Country Report

Laos

July 2007

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Contents

Laos

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2007-08 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

15 Economic policy

16 The domestic economy 16 Economic trends 17 Agriculture 19 Industry 20 Infrastructure 21 Services

22 Foreign trade and payments

List of tables

9 International assumptions summary 11 Forecast summary 16 Consumer price inflation 23 Merchandise trade 23 International reserves

List of figures

12 Gross domestic product 12 Consumer price inflation 17 Exchange rates

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Laos July 2007 Summary

Outlook for 2007-08 The ruling Lao People!s Revolutionary Party (LPRP) will remain firmly in control and will not face any serious challenge to its authority in 2007-08. There is unlikely to be any major change in the party!s ideology or policies following the appointment in 2006 of Choummaly Sayasone as the president and the party!s new chief. The pace of economic reform will remain slow, although the government!s efforts to join the World Trade Organisation may provide some impetus. Economic growth will remain strong, 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 widen in 2007-08.

The political scene The prime minister, Bouasone Bouphavanh, has taken a tougher stance on corruption, and the media are keen to play a greater role in helping to tackle official graft. The National Assembly (the legislature) has also been debating the formation of a national auditing organisation. The issue of Hmong migrants in Thailand continues to pose problems in Lao-Thai diplomatic relations. Links with Vietnam have been celebrated, and ties with other Asian partners have been strengthened.

Economic policy Further steps have been taken to de-dollarise the economy. Laos continues to make preparations to meet its commitments as a participant in the Association of South-East Asians (ASEAN) Free-Trade Area. Foreign donors remain supportive.

The domestic economy Real GDP growth remains strong, rising by 7.6% in the first half of fiscal year 2006/07 (October-September). Inflation has eased on a year-on-year basis. The kip has weakened against the Thai baht, but has been generally strong against the US dollar. The government has halted cash-crop concessions, owing to problems in keeping tabs on all projects awarded by different state agencies. The government has sought to improve its management of mining projects. Plans for two more "friendship" bridges across the Mekong river are moving ahead. The tourism sector has continued to grow.

Foreign trade and payments The merchandise trade deficit has widened, with export revenue rising by only 1.2% year on year in the first quarter of the year. International reserves have continued to rise.

Editors: Danny Richards (editor); Gerard Walsh (consulting editor) Editorial closing date: July 6th 2007 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, Choummaly Sayasone

National legislature A unicameral National Assembly; membership expanded to 115 seats following the April 2006 election

National elections The last National Assembly election took place on April 30th 2006. The next one is due in 2011

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 Bouasone Bouphavanh of Ministers Deputy prime ministers Somsavat Lengsavad Thongloun Sisoulith Asang Laoly Douangchay Pichit

Key ministers Agriculture & forestry Sitaheng Latsaphone Communications, transport, posts & construction Sommath Pholsena Defence Douangchay Pichit Education Somkot Mangnormek Finance Somdy Douangdy Foreign affairs Thongloun Sisoulith Industry & commerce Nam Vignaket Information & culture Mounkeo Ouraboun Justice Chaleuan Yapaoher Labour & social welfare Onechanh Thammavong Public health Ponemek Daraloy Security Thongban Sengaphone

Central bank governor Phouphet Khamphungvong

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Economic structure

Annual indicators 2002a 2003a 2004 a 2005 a 2006a GDP at market prices (K bn) 18,390 20,307 26,590 30,594 35,407 GDP (US$ bn) 1.8 1.9 2.5 2.9 3.5 Real GDP growth (%) 5.9 5.8 6.9 7.3 8.3 Consumer price inflation (av; %) 10.6 15.5 10.5 7.2 6.8 Population (m) 5.5 5.7 5.8 5.9 6.1b Exports of goods fob (US$ m) 301 335 363 553 882 Imports of goods cif (US$ m) 447 462 713 882 1,060 Current-account balance (US$ m) -26b -110b -56 b -219 b -149b Foreign-exchange reserves excl gold (US$ m) 192 209 223 234 327 Exchange rate (av) K:US$ 10,056 10,569 10,586 10,655 10,160 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2005 % of total Agriculture & forestry 44.8 Industry (incl construction) 29.5 Services 25.7

Principal exports 2004/05a % of total Principal imports 2004/05a % of total Garments 23.6 Fuel & gas 21.6 Timber & wood products 20.8 Materials for garment manufacturing 10.5 Electricity 18.2 Construction materials 3.3 Coffee 15.8 Foodstuffs 3.0

Main destinations of exports 2006 % of total Main origins of imports 2006 % of total Thailand 42.4 Thailand 69.0 Vietnam 10.0 China 11.4 China 4.2 Vietnam 5.5 Malaysia 4.2 Singapore 2.7 Germany 3.2 Japan 1.4 a Fiscal year (October-September).

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Quarterly indicators 2004 2005 2006 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Prices Consumer prices (2000=100) 156.2 155.1 155.9 160.9 166.4 169.0 168.8 n/a Consumer prices (% change, year on year) 9.5 7.9 7.1 5.9 6.5 9.0 8.3 n/a Financial indicators Exchange rate K:US$ (av) 10,810 10,547 10,341 10,577 10,872 10,831 10,494 10,142 Exchange rate K:US$ (end-period) 10,879 10,377 10,437 10,751 10,887 10,743 10,337 10,187 Bank rate (end-period; %) 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 Deposit rate (av; %) 6.83 6.25 4.33 4.67 5.00 5.00 5.00 5.00 Lending rate (av; %) 30.00 30.00 27.33 24.67 25.33 30.00 30.00 30.00 Treasury bill rate (av;%) 19.31 19.25 19.25 18.84 18.29 18.08 18.01 17.89 M1 (end-period; K bn) 1,056.3 1,207.3 1,260.7 1,170.8 1,189.2 1,558.9 1,665.7 1,670.5 M1 (% change, year on year) 40.1 44.3 21.3 17.1 12.6 29.1 32.1 42.7 M2 (end-period; K bn) 5,009.7 5,154.9 5,254.1 5,139.5 5,203.1 5,560.3 5,802.0 5,904.7 M2 (% change, year on year) 22.8 21.6 12.7 6.1 3.9 7.9 10.4 14.9 Sectoral trends Rice production (annual totals; '000 tonnes) ( 2,529 ) ( 2,350a ) n/a n/a n/a Foreign trade (US$ m) Exports fob 87.0 94.0 112.3 137.1 134.0 122.3 145.3 n/a Imports cif -115.1 -131.8 -184.5 -194.1 -220.8 -209.1 -223.9 n/a Trade balance -28.1 -37.8 -72.2 -57.0 -86.8 -86.8 -78.6 n/a Foreign reserves (US$ m) Reserves excl gold (end-period) 215.6 223.3 218.8 226.3 217.5 234.3 249.5 252.5 a Estimate. Sources: UN Food and Agriculture Organisation; IMF, International Financial Statistics.

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Outlook for 2007-08

Political outlook

Domestic politics There is no prospect that the ruling Lao People!s Revolutionary Party (LPRP) will face a serious challenge to its authority in 2007-08, despite the recent arrests of ethnic Hmong in the US accused of plotting a coup to overthrow the current regime. Domestically, the party maintains at least the compliance, if not the support, of the majority of the population. In an effort to bolster its support, the party and the government are taking steps to modernise so as to reduce the possibility that voter disaffection could lead to the emergence of a credible opposition. The prime minister, Bouasone Bouphavanh, has been frank on several issues, and seems to be winning public support for reforms that may disturb entrenched elites within certain sections of the government and the military. In early July the National Assembly (the legislature) approved Bouasone!s proposed cabinet reshuffle, which involved sacking the finance minister, Chansy Phosikham. Bouasone has halted grants of land concessions to investors in agricultural projects, and has promised to crack down on illegal logging. There are also efforts in train to give the media greater freedom, so that it can assist in improving governance and the general reform process. Despite continued internal ethnic tensions, the authorities maintained security and stability through the Lao New Year period (in April) and the early wet season, traditionally times when insurgents have attacked government and civilian targets. Nevertheless, the government will continue to struggle to project an image of stability in Laos until it finds a lasting solution to the "Hmong issue", amid persistent allegations of genocide of the Hmong. Dissent has become apparent in the south, where farming communities have expressed strong opposition to agricultural contract policies that have seen land appropriated by the authorities and granted to Vietnamese companies for rubber plantations. The government has swiftly backtracked on these deals, and is looking to defuse the situation urgently. Similar problems have not yet been reported in the central or northern provinces, but they are likely to occur if some of the contracts that have already been awarded to foreign investors are pushed through.

International relations Laos will push ahead with its policy of regional and international integration in 2007-08, while continuing to maintain firm ties with the ruling communist parties in neighbouring China and Vietnam. However, with regard to its ties with its fellow communist parties in Cuba and North Korea, the LPRP will remain careful not to become entangled in contentious international issues that could threaten its attempts to attract investment and aid from all quarters. The Hmong issue continues to undermine diplomatic relations with Thailand. Although both countries agree that the Hmong seeking asylum in Thailand are illegal immigrants, they seem unable to find a solution to the fate of these people that will not earn international condemnation. The government takes the issue seriously, and in May it sent the deputy foreign minister, Hiem Phommachanh, to Geneva, Switzerland, to reassure the UN Refugees Agency

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(UNHCR) that it was working jointly with Thailand to resolve the matter. The UNHCR later released a statement saying that it would not grant refugee status to the Lao Hmong in Thailand. The recent arrest of anti-Lao government plotters in the US could signal a new chapter in Lao-US relations. However, bilateral ties will remain prickly, given US pressure over the LPRP!s human rights record and continued resentment in Laos regarding the large amounts of ordnance dropped on the country by US planes during the Vietnam war that remains unexploded.

Economic policy outlook

Policy trends The government has received praise from foreign donors for its policy initiatives, particularly its sixth five-year plan (for 2006-10) and the general improvement in the investment environment. Providing a morale boost, the government’s long-term goal of lifting Laos out of the UN Development Programme’s list of least-developed countries by 2020 has been declared achievable by the World Bank. The government is taking steps to boost investment, with Bouasone taking the lead in investigating the potential to simplify investment procedures in a number of sectors and also, together with other ministers, making regular trips abroad to raise the country!s profile among potential investors. The government is expected to make solid progress on international trade reform over the next few years. It has set a target of joining the World Trade Organisation (WTO) by 2008, but this is highly ambitious, given that formal negotiations commenced only in late 2004. In February this year the government instructed ministries and agencies directly related to WTO negotiations to “hold seminars, conduct research and build development strategies to meet the demands of global integration”. The agricultural and forestry sector is expected to play an important role in preparations for WTO accession, as it contributes nearly one-half of the country!s GDP.

Fiscal policy The government will push ahead with efforts to improve its fiscal performance. In fiscal year 2005/06 (October-September) total budget revenue exceeded expectations for the first time, reaching K4.3trn (US$425m), around 2% above target and 10% more than the amount collected in 2004/05. The strong performance was largely owing to more efficient tax collection from all business units. The government is now targeting revenue of K5.5trn in 2006/07, which, given the solid performance of the mining sector, is possible. Despite this growth the government!s revenue position will remain weak, ensuring that the government will continue to run budget deficits. However, with continued pressure from multilateral donors, there will be little slippage in the fiscal reform process. To its credit, the government has been pushing ahead with plans for a value-added tax regime, which should be in place by 2008. This would limit the impact of falling customs revenue as the Laos completes its tariff-reduction obligations as a participant in the Association of South-East Asian Nations (ASEAN) Free-Trade Area (AFTA). On the expenditure side, the government has made progress in strengthening management of public spending with the support of international financial institutions, and efforts to restructure state-owned enterprises to increase transparency have continued,

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albeit at a slow pace owing to the poor quality of the bureaucracy. Assuming that the government remains prudent, the budget deficit (including grants) will stand the equivalent of around 4.3% of GDP in 2007-08.

Monetary policy The main challenge facing the Bank of the Lao People!s Democratic Republic (the central bank) remains that of reining in money supply growth"at the end of the first quarter of 2007 narrow money supply (M1) had expanded by 34.7% year on year, following growth of around 30% a year in 2005-06. 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 will continue to be a concern.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2005 2006 2007 2008 Real GDP growth World 4.8 5.3 4.8 4.6 OECD 2.6 3.2 2.5 2.6 EU27 1.8 3.0 2.7 2.4 Exchange rates ¥:US$ 110.1 116.2 117.9 106.3 US$:€ 1.246 1.256 1.359 1.383 SDR:US$ 0.677 0.680 0.653 0.641 Financial indicators € 3-month interbank rate 2.18 3.08 4.20 4.58 US$ 3-month Libor 3.56 5.19 5.30 5.29 Commodity prices Oil (Brent; US$/b) 54.7 65.3 65.0 60.3 Gold (US$/troy oz) 445.0 604.5 652.5 642.5 Food, feedstuffs & beverages (% change in US$ terms) -0.5 16.1 10.6 -0.2 Industrial raw materials (% change in US$ terms) 10.2 49.9 6.3 -14.2 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. Global GDP growth will slow in 2007-08, partly owing to the forecast slow- down in the US and the EU. Weaker growth in the EU is a particular concern for Laos, as it is an important market for Lao exports. Another focal point for Laos in terms of demand for its exports is the growth performance of its neighbours. Although the economies of China and Vietnam will remain robust, Thailand!s GDP growth rate has been affected by political turmoil in the country and the consequent weakening of business and consumer confidence. Global prices for food, feedstuffs and beverages will rise in 2007. However, a slight drop in prices in 2008 will help to alleviate upward supply-side pressure on local prices.

Economic growth Economic growth is set to remain fairly healthy in 2007-08, at around 6.5-7% a year, slightly lower than the pace of growth recorded in 2005-06. Growth will continue to be driven primarily by an expansion in industry, which has been growing at double-digit annual rates. The main drivers of industrial growth are

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construction and mining. Construction will be boosted by the rising number of infrastructure development projects, particularly road- and bridge-building and also power generation (construction of the US$1.2bn Nam Theun II hydro- electric project commenced in November 2005, and is progressing well). The outlook for the mining sector is positive, following an expansion of gold and copper mining, mainly driven by Australian mining firms. Although manufacturing will remain weak overall, the garment industry has responded well to increased competition following the expiry of the WTO!s quota system for textile exports at end-2004. However, garment exporters remain heavily dependent on the EU market, and when EU "safeguards" against imports from China expire in 2008, Lao exporters will suffer. Production of construction materials, such as cement, limestone and electric cable, is growing to meet the demands of large projects and a boom in house-building, but the market is still small. Agricultural growth remains slow, and the government!s recent moves to halt cash-crop concessions could negatively affect future growth prospects. The outlook for services is mixed. The tourism industry will continue to expand, supported by gradual improvements in the country!s poor infrastructure through domestic and foreign investment. 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 Annual inflation will ease down steadily in 2007-08 from an annual average of 6.8% in 2006. However, food prices picked up in the first half of 2007, with prices for rice, fish and vegetables all climbing, while outbreaks of Avian influenza (bird flu) have pushed up prices for meat. Higher food prices, together with rising fuel costs and upward pressure on domestic prices stemming from rapid growth in the money supply, mean that inflation is set to remain fairly high in 2007, averaging around 5%. However, lower import tariffs will offset some of the upward pressure on prices, particularly in 2008.

Exchange rates The kip has remained strong against the US dollar, and by early July was trading at around K9,580:US$1, compared with K9,650:US$1 at the beginning of this year. The strengthening trend in the kip-US dollar exchange rate has been driven by the strength of the Thai baht against the US dollar, as the authorities appear keen to prevent a dramatic shift in the kip!s value against the baht, owing to the importance of Thailand as a trading partner. Given that the baht is set to remain strong against the US dollar in 2007-08, partly owing to the weakness of the US dollar against most major currencies, the kip will not be subject to a marked depreciation against the US currency. Although the kip will appreciate against the US dollar in annual average terms in 2007, it will fall from its current highs, particularly in 2008, largely owing to downward pressure stemming from Laos!s large budget deficit and the widening trade and current- account deficits.

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External sector Laos!s energy and mining exports will remain strong in 2007-08. Exports of electricity are rising in line with growing demand in Thailand, and gold and copper exports will jump as new mines, such as the Phu Kham copper and gold mine, start production. However, after rising sharply in recent years, trends in global prices for gold and copper will not be as positive, thereby limiting growth in the value of Laos!s mining exports. Garment exports to the US have been increasing steadily since normal trade relations (NTR) status was accorded to Laos by the US in early 2005, but growth in garment exports overall will slow, owing to the poor competitiveness of the garment industry. 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 AFTA commitments, combined with the poor competitiveness of local products, will lead to strong growth in imports of consumer goods. The surplus on the services account will continue to rise steadily 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 continue to widen, reaching the equivalent of nearly 10% of GDP in 2008. This raises major concerns over whether the deficit is sustainable, 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) 2005 a 2006 a 2007b 2008b Real GDP growth 7.3 8.3 7.0 6.5 Gross agricultural production growth 2.5 c 3.5 c 3.2 3.0 Consumer price inflation (av) 7.2 6.8 5.0 4.8 Lending interest rate 26.8 30.0 28.5 29.0 Central government balance (% of GDP) -3.4 c -4.3 c -4.2 -4.3 Exports of goods fob (US$ bn) 0.5 c 0.7 c 0.7 0.8 Imports of goods fob (US$ bn) -0.8 c -0.9 c -1.2 -1.4 Current-account balance (US$ bn) -0.2 c -0.1 c -0.4 -0.5 Current-account balance (% of GDP) -7.6 c -4.3 c -8.6 -9.9 Exchange rate K:US$ (av) 10,655 10,160 9,658 9,808 Exchange rate K:¥100 (av) 9,680 8,742 8,195 9,231 Exchange rate K:€ (year-end) 12,672 12,860 13,558 13,292 Exchange rate K:SDR (year-end) 15,355 14,660 15,113 15,330 a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates.

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

Laos Asia excl Japan Laos Asia excl Japan 9.0 16.0 8.0 14.0 7.0 12.0 6.0 10.0 5.0 8.0 4.0 6.0 3.0 2.0 4.0 1.0 2.0 0.0 0.0 03 04 05 06 07 08 03 04 05 06 07 08 2002 2002

The political scene

The LPRP seeks to tackle graft The ruling Lao People’s Revolutionary Party (LPRP) and the government continue to threaten to take tough action to stamp out official corruption. In early July, during the most recent session of the National Assembly (NA, the legislature), the prime minister, Bouasone Bouphavanh, called for a crackdown on "corruption and luxury" among government officials. The government has already moved to increase public-sector salaries, reflecting the fact that patronage and minor corruption play a central role in the economy and the political system, partly because public-sector salaries remain low and tax collection is haphazard. In July the NA approved Bouasone!s proposal to reshuffle the cabinet, a move regarded as part of the effort to tackle corruption at the highest level. In the reshuffle the finance minister, Chansy Phosikham, was ousted, being replaced by his deputy, Somdy Douangdy. Other changes involved the sacking of the sports minister, the environment minister and two ministers at the Prime Minister!s Office. In April the vice-president, Bounyang Vorachit, stated that the media should play an active role in addressing the “dangerous” problem of corruption, but he added that it should do so in a “constructive” way that promoted party policy. However, the state continues to control local media. Although journalists are usually left to conduct their work freely, there is an underlying fear within the Lao media that sensitive stories will leave journalists (who are in effect state employees) open to retribution while there are no laws in place to protect them. In recent years, however, Lao journalists have begun debating sensitive matters of national policy in public, and have now taken bolder steps in this direction. The media law drafted by journalists in the 1990s and amended by the Ministry of Justice last year has been debated in the NA. The minister of information and culture, Mounkeo Ouraboun, has been lobbying for the bill to be passed, but is wary of party interference, recently saying that “if the law aims to tie [the media’s] neck, we would prefer not to have a law”. Mounkeo recently convened a meeting of leading journalists to discuss the law, an event which one national newspaper described as previously unimaginable and “the

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first time the leadership officially recognised that the quality of the Lao media was low and no longer inspired readers and viewers”. In other anti-corruption moves, the NA recently debated legislation to introduce an independent national auditing organisation. The Lao media quickly picked up on attempts by certain members of the legislature to introduce amendments that would give the president or particular ministers executive control over the body. The media also published the views of other members who insist that such an organisation will be useless unless its independence is guaranteed.

The issue of Hmong migrants Relations with Thailand remain cordial, but continue to be soured by the issue continues to pose problems of 6,000-7,000 ethnic Hmong living in camps in Thailand. These people claim to be refugees seeking asylum from Laos, but the Thai authorities do not want to allow them to settle permanently in the country. Attempts to return groups of Hmong to Laos have met with violent resistance in the past, and no third country has offered to take large numbers of them. The issue was further complicated in mid-April, when the Lao government held an internal press conference (for state media only) to hand over 21 Hmong girls, who had been missing for over two years, to their Lao-based relatives. The girls were part of a group of 27 Hmong arrested by Thai police after being caught outside the confines of the refugee camp in Petchaboun. The Lao Ministry of Foreign Affairs claims that the Thai police forcibly repatriated the girls to Laos without telling the Lao authorities where or when they were sent over the border, despite official requests for information on the matter. The foreign affairs minister, Somsavat Lengsavad, who is also a deputy prime minister, accused the Thai authorities of “reckless action” that violated the rights of children and co-operation mechanisms between the two countries. There has been no explanation of where the girls have been for two years or where the missing six people from the arrested group may be. In May the two sides did co-operate on the repatriation of 31 Hmong to Laos, although these people had entered Thailand only two weeks previously and were not part of the mass of refugees in camps in Petchaboun. The minister of foreign affairs, Thongloun Sisoulith, another deputy prime minister, visited Thailand in April to discuss the Hmong issue. Other subjects up for discussion included co-operation to contain the spread of avian influenza (bird flu), plans for new bridges over the Mekong river and border demarcation.

US arrests of Hmong "coup In June ten people were arrested in the US on charges of violating the US

plotters" attracts LPRP praise Neutrality Act by plotting to overthrow the sovereign state of Laos. LPRP leader welcomed the news of the arrests, having long suspected that several factions in the US were supporting efforts to destabilise the LPRP regime. One of the arrested is the former general of the Lao Royal Army, Vang Pao, a leading figure in Hmong opposition to the LPRP and a focal point of anti-LPRP feeling within the Lao diaspora in the US. The charges against the men relate to an alleged coup plot, codenamed Operation Popcorn, to oust the LPRP with the help of "underground sympathisers" in Laos. The plot is thought to have featured a detailed budget of US$28m, around US$10m of which would have been spent on weapons. The planned coup would have been violent, with the plotters considering bombing government buildings in Laos and "neutralising"

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government officials. Although it is unlikely that such a plan would have been put into action, let alone been successful, the authorities in the US have taken the matter seriously, and the accused plotters have been denied bail.

Links with Vietnam are Political and economic links with Vietnam remain strong, with the two

celebrated countries this year celebrating the 45th anniversary of the establishment of diplomatic ties and the 30th anniversary of the signing of a co-operation treaty. The president of Vietnam’s legislature, Nguyen Phu Trong, made an official visit to Laos in April and pledged that the two countries would bolster their “special co-operation for common development”. The following month a high-level military delegation from Laos was received in the Vietnamese capital, Hanoi. The close political ties between the ruling parties of Laos and Vietnam date back to the formation of Ho Chi Minh’s Indochina Communist Party in the 1930s, and in recent years trade and investment connections have flourished. Vietnam now ranks second among foreign investors in Laos, and two-way trade was worth US$240m in 2006. In May the two countries agreed to further co-operation and mutual assistance in religious affairs, “to help their people understand and hold religious practice in line with their countries! laws”. Both Laos and Vietnam have received international criticism in the past for the persecution of religious groups.

Ties with Asian partners are Chinese investment continues to pour into Laos as investors seek to take advan-

strengthened tage of a planned free-trade agreement between China and the Association of South-East Asian Nations (ASEAN), of which Laos is a member. Qin Guangrong, the governor of China’s Yunnan province, which borders Laos, led a delegation to Vientiane in early April seeking concessions for Chinese investors in construction, hydropower, tourism, mining and agriculture. The delegation reportedly donated Rmb6m (around US$750,000) to various Lao state projects during its three-day visit. Despite China’s growing influence, Laos still regards Japan as a vital supporter, particularly in the field of development aid. However, although by far the biggest provider of aid to Laos, Japan currently ranks as only the fifth-largest investor in the form of business capital. Bouasone is keen to expand links with Japanese investors, and in May visited the Japanese capital, Tokyo, where he secured an agreement from his hosts to organise a bilateral conference at the end of this year with the intention of drafting an investment treaty. In return Bouasone signalled that Laos, a landlocked nation, would join the International Whaling Commission, pre- sumably to support Japan’s pro-whaling stance. Lao officials have also sought to improve ties with South Korea. Somsavat visited the South Korean capital, Seoul, in April, ostensibly to tie up an aid deal, but also to smooth relations following an embarrassing diplomatic incident earlier in the month. In April the Lao government handed over to the South Korean authorities three teenage asylum-seekers from North Korea. Lao border police had arrested the three, who had made their way overland to Laos through China, while they were trying to cross the Mekong river to reach Thailand. Human rights groups accused Lao officials of trying to “sell” the three to anti- North Korea groups for US$1,000 each. North Korea reportedly asked the Lao government to hand the three over to its embassy in Vientiane, but when the

Country Report July 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 Laos 15

story became international news the teenagers were quickly transferred to the care of South Korean officials. South Korea continues to fund improvements to education in Laos, agreeing to pump US$2.5m into primary school construction over the next two years.

Economic policy

Small steps are taken to The Bank of the Lao People’s Democratic Republic (the central bank) is

de-dollarise sustaining efforts to "de-dollarise" the Lao economy by applying pressure designed to encourage traders and businesses to conduct transactions in kip. Laos ranks among the top five most dollarised economies in the world, with the majority of bank deposits held in the country being in US dollars, while the Thai baht is the dominant currency in cash transactions. A prime ministerial decree issued in mid-May requires all businesses to advertise their prices in kip, and also instructed the central bank to open more foreign-exchange points so that people can trade in their foreign currency for kip. If the government retains a softly, softly approach to currency reform and is also able to maintain exchange-rate stability and increase access to financial services, Laos may become one of the few economies in the world to achieve some success in efforts to de-dollarise its economy.

AFTA preparations continue The government continues to prepare to meet Laos!s commitments as a member of the Association of South-East Asian Nations (ASEAN) Free-Trade Area (AFTA). The government’s fiscal policy department is currently compiling lists of products that will carry a reduced import tariff of 0-0.5%. Of over 3,500 registered products on the import list, almost 1,250 are already on the reduced tariff list and another 2,126 have had their import tariffs temporarily suspended. The government is permitted to reserve around 180 products on “sensitive” and “general exclusion” lists that will remain subject to their existing tariffs. Vehicles and agricultural and industrial products are likely to feature on these lists. In other budget-related matters, the Ministry of Finance is planning to alter the distribution of the state budget across the country from the next fiscal year in a bid to improve revenue collection from the country’s 17 provinces. The budget allocation for each province has traditionally been decided by personal negotiations between officials, but the ministry has decided that allocation in proportion to population will result in a fairer distribution of central funds. The director-general of the ministry’s fiscal policy department, Bounthong Keomahavong, has said that “local budget allocation has a significant effect on revenue collection”, and that the new system would be “transparent, and most importantly, fair”.

Donors remain supportive Multilateral aid organisations and bilateral donors remain vital to the Lao economy, underpinning practically every sector of national development. In recent months donors have supported further development programmes in the country. In June the UN Development Programme and the Swiss Agency for Development and Co-operation disbursed US$10.3m for public administrative reforms in 2007-10. The UN Children!s Fund (UNICEF) also recently announced

Country Report July 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 16 Laos

a new US$40m country programme for 2007-11, representing a US$10m increase in funding compared with the previous programme.

The domestic economy

Economic trends

GDP growth remains strong According to official announcements, real GDP growth remains strong, standing at 7.6% year on year in the first six months of fiscal year 2006/07 (October-September). According to the prime minister, Bouasone Bouphavanh, the official target for GDP growth for this period was "not less than 7.5%". The agricultural sector has been relatively weak, growing by 2.4% year on year in the first half (to account for 40.7% of GDP). The industry and services sectors recorded much stronger growth, at 15.2% and 7% respectively. Industry accounted for 33.3% of GDP growth, while services accounted for 26%. In an indication of the buoyancy of the economy, approved investment in the first half of the current fiscal year reached US$440m, close to the targeted sum of US$500m for the whole year. The government approved 122 projects during the period. Industry attracted the most significant proportion, with 15 new projects worth US$126m in all. A total of 28 agricultural projects worth a combined US$109m were approved, as were 17 mining projects, worth US$75m.

Inflation eases on a year-on- Inflation remains low compared with the double-digit rates recorded in recent

year basis years, falling to 3.6% in April. Owing to the sharp pick-up in prices in the first few months of the year, in January-April inflation averaged 4.7%, although this was down from 6.8% in the whole of 2006. Although inflation has slowed on a year-on-year basis, rising food and fuel prices have put upward pressure on the general price level in recent months, with month-on-month inflation rising to 0.8% in April. Food prices have continued to increase in urban areas since the beginning of the rainy season in early May, with rice prices in the capital, Vientiane, rising from K4,500-5,000 (47-52 US cents) per kilogram to K5,500-6,500/kg between May and June. Retail fuel prices have also increased, with fuel prices in Laos generally being quick to follow trends in world prices.

Consumer price inflation % change, year on year % change, month on month 2006 Sep 5.5 0.1 Oct 3.7 -0.9 Nov 4.4 -0.5 Dec 4.8 0.2 2007 Jan 5.5 0.4 Feb 4.9 0.2 Mar 4.7 0.2 Apr 3.6 0.8

Source: IMF, International Financial Statistics.

Country Report July 2007 www.eiu.com © The Economist Intelligence Unit Limited 2007 Laos 17

The kip weakens slightly The slight strengthening of the Thai baht against the kip since May has resulted in higher prices for various imports, especially construction equipment. By early July the baht was selling at K279:Bt1, up from K275:Bt1 in early May, according to buy rates published by the state-owned Banque pour le Commerce Extérieur Lao. The kip continued to strengthen against the US dollar through the first half of the year, reaching K9,550:US$1 in early June, up from K9,634:US$1 in early March and K9,645:US$1 in January. However, the kip weakened slightly in July, dropping to around K9,580:US$1 on July 5th.

Exchange rates (buying rate, first day of month; inverted scales)

K:US$; left scale K:Bt; right scale 9,000 255

9,500 260

10,000 265

10,500 270

11,000 275

11,500 280 Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul 2005 06 07

Agriculture

Cash-crop concessions are In May Bouasone decided to stop issuing land concessions for agricultural

halted projects. This followed an admission that, with the surge in foreign investments, the authorities were having difficulty in supervising the various concessions that had been awarded by different state agencies. Land disputes began occurring in the south of Laos in April following the granting of large concessions for rubber and other cash crops to Vietnamese investors. The government promotes an investment strategy that it calls the 2+3 Policy, which involves rural villagers providing their land and labour, and investors providing funding, technical training and a ready market. However, according to officials from the National Land Management Authority, some investors are not following this policy. Following complaints from villagers in Champassak province, the authority established that some investors were merely clearing valuable forest and traditional crops without planting any new crops, and recommended that the cabinet cease granting land concessions throughout the country. Despite this setback to prospects for the agriculture sector, rubber promotion continues, with local agricultural officials in the northern province of Luang Namtha pushing to meet the estimated 2m tonnes a year of rubber that Chinese companies are keen to source from Laos. Luang Namtha is currently the largest rubber-producing province, with more than 10,000 ha of its 28,700 ha of land having been planted with rubber so far. In April a Chinese company,

Kunming Gao Shen, unveiled a plan to find 500 ha of land for a plantation and a processing factory in Bolikhamxay, but this will be subject to interpretations of government policy in the near future. In Savannakhet a Vietnamese company, Foodingco Danang-Savannakhet, has signed an agreement to undertake a trial of joint cassava and acacia plantations. Both crops have a readymade market in the region, with acacia trees feeding plywood and pulping mills and cassava being shipped to China and Vietnam for food-processing. The firm aims eventually to grow the two crops on 2,000 ha of land. Cassava is in demand on the regional market as an ingredient in both human and livestock food products, and also has potential as a biofuel raw material. A Singaporean company, Latco, has opened an office in Xieng Khouang to buy dried cassava from local farmers at US$40 per tonne or fresh tubers at US$30 per tonne.

The outlook for coffee and rice The outlook for coffee producers in Laos has brightened after two years of

improves miserable harvests. Weather conditions have been favourable for the 2007 harvest, and improvements in processing, packaging and marketing techniques should lead to greater profits for the country’s six main coffee producers. The president of the Lao Coffee Association, Sinouk Sisombath, has also been successful in lobbying the government to create a coffee management board that will support the industry. Improved varieties and farming techniques are likely to result in a better rice harvest this year, especially in the dry season. The authorities in three southern provinces have said they are confident that average yields will increase from 4.5 tonnes to 5 tonnes per hectare, following work with farmers over the past few seasons. Agricultural processing is also growing in the country through investments from China and Thailand. In April the Lao Agro-Industry Company began producing canned sweetcorn for export to American and European markets, and is also canning local produce such as mango, baby corn, bamboo and rambutan. Exports are projected to increase to over 3,200 tonnes this year, but the company is struggling to source enough supply to maintain production runs.

Outbreaks of bird flu are The outbreaks of avian influenza (bird flu) reported in early 2007 appear to

brought under control have been brought under control, and the authorities allowed sales of poultry and eggs to resume just before the Lao New Year festival in April. The government was keen to reintroduce poultry to the market in a bid to control spiralling meat prices, and attempted to ensure that chicken, duck and egg sales recommenced at “normal” prices. However, the price of chicken in Vientiane was almost double its pre-bird flu rate when sales resumed. After 300,000 birds were culled around Vientiane in March, the authorities continue to monitor poultry farms and the movement of bids and eggs, under a heftily financed international assistance programme co-ordinated by the World Health Organisation and the UN’s Food and Agriculture Organisation. Measures to curb the spread of the virus include a possible ban on poultry breeding in the four innermost districts of Vientiane, a measure that would entail substantial change in the semi-rural villages that make up the Lao capital.

Industry

The government seeks to The booming mining sector in Laos sustained its growth momentum during the improve mining management first half of 2007, and the government is looking to consolidate this by improving its management of the numerous concessions awarded throughout the country. The list of available concessions drawn up by the Department of Geology and Mines has been almost completely filled by signed agreements, but at least 15 investors face losing their concessions owing to inactivity. A total of 119 companies are currently registered as operating 193 mining projects across the country. Chinese companies head the investment list in Lao mining projects, managing 52 operations including surveying, prospecting, excavation and production of charcoal, gold, copper and iron ore. The country’s largest mine, the gold and copper deposit at Sepon, run by Australia!s Oxiana Resources, continues to perform well. Oxiana’s Lao holding company, Lane Xang Minerals, paid just under US$50m in taxes to the government in 2006, compared with US$7m in 2005, following increases in international gold and copper prices and a huge leap in copper production. The company is by far the largest taxpayer in the country. Although most of the minerals extracted in Laos are exported immediately, the boom in mining projects has created some opportunities for spin-off industries, with limestone processing set to attract major investment in 2007. A local investor, PK Limestone, is investing over US$12m to build a limestone processing facility in the central province of Khammouane. Limestone is vital in processing the gold and copper emerging from the major mines in Savannakhet and Xieng Khouang provinces. Although Laos is naturally rich in the stone, mining ventures currently have to import lime from Thailand. The new limestone plant will in turn stimulate the extraction of anthracite in southern Laos to fuel it.

Oil and gas exploration is to UK-based Salamander Energy has resumed oil and gas exploration in Laos ten

resume years after exploration ceased during the 1997-98 Asian economic crisis. The company expects to spend US$2m-3m over the next three years, and may extend the exploration process for a further two years. Previous exploration attempts have found encouraging signs of gas and oil in the country, but were abandoned before any concrete results could be obtained. In June this year Salamander signed a profit-sharing agreement with the Lao government, which stated that 45% of profits from any oil sales and 37% of profits from any gas sales resulting from the survey would be paid to the government.

Power plants are progressing More investments in hydropower appear likely as Laos continues to search for

as planned partners to harness its estimated total hydropower potential of 23,000 mw. Although a mere 5% of that maximum is currently being generated, good progress is being made on the building of the huge Nam Theun II dam, construction of which is now over 50% complete and on schedule, while several other projects are also well under way. Laos currently has 11 major and 40 small hydropower plants on stream, with a combined installed capacity of over 670 mw, around two-thirds of which is exported to Thailand. By 2020 the

government is aiming to have 29 major hydropower plants in operation, with a total capacity of over 8,650 mw. In early April Thailand’s state-owned electricity utility, EGAT, announced that it had agreed to construct a 261-mw plant at what will become the Nam Ngieb I dam site in Laos. EGAT signed a memorandum of understanding with the Lao government, a Japanese electricity generator, Kansai, and a Thai conglomerate, Rojana Industrial Park. According to EGAT, Kansai initiated the project and invited EGAT to participate. Kansai plans to hold a 40% stake, EGAT 25%, the Lao government 20% and Rojana 15%. The dam will be financed by equity (30%) and borrowing (70%), with EGAT predicting a 14% return on its investment of Bt1.4bn (US$40m). The Nam Ngieb project is expected to come on stream in 2014.

Chinese and Malaysian hydro International non-governmental organisations have called for Laos to abandon deals are in the pipeline plans for the Don Sahong dam on the Mekong river. Mega First Corp of Malaysia, a conglomerate that is involved in constructing and operating power plants, is currently conducting a feasibility study on the 240-mw dam, which would be the first to be built on the lower Mekong mainstream. Opponents of the dam claim that it would block fish migration and undermine fishery-based livelihoods in the four countries of the lower basin, namely Cambodia, Thailand, Vietnam and Laos itself. Another Malaysian energy group, AP Bizlink, has signed an agreement to survey the Nam Fa hydropower project in the north-western provinces of Bokeo and Luang Namtha. The US$2m survey is expected to take about 18 months. The Nam Fa project will produce an estimated 150 mw of electricity for domestic use and export to Thailand, and is expected cost around US$1.5m per megawatt of capacity to construct. A Chinese investor, Sinhydro, will hold an 85% share in the Nam Ngum 5 hydropower project, construction of which will start in 2008. Construction of roads to the site, in Xieng Khouang province, is due to start in mid-2007, after the concession and power-purchase agreements were signed with the government in April. The US$200m project will result in a 120-mw plant that can generate about 500 gwh of electricity per year.

A new cement plant The small Lao cement industry continues to grow, with a new plant starting

commences operations production in May. The Lao-Chinese plant in Khammouane province will be the largest in the country, producing around 1m tonnes annually under the Golden Lion brand. The company is 60%-owned by the Chinese Yunnan International Economic Technical Co-operation Company, and plans to export one-half of its output to Thailand. Three grades of cement are produced by the factory, with the highest grade being made available to hydropower companies for dam construction.

Infrastructure

Plans for another two Both Laos and Thailand have reaffirmed that they plan to build another two

“Friendship" bridges progress “Friendship” bridges across the Mekong river. (There are already two bridges in place, one crossing from Thailand’s Nong Khai to Vientiane, and the other from

Mukdahan in Thailand to Savannakhet.) After recent Thai media reports that local people in both countries were unhappy with the land purchase arrangements surrounding the building of the bridges, government officials from the two countries have said that the projects will not encounter any obstacles. The third bridge will connect Thakhek in Laos!s Khammouane province with Thailand!s north-eastern province of Nakhon Pranom, and the fourth will connect Houayxay, in the north-western Lao province of Bokeo, with Chiang Khong in Thailand’s Chiang Rai province. The Lao Ministry of Foreign Affairs has said that Thailand will contribute one-half of the construction costs of the fourth bridge, and that a Chinese government loan will account for the balance. Thailand has requested nine more months to complete the bridge design. Construction could then begin, taking about four years to complete. Thailand has hinted that it wants to build a railway line to this bridge that would connect northern Thailand to China’s Yunnan province. Given the mountainous topography of northern Laos, this seems destined to remain a pipe-dream. Plans for the third bridge, further south, still await the expropriation of land on the Thai side, but construction is expected to start at the end of this year or early in 2008, and is likely to be completed before the fourth bridge is finished.

Thailand supports the The international airport at Pakse in southern Laos is to be improved using a improvement of Pakse airport Bt320m (US$9.1m) soft loan from Thailand. This deal follows a Lao request for Thai support to expand the airport to meet international aviation safety standards. Thailand initially approved the arrangement in March 2004. The package consists of a US$6.4m low-interest rate loan and a US$2.7m grant. The loan component carries an annual interest rate of 1.5%, to be paid back over 30 years with a ten-year grace period. Thai consultancy and construction firms will be engaged in the contract, and at least 50% of the goods and services procured must be sourced from Thailand.

A Malaysian firm considers a A Malaysian technology company, Time Engineering, is investigating the

4G mobile project possibility of testing new fourth-generation (4G) wireless mobile com- munication technology in Laos with a view to developing the system for sale across South-east Asia. The company would like to turn Vientiane into a "WiMAX city" with widespread access to the latest generation of wireless technology. The Lao government’s Science, Technology and Environment Agency has signed an agreement with the company to survey the proposal, which would cost around US$10m to install. Malaysia itself cannot currently

host this technology, as 3G systems are already in place there.

Services

Access to financial services is Access to financial services is expected to improve as the new finance

set to increase legislation passed at the end of 2006 takes effect. The previous regulations weighted the market heavily in favour of state-owned banks, with private providers being limited in the range of services that they could provide and forbidden to open branches outside Vientiane. These restrictions have been lifted, and identical capital requirements now apply to all banks. Further

regulatory reform is expected in the future under a guidance programme sponsored by the Mekong Private Sector Development Facility, a unit of the International Finance Corporation (IFC, the World Bank!s private-sector financing arm). Following the implementation of the new law, Australia’s ANZ Bank is due to open its first branch in Laos in mid-2007, and the IFC has acquired a 10% stake in its Lao operation as part of its strategy of developing “frontier markets”. In other developments in the financial sector, Japanese assistance to the government is helping to develop a bond market, but according to the director of the fiscal policy department, Bounthong Keomahavong, many problems remain to be addressed. According to Bounthong, Laos must first improve debt management and cashflow and develop regulations to ensure that markets are linked to each other.

Tourism continues to grow Tourism is now the largest earner of foreign currency for Laos, and is seen as a means of distributing rising income across a wide section of the population. The Lao National Tourism Administration (LNTA) is promoting ecotourism as a means of bringing visitors to small villages in rural areas, and is also organising a hotel and guesthouse rating system to help clarify accommodation standards. A recently published LNTA report shows that tourists spend less time and money in Laos than they do in neighbouring countries, and the administration is now working on strategies to increase the length of stays. Around 70% of tourists come to Laos after visiting other countries, and spend only US$12-30 per day. A total of 1.2m arrivals were recorded in 2006, an increase of 11% over 2005. In the first three months of 2007 arrivals reached 428,000 a 30% year-on- year rise. Reflecting growing foreign investor interest in tourism, a South Korean project aims to capitalise on the building of another bridge over the Mekong river (in Bokeo province) by building a US$40m golf and spa resort for high-end tourists. The Green City company is currently liaising with provincial authorities to try to buy land from local people, having set aside US$400,000 for the purpose. The national carrier, Lao Airlines, is also expanding its domestic schedule as tourism and business growth fuels demand, enabling it to cash in on its monopoly within the country. Internationally, other airlines have secured routes into Laos, with a Malaysian-based budget airline, Air Asia, starting direct flights between the two countries from July, and Thailand’s Bangkok Airways starting flights to the southern city of Pakse.

Foreign trade and payments

The trade deficit widens as According to the latest trade data published by the IMF, Laos recorded a

export growth slows merchandise trade deficit of US$89.8m in the first quarter of 2007, the largest deficit since the third quarter of 2005. Export revenue rose by only 1.2% year on year in the first quarter of 2007, to US$175m. Exports rose sharply during 2006, jumping from US$173m in the first quarter to US$257m in the fourth quarter. A breakdown of Laos’s exports in recent quarters is not available. Imports totalled

US$265m in the first quarter of 2007"up by 6.1% year on year, but practically unchanged compared with the quarterly average recorded throughout 2006.

Merchandise trade (US$ m) 2006 2007 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Exports fob 173.0 204.9 247.1 257.0 175.1 Imports cif -249.7 -259.4 -287.9 -263.3 -264.9 Balance -76.7 -54.5 -40.8 -6.3 -89.8

Source: IMF, International Financial Statistics.

The Thai embassy in Laos has predicted that Laos will establish a trade surplus with Thailand, its leading trade partner, within the next five years. The embassy’s commerce attaché, Chalaempon Pongchabubnapa, said that Laos’s trade deficit with Thailand had been narrowing ever since Laos began exporting electricity to Thailand in 1998. However, according to data published by the Bank of Thailand (that country!s central bank), in January-May this year Laos recorded a merchandise trade deficit of US$366m, up from a deficit of US$200m in the year-earlier period. Thailand’s exports to Laos reached US$506m in January-May, up by 20% year on year, while Thailand’s imports from Laos rose by 37% year on year to US$140m. The drop in imports from Laos primarily reflected a 62% year-on-year contraction in May. Trade and investment links with China continue to expand. Two-way trade in January-February 2007 was worth US$40.3m, up by 24% year on year. China became the top investor in Laos in the first three months of 2007, with Chinese firms investing over US$120m in 223 projects. Vietnamese investment in the same period totalled US$84m, while Thai projects amounted to US$71m.

International reserves Laos!s total international reserves position has risen sharply in recent months,

continue to rise reaching US$453m in April, up from US$334m at end-2006 and around US$240m at end-2005. However, in line with the upward trend in the import bill, Laos!s reserves position is still weak, providing coverage of only around four months of imports, down from coverage of over five months in 2004. Although the merchandise trade account remains in deficit, inflows of remittances, foreign direct investment and international aid have helped to prop up international reserves.

International reserves (US$ m) 2006 2007 Dec Jan Feb Mar Apr Foreign-exchange reserves excl gold 312.2 326.6 352.6 374.9 430.8 SDRs 14.7 14.6 14.7 14.8 14.9 Gold (national valuation) 7.4 7.4 7.4 7.4 7.4 Total international reserves 334.3 348.6 374.7 397.1 453.1

Source: IMF, International Financial Statistics.