External Debt Management in Cambodia and Lao PDR, by Tarun Das

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Report on Capacity Building on External Debt Managementin Cambodia and Lao PDR in the Era of Globalization

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Tarun Das1

Resource Person, UN-ESCAP

March 2006

1This report expresses personal views of the author and should not be attributed to theviews of the Ministry of Finance, Government of India or the UN-ESCAP, Bangkok. Theauthor would like to express his gratitude to the UN-ESCAP, particularly the Poverty and

Development Division, for providing an opportunity to prepare this report and the

Ministry of Finance, Government of India for granting necessary permission for that.

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Contents

1. Introduction

2. Scope and objectives of Report

3. Methodology

4. Cambodia

4.1 Cambodias Macroeconomic Developments in 2005

4.2 External debt situation in Cambodia4.3 Institutional arrangement for external debt management4.4 Evaluation by international organizations4.5 Major areas of concern and recommendations

5. Lao PDR

5.1 Macro-economic developments in Lao PDR5.2 External debt situation in Lao PDR5.3 Major areas of concern and recommendations

6. Concluding observations

Selected References

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Report on Capacity Building on External Debt Managementin Cambodia and Lao PDR in the Era of Globalization

Tarun Das, Resource Person, UN-ESCAP, Bangkok

1. Introduction

A wider project on management of external debt in heavily indebted Asian countries forpoverty reduction and achievement of the United Nations Millennium DevelopmentGoals (UN-MDG) is being executed by the Poverty and Development Division (PDD),UN-ESCAP, Bangkok. As a part of this project, two consecutive National Workshops onCapacity Building for External Debt Management in the Era of Rapid Globalisationwere held in Cambodia and Lao PDR during 20-24 February 2006. The first was heldjointly by the UN-ESCAP and the Ministry of Economy and Finance, Government of

Cambodia at the Economics and Finance Institute, Phnom Penh during 20-21 February2006, followed by the second held jointly by the UN-ESCAP and the Ministry ofFinance, Government of Lao PDR at the Lao Plaza Hotel, Vientiane during 23-24February 2006..Both these workshops were participated by government departments and otherorganizations concerned with the management of external debt in the respectivecountries. The workshops were highly interactive in nature with presentations made by both the UN-ESCAP officials and consultant, country experts and multilateralorganizations. This Report by the resource person contains major conclusions andrecommendations with respect to the management of external debt in Cambodia and Lao

PDR following the presentation and wide ranging discussions in the workshops and isnow submitted to the Poverty and Development Division of UN-ESCAP.

2. Scope and Objectives of the Report

The aim of the workshops in Phnom Penh, Cambodia and Vientiane, Lao PDR was toassist the respective governments and in particular the Ministry of Finance to improvecapacity building in external debt management in the light of international best practices.

At the outset, it must be noted that the report deals primarily with the management ofexternal debt and does not deal with all aspects of public debt consisting both domesticand external debt. Much of the international best practices dealing with sovereign debt(such as the IMF Guidelines for Public Debt Management1- the IMF Guidelines) isconcerned with the management of public debt in total, not just external debt. Likewise,most of the country laws deal with the totality of sovereign debt. This is evidenced by thetitles of such laws in many countries (common titles2 include Fiscal Responsibility Law

1 Prepared by the Staffs of the International Monetary Fund and the World Bank, and dated 21 March 2001.2 http://www1.worldbank.org/publicsector/pe/countrybudgetlaws.cfm.

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and, among the poor, a larger share was closer to the poverty line. Poor households inrural areas have higher dependency burden and lack human capital: they tend to beuneducated, unskilled and unhealthy, while urban poor are subject to insecurity ofhousing rights and lack of opportunities for gainful income generation.

Fiscal Policy

Basic objectives of fiscal policy are to maintain a sustainable fiscal balance with gradualincrease in budget allocation for social and economic sectors through curtailing andrationalizing public expenditure and by broadening tax base, preventing tax evasion andleakage in expenditure, and strengthening tax administration for higher revenuerealization. Furthermore, prudent fiscal policy has been recognized as key to ensuringprice stability in Cambodia's highly polarized economy.

Fiscal performance in 2005 was good, with improved revenue mobilization andexpenditure restraint. The 2005 Budget was implemented with extreme prudence and

caution to make room for additional expenditure for financing important reform programs, such as the civil service reform, improvements in physical infrastructure,especially roads and bridges, while trying to avoid high inflation.

Domestic revenueincreased from 11.3 percent of GDP in2004.to 11.7 percentof GDP in 2005. Thetax revenue increasedfrom 8.4 percent ofGDP in 2004 to 8.7 percent of GDP in2005. However, thenon-tax revenue isexpected to be ataround 2.5 percent ofGDP.

Monetary Policy and Performance

Broad money recorded a robust growth of 20 percent in 2005, due to the increase inforeign currency deposits and credit to the private sector. Foreign currency deposits, thelargest component of broad money, recorded an increase of 20 percent, witnessing a firmconfidence in the banking sector and in the economic policy of the Royal Government ofCambodia. Credit to private sector rose by 40%, driven by the construction of hotels andhouses. Capital and reserves of the banking system continued to rise, up by 9.6% in 2005,reflecting the banks' efforts to strengthen their capital base in compliance with the recentrequirements of the law. Gross official reserves rose by 12 percent reflecting continued

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strong export performance, sustained tourist arrivals, and other forms of capital flows,including FDI.

Despite high oil prices, the government was successful in maintaining inflation undercheck and ensuring a stable exchange rate. Inflation rate reached 5.8 percent at the end of

2005,higher than the last 5 years due to the impacts of higher oil prices. The Cambodianriel-US dollar exchange rate depreciated by 2.48 percent, up from 4,035 riels per USdollar at the end of 2004 to 4,135 riels per US dollar at the end of 2005. There wasincreased inflow of foreign investment in oil refinery, hotels, ports and cement, tobaccoand cigarette industries.

External sector performance

The external sector performed well in 2005, despite high oil prices and higher tradedeficit. Provisional BOP data for 2005 indicated that the current account deficit,excluding official transfers, increased from -9.9 percent of GDP in 2004 to -10.3 percent

of GDP in 2005, reflecting the impact of higher petroleum prices and net income debits.

Nearly the entire current account deficit was attributable to an increased deficit in thetrade balance. While exports increased by 9.8 percent, imports increased by 17.6 percent.Exports of textile, clothing and footwear, which accounted for more than 70 percent ofCambodias exports, continued to expand. Non-garment exports were estimated to haveincreased at a faster pace than the garment sector, and produced 13 percent of Cambodia'stotal export earnings. This group includes traditional agricultural commodities such asrubber, wood products, fishery products, and paddy rice. In order to reduce thedependence of the economy on a single commodity and to utilize the country'sagricultural potential in a more dynamic way, the government has encouraged privateinvestment in the agricultural sector and the agro-industries.

The overall balance increased from a surplus a surplus of 0.9 percent of GDP in 2004 to1.1 percent of GDP in 2005 due to larger inflows on capital and financial accounts. Onthe whole, a positive overall surplus was achieved, while gross international reservesexpanded further to cover more than 2.5 months of import of goods and services.

4.2 External Debt Situation in Cambodia

In the latest issue of Global Development Finance (2005), the World Bank classifiedCambodia as a moderately indebted low income (MILI) country. Its major problem isthe low level of income. Policy prescriptions include improvement in real economicgrowth, continuation of sound macro-economic policies and strengthening legal andinstitutional set up for management of public debt including external debt.

As evidenced by major external debt statistics summarized in Table-1, positive aspects ofCambodian external debt include favourable debt service ratio, low share of short-termdebt and high share of concessional debt in total debt. However, there had been mixedtrends of external debt sustainability indicators in Cambodia in recent years. As judged

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by some indicators, external indebtedness of Cambodia improved to some extent in 1999-2003. External debt service (to exports) ratio declined significantly from 2.1 percent in1999 to 0.9 percent in 2003 and the external debt to exports ratio declined from 162percent to 115 percent over the same period due to substantial growth of exports. Theshare of exports in GNI improved from 46 percent to 68 percent in 1999-2003, the share

of multilateral debt in total debt improved from 13 percent to 26 percent, and the share ofconcessional loan in total external debt remained more or less stable around 89 percentover the same period. On the other hand, there was deterioration in some debt indicators.The external debt to GNI ratio increased from 75 percent in 1999 to 77 percent in 2003,the ratio of short-term debt to total debt increased from 6 percent to 7 percent over thesame period and the country has foreign exchange reserves, equivalent to only 3.7months imports cover.

Table-1: External Debt in Cambodia (in US$ million)

Items 1990 1999 2000 2001 2002 2003

Total Debt stock (EDT) 1846 2518 2628 2697 2900 3139

Long term debt 1683 2293 2328 2393 2587 2814Public & guaranteed 1683 2293 2328 2393 2587 2814

Private non-guaranteed 0 0 0 0 0 0

Use of IMF credit 27 73 73 80 96 104

Short-term debt 136 152 227 224 217 221

Total debt service (TDS) 30 32 32 22 21 25

Interest payments (INT) 30 14 18 9 8 9

Interest on long term debt 29 12 12 5 6 8

Interest on IMF loan 0 1 1 1 1 1

Interest on short term debt 1 1 5 4 1 0

Gross national income (GNI) 1115 3354 3461 3571 3831 4060

Exp.of goods and services (XGS) 1555 1997 2263 2525 2741

Workers remittances 0 106 121 133 140 138Imp.of goods & services (MGS) 2033 2457 2635 2907 3216

International reserves (RES) 509 611 697 913 982

Current account balance -188 -135 -86 -55 -125

Sustainability Debt indicators (in percent)EDT/ XGS 162 132 119 115 115

Long term debt/ XGS 147 117 106 102 103

Public & guaranteed / XGS 147 117 106 102 103

Private non-guaranteed/ XGS 0 0 0 0 0

Use of IMF credit/ XGS 5 4 4 4 4

Short-term debt/ XGS 10 11 10 9 8

EDT/ GNI 166 75 76 76 76 77

Long term debt/ GNI 151 68 67 67 68 69

Public & guaranteed / GNI 151 68 67 67 68 69

Private non-guaranteed/ GNI 0 0 0 0 0 0

Use of IMF credit/ GNI 2.4 2.2 2.1 2.2 2.5 2.6

Short-term debt/ GNI 12.2 4.5 6.6 6.3 5.7 5.4

TDS/ XGS 2.1 1.6 1.0 0.8 0.9

INT/ XGS 0.9 0.9 0.4 0.3 0.3

INT/ GNI 2.7 0.4 0.5 0.3 0.2 0.2

RES/ EDT 20 23 26 31 31

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RES/ MGS (months) 3.0 3.0 3.2 3.8 3.7

Short-term debt/ Total debt 7.4 6.0 8.6 8.3 7.5 7.0

Concessional debt/ EDT 91 90 88 88 89 89

Multilateral debt/ Total debt 0.1 13 14 16 21 26

XGS/ GNI ratio 46 58 63 66 68

MGS/ GNI ratio 61 71 74 76 79

C/A Balance as % of GNI -5.6 -3.9 -2.4 -1.4 -3.1Source: Global Development Finance 2005, World Bank

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External debt - of which about 60 percent is owed to the United States and the RussianExternal debt - of which about 60 percent is owed to the United States and the RussianFederation - constitutes 94 percent of Cambodias public debt. At end-2004, CambodiasFederation - constitutes 94 percent of Cambodias public debt. At end-2004, Cambodiastotal external public debt was $3.1 billion (64 percent of GDP), while domestic debttotal external public debt was $3.1 billion (64 percent of GDP), while domestic debt amounted to 4.1 percent of GDP, denominated entirely in local currency.amounted to 4.1 percent of GDP, denominated entirely in local currency.

Cambodias two largest creditors are the Russian Federation and the United States.Cambodias two largest creditors are the Russian Federation and the United States.Cambodia is not servicing its debt to either creditor and is making efforts to concludeCambodia is not servicing its debt to either creditor and is making efforts to concludeagreements with both creditors under the framework of the Paris Club. It is trying to haveagreements with both creditors under the framework of the Paris Club. It is trying to have a debt restructuring agreement with the US and Russia in 2006. As a consequence,a debt restructuring agreement with the US and Russia in 2006. As a consequence,Cambodias net present value (NPV) of external debt to GDP ratio would drop from 47.0Cambodias net present value (NPV) of external debt to GDP ratio would drop from 47.0 percent at end-2005 to 24.5 percent in 2006.percent at end-2005 to 24.5 percent in 2006.

At present, the Cambodias authorities are conducting negotiations with the RussianAt present, the Cambodias authorities are conducting negotiations with the RussianFederation and the United States on the rescheduling of its pre-1993 financial obligations.Federation and the United States on the rescheduling of its pre-1993 financial obligations.Technical discussions have taken place with a view to reconciling outstanding issues. TheTechnical discussions have taken place with a view to reconciling outstanding issues. Thegovernment is currently reviewing documentation from the United States to determinegovernment is currently reviewing documentation from the United States to determinethe exact amount of claims. The U.S. insisted that they would not write off any debtsthe exact amount of claims. The U.S. insisted that they would not write off any debts contracted by Cambodia during the war of 1970-75.contracted by Cambodia during the war of 1970-75.

The U.S. and Cambodia have disputed the total amount of principal. While the U.S.The U.S. and Cambodia have disputed the total amount of principal. While the U.S. suggested that there are sufficient evidence that the total amount of US$162 million issuggested that there are sufficient evidence that the total amount of US$162 million is Cambodias obligation. Cambodia claims that some documents are unclear and the part ofCambodias obligation. Cambodia claims that some documents are unclear and the part ofthe claim are not Cambodias obligation. The U.S. claims that, after agreeing on the totalthe claim are not Cambodias obligation. The U.S. claims that, after agreeing on the total principal amount, Cambodia and the U.S. need to sign the bilateral agreement based onprincipal amount, Cambodia and the U.S. need to sign the bilateral agreement based onthe 1995 Paris Club agreement (i.e., flow rescheduling on Naples terms assuming a 40-the 1995 Paris Club agreement (i.e., flow rescheduling on Naples terms assuming a 40-

year maturity, 16-year grace period, and an interest rate of 3 percent).year maturity, 16-year grace period, and an interest rate of 3 percent).

After signing the bilateral agreement, both need to calculate arrears up to now and, ifAfter signing the bilateral agreement, both need to calculate arrears up to now and, ifnecessary, Cambodia need to ask rescheduling those arrears through the Paris Club.necessary, Cambodia need to ask rescheduling those arrears through the Paris Club. Cambodia and the Russian Federation have discussed rescheduling with a stockCambodia and the Russian Federation have discussed rescheduling with a stockoperation. They have agreed that (1) after applying the stipulated exchange rate and theoperation. They have agreed that (1) after applying the stipulated exchange rate and the 70 percent upfront discount, the total debt is US$457 million, and (2) interest rate for the70 percent upfront discount, the total debt is US$457 million, and (2) interest rate for the precut-off-date debt is about 0.8 percent with concessional repayment schedule.precut-off-date debt is about 0.8 percent with concessional repayment schedule.

However, the countries have disagreed on (1) classification of US$40 million as eitherHowever, the countries have disagreed on (1) classification of US$40 million as eitherpre-cut-off-date or post-cut-off-date debt and the interest rate on the post-cut-off-datepre-cut-off-date or post-cut-off-date debt and the interest rate on the post-cut-off-datedebt. The latest bilateral discussion was held in Moscow in June 2005. No agreement wasdebt. The latest bilateral discussion was held in Moscow in June 2005. No agreement was reached. The assumption for the macroeconomic framework is (1) the disputed US$40reached. The assumption for the macroeconomic framework is (1) the disputed US$40

million is classified as pre-cut-off-date debt, and (2) the interest rate for the post-cut-off-million is classified as pre-cut-off-date debt, and (2) the interest rate for the post-cut-off-date is about 3 percent, in line with the Russian claim.date is about 3 percent, in line with the Russian claim.

Cambodian authorities are making best efforts to reach a debt rescheduling agreementCambodian authorities are making best efforts to reach a debt rescheduling agreementwith the United States and the Russian Federation. Restructuring is critical forwith the United States and the Russian Federation. Restructuring is critical forCambodias debt sustainability.Cambodias debt sustainability. Agreement on debt rescheduling with the U.S. and RussiaAgreement on debt rescheduling with the U.S. and Russiamay reduce amortization payments, but it could increase interest obligations. Cambodiasmay reduce amortization payments, but it could increase interest obligations. Cambodias

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external debt repayment will have significant impact on budget execution and thereby onexternal debt repayment will have significant impact on budget execution and thereby onpoverty reduction goals.poverty reduction goals.

By 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt isBy 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt isestimated to be about 39.4 percent of GDP, and debt service will equal 1.3 percent ofestimated to be about 39.4 percent of GDP, and debt service will equal 1.3 percent of

exports of goods and services. However, the fiscal burden of the debt is heavy, given theexports of goods and services. However, the fiscal burden of the debt is heavy, given thelow revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debtlow revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debt management policy and strictly avoid non-concessional financing.management policy and strictly avoid non-concessional financing.In the 1980s Russia granted interest-free loans for the rehabilitation of Cambodia fromIn the 1980s Russia granted interest-free loans for the rehabilitation of Cambodia fromthe scourges of war and genocide. The Russian Federation participated in the Paris Clubthe scourges of war and genocide. The Russian Federation participated in the Paris Club as a creditor. Countries that have obtained, or will obtain in the future, a concessionalas a creditor. Countries that have obtained, or will obtain in the future, a concessionalrescheduling from Paris Club creditors receive an up-front discount of 70 percent on allrescheduling from Paris Club creditors receive an up-front discount of 70 percent on allpre-1992 debts to Russia before the application of Paris Club terms.pre-1992 debts to Russia before the application of Paris Club terms.

The amounts remaining after the up-front discount are denominated in a mutually agreedThe amounts remaining after the up-front discount are denominated in a mutually agreedcurrency and are considered commercial debt (non-concessional) for Paris Club purposes.currency and are considered commercial debt (non-concessional) for Paris Club purposes.The remaining amount after the exchange rate uncertainty reduction, Russia appliedThe remaining amount after the exchange rate uncertainty reduction, Russia appliedNaples Terms under the Paris Club Agreement for most of the countries, including theNaples Terms under the Paris Club Agreement for most of the countries, including thenon-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term ofnon-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term ofloan (interest rate, grace period and payment modality).loan (interest rate, grace period and payment modality).

The amounts remaining after the up-front discount are denominated in a mutually agreedThe amounts remaining after the up-front discount are denominated in a mutually agreedcurrency and are considered commercial debt (non-concessional) for Paris Club purposes.currency and are considered commercial debt (non-concessional) for Paris Club purposes.

The remaining amount after the exchange rate uncertainty reduction, Russia appliedThe remaining amount after the exchange rate uncertainty reduction, Russia appliedNaples Terms under the Paris Club Agreement for most of the countries, including theNaples Terms under the Paris Club Agreement for most of the countries, including the

non-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term ofnon-HIPC. The final balance will be negotiated to (i) reschedule, (ii) change the term ofloan (interest rate, grace period and payment modality).loan (interest rate, grace period and payment modality).

Agreement on debt rescheduling with the U.S. and Russia may reduce amortizationpayments, but it could increase interest obligations. Cambodias external debt repaymentwill have significant impact on budget execution and thereby on poverty reduction goals.By 2008, after rescheduling of its pre-1993 obligations, Cambodia's external debt isestimated to be about 43 percent of GDP, and debt service will equal 2.6 percent ofexports of goods and services. However, the fiscal burden of the debt is heavy, given thelow revenue to GDP ratios. Thus Cambodia intends to pursue prudent external debtmanagement policy and strictly avoid non-concessional financing.

4.3 Institutional arrangements for external debt management

Institutions engaged in the management of external debt in Cambodia include theParliament, Treasury Bills Commission (TBC), Ministry of Economy and Finance,National Treasury (NT), Investment and Cooperation Department and the National Bankof Cambodia (NBC) with distinctive roles and responsibilities.

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Parliament is thefinal authority for approval of annual budget and makes laws to regulatepublic finance and public debt from both domestic and international sources. It alsochecks the proper use of resources including debt to avoid mismanagement of publicdebt.

The Treasury Bill Commissionis chaired by the Secretary of State, Ministry of Economyand Finance (MEF) with the Deputy Governor, NBC as Vice-Chairman, andDeputy. Sec. Gen, Chief of NT, and Directors, Operations Department, Finance Industry,Budget, AEF Department in the MEF as members. It takes policy decisions on issuesrelated to public finance including domestic debt and cash management and issuesappropriate instructions to NT and NBC for effective enforcement of the policies. It also prepares draft bills for parliament approval and issues terms, amount and timing forTreasury Bills.

National Treasury builds and presents financial consolidated report and ensures generalbalance of accounts. It is in charge of settlement of expenses, payrolls, collection of

revenues foreseen by finance law, balance and control revenues and expenditure. Itmanages cash flow, national budget, autonomous budgets and reserve accounts. It alsomanages the treasury accounts deposited with NBC. In conformity with the internationalbest practices, NT is moving from cash to accrual accounting.

Investment and Cooperation Department manages public investment and makes liaisonwith IFI, which prepare all public agreement regarding economic and financialassistance, loan contracts, guarantees and on-lending operations. It records all debtagreements and its corresponding transactions and settlement. It makes projections forexternal debt services and disbursement for budgetary purpose, and orders the paymentfor external debt services.

National Bank of Cambodiaparticipates in the management of external debt and claims.It assist in the debt management by conducting securities operation, perform open marketoperations in the secondary market and provides guarantees to foreign creditors fordomestic borrowers

4.4 Evaluation by the International Financial Institutions

Under the Multilateral Debt Relief Initiative, the IMF Executive Board approved inDecember 2005 debt relief for Cambodia. The IMF will provide 100 percent of debt reliefon all debt incurred by Cambodia to the IMF before January 1, 2005 amounting to US$82million. The international community has made these additional resources available tohelp Cambodia make progress toward the Millennium Development Goals (MDGs).

Cambodia has qualified for IMF debt relief because of its satisfactory overall economicperformance in recent years with progress in poverty reduction and improvements in public expenditure management. Since 1999, Cambodia enjoyed robust economicexpansion, with annual growth rates averaging over 7 percent and inflation being keptunder control.

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During this period, the Royal Government has shown strong commitment toimplementing its National Poverty Reduction Strategy, and improving publicadministration, in particular public expenditure management. Performance in these areas provides assurance that resources made available under the Multilateral Debt Relief

Initiative will be used effectively.

4.5 Major Areas of Concerns and Recommendations

At present Cambodian external debt is manageable with favourable external debt

service ratio, low share of short term debt and high share of concessional debt intotal external debt, but its sustainability in the long term may create problems unlessappropriate macro economic and financial policies are put in place to improverevenues and exports and overall economic development.

There are down side risks due to low revenue/GDP ratio and its pressure on the

government budget.

There is lack of a proper mechanism to monitor and manage external debt. A full-

fledged debt office with independent front, back, middle and head offices may beestablished in the medium term as per international best practices.

There is instability of economic growth over the years, as real GDP growth declined

from 5.7 per cent in 2001 to 4.3 percent in 2004 although it is expected to increase to6 per cent in 2005. In order to achieve broad based growth in the medium and longterm it is desirable to improve investment climate, to diversify the economy, toreduce transactions cost for doing business, to increase productivity for private sector

development, and to improve human and physical infrastructure.

The health of public finance remains weak. Budget deficit declined from 6.6 per

cent in 2002 to 5.5 percent in 2005 but still remained high. Revenue/GDP ratio islow at 12 per cent in 2005. It is desirable to continue with sound fiscal and monetarypolicy for realizing sound public debt management. Tax reforms need to continueand tax administration further strengthened for enhancing revenue realizations.

There is high dependency on exports of garments and wood products, which makes

the country vulnerable to external shocks. It is desirable to diversify exports andcontinue reforms for encouraging private investment and public-private partnership.

Trade balance is deteriorating and the current account deficit is rising (from 1.5 per

cent of GDP in 2002 to 4.9 per cent in 2005). Trade balance should be improved to asignificant degree in order to reduce external vulnerability.

Current account balance at 10.3 per cent of GDP in 2005 is high and is a matter of

concern. The deteriorating current account balance, mainly caused by poor

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macroeconomic performance, needs to be arrested by broad basing economic growthand removal of impediments to the private sector development.

Given a flexible exchange rate regime, exchange rate volatility is another area of

concerns. Although a flexible exchange rate regime helps cushion the external anddomestic shocks, it may create problems for financing debt services in the case ofexcessive depression of domestic currency. Exchange rate fluctuations may alsocreate contingent liabilities for the government in future. It is desirable to fixbenchmarks for composition, interest rates and maturity of public debt.

Government apparatus is weak and overloaded reflecting the negative effects of the

war. Institutional mechanism is yet to be in full gear to facilitate growth anddevelopment. It is desirable to strengthen institutional and legal systems and toensure good governance.

A dollarised economic system has both advantages and disadvantages. It deprivesthe country to make use of domestic monetary and fiscal policies for the countrysdevelopment. There is a need to have a long-term mechanism to give the localcurrency a larger role in the economy. For this, steps are needed to build the publicconfidence on the local currency as a store of value and a medium of exchange.

There is slow financial sector development and legal and institutional reforms

remain inadequate despite reform efforts. It is desirable to achieve a sound bankingand financial system by further progress made in the regulation and supervisionsystems and through an active use of global standards for capital adequacyrequirements, accounting, auditing, and disclosure.

As in the most developing countries, the bond market is weak and needs to be

developed for encouraging both savings and investment.

Debt rescheduling may reduce amortization payments, but it could increase interest

obligations. As a result budgetary pressures could be high, particularly in view of thelow revenue/GDP ratio. Negotiations are taking place for rescheduling the countryspre-1993 debt obligations with Russia and the United States. If debt reschedulinggoes ahead as intended, Cambodias medium term debt stock is sustainable, particularly in view of the high concessionality of the debt stock. Therefore,Cambodia needs to pursue a strong debt management strategy and avoid non-

concessional borrowing.

Even after rescheduling NPV of public debt would be still high at 230 per cent of

total revenue as revenue ratios are low. Debt servicing could be under strain andcould have negative implications on the countrys investor perception and thedevelopment process. Anticorruption rules and regulation and increase transparencyin both public and private sector. It is necessary to take measures to increase revenuethereby reducing the pressure on the budget.

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Increasing debt/GNI ratio from 75% in 1999 to 77% in 2003 is a matter of concern.

It is advisable to improve public expenditure management, in particular lending toSOEs and government guarantees, thereby contain the growth in debt.

Most of the external debt is denominated in dollars and rubles. It is necessary to fix

currency mix and interest rate mix.

There is no single institutional body for management of external debt in Cambodia.

Operational debt management functions are scattered among different institutions.There is lack of coordination, no communication in some cases and inconsistency inactions. There is need to have a good coordination between the fiscal and monetarypolicy advisers and the debt management function.

There is also lack of qualified and sufficient staff and proper performing computerbased debt management system. There is no systematic analysis of public debt.

There is need to introduce a legal framework for management of public debt, tostrengthen institutional arrangement with clear rules and responsibilities, and tocoordinate debt management functions among various authorities. It is necessary tostrengthen capacity of staff to undertake specific debt analysis including risk.

There is absence of a proper mechanism to monitor and manage debt, which may

have adverse impact on governance and sustainability of debt in future. It is

advisable to establish urgently an institutional framework (UNCTAD-DMFAS orsimilar arrangement) to record and manage debt and to put in place a debtmanagement strategy and risk management framework.

In the absence of a proper framework, monitoring of external debt appears to be weak. Itis advisable to put in place well articulated and clearly defined role of responsibilities forstaff, clear monitoring and control policies and reporting arrangements. It is alsonecessary to assess debt sustainability regularly and take corrective measures in time.

It is necessary to set up Middle Office for external debt to perform debt sustainabilityanalysis and to incorporate it into debt choice for annual budget.

5. Lao PDR

5.1 Economic Development in LAO PDR

In recent years Lao PDR has made significant economic progress. Real GDP growth ratehas improved from 5.8 per cent in 2000-01 to 6.5 percent in 2004-05 and rate of inflationhas decelerated from 26.9 per cent to 9 per cent over the same period.

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Table-2: Trends of growth rates and inflation rates in Lao PDR since 2000-01

2000-01 2001-02 2002-03 2003-04 2004-05

GDP growth rate (%) 5.8 5.9 5.9 6.2 6.5

Inflation rate (%) 26.9 8.9 11 15 9

Monetary Policy

Bank of Laos (BOL) conducts its monetary policy trough open-market operation tostabilize the value of the kip. However, there are severe limitations for conductingindependent monetary policy due to the existence of a highly dollarised economy andwidespread use of hard currencies for domestic transactions.

During 2004-05, broad money supply (M2) grew by 9.2 per cent, inflation was moderateat 6.5 per cent, exchange rate was almost stable with marginal depreciation of Kip by0.16 per cent in terms of US $ and the foreign exchange reserve amounted to 3.5 monthsof imports.

Fiscal Performance and Outlook

The Budget outcome for FY 2003/04 was satisfactory with achievement of revenuetargets, while total expenditure and net lending amounted to only 74.3 per cent of the plandue to the shortfall of capital expenditure and on-lending by 58.5% of plan.

Fiscal reforms in 2004-05 includes amendments of the Tax Law for revision of theturnover tax rates, increase of the minimum threshold for payroll tax, reduction of themaximum rate of payroll tax, consolidation of the tax rate on rental income andstrengthening of the tax administration. Because of these reforms, government revenue is

expected to reach 15 per cent of GDP by 2010.

The Customs Law was also amended to meet international standards and best practices,to provide greater clarity on the rights and roles of central and provincial custom officesand to introduce the concept of regional offices.

Expenditure reforms aimed at enhancing policy consistency, transparency andaccountability in public expenditure management.A Public Expenditure Management Strengthening Program (PEMSP) is operational forfiscal planning and budget preparation, execution, accounting and financial reporting,improving capacity building and strengthening the

Financial Legislation and Regulatory Framework.Public Expenditure Reviews and Public Expenditure Tracking Surveys were conductedregularly as a part of. Monitoring and Evaluation System for PEMSP,

Performance of State Owned Commercial Banks or SOCBs has been improvinggradually, but many challenges remain for improving quality of assets and loan portfolio,delineation of non-performing loans and strengthening of management and supervision of

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Boards, recapitalization of weak banks and general improvement of audit and accountingsystems as per international best practices.

The government is making an attempt to adjust the balance between current and capitalexpenditures, move from project support to programmatic approach in PEM support area

and to appoint International Banking Adviser(s).

Medium Term Outlook

Medium term scenario envisages the economy growing at 7.5 to 8% per annum inducedby large foreign invested projects in the mining and hydropower sectors. Inflation rate isexpected to remain at one digit level, provided that monetary and fiscal policies remainprudent. Strong export growth, mainly from mining sector, is expected to offset the highoil price risk.

Despite an increase in the external current deficit, primarily caused by imports for big

economically viable project, the underlying external position remains manageable.Current account deficit is expected to be financed by the capital inflows consisting ofmainly increased inflow of FDI and continuance of concessional medium and long-termborrowings.

5.2 External debt situation in Lao PDR

In the latest issue of Global Development Finance (2005), the World Bank classifiedLao PDR as a severely indebted low income (SILI) country. Like Cambodia, its majorproblem is the low level of income.Policy prescriptions for both these countries includeimprovement in real economic growth, continuation of sound macro-economic policiesand strengthening legal and institutional set up for management of public debt includingexternal debt.

As is evidenced by the World Bank statistics summarized in Table-3, positive aspects ofLao PDR external debt, similar to those in Cambodia, include favourable debt serviceratio, low share of short-term debt and high share of concessional debt in total debt.However, there were mixed trends of external debt sustainability indicators in Lao PDRin recent years. As judged by some indicators, external indebtedness of Lao PDRimproved to some extent in 1999-2003. The external debt to GNI ratio declined from 177percent in 1999 to 142 percent in 2003, the share of multilateral debt in total debtimproved from 42 percent to 50 percent and that of concessional loan in total externaldebt remained more or less stable around 98 percent over the same period. Level of short-term debt remained negligible and the country had foreign exchange reserves, equivalentto 5.5 months imports cover in 2003 compared to 2.6 months import cover in 1999. Onthe other hand, there had been deterioration in some other debt indicators. External debtservice (to exports) ratio increased significantly from 7.7 percent in 1999 to 10.4 percentin 2003 and the external debt to exports ratio increased from 528 percent to 592 percentover the same period due to poor performance of exports. The share of exports in GNIdeclined from 34 percent to 24 percent in 1999-2003.

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Table-3 External Debt in Lao PDR (in US$ million)Items 1990 1999 2000 2001 2002 2003

Total Debt stock (EDT) 1768 2527 2502 2495 2665 2846

Long term debt 1757 2471 2453 2456 2620 2801

Public & guaranteed 1757 2471 2453 2456 2620 2801

Private non-guaranteed 0 0 0 0 0 0

Use of IMF credit 8 53 42 37 43 44

Short-term debt 3 3 7 2 2 1

Total debt service (TDS) 9 37 41 44 45 50

Interest payments (INT) 3 9 10 10 11 12

Interest on long term debt 3 9 10 10 11 12

Interest on IMF loan 0 0 0 0 0 0

Interest on short term debt 0 0 0 0 0 0

Gross national income (GNI) 866 1428 1657 1715 1694 2004

Exp.of goods and services (XGS) 105 479 513 483 434 481

Workers remittances 11 1 1 1 1 1

Imp.of goods & services (MGS) 215 629 638 599 505 557

International reserves (RES) 8 135 144 151 216 257

Current account balance -55 90 -8 -82

Sustainability Debt indicators (in percent)

EDT/ XGS 1684 528 488 517 614 592

Long term debt/ XGS 1673 516 478 508 604 582

Public & guaranteed / XGS 1673 516 478 508 604 582

Private non-guaranteed/ XGS 0 0 0 0 0 0

Use of IMF credit/ XGS 8 11 8 8 10 9

Short-term debt/ XGS 3 1 1 0 0 0

EDT/ GNI 204 177 151 145 157 142

Long term debt/ GNI 203 173 148 143 155 140

Public & guaranteed / GNI 203 173 148 143 155 140

Private non-guaranteed/ GNI 0 0 0 0 0 0

Use of IMF credit/ GNI 0.9 3.7 2.5 2.2 2.5 2.2

Short-term debt/ GNI 0.3 0.2 0.4 0.1 0.1 0.0

TDS/ XGS 8.6 7.7 8.0 9.1 10.4 10.4

INT/ XGS 2.9 1.9 1.9 2.1 2.5 2.5

INT/ GNI 0.3 0.6 0.6 0.6 0.6 0.6

RES/ EDT 0.5 5 6 6 8 9

RES/ MGS (months) 0.4 2.6 2.7 3.0 5.1 5.5

Short-term debt/ Total debt 0.2 0.1 0.3 0.1 0.1 0.0

Concessional debt/ EDT 99 98 98 98 98 98

Multilateral debt/ Total debt 15 42 42 42 46 50

XGS/ GNI ratio 12 34 31 28 26 24

MGS/ GNI ratio 25 44 39 35 30 28

C/A Balance as % of GNI -6.4 6.3 -0.5 -4.8

Source: Global Development Finance 2005, World BankDebt Sustainability

Laos faces risks from a high debt burden. Even in high case projection, the NPV of publicexternal debt is above the threshold level for eligibility from debt relief under the HighlyIndebted Poor Countries (HIPC) initiatives and others.

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IMF defines debt sustainability as a situation in which a borrower is expected to be ableto continue servicing its debts without an unrealistically large future correction to thebalance of income and expenditure

Lao PDR is trying to restructure the

Bilateral debt for reduction of debt burden and uncertainty, to enhance access to exportmarkets in order to increase debt service capacity and to sstrengthening institutional setup for debt management.

5.3 Major Areas of Concerns and Recommendations

Medium term debt service burden of Lao PDR is manageable with favourable debt

service ratio, low share of short-term debt and high share of concessional debt.However, sustainability of debt requires that the country should continue with soundeconomic policies and reforms, particularly for fiscal reforms and attraction offoreign investment.

Lao PDR falls under the high debt stock-high risk category among low-income

countries and needs to be prudent in utilization of debt for high return projects.

External debt service/exports ratio increased from 7.7% in 1999 to 10.4% in 2003

and is a matter of concern. It is desirable to diversify exports and to encourage non-debt creating financial flows.

Lao PDR is potentially eligible for debt relief under HIPC. It is advisable for the

country to avail of such facilities from multilateral financial institutions.

Despite relatively high economic growth in the recent past, savings and investmentratios of Lao PDR remain low at 17 per cent and 21 per cent of GDP, respectively. Itis desirable to encourage savings by creating a conducive macroeconomicenvironment and establishing efficient institutional set up. It is also necessary toencourage investment by reducing regulatory and entry barriers and the transactionscost for doing business.

Government revenue at 12.5 per cent of GDP is low and puts constraints on public

expenditures, which is also low at 17 per cent of GDP. It is desirable to continue withsound fiscal and monetary policies to encourage private participation includingforeign investment. It is also necessary to take appropriate tax reforms and to

strengthen tax administration for enhancing revenue collections.

Trade deficit at 15 per cent of GDP in 2004 is also high and vulnerable to external

shocks needs to be reduced by encouraging exports.

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Current account balance at 10.3 per cent of GDP in 2005 is also high and needs to

be reduced to avoid external shocks by broad basing exports and flows on invisiblesaccount.

Despite significant reduction in recent years, current inflation rate at more than 9 per

cent is high as it hurts everybody particularly the poor whose incomes are notindexed to prices. Containment of inflation should remain high on the agenda of thegovernment. Government should adopt anti-inflationary fiscal and monetary policies.

Given a flexible exchange rate regime, exchange rate volatility is one area of

concern. It is necessary to manage exchange rate by appropriate monetary policiesfor orderly movement of exchange rates.

Foreign reserves could be increased to more comfortable levels over the medium

term and should be monitored regularly.

There is high dependency on a limited number of exportable products, which makesthe country vulnerable to external shocks. It is necessary to diversify exports and toencourage trade creating foreign investment.

It is desirable to develop human resources and institutional framework to take the

country forward in a globalised setting.

Debt recording system is defunct and it is desirable to urgently get the system back

on track to enable proper recording and monitoring of external debt.

Financial and capital markets are still at an early stage of development despiteimprovements made during the past two decades. It is advisable to achieve a soundbanking and financial system with more efficient regulation, supervision and legalsystems and active use of global standards for capital adequacy requirements,accounting, auditing and disclosure.

Weak bond market needs to be developed to boost both savings and investment.

Most of the external debts are highly concessional. Yet the external debt has

increased sharply in recent years from 69 per cent of GDP in 2003 to 82 percent ofGDP in 2004. The rising debt stock and debt service ratios are matter of concern. It is

desirable to tighten, streamline and prioritize new borrowings for developmentneeds.

External debt is denominated mostly in dollars. Exchange rate depreciation in terms

of US dollar may create problems for financing debt services and contingentliabilities for the government. It is advisable to set benchmarks for composition ofpublic debt in terms of domestic and external debt, interest rates and maturity ofexternal debt.

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Lao PDR is reluctant to benefit from the HIPC initiative due to fear that it may loose

concessional loans/grants provided by some bilateral donors. It will be beneficial forthe country to avail of HIPC facilities from multilateral organizations as it willimprove capability of the country to take structural reforms and stabilization policiesfor enhancing efficiency, productivity and competitiveness of industries and to

impart dynamism to overall growth process.

6. Concluding Observations

International best practices for management of external debt leads to the following broadconclusions:

(a) Management of external debt is closely related to the management of domesticdebt, which in turn depends on the management of overall fiscal deficit.

(b) Debt management strategy is an integral part of the wider macro economic

policies that act as the first line of defense against any external financial shocks.

(c) For an emerging economy, it is better to adopt a policy of cautious and gradualmovement towards capital account convertibility.

(d) At the initial stage, it may be prudent to encourage non-debt creating financialflows (Foreign Direct Investment and Equity Portfolio) followed by liberalizationof long-term and medium-term external debt.

(e) Big bullet loans are bad for small economies, as these can create refinancing risk

that many countries would be well advised to avoid.

(f) It is not enough to manage the government balance sheet well; it is also necessaryto monitor and make an integrated assessment of national balance sheet and to putmore attention on surveillance of overall debt- internal and external, private and public. In each of the major Asian crisis economies- Indonesia, Korea andThailand- weakness in the government balance sheet was not the source ofvulnerability, rather vulnerability stemmed from the un-hedged sort-term foreigncurrency debt of banks, finance companies and corporate sector.

(g) It is not sufficient to manage the balance sheet exposures, it is equally importantmanage off balance sheet and contingent liabilities. Emerging as well as advanced

economies have experienced how bad banks can lead to large costs to theeconomy and an unexpected weakening of the governments balance sheet.Government guarantees of private debt can also have similar adverse impact.

(h) It is necessary to adopt suitable policies for enhancing exports and other currentaccount receipts that provide the means for financing imports and debt services.

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(i) Detailed data recording and dissemination are pre-requisites for an effectivemanagement and monitoring of external debt and formulation of appropriate debtmanagement policies.

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(j) There is a need to set up an independent Public Debt Office with the followingfunctions:

To deal with both domestic & external debt

To set bench marks on interest rate, maturity mix, currency mix,

composition of debt in terms of domestic and external debt

Identification and measurement of contingent liabilities

Policy formulation for debt management

Monitoring risk exposures

Building Models in ALM framework

i.

(k) It is vital that external contingent liabilities and short-term debt are kept withinprudential limits.

(l) It is important to strengthen public and corporate governance and enhancetransparency and accountability.

(m)It is also necessary to strengthen the legal, regulatory and institutional set up formanagement of both internal and external debt.

(n)(o) A sound financial system with well developed debt and capital market is an

integral part of a countrys debt management strategy.

Selected References

Bandera, Amarakoon (2006a) Regional overview and importance of strengthening debtmanagement strategy, presentations made in Phnom Penh, Cambodia on 20 February2006 and in Vientiane, Lao PDR on 23 February 2006.

________ (2006b) Recommendations and conclusions on the management of externaldebt in Cambodia, presentation made in Phnom Penh, Cambodia on 21 February 2006.

________ (2006c) Recommendations and conclusions on the management of externaldebt in Lao PDR, presentation made in Vientiane, Lao PDR on 24 February 2006.

Chhon, Keat (2006) Opening remarks at the National Workshop on Capacity Buildingfor Management of External Debt in the Era of Rapid Globalisation, Phnom Penh,Cambodia 20 February 2006.

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Das, Tarun (2006a) Conceptual issues and debt sustainability, presentations made inPhnom Penh, Cambodia on 20 February 2006 and in Vientiane, Lao PDR on 23 February2006.

_______ (2006b) Intercountry comparisons of external debt and international best

practices for management of external debt, presentations made in Phnom Penh,Cambodia on 21 February 2006 and in Vientiane, Lao PDR on 24 February 2006.

_______ (2006c) Management of external debt in India and lessons for developingcountries, presentations made in Phnom Penh, Cambodia on 21 February 2006 and inVientiane, Lao PDR on 24 February 2006.

________ (2006d) Management of External Debt- International Experiences and

Best Practices, Best Practices series No.9, UNITAR, Geneva.

________ (2006e) Management of Public Debt- International Experiences and Best

Practices, Best Practices series No.10, UNITAR, Geneva

ESCAP (2005) Implementing the Monterrey Consensus in the Asian and Pacific Region-Achieving Coherence and Consistency, United Nations, New York, 2005.

International Monetary Fund (2003) External Debt Statistics- Guide for Compilersand Users, 2003, IMF,Washington D.C.

_______ And the World Bank (2003) Guidelines for Public Debt Management:Accompanying Document and Selected Case Studies, 2003, Washington D.C.

Naron, Hang Chuon (2006a) Situation analysis and current issues of Cambodianeconomy with special emphasis on fiscal and debt issues, presentation made in PhnomPenh, Cambodia on 20 February 2006.

_______ (2006b) Debt management strategies and issues relating to legal andinstitutional framework, presentation made in Phnom Penh, Cambodia on 20 February2006.

Saysamone Xaysouliane (2006) Macroeconomic performance, fiscal sustainability anddebt management in Lao PDR,presentation made in Vientiane, Lao PDR on 23 February2006.

Taliercio, Rob (2006) External debt and risk management, presentation made in PhnomPenh, Cambodia on 21 February 2006.

Thirong, Pen (2006) Issues of external debt management in Cambodia, presentationmade in Phnom Penh, Cambodia on 21 February 2006.

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World Bank(2000) Sovereign Debt Management Forum: Compilation of Presentations,November 2000, World Bank, Washington D.C.

External Debt Management in Cambodia and Lao PDR, by Tarun Das

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