International Trade Policy in the Lao PDR

Draft1

February, 2003

1. EXECUTIVE SUMMARY

The Lao PDR is a landlocked country whose most important trading partner is Thailand,

which supplies about 68 per cent of its imports and buys about 32 per cent of its exports.

It has been a member of the ASEAN Free Trade Area since 1997. Traditionally, its main

exports used to be timber and coffee. However, in the last decade, the rapid growth of the

garment industry, the slump in world coffee prices and the banning of exports of logs and

rough sawn timber have resulted in garments now being its single most important single

export. The principle imports are machinery and equipment, vehicles and fuel.

The economy was substantially liberalized in the late 1980s, when the transition

from a state-controlled system to a more market-oriented one was initiated. Import tariffs

have been substantially reduced in the last decade. More recently, a major trade

liberalization occurred in 1995, when the former tariff schedule, which had a maximum

ad valorem rate of 150 per cent, was replaced by the current schedule, which has only six

separate rates, which are 5 per cent, 10 per cent, 15 per cent, 20 per cent, 30 per cent and

40 per cent. However, as in many countries, the effective rates of protection for most

import-competing manufacturing industries are probably much higher than the

corresponding nominal tariff rates because of low import duty rates, or complete

exemptions, on the capital equipment and raw materials used by these industries.

The median customs import duty for all 3551 items identified in the Customs Duty

schedule is 5 per cent, the un-weighted average duty rate for these items is 9.5 per cent

and the import-weighted average duty rate is 14.7 per cent. However, the average

collected duty rate is probably only about 3 per cent. These estimates imply that, on

average, about 80 per cent of the legislated import duties are exempted in practice.

1 This draft was prepared by George Fane, ANU, acting as a consultant for the World Bank Institute.

Substantial help was provided by officials of the World Bank and the Government of the Lao PDR. The

opinions expressed are his and not those of the WBI or the government.

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Possible reasons for the very exemption rate include AFTA preferences, the right of

manufacturing exporters to duty free imports of raw materials and the right of approved

domestic and foreign investors to import vehicles, machinery and capital equipment at a

duty rate of only 1 per cent, rather than the rates of 5 to 40 per cent listed in the Customs

Duty schedule. Other possible explanations of the exemption rate may involve duty free

imports by state agencies, state owned enterprises and influential private enterprises.

Duty free access of exporters to raw materials can be justified as a poor substitute for free

trade, but better than nothing. However, the other grounds for exemptions violate the

basic principle of efficient taxation, which is that the base of any tax should be as broad

as possible, so as to allow the average tax rate to be set as low as possible. Setting

relatively high rates on a small base results in the misallocation of resources between

activities that are able to get low rates, or complete exemptions, and those that are not

able to get these privileges. It also generates wasteful and potentially corrupt competition

for exemptions.

Desirable trade policy reforms are:

• The list of imports and exports that are prohibited for moral, health, quarantine and

security reasons should be defined as narrowly and as precisely as possible to ensure

that the existing barriers to imports of rifles and sporting guns, casino equipment,

communication equipment, fuels and lubricants are not excessive and are not used to

protect domestic producers.

• The removal of the ban on exports of logs and rough sawn timber. Excessive

depletion of forests should be controlled by production royalties.

• In cases in which import licensing is being used to protect domestic producers, it

should be replaced by equivalent import taxes.

• The 80 per cent average rate of duty exemptions is excessive. Duty free access to raw

materials for exporters is desirable, but duty free access of most foreign and domestic

investors to materials and capital equipment is undesirable and should be replaced by

setting low rates of duty on these items that would apply to all domestic purchasers.

An appropriate rate might be 5 per cent.

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• The reductions that have occurred in import duty rates over the last 8 years should

continue. It would be desirable to move towards a single uniform import duty rate on

all items of perhaps 5 per cent, from which the only exemptions would be duty free

access of exporters to raw materials.

• Full unification of the exchange rates should be implemented by removing all

exchange controls on current account transactions.

It would be sensible to implement trade liberalization in the way chosen by several of the

original members of ASEAN: liberalizations that are required under AFTA commitments

should be made available to all countries on a most favored nation basis.

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2. COMPOSITION AND DIRECTIONS OF TRADE

2.1 Exports

The Lao PDR’s exports are heavily concentrated into just three products and that this

concentration has become even more marked since 1996. These three products are

garments, coffee and wood products. Table 1 shows that in 1996, according to the data of

the Bank of the Lao (BOL), these three products accounted for 78.6 per cent of all

Laotian exports, but by 2001 this combined share had increased to 90.0 per cent.2 Further,

this increase had occurred despite a fall in the share of coffee exports in total

merchandise exports from 9.2 per cent in 1996 to 2.5 per cent in 2001. Therefore just two

products—garments and wood products—accounted for 87.5 per cent of total

merchandise exports. Between 1996 and 2001, garments overtook wood products to

become the largest single category of exports. By 2001, garments accounted for 49 per

cent of all exports, while wood products accounted for 38.4 per cent.

The Lao PDR’s garment industry now consists of 53 specialist exporting firms.

Although it has grown rapidly, it is still much smaller than that of Cambodia, let alone the

export industries of the South and East Asian giants. As a result, buyers in Europe and

North America often turn to Lao exporters when their regular large suppliers, in countries

such as India, China and Vietnam, are unable to meet particular orders. Similarly, when

the Lao specialist exporters receive orders that are too big for them to fill, they

subcontract the work that they cannot do themselves to one or more of 27 manufacturers

that act both as sub-contractors for exporters, and also as producers for the local market.

Lao exports are also highly concentrated among a few purchasing countries. The

single most important destination is the European Union (EU), which bought 54 per cent

of Lao PDR’s coffee exports and 88 per cent of its garment exports in 2000. In total, the

EU bought 48.5 per cent of all exports. The next most important export market is

Thailand, which bought 31 per cent of total Laotian exports in 2000. The bulk of Laos’s

exports to Thailand are wood and wood products, and Thailand purchased 76 per cent of 2 All the estimates in this section are from Brenning et al. (2002, Table 1). The data on exports by product

reported in the main text are based on the data of the Bank of the Lao PDR (BOL). Brenning et al. show

that there are substantial differences among the trade data produced by the BOL, the Ministry of

Commerce, the IMF and UNCOMTRADE.

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Laos’s exports of these items. However, Thailand bought only 1 per cent of Laos’s coffee

exports and almost none of its exports of garments. In total, according to the

UNCOMTRADE data, all the ASEAN countries except Thailand together bought only

another 1 per cent of Laos’s total exports and the next three largest buyers are Japan (5

per cent), USA (4 per cent) and China (3 per cent). However, the UNCOMTRADE data

exclude Vietnam.

Having exports so highly concentrated obviously makes the Lao PDR’s ability to

earn foreign exchange vulnerable to fluctuations in the prices of a few products. For

example, between May 1997 and May 2002, the world price of coffee fell by 74 per

cent.3 Since these exports were about 8 per cent on average of total Lao exports over this

period, the fall in coffee prices produced a decline in Laos’s terms of trade of about 6 per

cent.

There are currently concerns about Laos’s future foreign exchange earnings from

each of its two major exports. First, export receipts from timber and wood products may

be disrupted in the short run by the decision to ban exports of logs with effect from late

2001. In the medium run, the ban could raise export receipts by increasing the share of

timber that is exported in the form of higher value added furniture rather than logs.

However, it is argued in sub-section 3.3 that the ban is not a good way of overcoming the

problems that it is addressed to handle. Second, the phasing out of the Multi Fibre

Arrangement (MFA), which is due to be completed by 2004, will disadvantage Laotian

garment exporters, since their exports of most relevant products are too small to be

restricted by the MFA, whereas it does seriously restrict the exports by their larger

competitors, such as China, India and Vietnam.

2.2 Imports

Based on UNCOMTRADE data, Brenning et al. (2003, Table 11) estimate that

consumption goods accounted for 40 per cent of the Lao PDR’s imports in 2000.

Investment goods accounted for 33 per cent and intermediates for the remaining 27 per

3 The ‘indicator price’ of the International Coffee Organisation fell from $1.80/lb. to $0.47/lb. over this

period (http://www.ico.org/asp/display10.asp).

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cent. The share of intermediates was roughly equal to what it had been a decade earlier,

but the shares of the other two categories were reversed between 1990—when investment

goods accounted for 40 per cent of imports and consumption goods for 34 per cent of

total imports—and 2000.

Table 2 shows that Laos’s imports are much less highly concentrated among

products than its exports and, again in contrast to the increasing concentration of exports,

the degree of import concentration has been decreasing. The three most important

categories of imports are machinery and equipment, vehicles and fuels. According to the

BOL data, these three categories accounted for 59 per cent of imports in 1996, but for

only 47 per cent of all imports in 2001. In 1996, imports of machinery and vehicles were

each more than twice as large as imports of fuel, but by 2001, the three main categories

were all similar in size: machinery accounted for 17 per cent of total imports, while fuel

and vehicles each accounted for 15 per cent.

Despite the lower concentration among products of imports than of exports, Laos’s

total import bill is probably more sensitive to price volatility than its export earnings.

This is due mainly to the fact that fuel prices are highly volatile and fuel imports are

larger in absolute terms than any component of exports. Although imports of fuel

averaged only 17 per cent of total imports over the period 1996–2001, whereas exports of

wood products, garments and coffee averaged 37 per cent, 35 per cent and 8 per cent,

respectively of total exports over the same period, fuel imports averaged $96

million/year, whereas exports of wood products, garments and coffee averaged only $89

million/year, $80 million/year and $21 million/year, respectively. The apparent paradox

is explained by the fact that total imports were 2.4 times as large as total exports over this

period.

In terms of regions of origin, Laos’s imports are very highly concentrated on

Thailand, which in 2000 was the source of $386 million, or 63 per cent of all imports,

according to the UNCOMTRADE data. The next two largest suppliers were China ($35

million, or 5.7 per cent of total imports) and the EU ($33 million, or 5.3 per cent of total

imports). However, these data exclude imports from Vietnam, which was the source of

$70 million of imports in 2000 according to the estimates derived from Vietnamese data

by Brenning et al. (2002: 39).

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3. TRADE REGIME

A country’s trade regime consists of the arrangements, mainly specified by the

government, for regulating and taxing or subsidizing international trade. The two most

basic parts of any trade regime are the customs duties on imports and exports and the

licensing arrangements for imports and exports. In countries with foreign exchange

controls there are usually important interactions between duties, licensing and foreign

exchange arrangements. The Lao PDR is not an exception to these generalizations.

Another very important part of any trade regime is the system for providing some

importers, or exporters, with certain exemptions from the normal rates of duty. The three

main types of duty exemptions in Laos are those for approved foreign and domestic

investors, those for exporters of manufactures and those arising from the fact that the Lao

PDR is a member of a preferential regional trade bloc, the ASEAN Free Trade Area

(AFTA).

3.1 Customs duties on imports and exports

Import tariffs have been substantially reduced in the last decade. A major liberalization

occurred in 1995, when the former tariff schedule, which had a maximum ad valorem rate

of 150 per cent, was replaced by the current schedule, which has only six separate rates,

which are 5 per cent, 10 per cent, 15 per cent, 20 per cent, 30 per cent and 40 per cent.

The 5 per cent and 10 per cent duty rates apply to imports of raw materials, agricultural

inputs, capital equipment and essential consumption goods, such as basic foods and

pharmaceuticals. The 40 per cent duty rate applies to products such as motor vehicles,

tobacco, perfume and other luxury goods. As in many countries, the principle underlying

the tariff system is to apply the lower rates of duty to raw materials used by domestic

producers, and to use the higher duty rates to protect domestic producers against import

competition. The effect of such tariff structures is that the effective rates of protection for

manufacturing activities are generally much higher than the average tariff, or even than

the highest rate on any particular product.

The effective rates of protection on manufacturing activities are also increased by the

policy of allowing approved foreign direct investors, and joint ventures between foreign

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and local partners, to import capital equipment and machinery subject to a duty of only 1

per cent. Approved local investors in large scale enterprises can also qualify for similar

concessionary duties on imports of capital equipment and machinery.

Table 3 reports the estimates of the Working Party on WTO Accession (2001).

According to this report, the median customs import duty for all 3551 items identified in

the Customs Duty schedule is 5 per cent, the unweighted average duty rate for these items

is 9.5 per cent and the import-weighted average duty rate is 14.7 per cent. It is interesting

to compare these estimates with the Department of Customs (DOC) data in Table 2 on

the value of merchandise imports, the total duty payable and the total duty paid during the

October-December quarter of 2000, that is, the first quarter of the fiscal year, 2000/01. It

is unfortunate that DOC is not able to supply this data for a longer period, since the

figures for one quarter may be unrepresentative. However, in the absence of more

comprehensive data, we are forced to use those for this particular quarter. In fact, Table 4

gives a very similar estimate of the average import-weighted duty: customs duty payable

in kip were 14 per cent of the value of imports in kip. The closeness of this estimate to

the import-weighted average duty rate of 14.7 per cent in Table 3 suggests that the pattern

of imports in the last quarter of 2000 is not unrepresentative of the pattern over a longer

period.

A very interesting feature of Table 4 is the very wide gap between the duty payable

of 14 per cent of the value of imports, and the duty actually paid, which was only 3 per

cent of the value of imports. This difference implies that almost 80 per cent of duty

payable is foregone. The main reasons for the large share of duty foregone are:

• AFTA preferences.

• The right of approved domestic and foreign investors to import vehicles,

machinery and capital equipment at a duty rate of only 1 per cent, rather than the

rates of 5 to 40 per cent listed in the Customs Duty schedule and used for

calculating both the imported weighted tariffs in Table 3 and the average duty

payable in Table 4.

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• The right of approved manufacturing exporters, under the temporary importation

scheme described in section 3.6 below, to avoid duty on all imports of raw

materials for use in making manufactured exports.

• Other grounds for duty exemption include:

o Garment manufacturers that normally specialize in exports can import yarn

and cloth for domestic sales at a duty rate of only 1 per cent, rather than the 10

per cent normally payable on average, if they can demonstrate to the

satisfaction of DOC, MIH and MOC that their domestic sales replace imports.

This is discussed in more detail in Section 3.5.

o Government agencies, and ministries and the military can import duty free.

o Diplomatic missions can import duty free, under Article 56 of the Customs

Law, provided that the imports are not re-sold on the domestic market.

o Certain individuals have the right to import vehicles at a duty rate of only 10

per cent, rather than the 40 per cent in the Customs Duty schedule. These

individuals include senior government officials, heroes of the country (those

who took part in Laos’s independence struggle) and pensioners.

Although the practice of exempting a high proportion of imports from customs duty is

quite common in developing countries, it violates the most fundamental principle of

efficient taxation, which is that the base of any tax should be as broad as possible, so as to

allow the average tax rate to be set as low as possible. Setting relatively high rates on a

small base results in the misallocation of resources between activities that are able to get

low rates, or complete exemptions, and those that are not able to get these privileges. At

best, the practice of granting numerous exemptions also results in the direct wasting of

resources in socially wasteful lobbying for special treatment; at worst, it leads to

corruption. Since the decrees specifying the rights to exemptions are far less detailed than

the Customs schedule itself, it is obvious that there must be ‘gray’ areas in deciding

whether particular items are eligible for exemption or not.

In some cases, there are potential second best justifications for exemptions. The most

important example is the temporary importation regime for manufacturing exporters,

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which partially offsets the anti-trade bias of import barriers. Of course, these exemptions

are a poor substitute for free trade, since duty free access to imported raw materials does

not undo all the anti-trade bias of the import and export barriers on other products.

Relative to any nominal exchange rate, import barriers directly raise the domestic prices

of all imported goods, and indirectly raise the domestic prices of non-traded goods and

domestic factors of production. Duty-free access to raw materials and capital does not

compensate exporters for the higher prices that they must pay for non-tradable inputs and

factors of production, such as labor and land. Therefore, even with such duty free access,

exports and imports are lower than they would be in the complete absence of trade

barriers. Besides, duty free access to raw materials for manufactured exports does not

compensate the exporters of coffee, wood products, electricity and other non-

manufactured items for the higher prices they must pay for factors and other inputs, let

alone the explicit export taxes that are levied on some of these items, such as coffee and

wood products.

3.2 Other taxes collected by DOC

In addition to export and import duties, DOC is also responsible for helping to collect

four other taxes. These are the excise tax, the additional excise tax, the turnover tax and

the profit tax. Since the excise tax is levied on the value of imports, inclusive of customs

duty, and since the turnover tax is levied on the value of imports inclusive of both

customs duty and excise tax, the overall rate of tax can be very high. The case of

imported motor vehicles provides the most extreme example of this. The calculation

below shows how the combined rates of these three taxes builds up to 214 per cent in the

case of a vehicle with an engine capacity of over 2000 cc, on which the import duty is 40

per cent, and the excise duty is 104 per cent of the price inclusive of import duty.

Price of imports, cif: 100.00

Import duty at 40%: 40.00

Price inclusive of import duty: 140.00

Excise duty at 104% of price inclusive of import duty: 145.60

Price inclusive of import duty and excise tax: 285.60

Turnover tax at 10% of value inclusive of import and excise duties: 28.56

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Price inclusive of import and excise duties and turnover tax: 314.16

Since the excise and turnover taxes are levied on both domestic production and imports,

they are not taxes specifically on trade in the sense that they do not change the relative

prices of the corresponding domestic and imported products. In the case of domestic

production of vehicles, the imposition of an excise tax at 104 per cent and the turnover

tax at 10 per cent would raise an ex factory price of 100 to a price to final buyers of

224.40. The corresponding import price of 314.16 is of course exactly 40 per cent above

this price of domestic production. But since the highest rates of excise tax are applied to

items for which there is, as yet, no domestic production, the distinction between taxes on

trade and taxes on luxury consumption is mainly semantic.

Table 4 shows that the ratio of tax paid to tax payable is even lower in the case of

export and excise duties than in the case of import duties. Indeed, none of the additional

excise duty payable was actually paid. However, the ratios of tax paid to tax payable

were much higher for turnover and profits tax than for the customs and excise duties.

3.3 Licensing of imports and exports

Most import licenses are issued by the Department of International Trade, Ministry of

Commerce and Tourism (MOCT) under Decree No. 462/MOC of 8th December 1993.

Certain chemical and pharmaceutical imports are licensed by the Ministry of Public

Health. The former licenses lapse after 90 days, the latter lapse after 60 days. To be

eligible to apply for an import license from MOCT, a person or firm must be a registered

importer. Importers can only import for their own businesses and cannot act as

commission agents for others. Import licenses are consignment specific: the application

form requires the applicant to specify the source of financing, method of payment,

invoice number, description of goods, method of packing, country of origin, gross and net

weight, quantity of goods, unit price, total value in kip and foreign currency, port of

entry, method of transport, final destination, countries of transit, and name of person who

is to receive the goods. Licenses are non-transferable.

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Trade licensing before 2001/02

The licensing requirements were substantially liberalized in 2001/02, but until then, a

license was required for every export and for every import, other than:

• Imports of yarn and textiles used by the garment manufacturing industry.

• Imports from ASEAN countries of products that are listed both on the ASEAN

Free Trade Area CEPT Inclusion List of Lao PDR and on the corresponding list

of the exporting country.4

According to the Memorandum on WTO Accession, licenses were granted automatically

for all imports other than those listed below. The restricted items are grouped by the

reasons given for licensing them by the Accession Memorandum:

1. Cement

2. Steel bars for construction

3. Motor vehicles, including motor cycles

4. Foodstuffs

5. Seeds

6. Chemical fertilizers

7. Casino equipment

8. Rifles and sporting guns

9. Certain print and audio-visual material

10. Certain chemicals, including drugs, amphetamines and explosives

11. Communication equipment

12. Fuels and lubricants

According to the Accession Memorandum, the barriers on items 1 and 2 are imposed

to protect infant industries; those on item 3, motor vehicles, are imposed to prevent traffic

congestion; those on items 4, 5 and 6 are imposed for food security reasons; those on

items 7 to 11 are imposed to protect public morals and safety; no rationale is explicitly

stated for the barriers on item 12. In some cases, these rationales are somewhat obscure,

for example, there would seem to be more effective ways of alleviating traffic congestion

than imposing import duties on vehicles. Indeed, the Accession Memorandum seemingly

4 Annex 3 of Working Party on the Accession of the Lao PDR (2001).

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acknowledges this by stating that the government is looking for other instruments for

achieving this goal. Similarly, barriers to the importing of chemical fertilizers would

seem to be a counterproductive way of promoting food security, and one can wonder

whether all the licensing regulations under items 7 to 11 are strictly needed for protecting

public morals and safety. Since there is no detailed list of the relevant items by HS code,

there is no way of judging this. The lack of precision in the regulations presumably

creates uncertainties for importers, and the potential for corruption.

Similar arguments apply to the restrictions on log and timber exports to protect

forests. If the objective is to restrict logging, the appropriate tax is a production royalty

levied at the same rate on domestic and export sales. The actual arrangements seem to

subsidise domestic furniture manufacturers by artificially holding down the price of

timber, while allowing finished and semi-finished products to be exported at low, or zero,

duty rates.

Trade licensing after the reforms of 2001/02

Since 2001, there has been some liberalization of the list of items for which import

licenses are required. For example, licenses are apparently no longer required for sugar,

and beer. According to Regulation No.0161/MoCT of 11th February 2002, the list of

controlled imports for which approval from the relevant line ministry is required includes

food, seeds, fertilizers and insecticides, as well products controlled for reasons of

morality and culture. There does not appear to be a publicly available comprehensive list

of all 3551 HS code items classified by the licensing restrictions that apply to each of

them.

The MOCT stated that general export licenses have now been abolished, although

bans still apply to exports of logs, rough sawn timber and items restricted on grounds of

public safety, protection of public morals and the protection of wild animals.

A very important reform of the import licensing system was introduced at the

beginning of the fiscal year 2001/02 when the very bureaucratic system which required

importers to obtain licenses for every shipment was replaced by a much more flexible

system. Under the new system, importers, exporters and manufacturers large enough to

be licensed to import and export on their own account must draw up an annual business

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plan in which they set out their proposed imports and exports. These plans are submitted

for approval to MOCT, the Ministry of Industry and Handicrafts (MIH) and DOC. If

approved, the importer can import the products on the plan up to the approved amounts,

without having to apply for a separate license for each shipment. Firms can apply to have

their plans varied if, for example, sales are faster, or slower, than initially anticipated.

3.4 Foreign exchange controls

Because the Central Bank rations foreign exchange at the official rate, there is a gray, or

parallel market, in which the price of foreign exchange is higher than the official price at

which on-shore commercial banks sell it to approved purchasers. The banking system,

which is dominated by three state banks, is required by the Central Bank to allocate

foreign exchange on a preferential basis to imports of 20 priority items. Since the price of

foreign exchange in the parallel market exceeds that in the official market, this effectively

imposes an additional barrier to imports of non-priority items. However, in the recent

past the premium of the price of foreign exchange in the parallel market over its price at

the official rate has usually been less than 2 per cent (see below).

The priority import items for which foreign exchange is provided at the official rate

are essential products that cannot be produced in Laos. Examples of these priority items

include gasoline, fertilizers, milk powder, certain construction materials, capital

equipment, pharmaceuticals and basic foods that are not produced in Laos; however,

basic foods that are produced in Laos, such as noodles, are not on the priority list.

Importers of the priority items can generally obtain the foreign exchange needed to pay

for them, up to approved amounts, from the commercial banks.

Importers of non-priority items, such as cake, confectionary, watches, noodles,

calculators, television sets, vehicles, motor cycles and a host of other non-essential or

locally produced items are often unable to obtain foreign exchange from the commercial

banks, and must buy it at the higher rate that applies in the parallel market. The supply of

foreign exchange to this market comes partly from exports that are legal in themselves,

but whose proceeds are illegally diverted from the official to the parallel market, and

partly from the proceeds of smuggled exports. The demand for foreign exchange in the

parallel market comes from all those who are rationed, or banned, from buying as much

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foreign exchange as they want in the official market. Those wishing to finance capital

flight and non-priority imports are obvious examples of buyers in the parallel market.

Exporters are supposed either to convert their foreign exchange proceeds to kip at

on-shore banks at the official rate, or to use them to pay for imports, or to keep them in

foreign currency denominated accounts at on-shore banks. In practice, however, it is hard

to stop some exporters selling part, or all, of their foreign exchange receipts in the

parallel market. The parallel market means all transactions involving the exchange of

local currency for foreign exchange that are done without the intermediation of a

domestic commercial bank. It is most visible when it involves the physical exchange of

kip notes for dollar notes, but most parallel market transactions are apparently done by

exchanging checks, with perhaps the pretence that the checks are being used to pay for

underlying transactions in goods or services.

According to a senior banker at a state owned commercial bank, all transactions in

the parallel market are technically illegal. According to Presidential Decree No. 01 of

August 9th 2002, individuals and business cannot hold foreign currency and must deposit

it in on-shore bank accounts that can only be used to make purchases from non-residents

of approved imports, overseas travel, educational and medical expenses. It is illegal for

residents to use foreign exchange to make purchases from other residents, and buying and

selling foreign exchange for local currency can only be done legally by the commercial

banks, and authorized money changers.

In practice, the government has not attempted to enforce these restrictions. As a

result, many individuals and businesses with no foreign exchange earnings of their own

have bought foreign exchange in the parallel market, and used it to set up foreign

exchange accounts at onshore commercial banks. These foreign exchange deposits now

account for about 80 per cent of the total supply of broad money (M2) and the

commercial banks are apparently willing to transfer foreign currency balances from one

domestic account to another, in accordance with the instructions of the account holders,

even though such instructions are illegal in view of Presidential Decree 1/August 2002.

As long as the disparity between the rates in the parallel and official markets is

small, exporters may as well conform with the law and refrain from selling their foreign

exchange earnings on the parallel market. But once the premium becomes substantial,

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exporters, and particular small scale exporters, have an incentive to illegally sell their

foreign exchange directly into the parallel market. Since the exchange rate unification in

the 1980s, the government has done little to prevent such illegal actions and the

differential between the official exchange rate and the parallel market rate has usually

been small. At the end of 1998, it was 11 per cent and since then it has generally been

much smaller still. In 2002, the parallel market premium has not exceeded 2 per cent and

has sometimes been as low as 0.5 per cent; in early November 2002, it was 0.9 per cent.5

3.5 Other exemptions from import duty for approved foreign and domestic investors

Under the Investment Law, foreign and joint venture investors have the right to import

machinery and capital equipment duty free. If they can demonstrate to the satisfaction of

the MIH, Ministry of Commerce and Department of Customs that their local sales are

replacing imports, then the imported raw materials are subject to duty of only 1 per cent,

rather than the 10 per cent that would otherwise apply.

Manufacturers are normally given permission to use their export proceeds to finance

imports on their own behalf, and can apply for foreign exchange from the banks if they

can show that it will be used to finance exports, or to replace imports. For example, some

garment manufacturers have recently been able to obtain allocations of official foreign

exchange and the right to import cloth and other raw materials at a duty rate of only 1 per

cent on the ground that they are producing school uniform shirts, formerly imported from

Thailand, for children in certain primary and secondary schools. The manufacturers

entered into contracts with particular schools to make their uniform shirts and were able

to attach copies of these contracts to their annual business plans. They also attached

declarations from the schools that the shirts had formerly been imported from Thailand.

Given this documentation, the applications for foreign exchange and duty concessions

were successful. In contrast, most producers of garments for the local market pay duty on

raw materials at 10 per cent and must buy their foreign exchange in the parallel market.

5 The data are for the premium of the parallel market rate over the BOL rate in kip/dollar. Source: Bank of

Laos.

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3.6 Export incentives

Tariff exemptions for exporters

Like most countries, the Lao PDR tries to provide exporters of manufactured goods with

duty free access to raw materials. The three main ways of doing this are listed below.

Only the first of these arrangements, temporary importation, is currently available to Lao

exporters, although there are plans to introduce the other two.

• Temporary importation, or duty exemption—no duty is paid on raw materials

that are to be incorporated into exports, but the exporter must provide evidence to

the customs department that the products are eventually exported.

• Duty drawbacks—duty is initially paid, but the exporters can apply for a refund

of duty by demonstrating that the products have been exported.

• Free trade zones—firms located in the zones can engage in both import and

export trade with foreign countries free of duty. Their sales to the domestic

market are subject to customs duty, although concessional treatment is common.

In principle, the temporary import regime is available to all exporters of manufactures. In

practice, it appears that almost the only users are the 53 specialist garment exporters. This

probably reflects the dominant share of garment exports in the Lao manufactured exports

and the fact that it is relatively easy for DOC to calculate the amount of imported raw

materials that are needed for each consignment of garment exports.

The specialist exporters generally import all their fabrics duty free and must

demonstrate to DOC that they have exported an equivalent amount of finished garments.

This is done using agreed technical coefficients. If the exporter imports 10 tonnes of

woven fabric for shirt manufacture, the Customs Department specifies an allowed

wastage rate of 5 per cent, for example, calculates that perhaps 1.6 square meters of cloth

is needed per shirt, estimates the weight of cloth at 120 grams per square meter and

reaches the result that perhaps 50,000 shirts can be produced from this amount of cloth.

The exporter must then export this number of shirts, or pay duty on the shortfall. If the

exporter subcontracts some of the work to one of the small sub-contractors, the exporter

17

supplies the cloth and receives, and then exports, the finished shirts. The exporter, not the

subcontractor, has the responsibility for demonstrating to customs that the duty-free cloth

imports have indeed been incorporated into exports. When the relatively small firms that

act as sub-contractors produce on their own account for the local market, they generally

pay duty at 10 per cent on the fabrics and other raw materials that they import.

The specialist garment exporters usually produce much higher quality items than

those sold on the local market, but occasionally they may sell some of their output

locally. In terms of the above example of the importation of cloth for 50,000 shirts, the

exporter might decide to sell 5,000 locally and export the remainder. In this case, the

export shortfall is 10 per cent of the total number for which cloth was imported duty free;

the exporter would therefore be liable for duty on 1 tonne of cloth, that is, 10 per cent of

the total amount of cloth that had been imported duty free. In such cases, the exporter

would normally include these local sales into the annual business plan, and would have a

good chance of being able to persuade MOCT and MIH that the local sale of export

quality shirts was replacing imports, and that the duty rate should therefore be only 1 per

cent, and not the 10 per cent that would apply to local sales that were not replacing

imports.

3.7 The ASEAN Free Trade Area (AFTA)

The Lao PDR became a full member of ASEAN in 1997. ASEAN now comprises all ten

countries in Southeast Asia: Indonesia, Singapore, Malaysia, the Philippines and

Thailand, Brunei Darussalam, Vietnam, Myanmar and Cambodia, as well as Laos itself.

As a consequence of joining ASEAN, Laos has made a commitment to liberalize its trade

with the other members in accordance with the ASEAN Free Trade Area (AFTA)

arrangements.

The importance of AFTA preferences to the six original members of AFTA—

Indonesia, Singapore, Malaysia, the Philippines, Thailand and Brunei Darussalam—is

limited by the fact that most of their trade is with non-ASEAN countries and that most of

their trade with ASEAN countries is with Singapore, which has always operated a regime

very close to free trade. However, in the case of the Lao PDR, AFTA preferences and

commitments are very important because at least 32 per cent of exports are sold to other

18

ASEAN countries, and at least 68 per cent of its imports are bought from other ASEAN

countries.6 Since these estimates are based on UNCOMTRADE data, and since these data

exclude Vietnam, the true ASEAN proportion are even higher.

The AFTA scheme sets obligations on members to liberalize their trade with other

members. These obligations are defined in terms of four lists of importable items, with

different obligations applying to the items on each list. Each ASEAN member must place

all its imported items on one or other of these four lists:

• The Inclusion List (IL) of imported items that are immediately eligible for

preferential treatment, if the exporting country satisfies certain conditions,

specified below.

• The Temporary Exclusion List (TEL) of items that must be moved onto the IL in

accordance with a specified schedule.

• The Sensitive List, which comprises unprocessed agricultural products (UAPs).

• The General Exception List (GEL) of items that are covered by Article XX of

GATT, such as those that threaten national security, public morals, health,

religion or the preservation of the national heritage.

For items on the IL and TEL, each member specifies a schedule of ‘Common Effective

Preferential Tariff’ (CEPT) rates. Items on the IL are potentially eligible for AFTA

preferences. Items that receive preferential treatment pay import duty at the CEPT rate of

the importing country and are exempt from non-tariff barriers. To actually receive AFTA

preferences, an imported item must not only be on the IL of the importing country and

satisfy a rule of origin requirement (namely, that at least 40 per cent of its value must

have been added in ASEAN), it must also satisfy two reciprocity conditions designed to

encourage members to move towards internal free trade by preventing free riding. First,

the exporting country must also have placed the product on its own IL. Second, if the

importing country’s CEPT rate for the item is 20 per cent, or less, the exporting country’s

CEPT rate for the same item must also be 20 per cent, or less. This means that if the

exporting country has not place the item on its own IL, or if it has done so, but set a

6 Brenning et al. (2002(Tables 4 and 13).

19

CEPT rate of more than 20 per cent, its exports of this item will not receive AFTA

preferences in other ASEAN countries with CEPT rates of 20 per cent or less.7 Taken

together, these conditions reward countries that place items on their ILs at CEPT rates of

20 per cent or less by allowing their exporters to benefit from whatever AFTA

preferences other members may grant on the same items, and by only requiring them to

grant their own preferences to members that impose CEPT rates on those items of 20 per

cent, or less.

The AFTA agreement specifies that items on the TEL must be gradually moved onto

the IL. The Lao PDR and the other new members of ASEAN—Vietnam, Myanmar and

Cambodia—are committed to move all the items on their TELs to their ILs by 2008. By

this date they must also have reduced the CEPT rates on their IL items to zero.8

For the six older members, the process of moving items from TELs to ILs and setting

zero CEPT rates on IL items is now almost complete. By May 2001, the ASEAN–6 had

included 98.3 per cent of all tariff codes in the CEPT arrangements and 92.7 per cent of

these included items already had CEPT rates in the range of only 0 to 5 per cent. This

provides the Lao PDR and the other new members with a strong incentive to move items

onto the ILs at CEPT rates of 20 per cent, or less. By May 2001, the four new members

had only included 54.2 per cent of all tariff codes, but since they also had 43.1 per cent of

all tariff codes on their temporary exclusion lists, they were committed to eventual intra-

ASEAN free trade on 97.3 per cent of their tariff lines (Soesastro, 2001: 230–1, Tables

12.1 and 12.2).

The commitments of AFTA members to liberalize trade in the UAPs on the SL are

less rigorous than those for items on the IL and TEL. Non-tariff barriers (NTB) on the SL

items must eventually be removed, and the new members of ASEAN are committed to

reducing the duty rates on imports of these items from ASEAN countries to between zero

7 Fukase and Martin (2001: 143). 8 The initial AFTA target was to reduce CEPT tariffs on IL items to between zero and 5 per cent. The six

old members of ASEAN were committed to reach this target by 2008. In 1999, the target was changed to

zero tariffs for all members, and the date by which the six old members had to reach it was brought forward

to 2003; the four new members were given an extra five years in which to reach the target (Soesastro,

2001).

20

to 5 per cent by 2015. The six older members are committed to achieving this goal by

2010, subject to a very few exceptions for ‘highly sensitive items’, of which the most

important are restrictions on rice imports to Indonesia and Malaysia.9 The Lao PDR has

not put any items onto a comparable highly sensitive list.

3.8 Policy recommendations

It would be desirable to fully unify the exchange rates by removing all exchange controls

on current account transactions. Since the premium of the market exchange rate over the

over the official rate is small the economic effects would also be small, but there would

be significant improvements in transparency and administrative simplicity.

As part of its AFTA commitments, the government is already committed to move all

the items on the TEL to the IL by the start of 2005 and to reduce the CEPT import duty

rates on IL items to the range 0 to 5 per cent by the start of 2008. It is also committed to

reduce the CEPT rates on items on the SL to the range 0 to 5 percent by the start of 2015.

Quantitative restrictions (QR)—such as quotas, restrictive trade licenses, and other

administrative controls—on imports of IL items from ASEAN countries must be

removed by the start of 2005. The government is not committed to stop using import

licensing as a way of protecting domestic producers of IL items until 2005, and could

continue to apply import licensing to SL items after 2005. However, it would be much

better to provide such protection by setting equivalent rates of import duty and removing

all restrictive licenses. This would have three main advantages: the revenue from the

duties accrues to the government, duties are more transparent than licensing, and on

occasions licensing may prevent domestic producers and consumers from obtaining items

that are urgently needed and for which they would be willing, if necessary, to pay very

high duty rates.

The government has undertaken to extend the removal of QRs to all countries on an

MFN basis and it would be desirable to also extend tariff cuts to all countries by making

the general import duty rates for all countries equal to the CEPT rates on imports from

9 Indonesia and Malaysia have agreed to remove NTBs on rice eventually, but they have not made

commitments to reduce tariffs on rice below 20 per cent.

21

ASEAN countries. This is the way in which trade liberalization was implemented by

other ASEAN such as Indonesia, Malaysia and Thailand.

The 80 per cent average rate of duty exemptions is excessive. Duty free access to

raw materials for exporters is desirable and should be made more easily available, but

duty free access of most foreign and domestic investors to materials and capital

equipment should be replaced by setting low rates of duty on these items that would

apply to all domestic purchasers. An appropriate rate might be 5 per cent.

Some countries, of which Chile is a notable example, have set a single low duty rate

for all imports. Such a policy has several major advantages: it avoids high barriers to

trade, it simplifies customs administration and it is a way of holding in check the

competition among domestic producers for relatively favorable treatment. This policy

could be combined with the Lao PDR’s commitments to ASEAN by gradually moving

towards a uniform rate on all imports of 5 per cent, from which the only exemptions

would be duty free access of exporters to raw materials. There would be substantial

economic benefits if a political consensus for moving to complete free trade could

eventually be built.

22

References

Brenning, Mikael, Somneuk Davading and Bruno Dissman (2002). Composition and

Evolution of Lao PDR’s External Trade, UNIDO Integrated Programme for Lao PDR,

Vientiane.

Fukase, Emiko and Will Martin (2001). ‘Economic and Fiscal Implications of Cambodia’s

Accession to the ASEAN Free Trade Area’, Asian Economic Journal, 15, no. 2, 139–72.

Working Party on the Accession of the Lao PDR (2001). Accession of the Lao People’s

Democratic Republic. Memorandum on the Foreign Trade Regime. Addendum 28 March,

2001.

Soesastro, Hadi (2001). Chapter 12 in Tay, Simon S.C., Jesus P. Estanislao and Hadi

Soesastro (eds) Reinventing ASEAN, Singapore: Institute of Southeast Asian Studies.

23

Table 1. Exports by commodity (Bank of Laos data)

Wood

products

Coffee Garments Other Total

Values: $ million $ million $ million $ million $ million

1996 124.6 25.0 64.1 58.2 271.9

1997 89.7 19.2 90.5 50.5 249.9

1998 115.4 48.0 70.2 36.3 269.9

1999 54.9 15.2 65.6 74.6 210.2

2000 72.9 12.1 91.6 40.6 217.2

2001 78.2 5.0 100.0 20.4 203.6

Average 89.3 20.8 80.3 46.8 237.1

Shares % % % % %

1996 45.8 9.2 23.6 21.4 100.0

1997 35.9 7.7 36.2 20.2 100.0

1998 42.8 17.8 26.0 13.4 100.0

1999 26.1 7.2 31.2 35.5 100.0

2000 33.6 5.6 42.2 18.7 100.0

2001 38.4 2.5 49.1 10.0 100.0

Average 37.1 8.3 34.7 19.9 100.0

Source: Brenning et al. (2002), Table 1.

24

Table 2. Imports by commodity

Fuel Vehicles,

motor cycles

and parts

Machinery,

construction,

electrical

equipment

Other Total

Values: $ million $ million $ million $ million $ million

1996 65.6 155.4 172.5 273.5 667.0

1997 76.4 132.5 134.8 249.4 593.1

1998 123.6 95.8 125.5 199.7 544.6

1999 73.4 109.9 111.5 246.8 541.6

2000 158.2 62.2 59.4 245.9 525.7

2001 76.0 78.0 86.3 273.4 513.7

Average 95.5 105.6 115.0 248.1 564.3

Shares: % % % % %

1996 9.8 23.3 25.9 41.0 100.0

1997 12.9 22.3 22.7 42.1 100.0

1998 22.7 17.6 23.0 36.7 100.0

1999 13.6 20.3 20.6 45.6 100.0

2000 30.1 11.8 11.3 46.8 100.0

2001 14.8 15.2 16.8 53.2 100.0

Average 17.3 18.4 20.1 44.2 100.0

Source: Brenning et al. (2002), Table 2.

25

Table 3. Legislated import duty rates by broad sector

Sector Product Duty rate (%)

Agriculture: crops Seeds 5

Fertilizer 5

Other 5 – 40

Agriculture: livestock Feed 5

Fisheries 5 – 20

Manufacturing Raw materials 5 – 10

Packaging 10 – 20

Energy 5 – 20

Machinery and equipment 5 – 20

Trucks 5 – 30

Cars 40

Beer and alcohol 30 – 40

Other 10 – 20

Consumer goods Luxury—food 10 – 30

Luxury—non-food 10 – 40

All import items Median import duty 5.0

Unweighted average import duty 9.5

Import-weighted average import duty 14.7

Source: Working Party on the Accession of the Lao PDR (2002), pp.18–19.

26

Table 4. Trade taxes payable, paid and foregone, October–December 2001.

Base of tax

(i.e., exports,

imports, or

both)

$ million

Base of tax

kip billion

(% of value

of trade)

Tax payable

kip billion

(% of value

of trade)

Tax paid

kip billion

(% value

of trade)

Tax

foregone

kip billion

(% value of

trade)

Export duty 31.1 232.1

(100.0)

23.1

(10.0)

4.0

(1.7)

19.1

(8.2)

Import duty 124.1 935.6

(100.0)

130.8

(14.0)

28.1

(3.0)

102.7

(11.0)

Excise tax 124.1 935.6

(100.0)

159.0

(17.0)

18.9

(2.0)

140.1

(15.0)

Additional

excise tax

124.1 935.6

(100.0)

9.9

(1.1)

0.0

(0.0)

9.9

(1.1)

Turnover tax 155.2 2103.3

(100.0)

73.2

(3.5)

24.9

(1.2)

48.3

(2.3)

Profit tax 155.2 2103.3

(100.0)

0.66

(0.03)

0.53

(0.03)

0.13

(0.01)

Source: Statistics and Planning Division, Department of Customs, Ministry of Finance,

Statistics of Merchandise Export and Import Products, 1st quarter 2001/02.

Note: the base of the export duty is the total value of merchandise exports (f.o.b.); the

base of the import and excise duties is the total value of merchandise imports (c.i.f.); the

base of the turnover and profits taxes is the sum of merchandise exports and imports.

27

28

Table 5. Classification of importable items according to AFTA product lists

Number of product items, and

(percentage of total)

1997 2001 2002 2003 2004 2005

Inclusion

List

533

(15.0)

1,673

(47.1)

2,098

(59.1)

2,523

(71.1)

2,948

(83.0)

3,373

(95.0)

Temporary

Exclusion List

2,820

(79.4)

1,716

(48.3)

1,291

(36.4)

866

(24.4)

441

(12.4)

16

(0.5)

Sensitive

List

96

(2.7)

88

(2.5)

88

(2.5)

88

(2.5)

88

(2.5)

88

(2.5)

General

Exception List

102

(2.9)

74

(2.1)

74

(2.1)

74

(2.1)

74

(2.1)

74

(2.1)

Total,

All lists

3,551

(100.0)

3,551

(100.0)

3,551

(100.0)

3,551

(100.0)

3,551

(100.0)

3,551

(100.0)

Source: Lao authorities and UNIDO research team calculations.

Note: the rules governing commitments to liberalize import restrictions for items on each

list are described in the main text.