Country Report

Laos

April 2006

The Economist Intelligence Unit 26 Red Lion Square, London WC1R 4HQ United Kingdom

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Laos 1

Contents

Laos

2 Summary

3 Political structure

4 Economic structure 4 Annual indicators 5 Quarterly indicators

6 Outlook for 2006-07 6 Political outlook 7 Economic policy outlook 8 Economic forecast

11 The political scene

13 Economic policy

15 The domestic economy 15 Economic trends 16 Agriculture 17 Industry 18 Infrastructure 20 Services

21 Foreign trade and payments

List of tables 8 International assumptions summary 10 Forecast summary 21 Trade with Thailand

List of figures 11 Gross domestic product 11 Consumer price inflation 17 Exchange rates

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Laos April 2006 Summary

Outlook for 2006-07 The ruling Lao People's Revolutionary Party (LPRP) will remain firmly in control in 2006-07. There is unlikely to be any change in the party's ideology or policies following the appointment of Choummaly Sayasone as the party's new chief in March 2006. The pace of economic reform will remain gradual, although the government's efforts to join the World Trade Organisation (WTO) may provide some impetus. Economic growth will remain robust, supported by trade growth and increased investment from Laos's neighbours. Consumer price inflation will ease steadily, remaining in single digits. Despite rising exports, the current- account deficit will remain large in 2006-07.

The political scene The LPRP has held its eighth party congress, and Choummaly has succeeded Khamtay Siphandone as the party's general secretary. There were few other major changes during the congress in March, although younger and fresher faces are appearing in the leadership hierarchy. Preparations for the April 30th National Assembly (the legislature) elections have progressed well, with 175 candidates set to contest 115 seats. The LPRP has maintained close ties with Laos's neighbours in recent months, most notably with Myanmar (Burma) and Cambodia.

Economic policy The IMF has praised the government for its "disciplined economic management", but the Fund's directors have warned that there are policy challenges facing the government. The sixth five-year National Socio-Economic Development Plan has been formulated, with the state's role set to remain important. However, the party continues to recognise that other sectors should be encouraged to help to strengthen the economy.

The domestic economy Inflation has remained high, particularly in the north of the country, but the kip has strengthened against the US dollar. Investment in rubber production has expanded, and the mining sector remains highly active. There has also been continued foreign interest in hydropower projects. Problems remain in rural utilities, but telecoms usage and coverage has expanded. The tourism industry continues to thrive as international arrivals increase.

Foreign trade and payments Trade with Thailand has increased, whereas exports to the US have finally started to rise sharply following the granting of normal trade relations status in 2004. Foreign aid has continued to flow in, with Japan remaining a leading benefactor. Editors: Danny Richards (editor); Gerard Walsh (consulting editor) Editorial closing date: April 5th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Lao People's Democratic Republic

Form of state One-party rule

The executive The Council of Ministers is the highest executive body; the vice-chairmen of the council (deputy prime ministers) oversee the work of ministers; all members of the council are appointed by the chairman of the Council of Ministers (the prime minister)

Head of state The president-elect, General Choummaly Sayasone

National legislature A unicameral National Assembly; membership will expand to 115 seats in the 2006 election

National elections The last National Assembly election took place on February 24th 2002; the next election will be held on April 30th 2006

National government The Lao People's Revolutionary Party (LPRP) dominates the government and bureaucracy

Main political organisations Lao Front for National Reconstruction (LFNR), an umbrella organisation, the main component of which is the LPRP

Main members of Council Prime minister Bounyang Vorachit of Ministers Deputy prime ministers Somsavat Lengsavad Thongloun Sisoulith Asang Laoly Bouasone Bounphavanh State Planning & Co-operation Committee president Thongloun Sisoulith

Key ministers Agriculture & forestry Siene Sapangthong Commerce & tourism Soulivong Daravong Communications, transport, posts & construction Bouathong Vonglokham Defence Douangchay Pichit Education Phimmasone Leuangkhamma Finance Chansy Phosikham Foreign affairs Somsavat Lengsavad Industry & handicrafts Onnueua Phommachanh Information & culture Mounkeo Ouraboun Justice Kham Ouane Boupha Labour & social welfare Somphanh Phengkhammy Public health Ponemek Daraloy Security Thongban Sengaphone

Central bank governor Phouphet Khamphungvong (acting)

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Economic structure

Annual indicators 2001a 2002a 2003 a 2004 a 2005b GDP at market prices K bn 15,702 21,499 25,600 29,204 33,877 GDP US$ bn 1.8 2.1 2.4 2.8 3.2 Real GDP growth (%) 5.8 10.6 6.6 5.0 7.0 Consumer price inflation (av; %) 7.8 10.6 15.5 10.5 7.0 Population (m) 5.4 5.5 5.7 5.8 5.9 Exports of goods fob (US$ m) 311 298 359 361 – Imports of goods cif (US$ m) 528 431 482 506 – Current-account balance (US$ m) -82 – – – – Foreign-exchange reserves excl gold (US$ m) 131 192 209 223 – Exchange rate (av) K:US$ 8,955 10,056 10,569 10,586 10,655 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003 % of total Agriculture & forestry 48.6 Industry (incl construction) 25.9 Services 25.5 GDP at factor cost 100.0

Principal exports 2003 % of total Principal imports 2003 % of total Garments 26.2 Consumption goods 49.2 Timber & wood products 23.3 Construction & electrical equipment 12.1 Electricity 22.7 Materials for garment industry 10.6 Coffee 4.5 Machinery & equipment 10.2

Main destinations of exports 2004 % of total Main origins of imports 2004 % of total Thailand 19.3 Thailand 60.5 Vietnam 13.4 China 10.3 France 8.0 Vietnam 7.1 Germany 5.3 Singapore 4.0 UK 5.0 Germany 2.6

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Quarterly indicators 2003 2004 2005 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Prices Consumer prices (2000=100) 143.8 145.5 151.9 156.2 155.1 155.9 160.9 166.9 Consumer prices (% change, year on year) 13.6 12.5 12.4 9.5 7.9 7.1 5.9 6.9 Financial indicators Exchange rate K:US$ (av) 10,476 10,429 10,557 10,810 10,547 10,341 10,577 10,872 Exchange rate K:US$ (end-period) 10,467 10,461 10,779 10,879 10,377 10,437 10,751 10,887 Bank rate (end-period; %) 20.00 20.00 20.00 20.00 20.00 n/a n/a n/a Deposit rate (av; %) 8.33 10.33 8.00 6.83 6.25 n/a n/a n/a Lending rate (av; %) 27.00 27.00 30.00 30.00 30.00 n/a n/a n/a Treasury bill rate (av;%) 21.68 21.68 21.23 19.31 19.25 n/a n/a n/a M1 (end-period; K bn) 836.54 1,039.23 1,000.08 1,056.31 1,207.29 1,260.73 1,170.76 1,189.23 M1 (% change, year on year) 42.5 36.9 35.1 40.1 44.3 21.3 17.1 12.6 M2 (end-period; K bn) 4,237.9 4,662.7 4,842.3 5,009.7 5,154.9 5,254.1 5,139.5 5,203.1 M2 (% change, year on year) 20.1 21.7 21.8 22.8 21.6 12.7 6.1 3.9 Sectoral trends Rice production (annual totals; '000 tonnes)a 2,375 ( 2,529 ) ( 2,350 ) Foreign trade (US$ m) Exports fob 80.8 94.4 85.7 87.0 94.0 135.0 137.0 109.9 Imports cif -130.8 -141.5 -117.4 -115.1 -131.8 -199.8 -182.7 -169.1 Trade balance -50.0 -47.1 -31.7 -28.1 -37.8 -64.8 -45.7 -59.2 Foreign reserves (US$ m) Reserves excl gold (end-period) 208.59 205.94 221.80 215.64 223.25 218.81 226.28 117.49 a Estimate for 2005. Sources: UN Food and Agriculture Organisation; IMF, International Financial Statistics.

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Outlook for 2006-07

Political outlook

Domestic politics The ruling Lao People's Revolutionary Party (LPRP) will maintain a firm grip on power in 2006-07. During the LPRP's eighth party congress, which took place in late March, there was a traditional round of reshuffles in the Politburo and Central Committee designed primarily to consolidate the party and the military's control of Lao politics. The most notable change in personnel during the congress was the appointment of Choummaly Sayasone as the party's general secretary and president elect, replacing Khamtay Siphandone, who retired after spending 14 years at the party's helm. This change at the top of the party, however, is not expected to bring about any major change in party ideology or policy. The LPRP's congress, which takes place every five years, will not be the only major political event during the first half of this year. Elections for the National Assembly (the legislature) will take place on April 30th, a year early, ostensibly to coincide with the LPRP congress. Members of the newly elected legislature will be expected to rubber-stamp the government reshuffles announced at the congress. National Assembly candidates have been selected according to their "suitability" and have been issued with instructions on how to campaign. The National Assembly has been expanded in size, but it will comprise only party members, and a major shift towards an independent and assertive legislature is not expected. Security and internal peace has been maintained across the country in recent months, and bombing incidents and rural gun fights appear to have halted, at least temporarily. This may be because of increased efficiency and vigilance among the security forces, who have been aided by personnel and training offered by Vietnam, or because the government has at last reached a settlement of some kind with disaffected ethnic Hmong groups, who have largely been blamed for bombing incidents. Many such Hmong have fled to Thailand in search of asylum, whereas others have surrendered and been granted land and housing. The majority of Hmong communities in the country appear to enjoy improving economic and social conditions, and a Hmong woman, Pany Yathortou, has been appointed to the Politburo. There are other less plausible theories behind this trend of increased peace and security, namely, that the bombing campaigns were actually a symptom of internal struggles within the LPRP and the government, and were suspended as the compromises of the eighth party congress were thrashed out in closed meetings over the past few months. There is no sign that political opposition inside the country is either being organised or repressed, as those who do not have faith in the present system continue to keep quiet. Opposition to the government remains loudly voiced in the Lao diaspora, but the assassination of a Lao royalist figure in Thailand early in 2006 will not have helped the organisation of such dissident groups.

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International relations The LPRP has pushed ahead with a policy of international integration, while re- emphasising its ties to its traditional allies, Vietnam and China. The government continues to seek to attract foreign aid and investment, capitalising on the interest shown in the country by Japan, Australia and France, while attracting new aid and investment from a number of other countries, including the US and South Korea. Laos, one of the four least-developed nations in the Association of South-East Asian Nations (ASEAN), will continue to cultivate stronger ties with the other three—Cambodia, Myanmar and Vietnam. All four countries, known as the "CLMV", have agreed to improve co-operation in order to boost economic growth.

Economic policy outlook

Policy trends At the eighth LPRP congress in March Khamtay, the outgoing party chief, announced that the country's economy would be switched from "slow placed and unsteady development to faster and more stable progress". Although much of the congress rhetoric is traditional party propaganda, there is little doubt that the pace of economic change is picking up. However, economic management remains weak and the overall situation fragile, mainly owing to the long- standing problem of loss-making state-owned enterprises (SOEs) that continue to enjoy the credit facilities of the state banking system. Lack of structural reforms in this area are hindering development of the economy as a whole, and despite government pronouncements recognising the need for reform, resistance from vested interests in the ruling class renders progress difficult. In other areas progress will be more rapid. There will be improvements in the overall quality of Laos's business environment in 2006-07, in line with the introduction of a new enterprise law and amendments to the foreign investment law. The government is also expected to make solid progress on international trade reform over the next few years. It has begun formal negotiations to join the World Trade Organisation (WTO). A target date has not yet been set for the country's accession to the WTO, but it is probably no more than two or three years away.

Fiscal policy The government will continue to face a number of fiscal policy challenges in 2006-07, namely those of strengthening its revenue base and improving public expenditure management. There have been rumours that the government is considering substantial tax increases for foreign workers in Laos and for foreign invested companies. The latter seems unlikely given the government's desire for more overseas investment, but foreign workers currently enjoy low tax rates that are not part of constitutional law, but merely extended by the grace of a presidential decree. Spending is set to increase, provided that reforms aimed at substantially raising government revenue are actually pushed through. The IMF continues to encourage a wider and more efficient tax regime that incorporates a value-added tax (VAT) system, but despite official approval of such policies, action remains slow in these areas. The goal is to ensure that a VAT regime is in place before the government completes its tariff reduction obligations as part of the ASEAN free-trade area (AFTA) in 2008, as lower import tariffs will obviously mean less revenue from this source. Over the next few years the

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government's target is to keep the budget deficit excluding grants (which is financed largely by external loans) below 9% of GDP. (Our figures are for the budget deficit including grants, and are based on series provided by the IMF.)

Monetary policy There is unlikely to be any marked improvement in the conduct of monetary policy in 2006-07, with the government's fiscal policy concerns taking centre stage and the Bank of the Lao People's Democratic Republic (the central bank) remaining largely ineffective. The main challenge facing the central bank remains that of reining in money supply growth. In its 2005 Article IV consultations, the IMF's directors welcomed the Lao authorities' intention to continue to gear monetary policy towards reducing inflation, and they agreed that the central bank's net domestic assets should remain the main anchor of monetary policy. There will be steady improvements in the competitiveness of the banking system following gradual reforms (such as the lowering of entry barriers) initiated by the central bank, but politically directed lending remains a problem, and non-performing loans held by state-owned commercial banks (SOCBs) will continue to be a concern. Indeed, the Fund has noted that rapid credit expansion by SOCBs posed a risk to monetary stability.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2004 2005 2006 2007 Real GDP growth World 5.1 4.6 4.3 4.1 OECD 3.2 2.6 2.5 2.3 EU25 2.4 1.6 2.1 2.3 Exchange rates ¥:US$ 108.1 110.1 113.3 104.5 US$:€ 1.244 1.245 1.248 1.338 SDR:US$ 0.675 0.677 0.681 0.653 Financial indicators € 3-month interbank rate 2.13 2.15 2.90 3.69 US$ 3-month Libor 1.62 3.56 5.32 4.95 Commodity prices Oil (Brent; US$/b) 38.5 54.7 60.0 55.3 Gold (US$/troy oz) 409.5 445.0 525.0 500.0 Food, feedstuffs & beverages (% change in US$ terms) 8.5 -0.2 -0.5 -2.3 Industrial raw materials (% change in US$ terms) 21.0 10.5 11.7 -15.8 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Global GDP growth slowed to an estimated 4.6% in 2005. A further modest slowdown is forecast for this year and next, with global growth averaging 4.3% in 2006 and 4.1% in 2007. The Economist Intelligence Unit forecasts that GDP growth in the US will slow in 2006-07, but growth in the EU, which is an important export destination for Laos, will pick up during this period. Asia and Australasia (excluding Japan) will enjoy the fastest rate of expansion of any world region in 2006-07, with Vietnam's economy set to remain robust and Thailand's GDP growth rate picking up after dipping in 2005. Average annual

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prices for crude oil (dated Brent Blend) will rise further in 2006 before falling by 7.9% in 2007, thereby easing domestic inflationary pressures that have been caused by rising retail fuel prices. Global prices for food, feedstuffs and beverages will also fall in 2006-07.

Economic growth Economic growth in 2006-07 is set to remain healthy, at around 6-7% a year, driven primarily by an expansion in industry, which has been growing at double-digit rates. The main drivers of industrial growth will continue to be construction and mining. Construction will be boosted by the rising number of infrastructure development projects, particularly in the areas of road- and bridge-building and also power generation. Construction of the US$1.2bn Nam Theun II hydroelectric power project commenced in November 2005. The outlook for the mining sector is positive, following an expansion of gold and copper mining, mainly by Australian mining firms. Manufacturing, however, will remain weak, with the garment sector suffering from a lack of competitiveness. Agriculture will remain vulnerable to adverse weather conditions (such as drought and flooding), with a heavy reliance on rice. However, the government is increasingly keen to support farmers, partly through foreign aid, in dealing with such problems. The outlook for services is mixed. The tourism industry will continue to expand, but security concerns and the country's weak infrastructure will prevent the industry from achieving its full potential. Demand for trade-related services will increase as merchandise export growth strengthens, but growth in financial services will remain slow, owing to the continued weakness of the banking sector.

Inflation Average annual consumer price inflation is estimated to have eased to around 7.2% in 2005, down from 10.5% in 2004. Inflationary pressure in 2005 largely emanated from rising prices for food and fuel. In view of the expectation that prices for rice and fuel will be relatively more stable in 2006-07 (global rice prices are set to fall during this period, while crude oil prices will fall in 2007), inflation will ease further over the next two years. Upward price pressures, however, will generally persist owing to the high budget deficits and fairly rapid growth in money supply.

Exchange rates The kip depreciated steadily against the US dollar in 2005, weakening by an annual average of around 0.7% year on year. However, in late 2005 the kip began to strengthen against the US dollar, and this trend continued into early 2006, reversing the depreciation recorded over the past year. Indeed, the kip was trading at around K10,360:US$1 at the end of March, reflecting a year-on- year appreciation of nearly 1%. In 2006 the kip will remain fairly strong, partly because of rising domestic confidence in line with the buoyant economy, but also reflecting the general weakness of the US dollar against most major currencies. However, the kip will still be vulnerable to downward pressure owing to the large government budget deficit and the widening trade and current-account deficits. The government's ability to defend the currency remains hampered by its meagre foreign-exchange reserves.

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External sector Laos's exports are forecast to continue to expand in 2006-07, but the pace of growth will be below that recorded in 2005—robust demand in Laos's main export markets, particularly Thailand and Vietnam, in addition to high prices for its mining commodities, gold and copper, contributed to a sharp rise in exports in 2005. Although the US remains a relatively minor export destination, exports to the US will expand rapidly over the next few years, boosted by the granting of normal trade relations (NTR) status by the US in late 2004. Exports with the most potential for expansion include furniture, textiles and handicrafts. However, the poor competitiveness of the garment industry will prevent Laos from obtaining the full benefit of greater access to US markets. Despite continued growth in exports, the merchandise trade deficit will widen as the import bill expands, primarily because of imports of construction materials and machinery for new mining and hydropower projects. This forecast also reflects the expectation that lower tariff barriers in line with ASEAN Free-Trade Area (AFTA) commitments combined with the poor competitiveness of local products, will lead to robust growth in imports of consumer goods. The surplus on the services account will continue to rise in line with the expanding tourism industry, but this will only partly offset the merchandise trade deficit. The surplus on the transfers account will also continue to be offset by the deficit on the income account, with the latter rising as profits are remitted from foreign-invested mining projects. As a result of these trends, the current-account deficit will remain around 15-16% of GDP in 2006-07 (based on recently revised historical current-account data published by the IMF). This raises major concerns over the deficit's sustainability, but inflows of aid and investment in mining and power projects should be sufficient to cover the external financing requirement.

Forecast summary (% unless otherwise indicated) 2004 a 2005 b 2006c 2007c Real GDP growth 5.0 7.0 6.5 6.5 Gross agricultural production growth 2.0 b 3.2 4.0 4.0 Consumer price inflation (av) 10.5 7.2 5.9 5.5 Lending interest rate 29.3 25.8 25.0 25.0 Central government balance (% of GDP) -3.8 b -3.7 -3.6 -3.4 Exports of goods fob (US$ bn) 0.5 0.7 0.8 0.9 Imports of goods fob (US$ bn) -1.0 -1.3 -1.5 -1.7 Current-account balance (US$ bn) -0.4 -0.5 -0.6 -0.7 Current-account balance (% of GDP) -13.1 -16.5 -14.7 -16.4 Exchange rate K:US$ (av) 10,586 10,655 10,494 10,715 Exchange rate K:¥100 (av) 9,790 9,680 9,266 10,254 Exchange rate K:€ (year-end) 14,048 12,672 13,961 14,247 Exchange rate K:SDR (year-end) 16,115 15,355 16,050 16,517 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

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Gross domestic product Consumer price inflation (% change, year on year) (av; %)

Laos Asia excl Japan Laos Asia excl Japan 12 16 14 10 12 8 10 6 8 6 4 4 2 2 0 0 02 03 04 05 06 07 02 03 04 05 06 07 2001 2001

The political scene

There is a new party chief, but The ruling Lao People's Revolutionary Party (LPRP) held its eighth party

policy remains unchanged congress in late March, during which Choummaly Sayasone replaced Khamtay Siphandone as the party's secretary general. Khamtay, an 82-year-old veteran revolutionary, had been at the helm of the party for 14 years, but his stepping aside is unlikely to bring about any major change in the way the party operates. Indeed, the promotion of Choummaly to LPRP secretary general, and effectively to president-elect, reaffirms the traditional direction of the party. Lao media, which remains under firm state control, reported the pronouncements of the congress in detail, including the president's desire that the state power system will continue forward "under the leadership of the party, with new firm steps… towards the objective of socialism". After the congress Choummaly stated that the party's members had unanimously approved the party's political report. The report outlined the party's two ambitious goals for national development: to lift the country out of the underdeveloped status by 2020, and to eradicate poverty throughout the country by 2010. Choummaly, who is an army general and revolutionary veteran from the remote southern province of Attapeu, has long been seen as the military's preferred candidate to succeed Khamtay, the last of the revolution's original leaders. It is not expected that Khamtay's retirement will see his family's economic or political influence wane. As with another former president, Nouhak Phomsavanh, who is now a "senior party adviser", Khamtay will remain a strong presence in Lao politics for as long as his health permits. Despite the predictable continuity seen at the eighth party congress, younger and fresher faces are appearing in the leadership hierarchy. During the recent congress there were two new appointments to the 11-member Politburo, with Pany Yathortou, a daughter of a Hmong revolutionary hero, becoming the first female member of the party's top body. Joining Pany as a new face in the Politburo is long-serving foreign minister and deputy prime minister, Somsavat Lengsavad. Pany, currently vice-president of the National Assembly (the legislature), is tipped to move up to the top job at the legislature after the next

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elections, whereas the current assembly president, Saman Vinhaket, has moved on to a senior party position at the top of the Politburo. Somsavat, who has generally been seen by the diplomatic community in Laos as the brave new face of a non-military and non-Vietnam-tied generation, has perhaps had to wait longer than expected for promotion because of his image as a potential reformer. Over the past few years, however, he has shown his conservative credentials by playing a patient game of polite quietness with both the international community and foreign media. Somsavat is often touted as the head of a "Chinese faction" within the government, which is sometimes supposed to be in opposition to the traditional Vietnam-allied military wing. There can be no doubt that the foreign minister, who was educated in Beijing and speaks fluent Mandarin, has an affinity with China, especially after he spoke during the congress of the benefits of enhancing co-operation with the giant northern neighbour. The party's Central Committee has also received an injection of new members, with more women and ethnic minority members being appointed to the 55- strong committee. However, the committee, which now includes two sons of the deceased revolutionary strongman Kaysone Phomvihane and one of Khamtay, remains dominated by the families at the top of Lao political life. The 11 members of the Politburo

Choummaly Sayasone: President-elect and secretary general of the ruling Lao People's Revolutionary Party (LPRP) Samane Viyaket: President of the National Assembly Thongsing Thammavong: Mayor of Vientiane Bounyang Vorachit: Prime minister Sisavath Keobounphanh: President of the Lao Front for National Construction Asang Laoly: Deputy prime minister Bouasone Bouphavanh: Deputy prime minister Thongloun Sisoulith: Deputy prime minister Douangchay Phichit: Minister of defense Somsavat Lengsavad: Deputy prime minister and foreign affairs minister Pany Yathortou: Vice-president of the National Assembly

Preparations for legislature Preparations for the sixth National Assembly elections have progressed well,

elections progress well despite being called early. (The official reason for bringing the election forward one year was so that it would coincide with the LPRP's eighth congress. The National Assembly usually follows a five-year cycle, and the next election was not due until early 2007). Around 2.7m people have been registered to vote for their representatives in the legislature on April 30th, up by around 200,000 compared with the previous election. Despite being free to vote, there is little meaningful choice in terms of candidates. All candidates who stand for election must be approved by the party-controlled Lao Front for National Reconstruction, which comprises such organisations as trade unions, peasant associations and religious and business groups. A total of 175 candidates have been selected to stand for the 115 seats available in the expanded legislature, three of whom, Thongsing Thammavong, Bouasone Bouphavanh and Thongloun Sisoulith, are Politburo members.

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Perhaps reflecting the fact that the majority of the members of the previous legislature are not standing again this year, candidates in this election have been warned to be aware of party policy and to avoid denigrating each other. In previous elections, there was a noticeable lack of any party manifesto and candidates displayed competitiveness in the hustings organised at district level. Several provincial election committees have emphasised the need to educate the electorate on how to select their preferred candidates, with many voters apparently assuming that they are supposed to vote for the candidates in the numerical order in which they are listed. Interestingly, prospective assembly delegates are not listed alphabetically or in order of age, and it does seem that the most senior party members are listed at the top of each provincial list of candidates. Each NA delegate represents approximately 50,000 Lao citizens.

LPRP maintains close ties The LPRP leadership continues to push on with its effort to integrate Laos even

with neighbours deeper into the Association of South-East Asian Nations (ASEAN), and it is particularly keen to bolster ties with neighbouring Cambodia and Myanmar (Burma). The country's close ties with Cambodia were recently symbolised by a state visit to Laos by the Cambodian monarch, King Norodom Sihamoni, in March. During his visit, which was ostensibly aimed at shoring up ties between the two countries, the Cambodian king met Khamtay, in addition to Saman and the prime minister, Bounyang Vorachit. The LPRP's relations with the State Peace and Development Council (the ruling military junta in Myanmar) were boosted in late 2005 during a meeting of leading officials in Mandalay, Myanmar, with both sides agreeing to further co- operation in a number of sectors, including law and tourism. Laos is a close ally of the military dictatorship, even receiving occasional aid from it in the form of agricultural expertise. The two countries have agreed to build a linking bridge across the Mekong, and are looking for financial backing for this project.

Economic policy

Development plans include In its 2005 Article IV consultation with the IMF, the report for which was

roles for non-state sectors published in late March this year, the government received general praise from the Fund's directors for its progress in reducing poverty and maintaining stable macroeconomic conditions. The Fund has attributed much of this success to "disciplined economic management". However, the Fund highlighted some of the challenges facing the government, most notably those of improving the trade and investment regime to enhance competitiveness and strengthening the management of public expenditure. The government has now formulated its sixth five-year National Socio-Economic Development Plan (NSEDP) for 2006-10 through which its aims to tackle some of these challenges. The reform rhetoric in the plan is impressive, but the state's role in the economy will remain important. Although the plan centres on "improving and promoting the state and people's co-operative economy", there are provisions for "encouraging economic development of other sectors so that they will render strength to the national economy". Private domestic and foreign investment is buoyant. According to the director-general of the Department of Promotion and

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Management of Domestic and Foreign Investment, Houmpheng Souralay, 143 investment projects were approved in 2005 with a combined value of around US$1.3bn. Foreign contributions are expected to fund much of the investment required to meet the targets of the NSEDP. The government has become more aggressive in attracting foreign exchange, and the signs are that this policy is set to continue. A US$350m deal signed in March allowing the Indian Aditya Birla Group to develop a wood pulp plant and plantations in southern Laos shows a new willingness on the part of the government to sign long-term agreements with foreign businesses.

A shift in the geographical focus of economic policy has also become evident, with the creation of a new "special economic zone" in the Seno area of Savannakhet Province (the Savan-Seno special zone) in late 2005 and the abolition of the old Xaysombun zone in early 2006. (The Xaysombun zone, which was closed to foreigners, was often rumoured to be a front for illicit military activities such as opium-growing, logging and fighting against Hmong rebels.) The Savan-Seno special zone is essentially a concession to Malaysian developers, Outclass Finance Incorporation. Outclass has been granted 300 ha to develop an international free-trade zone that it is touting as "the second Hong Kong". The company envisages a trade hub at the centre of the Indochina Peninsula, and a stepping stone for Chinese products entering the regional market. They also plan to transfer high-tech manufacturing plants from Malaysia and to develop garment production. According to Outclass, a large- scale Chinese bio-fertiliser producer and a jatropha bio-fuel company are negotiating rights to locate at Savan-Seno, as is an off-shore Chinese investment bank. A Middle-Eastern airline is also reported to be interested in creating an international airport and airline under the free-skies policy afforded the area by the government. The Lao authorities will take 30% of all profits generated in the zone.

Although investment in the provinces seems to be booming, the capital, Vientiane, is suffering by comparison. Although the capital has become a magnet for Lao money, with new buildings, cars and roads appearing at a frantic rate over the last three years, the Vientiane Planning and Investment Service announced that investment had dropped off in the second half of 2005. The service's deputy director, Bouakham Thipavong, has complained that the government's promotion of investment on the Internet is inadequate, and that a lack of infrastructure in industrial zones is also putting potential investors off.

There are growing calls A leading Lao economist, Dr Leeber Leebouaphao, who is the acting director of fo r competi tio n the National Economic Research Institute, has called for increased competition to stimulate the Lao economy, providing further evidence of efforts to push the country's steady march towards a market economy. In early March Dr Leeber said that the country required legislation to guarantee competition between businesses, and that such a move would lead to increased quality and quantity of production. Although the government has embraced competition to some extent, there are still strong protection mechanisms in place for leading industries, such as the airlines, and rural authorities often fail to see the benefits

Country Report April 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Laos 15

of allowing competition in their areas of jurisdiction, instead preferring to sign deals with agricultural investors that set up situations of monopsony. Laos currently has no direct laws to ensure competition, although several prime ministerial decrees have encouraged the abolition of monopolies. Dr Leeber was quoted in the national press in March as advocating a business competition policy and law to help to ensure equality between businesses and to eliminate unfair trade practices. The vice-president of the Committee for Planning and Investment, Dr Lien Thikeo, backed the call, saying that competition, supported by legislation, was important for Lao economic development.

The domestic economy

Economic trends

Inflation remains high, Although month-on-month inflation continues to fluctuate, year-on-year

particularly in the north inflation remains high, reaching 8.1% in January and 8.5% in February, according to official data. Inflation is significantly higher in the north, where tourism, Chinese migration and road building are all stimulating the local economy. Across the country, inflation in February varied from 14.6% in the main tourist destination of Luang Prabang to 7.6% in the southern province of Champassak. The consumer price index picked up by nearly 0.8% month on month in February after dipping by 0.3% in January. Changes in food prices have contributed to much of this variation. In January food prices decreased by 0.6% month on month, mainly driven by seasonally lower rice and vegetable prices in the provinces. Clothing prices also decreased as the cold season came to an end, but prices started to rise again slightly in February, with food prices rising by 1% because of high meat prices. Fuel prices also fell in January before rising again in February. In January the Bank of the Lao People's Democratic Republic (the central bank) released a K50,000 (around US$5) banknote, claiming that not only would the new notes facilitate cash transactions and increase kip utility value among users, but that they would also provide economic and monetary stability. The previous highest value banknote in circulation was the K20,000 bill, and businesses have long relied on the US dollar and the Thai baht for high value deals. Acting governor of the central bank, Phouphet Khamphunvong, in November announced moves to encourage the public to use kip in all transactions, setting up inspection units to ensure that outlets and traders quoted prices in kip rather than dollars or baht. More state and private currency exchanges have opened, and the number of automated teller machines (ATMs) has increased in Vientiane. The 50,000 kip note is rarely spotted, however, and has perhaps been held back from full circulation for fears that it will fuel inflation. Indeed, rumours abound that the central bank is to release low-value coins in a separate bid to increase the use and value of the kip.

The kip remains strong The Lao kip has strengthened against the US dollar, standing at K10,306:US$1 at the end of March compared with 10,800:US$1 in December last year. More significantly given the global weakness of the US dollar, the kip has held stable against the Thai baht, at around K265:Bt1. High demand for kip can often drive the exchange rate down at the end of a month, as businesses look for payroll cash, but the kip is also proving more attractive as the Lao economy and the capital city, Vientiane, continue to develop. In March it was frequently quoted at under K10,300:US$1, and the profits to be gained by dealing foreign currencies on the black market have, for now, all but disappeared.

Agriculture

Rubber output is set to expand Agro-business appears to be making a belated contribution to the Lao economy as the central government relaxes controls over provincial agricultural policies. Taking advantage of newly decentralised powers, and a generous domestic investment regime, provinces across Laos have embraced foreign investment in agriculture, notably from neighbouring Vietnam and China. Rubber is the in- vogue commodity, as world prices climb after a long period of depression. The latest in a series of agreements made at provincial level was the announcement that China's Junnan Biological Products Group (JPBPG) will plant 2,500 ha of rubber trees in Vientiane province this year. The deal, which was signed in March, grants a 50-year concession to JPBPG and is worth US$15m. The group will build a rubber-processing plant and export the material to China and Europe. In late February another Chinese company, Yunnan Lilieng, was granted a 500-ha concession to produce rubber in five districts of Xayaboury province for 30 years. In the southern province of Sekong, provincial authorities have declared plans to work with a Vietnamese investor to expand rubber plantations to a reported 50,000 ha over the next five years. Such plantations may raise the profile of the country but are not guaranteed to bring wide-reaching economic benefits. In some of the deals the investors appear to have secured contracts on generous terms, and the questions of land rights and labour may come back to haunt the authorities. It is possible that the

large Vietnamese operations in the south will be tended by a major influx of Vietnamese labourers, adding to the pattern of migration that has already become apparent there. Other crops are attracting investment too, with the Aditya Birla Group of India being granted a eucalyptus concession for 75 years on over 50,000 ha of land in central and southern Laos. The contract is worth US $350m. Vietnam is looking to exploit Laos's bamboo forests, whereas Thai investors have been busy moving sugarcane and maize crops to Laos, where land is not yet degraded. Despite growing interest in other crops, producers of one of country's main commodities, coffee, suffered a second consecutive year of falling output in 2005, and this year's expected yield of 6,000 tonnes is just over a quarter of the 2004 harvest, thus denying Lao producers the chance to cash in on rising world prices. Part of the problem is that rainfall has again been insufficient on the coffee-growing Bolovens Plateau in the southern province of Champassak.

Bird flu preparedness remains Laos has not suffered any major recurrence of avian influenza (bird flu) since a priority 2004, but the authorities remain keen to bolster their preparedness for such an event. In late February Germany donated more than US$2m through the UN Food and Agriculture Organisation to support Laos's efforts to prevent outbreaks of bird flu. The funds will mainly be used to improve disease control and surveillance systems, but some money will be used to finance public awareness campaigns. In January officials from the Ministry of Agriculture and Forestry met to discuss strategy plans to deal with the threat of bird flu plans. These plans include the development of disease-free management systems and efforts to enhance surveillance. Bird flu resulted in the culling and deaths of around 150,000 birds in Laos in 2004, according to official data.

Industry

Mining sector remains A Lao company, Tin Keo Bualapha, has joined the investment fervour in the

highly active mining sector, announcing in March a US$1m investment to produce tin for export to Asian countries. Tin Keo Bualapha signed a contract with the government to excavate and process tin over an area of 175 ha in Khammouane province. The company warned that all export contracts were subject to production tests that had yet to be carried out, but it was confident that its early survey predictions would be proved correct. The company plans to export the tin to Vietnam, Thailand, Malaysia and China. Nine more investment projects are currently surveying for tin in Laos, six of them in Khammouane. The Sepon copper- and goldmine, owned and operated by Lane Xang Minerals, a local subsidiary of Australia's Oxiana Resources, in southern Laos continues to expand and exceed production targets. Oxiana recently announced that gold reserves at Sepon are 900,000 oz (25.4 tonnes) smaller than previously estimated, but there remains the prospect of future finds in the area. Meanwhile, after numerous delays, the Phu Bia mine, which is operated by Australia's Pan Australian Resources, has begun pouring and shipping gold under difficult conditions in Xieng Khouang province, and is expected to bring in substantial revenue for the area and the government, which owns a 10%

stake in the mine. In late March Pan Australian Resources announced plans to move ahead with the Phu Kham copper and goldmine. Construction of the mine could be completed in 2007, with production set to commence in 2008. The firm is expecting to be capable of producing about 50,000 tonnes of copper, 100,000 oz of gold and 400,000 oz of silver a year

The hydropower rush Since the 1980s Laos has been looking for international partners to develop the gathers pace country's potential for hydroelectric power generation. Construction work is well underway on the large 1,070 mw Nam Theun II Hydroelectric Project and the government is now pressing forward with long-established plans to develop several other potential hydropower sites in Laos. The Nam Theun II project is reported to be approximately 10% complete, with the Nam Theun River being successfully diverted in early March. The dam is set to become operational in the second half of 2009. In late March the Mega First Corporation Berhad (MFCB) of Malaysia signed a deal to survey the Don Sahong hydro-project in Champassak. If the US$300m project goes ahead, it will generate around 240 mw for both domestic consumption and export. A memorandum for a new 465-mw hydropower project worth US$535m in Attapeu province was also signed with a Vietnamese consortium in March. The group, Viet-Lao Power Investment and Development Joint-Stock Company, had already signed a construction agreement in late 2005 for a separate project, Xekaman III, in the same province, with a quoted value of US$273m. There is also Russian interest in Laos's hydropower potential. In March the Russian Regional Oil Company signed a memorandum of understanding with the Laos government to survey the 470-mw Xekong IV hydropower project. In late 2005 the firm also signed an agreement related to three other hydropower projects with a combined capacity of 573 mw and total investment of US$680m.

Infrastructure

Problems remain in Water and electricity services continue to improve in urban centres, whereas rural utilities most rural areas remain without any utilities. A US$5.6m water treatment plant in Vientiane is expected to open in June, several months behind schedule. The plant, the third in Vientiane, is expected to solve water supply problems for over 100,000 people in the capital. Laos was acclaimed as a world leader in urban water regulation and improvements at a major water engineering conference held in Vientiane in 2004. However, the rural sector continues to lag behind with more than 5,000 Lao villages (44% of the national total) still having no access to clean water. Despite this, donors and domestic investors continue to channel most effort to urban projects, as evidenced by a recent US$9m loan from the OPEC Fund for International Development to finance water supply in 11 towns in northern and central Laos. Lao consumers currently pay under cost-price for water and electricity, but rates are steadily climbing as the government relaxes controls. Unpaid utility bills continue to hinder development in both these sectors, with state agencies being

the worst offenders. In early 2006 the state-owned electricity provider, Electricité du Laos, declared that the electricity supply to all defaulting farmers would be cut off after one month, though political pressure appears to have rendered this threat idle.

Telecoms usage and In the five years since the monopoly of state telecommunications provider Lao

coverage grows Telecom (Laotel, a joint venture between the state and Thailand's Shin Satellite) ended, fixed-line telephone use has grown from three phones per hundred people to ten phones. Telecom networks now cover 80% of towns and 60% of rural villages, and the director-general of Laotel, Houmphanh Intharath, stated in March that he believed that his company's network would continue to expand by 5-8% per year, meaning that full coverage will be possible by 2010. Laotel itself remains under pressure from increasing competition, particularly in the Internet and mobile-telephone markets. However, the company plans to expand and improve its services, particularly in the north of the country. In late January Houmphanh announced that Laotel would invest more than US$25m for this purpose, and that the company aimed to increase its customer base to 560,000 to 600,000 by end-2006 up from its current base of 470,000. Laotel's main competitor in the mobile sector is Millicom Lao, a joint venture between Luxembourg-based Millicom and the government, which operates the "Tango" service. The company has revolutionised the mobile sector in Laos since it came into operation in 2003 through slick first-world marketing and professional customer service. Laotel has tried to respond, opening an impressive customer-service centre in Vientiane at the beginning of 2006, but its service remains beset by technical limitations. Enterprise Telecommunications Lao, a state company that split from Laotel in 2001, announced in March that it would invest US$10m in developing networks in neighbouring China, Cambodia and Myanmar. The company currently has 200,000 customer numbers and is aiming to increase this to 700,000 in the next four years.

Road construction is Work commenced in early 2006 on the Japanese-funded road from Vientiane's picking up Wattay International airport to the Friendship Bridge, which spans the Mekong River to link the capital to Thailand. The first phase of the 25.6-km road is reported to cost ¥2.9bn (US$26m). The development of roads also continues in other parts of the country, with a 146-km road through Khammouane Province to the Vietnamese border opening in March 2006. This is the first large-scale road project to have been designed by Lao engineers and funded by the Lao government. The area around this road and the neighbouring districts of Savannakhet province is the Seno-Savannakhet Special Economic Zone. In the north and south of the country major roads are under construction. The North-South corridor, linking Bangkok and Yunnan, passes through the north- western provinces of Bokeo and Luang Namtha, whereas the East-West corridor between Burma and Vietnam runs the whole width of Savannakhet province, in the south of Laos. This road is approaching completion, but has been delayed by the accident that occurred in 2005 during construction of the third Mekong bridge between Savannakhet city and the Thai town of Mukdahan. In

theory, this link gives Laos easy access to the Vietnamese port of Danang, though in practice the difficulty of safely transporting freight through Vietnam means that Lao exporters continue to use the expensive overland route to Bangkok ports. Thai-Vietnamese trade is already booming along the road through Savannakhet, and many rural villages have been relocated to alongside the road. However, few have yet managed to use this resource for their own economic benefit.

Services

Tourists are increasingly The tourism industry continues to expand, and the country's main tourism

drawn to Laos destination, Luang Prabang, played to host the Mekong Tourism Investment Summit at the end of March, with public- and private-sector tourism professionals meeting together to discuss ways to encourage growth in the sector. During the summit, the Lao National Tourism Administration (NTA) released a report, in which it stated that total international arrivals reached nearly 1.1m in 2005, earning US$146m in foreign currency up from US$113m in 2002. The expansion in tourism is most evident when considering the increase in arrivals at Luang Prabang airport as the first point of entry, more than 33,000 in 2005 compared with less than 4,000 in 2001. The infrastructure available to guests is improving, with regular hotel and guest house openings in the major cities. According to the NTA, in 2005 the number of hotels rose to 165 from 148 in 2004, whereas the number of guesthouses increased by more than 100 to 923 during the same period. There could be even faster growth in tourism in Luang Prabang, which is a Unesco World Heritage Site and was voted by Germany's Wanderlust magazine as the world's top tourism destination in 2005. Bangkok Airways, a privately owned Thai airline, has revealed plans to build a new airport for the city. In early April the airline's chief executive, Prasert Prasarttong-Osoth, said that his company was ready to invest in building a new airport, but it had yet to formally propose such plans to the Lao government. Most of the tourist arrivals in 2005 comprised Thai nationals, around 603,000, followed by visitors from Vietnam (around 165,000), the US (47,427), China (39,210) and France (35,371). Chinese tourists continue to grow in number and spending power, and Chinese developers have now moved into Laos to tap this market. Construction of the Golden Boten City in Luang Namtha began in late 2004 and is scheduled to last ten years. The Chinese group building the city, on over 1,640 ha of land, believe that over 1m Chinese travellers pass through the border post of Boten every year, and thus are willing to invest US$103m just in the first three years of the project. According to project director, Wong Man Suen, the company is building warehouses for storing materials from abroad, international meeting centres, agricultural and industrial processing factories and entertainment venues. Five ethnic minority villages were resettled to make way for the development.

Air transport agreement could Overhead flyover fees for aeroplanes crossing the country have been a

help to boost tourism traditionally high earner of foreign income for the country, making the Department of Civil Aviation a strategic office in the government. The department is planning to increase revenue, but it could be held back by having to satisfy the political conditions laid upon it. As a member of the CLMV sub- regional air transport group (comprising Cambodia, Laos, Myanmar and Vietnam), the department hosted a meeting in March to develop unlimited travel between these countries. Laos, Myanmar and Vietnam have accepted the multilateral agreement, but Cambodia has yet to agree to the deal. The state-owned national airline, Lao Airlines, continues to be a thorn in the side of the nation's economy, with successive prospective investors in the ailing state carrier put off by the government's reluctance to scrap the two-tier payment system. Lao nationals currently pay a fraction of the normal fare when using the airline domestically. Lao Airlines now has no jets, depending solely on two ATR turbo-props to cover most of its schedule. However, in a positive step for the airline, it signed an agreement with the Thai national airline, Thai Airways International, in late March, under which the two airlines will launch joint routes.

Foreign trade and payments

Exports to Thailand and the Official data for trade have not been updated since our previous report, with US are rising the latest data release showing that Laos recorded a merchandise trade deficit of US$169.7m during the first three quarters of 2005. More recent data, however, are available for trade with Thailand. According to the Bank of Thailand (Thailand's central bank), Laos's exports to Thailand have been rising rapidly, nearly doubling year on year in 2005 to US$224m. The pace of growth in exports to Thailand was even more rapid in early 2006, with exports rising to around US$71m in January-February, more than four times the level in the year- earlier period. Thai exports to Laos have also risen, reaching US$775m in 2005 (up by 33% year on year) and US$161m in January-February this year (up by 54% year on year). Bilateral trade therefore remains heavily in Thailand's favour. One of the main reasons for the expansion in exports to Thailand is the promotional privileges granted under the Generalised System of Preferences under the Irrawaddy, Chao Phraya, and Mekong Economic Co-operation Strategy. These privileges include tariff-free exports of a number of agriculture commodities, such as soybean, sweetcorn and maize.

Trade with Thailand (US$ m, unless otherwise indicated) 2004 2005 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Imports 138 159 177 204 178 216 Exports 27 29 29 39 57 99 Balance -111 -130 -148 -165 -121 -117

Sources: Bank of Thailand.

Laos also appears to be reaping the benefits of having normal trade relations (NTR) status with the US (a status that was granted in late 2004). However, trade with the US remains limited. In 2005 Laos exports to the US rose by 25% year on year to US$4.2m, according to the US Census Bureau. In January 2006 exports jumped to US$581,000, up from only US$30,000 in the year-earlier period. Nearly all of this trade comprises exports of garments, and it is probable that Lao exporters have benefited from US restrictions on imports of garments from China. US exports to Laos reached US$9.8m in 2005, up from US$5.9m in the year-earlier period.

Aid continues to flow in Japan remains Laos's leading source of official development assistance (ODA), and is planning to provide over US$9m in non-project grant aid for fiscal year 2005/06 (October-September). According to the Japanese ambassador to Laos, Makoto Katsura, the government can use this aid in any activity it sees as beneficial to Laos. The fund comes on top of much larger sums of project- specific aid supplied by Japan in sectors such as road construction, education, health, agriculture, legal reform and unexploded ordnance clearance. In mid- February Japan signed agreements to provide K16.8bn (US$1.6m) in grants to the government to fund work on hospitals and water supply in Vientiane. One of the problems Laos has in co-ordinating the large amounts of ODA it receives is perceived to be the three-way divide in the donor community. Aid mainly arrives through Japanese, French and international organisation channels, with the international organisations working in English. It is not uncommon for all three channels to be working on similar projects without sharing information. The UN Development Programme (UNDP) has pledged a large increase in funding to the country for 2006, with its annual budget rising from US$9.2m to over US$14m. After a period of budget cuts in the late 1990s UNDP assistance to Laos has steadily risen again, focusing on capacity-building projects such as governance and legal reform. In 2005 the agency launched a corruption awareness campaign, and it has persisted in offering both assistance and quiet criticism of government policy.

International reserves pick up Total international reserves (including gold) picked up towards the end of 2005, reaching US$231.2m in November compared with US$217.7m in August, according to the latest available data from the IMF. Although the size of the reserves often fluctuates from month to month, there has been a clear strengthening trend over the past five years. However, total reserves are estimated to be equivalent to only around three months of imports.

International reserves, 2005 (US$ m) Jul Aug Sep Oct Nov Foreign exchange reserves excl gold 202.3 198.1 203.1 207.8 212.0 SDRs 14.4 14.5 14.4 14.3 14.1 Gold (national valuation) 5.1 5.1 5.1 5.1 5.1 Total international reserves 221.8 217.7 222.6 227.2 231.2

Source: IMF, International Financial Statistics.