Laos Economic Monitor, May 2023: Navigating economic uncertainty - key findings (2023)

Structural challenges, macroeconomic instability and a deteriorating external environment hampered economic activity in the Lao People's Democratic Republic.GDP growth is projected at 2.7% in 2022, supported by a gradual recovery in tourism and other services. While the Laos-China Railway and the new dry port boosted tourism and trade flows, and industrial activity was supported by natural resource exports, the recovery was marred by macroeconomic instability and external factors. The need to service huge foreign debts, combined with high import prices and a shortage of foreign exchange, led to a sharp drop in the value of the kip. This leads to high inflation, which in turn weakens income, consumption and investment. For many households, real incomes are falling, as are spending on health and education.

· Kip depreciates sharply in 2022, driven by persistent external imbalancesand keys Thai baht and dollar up 32% and 43% respectively in year to April 2023.The exchange rate has stabilized recently on the back of tightening monetary policy. However, limited foreign exchange liquidity and low reserves led to foreign exchange rationing by commercial banks and promoted the development of a parallel foreign exchange market.

· Depreciation of the kip and rising world prices lead to high inflation, and 40% in the year to April 2023. Rising global raw material prices, especially fuel and fertilizers, lead to higher costs for locally produced raw materials and commodities. Food prices rose 52% year-on-year, severely affecting poor urban households.

· Real household income suffers from runaway inflation.althoughTonFrom May 2022 to December 2022, the share of households reporting a loss of income decreased, with nearly two-thirds of workers seeing income stagnate or decline amid rising costs of living. By the end of 2022, 64% of households in Laos will have the same or lower budget than the previous year.

· Fiscal consolidation driven by tighter spending and slightly higher domestic revenue. The fiscal deficit narrowed slightly, with preliminary results excluding interest payments showing a small surplus. However, with high debt service obligations and revenues still below pre-pandemic levels, total financing needs remain substantial. Lack of fiscal space limits the ability of governments to support poor households or invest in health and education.

· Public debt and publicly guaranteed debt have reached critical levels, undermining macroeconomic stability and development prospects.Laos faces solvency and liquidity challenges, with debt projected to exceed 110% of GDP in 2022. The energy sector accounts for about 37% of the debt stock in 2021. China holds about half of its external debt stock and plans to repay that debt 2023–26. Public spending on education and health falls from 4.2% of GDP between 2017 and 2022 to an estimated 2.6% of GDP over the same period, as debt-service spending rises from 35% to 61% of domestic income.

· External imbalances remain high as foreign exchange is needed for imports and debt servicing. Relative to GDP, the current account balance deteriorates slightly in 2022 due to a reduction in the trade surplus and higher net income payments. Export growth was partly offset by higher import prices, especially fuel. Capital inflows remained limited due to lower foreign investment. Only one-third of export earnings go to the domestic banking sector, and foreign exchange levels are insufficient.

· The economy is expected to grow by 3.9% in 2023, accelerating to an average of 4.3% in the medium term, driven by a continued recovery in services and exports.External demand is expected to help support manufacturing and agricultural exports, while industry will benefit from investments in the energy sector and special economic zones. However, growth is expected to remain below pre-COVID levels due to structural weaknesses. Inflation will remain elevated in 2023, partly due to high commodity prices and a depreciating kip. The economy could recover more quickly if structural imbalances were addressed.

· Nominal household incomes are expected to increase gradually, even if they are affected by the high cost of living.Inflation weakens purchasing power, increases consumption costs, depletes household savings and human capital expenditures, and puts many households at risk of poverty. Assuming Laos continues on this fragile recovery path, per capita income growth will remain below pre-pandemic levels and below its regional peers in the medium term.

· The economic outlook faces significant downside risks.external risk Including low growth and demand in the regional economy. On the other hand, inflation in advanced economies could trigger further rate hikes and put renewed pressure on the Kip. Domestic risks include external debt refinancing problems, slow progress in structural reforms, and deterioration in bank balance sheets. Labor shortages caused by immigrants seeking higher wages could also undermine prospects for recovery in agriculture, manufacturing and services.

To restore macroeconomic stability, reforms are needed in five key policy areas:

  1. Increase public revenues to protect spending on education, health and social protection;
  2. improving the distribution and efficiency of expenditure;
  3. speed up debt negotiations;
  4. enhance the stability of the financial sector; and
  5. Improve business environment, promote investment and export.

Furthermore, improving the availability, timeliness, and quality of data is key to effective evidence-based decision-making.

Thematic segment: Impact of macroeconomic instability on Lao households

Households in Laos are feeling the effects of ongoing macroeconomic instability.Low-income households tend to be more vulnerable to inflation than wealthier households because they have limited coping capacity and lack the financial reserves to handle rising living costs. Poorer households are also more likely to be affected by declines in social spending, as gains from public health and education services make up a larger proportion of their income.

Inflation has affected nearly 90% of households in Laos, forcing them to adopt coping strategies.From May to December 2022, the cost of living in urban and high-income households increases by approximately 24.5% and 22.5%, respectively, due to sharp increases in food and transportation prices. While low-income and rural households are less exposed to inflation, the impact is still widely felt as agricultural input prices rise. Meanwhile, the minimum wage and public sector wages lost 27% and 24% of their real value respectively over 2020-22. In response to inflation, more than three-quarters of affected households reduced food consumption or switched to cheaper homegrown or wild foods. This can lead to poor food and nutrition security.

Constrained government and household budgets have led to a decline in human capital spending, especially among low-income households.Inflation and currency devaluation lead to higher costs of public health and education, while rising debt burdens, stagnant government revenues, and increases in other spending categories crowd out social spending. . Low-income households are expected to feel the strongest adverse effects, as the wealthiest are more likely to have access to private health and education services. Among households hit by inflation, more than half have reduced spending on education and health care. According to reports, about 7% of children from low-income families will drop out of school in 2022, mainly for economic reasons.

Major policies to mitigate the adverse effects of macroeconomic instability:

  • Reallocate public spending to priority areas, including health and education.
  • Redesign fiscal policy to target support for the poor and vulnerable. Shifting from tax cuts and exemptions to more progressive fiscal interventions, such as targeted cash transfers, would allow governments to protect household livelihoods from sustained price shocks at lower fiscal cost.
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