Laos' economy less affected by crisis, but sustaining growth a challenge

With a relatively unsophisticated economy that is agriculture- and natural resource-based, Laos has been affected by the crisis less than some neighboring countries.

In the aftermath of the 1997 Asian crisis, Lao PDR grew steadily, on average by 6 percent a year in real terms. Laos also impressively lifted one-eighth of its population out of poverty between 1993 and 2003. Laos aims to graduate from a low-income country status by 2020. The current global financial crisis, however, will slow down the progress in poverty reduction, as well as the growth rate and reduce government ability to invest in health, education, and infrastructure, therefore lowering Laos' chances to fulfill this goal (for more, see the World Bank's East Asia & Pacific Update, a regional economic assessment released today).

One of the poorest countries in the world, Laos is a small land-locked country in Southeast Asia, bordering and trading with China, Vietnam, Thailand, and Cambodia. Laos has a relatively unsophisticated economy that is agriculture- and natural resource-based, although industry as share of GDP has been growing steadily in the last decade. The population of around 6 million people engages mostly in subsistence agriculture.

So far, Laos has been affected by the crisis less than other countries, because:

• Underdevelopment and relative closeness of the country's economy – curses that turned out to be a mixed blessing.
• The Lao financial sector did not rely on external financing and was at the very first steps of opening up when the crisis started, suffering through its own insolvency issues.
• The financial sector also did not provide much services to the private sector (lending is only around 10 percent of GDP), as Laos struggled to reform it during the transition from a planned to a market economy.
• The country also does not have a capital market, which means that there is no easy way for capital to flow out of the country or to immediately have an impact on growth and investment through corporate equity markets. The impacts are therefore entirely through the real economy: exports (especially exports of metals) and reductions in the foreign direct investments (in mining and hydro-electricity).

As a very poor and aid-dependent country, Laos deals with different issues than its middle-income, more developed neighbors. Short of spending money on a sophisticated stimulus package, the Government is struggling to balance the budget, which is in double jeopardy from declining revenues and demands for more spending to mitigate crisis impacts – without the ability to borrow on international markets. More spending demands come from the fact that Laos will host Southeast Asian Games this year, an event for which sizable public investments are needed. But the country's revenues are projected to decline due to the sharp fall in copper prices and sluggish activity in the export sectors. One of the government's proposed responses is to cut public investment spending. This, however, will have an additional negative impact on future growth.

Laos is still projected to grow in 2009 at or slightly below 5 percent. However, its ability to sustain this growth will heavily depend on growth in China and the rest of the world, the availability of international financing for large hydro-electric dams and mining projects, and crisis-response policies that while stimulating the economy do not reduce its future growth.

Some issues are interesting to look into in more detail: What is the role and impact of the mining industry in the crisis? What are the best options for the fiscal response to the crisis? And will the vulnerabilities in the banking sector jeopardize the Central Bank's ability to mitigate crisis impacts through monetary means? One more question to answer is whether multilateral and bilateral donor countries, on which the economy now so strongly depends, will be willing and able to step up efforts to help Laos deal with the impacts of the crisis. I will discuss these issues in the weeks to come. Please also send me your questions and topics you would like to discuss in the comments section below.

Image credit: vredeseilanden at Flickr under a Creative Commons license.