Laos and the Reality of Chinese Debt

In January 2017, the Indian strategist Brahma Chellaney wrote an article for Project Syndicate that would do more than perhaps any other to shape Western perceptions of China’s burgeoning global economic influence. The article argued that through its Belt and Road Initiative (BRI), announced by President Xi Jinping four years earlier, China was “supporting infrastructure projects in strategically located developing countries, often by extending huge loans to their governments. As a result, countries are becoming ensnared in a debt trap that leaves them vulnerable to China’s influence.”

The article was titled, “China’s Debt Trap Diplomacy.”

Chellaney’s coinage was almost perfectly tuned to the shift of opinion then underway in Washington, where the first Trump administration had taken office just three days before the article’s publication. As U.S. attitudes toward China soured, the idea that Beijing was practicing “debt-trap diplomacy” across the globe soon became more or less the conventional wisdom among U.S. China hawks. The phrase would be employed in official communications by both the Trump and Biden administrations, and was used liberally – and mostly uncritically – in American media reports about China’s growing economic presence abroad.

In recent years, numerous scholars have challenged the “debt-trap diplomacy” meme, arguing that it presents a caricature of China’s engagement with the Global South. Many have concluded that the debt troubles of developing nations have less to do with China’s lending practices and more to do with the poor decision-making of recipient governments – a fact only underscored by the cases in which recipient governments have taken the initiative and shaped Chinese projects in order to serve their own interests. They have also pointed out that there are few, if any, cases of Chinese banks seizing foreign assets, and that many case studies, such as Sri Lanka’s Hambantota Port, have been grossly misinterpreted. In many ways, these critics argue, China’s economic diplomacy bears an uncomfortable similarity to the approach taken by international financial institutions like the World Bank and International Monetary Fund.

However, this is not to say that Chinese debt has not had deleterious effects. Take the case of Laos. According to a report published last month by Sydney’s Lowy Institute, the Southeast Asian nation remains trapped in a “suffering an acute debt crisis with no apparent way out,” in which China has played a prominent role.

The scale of Laos’s crisis is considerable. The country’s public and publicly guaranteed debt now likely stands at more than 100 percent of GDP, around half of which is owned to Chinese policy banks. The cost of servicing this debt now eats up more than half of domestic government revenues, even taking into account large Chinese repayment deferrals. This has left little fiscal space for vital education and health spending, threatening “a lost decade of sub-par growth and stalled poverty reduction – a dramatic reversal of the economic optimism of previous decades.”

China’s role in this crisis is clear. The Lowy report stated that in the mid-2010s, a decade after emerging from the doldrums of the Asian financial crisis, Laos turned to China to fund extravagant infrastructure projects, such as the $6 billion Laos-China Railway, and to realize its ambition of becoming “the battery of Southeast Asia” by building cascades of hydropower dams. The result was a “stunning re-expansion” of the country’s sovereign debt, from less than $4 billion in 2010 to more than $10.5 billion in 2023. The energy sector accounts for the majority – around $6 billion – of this total.

At the same time, the situation was worsened further by the Lao government’s fiscal profligacy and rampant corruption and tax evasion, which by the government’s own admission were starving the state of revenue. This pushed the authorities to take on additional short-term debt in order to keep basic services functioning.

The problem is that the government’s massive infrastructure projects have never yielded the gains that might have justified taking on such large amounts of debt. Between 2009 and 2023, Laos oversaw an extraordinary increase in hydropower development, ramping up installed capacity by 14 times and borrowing billions of dollars to do so. But instead of being exported, as the government planned, most of this new power generation capacity went to serve the domestic energy market, which was quickly glutted with power. Under domestic power purchasing agreements, which required the state power utility EDL to guarantee that it would purchase the generated power at a set price, whether or not there was any demand for it, the state was forced to eat massive losses, on top of the original loans.

Laos’s debt burden left the country poorly equipped to handle the economic downturn that accompanied the COVID-19 pandemic in early 2020, and the global oil shock that followed the Russian invasion of Ukraine in early 2022. These external shocks prompted large financial outflows, sharp increases in U.S. interest rates, and an appreciating U.S. dollar, all of which sent the kip into a tailspin – and Laos into an official state of crisis. The Lao currency has since shed more than half its value, dropping from around 9,000 kip to the U.S. dollar at the start of the pandemic in 2020 to more than 21,000 today.

Given that most of Laos’s external debt is denominated in U.S. dollars, this has sharply increased the debt servicing costs right at the moment that the country was experiencing an economic downturn, creating a vicious downward spiral. Accordingly, annual debt servicing costs rose from $375 million in 2016 to $1.2 billion in 2020 and $1.7 billion in 2023. As things stand, the Lao economy “is now almost entirely dependent on annual debt deferrals by China,” the Lowy report concluded.

Given the scale of Laos’ crisis, and China’s prominent role within it, the Lowy Institute report argued that Laos comes as close as any nation does to realizing the dark premonitions of Chinese “debt-trap diplomacy.”

“The pattern of heavy Chinese policy bank lending into the Lao energy sector, resulting in massive overcapacity, financial losses, and finally the takeover of its energy grid by a Chinese state firm, may be the closest evidence to date of such a strategy,” it stated. Indeed, the report argued that the case of Laos offers a more convincing example of a “debt trap” than Sri Lanka, the nation most often cited in this respect. Chinese debt makes up just 9 percent of total Sri Lankan sovereign debt, compared to around half in the case of Laos.

Even then, the Lowy Institute report concluded that there is limited evidence of a purposeful Chinese plot to ensnare Laos in a debt trap. Instead, it argued that Lao elites are “equally to blame for the poor decisions that ultimately led to crisis” and that the risks of Laos’s current economy trajectory should have been clear to policymakers long before the onset of COVID-19.

To be sure, China bears a considerable share of the responsibility for the situation – and for helping Laos extract itself from its current predicament. While the Chinese government was not the only investor in Laos’ bloated hydropower sector, it was nonetheless “the primary financier of domestic transmission infrastructure and dams contributing to overcapacity in the domestic energy market.” Chinese policy banks also failed to conduct due diligence on projects, and may even have had an incentive to approve projects given that much Chinese funding was “recycled” back to Chinese construction companies. In sum, China “lent on a huge scale to a country with weak institutions and limited ability to productively absorb the investment.”

Where does Laos go from here? The report concluded by stating that the Lao government’s chosen course of action – rely on Chinese debt deferrals until the country is able to “grow its way” out of the crisis, while imposing fiscal austerity on the Lao public – is unlikely to succeed, given the country’s poor growth prospects. It argued that Laos “cannot escape crisis in the absence of substantial debt relief, even under the most optimistic scenarios.”

Any solution needs to involve China, although Beijing has so far responded to the debt problem by kicking the can down the road. The problem, the report argues, is that the governments of both nations have a strong incentive to avoid admitting failure and bearing the political costs that stem from that.

Whatever happens to Laos, the country’s current plight offers timely reminder that nations have the responsibility to conduct due diligence when they take on large foreign debt – whether from China or from anywhere else.