Laos risks lost decade unless China provides debt relief

Laos is suffering an acute debt crisis with no apparent way out. This is a shocking reversal of the optimism of the pre-COVID-19 era, when economic growth averaged over 7% annually. While the benefits excluded much of the rural poor, this was still among the best growth records in the developing world. What went so wrong, so quickly?

Laos' development trajectory has been derailed since the 2020 pandemic began. The country's currency has lost half its value against the U.S. dollar. Public and publicly guaranteed debt now exceeds 100% of gross domestic product. Over half of government revenues go to debt repayments. Public spending on health has halved, with knock-on effects for child malnutrition. School enrolments have dropped sharply, while thousands of working age youth have left the country in search of higher wages elsewhere. Household savings for many are depleted, with years of inflation undermining purchasing power.

Our new Lowy Institute study tracks the drivers of Laos' debt crisis, from murky infrastructure deals to ad hoc debt negotiations with China.

While coinciding with a series of overlapping global economic shocks, including the pandemic and Russia's invasion of Ukraine, these events were only triggers for a crisis years in the making due to unsustainable borrowing and poorly planned investments associated with China's Belt and Road Initiative.

Costly flagship projects like the $6 billion Laos-China Railway have drawn attention. However, the government's minority stake in the project has contained its role in Laos' debt crisis. The far larger debt burden stems from unplanned hydropower and energy transmission projects.

Despite the government's "Battery of Southeast Asia" initiative aimed at exporting electricity to the region, we catalogue massive overinvestment aimed at Laos' small domestic energy market. This has resulted in an estimated $3.9 billion in idled power capacity, roughly a quarter of Laos' entire GDP. Most of the dams and domestic transmission projects were financed by the Export-Import Bank of China and China Development Bank.

Although Laos' many export-based hydropower plants should be profitable, full state revenues are delayed for 25 to 30 years under build-operate-transfer concession contracts with foreign investors.

In parallel, the government also let state revenues decline during the boom years. To plug the gap, Laos increasingly borrowed from international capital markets at high interest rates.

Five years after COVID, Laos remains shut out from international bond markets and is fully dependent on annual ad hoc repayment extensions from China, its largest creditor.

Unlike Zambia or Sri Lanka, Laos has not turned to the International Monetary Fund for structured debt relief. Instead, Laos and China appear to be pursuing an "extend and pretend" strategy, avoiding public acknowledgement of the failure of the "China model" in Laos. This not only leaves Laos highly vulnerable to any further economic shocks but could generate a lost decade or worse for the people of Laos.

Economic stress is surfacing elsewhere. Road infrastructure has been heavily degraded by mineral transport trucks heading to China. Laos was recently added to the Financial Action Task Force's gray list for poor enforcement of financial crime regulations -- a move linked to its lawless casino sector and scam economy. Piling on the pressure, in March, Power Construction Corp. of China took Laos' state energy company to a Singapore arbitration court over $555 million in unpaid debt and interest.

The government has responded with tax hikes and state asset liquidations, including selling a 90% stake in the domestic electricity grid company to a Chinese company. An additional proposal to privatize and rebundle the majority of state hydropower assets suggests Laos may need to sell off the family silver to keep up debt repayments.

Since 2023, the government has managed budget surpluses, but at steep costs to social spending on health, education and poverty reduction. Without substantial debt relief, these budget cuts would need to be maintained indefinitely. Laos aims to move forward with its plan to graduate from U.N. least developed country status by 2026, yet large segments of the population remain deeply economically vulnerable. Absent this relief, the country will be left with little capacity to respond to the mounting impacts of climate change.

It doesn't need to be this way.

Our research shows that Laos' need for debt relief is clear. Whether via a China-led bilateral deal or a multilateral IMF-coordinated restructuring, action is needed. As Laos' major creditor, China must play the leading role.

By resetting Laos' debt to sustainable levels, the country can regain its footing and prioritize development strategies that combine poverty reduction, enhanced environmental governance and more effective infrastructure oversight, helping secure the future that its people deserve.