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Rating Action:

Moody's assigns first-time issuer rating of B3 to Laos with a positive outlook

08 Jan 2020

Singapore, January 08, 2020 -- Moody's Investors Service ("Moody's") has today assigned a first-time local and foreign currency long-term issuer rating of B3 to the Government of Laos with a positive outlook.

The factors supporting the rating are:

1. Economic strength of "ba3", which balances Laos's high economic growth potential against relatively low incomes, the small size of the economy and exposure to environmental risks.

2. Institutions and governance strength of "b3", which balances weak executive institutions, low administrative capacity, and very limited transparency and accountability against a lengthening track record of effective monetary management.

3. Fiscal strength of "caa1", which reflects a high government debt burden for the size of the economy and the government's narrow revenue base that constrains fiscal flexibility, although the largely concessional debt supports debt affordability.

4. Susceptibility to event risk of "ba", driven by external vulnerability risk given structural current account deficits and low foreign exchange reserve buffers.

The positive outlook reflects Moody's assessment that effective implementation of ongoing infrastructure investment and fiscal reforms would deliver net positive benefits to the economy and the government's fiscal position. This would in turn strengthen Laos's credit metrics to be consistent with a higher rating.

Moody's has also assigned local currency bond and deposit ceilings of Ba3, a foreign currency bond ceiling of B1, and a foreign currency deposit ceiling of Caa1. The local currency bond ceiling reflects the maximum credit rating achievable in local currency for a debt issuer domiciled in Laos (similarly for a bank deposit). The ceilings on foreign currency bonds and bank deposits capture foreign currency transfer and convertibility risks.

RATINGS RATIONALE

RATIONALE FOR THE B3 RATING

HIGH ECONOMIC GROWTH POTENTIAL BALANCED AGAINST RELATIVELY LOW INCOMES, THE SMALL SIZE OF THE ECONOMY AND EXPOSURE TO ENVIRONMENTAL RISKS

Laos's "ba3" economic strength is underpinned by the country's high growth potential. Moody's expects real GDP growth to remain high around 6.5-7% over the next few years, supported by the ongoing implementation of hydropower projects, which will contribute to exports, and mining production. Moody's further expects the completion of the China-Laos railway project by the end of 2021 to increase physical connectivity, lower the cost of transport and logistics, and raise economic competitiveness, albeit from relatively low levels.

At the same time, relatively low household incomes and the small size of the economy compared to similarly rated peers reduce the economy's capacity to absorb shocks.

Moody's assessment of economic strength also takes into account the country's exposure to environmental risks. In particular, increased frequency of droughts due to climate change would reduce Laos's hydropower production potential and weigh on economic growth and government finances.

WEAK EXECUTIVE INSTITUTIONS, LOW ADMINISTRATIVE CAPACITY, VERY LIMITED TRANSPARENCY AND ACCOUNTABILITY BALANCED AGAINST EFFECTIVE MONETARY MANAGEMENT

Moody's assessment of Laos's "b3" institutions and governance strength is in part informed by the country's weak scores in the Worldwide Governance Indicators (WGI), across various dimensions.

Administrative capacity and transparency are low, affecting the effectiveness of policymaking, although data availability is gradually increasing. There are also no effective checks and balances and very limited separation of powers and accountability, which together with high levels of corruption points to weak governance. Moreover, in Moody's assessment the regulation of the banking system is relatively weak, with large, unreported, nonperforming assets despite a long period of high economic growth.

However, macroeconomic policymaking institutions continue to demonstrate a lengthening track record of effective monetary management. This is marked by low inflation and inflation volatility in recent years and the absence of boom-bust economic cycles, which Moody's expects will continue over the next few years.

Recently, adherence to fiscal consolidation, despite the negative impact of natural disasters on government finances, points to potential improvements in fiscal policy credibility and effectiveness from very low levels.

HIGH GOVERNMENT DEBT BURDEN AND NARROW GOVERNMENT REVENUE BASE CONSTRAINS FISCAL FLEXIBILITY, ALTHOUGH LARGELY CONCESSIONAL DEBT SUPPORTS DEBT AFFORDABILITY

Laos's "caa1" fiscal strength reflects a high government debt burden for the size of the economy and the government's narrow revenue base that constrains fiscal flexibility.

At around 15-16% of GDP, government revenue is among the lowest across sovereigns that Moody's rates. Ongoing fiscal reforms and the gradual expiration of tax exemptions for hydropower projects will likely raise revenue over time, but infrastructure spending needs will continue to limit the policy room for fiscal manoeuvre in light of the government's commitment to narrower fiscal deficits. Moody's expects the government's fiscal deficit to average around 3.5% of GDP over 2020-21, compared to 4.6% in 2018.

As fiscal consolidation proceeds, Moody's also expects the debt burden to gradually decline over the next few years, falling towards 53% of GDP by 2022-23, compared to Moody's estimate of the debt burden at around 60% of GDP for 2019. However, a track record of sustained fiscal consolidation has yet to be established and the debt burden will remain relatively high compared to similarly rated peers.

High debt affordability supports fiscal strength, since government debt is mostly owed to bilateral and multilateral partners at concessional terms.

EXTERNAL VULNERABILITY RISK DUE TO LOW FOREIGN EXCHANGE RESERVE BUFFERS DRIVE SUSCEPTIBILITY TO EVENT RISKS

Laos's "ba" susceptibility to event risk is driven by external vulnerability risk. External vulnerability risk stems from the country's low foreign exchange reserves adequacy, particularly given structural current account deficits. Foreign exchange reserves only cover slightly more than one month of imports, while coverage of external debt due over the next year is also very low. Very low reserves coverage is partly mitigated by the existence of foreign currency deposits held in nostro accounts at the central bank and the fact that, while the current account deficit is wide, it is almost entirely financed by stable foreign direct investment. Moody's also expects the current account deficit to narrow to around 4-5% of GDP over the next two years, compared to an average deficit of more than 8% of GDP over 2016-18.

Meanwhile, Moody's assesses Laos's banking sector risk to be "baa". This in part reflects Moody's view that low levels of reported nonperforming loans do not accurately reflect banks' asset quality that is much weaker. Two smaller state-owned banks remain undercapitalised and high levels of dollarisation raise foreign exchange risks for the system as a whole. However, the structure of the banking sector limits contingent liability risk, given the sizeable share of foreign bank branches that Moody's expects will receive head office support in times of crisis.

Government liquidity risk is also "baa", which balances modest gross borrowing requirements given the concessional nature of external debt, against Laos's reliance on external financing. Limited domestic liquidity, in part related to high dollarisation levels, will continue to constrain the development of domestic capital markets, which remain very shallow. Although the government has been successful in tapping foreign investors in foreign currency, particularly in the Thai market, it does not have a broader a track record of being able to exercise a wide range of options for external financing.

Moody's assesses political risk in Laos to be "a", reflecting the stable political environment. This is in part due to economic and social policies that have contributed to consistent income growth. Furthermore, the government continues to prioritise sustainable development, including through its Vision 2030 based on "leaving no one behind". Political risks relate to a very low probability, moderate impact scenario of external political influence that has the potential to disrupt policymaking, reform implementation and debt consolidation in Laos.

RATIONALE FOR THE POSITIVE OUTLOOK

The positive outlook is driven by Moody's assessment that the implementation of large infrastructure projects, including the hydropower dams and the China-Laos railway, if managed effectively, would deliver net positive benefits to the economy and raise government revenue and exports. This would allow for a faster reduction in the debt burden and alleviate external risks compared with Moody's current expectations.

Ongoing fiscal reforms, including efforts to widen the tax base and strengthen expenditure and debt management, also have the potential to shore up fiscal strength and Laos's credit profile over time.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental considerations are material to Laos's credit profile, as the country is vulnerable to climate change risk. Natural disasters, including storms, floods, landslides and droughts, have adversely affected agricultural conditions and weighed on economic growth. Increased frequency of droughts due to climate change would also reduce Laos's hydropower production potential. Furthermore, substantial reconstruction and rehabilitation costs following natural disasters constrain fiscal flexibility.

Social considerations are relevant to Laos's credit profile. Laos's economic strength score incorporates social considerations related to the low level of human capital and limited access to quality healthcare and education. That said, the country benefits from a young population, while per capita incomes have doubled over the past 10 years given strong and stable economic growth.

Governance considerations are material to Laos's credit profile. The country's rankings on the WGI are low and point to weak rule of law and control of corruption. Transparency and accountability in government policymaking remain limited owing to the institutional setup that is closely intertwined with the political structure, notwithstanding recent improvements in data availability.

WHAT COULD CHANGE THE RATING UP

Prospects of a substantial and sustained reduction in the debt burden, including through fiscal consolidation or revenue expansion beyond Moody's current expectations, would be credit positive. This could happen in the context of effective implementation of the large infrastructure projects that raises economic competitiveness and prospects for diversification, increasing the resilience of the economy to shocks, and raise government revenue. In addition, a reduction in external vulnerability risk, in particular through a sustained accumulation of foreign exchange reserve buffers would also place upward pressure on the rating.

WHAT COULD CHANGE THE RATING DOWN

The positive outlook signals that a rating downgrade is unlikely over the near term. Downward pressures on the rating would be likely in case of a further weakening of Laos's external position, indicated in a decline of already low foreign exchange reserves coverage of imports and external debt. A weakening of Laos's fiscal and debt metrics either because government revenue is not keeping up with the pace of expenditure growth and/or because of the crystallisation of contingent liabilities on the government's balance sheet pointing to a sustained and material rise in the debt burden would also put downward pressure on the rating. Finally, further failures in the banking system that involved material fiscal costs and weighed on growth on a prolonged basis because of constrained credit supply would weigh on the rating.

GDP per capita (PPP basis, US$): 7593.7 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 6.4 (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.5 (2018 Actual)

Gen. Gov. Financial Balance/GDP: -4.6 (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -8.0 (2018 Actual) (also known as External Balance)

External debt/GDP: 92.9 (2018 Estimate)

Level of economic development: "b1" level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 11 November 2019, a rating committee was called to discuss the rating of the Laos, Government of. The main points raised during the discussion were: the issuer's Economic Strength, Institutions and Governance Strength, Fiscal Strength and Susceptibility to Event Risk, with a view to assigning a first-time public issuer rating to the Government of Laos.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

This rating action concerns a new rating for an issuer not previously publicly rated by us at the time that the sovereign release calendar was published, and is therefore being released on a date not listed in that publication.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Christian Fang
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
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