The queues of cars from Laos waiting to fill their tanks at petrol stations across the border in Thailand have sparked fears the landlocked Asian country’s debt is spiralling out of control and could go the way of Sri Lanka.
Laos has been struggling with heavy debt mainly due to mega infrastructure projects, such as the Laos-China railway. Around half of the country’s projected debt stock of over 100 percent of GDP is owed to China, but despite claims to the contrary, Laos is not debt-trapped by Beijing. The answer to why lies in the mutual dilemma both countries face.
Indebted infrastructure projects can affect both the debtor and the creditor — a ‘debt trap’ for a debtor often suggests a ‘debt trap’ for a creditor with non-performing assets.
It is therefore within both nations’ interest to contribute to Laos’ economic growth and generate sustainable economic and social returns from projects.
As the world’s public and private debt reached 247 percent of global GDP in 2021 (almost 20 percent above pre-pandemic levels), according to the latest available figures, knowing which countries might default and risk plunging into economic turmoil can make a difference to future outcomes.
Along with Laos, Sri Lanka and Japan also have a growing mountain of public debts. The origins of their debt may vary but are connected by a common thread — it will fall on the next generation if left unchecked.
How the debt story plays out depends on the actions of both the debtor and the creditor.
Sri Lanka defaulted on its debt in May last year and its sovereign debt reached 103 percent of GDP in 2021. Two-fifths are owed to diverse external creditors, exposing Sri Lanka to complex coordination challenges.
One expert described the crisis as caused “almost entirely by unwise policy decisions made by the Rajapaksa administration” — Mahinda Rajapaksa was sworn in as President in 2005 before appointing family members to senior political positions. Years of poor political decisions resulted in loss sharing between ordinary Sri Lankans, foreign taxpayers and wealthy investors.
The government reached an agreement with the International Monetary Fund (IMF) in September 2022 on a four-year program to be supported by a USD$2.9 billion financing arrangement. However, the IMF’s financing precondition requires burden sharing, in line with a ‘comparability of treatment’, among Sri Lanka’s diverse creditors — nations and international bondholders in the market. Official bilateral creditors such as China, India and Japan are now in a tug-of-war due to their geopolitical interests.There is also tension between official creditors and profit-motivated private investors
Japan is also a concern, with its government gross debt at 262 percent of GDP at the end of 2021, nearly doubling since 2000. There’s been repetitive government growth strategies such as Japan's Revitalisation Strategy, and politically driven extravagant spending, which ended up as unaccomplished aspirations. The IMF points out the government’s tendency to present optimistic growth prospects and recommends ‘adopting more realistic projections.’
The government’s funding gap is being filled by just one taker. “The Bank of Japan is effectively the only willing purchaser in the market for Japanese government bonds,” Japanese economist Kato Izuru wrote last month.
The bank’s prolonged purchase of bonds since 2013 has allowed the illusion of affordability and for government borrowing to persist — creating distorted bond market conditions. In January, the central bank decided to maintain its policy to purchase bonds without setting an upper limit. It allowed ten-year bond yields to remain at around zero percent. The government and the central bank are trapped in a vicious cycle of excessive debt burden.
There is a shadow of fiscal dominance where central bank caps interest rates at low levels to reduce the costs of servicing government debt. Economics tells us that Japan cannot keep interest rates low, maintain a stable currency and keep up free capital flows simultaneously. The theory is called ‘the impossible trinity.’
The yen, staying around 130 per US dollar, has lost value since the beginning of global monetary tightening trends and is 42 percent cheaper than the highest value of 76 yen per dollar in January 2012.
A weaker yen implies the products and services offered by Japanese labour are at bargain prices while households face import-induced price hikes. Core consumer prices rose by 4.2 percent in January 2023, compared to a year earlier, the highest since 1981. A rise in interest rates will soon become inevitable despite the bank’s insistence on easing monetary policy, as long as capital control is an inconceivable option.
Japan’s political motives cannot survive market forces in the long term. Politically motivated narratives negate a sense of urgency, prolong the affordability illusion and postpone needed actions. Still, market forces do not wait forever and penalise unwise policy decisions. A nation’s bargaining power over market forces is submissive. We are yet to see how long Japan can escape the ‘moron risk premium’. What if Japan faces such a premium while emergency measures by its central bank may be depleted, unlike the UK?
International politics can mislead our understanding of finances through geopolitically ill-motivated narratives. For example, claims of debt trap diplomacy or a campaign for enhanced defence capabilities against security threats. Geopolitical motives may sound plausible initially, but turn out to be a false alarm or groundless. Economic rationale matters for the debtor and the creditor. As there is no such thing as a free lunch.
So who eventually can be trapped with the debt burden? The answer varies depending on if or when the policymakers take precautionary or remedial action to avoid overburdening current and future generations.
Toshiro Nishizawa is Professor at the Graduate School of Public Policy, the University of Tokyo. He declares no conflict of interest.
Originally published under Creative Commons by 360info™.
