Via Emerging Markets blog, a report on Laos:

Laos – the sleepy, land-locked nation often overlooked in favor of neighboring Thailand or Vietnam – is finally garnering the international attention that it deserves. The “Jewel of the Mekong” posted 8.0% GDP growth in 2011 and has been the fourth steadiest-growing economy in the world over the last nine years. Despite being the smallest economy in Southeast Asia, it is also slated to be the fastest-growing in the region this year, on track to post 8.3% GDP growth according to the IMF.

This article is an excerpt from Leopard Asia Frontier Fund’s upcoming November 2012 newsletter. You can subscribe to the newsletter here.

2012 has been a landmark year for Laos, both in diplomatic and economic terms. The country has continued to make evident strides towards international integration and regulatory reform, as evidenced by Hillary Clinton’s visit in July – marking the first time in more than half a century that a US Secretary of State had stepped foot in the country. In November, Laos’ bid for accession to the World Trade Organization was approved and its capital, Vientiane, hosted the 9th Asia-Europe Summit Meeting (ASEM). Both events are pivotal milestones for Laos to develop stronger links with the global economy. Significant revisions have also been made to the country’s laws on investment promotion, corporate tax rates, and business creation, prompting the IFC/World Bank to name Laos (alongside Mongolia) ‘the economy with the most reforms in East Asia and the Pacific’ in its Doing Business 2013 report.

The political landscape, however, does not appear likely to change in the near future. Regardless, the Lao People’s Revolutionary Party (LPRP), which has held power for over three decades, will continue to gradually introduce pro-business legal reforms and other economic liberalization measures while maintaining its stranglehold on political power. The next general election is not until 2015, and robust economic growth will further contribute to the ruling party’s firm grip on government.

In the meantime, the government is anticipated to continue the economic gains it has achieved over the past decade. Laos’ GDP was US$8.3 billion in 2011, with agriculture and tourism as the two largest economic sectors. Rice accounts for the vast majority of agricultural production, but coffee, sugarcane, tobacco, and cotton also contribute to agricultural output. Laos’ main exports are minerals, timber, garments, and electricity. Notable high-growth sectors in the country include construction, manufacturing, and mining – all of which are booming and will continue to drive the country’s accelerated growth. Currently, Laos’ major mineral wealth lies in its copper and gold deposits, but mines are being developed to produce potash, a key ingredient of fertilizer, as well as bauxite, zinc, iron ore, and lead.

Laos has benefited immensely from its location, and its steady economic expansion has been underpinned by growth amongst key trading partners in the region. Thailand and Vietnam, both prominent regional economic players, border it on either side. It also neighbors two of Southeast Asia’s up-and-coming markets, Myanmar and Cambodia. The ASEAN economic integration, planned for 2015, will provide an additional boon to Laos’ growth prospects by creating a single regional market – removing tariffs and revamping customs and labor migration laws.

China, bordering Laos to the north, has had its endless appetite for resources whetted by Laos’ reserves of gold, copper, potash, bauxite, rubber, and pulp. The Chinese have invested over US$3.3 billion in Laotian infrastructure, construction, and telecommunications projects, including the major highway that links China’s Yunnan Province with Bangkok via Laos. In November, China agreed to finance a US$7 billion, 420 km rail link to export raw materials and connect Vientiane with the Chinese border. The project will be the largest investment in Laos’ history and construction will commence in 2013. The building of another rail project, a US$5 billion line linking the country with Vietnam, is also scheduled to go underway in January 2013 with backing from a Malaysian investor.

The most valuable asset for Laos is its hydropower, estimated at potentially 26,000 megawatts and primarily earmarked for export to neighboring countries with high demands for electricity. The Laotian government has touted the country as the “Battery of Asia” with existing hydroelectric dams funded by both development banks and private-sector financiers. Nam Theun 2 dam, which began operations in 2010, is one of the largest hydroelectric dams in Southeast Asia and, in addition to contributing a projected US$2 billion in revenue to the Laos government over the next 25 years, has sparked interest amongst foreign investors in Laos’ hydroelectric sector. The government’s ambitious plans for hydropower export have not been without controversy, however. In November, Laos gave the green light for construction to begin on Xayaburi, a US$3.5 billion mega-dam that is Thai-financed and will produce energy for export to Thailand. The dam is the first on the Lower Mekong and has come under criticism from both environmentalists and neighboring countries that assert that it will disrupt fish migration patterns and affect millions in the region whose livelihoods depend on the river.

As a rapidly growing yet small economy, it seems fitting that Laos’ stock exchange currently only lists two companies. The Laos Securities Exchange (LSX) is the first and only bourse in the country and was established as a joint venture between the Bank of Lao (51%) and the Korea Exchange (KRX), which provides technical and financial support and owns a 49% stake. The LSX began operations in January 2011 with two initial public offerings (IPOs): EDL-Generation (EDL), a subsidiary of the state-owned power company Electricite du Laos, and Banque Pour Le Commerce Exterieur Lao (BCEL), a state-owned bank. 25% of EDL’s shares and 15% of BCEL’s shares were floated and the listings generated significant domestic and international investor interest. The two companies raised a combined US$140 million, and the LSX, with an instant market capitalization of US$600 million, became the world’s smallest stock exchange.

Although small, the LSX has achieved strong performance in 2012. The Laos Securities Exchange Composite Index has surged 33% year-to-date and a number of companies are now considering listing on the LSX, particularly considering the recent success of EDL, whose stock price has surged since November and offering a 1-year return of 41%. The Laos-Indochina Group, which grows cassava and tapioca, is expected to list soon as the first private company on the exchange. Both Enterprise of Telecommunications Lao (ETL), a state-owned internet and mobile-phone provider, and Lao World Group, a privately-owned diversified group with interests in agriculture, engineering, construction, and tourism, are also intending to list. Two other firms looking at the benefits of launching an IPO on the LSX are Lao Airlines, the national carrier wholly-owned by the government, and Lao Brewery Company, a 50-50 joint venture between the Lao government and Carlsberg, the Danish brewer.

As Laos’ hydropower and mineral exports increase, its impressive economic growth will continue and investment opportunities in the once-backwater Mekong nation will catch the eyes of both regional and international players. But as with any frontier market, there are serious challenges that Laos will have to face moving forward. Despite planned road and rail upgrades, the country’s poor infrastructure, corruption, and predominantly unskilled labor force may limit large-scale production and distribution. Income inequality is on the rise, particularly between urban and rural areas. Vientiane buzzes with sparkling Range Rovers and construction projects, while many provinces remain isolated and poverty-stricken. China’s hunt for arable land is contributing to rapid deforestation in Laos, and many feel that the Xayaburi Dam needs a more thorough environmental assessment. If the Laos government pushes forward with plans for the dam against the wishes of neighboring Cambodia and Vietnam, it may damage regional cooperation down the road. As sleepy Laos begins to stir, its economic horizon looks bright and its natural resources will continue to propel its growth. But as the Battery of Asia lights up, the government will need to take measures to ensure that the resource revenues contribute to broader domestic development.