Tracking the Hidden Forces Behind Laos' 2022 Exchange Rate Crisis and Balance of Payments Instability

Abstract

This working paper uses a Dynamic Factor Model ('the model') to identify underlying factors contributing to the debt-induced economic crisis in the People's Democratic Republic of Laos ('Laos'). The analysis aims to use the latent macroeconomic insights to propose ways forward for forecasting. We focus on Laos's historic structural weaknesses to identify when a balance of payments crisis with either a persistent current account imbalance or rapid capital outflows would occur. By extracting latent economic factors from macroeconomic indicators, the model provides a starting point for analyzing the structural vulnerabilities leading to the value of the kip in USD terms dropping and contributing to inflation in the country. This findings of this working paper contribute to the broader literature on exchange rate instability and external sector vulnerabilities in emerging economies, offering insights on what constitutes as 'signals' as opposed to plain 'noise' from a macroeconomic forecasting standpoint.