The Diplomat Weekly commented on May 31, What caused the currency crisis in Laos?
The economic situation in Laos has begun to deteriorate over the past few weeks, fuel shortages have been reported to the brim, and the depreciation of kip has further pushed up import cost prices, with the dollar exchange rate of the Lao kip about 9400 in September 2021, but fell to 13450 last week.
Although the Lao Central Bank announced a response to the depreciation of the kip, it may have led to this situation for currency manipulators and speculators. At present, Laos has some economic deterioration, but there are also deeper structural problems behind this.
The first is the Fed's interest rate hike, which led to a relative appreciation of the dollar. The Fed's interest rate hikes usually have a major disruption to the global economy, triggering capital withdrawals and sharp exchange rate depreciations in some countries, especially emerging market countries. Especially those countries with fiscal and current account deficits.
This would allow emerging markets to reserve large foreign exchange reserves that can be used to prop up currencies during periods of high volatility. This sends a message to global creditors about their ability to repay their debts.
For some time, it has been doubtful that Laos is solvent. Because Laos imported $6.36 billion of goods in 2021 and the balance of payments has been accumulating large amounts of debt, all of this increases the likelihood of a large-scale outflow of Lao capital.
Investors believe that Laos has insufficient foreign exchange reserves. As of December 2021, Laos has only $1.26 billion in foreign exchange reserves.
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Coupled with the impact of the climb in commodity prices such as fuel oil, it has caused economic liquidity crunch in the short-term economy and economic difficulties in the short term until fuel prices stabilize. But this situation is not only happening in Laos, which is the difficulty that every country is facing at present. However, it is worth mentioning that the fuel will eventually come down.
But in the long run, the biggest question is whether Laos has too much international debt that could increase its productive capacity. So where do these liabilities come from? This has to start with investment.
In recent years, foreign investment in Laos has increased dramatically. Net foreign direct investment increased from US$635 million in 2012 to US$1.7 billion in 2017. The rate of foreign investment has declined in recent years, but net investment will still exceed $1 billion in 2021.
Foreign investment is a bit like a double-edged sword, as these investments must ultimately be repaid to the owners of capital through dividends and interest. As a result, capital outflows from the domestic income account have also increased as foreign investment has increased, with total laos outflows totaling $1.23 billion in 2021.
The question is what is the purpose of the investment? If investment increases productive capacity beyond the cost of capital, it is the net benefit of the domestic economy. If the cost of capital exceeds economic efficiency, they drag down the domestic economy, eventually leading to Laos becoming heavily indebted internationally.
Capital markets believe the latter is more likely to happen, as the sharp depreciation of Kip in recent months, rising commodity prices and fed rate hikes will accelerate the process, coupled with low investor sentiment and low levels of foreign exchange reserves, so it can happen anyway.
Laos is a country of only 7 million people, the domestic market is limited, and most foreign investment is mainly in infrastructure such as power generation and transportation. Laos' electricity exports have increased significantly, but almost all of them have been absorbed by Thailand.
According to the OEC, Laos exported $272 million in electricity to Thailand in 2010. In 2020, it surged to $1.9 billion, accounting for 31% of all exports. Almost all electricity is purchased in Thailand. But is it enough?
For it to make a difference, Laos must convert foreign investment into exports, sell electricity from foreign-owned power plants to Thailand, and increase the amount of goods and services exported to China through the China-Laos railway. It's hard to say what will happen in the long run. But Laos' exports are likely to flourish in 10 years, and these investments have proven to be worth the risk.
But for now, the Lao economy relies heavily on exports to neighboring countries, namely Thailand and China. Second, all foreign investment has increased the accumulation of debt in Laos, which, combined with its lack of large foreign exchange reserves, has made Laos, a population of 7 million, particularly sensitive to this round of global financial shocks.
So what exactly caused the Lao currency crisis can be summarized as the climbing of commodity prices such as fuel, the Fed's interest rate hike, and the depreciation of kip prices in the short term are the fuse of the Lao currency crisis. In the long run, Laos' external debt has increased and foreign exchange reserves have been shortfalls, which is why Laos has borne the brunt of global inflation in Southeast Asia.