Lao Economic Monitor, October 2024: Reforms for Stability and Growth: Key Findings

Part A: Recent Economic Developments and Outlook

• The weak kip means continued high inflation and lower domestic consumption. From January to September 2024, the kip weakened by 19% against the US dollar at official rate, and by 28% on the parallel market. This pushed up consumer price inflation to an average of 25% over the same period. For every 1% fall in the value of the kip on parallel exchange markets, private consumption drops by an estimated 0.6%, in turn eroding domestic welfare and demand.
• Despite some progress in increasing public revenues, Laos’ fiscal stabilisation measures have largely depended upon limiting public expenditure, notably on health, education and social protection. Revenue collection has Improved, largely due to higher profit tax and VAT collection. However, overall revenue capacity is still low, with tax incentives granted under investment agreements severely undermining the tax base. Interest payments on debts have grown because of currency depreciation and higher interest rates. Meanwhile, the share of GDP spent on health and education is about half what it was in 2013, jeopardizing the long-term productivity of the workforce.
• Public debt remains unsustainable, with domestic financing sources under pressure. Laos faces solvency and liquidity challenges, owing to financing needs, limited financing options, low foreign exchange reserves, and significant depreciation pressures. Total public and publicly guaranteed debt remains high, at 108% of GDP at the end of 2023, or 116% of GDP if domestic expenditure arrears and a swap arrangement are included. A credible debt restructuring plan and improved debt management will be needed to restore debt sustainability.   
• Foreign exchange market imbalances persist, putting pressure on the exchange rate. The positive current account balance, according to official data, has not contributed to a better balance of demand and supply of foreign exchange for two main reasons. First, imports are underreported when compared to data from partner countries. Second, in the first half of 2024 only about 65% of official export proceeds entered the country’s financial system, with the remainder retained offshore. The lack of foreign exchange liquidity constrains the government’s ability to meet debt service obligations and limits the central bank’s ability to meet demand from importers.
• Macroeconomic imbalances are expected to persist and hinder growth prospects, unless there is debt restructuring and more progress on reforms. Real GDP is estimated to grow by 4.1% in 2024, due to the performance of tourism, transport and logistic services, and investment in power generation. These sectors are expected to sustain growth beyond 2024, but their contribution will be undermined by labor shortages and higher costs. High inflation will hit real household incomes, thereby depleting family savings, consumption and human capital spending.
• Space for development spending will remain constrained. Revenue is expected to increase gradually, owing to recently introduced tax adjustments, but total expenditure is also expected to rise due to interest payments on debt. The World Bank/IMF Debt Sustainability Analysis rates Laos as being in unsustainable public and external “debt distress” and depreciation of the kip is expected to continue driving up the debt ratio, despite GDP growth.
• Restoring macroeconomic stability requires a strong commitment to five critical reform areas: (i) curbing tax exemptions and reforming excise taxes (for example on tobacco, alcohol, and fuel) to raise revenues and boost spending on social services; (ii) expediting ongoing debt renegotiations and strengthening public debt management; (iii) managing risks from contingent liabilities related to state-owned enterprises and public-private partnerships; (iv) strengthening financial sector stability; and (v) improving the business environment to promote investment and exports.

Part B: More Revenues, Better Health – Implementing health tax reforms for Laos

• Health taxes are excise taxes imposed on products with a negative public health impact - tobacco, alcohol, and sugar-sweetened drinks. These taxes make for healthier populations and generate revenues for the state budget. Evidence shows that a 10% increase in cigarette, alcohol, and sugary drink prices leads to about 5%, 3% and 9% declines in demand for these products.
• Health excise taxes can secure more tax revenue for Laos. To realize these gains, the tax structure and tax rates need to be revised. On average, governments across the world raise revenues worth about 0.6% and 0.3% of GDP from tobacco and alcohol excise taxes. Laos collects less than 0.08 and 0.4% of GDP from tobacco and alcohol excise taxes.
• An Investment License Agreement has impeded the effectiveness of tobacco tax collection in Laos. The 25-year agreement was signed by the government in 2001 to create a joint-venture with an international cigarette manufacturer and provides a preferential reduced tax rate that prevents the collection of all applicable taxes. The agreement is the primary reason for low cigarette prices, low tax revenue, and the resulting health and economic harm. The agreement will renew automatically unless it is cancelled in 2024. The government should therefore end these exemptions and privileges without delay.
• The excise tax reforms approved in 2023 and effective from the beginning of 2024 are projected to have almost no impact on smoking prevalence or on real revenue cigarette taxes. Benefits from changes to alcoholic and non-alcoholic beverage excises are projected to be low.
• The World Bank gives recommendations for reforming taxes on cigarettes and alcohol. For cigarettes, a mixed tax structure of a specific tax amount in kip per pack and a tax rate on the producer price should be applied. The kip amounts should be increased annually to catch up with neighbouring countries. For alcohol, a uniform fixed amount of tax should be applied on volume sold for each alcohol type (beer, wine, spirits). Once the new tax policy is firmly in place, a simple alcohol-strength tax tier structure could be considered since this will further reduce the amount of pure alcohol consumed.
• The proposed reforms would bring in additional revenue of over 2.75 trillion kip within the first year, equivalent to almost 0.8% of GDP. Health excise tax reform is in line with the National Socioeconomic Development Plan Financing Strategy and the National Agenda on Addressing Economic and Financial Difficulties. The proposed policy is conservative - the average excise tax on a packet of cigarettes was 8,000 kip in lower-middle-income countries in 2020 and the recommended beer excise is the same as that currently applied in Viet Nam.
• Excise tax reforms should be accompanied by steps to enhance tax administration. While efforts to modernise tax administration are ongoing, a longer-term development agenda is needed in areas such as digital tax administration and implementation of a track and trace system. Other actions to strengthen tax administration, and to provide additional revenue for health without increasing the size of the public budget, can include the use of technology to aid monitoring, enforcement, and licensing.