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Monetary Policy in Laos
by Staff of FREE LAO ALLIANCE (July 2000)
The current monetary policy in Laos does not seem to work effectively in protecting the value of the Kip. The Bank of Laos (BOL) appears to remain inactive in light of the recent sly of the Baht. BOL appears to follow its old policy in shadowing the Kip against the Baht.  This policy work somewhat prior to the floating of the Baht in mid 1997; however, after the floating of the Baht, BOL seems to have been left with no new policy in managing the national currency of Laos.

     Presently, the Baht is trading at 40.03 Baht to a dollar (US) [July 8, 2000].  At the same time, the rate for the Thai Baht against Laotian Kip remains at 190.79 Kip to one Baht and 7,600 Kip to one US dollar. At this rate, we see that the Kip is being under valued.  Our calculation illustrates, thus:

STEP-1
     $1,000 x 40.03 Baht = 40,030 Baht.  If you have $1,000, you can convert to the Baht and receive $40,030 at any Thai Bank.  For the sake of our discussion, we shall make the Siam Commercial Bank (Vientiane Branch).

STEP-2
     Take that 40,030 Baht from Siam Commercial Bank at Vientiane Branch and walk across the street to the Banque Pour La Commerce Exterior Lao and exchange it for the Laotian Kip.  The official rate for the Kip against the Thai Baht is 190.79 Kip to one Baht. Here, 40,030 Baht x 190.79 Kip = 7,637,323.70 Kip.

STEP-3
     Ask the same clerk in the Bank to exchange the Kip you have now into the US dollar.  The official rate declared and maintained by BOL, despite changes in circumstance----day-by-day---is 7,600 to US$1 or 7,637,323.70 % 76,000 = $1,004.91.  There is $4.91 to be made for every $1,000.

     The currency market in Laos is imperfect.  The imperfection is not created by the market, but dictated by the country's central bank to maintain its "official rate" at 7,600 Kip per dollar.  To non-policy makers, an imperfection of a mere $4.91 for every $1,000 is not much, but to policy makers, such an imperfection can stifle economic growth and hinders the country's ability to defend its currency against speculation and profiteering.

     The imperfection is even more worrisome when we consider that Laos' annual per capital income is about $210.  An imperfection of $4.91 per $1,000 or $0.49 per dollar means that on average a Laotian in the country is losing 0.23% of his livelihood to BOL's deflationary policy.

     A foreign bank or finance company operating through intermediary, such as Citbank (Vientiane), Siam Commercial Bank, or Thai Military Bank----all maintain a least one branch in Vietiane---can really devastate Lao's economy and its infantile financial infrastructure if any of these more sophisticated players is bent on currency speculation.

     What we have stated thus far represents a concern from an insider's perspective, i.e. the assumption is based on the fact that "if we were living in Laos ..."  What if we were living outside or Laos or we were foreigners looking INTO Laos, will the prospect change at all?

     The question is not merely academic, but has a practical implication.  If we were foreigners or someone outside of Laos thinking of investing or doing business in Laos, we would go through the same triangulation analysis outlined above.  We now hold $1,000.  The official rate maintain by BOL is 7,600 Kip per dollar.  By exchanging $1,000, we receive 76,000,000 Kip.  Despite the fact that we become instant millionaire, we actually committed economic waste by exchanging that dollar to the Kip. Had we converted the $1,000 to the Baht first and than from the Baht to the Kip, we would profited 37,323.70 Kip.  This lost is not a potential lost, but a real devaluation of my money in hand.  Under such circumstance, a reasonable person would prefer to covert the dollar to the Baht first then the Kip to prevent that loss of 37,323.70 Kip; hence, the demand for the Kip is LOW.  Low demand for the Kip means that it is devalued in the open market.  In a country where 80% of its consumer goods are imported, this state of affairs means that for every $1,000 worth of good imported, the Laotian people are paying $4.91 premium as a result of BOL's inability to effectively manage the Kip.

     Official rate is not a bad thing if the State knows how to apply it.  Before the floating of the Thai Baht, the dollar was traded at 25 Baht to a dollar.  That rate has been stable for almost a decade.  It was possible because the Bank of Thailand (BOT) followed a policy of basket of currencies.  Any given moment, BOT is constantly buying and selling the Thai Baht against 10 to 15 other major currencies to correct any imperfection as we
demonstrated above in the case of Laos.  However, such a proactive policy requires the BOT to maintain a group of administrators to conduct the day-to-day and minute-to-minute  currency management.  These administrators have to work closely with the BOT.  As the economy grows, currency transactions become increasingly difficult to manage.  Coupled with other factors, BOT was forced to abandon the policy.  BOT floated the Baht; it plunged.

     The Thai experience teaches us 2 things: (i) official rate in Laos must be effectively managed to avoid devaluation of the Kip, and (ii) because Laos is import-dependent, state involvement in the currency market is inevitable.  Such an involvement must be guided by active participation by BOL in the market; specifically, it must engage in active currency trading to the extent that it can influence currency market condition in Laos.

     Currency devaluation is a good thing if the country is export-dependent.  However, Laos imports 80% of its consumer goods.  16% of its state budget depends on foreign donation. 80% of the country's export comes from one source, i.e. electricity.  Devaluation of the Kip will not help Laos.

     It does not matter if you are a communist, a nationalist, a democrat, or a monarchist, a leader not guided by sound economic policy will ultimately lead the country into poverty and unrest.