Laos has enjoyed economic growth rates in recent years that have been the envy of many of its fast-growing regional peers, despite being Southeast Asia’s second-poorest nation.

But after several years of gross domestic product (GDP) growth of over 7%, signs of a slowdown are emerging as inflation kicks up, public debt rises and private sector-led growth remains hamstrung by over-investment in hidebound state-owned enterprises (SOEs). Growth has tapered off from 7% in 2016 to 6.9% last year and is expected to slip further to 6.7% this year.

Bouasone Bouphavanh, president of the National Institute for Economic Research, stressed at a conference held in Vientiane last month that the government should recognize that “economic restructuring or reform [is] essential to enable any country to break through the hardship of economic downturn as well as other economic difficulties,” local media reported.

Economic restructuring isn’t a new concern for Bouasone, a former prime minister who earlier this year said that private sector-led growth is essential to the communist nation’s economy, especially as it becomes less reliant on natural resource extraction in the years ahead.

But if private business is to achieve lift-off in Laos, a country of around seven million, local entrepreneurs will need more access to credit, analysts say. That’s not readily available in Laos, where securing loans and credit is difficult for both businesses and individuals due to a nascent and undercapitalized banking system.

Laos – Lao Development Bank – Finance – Youtube
A branch of the state-run Lao Development Bank in Vientiane. Photo: YouTube

The communist party-run government was praised in 2017 for injecting additional capital into Banque Pour Le Commerce Exterieur Lao Public (BCEL), one of the country’s largest state-owned banks. But the bank’s lending into the economy is slowing – it rose by “only” 10% in 2017 compared to almost 20% growth in previous years, according to a report by the Lao National Economic Research Institute.

The World Bank puts industrywide loan growth at 11% for 2017, compared to 21% in 2016, while noting that credit growth was slowing also in the first quarter of this year. This figure may be skewed somewhat by a trend of borrowers shifting towards more private and less state-sector banks.

Lao National Economic Research Institute data indicates that the amount of bank loans to private-sector firms increased by 14% last year, while loans to state-owned enterprises contracted by almost 3%. Some economists say that is because the government is phasing out some publicly-funded investment projects due to rising national debt, a growing budget deficit and an overall government goal to rein in the state sector.

While more than 90% of all businesses in Laos are classified as small- and medium-sized enterprises (SMES), only one in five of these companies has access to bank credit, according to the International Monetary Fund (IMF).

“Helping SMEs to gain access to formal market-based financing is an important underpinning for inclusive growth and employment creation,” an IMF spokesperson said.

“Microfinance and capital markets remain relatively shallow. Focusing reforms on the banking sector to support inclusive growth and help ensure financial stability, therefore, is a priority. A key step is to raise capital in a number of majority-publicly-owned banks and some private banks,” the spokesperson added.

Prime Minister Thongloun Sisoulith of Laos attends talks with Chinese Premier Li Keqiang (not pictured) at Great Hall of the People in Beijing, China, November 28, 2016. Photo: Reuters/Thomas Peter
Prime Minister Thongloun Sisoulith at the Great Hall of the People in Beijing, China, November 28, 2016. Photo: Reuters / Thomas Peter

Economists say there is still much the Lao government can do to boost lending. After a Cabinet meeting in June, Prime Minister Thongloun Sisoulith announced revisions to the SME Promotion and Development Fund, an investment board designed to provide capital to such firms.

More recently, Thongloun told the National Assembly that encouraging SME growth would be one of the government’s eight core economic objectives.

The Bank of Laos, the nation’s central bank, has also been praised for introducing new procedures to avert financial risks in the banking sector. Those include instructions to all commercial banks to prepare action plans to comply with Basel II capital adequacy requirements.

Consumer-based lending is particularly laggard. A World Bank report published in June, using data from 2014, found that only 47% of adults in Laos were using at least one regulated financial service, much lower than in many other Asian nations. Analysts say this percentage has most likely risen since 2014, but probably not by very much.

Because of the lack of regulated financial services available to ordinary Laos, the number of people who use informal finance services, such as money lenders, was as high as 60%, as opposed to 33% in Myanmar, according to the same World Bank report.

Laos-Public Debt-Graphic-Trading Economics
Lao public debt as a percentage of GDP.

The report asserted that many people in Laos prefer to use informal financial services, despite high interest rates and other risks, because they are easier to access than formal financial providers, which are often tied down with red-tape.

Indeed, some say that the best move the government could make would be to ease control over the banking sector by removing restrictions on who can get loans and lightening regulations on the financial services themselves.

There are steps being taken in that direction. Earlier this year, the government said it would issue new directives to streamline approval processes for loans, which should allow consumers and businesses to access more credit.

Moreover, there has been a gradual shift toward more private banking activities. At the end of 2017, almost 43% of the total assets in Laos’ banking sector were controlled by state-owned commercial banks, down from 55% in 2012. Meanwhile, stakes in the banking sector controlled by foreign, privately owned or joint ventures is rising, according to the World Bank.

The micro-finance sector is also expanding in Laos, but not nearly as quickly as it has in neighboring countries like Cambodia, where the size of the average micro-loan is now among the highest in the world.

Fast deregulation of Cambodia’s micro-finance sector has caused numerous problems, including rising indebtedness, but underlying demand shows many Cambodians are willing to take the borrowing risk. By the middle of 2017, total assets of micro-finance institutions in Laos amounted to roughly US$450 million, up 11% from the previous year.

Luang Prabang, Laos - November 29, 2009: A young female vendor in traditional clothing sits waiting for customers amidst her produce (banana, eggs, melons, baskets) at an outdoor market in Luang Prabang, a UNESCO World Heritage Site.
A Lao vendor in traditional clothing sits waiting for customers at an outdoor market in Luang Prabang. Photo: iStock/ Getty Images

If Laos’ private sector needs more credit to drive the economy forward, then the government arguably needs to restrain its borrowing. For years, Vientiane has been advised to trim expenditure on its bloated civil service and curb spending on infrastructure works, while also reforming its SOEs to bring them more in-line with their profit-oriented private sector rivals.

Public debt was $13.6 billion at the end of 2017, or roughly 61% of annual GDP. Almost half of that amount is owed to China, including loans for a new high-speed rail line, which some analysts say Laos on the verge of a potential “debt trap.”

A World Bank report from earlier this year warned that since public debts are increasingly from loans with less concessional terms than previously, including through bond issuances, it makes Laos “increasingly vulnerable to risks of sudden exchange-rate volatility, and to a lesser extent to an upward movement in external interest rates.”

That said, the government doesn’t appear be doing enough to reduce its deficit. Total revenue collection actually contracted last year, down to 16.1% of GDP compared to 16.5% of GDP in 2016. This was partly put down to declining imports, which reduced the amount of excise taxes the government collected.

At the same time, and despite constant warnings from international financial bodies to avoid overspending, government expenditure rose slightly in 2017, up to 21.4% of GDP in 2017 from 21% the previous year. But while the communist government is advised to tighten its belt or suffer consequences, if it wants to maintain sustainable economic growth rates it must allow private businesses to loosen theirs.