In June 2022, the Statistics Bureau of Laos announced that inflation had risen to a 22-year high of 23.6%. Staple goods have been fast becoming scarce and purchasing power of the country’s population declining at an alarming rate. According to the World Bank estimates, Laos’ foreign and domestic debt shot up to more than $14.5 billion (€14.2 billion). There is a concern that an escalating debt crisis has been pushing the economy towards a meltdown. Laos’ foreign exchange reserves depleted so low that experts worried that the Southeast Asian nation might be embarrassingly close to a loan default. There appeared no way out for the small, landlocked nation, except for external assistance, to honour its debt obligations. “It is on the brink of default,” Anushka Shah, vice president and senior credit officer at Moody’s Investors Service, stated unequivocally in mid-June, according to a DW report in August. A debt default is likely to escalate borrowing costs, and undermine prospects of public investment in social welfare and poverty reduction. How Laos and its development partners manage the crisis will leave an imprint on the shape of the country for many years to come. There is a unique aspect to the crisis, however. Laos owes about half of its foreign debt to China, which has lent the money to finance infrastructure projects such as hydropower plants and railway lines. Most of Laos’ public and publicly guaranteed debt is associated with the hydropower sector, and other large scale infrastructure schemes such as the $5.9 billion Lao-China Railway project. The funding for Laos’ infrastructure projects has come from loans through Chinese state-owned policy banks—the China Development Bank (CDB) and Export-Import (Exim) Bank of China. Even before the onslaught of COVID-19, the World Bank and IMF through the Low-Income Country Debt Sustainability Framework had identified Laos as potentially suffering from a high risk of debt distress. The accumulation of sovereign debt in itself is not necessarily a problem, but Laos’ position as a small, emerging economy placed the country at heightened risk of distress. Funding for resource projects had produced a mismatch between the longer-term mobilisation of state revenue and the short-term maturity of debt obligations. According to a
2020 World Bank report, about 50% of Laos’ debt is in foreign currencies, largely Thai baht and US dollars. Since instalments are to be paid in foreign currency, which exceeds Laos’ foreign exchange reserves, the country is now risks sinking into a reinforcing financial (banking and liquidity) crunch. While the Laos population has avoided high COVID infection rates, a massive decline in tourism revenue, breakdown of supply chains, and a loss of up to $100 million in remittances from workers forced to return from Thailand have added to the financial cost of the pandemic. As fiscal pressure was building, in May and June 2020 Fitch and Moody’s respectively issued sovereign credit downgrade warnings. The crunches arrived in mid-August 2020, with Moody’s downgrading the sovereign issuer rating from B3 to ‘Caa2’, the last rating before debt default, with a
negative outlook. In discussions over Laos’ debt distress, attention often focuses on the Laos-China Railway project, financed through China’s Exim Bank under the umbrella of the Belt and Roads Initiative. The construction cost of US$5.9 billion (one-third of Lao GDP in 2017) are shared between Lao PDR and China at a ratio of 30/70, but the high costs nevertheless present risks. Forty percent of construction is funded through equity, with one-third provided by the Lao Government (partially funded through loans from the Export-Import Bank of China) and the remaining twothirds funded by China. The remaining 60 percent of costs will be funded through loans taken on by the Lao-China Railway Company, a State-owned Enterprise with
30 percent Lao and 70 percent Chinese ownership. While the Government of Laos is optimistic for this railway to serve as an export and trans-shipment gateway between the Mekong region and China, there is also a high probability that the railway will be unprofitable for the coming years, according to a 2020 Asian Development Bank Institute (ADBI) working paper contributed by J A Lane.
There are other major infrastructure projects formally linked to the BRI in Laos, including the $2.7 billion Nam Ou hydroelectric scheme managed by the Power Construction Corporation of China and the Nam Tha 1 dam, a smaller hydroelectric project near the Lao-China border developed through China Southern Power Grid Company. More critical to Laos’ current debt distress is the energy sector. The liabilities of the state-owned Électricité du Laos (EDL) may be as high as $8 billion. Moreover, its debt servicing obligations are set to increase, from $400 million in 2020 up to $800 million in 2023. How exactly EDL landed itself in such a precarious financial predicament is a complicated story. Take, for example, Power China’s 1272
megawatt (MW) $2.7 billion Nam Ou River Cascade, constructed by Sinohydro, and financed by the China Development Bank under the auspices of the BRI. The Nam Ou Cascade cannot possibly cater to the key domestic demand centre in the Vientiane Capital region, for reasons of distance and mountain ranges. In 2020, the Minister of Energy and Mines confirmed that the Nam Ou Cascade was built primarily to supply electricity to the Lao-China Railway. But the construction of the railway and a domestic electricity grid got delayed and the authorities did not know
how to transmit the excess electricity generated. EDL was forced to reduce capacity utilisation on some of its own new, fully state-owned dam facilities, such as the two Nam Khan dams in Luang Phrabang Province. It has to continue purchasing power from the Nam Ou Phase 1 dams, since the terms of the agreement virtually makes it compulsory.
A second issue which appears to have landed EDL into debt distress relates to its participation in Engineering Procurement Construction (EPC) contracts, or socalled ‘turnkey’ construction contracts. Chinese banks have financed all of Laos’ fully state-owned dams since 2005, starting with the Nam Mang 3 project, almost all through China Exim Bank. Under such EPC contracts, Chinese bilateral loans were typically recycled back into Chinese engineering and construction companies including Sinohydro, China Gezhouba Group Company (CGGC), China National Machinery Industry Corporation Ltd (Sinomach) and China National Heavy Machinery Corporation (CMHC). To put in perspective, one such EPC contract, involving the China Exim-financed Nam Ngum 4 Hydropower Project in 2015 involved a design-build and turnkey agreement of $706 million. The construction companies are allowed to make their profits before the handover of the project. This mechanism provides scope for inflated cost structures and rent-seeking, particularly for Lao state-owned dam development and transmission line construction projects. Laos has now joined a number of other developing countries, including Zambia and Angola, which have overextended themselves on loans from Chinese banks.
The worst-case scenario is a continued debt spiral, through currency and inflation channels, leading to slower growth and further rise in the cost of debt servicing. The issues must be addressed because, as one analyst wrote in Financial Times in September 2020, even with global interest rates at an all-time low, ‘at some point, the budgetary constraints become such that governments can’t meet both their expenditures and interest payments …if debt continues to balloon at such a pace, it becomes unsustainable’. According to AidData Lab, a research lab at William & Mary’s Global search
Institute, the total value of Laos’ public debt to China is about $12.2 billion. Since 2013, China has invested more than $800 billion into its Belt and Road Initiative, with Laos as a key ally to build stronger economic ties across Southeast Asia. Critics of Beijing’s global expansion and infrastructure-led foreign policy, however, warn that poorer nations like Laos could risk falling into China’s “debt traps,” which allow Chinese investors to take possession of key national assets when debtor nations cannot repay the loans. Laos must repay $1.3 billion of external debt every year until 2025, which almost equals the country’s federal exchange reserves and half of total domestic revenue, according to the World Bank. The World Bank forecasts that even though Laos’ economy will grow by 3.8% this year, it will not be enough to generate the fiscal revenue needed for the government to pay its foreign debt. Since May 2020, things have almost been spiralling out of control with the kip (the Laotian currency) crashing against the dollar, oil companies stopped supplying gasoline. Long queues appeared in the provinces and in the capital, Vientiane. The tug of war with the government only ended when it arranged for a new means of payment to ensure two months’ supply of fuel via Thailand, while keeping the kip stable, thanks to exchange controls, at two-thirds of its value against the US currency of a year ago. The ratings agency Fitch announced in August that it will withdraw its rating for the government of Laos, as the country grapples with one of its worst economic crises in years. Such withdrawal of the rating occurs when the agency believes it has insufficient or otherwise inadequate information to support the maintenance of the Credit Rating. Much of Laos’ debt is owed to state-owned Chinese enterprises, and the government appears set on negotiating directly with Beijing in order to restructure some of its debts. However this process pans out in the short term, the country’s economic challenges appear far from over.