ECONOMIC DEVELOPMENT AND SUSTAINABILITY ISSUES FOR ENERGY PROJECTS IN LAOS

Paper prepared by Kamal Malhotra, Co-Director, Focus on the Global South, Chulalongkorn University Social Research Institute, Bangkok, Thailand, November 1996.

This paper is based on, but an elaboration of, a presentation by the author entitled "Economic Development and Sustainability: Energy Projects in Laos and the Mekong Region". The talk was delivered at a conference "Generating Power and Money - Australia’s and Thailand’s Roles in Hydro Projects in Laos", held in Melbourne, Australia on October 28-29, 1996. The conference was jointly organised by the Australian Council for Overseas Aid (ACFOA) and The Center for Asia Pacific Studies, Victoria Institute of Technology.

A. SELECTED ASPECTS OF LAOS’ ECONOMIC AND DEVELOPMENT CONTEXT

With a 1994 Gross Domestic Product (GDP) of approximately US$1.6 billion, a GDP per capita of approximately $250 and a per capita external debt of $500, the Lao People’s Democratic Republic (Lao P.D.R.) certainly ranks as one of the world’s poorest and most highly indebted poor countries (HIPCs) according to conventional World Bank and donor criteria.

Although classified as one of only three HIPCs in Asia (together with Vietnam and Myanmar), Laos’ debt is currently regarded as sustainable by the World Bank and donors generally, largely because most of it was incurred as rouble-denominated debt from the erstwhile Soviet bloc and, apart from being on highly concessional terms, is still carried at book exchange rate values that prevailed before the dramatic change in the value of the rouble.

In addition, and quite importantly for Laos, the conventional economic and monetary indicators used to assess debt sustainability by both the World Bank and IMF (e.g. debt to export ratio, total debt as a % of GDP) clearly understate the real debt burden on a country such as Laos which has both a subsistence history and current economic, social and institutional constraints that make repayment of even a modest debt a serious burden with significant opportunity costs.

Indeed, ironically, part of the reason that Laos’ debt may well be regarded as sustainable and not a cause for concern by its bilateral and multilateral donors is because Laos has historically been a largely subsistence economy which has not had a high proportion of monetary, hard currency or commercial transactions with the external world. This is already changing, and as such change accelerates, as it inevitably will in the coming decades, Laos’ external debt sustainability is likely to become increasingly precarious.

Laos’ debt dependency is magnified and made even more precarious by its high dependence on Official Development Assistance (ODA), which even if concessional, is increasingly skewed in favour of loans rather than grants. Indeed, approximately 50% of Laos’ current concessional loans are accounted for by just two multilateral bank sources i.e. the World Bank and the Asian Development Bank.

It is against this economic and development context that we need to assess the economic potential and sustainability of Laos’ proposed "high speed" economic growth strategy which is overwhelmingly premised on the development and export of hydropower to neighbouring Thailand with the objective of generating large amounts of both foreign exchange and export revenue.

Such an assessment is attempted in this paper, drawing both on Laos’ past experience with hydrodams and its current plans which include the approval of 23 Memoranda of Understanding (MOUs) with foreign dam builders, for construction and commissioning over the next 20 odd years.

B. LAOS’ PROPOSED DEVELOPMENT STRATEGY AND ITS DILEMMAS AND CHALLENGES

It is clear that despite some misgivings about the social and environmental consequences of such a development model, which were clearly discussed at some length in the lead up to and during the March 1996 Party Congress, that Laos’ leaders are embarked on trying to emulate at least some aspects of the so-called "miracle" economic growth Newly Industrialized Country (NIC) model of both the first generation (e.g. Singapore, S. Korea, Taiwan) and second generation countries (e.g. Thailand, Malaysia) that have pursued different variants of this model with varying degrees of success.

Laos’ attempts to follow such a model coupled with a Kuwait-style reliance on one resource (i.e. hydropower in the case of Laos) appeals to its leaders because it appears to offer the possibility of quick economic returns and wealth through economic liberalization without the need for any political liberalization.

Despite the considerable disquiet that grassroots party ranks apparently expressed at the March 1996 Party Congress about what such a model,(which was embarked on with the proclamation of the New Economic Mechanism-NEM in 1986) has delivered so far for the ordinary Laotian, it is clear that the general direction charted through the NEM in 1986 will remain unchanged, notwithstanding the Party leadership’s continuing socialist rhetoric.

In this context, hydropower development, not for consumption in Laos, (due to lack of adequate demand) but for revenue generation through energy/electricity export to regional neighbours, primarily Thailand, is being viewed as a quick fix panacea for all of Laos’ economic and development problems and aspirations.

While approximately 60 hydropower projects are on the drawing board(even though most people agree that many will never progress beyond this stage) and 23 MOUs have already been approved and signed by the Government of Laos (GoL), no single project symbolizes the GoL’s hydropower strategy more vividly than the controversial Nam Theun II dam, which alone is expected to cost an amount which approximately equals the entire GDP of Laos. According to the World Bank, if it goes ahead, it is also expected to generate cash inflows of about US$ 3 billion for the Lao government over the twenty five year build-operate-transfer (BOT) concession period provided to the foreign dam building consortium and about US$ 450 million per annum for the remaining life of the dam.

However, Laos’ real dilemma is that there is no quick fix through large-scale hydrodam construction or an easy alternative economic option which will guarantee economic growth and development for its population.

Clearly, at least from my perspective, there is no forseeable economic development strategy option for Laos without an important component of hydropower development. Indeed, a viable path to Laos’ economic and social development, given the country’s landlocked nature, natural resource base and skill base and mix, is inextricably linked up with hydropower development in some form.

The issue, then, is not whether Laos should pursue hydropower development, but rather what form and pattern this should take and what importance this sector or component should be given in the country’s overall mix of economic strategies, especially as a way to generate export revenue.

Laos’ mix of strategies need to be both more broad-based and domestic centered than they currently appear to be. They should definitely not be so overwhelmingly dependent on one non-renewable resource (water) and one export market (Thailand).

Most of the current critique of Laos’ hydropower export strategy focuses on the environmental and social costs of such a strategy . Regardless of the validity of such a critique, it fails to address both the economic sustainability dimensions of such a hydropower strategy or the question of viable economic alternatives to it. This is an important gap, since in the absence of easy economic growth and development options for Laos, the battle over both the type and scale of hydropower development in the country is much more likely to be won or lost on the basis of its economic sustainability than on the merits or demerits of arguments focused primarily or exclusively on social and environmental issues, notwithstanding the latter’s acknowledged importance.

This paper will, therefore, attempt to focus on the crucial issue of the economic sustainability of hydropower development as a primary strategy of economic growth and development in the particular context of the Lao P.D.R. It will, I hope, be successful in making a compelling case for why a strategy dependent on large-scale hydropower development, in this day and age, and in the particular economic, social, environmental and especially institutional context of Laos, is less than compelling or economically defensible.

I hope, that in successfully doing this, this paper will also help debunk GoL, World Bank, dam builder and other optimistic assessments(including those of some conservation groups) that a positive decision on mega-dams such as Nam Theun II, because of their enormous projected foreign exchange, cash and revenue flows and the potential use of these flows in the mitigation of the accepted social and environmental costs, is the best option for the country.

Proponents argue that such dams are desirable not just for Laos’ economic growth and development, but also as a way of better conserving the environment (including endangered species of flaura and fauna) and improving the economic and social circumstances of communities which will be displaced and resettled as a result of the dam.

This paper will attempt to argue that such projections are fundamentally flawed on economic grounds and that there are more economically viable options for Laos, both for hydropower development and the country’s overall economic growth and development strategy.

While some aspects of the economic arguments presented in this paper are likely to be valid for large-scale hydrodam development in general, a number are specific to the particular context of Laos (e.g. debt sustainability implications). Therefore, care will need to be exercised by readers who wish to extrapolate or apply the arguments used below to other large-scale hydrodams in either the broader Mekong basin region or elsewhere.

C. LAOS’ HYDROPOWER DEVELOPMENT STRATEGY: SOME ECONOMIC CONCERNS AND ISSUES

The economic issues and concerns discussed below are based on an analysis of Laos’ two major existing dams, Nam Ngum and Xeset, as well as on analysis done by independent economists and consultants on different aspects of three proposed dams i.e. Nam Theun II, Nam Theun-Hinboun and Nam Leuk.

Therefore, the issues and concerns raised are, at the very least, relevant to the three proposed dams; there is every reason to believe, however, that much of the analysis will be relevant to many of the other dams in Laos for whom MOUs have already been signed and for which feasibility studies have either been completed or are currently in progress.

My concerns and issues can be broadly categorized under four headings.

1. A Fundamentally Flawed Cost-Benefit Analysis (CBA) Concept, Design and Process

Even allowing for the many and obvious limitations of CBA, a number of serious concerns warrant raising, based on an assessment of the feasibility studies done by dam building consultants such as Snowy Mountain Engineering Consultants (SMEC) and Transfield, both of whom are private Australian consulting firms. The important ones are:

* the fundamental principles of CBA were not adhered to.

Such principles should include long-term economic and financial viability, equity of distributional costs and benefits, intergenerational equity and comprehensiveness in the CBA to include not just economic and financial but social, environmental, technical, institutional and political costs, benefits, opportunities and risks.

The CBAs done by the consultants appear to have focused almost entirely on economic and financial aspects to the serious detriment of other aspects. This is a particularly serious concern in a country like Laos where the social, political and institutional constraints and costs are particularly important to consider.

* the almost total absence of participation or even consultation with the people and communities that will be affected (e.g. displaced, resettled) as a consequence of the proposed dams.

* at least three fundamental flaws with the use of the Net Present Value(NPV) calculation, (discounted total project benefits minus discounted total costs) which together with the Internal Rate of Return (IRR - which is the interest or discount rate for which the NPV=0) were the basis on which the economic viability and sustainability of the three proposed dams were recommended by the consulting firms.

These limitations are all generic to the NPV concept and calculation (and not specific to its use in Laos or to hydrodams!) and are quite serious. They include:

- a serious underestimation of the social opportunity costs of the proposed hydrodams and thereby the best use of investment capital and finance. A high NPV, therefore, could reflect an inadequate search for alternative projects rather than a potentially viable project.

- even more importantly, by discounting the value of the future, the NPV gives much less weightage to future generations of people than it does to present ones. This creates a serious dilemma because it presents and highlights an inherent contradiction between the concepts behind NPV and sustainable development because the latter is premised and based on the fundamental principle of inter-generational equity.

- an inadequate and misleading basis of estimating debt sustainability, especially for a heavily indebted poor country (HIPC) such as Laos. This is because the discount rate used to determine the NPV of loans is too high for HIPCs and a relatively small change in the discount rate used leads to a proportionately much bigger change in the NPV.

As a result, the use of too high a discount rate has inevitably led to a significant underestimation of the severity of Laos’ debt problem. This will be an even more serious issue in the future, especially if Laos goes ahead with its multiple dam plans since all of them will involve the use of debt finance, both multilateral and private.

* erroneous assumptions about critical economic variables (e.g. actual production, price, schedule slips) and inadequate "sensitivity" analyses on these variables to establish both more realistic and pessimistic scenarios of economic viability and sustainability. It appears that only optimistic scenarios were considered with respect to all the key variables.

This is elaborated below with data and examples, as follows:

(i) estimates of actual production ("plant factor") compared to the dams’ theoretical production capacity appear to have been wildly optimistic and unrealistic.

According to a June 1996 report by Thomas Adams, Senior Consultant at Borealis Energy Research Association in Canada, as against Nam Ngum’s actual experience of 48% (1993), Xeset’s of 64% (1995) and the average global figure, including that of the United States, of between 45-50% "plant factor", the economic analysis for Nam Theun-Hinboun projects this to be 87% (Asian Development Bank). The estimates provided for Nam Theun II are also unrealistically high at 84%, according to SMEC’s 1990 feasibility study.

Furthermore, the sensitivity analysis on the "plant factor" allows for a reduction of only 20%, in the case of Nam Theun-Hinboun, according to Mr. Adams, whereas, based on the actual global and Lao experience for large-scale hydropower projects, it would appear to be more realistic and prudent to allow for a 50% reduction from the "plant factor" projections of both Nam Theun II and Nam Theun-Hinboun.

This appears particularly wise because of the acknowledged paucity and lack of hydrological and streamflow data for any reasonable period of time and the major seasonal variations that regularly occur in the tropics.

Indeed, according to Dr. Wayne C. White of the U.S. consulting firm SmithOBrien’s July 1996 report, an analysis of the Nam Theun II dam, based on SMEC’s 1990 feasibility study data, shows that even a 20 % reduction in "plant factor" performance could lose the project US$ 7 million in its very first year of operation. The NPV at the end of the project would be US$ 105 million, an amount which is less than the opportunity cost of sustainable forestry in the Nakai Plateau (the proposed dam’s location) which is estimated to be US$ 135 million.

(ii) the dam consultants price and revenue projections are too optimistic.

The price of 4.55 US cents per kilowatt hour (kwh) for Nam Theun II and 4.3 US cents per kwh for Nam Theun-Hinboun implies a premium of between 25-50% on existing Nam Ngum (3.6 US cents per kwh) and Xeset prices. Nor do the sensitivity analyses on this crucial variable allow for a 20-50% reduction. Indeed, only a 10% reduction is allowed for in the sensitivity analysis.

This is unrealistic not only because of the current price that Thailand buys hydropower at from Laos, but more importantly, because of Thailand’s Independent Producers Program (IPP) and the emergence of relatively cheaper alternative and competing technologies such as gas fired co-generation technologies now being used in Canada and United States, which according to some estimates, will be able to deliver prices of between 2-2.5 US cents per kwh within the next five years.

Thailand’s IPP program, on the other hand, is increasing the range of options and sellers of electricity to it. Through a competitive bidding process that the Thai monopoly, the Electricity Generating Authority of Thailand (EGAT) is now actively encouraging, it is also attempting to simultaneously lower the price at which Thailand can meet its projected future demand for energy into the next millennium.

Neither of these trends augur well for Laos’ medium or long-term prospects in its principal market. A 10% sensitivity analysis on this crucial foreign exchange, cash and revenue variable, (which is the main basis for raising project finance, equity and a World Bank partial risk enclave guarantee from the IBRD for the Nam Theun II dam project) is, therefore, clearly inadequate and somewhat disingenuous.

(iii) inadequate assumptions and sensitivity analyses on inflation adjusted cost overruns.

Already, even before project finance has been secured, it is estimated that Nam Theun II will cost at least US$ 1.3 billion, if not US$ 1.4 billion as against the earlier estimate of US$ 1.2 billion. A recent World Bank paper indicates that the global experience is one of an average cost overrun of 30% which would imply a much higher final figure for Nam Theun II if it does finally go ahead. Indeed, Xeset, a considerably smaller dam project in Laos, had a 26% cost overrun.

Yet, once again, the sensitivity analysis provided in the feasibility study is only for an optimistic 10% inflation adjusted cost overrun. This is clearly inconsistent with both the global and Laos specific experience.

(iv) no allowance or sensitivity analysis for what is sometimes referred to as "sunk" cost or "stranded" capital.

This is a particular worry for the future, given the rigidities of large-scale hydropower projects in the face of the much more flexible, alternative technologies (e.g. combined-cycle gas turbines) which could relegate large-scale hydro to the obsolete dustbin of a bygone era within the next decade.

(v) schedule slips as distinct from cost overruns. According to a World Bank review, the global record points to an average of 25% and a time lag of 18 months from the intended date of project completion. However, the sensitivity analysis on this allows for a schedule slip of only 12 months, not the average 18 months.

- the total lack of sensitivity analysis on institutional capacity despite the widespread agreement that this is an important constraint in the case of Laos.

Such institutional constraints include the lead time to begin operation or implementation, absorptive capacity of both central and local government, the capacity and skills of the workforce and their training needs, the relative difficulty (for the GoL) of obtaining the necessary project financing, their management, operations and maintenance capacity and last, but clearly not the least, the government’s limited regulatory and administrative capacity.

The particular circumstances and institutional constraints of the Lao government’s Electricite du Laos (EdL) merit special mention. EdL received aid from the Asian Development Bank (ADB) worth US$ 72,179,000 between 1987 and 1994 against an average revenue of only US$ 32.4 million per year during the same period.

It is clear that EdL would be financially non-viable and, indeed, even bankrupted without aid to cover its equity and interest coverage ratios.

Japanese aid for the Nam Ngum dam also indicates that the project would have been non-viable without it.

These financial and other institutional capacity constraints of EdL are a major impediment to the effective and sustainable development of Laos’ hydropower potential.

2. Future External Debt and Other Macroeconomic Implications and Impact

Various critical aspects of Laos’ current external debt situation have already been described and analysed in earlier sections of this paper. The future dangers in this respect have also been implied. This brief section will, therefore, merely illustrate the magnitude of Laos’ potential debt burden if it were to embark on an economic growth and development strategy that is driven by large-scale hydropower development.

The best way to do this is to quote from Thomas Adams’ analysis of the debt-equity calculations for the Nam Theun-Hinboun dam. Based on his independent analysis and calculations he believes that the ADB’s 60:40 debt-equity calculation significantly understates the Lao government’s total liability. He believes that since US$ 226 million of the total estimated dam cost of US$ 270 million (1994 dollars) is ultimately money borrowed by the Lao government, the correct debt-equity ratio is actually 83.8:16.2.

Such a high debt-equity ratio would be even more unsustainable if the dam cost was higher which it clearly will be in many cases (e.g. as earlier indicated, Nam Theun II will cost at least US$ 1.4 billion). Indeed, according to the World Bank, even in a much bigger and richer country such as Guatemala, the final cost of just one project, the Chixoy Dam ($944 million), represented 40% of the country’s 1988 external debt.

Related to the above but somewhat distinct from the debt issue is the potentially high opportunity cost of the Lao government investing so much of its limited resources in hydrodams. This is obviously an issue of critical importance in a country such as Laos where resources are extremely scarce and where the opportunity cost of capital is, therefore, extremely high.

Also related is the direct and indirect credit exposure that the Lao government is able to absorb and withstand in relation to one project such as Nam Theun II without both strain and stress and a high opportunity cost in alternatives foregone and spread over a broader range of smaller energy and other projects.

Indeed, the opportunity cost of not using the same resources to invest in education or health in Laos may, at least in the medium to long term, be higher than the benefits from the large-scale hydropower investment. This appears to have been the case in the Arun III dam in Nepal.

Such an assessment came from none other than the person who was then the World Bank’s divisional chief for Nepal. He apparently resigned because he believed that the Bank was pursuing the dam project despite its own analysis which indicated that economic returns would be higher if the same funds were spent on education or health (Mr. Wolfensohn, the World Bank President later withdrew the Bank from the project but it is unclear if this was one of the reasons for his decision which, most likely, was driven as much if not more by political considerations than economic ones given the active national and international campaign against Arun III).

A third concern at the macroeconomic level is the possibility of what economists refer to as the "Dutch disease" afflicting the Lao economy, particularly as a consequence of mega dams such as Nam Theun II.

This so-called "disease" results when relatively large foreign exchange cash inflows, such as those projected from the Nam Theun II dam, lead to an appreciation and overvaluation of the country’s exchange rate, thereby making its other exports less competitive in the international market. If this were to happen, it would result both in lower revenues from them and the compounding of Laos’ dependence on one export product (hydropower).

Such macroeconomic distortions, if they were to result, would increase Laos’ vulnerability to regional and global variables and to EGAT, in particular.

Finally, the macro and micro economic implications and impact, on both local employment and domestic prices and inflation, of the expected large influx of expatriate consultants and skilled and other labour will need to be studied. It is realistic to assume that these labour market factors will result in significant distortions to both the local community and national economies in a small and still largely non-monetized economy such as Laos’.

3. The Vulnerability of Dependency on One Market

This issue, which relates to EGAT and Thailand, has already been touched upon in the previous section of this paper. It may, however, be useful to summarize some of the key issues that pertain to this concern. These are:

- the heavily skewed bargaining power in favour of EGAT. This was best illustrated by the recent shocking but successful arm-twisting of the GoL by EGAT to allow the construction of transmission lines from Yunnan Province in S.W. China (a Lao government competitor) to Thailand as a precondition for buying electricity from it.

- the real possibility of EGAT being able to further increase its relative bargaining power vis-a-vis the GoL, (which, as already indicated, is already heavily skewed in its favour), as a consequence of the increased availability of cheaper, alternative energy sources. Some independent estimates indicate that Australian coal-fired energy, in the year 2008, will be available at 4.8 US cents per kwh as compared with the earlier agreed contract price of 6.3 US cents per kwh between the GoL and EGAT in the same year for Nam Theun’s output.

- problems of "slippage". It is already clear that even if it goes ahead, the commencement of Nam Theun II’s construction will be delayed till at least the end of 1997 . As a result, the earliest that it will be able to supply EGAT will be 2002, instead of 2000.

This has already led EGAT to recently announce both that it is cancelling its current purchase price agreement with the GoL (which will need to be renegotiated) and that it will significantly increase its energy supply quota from the IPPs.

EGAT has signed contracts to buy 4200 MW from the IPPs but plans to increase this. The larger IPPs have already offered to sell greater than 16,000 MW to EGAT while the Small Power Producers Program (SPP) has offered to sell more than 4500 MW. EGAT already has an agreement to buy 1729 MW from 50 SPPs (out of the 80 SPPs that have, so far, applied to it).

The latter should be a cause for concern to the GoL not just because of the IPP quota increase but also because, according to some sources, the competitive bidding being encouraged by EGAT amongst the various IPPs is already leading to price quotations as low as 3.5 to 4 US cents per kwh from them. This must have the GoL worried, given that it now has to re-negotiate its earlier higher (4.55 US cents per kwh) purchase price agreement with EGAT.

While both Vietnam and China are viewed as additional markets by Laos, both are unlikely to account for significant demand, at least in the short-term, given their own hydrodam plans and limited effective excess demand.

4. The Public Subsidy of the Private Sector

The BOOT arrangements under which Laos’ many dams are proposed are often presented as beneficial to Laos both because they are expected to bring in private foreign capital and finance that Laos would otherwise not be able to access and because of their projected foreign exchange, revenue and cash flow benefits for the overall economy.

This depiction often gives the impression that such projects and the investments that they entail are "free" and have no opportunity cost for the GoL or subsidy from it.

While this paper is not the appropriate place to elaborate all the pros and cons of BOOT schemes for a country such as Laos, it is necessary to outline both the myriad ways in which private investors will be subsidized by the government and people of Laos and the implications of the partial risk guarantee that the World Bank has been requested to provide for the Nam Theun II dam. The brief outline which follows should clearly illustrate that there are both significant opportunity costs and public subsidies involved in all such so-called " private sector" projects.

Examples of the public subsidy of private sector investors clearly include the GoL’s provision of tax and other incentives to them (e.g. full repatriation of profits, tax holidays), its responsibility for the social, environmental and resettlement issues and costs and the utilization of its precious and limited concessional IDA credits for this purpose, its free supply of the country’s non-renewable resources and its responsibility for all the so-called "sovereign" project risks.

This latter set of risks deserve further description and discussion because they are the cause of the request to the World Bank to provide a partial risk guarantee (against default by the GoL) in the case of the Nam Theun II dam.

According to a very recent World Bank memorandum, commercial lenders and private investors remain reluctant to provide long-term financing for large projects in countries such as Laos because of their lack of creditworthiness, regulatory arrangements and sovereign risks.

Sovereign risks are defined by the Bank as risks relating to "government credit and performance, including interference with the project, nonfulfillment of government obligations under its (BOOT) concession contracts, foreign exchange convertibility, expropriation, civil wars,

etc.".

Such risks, which include "breach of contract" imply that no subsequent GoL ( in the next 25-year period, in the case of Nam Theun II) can change any aspect of the contract, even if it feels and is elected by the Lao people on a political platform that argues that certain provisions of the contract limit or infringe the national sovereignty of the Lao P.D.R.

Moreover, no new regulatory framework to ensure compliance with what is perceived to be the national interest by future Lao governments can be implemented without a "breach of contract" and a consequent call on the guarantee by the private investors involved.

This scope of coverage is, clearly, far broader than the traditional World Bank Group guarantees that have been provided so far through the Multilateral Investment Guarantee Agency (MIGA).

It is this broad range of risks that the private sector consortium is seeking World Bank protection (against the GoL) for. Ironically, the World Bank, while offering such a facility to the private sector through the mechanism of IBRD partial risk and partial credit guarantees, has no parallel mechanism for guaranteeing the GoL (or any other developing country government) from the multiple risks they face whilst dealing with private investors, especially foreign ones who, among other measures, can walk away from a project if it goes wrong for them, leaving huge amounts of physical, financial, human, institutional and political capital stranded or sunk as a result of their actions!

The World Bank Group is currently considering multiple involvements in the Nam Theun II dam project (e.g. through IFC ‘A’ and ‘B’ loans, MIGA, IDA credits and an IBRD "enclave" partial risk guarantee).

If it does agree to extend the US$ 100 million guarantee that it is currently considering (to support the estimated US$ 1.2 to 1.4 billion dam cost), Laos will be the first IDA-only country to get an IBRD partial risk "enclave" guarantee from the World Bank. The GoL will, however, have to commit to providing a counter-guarantee for the project.

The Bank’s appraisal will include a country credit risk analysis to ensure that the GoL will be able to repay its debt and other counter-guarantee obligations to the Bank as a preferred lender in the event of a call on the guarantee. This presents both a risk and an opportunity cost for the GoL.

Moreover, the GoL will have to pay both a Guarantee Standby Fee (a commitment charge of at least 25 basis points annually, but possibly higher for an IDA-only country such as Laos, for the period when the guarantee is in force but not callable) and a Guarantee Fee which could be as high as 3% per annum on the amount of the guarantee callable at any particular point in time after the non-callable period is over.

In the event of a call on the guarantee, the agreement between the GoL and IBRD will require the government to pay the Bank the full amounts that IBRD would have already remitted to commercial lenders. The ability of the Bank to demand immediate payment or set new repayment terms for the GoL is expected to act as a deterrent to "sovereign" default.

As in all guarantee operations, the Bank would also have subrogation rights. What this means is that, in the event of default by the GoL, the World Bank, through IBRD, would have claim not only to the counter-guarantee but also to a part of the project security (e.g. mortgage on project assets and land, cash and insurance proceeds, debt service reserves).

It should be clear from the description and analysis just provided that foreign capital borrowed for projects such as Nam Theun II is neither free or risk free for the Lao people and government. There is also a considerable element of public subsidy of private interests in the guarantee and counter-guarantee arrangement and structure. Indeed, there appears to be a very thin line between sovereign and commercial risks in the definition used by the Bank. It can, therefore, be persuasively argued that both the World Bank’s guarantee and the Lao government’s counter-guarantee have the potential to insure private investors not just against sovereign risk , but also partially against some commercial risks. This is, clearly, an unacceptable use of public money, more so when the most substantial share of the profit from the project will accrue, tax-free, to the private investors for at least 25 years.

D. TOWARDS AN ALTERNATIVE FRAMEWORK FOR ECONOMIC GROWTH AND DEVELOPMENT IN LAOS

An alternative framework for Laos’ economic growth and development must start with an alternative set of objectives. These should emphasize the optimization of growth and its broad-based distribution. It should also have people-centered development with a preferential option for the poor and powerless as a central tenet. Such a framework is very different from the Lao government’s current attempts to achieve a quick-fix, high speed miracle economic growth strategy.

Such an alternative framework will require a sustained and continuous process of capacity-building for broad-based participation in policy-making by ordinary Laotians which the current political system does not adequately allow or facilitate.

An alternative and more participatory process of policy formulation will inevitably lead to changes in economic growth and development policy content. While, as earlier stated, a hydropower development strategy is bound to be part of such an alternative content mix, there are likely to be important differences in the nature and pattern of the hydropower development options that are pursued with a probable bias in favour of smaller and medium sized hydropower development projects which are likely to be both more amenable to community management, maintenance and control and more suited to the institutional and financial capacity of the Lao government.

Before concluding, it may also be useful to sound a final note of caution.

Both history and the experience of other countries in S.E. Asia and Latin America have shown that foreign private capital can be most usefully harnessed for the benefit of an economy’s growth and development if the national government has developed strong regulatory and enforcement capacity vis-a-vis both the private sector and the inflow of portfolio and investment capital.

The serious lack of such capacity is currently a crucial institutional weakness in the case of Laos. It is, therefore, urgent and highly advisable for both the GoL and foreign donors to make a long-term and more serious commitment to invest in appropriate state and government regulatory mechanisms and their enforcement capacity before throwing open the country’s doors in an indiscriminate way to foreign private investors.