Comment on “Macroeconomic Imbalance, External Debt, and the Financial System in Laos”

Abstract

The Lao economy has gradually recovered since mid-2022, helped by a crawl toward prepandemic normalcy with eased mobility restrictions and cross-border economic activity promoted via the Laos–China railway. The economy avoided collapse amid pandemic adversities due to people's reactionary self-protection, such as a temporal shift to a self-sufficient lifestyle. Nevertheless, the currency depreciation and higher fuel prices raised price levels by 73% in 2022–2023. Households with foreign-currency-denominated assets have hedged against inflation, as foreign currency deposits grew 2.3 times in kip terms in the same period, creating distributional impacts for the haves and have-nots. Overall, the surviving Lao economy faces macroeconomic imbalances, overshadowed by a public and publicly guaranteed debt of 112% of gross domestic product (GDP) at the end of 2022.

The Lao economy grew by 7–8% annually over a decade before slowing down to 3–6% in 2018 onward as the government recognized the urgent need for fiscal consolidation. The higher growth until 2017 was driven by ambitious infrastructure investment, synchronized with widening external current account deficits financed by massive foreign direct investment and parallel public sector borrowing. Heightened fiscal and external sector vulnerabilities accompanied this accelerated growth.

Despite the government's efforts to promote the manufacturing sector, the economy's reliance on the resources-based sector persists. According to the Lao Statistics Bureau, between 2015 and 2022 the agricultural share of GDP gradually declined from 18% to 15%, and the mining and quarrying share from 12% to 7%, but the electricity share increased from 8% to 14%. In the same period, the nontradable sector remains dominant, with services remaining above 40% and construction increasing from 7% to 12%. In contrast, the manufacturing sector remained around 9–10%.

Manufacturing faces such structural constraints as labor shortages and competitive imports from Thailand and China. One to three minimum wage differentials between Laos and Thailand encourage Lao workers to pursue jobs in Thailand, the largest cross-border destination for Lao workers with 226,000 documented Lao migrant workers as of mid-2023, according to the International Labour Organization. Industrial diversification is a challenge, except for tourism potential for now.

Considering the resources-based sector's dominance in the Lao economy, Mieno and Demachi (2024) should re-examine their claim that the fear of the resource curse is not imminent.

Chronic current account deficits due to large debt servicing and unbanked foreign exchange earnings kept foreign exchange reserves around US$0.6–1.0 billion in the 2010s. However, the Export–Import Bank of China's debt service deferrals since 2020 and the swap arrangement with the People's Bank of China helped increase the reserves to US$1.8 billion as of September 2023.

Recent research shows that a debt trap narrative vis-à-vis China's Belt and Road Initiative (BRI) is an unfounded myth (Nishizawa, 2023). A debtor trapped with unsustainable debt gets its creditor trapped with unpaid debt.

China has reduced its overall BRI lending since 2017 to address its borrowers' debt overhang. However, some countries' outstanding BRI debts are already high enough to require China's debt relief action. With 49% of its external public debt owed to China, Laos can only restore debt sustainability with upfront debt treatment, such as a significant debt reduction in net present value terms (Nishizawa, 2023).

The government policy to address debt distress has distorted the domestic financial system. Domestic payment arrears as a means of government finance eventually turned into “triangle bonds” with negative spreads for the banks holding these bonds. Domestic bonds show another salient distortion. Ten-year government bonds offered an 8.15%-kip coupon rate in December 2023, even under the double-digit inflation since mid-2022.

The concern about government intervention in the domestic financial system makes Lao nationals prefer holding their wealth in foreign currencies and keeping foreign exchange earnings unbanked. Mieno and Demachi (2024) are silent on the implications of this persistent dollarization for the domestic financial system.

Structural savings-investment gaps, observed as current account deficits, explain Laos' continued reliance on foreign capital. If such deficits continue, domestic bonds can only partially substitute for foreign capital. Even worse, government bonds may crowd out local private investment. The government's goal should be to take steady steps over the long term toward creating a well-functioning financial system to mobilize domestic savings sufficient to finance productive investment.