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FT Confidential Research

Southeast Asia's foreign debt spirals

High levels of borrowing a concern for six nations in region

Laos' President Bounnhang Vorachith (L) shakes hands with Chinese President Xi Jinping (R) before a bilateral meeting at Diaoyutai State Guesthouse in Beijing last year    © Reuters

Six Southeast Asian countries, led by Laos, have much higher external debt levels than the developing world average, sparking concern that the region may be heading for a debt crisis.

Laos has the highest level of external debt to gross national income in Southeast Asia at 93.1 percent, compared with an average of 26 percent for all developing countries, according to an analysis of World Bank data by FT Confidential Research. Malaysia, Cambodia and Vietnam have the next highest debt ratios in the region, according to the study.

Laos, like Malaysia, is shouldering a multibillion dollar debt burden for infrastructure projects negotiated under China's Belt and Road Initiative. One example is a $5.8bn plan to connect Kunming in southern China to the Laotian capital of Vientiane, which will consume resources equal to nearly 40 percent of the country's gross domestic product. About two-thirds of Laos's debt is denominated in foreign currency, so a sudden depreciation of the Lao kip is the biggest risk to the country's debt sustainability. The International Monetary Fund has identified Laos as being at high risk of debt distress, although the government has shrugged off the problem.

In Malaysia, where external debt has reached 69.6 percent of national income, newly elected Prime Minister Mahathir Mohamad has ordered a renegotiation of four costly BRI projects approved under the scandal-struck previous government of Najib Rezak, including a a $14bn railway to connect Port Klang, the country's busiest port, to the east coast. Mahathir wants better financial terms.

Southeast Asian countries are mindful of what has happened in south Asia, where Sri Lanka recently sold China a 99-year lease on a Beijing-built strategic new port because it could not repay the debt. However Southeast Asia's debt levels are generally higher than south Asia's; in the latter region only the small countries of Bhutan and Sri Lanka have above-average debt.

The six most-indebted Southeast Asian countries have been piling up foreign loans in the past five years, particularly Cambodia, Laos, and Vietnam. Cambodia recorded 142 percent growth in its external debt, the fastest rate of debt increase in the region and it now stands at 54.4 percent of GNI. China is Cambodia's largest bilateral creditor, with about 70 percent of its external debt in 2016. It is also the largest creditor to Laos, according to the IMF.

Despite its rapid debt growth, FTCR believes Cambodia's risk of distress to be less than that of Laos, Malaysia, and Indonesia. We single out these three countries because of their low ratio of foreign reserves to short-term external debt and their high ratio of external debt to exports.

As of 2016, Malaysia's foreign currency reserves were only 1.1 times the amount of foreign debt coming due within one year. This situation has deteriorated since at least 2008. Following the recent revelation by Lim Guan Eng, finance minister, that the country's total debts and other liabilities are nearly 60 percent greater than reported by Najib's government, the burden of short-term debt may be a lot greater, too. Thailand and Vietnam are better protected by foreign reserves, with each holding about 6.1 times the amount of short-term external debt.

Laos, Malaysia and Indonesia also have the least favorable ratios of external debt to exports, an indicator used by the World Bank to assess a country's ability to make repayments. The ratios for Laos and Indonesia stood at 327.9 percent and 184.2 percent respectively in 2016, well above the average for low and middle-income countries, of 107 percent. Malaysia's debt to export ratio was 94.5 percent, but this may change given Lim's update, the details of which are not yet public.

For Malaysia and Indonesia, rising prices of key export commodities should improve their ability to pay their debts. We expect trade surpluses to strengthen their foreign reserves well into next year.

In Indonesia, rising debt -- particularly from China -- is likely to become a big political issue ahead of national elections next year, when President Joko Widodo will seek a second term. As in Malaysia during its recent general election, anti-China rhetoric is likely to win some votes for the opposition.

According to Bank Indonesia, the country's debts to China have more than doubled under Widodo: excluding loans from Hong Kong, they amounted to $16.7bn in April, 110.5 percent more than when Widodo took office at the end of 2014. China's share of Indonesia's overall bilateral loans has also doubled, from 4.5 percent in 2014 to 9.2 percent. Under Widodo, China has become Indonesia's third-largest lender after Singapore and Japan. If we include loans from Hong Kong, China could pass Japan as Indonesia's second-largest lender as early as next year.

Nevertheless, Chinese loans make up only about 4.6 percent of Indonesia's total external debt -- posing no significant risk to the country's debt sustainability. The increase of Chinese loans reflects closer economic relations, rather than overdependence on China.

Moreover, since the 1997-98 Asian financial crisis, Indonesia has adopted a fiscal regime that favors capital markets over bilateral loans. This policy remains intact under Widodo as the share of Indonesian securities in overall external debt continues to expand. A big downside to this policy is that foreign investors hold about 40 percent of local currency bonds. This dependence on foreign funds makes the rupiah highly vulnerable to capital outflows. Rather than Chinese loans, currency volatility is the biggest risk to the Indonesian economy.

The FTCR study used the World Bank's International Debt Statistics report for 2018, excluding Brunei, East Timor and Singapore.

Andi Haswidi, Indonesia Researcher, FT Confidential Research 

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.

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