Laos: Risk Assessment
Business Climate Rating1
Sustained growth in 2012 thanks to vigorous FDIs in mining and hydroelectrics
Growth was remarkably dynamic in 2011 driven by the construction, mining and hydroelectric sectors. The operational start-up of the Nam Theun II dam in March 2010 significantly increased electricity exports to Thailand. Moreover, increased gold, copper and bauxite extraction, the rebound of exports (textiles and tourism) and good agricultural performances buoyed the economy.
In 2012 economic activity will continue to grow, driven by the expansion of the mining, hydroelectric and construction sectors and by booming tourism. In addition to the successful start-up of the Nam Theun II dam, the ongoing construction of the immense Hongsa thermal power station fueled by lignite and the development of the second biggest aluminum mining project in the world, operated by foreign companies, have opened the way for Australian, Malaysian, Vietnamese and Chinese companies which are beginning to invest in the country’s raw materials. In addition, the construction of ten new hydroelectric dams in the next five years has already been approved by parliament as part of the National Socio-economic Development Plan. The country’s natural resources are expected to meet the needs of neighbors specialized in the manufacturing industry (a consumer of raw materials), of which Thailand and Vietnam are among the most important. Moreover, FDIs are often accompanied by infrastructure projects (roads, bridges etc.) on the pattern of the Chinese project of making the Mekong a major transport channel. Laos is therefore undergoing an extremely important transition: from a self-sufficient and enclosed agricultural economy, the country is transforming itself into a renter state open to dynamic neighbors.
However, this strategy is not without risks and this development in the use of natural resources could lead to social imbalances. There are still tensions in the primary sector, where agriculture continues to be mainly devoted to food production. Poor harvests are likely to keep inflation relatively high. Moreover, a renter economy generally results in high vulnerability to exogenous changes, particularly to fluctuations in world prices.
Weak financial position
The budget deficit is expected to narrow further in 2012, thanks to higher mining revenues. However, apart from the introduction of VAT, revenue from other non-mining taxes is not expected to increase. The risk associated with the development of a renter economy is that, with revenue easily derived from the rent, there is less and less incentive to conduct rigorous fiscal policies. In this context, public debt will remain high and servicing it will still be a burden on fiscal revenues.
Moreover, with a current account deficit reaching an alarming level, external over-indebtedness is significant. Despite the rise in exports of raw materials, the current account deficit will remain substantial in 2012 because of massive imports of capital goods. Moreover, the level of foreign exchange reserves will remain very low (2 months of imports), which will threaten the stability of the exchange rate.
Finally, the situation of the banks – under-capitalized and burdened with non-performing loans – constitutes a major risk element. Despite the low level of bank inter-mediation, the credit risk bears watching because of the significant credit growth since 2009 and the lack of adequate supervision.
Persistent structural weaknesses
Despite political stability, the business environment remains extremely weak. Moreover, the advent of a renter economy is not generally favorable to better governance – already among the weakest in Asia. Besides, although measures have been taken to improve education and health, the level of education remains very low and the health system underdeveloped.
- Abundant natural resources: minerals (gold, copper, bauxite, iron, zinc), oil, agricultural raw materials (maize, rice, sugar cane, rubber, manioc, soya, coffee)
- Foreign investment in raw materials sector
- Regional integration (ASEAN) and trade-liberalization policy (WTO admission process under way)
- Political stability
- Governance shortcomings
- Weak banking sector
- Significant sovereign risk because of high debt level
- high poverty rate