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While most ASEAN economies are stabilizing and have increased their reform and recovery efforts, Laos - the poorest member of the grouping - has not only been left behind, but is facing a severe economic crisis which could effect free-market reforms and lead to the partial return to a more centrally-controlled economy. Since 1997, the Lao currency has experienced the highest rate of depreciation in ASEAN - from 700 kip to the dollar before the Asian financial crisis began in mid-1997 to about 9,000 in November - and it is the only country in the region with triple-digit inflation. Hardliners in the ruling Lao People's Revolutionary Party are increasingly blaming the country's woes on the opening up of the country to outside investment and influences. This sentiment is also shared to some extent by Cambodia and Vietnam. Significantly, the three ASEAN members - once part of a communist bloc in Southeast Asia - met separately on 20 October in Vientiane for an “unofficial summit” but, in effect, setting up a bloc within the bloc.
Laos first introduced reforms under a policy called the New Economic Mechanism in 1986. Between 1992 and 1997, foreign investment flowed into the country, and annual GDP growth averaged 7 per cent. But then came the crisis of 1997, and the Lao economy went into a tailspin. The main problem for Laos was that 74 per cent of all foreign direct investment came from Thailand, and 30 per cent of its exports depended on the Thai market. With their own finances in turmoil, Thai investors suddenly had more important priorities than investing in Laos - but the crisis was also caused by weaknesses in Laos's own economic policies. According to a recent study by IMF economists, 'weak macroeconomic management was compounded by lengthy consensus building in the decision-making process, making it more difficult for the country's authorities to react quickly to the deteriorating macroeconomic situation'.
By May 1999, the kip had lost more than 80 per cent of its value against the dollar and inflation was running at 150 per cent. On 19 September, the government decided to intervene to attempt to 'control' the exchange rate by diktat. The kip doubled its value vis-a-vis the Thai baht and the US dollar almost overnight. But the positive effects of the intervention was short-lived and, within days, the kip began to slide again. The outcome has been a flight of capital to banks in Thailand across the Mekong river, causing even more confusion and further weakening confidence in the economy as a whole.
Laos's fundamental problem is that the country for years has been living beyond its means. In 1997, the year of the crisis, US$706 million worth of foreign goods were imported, while exports totalled a mere US$359 million. In 1998, the gap was not quite as wide - $552.8 million worth of imports and $369.5 million in exports - but much more had to be done to revitalise the moribund Lao economy, economists said. Nor was the problem something new. Official statistics show that the last Lao trade surplus was in 1928. Since then, the country has lived on subsidies and aid from, successively, France, the United States, the Soviet Union, and the Western donor community.
But the crisis of 1997 made everything worse. Laos' earlier stability was based on two pillars: tight fiscal policies and strong inflows of foreign investment. For several years, the Lao budget deficit was more than covered by donor financing, allowing the government to build up deposits with the banking system that could be used by other sectors. The inflow of foreign capital also provided a cushion against small shocks and helped finance imports. The Asian crisis knocked down both of these pillars. Foreign investment dried up and the budget became weaker.
The most important long-term impact of the crisis may be that Laos's long-anticipated mega hydroelectric power projects - which once were believed to hold the solution to the country's acute trade deficit - are in jeopardy. The biggest of those, a US1-1.5 billion dollar scheme to build a dam and a hydroelectric power station on the Nam Theun river in south-central Laos, has run into trouble as it needs World Bank guarantees for private loans. Laos' poor economic performance since 1997 may now prevent it from securing such guarantees as the World Bank, the IMF and donor countries are keeping their purse strings tight.
While there is no way back to the old, rigid socialist days of the late 1970s and early 1980s, when even more disastrous, Stalinist economic policies brought the country to its knees, the ruling elite are beginning to reassess the benefits of free-market reforms. State intervention in the currency market is one example of this new attitude. The government has also bought up shares in local companies to exert more control over the private sector. But, as the recent currency turmoil shows, these actions have been largely counterproductive. The IMF argues that Laos has to improve - not worsen - the climate for investment and business activity to restore external investment flows and boost exports, while Laos continues to do exactly the opposite.
If the Lao government does not address the problems facing it in a more imaginative way than just preaching more state intervention, social unrest cannot be ruled out. While recent reports in the Thai press of student-led anti-government protests in Vientiane seem to be grossly exaggerated, Laos is no doubt entering a new era of economic and political uncertainty.
WATCHPOINT: Social unrest may force Lao leaders to seek new solutions to economic problems.
About our company:
AFG Venture Group is an Asia and Australia based corporate advisory and consulting firm with over 20 years experience in creating alliances, relationships and transactions in Australia, South East Asia and India; including a 15 year history of corporate and equities advisory in Australia, undertaking merger, acquisition, divestment, fund raising and consulting for private and public companies.
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