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

Mieno and Demachi (2024) investigate the mid-term growth challenges in post-COVID-19 Laos by examining real sector growth, external fundraising, and the domestic financial system. They conclude that foreign direct investment (FDI)-driven export-led growth in mining, power, infrastructure, and some other areas may continue, although the sustained public debt from excessive investments to propel such growth carries remarkable risks. The external debt situation remains severe but may be manageable if the recent recovery trend of the real sectors persists. Mieno and Demachi claim that the underdeveloped domestic financial system is the major cause of the external debt problems and macroeconomic destabilization. These conclusions align with general local perceptions including my observations through regular field visits to Laos since the early 2000s. The following are summary and my comments on some of the shortcomings of Mieno and Demachi (2024).

In their Introduction, Mieno and Demachi start by pointing out that the recent macroeconomic destabilization, expressed in terms of the sharp depreciation of the Lao kip against the US dollar since 2021, but the role of the Thai baht in the Lao economy can hardly be overestimated. Thailand had been the only viable trade route for Laos' major cities before the completion of the Lao-Chinese railway in 2021. The exchange rate against the Thai baht often had a significant positive and negative impact on the Lao economy (Kyophilavong et al., 2018). The depreciation of the Lao Kip against the Thai Baht in the latter half of 2010s was more drastic (Ministry of Planning and Investment, 2021), therefore, explicitly discussing it might improve our understanding of the recent macroeconomic destabilization.

In their section 2, Mieno and Demachi illustrate how growth in Laos since the mid-2010 was propelled by investments financed mainly by foreign investors and government borrowing, and convincingly argued why a healthy fiscal condition is essential to such a growth model. Their section 3 provides an in-depth discussion of Laos' external debt, most of which was raised to finance economic growth described their section 2. They reveal, as expected, that Laos' external debt is concentrated in the neighboring countries such as China and Thailand. Mieno and Demachi rightly point out that China's financing of large infrastructure projects in Laos results from the alignment of interests of the parties involved. However, Mieno and Demachi stop short of generalizing this to the case with Thailand, which had a more extended history or similar development with the recently rising Vietnam. The presence of economically expanding neighboring countries has a significant implication for the viability and sustainability of the growth model based on foreign-funded infrastructure development.

Given the very limited data, Mieno and Demachi's section 4 is an outstanding analysis of the financial system in Laos. Here they conclude that the underdeveloped domestic financial system was a root cause of the worsening external debt and currency devaluation. The financial system in Laos was described as repressive, with low-interest policy and government bond allocation. Mieno and Demachi describe the triangle bonds in which the central and local governments' delinquent payments to the construction companies are transferred to the banks as policy measures impeding the sustainability of the banking business. Their detailed description of the operation of banks in Laos is remarkable and will remain a valuable resource for future research on the Lao financial sector.

However, at least three unanswered questions remain. First, why have foreign or foreign-operated banks done much better? Banks with higher degrees of state control indeed face more severe challenges under a repressive financial system. Still, the information about the inability of state commercial banks to generate profits, for example, sloppy loan administration, is overwhelming. Second, what are the impacts of the long-standing de facto dollarization, which is further expanding beyond the US dollar and Thai Baht to the Chinese Yuan, on the weak domestic financial system? Dollarization in Laos is complicated and extensive and remains a major unsolved problem since the establishment of Lao PDR (Kyophilavong, 2010). Lastly, what are the impacts of the “virtual” export earnings? About 70% of the USD 8.2 billion of exports in 2022 never arrived (Pongkhao, 2023). It is not clear if this was a result of escrow practices or other unclassified arrangements, but the arrival of such an amount of money, even just to be repatriated back by foreign investors, would have a great impact on the financial system in Laos.