1. COMMENTS ON THE DRAFT DECREE ON THE INTRODUCTION OF GOVERNMENT BONDS AND
GOVERNMENT GUARANTEED BONDS IN THE LAO PDR
Jean-Marc Lepain, Intergovernmental Fiscal Advisor
Date: August 22nd 2008
1. Background
In the aftermath of the Asian financial crisis, ASEAN + 3 countries have launch the Asian Bond
Markets Initiative (ABMI) to develop regional markets using common financial standards for
encouraging cross border investments. Since 2003, the Lao PDR has received the financial support of
the Japan-ASEAN Financial Technical Assistance Fund (JAFTA) in order to create a Government Bound
Market, and the ASEAN Secretariat has created the “Technical Assistance for Developing Bond
Markets in Lao PDR” programme which is now in phase 2. A roadmap and work programmes have
been developed for the creation of a bond market and the Government Joint Committee for Bond
Market Development has taken the responsibility for the roadmap implementation . Nomura, a
Japanese security firm, has been commissioned to prepare a draft decree for the regulation and
oversight of the Lao PDR Bond Market in replacement of the old Security Law.
On August 4th, the Department of Fiscal Policy of the Ministry of Finance has requested the
Intergovernmental Fiscal Adviser to review on its behalf the Draft Decree on Government Bonds and
Government Guaranteed Bonds prepared by Nomura. The Advisor has consulted with the Ministry’s
Treasury Department and other stakeholders and his conclusions, reflecting a consensus in the
Ministry of Finance, are presented in this memorandum.
2. Description of the decree
The objective of the decree is to put in place a Government bond market as part of a wider effort to
establish financial markets in Lao PDR, including a Stock Market and a Security Market for corporate
bonds. The decree on Government Bonds and Government guaranteed bonds will be completed by a
decree on Securities Markets that call for the establishment of a Market Authority and Credit Rating
Agencies
The decree covers the following topic: the products, the role of MoF in issuing bonds, the role of BoL
in organizing the sell of bonds, custodians, underwriters and investors.
2.1. Types of Government bonds
The decree covers four types of products: Treasury Bills with a maturity of less than one year,
Treasury Bonds with a maturity of one year or more, Government guarantee bonds issued by State
enterprises designated by the Prime Minister and Retail Bonds.
2.2. Currencies

2. Article 7 of the decree open the possibility to issue bonds not only in kips but in other currencies.
2.3. Investors
If we read correctly Article 8, the market will be open only to domestic investors which might include
“foreign organization and individuals working and living lawfully in Lao PDR”. Accepting foreign
institutional investors would require making the kip a convertible currency. However, there are good
reasons to exclude foreign investors as they are more likely to take a speculative approach and might
dramatically reinforce market fluctuations and increase volatility; as such is the case presently in
Vietnam. We advise the Ministry of Finance to review carefully the recent events in Vietnam before
making any decision.
2.4. Role of the Ministry of Finance
The role of the Ministry of Finance is to define the borrowing policy of the Government, to devise
issuing strategies and to prepare quarterly programmes for issuing treasury bills and treasury bonds.
Issuance of treasury bills is normally based on cash management requirements. A fine-tuned T-bill
policy will not be possible before the Treasury System is implemented. Issuance of bonds depends
on the financing needs for long term investments, macro-fiscal sustainability and macro-economic
stability. The MTFF and MTEF will provide the key parameters for defining and piloting the borrowing
policy.
Article 21.2 says that “The volume and interest of each of the Treasury bills shall be determined
through auction results”. The syntax of the sentence does not appear correct but might mean that
the volume of T-bill effectively sold at and auction might depend on the auction result as it is the
case in the Dutch Auction system, used for example by the US Treasury. However that might not be
compatible with MoF borrowing policy and it needs to be further discussed as it might influence the
choice of an auction method.
MoF will establish the list of “underwriting organizations”. This will require some additional
regulation and the publication of selection criteria.
In the case of Government guaranteed bonds the role of MoF is strictly limited to issuing the
guarantee legal documents. However, guaranteed bond will impact the government solvability and
should be recorded as off-balance commitments. There is a risk for MoF to loose the control of its
fiscal policy if the Prime Minister Office can authorized SOEs to issue guaranteed bond without
referring to MoF. Within the framework of it borrowing policy, MoF might set limits for guaranteed
borrowing.
2.5. Role of the Bank of Lao PDR
Usual practices are that MoF give to the central bank a mandate for organising the issuance of T-bills
and T-bonds either through auctions, direct sales or underwriting. The central bank, as the

3. Government banker, will also collect interest and capital repayments. Often this mandate is
formalized by a Memorandum of Understanding signed between the MoF and the central bank.
The Central Bank is also responsible for creating a Central Security Depository (CSD) which normally
is not dedicated only to Government bonds but is open to all types of securities. The central bank is
then responsible for maintaining the CSD infrastructure and issuing all the related regulation. A
dedicated decree will need to be published by BoL. Additionally, MoF will need to establish the
principles of CSD accounting. Those principles might be integrated in the BoL Decree.
BoL will need to publish another decree on the eligibility criteria of candidate custodians and the
principles of their selection.
Eventually the Central Security Depository is linked to the payment system (Real Time Gross
Settlement) through a Delivery versus Payment System (DvP) that ensures that the payment is
absolutely simultaneous with the security transfer and that all systemic risks are eliminated.
2.6. Custodians and underwriters
The decree does not make a clear distinction between custodians and underwriters as custodians are
also expected to act as underwriters. A custodian is a financial institution that has received the
agreement of the central bank to hold and manage bonds recorded in the Central Security
Depository on behalf of its customers. This suggests that custodians might become active in
organizing a secondary market, either in organizing bond transactions between their customers or
selling bonds to each others.
3. Assessment of the decree
The technical content of the decree is excellent and reflect the expertise of Nomura. However, the
decree in the present stage remains high level and does not provide the sort of details required for a
bond market to become operational. The decree calls for (a) secondary regulation that will define
processes and procedures, (b) a clarification of the Government borrowing policy, (c) a feasibility
study.
As such the decree is not complete enough to allow a market to start operating. Not only it requires
as expected additional regulation, but a better definition of instruments and of participant
responsibilities must be introduced in the law. The scheduled feasibility study is expected to solve
these problems.
Secondary legislation could take the form of a circular issued by MoF or the Prime Minister Office
and a circular issued by BoL. Those circulars will give more information on the financial instruments
such as maturities, calculation of interest, secondary markets, method of auction, role of the
underwriters, conditions under which an investor can activate the Government guarantee,
accounting rules, custodian risk management rules and internal control, custodian insurance, etc.

4. In the absence of a State Borrowing Policy Paper, it is difficult to assess the decree. A Borrowing
Policy does not reflect only fiscal policy considerations but also monetary policy considerations that
must be discussed with BoL. The Government must first define the objectives of its borrowing policy
and then devise a strategy to meet those objectives. When such a strategy will be ready, it will
become possible to see if the decree and the secondary regulation allow meeting the objectives
through the approved strategy. In practice, drafting of the regulation will be impossible in the
absence of such a policy paper.
The decree does not say anything on market makers and by what mechanism the transaction price of
a bond will be established on the secondary market.
4. Borrowing Policy
It will not be possible to prepare the regulation required by the decree unless a Borrowing Policy is
put in place. The Borrowing Policy is currently under preparation by the External Finance
Department, but we have not had access to its preliminary findings and therefore are not in position
to make any recommendation.
The debt sustainability analysis conducted in 2007 indicates that the Lao DPR continues to face a high
risk of debt distress although all indicators at that time were positively oriented and debt service
ratio remaining relatively low. While nominal debt stocks have increase, strong growth has led the
nominal debt-to-GDP ratio to steadily decline since 2002. Since 2006 all debt service indicators have
reversed their upward trends, reflecting continued strong GDP and export growth. However the size
of the domestic public debt is negligible. This situation opens the possibility to substitute domestic
debt to international borrowing, although 75% of the country external public debt are highly
concessional loans.
Presently all domestic debt is made of short term T-bills. It pertains to the Borrowing Strategy to
decide if there is an opportunity to substitute long term bonds to short term T-bills, knowing that
such a policy can become effective only when the Cash Management System is implemented. The
Budget Law does not allow borrowing for financing recurring expenditures. However, from a cash
management viewpoint, when a treasury gap occurs, it is impossible to separate recurring
expenditures from investments. The usual policy is to use T-bills for short term gap resulting from
delay in revenue collection, and long term bonds for structural needs. If the analysis shows that there
is a minimum revolving stock of T-bills that represent a structural long term deficit, it is possible to
consider substituting long term bonds.
The question of substituting bonds to T-bills must be decided by an analysis of the opportunity cost.
Long term bonds represent for the Treasury a steady source of financing that reduces the interest
risk, especially within the context of raising inflation and interest rates. On the other hand, the cost
of borrowing long term is usually higher than the cost of borrowing short term. However, in Lao PDR
the market of interest rate instruments is not developed enough to make prediction on the yield
curve.
Another risk to be taken in consideration is the risk of depreciation of the Government bonds if
interest rates rise sharply (see Vietnam in section 6) and the risk that investors loose confidence in

5. the market, forcing the Government to borrow at higher rates. Many techniques exist for mitigating
this risk. Accounting rules play an important role. If insurance companies are obliged to mark to
market the value of their portfolio even if they intend to keep the bond until their maturation they
might be reluctant to buy the bonds or will ask for a risk premium. Central Bank policy plays also an
important role for the bank. Open market policy, pension and repurchase agreements might help in
creating some market liquidity.
The development of a Government bond market is far less risky than in international currencies. The
Decree opens the possibility of issuing bonds in foreign currency and this question should be decided
by the Borrowing Policy paper as it involves certain risks.
The borrowing policy should be formalized in a borrowing policy paper to be integrated in a Fiscal
Policy Declaration which is usually one of the preliminary budget formulation document presented to
the Cabinet and the Parliament.
5. Potential impact on the macro-economic and fiscal outlook
According to the IMF, “Public domestic debt in low-income country and emerging markets remains a
controversial issue…” (IMF Working Paper 07/127). An analysis of pros and cons leaves a very mix
image. Issuing domestic debt, whether to finance the fiscal deficit or to mop up liquidity, involves a
complex evaluation of the costs and benefits to the economy.
Traditional public finance literature highlights the risk of encouraging the issuing of domestic public
debt and its potential negative impact on private investment, fiscal sustainability, growth and
poverty reduction:
 The most prominent concern is the crowding out effect on private investment. Bank might
find investing in Government bonds an attractive low risk substitute to financing the
economy through commercial loans. This attitude might have in the long term a negative
impact on growth.
 Domestic borrowing is more expensive than concessionary borrowing. ADB and World Bank
Treasury Loans can be excellent substitute to domestic borrowing for financing structural
needs if the loan conditionality is accepted. With domestic borrowing, the final cost of
borrowing is unknown and might rise sharply due to rising interest rate and time
inconsistency when Government credibility is low.
 Stimulation of financial markets can contribute to economic growth in a way that
beneficiates only the affluent part of society but create a type of economy with more
exclusion for the poor.
However, in the recent years more voices have increasingly echo the positive view of many market
participants regarding the importance of domestic debt instruments for monetary, financial and fiscal
systems. The proponents of domestic debt stress its positive impact on growth, inflation and savings
as well as the contribution that more sophisticated financial markets can make to economic
development.

6. Here are some of the main advantages that they identify:
 The development of a Government bond market is an important stimulant to the
development of a security markets in the absence of potential private borrower. It will help
the Central Bank to set interest rates for different maturities and be used by commercial
banks as a pricing benchmark.
 Government bonds are an important instrument for the conduct of indirect monetary policy
operation and collateralized lending in inter-bank markets, reducing the need for frequent
central bank intervention.
 Domestic debt markets might stimulate population saving, having a positive effect on
inflation and on macro-economic stability. The example of China and India are often given,
but they are very large economies.
 International borrowing, even at concessionary rates, exposes the country to exchange rate
risk (although with a weak dollar the risk seams mitigated). Domestic debt reduces the
vulnerability to international market shocks.
 Budgets finance sectors such as agriculture, sanitation, public work which are unattractive to
the banks. Government bonds mobilize bank deposits and redirect national saving to the
financing of those sectors.
Coming to a clear cut conclusion in this debate is difficult. A complete review of these factors is not
possible in the framework of such a short note. Those questions need to de debated and clarified in
an in depth discussion of borrowing policy.
6. The example of Vietnam
Vietnam offers a good example of the damage that a poor borrowing policy can make. It is estimated
that by July 2008 Vietnam has issued more than US$ 15 billions of Government bonds, of which US$
3 billions are hold by foreign investors. With raising inflation, the Bank of Vietnam has been obliged
to raise significantly its rates. As a result Government bonds have lost 30% of their value and the
market confidence in Government has been greatly damaged. The depreciation has been aggravated
by foreign investors who have closed their positions and left the market. As a consequence if the
Government wants to mobilise capital at this moment, it has to pay a risk premium that put the bond
yield above inter-bank rates.
7. Feasibility Study
The implementation of a Government bond market will take many years and should be seen with the
context of the Government priorities. Although it is always possible to develop a legislative
framework to leave all options open, a bond market will also require a heavy investment in IT
infrastructure. For MoF, the priority should be the implementation of the Treasury System including
the cash management module, the implementation of a debt management system and the

7. implementation of the Treasury Single account. For BoL the priorities should be the implementation
of its General Ledger, the implementation of the account management system and the
implementation of its payment systems. Only when whose systems are in place, will it be possible to
consider a Central Security Depository and a Delivery versus Payment system. Therefore we are
considering a time horizon which is 4-5 years minimum. This gives already an indication that there is
no reason to speed up the development of security markets.
The delayed in BOL for implementing an information system covering banking operations, account
management and general ledger on one hand, and a real time gross settlement system on the other
hand, might become a serious bottleneck of the development of bond markets. It is important that
on this issue MOF and BOL coordinate their policy.
A feasibility study should take into consideration all those aspects. It is understood that the ASEAN
Secretariat is already preparing the Terms of Reference (ToR) of the next phase projects. Those ToR
include a feasibility study for issuing long-term bonds. This feasibility study will focus on three points:
 Whether the economy is stable enough to issue long-term government bonds, including
estimation of the possible size of the issuance;
 Identification of potential investors for long term government bonds;
 Suitable terms and conditions (i-e terms, interest rate, form, etc.) of Government long-term
bonds.
It should be noticed that the ToR do not include a feasibility study for the infrastructure and does not
seem to consider the prioritization of reforms within the Government.
8. Conclusions
 A good borrowing policy should be neutral in terms of size of the budget and budget deficit.
 The introduction of a Government bond market may have a significant impact on the
monetary and fiscal policy of the country and affect its macro-economic stability.
 The issuance of domestic debt has a combination of positive and negative effect on the
economy. There is no evident conclusion in the case of Lao PDR. The same causes produces
different effects in different countries, depending on the size of the economy, the culture of
people, their saving habits, attitude toward financial risks, experience with inflation, etc.
 The development of a long term bond market implies some serious risks that must be
carefully analysed.
 The Draft decree on Government Bonds and Government Guaranteed Bonds raise a number
of issues that can only be clarified within the framework of a borrowing policy study including
a debt sustainability analysis and a modelling of different scenarios.
 The Draft decree remains incomplete and will require for its implementation extensive
regulation that might require several decrees or circulars from the Prime Minister Office, the

8. Ministry of Finance and the Bank of Lao PDR. Without an approved Borrowing Policy Paper it
will be impossible to start drafting the regulation.
 The Feasibility Study scheduled by the ASEAN Secretariat will also be dependant for progress
on the Borrowing Policy Paper. In addition to the three points mentioned, the study should
also address the issue of the technical infrastructures required. It should include a tentative
date for starting the implementation of the Central Security Depository and an overall cost
estimate of the whole projects. It also needs to address the issue of the prioritization of the
different infrastructure projects inside MoF and BoL.