Cablegate: Financial Crisis Begins to Erode Pillars of Lao

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RR RUEHCHI RUEHCN RUEHDT RUEHHM
DE RUEHVN #0662/01 3571019
ZNR UUUUU ZZH
R 221019Z DEC 08
FM AMEMBASSY VIENTIANE
TO RUEATRS/DEPT OF TREASURY WASHDC
RUEHC/SECSTATE WASHDC 2335
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INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
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UNCLAS SECTION 01 OF 03 VIENTIANE 000662

SENSITIVE
SIPDIS

STATE FOR USTR BISBEE
COMMERCE FOR HPPHO

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD LA
SUBJECT: FINANCIAL CRISIS BEGINS TO ERODE PILLARS OF LAO
ECONOMIC GROWTH

1. (U) Summary: The weak integration of the Lao banking
system with the international financial system initially
cushioned the impact of the global financial crisis on
Laos--there are no tranches of subprime debt in the Lao
central bank. However, as the non-financial downturn has
spread globally, Laos has begun to register its impacts, with
the collapse of copper prices weighing heavily on exports and
future government budgets, and with uncertainty about power
demand, especially in Thailand, leading to the suspension of
several major hydropower projects and questions about the
pace of future expansion within the sector. The IMF has in
recent months twice downgraded its expectations of future Lao
growth and continues to emphasize the downside risk, and the
World Bank now projects 2009 Lao economic growth at 5%. The
Government of Laos (GOL), which only a month ago was
predicting 8% growth in 2009, now appears to recognize the
good times are coming to a halt. End Summary.

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COMMODITY PRICE COLLAPSE CUTS BOTH WAYS
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2. (U) As the global financial crisis began to freeze credit
and push down the stockmarket in the United States, the GOL
and many of the international financial institutions that
support government spending downplayed its local relevance.
The Lao Central Bank proudly noted that it had not purchased
any subprime securities. Even as the crisis spread to Europe
and Asia it was widely believed that Laos, with a banking
system only weakly integrated into the global credit network,
could escape a serious economic downturn. The fall of
commodity prices, in particular copper, reminded the GOL that
Lao economic integration has outpaced Lao financial
integration into the global economy.

3. (U) As the price of oil has fallen, so has the Lao bill
for imported petroleum products. According to the IMF, the
positive balance of payments effect from lower oil prices
should help offset the collapse in copper prices, previously
the single highest value export from Laos. While the country
as a whole might benefit from lower energy prices, the
government is expected to see a loss in tax revenue equal to
at least 1% of GDP from lower petroleum imports and mining
exports. In recent years, the GOL has received substantial
tax payments from Oz Minerals (previously Oxiana) and its
Sepon gold and copper mine. Since 2003, Oz has paid the GOL
over $230 million, with $135 million alone coming in FY 2007.
Oz believes its taxes funded about 20% of the government
budget in FY 2007. In September 2008, Oz General Manager in
Laos Peter Albert publicly asserted that, if prices and
profitability stayed high, Oz Minerals alone would contribute
almost $2 billion to the government by 2020, dwarfing the
expected $300 million contribution from the Nam Theun II
hydroelectric dam, often described as a project key to future
Lao economic development.

4. (SBU) Peter Albert was recently laid off from Oz Minerals
and the company may soon be forced to sell off large chunks
of assets to stay alive. Richard Taylor, Oz Mineral's
strategic analysis manager in Laos, told econoff December 19
that the company, which asked for a voluntary suspension of
share trading in Australia through December 29 while it tries
to refinance debt, had put itself up for sale as successful
refinancing is unlikely. Mr. Taylor noted that the company
is also temporarily putting off finishing a three-quarters
complete $200 million expansion of its successful Sepon mine
to conserve cash, although he expects the expansion to move
forward in 2010. He believes the GOL is now coming to grips
with the reality of the global recession and examining ways
to minimize its impact on Laos. With copper prices falling
almost daily, and currently around $1.30/lb, he sees Oz
making 2009 tax and royalty payments of about $20 million -
far below government expectations.

5. (U) Phu Bia Mining, another Australian copper and gold
mining firm which began exporting copper concentrate in 2008,
has also been forced to lower expectations of future tax
payments. With copper at $3/lb, 2009 tax and royalty
payments were expected to be approximately $85 million and
2010 payments $110 million. With copper prices falling, Phu
Bia circulated a briefing noting that copper at $1.75/lb
meant expected tax payments for 2009 production would fall to
$12 million. As copper prices continue to fall, the company
has announced it will delay its planned expansion and focus
on maintaining profitability. The World Bank, in its

VIENTIANE 00000662 002 OF 003

November Economic Monitor for Laos, projected mining tax and
royalty payments of around $60 million in 2009 for Laos.
However, this was predicated on $1.50/lb copper.

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UNCERTAIN OUTLOOK FOR POWER SECTOR
----------------------------------

6. (U) Rumors of major power projects running into financing
difficulties have circulated recently in Vientiane. On
December 17, the Director General (DG) of Investment
Promotion in the Ministry of Planning and Investment,
Houmpheng Souralay, said that developers of a planned 1,800
MW lignite plant in Hongsa, Xayaboury province, were halting
the project due to the global recession. DG Houmpheng also
announced that a number of large planned dam projects,
including the 440 MW Nam Ngum 3, 523 MW Nam Theun 1, 278M W
Nam Ngiep 1, and 1100 MW Nam Ou projects would be "suspended"
due to financing difficulties and as a result of as yet
unsuccessful attempts to revise the companies' power purchase
agreements, primarily with the Electrical Generating
Authority of Thailand (EGAT).

7. (SBU) In July 2008, the Ministry of Energy and Mines and
the Lao State Holdings Enterprise (LSTE) began publicly
discussing a need to renegotiate power purchase agreements
(PPA) with EGAT to take into account the rise in materials
costs, and the subsequent effect this would have on dam
profitability, and price rises in alternative (natural gas
and oil-fired) energy. EGAT reportedly agreed to renegotiate
the PPAs, but has made little effort to do so. A former
consultant to EGAT told econoff he believes there will be no
new PPAs until the Thai government enjoys real stability and
Thai electrical demand begins to rise. Dr. Somboun Manolom,
General Manager of the LSHE, told the Embassy on December 17
that a wide range of planned projects would be delayed at
least 1-2 years as EGAT is already projecting at least a 5%
decline in Thai electricity demand in 2009. Dr. Somboun
confirmed, however, that eight dams currently under
construction will be finished, as they already have PPAs in
place. Three of the eight, the 1088 MW Nam Theun II, the 615
MW Nam Ngum 2, and the 280 MW expansion of the existing
Theun-Hinboun dam, are designed primarily for export to
Thailand. A fourth, Xekaman 3, is designed for export to
Vietnam, while the remaining four (ranging from 2.4 to 120
MW) are for satisfying Lao internal demand.

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TOURISM IN 2008 FLAT
--------------------

8. (U) In December 2007, the New York Times ranked Laos as
the #1 "Place to Go in 2008." The GOL took notice,
projecting that over 1.8 million tourists would visit in
2008, up from about 1.6 million in 2006. Tourism accounted
for about 8 percent of GDP and generated about $233 million
in revenue during 2007. On December 8, the Lao National
Tourism Administration (LNTA) announced that 2008 numbers
were running only 3 percent ahead of last year through
October, and that about ten percent of tourists had canceled
visits since the start of the financial crisis.
Additionally, package tour bookings in the first half of 2009
are running fifty percent below 2008, according to the Lao
Association of Travel Agents. The closure of Bangkok's
international airport in late November-early December briefly
curtailed the number of visitors who could reach Laos from
abroad and likely helped push total 2008 arrivals below that
of 2007.

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IMF RATCHETS DOWN GROWTH PROJECTIONS
------------------------------------

9. (U) Benjamin Bingham, the IMF representative for Laos
(based in Hanoi) told a November 24 gathering of donors and
GOL luminaries at the UNDP-sponsored Round Table
Implementation Meeting that the IMF was forecasting a 5.75%
growth rate for Laos in 2009, down from about 7% in 2008. He
emphasized the large degree of uncertainty about the
projections and stressed that most risk was on the downside.
Just a month earlier, at a World Bank gathering, Mr. Bingham
and the senior World Bank economist for Laos, Katia
Vostroknutova, had presented a much more optimistic picture
of the Laos economy's reaction to the international crisis.

VIENTIANE 00000662 003 OF 003

10. (U) In its November Economic Monitor, the World Bank
projected 2009 growth in Laos at the "Low" end of about 5%,
returning to about 6 percent over the period 2010-2013. This
is not far from the average growth rate of 6.5% over the last
two decades, and assumed the delays in most large power
projects, zero growth in tourism in 2009, and an average
annual two percent growth in agriculture, and four percent
growth in services. In a December 19 meeting, the World Bank
held to its projections, which include an uptick in 2010 to
six percent GDP growth as the Nam Theun II project comes on
line.

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COMMENT
-------

11. (SBU) After initially appearing to adopt a dismissive
attitude towards the financial crisis, the GOL has begun to
show greater concern and more dispatch. According to senior
mining industry members, the Government met last week at the
ministerial level to discuss appropriate policy responses.
Robert Allen, General Manager for Country Affairs at Phu Bia,
noted that the GOL suddenly agreed to a number of
long-standing requests from the company, including an
agreement to lower electricity prices. When the local
English-language newspaper printed an article stating that Oz
Minerals would be cutting over 50% of its staff (not true,
says Oz), six separate ministers called the company to
discuss its situation.

12. (SBU) The loss of mining revenue and slowing of foreign
investment will hurt the budget and slow GDP growth, but are
unlikely to present any real challenge to GOL legitimacy.
The mining sector, in particular, is quite new to Laos and
essentially provided windfall revenue during the run up in
commodities prices worldwide; most of that revenue was
reflected in increased urban standards of living, with less
influence on the rural majority. With the mining windfall
ended for the time being, there will be more pressure from
parts of the GOL bureaucracy to expand economic reform, as a
means of attracting broader foreign investment. Rapid change
is far from the norm here, however, and we expect reform to
continue at a gradual pace. There will also almost certainly
be more appeals to the donor community, including to rising
donor China, to help Laos through this more challenging
economic patch.

HAYMOND

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