LAOS: IMF HINTS AT POSSIBLE MACROECONOMIC

UNCLAS VIENTIANE 000264

SENSITIVE
SIPDIS

STATE FOR EAP/MLS
STATE PASS TREASURY FOR SUSAN CHUN
STATE PASS COMMERCE FOR HPPHO

E.O. 12958: N/A
TAGS: ECON EFIN EINV EAID PREL LA
SUBJECT: LAOS: IMF HINTS AT POSSIBLE MACROECONOMIC
INSTABILITY

REF: VIENTIANE 179


1. (SBU) Summary: On May 27, a visiting IMF Article IV team
briefed interested donors. While not changing their
projected 2009 growth rate from 4.5%, the team noted that the
Government of Laos (GOL) must make tough choices in the next
18 months to avoid putting macroeconomic stability at risk.
Policy changes are required to lower a budget deficit now
grown to an estimated 8% of GDP, and off-budget expenditures
by the Bank of Laos should be minimized. Credit growth,
which expanded 80% in the last year, must be slowed to ensure
that a new wave of non-performing loans (NPLs) does not once
again bankrupt the state-owned commercial banks. The
government has approached donors, such as Japan and Korea, to
request concessional budget support and is so far striving to
minimize spending cuts. End Summary.


2. (SBU) An IMF team, led by senior economist Susan Baker
from Washington, DC and including senior resident
representative Benjamin Bingham, visited Laos for two weeks
in May for Article IV consultations with the GOL. On May 27,
the team gave a short briefing for donors to sketch the
results of the confidential discussions. The Article IV
report should be finished by early July, and will be
published soon afterwards if the GOL concurs (which it has
the past few years). According to the team, this mission,
which examined a broader range of economic indicators than
during a March visit (reftel),continues to expect 2009
economic growth of 4.5%, which should jump to 5% in 2010 as a
result of the Nam Theun II dam beginning operations.


3. (SBU) After forecasting a resumption of global growth in
2011, the team stated that the next 18 months would be "quite
challenging" due to dangerously expansionary fiscal and
monetary policies by the GOL, which the IMF believes places
macroeconomic stability at risk. Large off-budget
expenditures, directly financed by the Bank of Laos, for the
South East Asia (SEA) Games and the 450th Anniversary of
Vientiane, are contributing to a growing fiscal deficit now
estimated at 8% of GDP (versus 6.5% in March). If the
off-budget items are not counted, the deficit is
approximately 5.6% of GDP. Ms. Baker noted that foreign
reserves have already dropped by $100 million over the past
year, with a continued drop forecast unless the government
cuts expenditures. (Note: This drop would indicate reserves
of about $689 million, based on available information.
Reserves now are about twice what was available in 2006. End
note.) Despite this drop, the team suggested that reserves
continue to equal about 5 months of imports, although they
noted that projected imports had also fallen in their models.
As reserves fall towards three months of imports, the IMF
believes the chances of an exchange rate shock will rise.


4. (SBU) According to the IMF, the deficit has increased
primarily due to increased new spending, not a greater than
expected shortfall in revenue. Credit growth, primarily at
the state-owned commercial banks, is up 80% in the past year.
The quality of these loans is in doubt--private banks told
the IMF they were not seeing a large increase in profitable
projects, and the state-owned banks themselves are not known
for quality risk management. Combined with the BOL's
off-budget financing operations, the IMF team told the donors
it was worried the GOL would avoid cutting spending in light
of the large ongoing public projects and the government's
insistence that the economy will grow at 7.5% in 2009.


5. (SBU) COMMENT: Although constrained by confidentiality,
the IMF team's message was clear -- the GOL is spending
beyond its means and could soon find itself with dangerously
low foreign reserves and a banking sector burdened with large
numbers of non-performing loans. An exchange rate shock, and
the loss of macroeconomic stability, is a possibility.
Although the recommended policy choices do not appear overly
burdensome -- cut the deficit by 1.5% and slow credit growth
-- it is likely the GOL will search for donors to help cover
the fiscal gap while simultaneously hoping the IMF's
prediction for stronger global growth in 2011 produces enough
revenue to counter any difficulties. There has been little
interest among most donors in extending serious budget
support, although both Korea and Japan have been approached
by the GOL and, along with China, are the most likely
contributors. End Comment.
HUSO