Over the past decade, Laos has enjoyed among the most robust economic growth in Asia with an average 7.8%. This trend is forecast to continue in the coming years (+7.4%) driven by key hydropower investments and relatively diversified exports from electricity and mining to a fast rising tourism industry. Laos is reliant for nearly 30% of total exports on copper and hydropower. Therefore, the economy is somewhat exposed to lower copper prices and also to the Chinese slowdown and potentially lower FDI in a more global risk-averse climate. This moderate risk is reflected by a persisting large (but declining) current account deficit (50% of export receipts in 2015) which structurally results from high imports related to hydropower projects and Laos’ landlocked position. However, Laos’ small economy is likely to keep receiving a proportionally high amount of FDI in hydropower as it aims to become the “battery of South-East Asia”. Laos is indeed ideally centrally located in the Mekong region between Thailand, Vietnam and China where it exports electricity (equivalent to 10% of Laos’ total export receipts). Despite China’s slowing growth, regional electricity demand will continue to rise and be met thanks to new hydropower plants expected to be operational this year or planned in the future. Therefore, higher electricity exports, notably to Thailand, are expected to curtail progressively current account deficit ratios to around 30% of export revenues by 2020 ceteris paribus, and limit risks of balance of payment pressures in the deteriorated global environment. Further hydropower projects, building of cross-border train infrastructures, a strong real estate development and tourism should support growth in the coming years and offset potentially enduring lower mineral prices. National authorities should involve more the Laotian population in top industries as it remains overwhelmingly employed in subsistence agriculture in one of the poorest and least developed countries in South-east Asia. Meanwhile, the more challenging global context forces the national authorities to ease fiscal consolidation policy and will require progress on developing energy and transport infrastructures and moving forward structural reforms to maintain high growth levels and reduce poverty. Hence the chronic budget deficit is expected to pick up to 4% of the GDP this year. As a result, Laos’ public debt will gradually increase to a projected level of 70% of the GDP in 2020 (from 60% in 2013). The slow deterioration of Laos’ weak public finances happens in a context of historically low inflation fuelled by lower food and fuel prices, together with a firm kip’s peg to a strong USD. Laos’ economy still lags behind Asian communist peers such as China and Vietnam as its transition is not complete yet. It is evidenced by largely dominating state companies but also by high corruption and typical risks entailed by a one-party regime such as poor government transparency, arbitrary rules and politicized judiciary. Still, Laos has been making progress in reforms since the mid-80s in the frame of ASEAN economic integration which have allowed joining the WTO in 2013. Further integration is expected in the future to prepare domestic companies against more competition within the freshly born Asean Economic Community. The financial sector is in gradual development and access to capital markets slowly expanding. The state-dominated banking sector is nonetheless faced with rising bad loans in the infrastructure sector after years of booming credit growth (now down to an annual rate of around 20%) and therefore needs close monitoring. A major weakness for Laos lies in its reliance on external debt –increasingly from bilateral sources such as China - to finance its development. However, the high external debt-to-export revenues ratio, today above 190%, should gradually decrease towards less than 150% beyond 2020. As a matter of fact, a large share of external public debt – which accounts for more than half of total external debt - is related to hydropower investments and will thus be to some extent repaid by energy revenues once projects are completed. The non-payment risk on a largely foreign currency-denominated public debt is also mitigated by highly favourable debt terms and a stable exchange rate. Laos’ external liquidity is slowly improving with foreign exchange reserves at a record level in absolute terms and enough to cover the debt service in coming years. While they are under 6 weeks of import cover since 2012 due to heightened investment-related imports, the risk of external pressures is mitigated by a high dollarization of the economy and strong FDI inflows. Hence, Credendo Group classifies Laos in category 6/7 for short-term political risk. Enduring political stability under the single communist party’s (LPRP) rule greatly benefits Laos. Despite LPRP’s political dominance in a repressive and opaque regime, political protests are rare in the absence of any organized political opposition. Main risks to the political risk outlook directly relate to the consequences of Laos’ gradual economic transformation from agriculture to an industry-based economy. Social and environmental unrest is indeed on an upward trend, inequality as well in spite of Laos’ good track record on poverty reduction. Those risks are nevertheless manageable and represent a low risk to the LPRP’s legitimacy. The stable domestic picture is replicated externally through good relations with neighbouring countries, particularly with traditional ally and largest investor China. Since a too dominant China is fuelling rising anti-Chinese sentiment and social tensions among the population, Laos’ new leaders intend to slightly rebalance the economic and foreign policy focus. Still, the Chinese influential power should nevertheless prevail due to its huge investments in the hydropower, mining and transport, and to its reliable financial support.
29 Apr 2021
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