Can Laos manage its debt to China?

Photo:Kremlin

Laos borrowed heavily from China to finance key infrastructure and development projects. Prime Minister Thongloun Sisoulith claims the debts are manageable. Is he right?

By John Pennington

Laos’ economy is growing, but without outside assistance, the country cannot compete with its ASEAN neighbours. It turned to China for help. Its participation in the Belt & Road initiative (BRI) will bring a new railway connecting Yunnan province in China with the Laotian capital, Vientiane, as well as Malaysia and Singapore.

The 250-mile railway is scheduled to open in 2021. China claims it will turn landlocked Laos into a “landlinked” country.

The whole project will cost US$5.8 billion. Laos will only foot the bill for 30% of the project’s funding, with China covering the rest. However, Laos has to put up US$720 million immediately, US$250 million of which will come from the next five years’ budgets.

Chinese loans at low interest rates will fund the remainder of Laos’s share of the costs. According to the Center for Global Development (CGD), Laos will pay back the US$465 million borrowed from China’s Exim bank at an interest rate of 2.3%, with a five-year grace period and a 25-year maturity. This is in the lower range of what China charges. Pakistan, for example, pays up to 5% interest on its loans.

Debt levels are reaching alarming levels

Prime Minister Thongloun Sisoulith is adamant that borrowing money from China to finance projects is not putting the country at risk. “If we don’t borrow, Laos, as a least-developed country, won’t develop further,” he said.

He may be right, but the level of borrowing is alarming. The country’s gross debt is forecast to rise to more than 70% of Laos’ gross domestic product (GDP). The World Bank recommends that governments should aim for less than 40%; the International Monetary Fund (IMF) suggests 50%.

Furthermore, in 2017, the IMF raised its perception of Laos’ debt distress from medium to high as a result of its borrowing from China. The CGD in 2018 ranked Laos as one of the eight most vulnerable countries participating in the BRI.

Sources: CEIC, Trading Economics

What happens if Laos can’t pay?

There are other projects too. Laos has reportedly borrowed US$600 million for a hydropower project. There are concerns about how much money is flowing out of the country to Beijing.

“It’s not just the railway’s debt that’s of concern, but it’s the accumulating mass of debt related to Chinese projects in Laos that have put the country very much on alert for…overleveraged debt,” assessed Brian Eyler, Washington’s Stimson Centre’s Southeast Asia programme director.

The mounting debt to China – Laos’ leading investor and provider of significant aid assistance – leaves Vientiane heavily reliant on Beijing. What, therefore, happens if Laos falls short on its payments?

Laos might have to borrow even more to make up a shortfall. If Beijing exerts financial penalties for missed payments, Laos could end up inundated with more debt. It is hard to know exactly how China would react. Beijing takes an individual approach when dealing with countries that run into difficulty.

One extreme case is Sri Lanka, where Beijing now controls Hambantota port after the island nation could not service its debts. However other countries, like Mongolia, have been given additional credit after running into difficulties. Some have seen debts written off entirely.

Laos will hope its good relations with China will stand the country in good stead if it finds itself in a similar position. However, given the region’s history and political outlook, it is likely that Beijing would expect diplomatic concessions if Laos fell behind on loan repayments.

Concerns over Chinese influence are growing

While Sisoulith holds maintains the BRI will boost cooperation between the two countries and bring an abundance of work for Laotians, critics and residents argue that China benefits far more than Laos.

Laos-China railway bridge.
Photo:Mekong Luxury

Philip Alston, a UN special envoy for poverty and human rights, argues that the project will not generate jobs for Laotians. As he puts it, the government is “ticking boxes and boosting numbers, not the lives of Laotians.” Many of them are already worse off as the government ceded tracts of lands and displaced people to make way for development projects.

The BRI will improve connectivity, which will likely bring more Chinese tourists to the country.  However, this may not bring the revenue boost Laotians are hoping for. The majority of Chinese tourists stick to Chinese-owned businesses in the country.

Laos’ debt might be manageable for now, while the economy is growing, but there is a potential human cost that does not show up on any budget projection or balance sheet.

Expensive projects favour the rich elite, leaving the majority behind. Money set aside for repaying loans cannot be put into, for example, vaccination programmes or schemes to reduce child poverty.

Referring to statistics reporting that 20% of the countries’ children are underweight, 9% are severely malnourished and 33% have stunted growth, Alston warned: “You might have no interest in children, but all you have to know is they are the economic future.”

Laos is playing a dangerous game

Laos’ debt to China is manageable, but the government has adopted a very high-risk policy. It is gambling on BRI and other projects generating enough revenue to repay the loans. That relies on the touted financial benefits materialising and no budget-sapping crises occurring in the meantime. Both seem unlikely.

The reality is that such financial reliance on China means Laos is forced to cede political influence. There is evidence of this already as Laos – along with Cambodia – sides with China against their ASEAN neighbours in the South China Sea dispute.

Events elsewhere, such as Sri Lanka’s experience must serve as a warning for other BRI participants. Laos’ debt comes at a heavy diplomatic and human cost.

China’s relationship with Laos is a textbook example of Beijing’s chequebook diplomacy in action. Side with China and the debt will remain manageable. Stand up to Beijing, and the country’s economy could suffer further.