How Much Should We Worry About Laos’ Debt?

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How Much Should We Worry About Laos’ Debt?

Laos has several options for dealing with its debt crisis, and none of them are palatable.

How Much Should We Worry About Laos’ Debt?
Credit: Flickr/Prince Roy

The way Vientiane sees it, the risks of investing in public works and infrastructure development, even if funded by increasingly problematic debt from China, are greater than the risks of not investing at all. If Laos was to prioritize fiscal sustainability, the thinking runs, it would be left even further behind than it already is by its neighbors, which either have geographic advantages (ports and large populations for Thailand and Vietnam) or head-starts in low-cost manufacturing (for Cambodia and Myanmar).

Vientiane’s insistence on hydropower, funded by Chinese loans, is also partly justifiable. It lacks the geography for a large export sector, with no sea links to the West and an import-adverse China to the north. Domestic consumption is low. It’s also something of a sustainable export, given its neighbors will need to import energy for decades to come. The rare contempt with which Bangkok and Hanoi are now treating Vientiane for its refusal to back down over future dam-building is somewhat hypocritical; in a similar position, neither of those countries’ leaders would put regional interests above their own, and neither Vietnam or Thailand are world beaters in environmental protection, anyway. (One might inquire about the regional impact of Vietnam’s new coal-fired power stations, for instance).

The consequence of all this is mounting debt, expected to top off at 68 percent of GDP in 2020, from 59 percent last year, according to the World Bank.

Last month, Finance Minister Somdy Duangdy tried to explain the five reasons why Laos has gone from a debt problem to a debt panic. The first reason was the cost of building the country’s hydropower dams. (Fair enough, they might yield a future pay-off.) His second and fourth reasons basically referred to the decision to invest in unproductive enterprises that haven’t yielded enough revenue to repay their costs. His third reason was that the government has had to issue more bonds and take on more debt to fund its budget deficits over the years. The fifth was the lack of state revenue.

If he wanted to put it more simply, Somdy could have said that the communist government is good at spending money but not raising it. That’s been clear for years, and is in many ways a problem of the system as much as personnel who run the Lao People’s Revolutionary Party (LPRP): there is almost no oversight; the bureaucracy is run on loyalty not competency. There are no independent bodies to question government decisions, and almost no punishment for retiring officials. Most importantly, the entire political system dependent upon short-term gains since there’s no guaranteeing the Leninist edifice will be standing twenty years down the line.

The reasons are relatively straightforward, but what about the solutions? Vientiane has four main options. The first is to continue as it is doing and hope that real economic growth recovers to a faster rate than the debt servicing rate. Clearly, the pandemic-induced economic crisis is the reason why Laos’s national debt has been so problematic this year, by considerably driving down state revenue and increasing demand for expenditure . The Economist Intelligence Unit (EIU) reckons real GDP growth will be 0.8 percent this year before rising to 4.2 percent in 2021. (Remember that the country’s GDP was $18.8 billion in 2019.) Laos’s debt servicing obligations are estimated to reach $1.8 billion in 2020 and $1.9 billion in 2021, according to the EIU. Others say $1.2 billion this year. The Fitch Ratings agency reckons at least $1.1 billion in external debt servicing will be added annually between 2021-2024. The debt is far from certain to keep growing at that rate, but it is worrying considering that real GDP growth rates might not return to above 5 percent until at least 2022 or later. The World Bank reckons that the country’s economy will grow by just 4.4 percent in 2022. At the same time, its foreign-exchange reserves currently stand at just $1.3 billion, which Fitch reckons will fall to below $1 billion next year.

Moreover, for Laos’s economy to grow in the same way as it has in previous years (at 6.3 percent in 2018, for instance), the government will require additional credit. This appears the direction Vientiane is heading. One slight sensible change might be to tap international groups rather than China for the credit to finance the debt repayments, but the EIU notes that Laos prefers to take on additional loans from China as, unlike the International Monetary Fund (IMF), it doesn’t require Vientiane to disclose its finances. Moreover, in return for these loans its Chinese creditors are less likely to demand the types of conditions – like state-asset sales, strict austerity, and governance reforms – that would imperil the LPRP’s rule.

Nonetheless, it is worth considering these alternatives. So, secondly, the communist government could decide to slash state expenditure without raising state revenue in order to free up funds for debt repayment. This would mean cutbacks on capital investment and staffing in the monumental state sector, still one of the largest employers of the formal workforce, yet without making additional financial demands on the private-sector through taxation. The third option is to considerably increase revenue collection without cutting spending. Tax collection in 2019 was just 11.1 percent of GDP, actually down from 2018, and the World Bank expects it to drop to 8.2 percent this year and only rise to 9.5 percent by 2022 (and this is its optimistic outlook). The EIU expects overall government revenue to fall to 12.3 percent of GDP in 2020, compared with 19.1 percent last year. Nonetheless, neighboring Cambodia shows how with the political will, state revenue can be turned around: tax collection in Cambodia rose by more than 30 percent alone between 2018 and 2019.

The corollary to raising state revenue through taxation is the sale of state assets, but many have already been privatized and the only ones left are in strategic industries. Here we come to a problem. In September, Vientiane decided to essentially sell off most of its ownership of the country’s electricity grid (run by the state-owned Electricite du Laos) to a Chinese-majority joint entity, most probably in lieu of some debt repayment. But this sparked calls of a Chinese “debt trap.”

One ought to maintain skepticism of these claims: a “debt trap” suggests far more cunning than China typically shows in foreign policy and is more easily explained by foreign governments making poor financial choices and a vulture-like China then picking at the remains. But whichever way one looks at it, if Vientiane starts to divest its state assets, American or German companies are not going to be snapping them up; it will be Chinese firms. For one thing, Western governments have almost no footprint in Laos. For another, Beijing won’t mind buying up its SOEs (even the unprofitable ones) if it reckons on gaining more political leverage in Laos. The question for observers is whether they regard Laos’ public debt as more of a problem than foreign firms taking over more of the country’s formerly state-run assets. (After all, this was the way Brussels dealt with the Eurozone debt crisis in the early 2010s, which also saw Chinese firms buy up bottom-dollar state assets.)

Lastly, Vientiane could embark on an actual austerity drive, not just the one pledged since 2016, and significantly chop back on expenditure, both in terms of state sector wages and capital investment, as well as increasing state revenue collection. This wouldn’t dislodge China’s central role in the country. In fact, its private capital investment will become all the more necessary. But politics is the main impediment. Laos’s hermetic communist party doesn’t know how things will work out if it squeezes ordinary people for more money, whilst effectively promising them slower-paced improvements in living standards for the coming years and no greater political rights in return. The traditional social contract, after all, has been that the people stay away from politics and politics stays away from their pockets.

Also, a competent tax system requires a functioning bureaucracy, not an easy transition for a political system built around ties of patronage and loyalty. Significantly reducing the state-sector workforce will mean losing the support of those who put up with the communist system because it pays their wages. Not just that, but cutting back on the public sector will naturally inflate and embolden the private sector, which will become more demanding of the communist government for pro-market reforms.

After a change of leadership at the communist party’s quinquennial National Congress early next year, we may see a slight shift in direction. But all indicators point to business as usual. Laos has backed itself into a corner and its political system limits the possible routes of escape.