What’s Driving Laos’ Debt Crisis?

After gambling with “high risk” levels of debt distress for more than a decade, Laos has fallen into a debt crisis (and possibly a trap).

The latest data indicate that Laos’ total public and publicly guaranteed (PPG) debt increased from 68 percent of GDP ($12.5 billion) in 2019 to 88 percent ($14.5 billion) in 2021. Debt is forecast to surpass 100 percent of GDP this year and to continue growing in the coming years. External public debt amounted to 66 percent of GDP in 2021, around half of which is owed to China.

This significant increase in PPG has been mainly driven by the economic impacts of the COVID-19 pandemic and the recent worsening global macroeconomic environment amid the war in Ukraine. It may be made worse still by slower GDP growth in China (a major trading partner and investor in Laos). At the height of the pandemic, global debt reached (and surpassed) wartime levels, with more than half of the world’s poorest countries experiencing or being at high risk of debt distress. Lebanon, Sri Lanka, Suriname, and Zambia have all defaulted on their external debt in recent years. And while the G-20’s pandemic-induced Debt Service Suspension Initiative (DSSI) provided some temporary repayment relief for 48 participating low-income countries, the initiative has now finished.

In Laos, economic growth – indispensable to offset rising debt levels and ensure debt sustainability – fell dramatically to around 5.5 percent in 2019 and 0.5 percent in 2020 (from 6.2 percent in 2018 and an average of 8.0 percent in the early 2010s). Growth remains below pre-pandemic levels, despite an estimated rebound to 2.5 percent in 2021. The value of the Lao economy and the cost of its debt have been further threatened by the depreciation of the kip: Its value plummeted by 35 percent between February 2021 and August 2022, with inflation rising from less than 2 percent to 30 percent over the same period.

Public debt service payments were estimated at 48 percent of total revenues in 2021 (down from an expected 65 percent in Laos’ 2021 plan only thanks to debt service deferrals granted by major lenders in 2020-2021). Interest payments are expected to overtake total government spending on health and education combined in the very near term. Reserves to external debt stocks ratios have constantly declined since the early 2010s and are widely considered to be insufficient to meet the required annual repayments of $1.2-1.4 billion to 2026. In August 2022, Fitch downgraded Laos’ Long-Term Foreign-Currency Issuer Default Rating (IDR) to “CCC-” – the lowest sovereign rating in Asia without a default.

Expectedly, the current crisis has led to much speculation about what the near-term future will bring, as well as extensive commentary on possible causes, culprits, and consequences. Although the recent shocks have been pivotal in pushing Laos toward the edge of a debt crisis and possible default, the country’s current predicament seems more deeply entrenched in economic vulnerabilities that are inherent to the growth-centric agendas that have guided much international development efforts from the mid-1980s onward.

Causes and Culprits: Sowing the Seeds of Crisis

Debt-financed foreign investment has long been the bedrock of growth-centric development in Laos. With the exception of 2002-2003, Laos’s total external debt has grown year-on-year since 1970, accelerating significantly from 2005 onward.

In particular, foreign investment has been critical to the government’s two leading national development ambitions of becoming both the “battery of Southeast Asia” (via hydropower electricity exports) and the “land-linked” center of intraregional trade across mainland Southeast Asia and southern China (via transport infrastructure/corridors). These ambitions led, among other things, to the construction of the China-Laos high-speed railway project at a cost equating to around one-third of Laos’ total GDP in 2021, and more than 60 dams built over the past 15 years – with more than 200 additional dams planned or under construction.

Laos’ “land-linked” and “battery of Southeast Asia” ambitions are well supported by many of its major development partners, including via not fully responsible lending practices. Thailand’s 2012 halting of the requirement that foreign issuers have an investment-grade sovereign credit rating to issue bonds on the Thai market, for example, has allowed Laos access to bonds when it had no international credit rating at all. Regional transport and electricity connectivity are priorities of the Asian Development Bank’s Greater Mekong Subregion Initiative, and also advance ASEAN’s connectivity agendas. Nam Theun 2, the largest hydropower dam in Laos, received funding and technical support from the World Bank, while other hydropower projects across the country have primarily been funded by foreign investment from key regional partners, particularly Thailand and China.

Regarding the latter, hydropower investment in Laos provides lots of investment opportunities for Chinese construction companies and state-owned enterprises, notably Sinohydro, which became major builders of dams across Laos, while transport infrastructure such as the China-Laos railway advances Beijing’s Belt and Road Initiative via the China-Indochina Peninsula Economic Corridor. Around half of Laos’ planned and existing dams will be built by Chinese companies, with China’s growing investment coming at a time when many traditional donors have shied away from the sector due to mounting criticism.

It is important to emphasize, however, that China is one of myriad actors that have encouraged foreign-debt financed investment in Laos. Not only China, but also the government of Laos and many other key development partners have been betting on hydropower energy projects to “generate high and stable economic returns” upon completion, and in turn to “supply enough foreign exchange to service debt.”

Despite years of categorizing Laos as at high risk of debt distress, in 2019 the IMF and World Bank deemed Laos’ debt profile as sustainable on the basis that “factors, such as the large share of electricity export earnings under long-term intergovernmental power purchase agreements, and a strong and growing electricity exports market help mitigate risks, keeping the debt outlook sustainable.” As Laos now seeks to undergo post-pandemic economic recovery, Fitch has also stated that a return to stronger growth from 2024 onward is dependent on hydropower exports and cross-border flows.

For the 15-year period from 2003 to 2018, such an infrastructure (and resource extractive) led approach to growth appeared to be working: Laos’ economic growth remained above 6 percent, peaking in 2006 at 8.6 percent. This growth gave the government and its borrowers confidence, leading it to expand external borrowing, particularly from Thailand and China.

Yet caution is needed when celebrating Laos’ long growth trajectory, which has declined from 2010 onward (a full decade before the pandemic) and fallen rapidly from 2017 onward – dropping from 6.9 percent in 2017 to 5.5 percent by 2019. This decline in growth has been accompanied by a progressive deterioration in public finance sustainability, which was dramatically aggravated by the pandemic (countries with high levels of predominantly market-based and foreign currency-denominated debt are intrinsically more vulnerable to external shocks such as a pandemic), and more recently by inflation that has increased the level and cost of debt.

Despite the debt risks, and despite widespread criticisms from civil society organizations regarding the harmful social and environmental effects of many of the country’s megaprojects, the Lao party-state and many of its partners have continued to bet on hydropower, mineral exports, and transnational connectivity as the pathway to development success. Debt management is a priority of the government’s 9th Five-Year National Socio-Economic Development Plan (2021-2025), but the government has been unflinching about its development priorities, and seemingly unperturbed about its debt burden. In response to the World Bank and IMF’s 2019 Debt Sustainability Analysis (DSA), for example, the government stated that “debt is on a sustainable path and will be manageable.”

One result of this debt-fuelled development model is that the government now has a very reduced fiscal space, both in terms of strategies to consolidate its finances and in terms of its ability to progress on poverty alleviation objectives and human rights standards.

Consequences: Where to From Here?

The debt crisis has brought Laos into the international spotlight, and there are increasing attempts at predicting whether the country will soon default or not. This ultimately depends on the willingness of Laos’ creditors – first and foremost China – to find a viable solution.

Holding almost half of Laos’ debt, China will be critical to what happens next. It has offered debt relief to other countries, suspending interest payments and restructuring loans for some of its debtors, though it has been slow to join other nations in collaborative efforts toward debt relief. Laos is now being viewed as a test case for debates concerning China’s so-called debt-trap diplomacy, accusations that Beijing firmly rejects.

Some argue that China has good reasons to avoid a default – among other things because it would impact Chinese interests as well. It is difficult at this stage to predict exactly what may happen, in part because of the Chinese tendency, relevant in this case, to favor bilateral, case-by-case responses rather than more formal and predictable debt renegotiations/solutions.

Others have emphasized, however, that the current situation puts Laos at risk of increased (economic and political) “influence” from China. Such influence seems to have already manifested in a few recent developments that suggest a tendency by Laos to align to its main creditor’s preferences, including a partial “withdrawal” from other sites of international financial cooperation. Laos did not participate in the G-20’s DSSI, which may be linked to contractual terms of Chinese loans, and has demonstrated increased opacity with regard to debt accountability – for example by preventing the IMF from publishing its most recent findings conducted under Article IV consultations to exercise surveillance over the economic, financial, and exchange rate policies of its members.

Geopolitically, Laos has let itself be drawn more closely into China’s orbit for many years, but it has always sought to balance Chinese influence with that of its other major diplomatic partners, and particularly Vietnam. The pandemic may result in Laos losing control of this balancing act. Yet while China is critically important, the current debt crisis in Laos – and in Lebanon, Egypt, Suriname, Greece, Tunisia, Sri Lanka, Zambia, and elsewhere – is about much more than China.

To fully understand the deeper root causes of unsustainable debt in Laos, bigger questions must be asked about the exploitative nature of the global political-economic system, in which debt has long served as a tool of creditor domination over borrowers. At play here is what Éric Toussaint, a leading figure of the Committee for the Abolition of Illegitimate Debt (CADTM), describes as a system whereby “local elites ally themselves with big financial powers in order to subject their own countries and peoples to methods of power that transfer wealth towards local and foreign creditors.” While COVID-19 has seen a major increase in foreign debt, it bears noting that half of low-income countries were at high risk of debt distress prior to the pandemic, and that 147 governments have defaulted on debts since 1960.

Unless there is a dramatic change to Laos’ foreign-debt financed growth-centric development agenda – and this is unlikely – the “where to from here” will be further borrowing and a return to unsustainable and high-risk levels of debt that will likely bring further crisis during the next major shock to the global economy. While hydropower investment and resource extraction have driven strong economic growth in Laos in the past, it cannot be ignored that growth had been slowing year-on-year for a decade prior to the pandemic. Recovery through business as usual will further reinforce longstanding vulnerabilities in the economy that will make Laos vulnerable to future defaults. And they will continue to bring significant social and economic costs.

Laos does need to shift its environmentally and economically unsustainable development model, but so does much of the rest of the world.