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Economic Prosperity Beckons For Laos In The AEC Era

An interesting neighbour? Most people would immediately assume it’s Myanmar. While we cannot ignore the glittering promise of Myanmar’s emergence, I have noticed more and more that Laos is quietly becoming a force to be reckoned with as we enter the AEC era.

Despite its rich resource endowment, Thai investors may have overlooked Laos owing to its tiny economy, valued at just 3% of Thailand’s GDP and small population of just below 7 million. Plus, the underdeveloped terrain has left more than half the population living in rural areas mainly involved in subsistence agriculture farming. So we are looking at a landlocked country that lacks human capital both in terms of size and skill set, as well as the logistics necessary to drive the economy. Not to mention prevailing financial and regulatory concerns that still cannot be easily written off.

Indeed, Laos is small and high-risk from an investor’s perspective. But how long will it remain so, and when is it time for us to start paying more attention?

With ample mining resources and hydropower potential, it is not hard to imagine economic prosperity in a not-so-distant future for Laos’ economy. The message by Lao President Choummaly — that the country would enjoy medium-term growth of 8% per year and that it would graduate from the UN list of least developed nations by 2020 — should not be too far off the mark if Laos can unlock its economic potential.

Let’s look at some of the key drivers that will be crucial to achieve the aforementioned goals.

First, the most important trade — the export of copper-related products to Thailand and China — must continue its growth path. Laos’ copper exports account for 40% of total exports and 10% of GDP. Copper demand from Thailand has grown 15% per year, and has now doubled the demand from China due to its supply links with two of Thailand’s stronger sectors: electricity and electronics. By 2017, copper production in Laos is expected to surpass 200 thousand tonnes per year, strengthening its status as one of the top 15 copper producing nations in the world.

The cross-border sale of electric power has to transpire as scheduled. That means demand from neighbouring Thailand, Vietnam and China is secured and the construction pipeline of more than 15 thousand megawatts of power plants (about half the size of Thailand’s current capacity) is fully met between now and 2020 for overseas electricity sales. Currently, Laos exports about $600 million (19.5 billion baht) worth of electricity or about 20% of total exports, solely to Thailand.

Agricultural modernisation must be accelerated to increase productivity and take full benefit of the country’s natural fertility. Laos’ trade outlook seems brighter than ever with its recent accession to the WTO in early 2013. This trade development is on top of Laos’ already most favourable “Everything-But-Arms” trade scheme with the European Union, whereby it can export to Europe duty- and quota-free. Nevertheless, technology transfer is in dire need to improve crop yields. Despite water resources aplenty, extensive and effective water management is still key to enable export potential among many crops; namely, coffee, rice, sugar and rubber.

But perhaps as important is how the country diversifies into non-resource sectors, especially tourism. Such diversification will make economic growth more sustainable in the longer term. For tourism, Laos (especially Luang Prabang) has garnered growing interest. The country was cited as the best tourist destination for 2013 by the European Council on Tourism and Trade paving the way for a double-digit increase in tourist arrivals going forward. Revenue from mining and hydropower can certainly help promote and improve infrastructure and its supply chain to be even more suitable for Laos to diversify to related sectors like hotels and restaurants. If successful, the diversification will reduce dependency on other economies and limit external growth risk in the future.

Provided that Laos is effective in monetising its mining, hydropower and agriculture sectors, economic growth of 8% is certainly not too far-fetched. And if such a high growth level is sustained for five to six years, we could see Laos’ economy double in size.

It is worth noting that this economic potential cannot come to fruition without foreign investment in the country. The country itself lacks the domestic funding necessary to construct copper mines, large dams and advanced agricultural farming. For example, in the next five years, Laos plans to build at least 20 hydropower plants of more than 5,000 megawatts in total, each dam on average costing as much as 5% of Laos’ GDP, upfront.

Indeed, Laos’ economic growth hinges a great deal on foreign investment. Currently, Laos receives approximately US$2-3 billion of FDI a year, more than half of which is directed towards mining and hydropower industries.

So the real question is: will the country continue to attract enough FDI in order to ensure economic prosperity? Will the risks prove to be too high for investors?

Unfortunately, Laos is ranked in the bottom quartile of the World Bank’s “Ease of Doing Business”. Together with the lack of an official sovereign credit rating, this results in a general sense of high business risks across the board.

Yet, those with some exposure in Laos can tell you that for the key sectors like mining and power, the risks are manageable. The mining and power sectors are significantly more developed than other sectors. The concession agreements are very much on par with international standards, while the relevant laws have recently been updated. The royalty rates are considered competitive, and investors receive enhanced FDI incentives in the form of longer tax holidays, lower tax rates and various exemptions.

The power sector is undergoing drastic reform to improve the long-term financial credit of the state-owned off-taker Electricite du Laos (EdL). This includes spinning off EdL assets and transforming EdL into a power trader that earns profit from electricity sales margins. A monitoring programme by World Bank and the ADB is also in place to ensure EdL’s financial health.

Even repatriation risk is mitigated for mining and power. Of course, worries over money transfers and convertibility are to be expected for a small nation where fund flow concerns are omnipresent. For example, because there is a shortage of foreign reserves in the country, the central bank last year began to restrict the supply of foreign currencies to the public. But for the mining and power sectors, concession agreements typically guarantee fund transfers out of the country, further cementing strong government support for these two key sectors.

It is no surprise, then, that global mining firms are eagerly awaiting the next round of mining concession bidding, and that 80% of the upcoming hydropower projects have landed themselves foreign developers. If these large-scale FDI projects come through as commercially expected, Laos will easily become the fastest growing country in Asean.

Coupling that with growing wallets and rapid urbanisation rates, we can perhaps project a greater appeal for Laos’ economy. Laos has the fastest growing urbanisation rate in Asean at 35%, already thumping Myanmar’s 33%. The economic development will increase the domestic demand for this lower middle-income country. Sectors that should benefit from this include food and beverages, automobiles, energy, electrical appliances, and technology-related devices.

Laos is emerging strongly, albeit quietly. What an oversight it would be, with the cultural and geographical advantages we have, to miss out on the rise of this neighbour.

Source: Bangkok Post