Introduction

1. Since 2005, the economy of the Lao People’s Democratic Republic has grown at a rate of above 7 percent, one of the fastest rates of the region, accompanied by steady poverty reduction and favorable economic prospects. With its small, landlocked geographical position, total surface area of 236,000 square kilometers, and a population of approximately 6.7 million, Lao PDR has benefited from its considerable endowment of natural resources from mining, hydropower, and forestry production to sustain a rapid growth. The Government of Lao PDR (GoL) maintains a vision of a ‘land-linked’ rather than landlocked economy, prioritizing easy access to larger, emerging neighboring economies, with the opportunity to reach the broader Mekong region, including Southern China. Plans to invest in the Belt and Road Initiative will support public and private investment in transport infrastructure and promote tourism in the region, although debt implications need to be carefully assessed. Since 2015, Lao PDR is considered a lower-middle-income country based on its gross national income (GNI) per capita and is also in the medium human development category according to the United Nation’s Human Development Index (HDI), with a score of 0.586 in 2015 and a rank of 138 out of 188 countries.
2. Despite recent strong performance, Lao PDR faces considerable challenges to modernize its economy and deliver the structural transformation that has become critical for sustained and inclusive growth. Fiscal sustainability is an issue as low commodity prices result in lower-than-expected revenue income, and despite measures taken to cut spending and halt wage increases and staff recruitment in 2015 and 2016, the deficit stood at 5.5 percent of gross domestic product (GDP) in 2017 and is expected to decline to 4.9 percent of GDP in 2018. The country is at high risk of debt distress with public debt at around 60 percent of GDP in 2017 and is expected to further increase to 62.6 percent of GDP in 2018. Fiscal pressures have limited the ability of the public sector to allocate budget to social sectors and infrastructure maintenance that is needed to address the country’s development challenges.
3. The government faces significant public financial management (PFM) challenges. Weak and inefficient public sector management and uneven reforms ownership have been binding constraints to the pace and the effectiveness of PFM reforms. Lao PDR is at the lower end of most governance indicators in the Association of Southeast Asian Nations (ASEAN) region, particularly in terms of accountability, government effectiveness, regulatory quality, rule of law, and corruption. The importance of the overall PFM reform agenda to enhance quality and coverage in the delivery of public services is essential to the credibility of the policy-making agenda and to the mobilization of and support from the private sector and development community.
4. The Public Financial Management Strengthening Program (PFMSP) adopted in 2005 was one of the important components of the GoL’s long-term framework for public finance reform and supported the ‘first-generation reforms’ (2000–2013), such as the centralization of the National Treasury, customs, and tax functions; the introduction of a Treasury Single Account (TSA) in 2006; and rollout of the Government Financial Information System (GFIS) to the provincial level. After a gap of three years, ‘the second-generation reforms period’ was initiated following the appointment of a new government under a reform-oriented Prime Minister. With the top leadership’s commitment, including the Minister of Finance—who is also the Deputy Prime Minister—and his management team, the dialogue with the donor community has been revitalized and the pace of reform has accelerated.
5. Plans to improve governance of public resources require major changes in the strengthening of government institutions and respond to new development opportunities and challenges. The range of new laws that includes the new Public Procurement Law (October 2017) and the new Public
Debt Management Law (June 2018) that will better control public investment projects and strengthen debt management policy respectively, as well as the tax policy and administration reform and planned adoption of the revised value added tax (VAT) Law represent progress. However, to reduce debt vulnerabilities and maintain a pattern of expenditure that will support graduation from Least Developed Country (LDC) status, Lao PDR’s reform implementation needs to accelerate, and the agenda must adjust to new technology and innovation and related institutional transformation and develop knowledgeable and competent human resources.
6. The Public Expenditure and Financial Accountability (PEFA) assessment is therefore timely as it provides evidence on underlying PFM systems performance that can help shape the next generation of reforms. The overall objectives of this 2018 Lao PDR PEFA assessment based on the 2016 methodology are to help the GoL prioritize reform actions in the Vision to 2030 and Public Finance Development Strategy (PFDS) to 2025, build the capacity and understanding of technical staff to deliver the needed reforms, and establish a platform for measuring PFM progress. While there have been previous assessments in 2006 (external assessment) and 2010 (joint assessment with the World Bank) using the previous PEFA methodology, there has been no comparison made with the previous scores. This PEFA assessment is therefore intended to provide a baseline to anchor and measure the impact of ongoing reforms.
7. The assessment analysis period covers the previous three completed fiscal years (2014/2015, 2015/2016, and 2017 with a cutoff date of August 2018). It should be noted that the three-year period from 2014 to 2016 was marked by political transition and a change of government that affected the policy agenda.

Assessment of PFM system performance

8. Overall, the assessment confirms that Lao PDR’s new ambitious reform agenda is needed to establish solid foundations for improved PFM processes and procedures. The effectiveness of the PFM systems in place is limited, capacity for enforcement of the existing regulatory framework is lacking, and the monitoring of performance can still be considerably strengthened. Table 1 provides an overview of the performance ratings on the 31 indicators and 94 dimensions extracted from the scoring of individual indicators in Section 3 of the report where the narrative and justification for each score are presented. Annex 1 provides a table with a summary of the performance narrative for each dimension and indicator.
9. The emerging strengths in PFM in Lao PDR are primarily associated with the development of instruments that have allowed more prudent fiscal management and control of budget execution, such as the adoption and progressive implementation of the new State Budget Law (SBL) in 2015, the introduction of fiscal rules on the budget deficit and the debt-to GDP ratio, the progressive resolution of domestic payment arrears related to public infrastructure projects, and debt inherited from direct lending of Bank of Lao PDR (BoL) to local government’s off-budget infrastructure spending. A more solid treasury and cash management system at the central government level, and the focus on tax policy and management have created a solid platform for automation and integration of PFM processes and improved the quality of financial reporting and oversight. However, these initiatives are still to have a full impact on the PEFA scores in the relevant indicators.
10. Weaknesses are linked to the limited credibility of the budget as an instrument to achieve high-level policy objectives and the absence of a fully developed medium-term expenditure framework (MTEF) that is integrated into the budgeting process. Links between the multiyear strategic development plans approved at high level, sector strategic plans supported by development partners’ funding, and annual allocation of resources through the budget are weak. Budget monitoring is hampered by the manual consolidation of the expenditures below provincial level and the absence of systems to track resources available at the service delivery level. The absence of a unified chart of accounts to track expenditures by economic functional and programmatic classification hinders informed decision making. Fiscal data consolidated by the National Treasury rely on manual processes that may affect the data’s reliability. Government systems rely mostly on the GFIS with limited coverage and functions, which affects the timely and comprehensive budget execution reporting. The current GFIS covers only a subset of functionalities required for a full functioning budget execution system; core functionalities related to commitment controls and bank reconciliation are not yet in place and the district offices are not included in the GFIS coverage. The missing interface between the Automated System for Customs Data (ASYCUDA) under the Customs Department and the Tax Revenue Information System (TaxRIS) by the Tax Department (TD), with the GFIS does not allow for comprehensive and accurate revenue and expenditures records. The internal and external audit functions are not sufficiently resourced and skilled to mitigate the control weaknesses identified.
11. The assessment shows that two of the 31 indicators scored either ‘A’ or ‘B’, scores considered above the basic alignment with good practice. The remaining indicators received scores of either ‘C’ or ‘D’, which suggests basic alignment with the standards for a ‘C’ and weak performance for a ‘D’. Table 1 shows that the government’s reform program is timely and apposite for strengthening PFM practices. The scores for all 31 indicators and 94 dimensions are summarized in Table 2.

Impact on the main objectives of public finances

12. The impact of the PFM performance, as described earlier, on the overall achievement of the three main fiscal and budgetary outcomes is as follows:
• Aggregate fiscal discipline is affected by the limited capability to prepare robust projections of macroeconomic and fiscal performance. A thorough reporting of revenue and expenditure operations within and outside the budget has improved control over fiscal risks and commitments to maintain expenditures during budget execution, and delivery of the budget aggregates as planned is still insufficient.
• The government currently does not have a solid macro-fiscal framework and the definition of strict fiscal rules is limited in the absence of a consistent and sustainable fiscal strategy. The simple modeling instruments in place, based on realistic revenue forecasting and aligned with international practices, are undermined by political decisions inherited from the centrally planned systems (based on GDP targets). The platform established by the Fiscal Policy and Law Department (FPLD) as a medium-term fiscal framework (MTFF) provides a medium-term approach with forward estimates and fiscal outcomes; the fiscal rules on the total annual budget deficit, set at a maximum 5 percent of GDP, and the outstanding (foreign and domestic) debt, at not more than 60 percent of GDP, are not strictly obeyed.
• Cash management and payments of the main expenditures are controlled through the National Treasury and are set against the constraints of the quarterly and monthly plans from the approved State Budget. Payroll is centralized and has been strictly controlled since the overruns experienced in 2015. Expenditure arrears are not authorized and fiscal risks to the central government budget are identified. However, control over the provincial and municipal budgets is limited to cash rationing, even if it has not formally been the case in the recent years. Operations outside the government’s financial reporting by subnational level and state-owned enterprises (SOEs) still comprise significant amounts that are neither consolidated nor disclosed and therefore fiscal risks related to SOEs operations cannot be consistently monitored. The revenues and expenditures of the extrabudgetary funds have their own financial reporting and benefit from spending flexibility. The main problem concerning the budget carryovers at the end of each fiscal year has been addressed and payments allowed after the end of the closing date are based on liabilities recorded and authorized at the end of the fiscal year; therefore, if it delays the closing of accounts, it does not undermine the meaning of annual budgets.
• The revenue administration has not yet defined plans to improve tax compliance and collect tax arrears. The absence—at present—of a well-formulated risk-based administration of revenue is a constraint, as there is no structured and systematic process for assessing, ranking, and quantifying taxpayers’ compliance risks. The application of risk criteria and monitoring of the ageing and collectability of arrears is conditioned by the access to reliable and comprehensive data from internal and external sources through a proper tax information management system, which has still to be developed, and depends upon the enforcement capacity from the tax administration. At present, the tax legislation offers interpretation loopholes and many options for tax exemptions, and a significant amount of tax debts are being negotiated between tax collectors and taxpayers.
• Contingent liabilities are identified and analyzed but are not disclosed. The comprehensive overview of the exposure to significant risks from explicit contingent liabilities within the infrastructure sector has been consolidated at the high level of government and led to a concrete debt restructuring effort over the last two years but has not been made public. In addition, data on the quantification of, and provision for, implicit contingent liabilities, some of which may be considerable, are unavailable, for example, the potential need to bail out large SOEs with non-guaranteed debts. Additionally, the unavailability of information pertaining to explicit contingencies relating to health and social security schemes, with no data available on these, is also a concern.
• Weak medium-term planning processes, and the limited reliability of resource flows—and the budget adjustments driven by lower-than-expected revenue outturns—affect the capacity to deliver the plans at the sector level. Furthermore, the existing MTFF and MTEF established—with donor support—are not consistent with resource availability, and the link between capital and recurrent expenditure managed through distinct processes is weak. As a result, the framework is not used as a basis to focus on priorities in the allocation of funds among institutions and sectors, and strategic sector planning remains weak. Externally funded projects are monitored separately and there are no systems to track allocations received by service delivery units.
• Competitive tendering procedures for procurement can be improved to strengthen the way resources are allocated. The recently approved Public Procurement Law will have new instructions concerning the principles and operation of capital construction budgeting, including regulations on appropriations, fund allocation, payment, and final accounting for capital construction projects to bring it into line with good international practices.
• Public investment management (PIM) remains weak due to limitations in planning capacity and a systematic application of pre-feasibility and selection criteria. These weaknesses continue into the downstream phase, where the is no consolidated monitoring of decentralized implementation and processes for the costing, quality assurance, and reporting on value for money and fiduciary integrity are not harmonized. Detailed technical and costing guidelines are available at the central government level (provided by Japan International Cooperation Agency [JICA]) but the management of public investments is decentralized to the line ministries and provinces, with no standardized quality assurance for socioeconomic and environmental evaluations and no pre-feasibility studies.
• Weak monitoring of provincial government spending undermines the quality of local spending. The budget execution reports have limited reliability, as consolidation of the district level is entered manually into the GFIS.
• Ex post budget scrutiny reveals a mixed oversight performance between the external audit function and the National Assembly. The low capacity and absence of effective internal control and internal audit functions in line ministries and subnational governments has resulted in fragmented, suboptimal use of resources. The role of the State Audit Organization (SAO) in the oversight over government spending is essential, and budget execution of all central agencies and line ministries is audited, but there is no audit opinion and SAO reports are not published. The response by the government to audit recommendations is not monitored on an annual basis and there is no comprehensive, transparent, and effective follow-up on external audit and budget reports by the National Assembly.
• Transparency in public finances needs to be improved as does timely access to data and performance information. As Lao PDR is committed to improve PFM systems and adopt good governance principles, it has to improve accountability, transparency, and efficiency in all aspects of public sector performance. Inadequate information management systems, based on cash transactions, manual reconciliations, and cumbersome procedures should be upgraded to allow for effective management of public expenditures.

Ongoing and planned reform agenda

13. This PEFA assessment highlights PFM reform areas that have already been identified by the government and the approval of the Vision to 2030 and Public Finance Development Strategy to 2025 by the Prime Minister in July 2017 has placed PFM reforms as a government priority. The strategy provides the framework for the medium-and long-term reform envisaged by the government and has high-level political support. The main objectives of the PFDS are to strengthen public finances management to sustain dynamic and stable economic growth and to support a graduation from LDC status by 2020. Emphasis is on regional and international integration, while at the same time, focusing on protecting the environment, creating prosperity, and enhancing the livelihoods of all ethnic groups.
14. Fiscal consolidation and revenue mobilization have been defined as being of paramount importance to support the government’s need for infrastructure spending and effective delivery of public services. The new strategy aims at implementing a fiscal policy program to ensure macroeconomic and fiscal stability and strengthening the revenue and resource mobilization to support dynamic social and economic growth. The PFDS includes 10 strategies and action plans to support reform priorities in core PFM systems.

15. The wider donor community has renewed its commitment to support those reforms through funding and technical assistance (TA). The World Bank will continue to support this process through the ongoing Public Financial Management Reform Program Single Donor Trust Fund (PFM Reform SDTF) funded by the European Union (EU). Other donors, including the IMF, ADB and JICA are also providing assistance in the PFM area.