Landlocked and underdeveloped, Laos is a relatively remote country, squeezed in-between the bigger economies of neighbouring China, Thailand and Vietnam, and buffered by Myanmar and Cambodia at its extremities. It is run by one of the world’s few remaining communist governments, which pursues economic reform efforts with just enough vigour to keep the international donor community engaged with the population of six million people, most of whom do not have bank accounts.

Laos once had eight state-owned domestic banks, plus a handful of foreign bank branches cooped up in the capital, Vientiane. But because of a poor credit culture, these domestic banks tottered under the weight of non-performing loans and, over the years, have gradually been consolidated into just a handful.

Efforts by the Asian Development Bank and other donors to bring these state-owned banks to a modicum of sustainability have proved to be an uphill struggle. Banque pour le Commerce Exterieur (BCEL) seems to be in much better shape of late, but the other state-owned commercial banks remain technically insolvent, according to industry observers. Nonetheless, they continue to collectively account for about 60% to 65% of total banking assets in Laos.

Until recently, Laos’s banking community had distilled down to a few hardy stalwarts, including a number of Thai bank branches, Public Bank of Malaysia and the politically inspired Lao-Viet Bank – a joint venture between BCEL of Laos and the Bank for Investment and Development of Vietnam. But after a long hiatus, some new banks – both local and foreign – have recently appeared, adding a bit of zest to what had become a rather sleepy industry.

Local Phongsavanh Bank debuted a few years ago, but is yet to fulfil its initial promise. Perhaps the most recent entrant is Indochina Bank, the latest business venture of the KoLao Group, a Korean-led conglomerate that has a diverse spectrum of activities in Laos, from automobile retail to forestry. From neighbouring countries, micro-finance specialist ACLEDA Bank of Cambodia has recently established a Lao offshoot, and Sacombank – one of the leading joint stock banks in Vietnam – chose Vientiane as the venue for its first overseas branch, opening in December.

Developing market

ANZ Bank has also sought to pursue further its Greater Mekong sub-region strategy – similar in some ways to that of Standard Chartered Bank in the 1990s – by acquiring a 60% stake in Vientiane Commercial Bank, in late 2007, for $9.3m. The renamed ANZ Vientiane Commercial Bank (ANZV) also has a 10% stake held by the International Finance Corporation (IFC). ANZV is focusing on high-end retail and corporate customers, emulating ANZ’s highly successful model in neighbouring Cambodia. “We see this as a market that will continue to grow and develop. Since ANZ entered Laos we have seen a lot of change,” says Kerrod Thomas, managing director of ANZV.

There is speculation that a Franco-Lao banking joint venture is imminent, and that a Chinese bank may also enter the Lao market soon. At a time when banking sector consolidation seems to be a global trend, Laos appears to be heading in the opposite direction, despite the small scale of the domestic market: about $420m in loans and $1.2bn in total bank deposits.

However, with 20 banks now present in the country, some argue that the country is becoming ‘over-banked’. Depositors are permitted to have accounts in the local currency, the Kip (which has held its value surprisingly well of late), Thai baht or US dollars, and about 70% of all deposits are denominated in the latter two foreign currencies.

The passing of a new commercial banking law in 2007 is seen as the main trigger for this recent increase in the number of banks. The law now allows foreign banks to venture outside of Vientiane, having previously been strictly confined to the capital. ANZV recently opened a branch in the southern panhandle of Laos, in Pakse, and ACLEDA is also venturing out of the capital.

Phongsavanh Bank aspires to have a branch in all 18 of Laos’s provinces, but will have to pace itself. The commercial banking law stipulates that any new bank must have equity of $10m, of which $2.5m is held in reserve at the central bank, the Bank of the Lao PDR.

Laos will not be immune from recent global ructions, even if the ripple effects are taking longer to make their way to the country. Recent years had seen a marked rise in FDI inflows, notably in the mining and energy sectors. But with international prices for most minerals dropping markedly, and debt financing much harder to come by, the expectation is that FDI is about to contract substantially in 2009.

For those mines already in production, the government can expect markedly lower tax and royalty receipts, due to the decline in most commodity prices, which will in turn adversely impact on scarce state budget revenues. Revenues from what had been burgeoning tourism receipts will also probably decline.

The mighty 1070 megawatt Nam Theun II hydropower project – said to be 90% complete – should bring some welcome relief, but the $1.45bn plant is not expected to be fully on-stream until later in 2009. Several other large hydropower projects that were expected to go into construction have now been frozen, say local observers, citing a lack of debt financing and the need to get a viable pricing agreement with the sole customer for Lao electricity exports: neighbouring Thailand. (Although Laos aspires to become the ‘battery of south-east Asia’, principally by harnessing the Mekong river and its numerous tributaries, its own domestic energy needs are surprisingly small.)

A useful economic cushion will no doubt be provided by the international donor community, which has traditionally played an important role in supporting the Lao economy. But if donors are to underwrite more of the national budget, as the economy inevitably slows, they will almost certainly call for greater progress on various economic reform fronts. Their leverage in this regard had perhaps diminished in recent years, as the mining boom gave the Lao government optimism that it could rely less on the international donor community’s largesse. But now the tables have turned.

So what economic reforms might we see? At the most recent gathering of the National Assembly, an unprecedented number of laws were passed, including new laws for the critical power and mining sectors. (And for the first time, the National Assembly voted to reject a law, suggesting it is becoming a more independent legislative body.) Vientiane is also preparing to pass a new investment law, probably in mid-2009, which should improve the enabling environment for investors.

Levelling the field

This new law will entail the merger of current investment legislation for domestic and foreign investors, in a bid to create a more equitable playing field. But a critical determinant of this law’s success will be the extent to which a more efficient approval process is put in place. At present, foreign investors in particular must navigate through an arduous and opaque set of hurdles before getting a licence, in a process that can take many months to complete. This does much to offset the attractive 10% income tax rate levied on foreign investors.

Business turnover tax of 5% was officially replaced in January with value-added tax (VAT) of 10%, although implementing this new tax will probably be less than smooth. The government has also sought to accelerate its pursuit of World Trade Organisation (WTO) accession, which will no doubt entail a raft of business liberalisation measures. The government would like to see WTO membership being granted by October 2010. This same propitious date is also the deadline for the country’s first stock exchange. The Lao government seems undeterred by Cambodia’s recent decision to suspend its preparations for a stock exchange in Phnom Penh. Nor is it seemingly put off by the country’s small corporate sector, a paucity of large firms realistically able to consider an initial public offering, and little in the way of a domestic investors.

As all equity markets have lost their lustre of late (the stock market in neighbouring Vietnam was the worst-performing in Asia last year), the attraction of a Lao stock market has undoubtedly diminished. So beyond the allure of a stock market as a national totem of economic progress, one wonders whether it might not be better for those few Lao firms big enough and keen enough to issue shares to the public to find a listing in Singapore or Bangkok.

Originally published in The Banker, February 2009

COUNTRY PROFILE

LAOS

Population: 6.7mPop. growth rate: 2.3%Area: 236,800km2

Real GDP growth:

6.5%GDP per capita: $2,100Current account: -$37m

Literacy rate:

68.7%

Labour force:

2.1mUnemployment rate: 2.4%

Source: CIA Factbook 2009