safety Panel is operating) and the detailed implementationarrangements. The satisfactory completion of due diligence -- and any remedial actions that theBank may propose -- is an integral component of the Bank's decision-making framework forprocessing the project and this has been recognized by the Lao PDR Government.
11. The NT2 project involves application of all ten Bank safeguard policies. The projectdemands effective conservation and management of the watershed areas due to possible negativeenvironmental and social impacts. These relate to the construction of the dam and flooding ofland to fill the reservoir. Other impacts include resettlement of nearly 5000 persons, flooding ofdry season cultivation zones on the Xe Bang Fei river, ecological impacts relating to changes inwater quality and flow on the Xe Bang Fei and Nam Theun rivers, possible endangerment ofcertain rare fish and animal species, changes in the stock and migration of fish, and loss ofhabitat in the reservoir area from inundation. Unless these negative impacts are carefullymitigated, the net benefits flowing from the project may not be attractive enough to justify it.
12. Project preparation has focused on mitigating these negative impacts by ensuring that thedesign and implementation of plans pertaining to all of the Bank's safeguard policies are carriedout so as to meet or exceed Bank standards. Furthermore, the proposed Nam TheunEnvironmental and Social Project (NTSEP) supports, inter alia, resettlement and communitydevelopment, environmental capacity-strengthening, watershed area management and
ANNEX 5Page 4 of 5
environmental mitigation, and poverty reduction in the project area. Through these efforts, theGovernment seeks to ensure that the livelihoods of all who live in the project area are enhancedand that the environment -- in the project area and possibly beyond -- is conserved for the long-term. Potential conservation bienefits warrant special mention, as NT2 would help to preserveone of the few remaining pristine rainforest regions in the world. Without NT2, it is not clear ifor how such conservation cou] d be ensured. An independent International Advisory Group and aPanel of Environmental and Social experts advise the Bank and Government, respectively, onthese critical issues.
13. The design of risk mitigation measures is contained in three document packages (which aregoverned by the Bank's disclosure policy): the Environmental Assessment and ManagementPlan (EAMP), the Resettlement Action Plan (RAP) including an Indigenous PeoplesDevelopment Plan (IPDP), and the Watershed Conservation and Management Plan -- alsoincluding an IPDP. The preparation of these plans has been carried out by experts working forthe Government and the Developer, with substantial input from Bank staff (including theprovision of detailed comments and discussions on application of Bank safeguards policies).Implementation arrangements are included in these documents and completion of this work, tothe satisfaction of the Bank, would be a pre-requisite for Bank consideration of the NT2 project.
14. A strong dialogue is in p:rogress with both the Developer and the Government on projectquality and safeguard issues and there is a clear understanding by all parties on the what must bedone to comply with the Bank's guidelines and standards in this regard.
15. Broad-based Supportfor the Government's DevelopmentStrategy and the NT2 Project.Burden-sharing with other international donors is a critical element of the Bank's decision-making framework because of two factors. First, it is critical to the success of the project thatsustained progress on reforms be maintained over the long-run. The Government would receiverevenues for several decades and most of the policy and institutional reforms would also takeseveral years to complete. Thc: reforms are more likely to be fully carried out if major donors arealso deeply committed to the policy and institutional reform package while also supporting theimplementation of NT2-relatecl conditionality. Second, the NT2 project requires substantialexternal support, through granis (to finance the Government's contribution to equity in theproject), export credits, financial transfers, and technical assistance from donors other than theBank.
16. These requirements put the international donor community in a crucial role going forward.The Government will need to dtevelop a detailed program (building on ad hoc measures taken sofar) for systematic consultations with key international stakeholders to keep them informed. Forbilateral donors and the multilaterals, this will need to include briefing missions to importantdonor capitals as well as infonnal meetings in Vientiane. The UNDP supported round tablemechanism would also be used to keep donors informed and engaged.
17. International civil society has a legitimate and strong interest in the project as well --particularly since local civil society is not developed and there are no local NGOs. Localconsultations have been remarkable in the Lao context, but fall short of the expectations of theinternational community. Broad support from responsible international NGOs, particularly those
ANNEX 5Page 5 of 5
involved with environmental and social issues, provides much-needed comfort that theenvironmental and social issues relating to the project will be successfully managed in the event.It is, however, highly unlikely that anti-dam NGOs would cease to attack this project. Theylikely will continue to launch focused campaigns against NT2 -- including website appealsreaching large audiences.
18. A series of seminars on NT2 led by the Lao PDR Government would be proposed toengage international NGOs on the project. The tone of these seminars is likely to be set by theon-going debate on the World Commission on Dams report. The expertise of the InternationalAdvisory Group of the Bank and the Panel of Environmental and Social experts, engaged by theGovernment, would be made available at these seminars.
19. The importance of broad-based international support is well understood by the Governmentbut their capacity to network is severely limited. The Government is seeking Bank advice on itscommunications plan.
20. Project preparation continues within the framework described above. Emphasis goingforward will be on further development by the Government of specifics relating to safeguards,fiduciary elements, use of revenues, a strong communications plan, and monitorable benchmarksfor determining Lao PDR's policy and institutional readiness for the NT2 project.
ANNEX 6-LAO PDR - FMACThe Poverty Reduction Fund Project
Objective
In support of the governmenl.'s Five-Year Plan and Poverty Reduction Strategy, the projectwould:
* Assist villagers to develop community public infrastructure and gain improved access toservices;
* Build capacity and empower villages in poor districts to manage their own publicinvestment planning and subproject implementation in a decentralized and transparentmanner; and
* Strengthen local institutions to support participatory decision-making and conflictresolution processes at the village, khet (grouping of villages), and district levels,involving a broad range of villagers, including women and the poor.
Project Design Features
* Sub project menu limited to a list of eligible small scale public infrastructure and servicessub projects all within the implementation capacity of beneficiary communities;
* Utilizes a dual strategy of social control and technical oversight to attain sustainableoutcomes;
* Broad-based community participation and decision making;* Local contributions and ownership;* Transparency and accountability.
Project Components
* Sub-project grants to a v illage or group of villages;* Local capacity building;* National project management.
LAO PEOPLE'S DEMOCRATIC REPUBLICPeace Independence Democracy Unity Prosperity
1 o1 3MINISTRY OF FINANCE No ........ _. JMOF
Vientiane, date 2.4 M .W ,20
Mr. James D. WolfensohnPresidentThe World BankWashington, D.C.
Dear Mr. Wolfensohn
Letter of Development Policy
Our National Socio-Economic Development Plan for 2001-2005 of Lao PDR has focused onpoverty reduction through the promotion of stable and equitable growth. In conformity with theobjectives of the aforiementioned Plan, wf prepared, in March 2001, an Interim PovertyReduction Strategy Paper (I-PRSP) and presented it to the Boards of the IMF and the WorldBank. Our economic reform program supported by the Financial Management AdjustmentCredit (FMAC) and outlined below is an hored in both the I-PRSP and the National Socio-Economic Development Plan (NSEDP). The reform program will be given a forward-lookingthrust, beyond the life of the two-tranche JFMAC, in the full PRSP that we are currentlypreparing. We expect t7 present the full PRSP to the World Bank Board in FY 2003.
Macroeconomic 'ramework
Since the year 2000, we have pursued sound macroeconomic management and have restoredeconomic stability and low inflation.
This past first year under the Poverty Reduction and Growth Facility (PRGF), the economy hasgrown at a rate of 5.2 percent in 2001 and inflation remained under control at about 7 percent. Amodest fiscal slippag. through September 2001 was due to the decentralization initiative, but wepursued strong corrective measures in the new budget in the last quarter of the year, bringing thefiscal performance back on track.
For the medium term, we expect to contiiwue our macroeconomic policies to sustain anacceptable growth rate of about 5.5 to 6.1 percent, an inflation of about 5-7 percent, and a stableexchange rate to realize the objectives outlined in the I-PRSP and the NSEDP.
That Luang Road, P.O.Box: 46 Vientiane, Lao PDRTel: 412406,412417 Fax: (856-21) 412415,412405 Tlx: 4369 MOF LS
Our fiscal policies will strengthen macroeconomic stability and at the same time will meet pressures foradditional social spending. We envisage a fiscal deficit of about 5 percent of GDP. With improvementsin administration and compliance, we project an improved revenue performance that will allow additionalcurrent spending, including expenditures in the social sectors. We aim to limit domestic bank financingof the budget to 1/2 percent of GDP. We intend to shift expenditures composition toward currentspending, in line with the PRGF program, enabling us to accommodate the increase in government wagesand additional spending for maintenance and arrears payments. Our strategy is to strengthen overallpublic expenditure management to meet fiscal targets and to support the decentralization efforts.
Our objectives in monetary and exchange rate policy continue with keeping inflation under control andmaintaining a stable and flexible exchange rate system. The Bank of Lao People's Democratic Republic(BOL) will continue its discipline in budget financing.
We recognize that a sound macroeconomic framework is a pre-requisite to stable growth and povertyreduction. But if this is going to be sustained, we need to address effectively and directly the underlyingstructural weaknesses that impede the flow of resources in the economy to their best uses. Our recentexperience is that severe macro-economic instability undermines not only economic growth but alsopoverty reduction objectives. We are resolved, therefore, to address the systemic weaknesses in theeconomy that are the root causes of macroeconomic uncertainty.
The systemic weaknesses that our reform program addresses encompass the budget making process andpublic sector reform, the state owned enterprises, and the financial system. Together these weaknessesresult in a number of development. problems. In public sector management, there are problems in thebudget process as well as in natural resource management. At the budget stage the problems areinadequate attention to recurrent budget, excessive reliance on donor funded investment projects thatcause implementation problems, issues of non-transparency and inefficient use of resources. In naturalresource management, we are focusing on forestry practices that result in excessive depletion , yieldinadequate revenues for the budget and do not result in sufficient income earning opportunities at thelocal level. The state owned enterprises suffer from problems of high costs due to managerialinefficiencies and low prices that undermine their commercial viability. Weaknesses in the bankingsector have resulted in substantial non-performing loans and capital inadequacy that have impeded thebanks' capacity to support future growth and provide financial services to the poor. Our government isresolved to address these weaknesses.
Public Sector Management: The Budget
Our long-term vision for the public sector is to efficiently and effectively use public resources for povertyreduction and the promotion of sustainable growth. The key building blocks in the realization of thisvision include progressive adoption of best practices for: (i) budget planning; (ii) budget execution andcontrol; and (iii) transparency.
Letter of Development PolicyPage 2 of 19
Actions Recently Taken
Budget planning. We have already undertaken significant steps to improve the measurement of povertyand to enhance the poverty focus of public expenditures. The first Lao Expenditure and ConsumptionSurvey (LECS), conducted by the National Statistical Center (NSC) in 1993, was substantially improvedand updated in 1998. The basic poverty measurement initiatives have enabled us to complete our I-PRSPin April 2001 and we will complete the full PRSP in FY 2003.
To better achieve our development objectives, as outlined in the I-PRSP, and raise the share of recurrentspending, we have been reducing capital expenditures which peaked at over 70 percent of totalexpenditures in 1998/99, and have fallen to less than 60 percent in 2001/02. Further rebalancing of publicexpenditures was achieved through a 25 percent increase in basic civil servant wages from the start of2002 to compensate for past inflation. Given that a large portion of civil servants are teachers, this ishelping to reach the I-PRSP target of lifting the education's share of the budget to 13 percent.
With the assistance of the Asian Development Bank (ADB), we are better able to plan and manage publicinvestments. A Public Investment Plan (PIP) monitoring project that tracks donor-funded investmentexpenditures has been established and results are published annually. This is now being extended todomestically funded public investments. Decree No. 58/PM on Management of Public Investment hasbeen signed on May 22, 2002. This and the associated guidelines provide a rationalized framework forproject selection that involves streamlining by size and a two-stage process of evaluation against setqualification criteria, followed by a separate budget resource availability hurdle. This system is beingapplied now as the FY2002/03 investment proposals are received.
Budget accounting and control. Decree 20/PM of 1993 on Public Accounting is now being more fullyand effectively implemented with the establishment of an information and budgetary system in four pilotMinistries (Education, Health, Agriculture and Finance) with assistance from the ADB. This systemallows the systematic computerized recording and processing of expenditures by administrative units. Itincludes budgetary and accounting references, committed current and capital expenditures at the centrallevel, and it specifies budget allocations, payment orders and the value of budget allocations availableafter payment orders have been deducted.
To tighten the control of public resource flows, a Ministerial Decision was issued in 1999 requiring theMinistry of Finance's Treasury Department to exercise prior commitment controls on expenditures. Toensure that commitments are consistent with the budget, responsibility for the commitment controlfunction now rests with the Budget Department (Ministerial Decision No. 1706/MOF, dated October 22,2001).
Transparency. With assistance from the ADB, a National Audit Office (NAO) was established by DecreeNo. 174/PM in 1998 and began producing audits of central government ministries, provinces, andindividual projects. The NAO has been reporting annually to the President, the Prime Minister and theNational Assembly. The quality of its audits has been improving as the capacity of NAO staff isenhanced through continued ADB support.
Letter of Development PolicyPage 3 of 19
In line with the requirements of the PRGF, the Treasury Department has begun an inventory of Treasuryaccounts at all levels. This inventory, which is now almost complete, will allow MOF, working inconjunction with BOL, to identify and close all unauthorized Treasury accounts which facilitate theproliferation of off-budget revenues and expenditures.
Actions under FMAC
With the support of the proposed F MAC, we are taking several additional steps to further stabilize thebudgetary process and budget planning.
To promote transparency in our fiscal management, the 2000/01 budget outcome and the 2001/02 budgetplan with classification by ministry/province and services were published in the Official Gazette onMarch 25, 2002. The detail of the presentation has been substantially expanded, including breakdowns bysector at both central and provincial levels.
Decree No. 58/PM on the Managemnent of Public Investment has been issued, requiring that PIPsubmissions for new public projects in excess of 1 billion kips in the FY 2002/03 budget includeestimates of associated recurrent costs during the operating period. Guidelines for estimates of therecurring costs have been prepared for presentation at the provincial budget conferences in May 2002. Aworkshop on the subject for the Committee for Planning and Cooperation (CPC) and MOF staff held atthe CPC with the assistance of the World Bank in April this year was very useful in disseminatinginformation on these topics. The CPC will present the results of this work for the FY 2002/03 PIP to thedonors in October 2002. A consultant has been engaged to assist CPC with recurrent cost estimates underterms of reference agreed with the Bank.
As part of the second phase of the FMAC-supported program, the CPC will complete an assessment ofrecurrent cost estimates associated with new projects in excess of 1 billion kips.
Following the January 17, 2002 letter sent jointly by the World Bank and the IME to the Minister ofFinance concerning the draft Accounting Regulations and Procedures, and consistent with discussionsheld between the World Bank and the Accounting Departmnent in February 2002, revisions are beingprepared. This process is at an advanced stage and we expect to adopt by a Regulation of the Minister ofFinance on Public Accounting and Procedures for the implementation of Decree No. 20/PM on theGeneral Regulation of Public Accounting, dated February 18, 1993, and prepare a strategy for reform ofthe Department of Treasury. We expect that the Regulations and Procedures will be issued by end-June2002. These accounting reforms set the stage for the medium-term reforms for Treasury operations whichwill be developed in close collaboration with the International Financial Institutions (IFIs).
The enabling legislation for the establishment of a Procurement Monitoring Office (PrMO) is already inplace. We are moving forward with the establishment of the PrMO within the Ministry of Finance headedby a qualified and experienced Director and assigned with adequate staff and resources. In addition, wewill continue to revise the Implementing Rules and Regulations in line with the recommendations of the
1 Classifications are by ministry/province and service, so that it is possible to identify separately the centralministry and provincial spending on health, education, etc.
Letter of Development PolicyPage 4 of 19
World Bank's draft Country Procurement Assessment Review which we received on May 3, 2002. Acandidate has been identified for the position of PrMO Director.
Medium-Term Actions
A series of medium-term reforms of Treasury operations will be launched under the guidance of arecently formed Standing Committee headed by the Vice Minister of Finance. Key reforms will includeestablishment of Treasury offices in line ministries, closure of unauthorized Treasury accounts,consolidation of the network of Treasury accounts, revision of Treasury regulations including sanctions,and publication of a manual of consolidated laws, decrees and regulations for government-wide Treasuryoperations. Following the revision of Public Accounting regulations and refinements of the chart ofaccounts and budget nomenclature, the pilot computerized accounting systems will be extended to coverall central ministries and provinces. These initiatives will serve to improve both expenditure managementand revenue mobilization objectives by restricting the scope for unauthorized off-budget transactions andbringing about a closer integration of treasury, accounting and budget operations. In addition in themedium term we plan to introduce internal audit and accounting processes, to adopt international publicaccounting and auditing standards and to revise accounting decrees and regulations to clarify financialcontrol responsibilities among the central government and the provinces.
Further steps to improve the transparency of budget processes will include continued publication of thebudget plan and budget outcome and steps to reduce the publication lag. In the medium term, we intendto adopt legislation to provide greater autonomy for the National Audit Office (NAO) and to establish aneffective parliamentary oversight over public finances, and to make the audited annual accounts and auditreports of the NAO fully accessible to the public. We will also undertake a review to assess the scope forrationalizing the roles and responsibilities of the oversight agencies including the NAO, the StateInspection Agency, MOF's Inspection Department, the Permanent Economic Committee of the NationalAssembly, and the Business Improvement Office (BIO) within the Prime Minister's Office. We alsointend to introduce by appropriate legal instrument the principle that all subsidies and other quasi-fiscalexpenditures be reflected explicitly in the national budget. This will be reinforced by our program toenhance Treasury operations and closure of unauthorized accounts, thereby enabling us to progressivelyeliminate all off-budget revenues and expenditures.
Financial reporting in the private sector will benefit from the introduction of measures to improve theinstitutional framework for setting its accounting and auditing standards. These include efforts tostreamline various laws and regulations related to accounting and auditing practices in the private sector,as well as adoption of international accounting and auditing standards for this sector.
To enhance budget planning, we will improve revenue estimation methods and begin to reverse thepersistent pattern of revenue shortfalls and subsequent ad hoc expenditure cuts. We will develop betterunit cost measures for major expenditure programs, including health and education, to support morerealistic bottom-up estimation of the costs of achieving plan goals. The classification used by the CPC inthe PIP monitoring system will be aligned with the budget classification system, and the latter will beextended to allow identification of expenditures by program. These steps will allow us more directly toreflect the results of our poverty monitoring, expenditure tracking and PRSP work in public expenditureplans and expenditure outcomes.
Letter of Development PolicyPage 5 of 19
Public Sector Management: Forestry
The performance of the forestry sector, a key component of public ector management in Lao PDR, hasnot been as satisfactory as expec;ted. We believe that the contribution of forest resources to the incomesand livelihoods of rural people would be increased under better forest management system. This includesaddressing, among others, the issue of unplanned and uncontrolled logging. We are resolved to face thesechallenges in public sector management.
Actions Already Taken
We have taken a number of steps toward reforming the policy and institutional constraints challengingforestry and are working with a number of partners to build the capacity needed to improve managementof the resource. These steps incl ude reducing excess capacity in wood processing sector, mandating thattimber production be restricted to areas targeted for infrastructure development or covered by sustainableforest management plans, introduction of market-oriented timber sales methods, successful trials ofparticipatory forestry management and successful efforts to control illegal and unauthorized logging intargeted areas.
We recognize the full range of environmental, economic and social benefits that a well managed forestrysector will provide. The Lao PDR is well endowed with forest biodiversity and is recognized as the hostof unique and globally endangered species of plants and animals. Aware of the responsibilities that theseunique resources convey, we have established a system of National Biodiversity Conservation Areas andare introducing management and protection of these areas. In the future, we expect to improve the qualityof management of these areas by, among other things, employing participatory approaches that combineconservation with tangible contriibutions to the livelihoods of local people.
Actions under FMAC
The Ministry of Agriculture and Forestry (MAF) has formally approved the key Principles for VillageParticipation in Sustainable Management of Production Forests and the Office of the Prime Minister hasissued a Decree on Sustainable Management of Production Forest Area and superceding relevant articlesof existing orders.
Under the FMAC program, by end-March 2003, we will revise and strengthen the regulatory frameworkfor protected areas management ;md will issue, through the Ministry of Agriculture and Forestry,Regulations amending the Implementing Regulations on National Biodiversity Conservation Areas,Regulation No. 0524/AF.200 1, (.June 7, 2001), inter alia, to clarify the definitions and proceduresgoverning zoning and land use within said Conservation Areas, and eliminate inconsistencies in respect ofprotected species listings. Furthejrmore we will adopt, through the Ministry of Agriculture and Forestry,Implementing Regulations on Sustainable Forestry Management which include specific provisions toenable the involvement of local communities in production forest management.
Letter of Development PolicyPage 6 of 19
Our top priorities under the period of the FMAC program focus on bringing order and discipline to theexploitation of the country's production forest resources. Until now, these areas have not been adequatelymapped, inventoried, or their harvest properly planned and organized. Harvesting is considered byinternational norms to be of lower efficiency than expected. If proper forest management is notundertaken, pressures from mismanagement of the production resources would increase and result innegatively affecting our goals for sustained revenue mobilization and biodiversity conservation andrequire urgent attention and correction.
Recognizing that the capacity of government forestry agencies at all levels is limited, our strategy is toinvolve local communities in forest management by providing a framework for the rapid expansion of thearea under sustainable scientific forest management conducted in cooperation with Village ForestryOrganizations. A Decree and Implementing Regulations on Sustainable Forestry Management whichincludes specific provisions to enable the involvement of local communities in production forestmanagement will be adopted to provide guidance to the national, provincial and local agenciesresponsible for working with communities and Village Forestry Organizations on the basis of voluntaryVillage Forestry Agreements and written management plans. This regulatory framework will implementthe "Principles for village participation and other key principles in sustainable management of productionforests."
Implementation of this program, which we expect will be supported by international partners, is aimed atrapidly bringing a large portion of the production forest resource under sustainable management. Thiswill involve mapping, demarcation and registration of a network of production forest areas and thepreparation, approval and implementation of management plans.
We will initiate a forestry sector monitoring program to routinely assemble and analyze informnation onpolicy implementation and development results.
A comprehensive sectoral monitoring program will enable the government to monitor and report on theimplementation of this program and will be initiated with in the FMAC program.
Medium-Terms Actions for Forestry Sector
Looking beyond the FMAC program, we intend for the forestry sector to continue to develop as asustainable source of growth and public revenue and a means for poverty reduction. To support this, wewill continue our efforts to introduce more market-oriented timber sales methods, will develop policies toreduce excess capacity in the wood processing sector, and will complete the regulatory framework forforestry envisioned under the Forestry Law with well formulated Implementing Regulations covering allforest types and management systems under the law.
We also expect to continue investments in reforestation, plantation development and watershedmanagement. These efforts are vital to the development of alternative sources of raw material, and to theprotection of existing and planned downstream infrastructure. As with the management of naturalproduction forests and conservation areas, we intend to employ participatory methods and will consultwith a range of stakeholders to ensure broad-based support for sustainable development.
Letter of Development PolicyPage 7 of 19
State-Owned Enterprise Sector
We recognize that a well-functioning, financially-sustainable enterprise sector is important to improvingthe delivery of services to the poor, creating meaningful productive employment, as well as supportingthe transformation of the econom,y from an agrarian to an industrial and service-based economy. Many ofour enterprises have, in the past, supported a mix of social, political and economic objectives. With socialand political stability in place, ouir focus is now on enhancing the economic contribution of state-ownedenterprises. Our objectives are to improve the oversight and management of those SOEs which shallremain under state jurisdiction, in order to make them more commercially oriented, efficient and able tocompete with other enterprises. For several non-performing enterprises, this will require deep internalreform to strengthen management and eliminate non-productive activities. For infrastructure SOEs, thiswill require regulatory and tariff reform.
Actions Recently Taken
Commercialization. Our SOE reform policy must be viewed in light of gains made in implementing theNew Economic Mechanism, which dramatically reduced the number of SOEs through liquidation andprivatization, hardened budget constraints, and removed the monopoly status which many SOEspreviously enjoyed. Under the 1)94 Enterprise Law and implementing regulations, we introduced theframework for commercial autonomy and self-sufficiency of SOEs. All SOEs have introduced ExecutiveCouncils which govern SOEs, replacing the previous direct municipal or central government control andownership mechanism. The Office of State Assets within MOF was assigned to execute the fiduciaryresponsibility of the state as shareholder.
Privatization. From 1988 to 1997, we undertook a substantial program of privatization. Of over 600central and provincial SOEs which existed in 1988, only 91 remained as 100 percent state-ownedenterprises by 1995. In 1996, plans were developed to privatize an additional 58 enterprises.Unfortunately, the disruptions of the economic crisis delayed the SOE reform process, as it was difficultto force further adjustments in the midst of a harsh macroeconomic climate. By impactingmacroeconomic stability -- which is a prerequisite to foreign investor interest in transformed assets -- aswell as domestic purchasing power, the crisis made further progress on privatization very difficult.However, several enterprises, incl uding Lao Tobacco and Lao Telecom, continued to be privatized duringthis period.
Restructuring. A number of larger SOEs, including those in infrastructure sectors, have been unable toachieve financial sustainability, which in turn contributed substantially to both the non-performing loansproblem in the banking system and a fiscal drain on the budget. The performance of enterprises whichremain in state control during the crisis and through 2001 revealed weaknesses in the management andoversight of SOEs. In October 2000, we announced Policy Decision No 368/PMO, which provided thecontext for intervention to restruclture non-performing SOEs. In December 2001, Bolisat Phattana KhetPhoudoi (BPKP or Phoudoi), the enterprise responsible for the largest non-performing loans in thebanking system, was transferred to MOF, and the process of restructuring was initiated. Audits of LaoAviation and BPKP further strengthened the govermnent's commitment to finding a comprehensivesolution.
Letter of Development PolicyPage 8 of 19
SOE reform policy. In this broad context, we began to engage with the Bank in September 2001 throughthe FMAC program to improve the financial performance of state-owned enterprises and consolidate thegains previously made in transforming SOE management. We named a new Minister to head theBusiness Improvement Office (BIO) in order to lead enterprise reform policy, particularly with respect toSOEs. A target list of enterprises has been identified for restructuring by this office.
With respect to infrastructure SOEs, financial sustainability is a particularly difficult challenge in light ofthe need to undertake substantial investment programs to provide essential services to the poor. Integralto the financial sustainability of several of these enterprises is a combination of internal restructuring toreduce costs, combined with tariff reforms, and introduction of appropriate regulatory frameworks.
Water sector. We have established the Water Supply Authority (WASA) as the central regulatoryauthority for the water and sanitation sector of the country. The establishment of WASA in the Ministryof Communication, Transport, Post and Construction followed our water sector policy statement in 1999.The new policy changed the role of the central government from service provider to facilitator andcoordinator in the development process for water supply and wastewater management systems in urbanand rural areas throughout the country, including sector investment support. Work is underway withdonor support (ADB's Project Preparatory Technical Assistance, PPTA) to develop a legal and regulatoryframework for the water supply and sanitation sector under the auspices of WASA.
Our national water policy is described in the Prime Ministerial Decision No 37/PM in 1999 onManagement and Development of the Water Supply Sector. This document establishes the principles fora tariff policy and for the Provincial Nam Papa (PNP) operations on commercial principles in line withour national policy on working toward full cost recovery for urban water supply and centralizedwastewater systems, with progressive block rate tariff structures.
In accordance with the Decision 37/PM, the tariffs shall be set within the constraints of affordability andwillingness to pay, adopting a uniform province-wide tariff system with possibilities for crosssubsidizing. Average tariff has increased from 195 Kip/m3 in 2000 to 550 Kip/m3 in September 2001.WASA has authorized an increase to 650 Kip/m3 from July 2002. Nam Papa Vientiane has proposed atariff of 750 Kip/m3. However, further reforms are envisaged as tariffs still remain well below costrecovery and do not take into consideration new capital investment costs.
In a context of developing regulatory instruments for the sector, WASA has agreed, on our behalf, toreview the water tariff principles and elaborate a comprehensive water and sanitation tariff policy inconsultation with key stakeholders of the sector. The review is expected to be done in light of possiblefuture private sector participation in the water supply and sanitation sector.
Telecommunications. We have made a number of changes to the structure of the telecommunicationsector over the last decade. This includes introducing private investment through a joint venture (1994)as well as separating post from telecommunication (1995). A new telecommunication law was passed inApril 2001 and lays the framework for telecom regulations and entry into the sector. The sector has beenopen to competition since the beginning of November 2001. We issued a mobile license in early 2001 forMillicom International Cellular SA, a Luxembourg-headquartered international mobile investor.
Letter of Development PolicyPage 9 of 19
Until 1993, the Enterprise of Post and Telecommunications Lao (EPTL) was the 100 percent government-owned organization responsible ,For operating telecommunications in the country. In 1994, a joint venturewas established between the government and a Thai company, Shinawatra International Public CompanyLimited -- Lao Shinawatra Telecom Company Ltd. (LST) -- to operate telecom services (Telecom ProjectPhase III). We would like to note that this was not the first example of private investment in the telecomsector.
In 1995, ETPL was divided into Enterprise of Post Lao (EPL) -- responsible for postal services -- andEnterprise of Telecommunication Lao (ETL) -- responsible for telecommunications. In 1996, ETL andLST were merged to form Lao Telecommunications Company Limited (LTC) with the governmentowning 51 per cent and Shinawalra owning 49 per cent. LaoTel was granted a concession of 25 yearswith five-year exclusivity (through October 2001).
ETL was resurrected in August 2000 to hold grant-financed government assets. As a result, LaoTel endedup leasing certain network elements needed for its service provision such as the international gateway.With the expiration of LaoTel's exclusivity in October 2001, the way is now open for ETL to enter thesector as a telecom service provider. ETL plans to provide fixed telephone lines, mobile GSM and VOIPservices in 2002.
While a tariff structure exists in tlnis sector, we recognize that domestic tariffs are highly subsidized andwe need to develop a firmer policy for tariff determination. The Telecom Department, as the regulatorybody, is putting in place a tariff policy study and has requested assistance for the development of aregulatory framework including tariff rebalancing and interconnection charges as well as a framework forprivate sector participation and licensing arrangements.
Transport. We have approved three tariff increases for Lao Aviation over the last year. While werecognize that tariffs are not yet at cost recovery levels, we are considering a recent request from LaoAviation to increase tariffs from E; cents/seat/km to 20 cents/seat/km for domestic flights - bringing tariffsto cost recovery levels (at 65 percent capacity utilization) in the first quarter of 2003 .
Electricity. Since 1997, we have embarked on several activities for restructuring tariffs and regulation inthis sector, upon the preparation of parallel projects of the World Bank and ADB. The Ministry ofIndustry and Handicraft (MIH) issued in March 2001 a Power Sector Policy Statement (with World Banksupport) that established the following two main objectives for the Power sector: (i) to maintain andexpand an affordable, reliable and sustainable electricity supply within the country to promote economicand social development; and (ii) to promote power generation for export to provide revenues to meetGOL development objectives. It was agreed that the achievement of these twin goals depends oncontinuing progress in the following two areas:
Letter of Development PolicyPage 10 of 19
* Development and enhancement of the legal and regulatory framework to effectively direct andfacilitate power sector development; and
* Reform of institutions and institutional structures to clarify responsibilities and streamlineadministration.
Prior to the Policy Statement, our National Assembly enacted the Electricity Law (1977), an importantadvance in the development of a legal framework to attract, direct and control optimal investment inpower projects. Currently we are considering the separation of Electricite du Laos (EdL) from its off-gridand IPP responsibilities, and to establish an independent regulator. We are taking actions to mobilizeresources in support of an open debate on sector reform. We have also approved a proposal for a PPIAFsupported workshop on sector reform (scheduled to be held around November 2002) which would befollowed by the formulation of an action plan.
Our government's efforts to commercialize EdL started in the mid-i 990s under technical assistancesupport of the World Bank and ADB. Since then, EdL has been established as a separate juridical entitywith a functioning Board of Directors. Also, EdL has strengthened its financial management capability(with World Bank support), has been reorganized on the basis of cost centers that facilitate accountabilityof each operation and the utility has divested from some non-core activities (e.g. concrete pole plants).This process was supported by the enactment of the Electricity Law which supports thecommercialization of the sector. Following the 1997 regional financial crisis, EdL's financial situationwas seriously affected by exchange losses. In response to this situation, we proposed in December 2000 aFinancial Recovery Plan (FRP) for EdL that the Bank found satisfactory. This plan called for: (i)conversion of some debt to equity; (ii) temporary relaxation of onlending conditions to EdL, particularlyfor debt associated to social-oriented investments; (iii) undertaking a tariffs study and the subsequentimplementation of a new tariff policy; (iv) revaluation of fixed assets; (v) signing of a performanceagreement between EdL and our government; and (vi) review of EdL's investment plan. In spite of theslow implementation of the FRP at the onset, almost all the measures have been implemented at thisstage. New tariffs approved in early April 2002 will allow EdL to comply with financial covenants forthe first time in more than three years.
Actions under FMAC
The SOE reform program in FMAC, paralleling the objectives of the PRGF, is expected to contribute to astrengthened financial management of existing SOEs, enterprise restructuring, and tariff reforms.
In recognition that the monitoring of the operational and financial performance of SOEs, particularly atthe Provincial and District levels and among some ministries, is insufficient to support management offinancial risks and execution of SOE reform policy, our government has issued a Decree (i) requiring thatfinancial and operational performance of all SOEs at the ministerial, provincial and district levels bereported to the Ministry of Finance, (ii) specifying regular reporting requirements and (iii) stating thatnew SOEs to be established are those which are specifically approved by the Prime Minister, and whichwill provide essential services which cannot be currently provided by the private sector or by budgetarymeans; (iv) requiring the Ministry of Finance to publish in the Official Gazette the financial performance
Letter of Development PolicyPage 11 of 19
of SOEs on a quarterly basis; and (v) requiring the privatization or liquidation of those SOEs which haveproduced the greatest operating losses, or which otherwise fail to comply with this Decree.
To contain the growth of non-performing loans contributed by SOEs, we have prohibited non-commercialpolicy lending to SOEs, and all lending to SOEs with outstanding non-performing loans.
Recognizing that a limited number of SOEs have contributed disproportionately to non-performing loansin the banking system, the goverrnent has signed Memoranda of Understanding to initiate therestructuring process for BPKP, Lao Aviation, Nam Papa Lao and Pharmaceutical Factory No. 3. TheseMemoranda define the contribution of the enterprise, the Office of the Prime Minister and the Office ofState Assets of MOF with respect ito the preparation of time-bound restructuring plans for each enterpriseand the first stages of their implementation.
To better manage our utilities with a view toward cost recovery, we have initiated reforms in the tariffpolicy for electricity, water, transport, and telecommunications. For electricity, our government hasimplemented new electricity tariff policy, to be applied from May I for a period of 36 months. It consistsof an average monthly increase of :2.3 percent which will take the average tariff to Kip 665/K.wh by theend of the period (US cents 7 at the current exchange rate, between US cents 5 to 6 under our set ofassumptions). Following the proposal of the tariff study, the schedule will move towards a niarginal coststructure while keeping a lifeline tariffto protect low-income consumers.
For water, we have prepared a draft tariff policy outline for the water sector and submitted it to the Bankfor review. Policy objectives and principles have been laid out. These will be developed and firmed upafter consultation with the stakeholders (consumers and operators, national and local Treasury andinternational development agencies). Gradual increase of water tariffs is being implemented. The mostrecent set of tariff increases was auithorized by WASA on April 23, 2002.
The Ministry of Construction, Transport, Post and Communication (MCTPC) and Lao Aviation haverequested a tariff study to support the achievement of full cost recovery tariffs by the second tranchemilestone. An increase has been agreed between the MCPTC and Lao Aviation for domestic tariffs. It isagreed that the domestic tariffs for Lao Aviation would be the higher of $0.20/seat/kilometer or the tariffrequired to achieve full recovery of all operating maintenance and depreciation costs.
A study on tariff structure and tariff policy for telecommunications has been launched with grantassistance from JICA. We also have a JICA-financed consultant attached to the TelecommunicationsDepartment at MCTPC. The telecommunications department is preparing a telecom policy statement -and KfW of Germany has agreed to provide assistance.
In order to clarify the policy on management of SOEs we will issue, through MOF, ImplementingRegulations to the Decree on Management of State-Invested Enterprises, Decree No.54/PM dated May 9,2002.
Letter of Development PolicyPage 12 of 19
By end-March 2003, we expect to begin to realize some results of the Decree strengthening theperformance monitoring of SOEs. We will prepare, through the Ministry of Finance, an assessment of thefinancial performance of SOEs and, under criteria consistent with technical audit standards, and identifynon-performing SOEs that require (i) performance improvement; (ii) strengthening of financial reporting;or (iii) bringing them to the point of sale or liquidation, as the case may be. Gradually, this will beexpanded to all state-owned enterprises.
We will adopt a time-bound restructuring plan for BPKP, Nam Papa Lao, Pharmaceutical Factory No. 3,and Lao Aviation, and implement all of the actions under said restructuring plan, which in accordancewith such time-bound restructuring plan. Substantial progress is being made by each enterprise indefining its restructuring plan.
In SOE restructuring, we will execute, through MOF, memoranda of understanding for the developmentand execution of time-bound restructuring plans with DAFI and four loss-making SOEs which haveoutstanding, non-performing loans in excess of one billion kip.
We expect to complete ongoing financial restructuring of EdL, including revaluation of assets,amendment of selected subsidiary loan agreements, and debt to equity conversions.
We will also continue to pursue tariff reforms. For water, transport and telecommunications, we willadopt and publish tariff policies and structures incorporating: (i) cost recovery principles; and (ii) directedand transparent subsidies, if any, for the potable water supply and telecommunications sector, LaoAviation, and telecommunications sector; and will adopt a time-bound action plan for the implementationof said tariff policies. The implementation of tariff policy will be through appropriate legal instrumentssuch as Ministerial Regulations. We have commissioned studies to formulate tariff policy and tariffstructure to include cost recovery. These are expected to be ready by November 2002. Appropriatestakeholder discussions will be held and social impact studies will be carried out on the tariff policy foreach sector. The Terms of Reference for Social Impact Assessment Studies for the water sector havebeen drafted. Similar work for electricity and telecommunications will be addressed.
Going forward, we will clarify the role and strengthen the functions of regulatory bodies/departments.This will be accomplished through providing and developing adequate resources and capacity in water,telecommunication, energy and transport sectors.
In the water sector, the Water Supply Authority -- the water sector central regulatory authority for thewater and sanitation sector of the country is being assisted by ADB in developing its mandate, including abetter definition of its role, functions and jurisdiction.
In telecommunications, we will seek to define and strengthen the capacity of the Department ofTelecommunications in MCTPC as our designated regulator for this sector. In addition, we will work toidentify resource requirements for this agency under the grant from PPIAF. The regulatory frameworkwill also be developed under the PPIAF Grant.
Letter of Development PolicyPage 13 of 19
Transport. Our plan is to develop, a regulatory framework for this sector.
Energy. We will continue to implement the commercialization of EdL that was started in the mid-1990s,with strengthened management capacity and a firmer financial footing through the Financial RecoveryPlan (FRP).
Medium-Terms Actions
While the policies proposed for support under the FMAC represent a substantial effort by our governmentto address some of the most urgeni: deficiencies in the enterprise sector, the reform program will clearlyrequire a medium-term effort. The Office of State Assets will require further strengthening in order totake a proactive stance through early detection and intervention of enterprises which may cause financialdamage to the state budget or to the banking system. The capacity of the National Audit Office will alsorequire strengthening in order to execute more regular audits of key enterprises. The Boards of Directorsof state enterprises will need to become more effective in financial control and strategic management,both through training and through expansion of the use of independent, experienced directors fromoutside the civil service.
Through the enterprise restructuring process, we hope to identify and address many of the key obstaclesto financial sustainability of state-owned enterprises, including removal of non-commercial mandates onpricing and service delivery, strengthening of the social safety net to alleviate the impact of SOE reformon workers, reducing the cost and ijmproving the function of organizational structures, andinstitutionalization of effective management controls. To strengthen the incentives for all enterprises toachieve financial sustainability, we expect to have made substantial progress, with ADB support, onstrengthening the legal framework for insolvency, secured lending and civil procedures.
Beyond the FMAC, our medium-term vision for the enterprise sector is one in which all enterprises,irrespective of the nature of ownersihip, are able to contribute substantially to increased employmentgeneration and poverty reduction, irnproved service delivery, and macroeconomic stability. Realizationof this vision rests on five pillars:
establishment of a sound and stable investment environment for the development of allenterprises leading to the resumption of foreign and domestic direct investment flows;
* creation of a market-oriented regulatory framework and tariff regime for key infrastructuresectors which enables the private sector to contribute to essential service delivery on acompetitive basis;
* leveling of the playing field between SOEs and the private sector, including in the areas oftaxation and public procurement, to introduce greater competition between SOEs and the privatesector and to facilitate the flow of resources to areas of greatest demand;
* creation of a judicial system which is able to provide strong incentives to improve financialperformance and facilitate commercial transactions, including credit; and
* achieving a simple, manageable trade regime that promotes integration of Lao PDR first withinAsian Free Trade Agreement: and then within the global economy.
Letter of Development PolicyPage 14 of 19
This will require a substantial and cross-ministerial reform agenda, developed in consultation with theprivate sector, SOE managers, and the foreign investment community. To build ownership andcommitment to the reforms among all concerned stakeholders, we will establish a public-privateconsultative mechanism led by the CPC, with the support of the World Bank, IMF, ADB, and theMekong Project Development Facility. Our immediate priorities are to increase the attractiveness of LaoPDR as a destination for foreign direct investment, to simplify business registration procedures forforeign and domestic entrepreneurs, and to continue to reform the trade regime. Longer-term reformpriorities of the enterprise sector are expected to emerge from the consultations with domestic and foreignbusinesses.
With more progress on governance of state enterprises, improvement of the domestic business andregulatory environment, and a resumption of foreign investor interest in Lao PDR, the conditions will bein place for a resumption of the previous policy of ownership transformation on a more sound footing.Meanwhile, the government will continue to take a pragmatic approach to the question of ownershiptransformation, including the potential use of joint ventures to improve the performance of SOEs.In the medium term, the issue of transparency and financial accountability in the SOE sector will beaddressed though implementation of the following measures designed to improve its financial reportingand corporate governance: (i) requiring large SOEs to prepare financial statements in accordance withadopted standards and be annually audited by independent auditors; and (ii) publishing their auditedfinancial statements and making them accessible to the public.
We shall consider additional measures to achieve a more effective level of financial management. Theseinclude: (i) introducing an internal audit function in large SOEs; (ii) establishing audit committees of theboard; and (iii) strengthening the accounting professional organizations to become fully professionalbodies.
Financial Sector
Working closely with the World Bank, IMF and ADB, we have started to implement a comprehensivereform program in the financial sector. The program includes three main themes: ensuringmacroeconomic stability via banking reform, promoting broad-based growth via a strengthened financialsector, and unleashing the power of micro-finance to reduce poverty.
Actions Already Taken
We have taken a number of actions recently to stabilize the balance sheets of SCBs that include creditceilings, adherence to stricter classification of loans and provisioning, prohibition of lending to defaultingborrowers, suspension of accrual of interest on all NPLs and restrictions of the distribution of dividendsby the SCBs. We have also clarified the Tax Law to allow loan-loss provisions as a normal deductionagainst taxable income. Last year we took the disciplinary measure of removing top executives of LaoMay Bank to send a signal that mismanagement will no longer be tolerated.
Letter of Development PolicyPage 15 of 19
With the assistance of international financial institutions and bilateral donors, we have taken a number ofsteps to improve the overall climrrate for the financial sector. We have established a technical committee,the Working Committee for Financial Sector Development (whose membership includes MOF, BOL,Ministry of Justice, and CPC) wiith the mandate to oversee the preparation of policy reforms in thefinancial sector. We have formulated a vision of the Lao Financial Sector after discussions among seniorpolicy makers to build understanding, consensus, and ownership. We have established a BankRestructuring Committee (BRC) for restructuring of SCBs. The BRC prepared draft Memoranda ofUnderstanding with the IFIs stating the restructuring principles and strategy. To address the NPLproblem and its resolution we have launched an analysis to identify how to strengthen the legal andjudicial underpinnings of the involuntary process. We established a Steering Committee and ExternalCommittee for NPLs resolutions. We are also developing a voluntary process for NPLs resolution. Wehave agreed to initial outcome targets by setting specific numbers on NPLs to be resolved and in theprocess of resolution within the specific timeframe of FMAC.
In order to assess accurately the financial situation of the SCBs, we have commissioned audits of SCBsaccounts for three years (1998, 1999 and 2000) with assistance from AusAid. To bring the SCBs up todate in terms of banking technology in the future, we have initiated a World Bank-supported study toanalyze the information technology requirements for SCBs. Similarly, with World Bank support, wehave launched the study of the soc-ial impact of SCB restructuring in order to design an adequate socialsafety net for redundant workers.
Rural and micro-finance are important for a country such as the Lao PDR where the majority of thepopulation and the poor live in the country side. The needs for micro-finance, as effective means forpoverty alleviation, are most acute in these areas. In 1997, we undertook a survey of the sector withUNDP support. Based on the results evidencing a large unmet demand for micro-financial services, wepiloted an ambitious project to improve awareness, sensitization, and access of the people for micro-finance. With donor support, we built our capacity through exposure visits to various rural and microfinance initiatives in the region. The activities in this area have been given a new momentum with theestablishment of the Rural and Microfinance Committee to oversee government activities in this area andto prepare policy recommendations. With ADB support, we have agreed to launch an operationaldiagnostic and a financial audit of the Agricultural Promotion Bank (APB) with a view to gamerexperience and information on rural banking services and to restructure APB.
Letter of Development PolicyPage 16 of 19
Actions under FMAC
As part of FMAC preparation, we are continuing to deepen reforms in the financial sector. By the end ofMarch 2003, we will assess the measures undertaken to (i) avoid the deterioration of the SCBs' riskportfolio; (ii) implement its risk diversification rules; and (iii) effectuate the autonomy of SCBs. Thisregime shall remain in place until banks are actively engaged in their restructuring program. Furthermore,the BOL has issued (i) a set of Instructions to centralize credit decisions in SCBs' headquarters and limitindividual and group exposures; and (ii) a time-bound action plan. We shall retain this regime in placeuntil SCBs have acceptable credit policies and procedures. BOL will ensure compliance with thesemeasures.
We are committed to establishing SCB autonomy. To this end, the MOF has issued a Notice to SCBsincluding all future lending (including policy lending) be subject to commercial criteria. I delegated tothe SCBs' Boards of Directors to appoint Deputy Managing Directors and Branch Managers uponproposal of the Managing Directors and to allow SCBs to freely set interest rates on loans and deposits.The BOL is to prepare a time-bound action plan for implementation, monitor and ensure fullimplementation of this measure.
In addition, the BOL is considering an amendment to the Decree Law on Commercial Banks. Thisalleviates the concerns related to the permanence of Notice 0566/MOF on commitment to the autonomyof SCBs, dated March 31, 2002, as one area to be amended will precisely be on governance of SCBs toensure consistency with the Business Law.
Concerning SCB's institutional restructuring, we have signed a Memorandum of Understanding ofRestructuring (MOUR) for each SCB which includes (i) phased capital build-up based on improvedoperational performance; (ii) temporary management support to SCBs in the form of internationaladvisors; and (iii) an action plan in case SCBs do not reach performance indicators.
We are pledging to undertake several additional measures by end-March 2003 under the FMAC asfollow-up to the steps noted above to consolidate our reform effort. We intend to audit the calendar year2001 accounts of SCBs, and for the Agricultural Promotion Bank the calendar years 2000 balance sheetand 2001 accounts.
We are committed to have the SCB's institutional restructuring programs launched and by March 2003will procure the professional services of at least two banking advisors, to provide advisory services for themanagement of SCBs, with qualifications and experience adequate to carry out their services according todetailed terms of reference agreed.
Regarding non-performing loan resolution, we are requiring that by end-March 2003, SCBs resolve anaggregate amount of Kip 100 billion equivalent of SCBs non-performing loans of at least ten accountsthrough: (i) the liquidation of non-viable companies; (ii) the restructuring of viable companies such that
Letter of Development PolicyPage 17 of 19
their debts can be fully serviced by their cashflows; (iii) the seizure and sale of assets to recover cash; or(iv) the exchange of the loan for cash or marketable assets. We will also prepare an assessment thatidentifies ten non-perforning loan accounts undergoing resolution.
Our strategy is to increase access to financial services for the poor people. In consultation with MOF,BOL, and the relevant provincial authorities, and microfinance entities including Cooperative de Creditde Soutien aux Producteurs, Miicrofinance Project and Project de Developpement Decentralise dePhongsaly, will prepare a policy statement, an assessment and a time-bound action plan to address theimplementation of a rural and microfinance reform program.
Medium-Term Actions for the Financial Sector
Financial sector reform will continue to be pursued well beyond the current phase supporled by theFMAC and ADB's planned Financial Sector Program Loan III (FSPL III) to ensure that the financialservices needs of a growing economy are met and also adequate attention is paid to the less well-offsegments of the society.
Our objective is a Lao banking system with modem, sound, robust, efficient, and sustainable institutionsmeeting prudential standards. Banks will be cost-efficient and customer-oriented. We envisage acompetitive environment in which banks unable to comply with the law and regulations are removed, andthe better banks -- whether private or state-owned -- will be allowed to thrive.
To improve further the framework for sound commercial banking and the banking environment ingeneral, we are committed to implementing several measures. We will continue to build and strengthenthe capacity in the supervision department of the BOL. This includes providing, in the next two years,training in accounting, regulations, on-site inspection techniques and off-site analysis with support fromthe IMF and the EU. To support off-site analysis, we intend to establish adequate MIS for the supervisiondepartment to enable BOL staff to monitor the process.
Legal reforms for the financial sector are also on the anvil. We plan to conduct a review of the BankingLaw (Decree) in order to: (i) make it consistent with the Business Law (on corporate governance) forSCBs, (ii) increase competition outside the Vientiane area, and (iii) review capital requirements of banks.We intend to review our banking regulations with a view to bringing them into conformity withinternational banking standards. WVe are also committed to enhancing transparency in the banking system.To this end, we will modify Lao accounting standards to better conform with international accountingstandards and will implement a program of dissemination of banking laws. We will also improveenforcement of laws governing (i)i secured lending; (ii) bankruptcy; (iii) dispute resolution; and (iv) debtrecovery by enhancing the capacily ofjudges.
Letter of Development PolicyPage 18 of 19
The planned measures for improving legal capacity of judges outlined above, in conjunction withappropriate modification of the judicial;procedures, including the setting up of specialized courtsfor commercial dispute, will help in thet recovery of NPLs. A voluntary debt resolution processwill also be put in place to promote NPL resolution. To that end, a fully functional CreditBureau will be established to improve access to creditor and debtor records.
In the area of rural and microfinance, the specific policy measures to create an enablingenvironment will be articulated under FvIAC and the planned FSPL III and we intend toimplement those as per the action plan to be defined. However, we have already decided thatAPB should become a viable market-ornented rural financial institution.
To ensure smooth implementation of the credit, our government intend to establish a ProjectImplementation Unit (PIU) at the Ministry of Finance for the implementation of the FMAC byMay 2002.
Conclusion
My government has already implemented a number of policy measures and initiatives in the pasttwo years to first stabilize our economy and then to strengthen the gains so far achieved. Weconsider that the program as outlined in this letter will further enhance the economic and socialobjectives of the Lao People's Democraiic Republic and will enable us to better implement ourstrategy as set out in the I-PRSP and the draft NESDP. My government requests the WorldBank's assistance to facilitate the realization of this program.
ISincerely yours.
A-
Souih MAHALATHMinist of Finance
Lao People's Democratic Republic
Letter of Development PolicyPage 19 of 19
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 1 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR { Actions to be Taken by Lao PDR to Satisfy Secondf | ~~~~~~~~~~~~~~~~~Tranche Release Conditionsl
I. PUBLIC SECTOR REFORM
A. Planning
Recurrent and capital spending Issued a Decree on Public Investment Management 1. Completion, through CPC, of an assessment,are poorly balanced. requiring that PIP submissions for new public projects in in a manner and substance satisfactory to the
excess of 1 billion kip in the FY2002/03 budget include Association, of recurrent cost estimatesestimates of associated recurrent cos't du.ring opera'iug associated with new projects in excess of 1 billion
| period. | kip.
B. Budget Accounting and Control
The Public Accounting Law of EFFECTIVENESS CONDITION TO BE MET: 2. Preparation, through the Ministry of Finance,1994 does not provide an Adopt a Regulation of the Minister of Finance on Public in a manner and substance satisfactory to theadequate framework for public Accounting and Procedures for the implementation of Association, of a strategy for the reform of thefinancial management. Decree No. 20/PM on the General Regulation of Public Department of Treasury.
Accounting, dated February 18, 1993, satisfactory to theAssociation.
C. Budget TransparencyD.
The budget and expenditure Published in the Official Gazette the FY2000/01 outcomeoutcomes are not and the FY2001/02 budget with classification bycomprehensive, published in ministry/province and service with a separate identificationa timely way nor presented of the distinct central ministry and provincial expenditures by sectorin a manner that facilitates and expenditure category.public understanding orreconciliation with statedbudget priorities.
Financial Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 2 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
Absence of government agency 3. Establishment of a Procurement Monitoringto oversee country-wide Office within the Ministry of Finance, headed byprocurement and implement a qualified and experienced Director andeffective procurement training. assigned with adequate staff and resources in a
manner and substance satisfactory to theAssociation.
D. Natural Resources Management
Better management of forestry MAF approved the key Principles of Village Participation 4. Issuance, through the Ministry of Agricultureto increase government in Sustainable Management of Production Forests: PMO and Forestry, in a manner and substancerevenue, expand rural income issued a Decree on Sustainable Management of satisfactory to the Association, of Regulationsgeneration, and promote Production Forest Area and superceding relevant articles amending the Implementing Regulations onsustainability. of existing orders. National Biodiversity Conservation Areas,
Regulation No. 0524/AF.2001, (June 7,2001),inter alia, to clarify the definitions andprocedures governing zoning and land use withinsaid Conservation Areas, and eliminateinconsistencies in respect of protected specieslistings
5. Adoption, through the Ministry of Agricultureand Forestry, of Implementing Regulations onSustainable Forestry Management, satisfactoryto the Association, which includes specificprovisions to enable the involvement of localcommunities in production forest management.
Financial Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 3 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
II. SOE REFORM
A. Strengthen Oversight of Financial and Operational Performance of SOEs
Monitoring of the operational Issued a Decree: (i) requiring that financial and 6. Issuance, through MOF, of Implementingand financial performance of operational performance of all SOEs at the ministerial, Regulations to the Decree on Management ofSOEs, particularly at the provincial and district levels be reported to the Ministry of State-Invested Enterprises, Decree No.54/PMProvincial and District levels Finan.e; vil) speciv.y4g reguiar reporting requirements; dated May 9, 2002 satisfactory to the Association.and among some Ministries, is (iii) stating that new SOEs to be established are thoseinsufficient to support which are specifically approved by the Prime Minister,management of financial risks and which will provide essential services which cannot 7. Preparation of and furnishing to thepolicy. Strengthened oversight currently be provided by the private sector or by Association in a manner and substanceand control must be developed budgetary means; (iv) requiring the Ministry of Finance to satisfactory to the Association, through thethrough mandatory reporting publish in the Official Gazette the financial performance Ministry of Finance, an assessment of theand strengthening SOE of SOEs on a quarterly basis; and (v) requiring the financial performance of SOEs and, underExecutive Councils (boards). privatization or liquidation of those SOEs which have criteria consistent with technical audit standards,
produced the greatest operating losses, or which otherwise and identify non-performing SOEs that requirefail to comply with this Decree. (i) performance improvement; (ii) strengthening
of financial reporting; or (iii) bringing them toThe MOF and BOL prohibited non-commercial policy the point of sale or liquidation, as the case maylending to SOEs, and all lending to SOEs with outstanding be.non-performing loans.
B. Enterprise Restructuring
SOE losses have created I Transferred ownership of the largest loss-making SOE, 8. Adoption of a timebound restructuring plan,significant non-performning BPKP. to the Ministry of Finance for corporate satisfactory to the Association, for BPKP, Namloans in the banking system. restructuring in cooperation with the Office of the Prime Papa Lao, Pharmaceutical Factory No. 3, andThe debt is limiting the Minister. Lao Aviation, and implemented all of the actions
to finance future growth. ounder sad restructuracg plan, whrch sncapacity of thebankingsystemunaccordance with such time-bound restructuringOperational and financilal . .._.I._._._
Financial Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 4 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
restructuring of SOEs is plan are due within seven (7) calendar days priorneeded. to the exchange of views under Section 2.02(d) of
this Agreement.
9. Execution, through MOF, of memoranda ofunderstanding for the development andexecution of time-bound restructuring planswith DAFI and four loss-making SOEs whichhave outstanding, non-performing loans in excessof one billion, in a manner and substancesatisfactory to the Association
10. Completion of the financial restructuring ofEDL, in a manner and substance satisfactory tothe Association, including the revaluation ofassets, amendment of selected subsidiary loanagreements, and debt to equity conversions.
Financial Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 5 of 8REFORM PROGRAM MATRIX.
Issues/Objectives Actions Taken by Lao PDR Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
C. Tariff Reforms
Tariffs in the water, transport, Electricity: implemented new electricity tariff policy. 11. Adoption and publishing of tariff policiespower and telecommunication and structures incorporating: (i) cost recoverysectors are below cost recovery Water: prepared a white paper on tariff policy for the principles; and (ii) directed and transparentlevels, and enterprises lack water sector. subsidies, if any, for the potable water supply,autonomy to adjust prices. telecommunications sector and Lao Aviation;Insufficient separation of social Transport and Telecommunication: launched studies on and adoption of a time-bound action plan for theand commercial functions of tariff structure and start the preparation of tariff policies implementation of said tariff policies, all in aSOEs prevent sustainability of for Lao Aviation and Lao Telecommunication. manner and substance satisfactory to thethe enterprises and cause Association.macroeconomic risks.
A comprehensive approach totariff adjustmnent needs to beimplemented, includingefficiency improvements andtargeted subsidies for lowincome groups executedthrough the budget.
III. FINANCIAL SECTOR REFORM
A. Financial Sector Reform to Promote Macro-economic Stability
Measures to avoid deterioration BOL issued (i) an Instruction to stop the growth of SCBs'of SCBs portfolio, risk portfolio if the ratio of NPLs to credit risk portfolio
(net of provisions) exceeds 15 percent of loans made afterDecember 31 1999 and (ii) a time-bound action plan forThe quality of risk managementimlenao.
at branch level is weak. implementation.Procedures for risk
Financial Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 6 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR 1 Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
diversification are not BOL issued (i) an Instruction to centralize credit decisions 12. Preparation of an assessment, in a mannerimplemented. in SCBs headquarters and limit individual and group and substance satisfactory to the Association,
exposures and (ii) a time-bound action plan for that assesses the measures undertaken by theimplementation. Borrower to: (i) avoid the deterioration of the
SCBs' risk portfolio; (ii) implement its riskdiversification rules; and (iii) effectuate theautonomy of SCBs.
B. Banking Reforms to Support Broad-based Economic Growth
1. Framework for Sound Borrower committed to the autonomy of SCBs:Banking Minister of Finance issued a Notice to SCBs requiring that
all future lending (including policy lending) be subject toStructural measures to ensure commercial criteria; Minister of Finance issued athat the financial sector delegation of his powers to appoint deputy Managing
Directors and Branch Managers, to the SCBs Board ofDirectors, so that those managers are appointed by theBoards upon proposal of the Managing Directors.
Minister of Finance issued a Notice to SCBs to allow them 13. Audit, in a manner and substanceto set freely interest rates on loans and deposits; BOL satisfactory to the Association, the calendar yearprepared a time-bound action plan for implementation. 2001 accounts of SCBs, and for the Agricultural
Promotion Bank the calendar years 2000 balanceAccounting and Auditing sheet and 2001 accounts.
2. InstitutionalRestructuring MOFtBOL/SCBs signed MOUR for each SCB which 14. Procurement of the professional services of
Addressing SCBs financial and includes (i) phased capital build-up based on improved at least two banking advisors, to provideoperational weaknesses. operational performance; (ii) temporary management advisory services for the management of SCBs,
Financiai Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 7 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
support to SCBs in the form of international advisors and with qualifications and experience adequate to(iii) an action plan in case SCBs do not reach performance carry out their services detailed in terms ofindicators. reference satisfactory to the Association.
15. Resolution of an aggregate amount of Kip 100billion equivalent of SCBs non-performing loansof at '. .nt accout, ,i a uianner andsubstance satisfactory to the Association,through: (i) the liquidation of non-viablecompanies; (ii) the restructuring of viablecompanies such that their debts can be fullyserviced by their cash-flows; (iii) the seizure andsale of assets to recover cash; or (iv) the exchangeof the loan for cash or marketable assets.
16. Preparation of an assessment, in a mannerand substance satisfactory to the Association,that identifies ten non-performing loan accountsundergoing resolution.
Financial Management Adjustment Credit
LAO PDR - FINANCIAL MANAGEMENT ADJUSTMENT CREDIT Page 8 of 8REFORM PROGRAM MATRIX
Issues/Objectives Actions Taken by Lao PDR Actions to be Taken by Lao PDR to Satisfy SecondTranche Release Conditions
C. Micro/Rural Finance for Poverty Alleviation
Measures for the development 17. Preparation of, in consultation with MOF,of sustainable rural and micro- BOL, and the relevant provincial authoritiesfinance. and microfinance entities including Cooprative
PreparinQy a supportive de Credit de Soutien aux Producteurs,enviromnt Microfinance Project and Projet de
Developpement Dcentralise de Phongsaly, apolicy statement, an assessment, and a time-bound action plan to address theimplementation of a rural and microfinancereform program, all in a manner and substancesatisfactory to the Association.
IV. PROJECT IMPLEMENTATION UNIT
BOARD CONDITION (MET)Project Management Establishment of a Project Implementation Unit (PIM) at
the Ministry of Finance, satisfactory to the Association, forimplementation of the FMAC and the FMCBC by May2002, before Board presentation.
Financial Management Adjustment Credit
FMAC - Statistical AnnexPage I of 8
L,ao PDR at a glance 9/21/01
EastPOVERTY and SOCIAL Lao Asia & Low-
PDR Pacfic Income Development dtamond2000Populatlon, mid-year (rntHons) 5.2 1,853 2,459 ULe expectancyGNI per capita (Ailas metho USS) 290 1.060 420GNI (Abas method, US$ blil.ns) 1.5 1,964 1T030
Average annual growth, 199440
Population (%) 2.5 1.1 1.9 9rsLabororc () 2.2 1 4 2.4 GNI
per " primaryMost recent estimate (latest year available, 199400) capita enrollment
Povarty (% ofpopulabion below nabonal poverty line)Urban population (' of toal populaton) 24 35 32Life expectancy at bbth (yearq) 54 69 59Infant mortallty (per 1 O0 live bths) 93 35 77Child malnutrition (% of chdren under 5) 40 13 .. Aocess to improved water sourceAccess to an Impmved water source (X utpopulabon) 90 75 76Illteracy (% of populaton age 1*+) 51 14 38 L PORGross prlmaryenrollment (9 otschool-agepopulston) 112 119 96 ao
Male 123 121 102 Low-ncome groupFemale 101 121 86
KEY ECONOMIC RATIOS and LONG-TIRM TRENDS
1980 1990 1999 2000Economic ratios
GDP (USS bIllons) 0.86 1.8 2.1Gross domestic investment/GDP .. .. 22.7 20.4Exports of goods and servkceslGDP .. 11.3 24.7 22.9 TradeGross domestic saavngsaGDP ..Gross natlonal savings/GDP .. .. 16.4 14.6
Curent account balance/GDP .. -11.8 -5.2 -4.6 DomestIcInterest payments/GDP 0.3 0.5 0.5 savInInvestmentTotal debVGDP 204.5 143.8 116.4 s s/ngjTotal debt service/exports 8.7 7.1 7.5Present vatue of debVGDP 78.9Present value of debt/exports .. .. 267.2
Indebtedness19510-90 1990-00 1999 2000 2000-04
(average annual growth)GDP .. 6.5 7.3 5.7 6.6 -Lao PORGDP per capita .. 3.8 4.7 3.3 4.0 - Low-4ncome groupExports of goods and services .. ..
STRUCTURE of the ECONOMY1980 1990 1999 2000 Grwth of Investmnt and GDP (%)
(% of GDP) ioAgricultura .. 61.2 53.5 52.9Industry .. 14.5 22.5 22.8
Manufacuring .. 10.0 16.9 17.2Servces .. 24.3 24.0 24.3
0Private consumption 9. .. .. . 9 99 General govemment consumption . .. .. .. GD1 - GDPImports of goods and services .. 24.5
1980-90 199040 1999 2000(average annual growth)Agriculture 3.5 4.9 8.2 5.0Industry 6.1 11.0 8.0 7.6
Manufacturing 8.9 11.7 7.1 7.8Services 3.3 8.6 6.7 6.0
Private consumption ..General govemment consumption ..Gross domesUc InvestmentImports of goods and services ..
Note: 2000 data are preliminary estimates.
The diamonds show four key indicators In the country (in bold) compared with is hcome-group average. If data are missing, the dlmond wilbe incomplete.
FMAC - Statistical AnnexPage 2 of 8
Lao PDR
PRICES and GOVERNMENT FINANCE
Domestic pdces 1980 1990 1999 2000 Inflation (%)
(% change) .soConsumer prices .. .. 134.0 27 1 loo..Implicit GDP deflator .. 38 0 126.5 23.8
Government flnance 50(% of GDP, Indudes cunmnt grants) c <Current revenue .. 10.0 19.6 19.4 95 96 97 99 99 00Current budget balance .. . 9.6 8.9 - GDP deflator O CPIOverall surplus/defcit . .. -6.2 -5.7
TRADE
(US$ millions) 1980 1990 1999 2000 Export and Import levels (USS mill.)
Total exporis (fob) .. 363 393 80
Wood products .. . 106 120Agriculture .. .. 8 13 Manufactures . .. 100 88
Total imports (cif) . 554 591 400 J 99 * Food .w
Fuel and energyCapital goods 147 74 c _ _ _ _ _
Export prce index (1995=100) 94 . ..Import price index (1995=100) . .. .. . Exports ImportsTerms of trade (1995=100)
BALANCE of PAYMENTS
(USS millions) 1980 1990 1999 2000 Current account balance to GDP (%)Exports of goods and services .. 102 509 544 oImports of goods and services 214 601 636Resource balance . -111 -93 -93 - . I .Net income .. -1 -28 -37 * f- I I Net curren transfers .. 11 30 30 -10
Current account balance .. -102 -91 -99
Financing items (net) . 135 94 143Changes in net reserves 3 -34 -3 -44 -20
Memo:Reserves induding gold (US$ millions) . 0 106 140Conversion rate (DEC, local/US$) 10.2 708 6 5,864.4 6,280.8
EXTERNAL DEBT and RESOURCE FLOWS1980 1990 1999 2000
(US$ millions) Compositlon of 2000 debt (USS mill.)Total debt outstanding and disbursed 350 1,768 2,527 2,499
IBRD 0 0 0 0IDA 6 131 405 403 B 403
Total debt service 3 9 37 42IBRD 0 0 0 0 C42IDA 0 1 5 7
Composition of net resource flowsOfficial grants 16 47 56 65 E: 1,392Official creditors 54 146 61 55Private credrtors 0 0 0 0 DForeign direct investment 0 6 79 30Portfolio equrty 0 0 0 0
World Bank programCommitments 13 48 2 0 A-IBRD E -BilateralDisbursements 5 32 21 20 8- IDA D -Other mulblateral F -PnvatePrincipal repayments 0 0 2 4 C -IMF G -Shrort-tenrNet flows 5 32 19 17Interest payments 0 1 3 3Nettransfers 5 31 16 14
Development Economics/EASPR 9/21101
FMAC - Statistical AnnexPage 3 of 8
LAO PDR: KEY ECONOMIC INDICATORS, 1997-2004
Actual Prel. Est. Projected1997 1998 1999 2000 2001 2002 2003 2004
Growth Rates (%)Real GDP 6.9 4.0 7.3 5.8 5.2 5 5 6.0 6.5
Consumer price index (annual avg.) 193 85.3 127.1 25.1 8.5 7.2 5.0 5 0
Debt ServiceDebt service (US$ million) 37.0 38.0 64.0 73.0 74.0 81.0 89.0 96.0Debt service/XGS (%) 11.7 11.3 18.7 20.8 21 1 218 22.0 22.6Extemal debt /GDP (%/) 55.9 84.5 80.0 70.1 89.6 86.4 79.1 71 2
Ratios to GDP (current prices) (%)Investment 22.8 22.8 22.5 21.0 22.1 22.5 309 333National savings 12.2 12.7 14.8 12.7 14 6 15.1 15.2 16 0Public investment 15.3 15.5 13.3 13.0 12.6 12.7 12.7 12.7Private investment 7.5 7.3 9 2 8.0 9.5 9.8 18 2 20.6Ratio of public/private investment 2.0 2.1 1.4 1.6 1.3 1.3 0.7 06
Other ItemsExport growth rates (nominal) (%) -1.4 6.4 1.5 2.6 -0.3 6.2 8 7 5 4Import growth rates (nominal) (%) -6.0 -14.7 0.3 2.7 -2.0 4.5 8.1 7.3
Current account balance (US$ million)-before official transfers -282.0 -130.0 -129.0 -143 0 -108.0 -115.0 -123.0 -233.0
* percent of GDP (%) -16.3 -10 1 -8.8 -8.3 -6.2 -6.5 *6.5 -11 3-aHter official transfers -185.0 -56.0 -60.0 -24.0 -85.0 -61.0 -53.0 -151.0* percent of GDP (%) -10.6 4.4 -4.0 -1.4 4.9 -3.1 -2.8 -2.4
Gross reserves in weeks ofimports 2 5 2 2 2.1 2 5 2.5 2.8 3.4 3.9
Note Figures are roundedSource:
Actual data: Lao authorities and Bank and Fund staff estimates. Estimates and projections: World Bank and [MW.
FMAC - Statistical AnnexPage 4 of 8
LAO PDR: BALANCE OF PAYMENTS, 1997-2004(USS Million)
Actual Prel. Elst. Projected1997 1998 1999 2000 2001 2002 2003 2004
Exports (fob) 317 337.0 342.0 351.0 350.0 371.0 404.0 425.0
Imports (cif) 648 553.0 554.0 569.0 558.0 583.0 631.0 752.0
Trade Balance -331 -212.0 -212.0 -218.0 -208.0 -212.0 -227.0 -326.0
Services (Net) 28 71.0 98.0 126.0 146.0 146.0 159.0 147.0
Factor income (net) -21 -34.0 -45.0 -73.0 -68.0 -73.0 -79.0 -80.0of which: Interest -19 -26.0 -35.0 -37.0 -35.0 -38.0 -39.0 -44.0
Transfers (Net) 140 123.0 99.0 142.0 44.0 78.0 94.0 108.0of which:- Official Transfers 97 74.0 70.0 121.0 23.0 55.0 70.0 82.0- Private Transfers (net) 43 49.0 30.0 21.0 22.0 23.0 24.0 26.0
Current Account Balance -185 -56.0 -60.0 -24.0 -85.0 -61.0 -53.0 -151.0(excluding official transfers) -282 -130.0 -129.0 -145.0 -108.0 -115.0 -123.0 -233.0
Capital Account 154 38.0 63.0 68.0 84.0 65.0 64.0 179.0Medium and Long-Term 161 86.0 65.0 81.0 65.0 63.0 75.0 74.0-Disbursements 179 98.0 94.0 117.0 104.0 106.0 125.0 126.0- Amortizations/Principals -18 -12.0 -29.0 -36.0 -39.0 -43.0 -50.0 -52.0
Other capital flows 14 -17.0 -47.0 25.0 34.0 -39.0 -70.0 -63.0
DirectInvestment 104 56.0 82.0 31.0 33.0 41.0 60.0 168.0of which: hydropower 18.0 27.0 30.0 0.0 0.0 0.0 99.0
Errors and Omissions -125 -86.0 -37.0 -69.0 -48.0 - - -
Overall Balance -30 -18.0 3.0 44.0 -2.0 5.0 11.0 27.0
Financing 30 18.0 -3.0 -44.0 2.0 -5.0 -11.0 -27.0Change in Foreign Reserves 30 18.0 -3.0 -44.0 2.0 -25.0 -46.0 -47.0IMF (Net)Additional financing needs 0 0.0 0.0 0.0 0.0 20.0 35.0 20.0
Note: Figures are rounded.Source:
Actual data: Lao authorities and Bank and Fund staff estimates. Estimates and projections: World Bank and IMF.
FMAC - Statistical AnnexPage 5 of 8
LAO PDR1 KEY EXPOSURE INDICATORS(USS rnillion)
Prel Projected1997 1998 1999 2000 2001 2002 2003 2004
Total debt outstandinganddisbursed(TDOD) 955 1,087 1,178 1,220 1,571 1,540 1,507 1,475
PublicMultilateral 889 971 1,039 1,042 1,089 1,068 1,045 1,021Bilateral 67 115 125 129 433 429 426 424
Others 14.4 48.5 48.9 42.5 36.0 29.6
Key Debt Service Indicators (%/.)
Total debtVGDP 55.9 84.5 80.0 70.1 89.6 86.4 79.1 71.2DebtservicetXGNFS 11.7 11.3 18.7 20.8 21.1 21.8 22.0 226
Note: Figures are rounded.Source:
Actual data: Lao authorities and Bank and Fund staffestirmtes. Estirmtes and projections World Bank and IMF.
FMAC - Statistical AnnexPage 6 of 8
Financial Management Adjustment CreditSelected Indicators of Bank Portfolio Performance and Management
(As of May 15. 2002)
Indicator 1999 2000 2001 2002
Portfolio AssessmentNumber of project under implementation a/ 10 10 10 9Average Implementation Period (years) b/ 3.4 4.4 3.9 4.5Percent of problem projects by number a/ c/ 20 30 10 11.1Percent of problem projects by amount a! c/ 37.6 28.5 14.8 17.0Percent of projects at risk by number a/ d/ 20 40 30 33.3Percent of projects at risk by amount a/ d/ 37.6 37.9 43.6 41.6Disbursement ratio (5) e/ 18.8 12.3 25.1 20.8
Portfolio ManagementCPR during the year (yes/no) yes yes yes
Memorandum Item Since FY 80 Last Five FYs
Project evaluated by OED by number 19 6Project evaluated by OED by amount (US$ million) 355.3 122.0Percent of OED projects rated U or HU by number 36.8 33.3Percent of OED projects rated U or HU by amount 19.7 19.1
Note:a. as shown in the Annual Report on Portfolio Performance (except for current FY).b. Average age of projects in the Bank's country portfolio.c. Percent of projects rated U or HU on development objectives (DO) and/or implementation
progress (IP).d. As defined under the Portfolio Improvement Program.e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the
beginning of the year: investment project only.
* All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio,which includes all active projects as well as projects which exited during the fiscal yea
FMAC - Statistical AnnexPage 7 of 8
Lao People's Democratic RepublicStatus of Bank Group Operations
As of Date 05/15/2002Closed Projects: 20
IBRD/IDA *Total Disbursed (Active) 91.56
of which has been repaid 0.00Total Disbursed (Closed) 384.85
of which has been repaid 18.00Total Disbursed (Active + Closed) 476.41
of which has been repaid 18.00Total Undisbursed (Active) 97.89Total Undisbursed (Closed) 1.09Total Undisbursed (Active + Closed) 98.98
Active ProjectsBoard Last PSR Original Amount in US$ Millions Difference betweenDate Supervision Rating Expected and ActualFiscal DisbursementsYear Active Projects Development Implementation IBRD IDA Cancel. Undisb. Orig. Revised
Objectives Progress1999 P059305 Distribution Upland Dev. S S 2.0 0.6 0.72001 P065973 Agricultural Development S S 16.7 16.2 -0.31995 P004200 Health System Reform S S 19.2 6.9 9.0 0.31997 P004210 Highway Improvement III S S 48.0 8.4 10.51996 P004208 Land Titling S S 20.7 11.2 8.7 3.31994 P004207 Luang Namtha S S 9.7 0.2 0.21999 P042237 Provincial Infrastructure. S S 27.8 16.6 5.12001 P064821 Road Maintenance S S 25.0 21.3 1.6
Southern Province1998 P044973 Rehabilitation U S 34.7 16.5 6.1
OverallResult result 203.8 97.9 41.7 3.6
FMAC - Statistical AnnexPage 8 of 8
Lao People's Democratic RepublicStatement of IFC's
Held and Disbursed PortfolioAs of 5/01/2002
(In US Dollars Millions)
Held DisbursedFiscal Company Loan Equity Quasi Participation Loan Equity Quasi- ParticipationYear Equity. Equity
ApprovalSEF
1998 BAFCO 0.77 0 0 0 0.77 0 0 0SEF
1998 Endeavor 0.15 0 0 0 0.15 0 0 01998/00 SEF Settha 0.18 0 0 0 0.18 0 0 0
SEF Villa2001 Santi 1.15 0 0 0 1.15 0 0 0
TotalPortfolio: 2.25 0 0 0 2.25 0 0 0
IMAGING
Report No.: P 7526 LAType: PR