Sovereign Analysis /
Laos

Laos: Bailout or bust

  • Liquidity concerns ahead of the eurobond maturity in June 2021 have caused prices to decline

  • High external debt service, low reserves and limited financing options mean Chinese or DSSI relief is likely required

  • PSI may be unavoidable but restructuring is unlikely to be severe; we recommend Hold on Laos 21s

Laos: Bailout or bust
Tellimer Research
30 September 2020
Published byTellimer Research

Laos is the latest country to fall victim to concerns over debt sustainability, initially prompted by a downgrade to Caa2 by Moody’s on 14 August (see here) and exacerbated by an article in the Financial Times (here) on 3 September and a Fitch downgrade to CCC on 24 September (here). All three reports cited elevated concerns of debt distress amid severe liquidity stress, sizeable debt service payments and dwindling foreign reserves.

Limited domestic financing opportunities and a downgrading of Laotian bonds in the Thai capital market forced them to issue a US$150mn eurobond in December 2019 (0.8% of GDP or 11.5% of reserves), its first and only eurobond issuance. Maturing in June 2021, the bond looks more like a bridge loan and is the first sovereign eurobond ever issued with a maturity of less than two years. The bond was priced to yield c8.6% despite its 6.875% coupon, another sign of possible distress. 

The bond also has a unique structure, requiring a mandatory redemption if new notes are issued with a principal amount exceeding US$150mn. The mandatory redemption price is 101% of par until year-end, after which it drops to 100%. It is also callable at 101.71875% and has CACs with a 75% threshold.

Given its size, the bonds are illiquid but do trade from time to time. Up to the release of the Moody’s report they were indicated just below par according to Bloomberg, before falling to the low 90s. The market context is now 80/85 according to indicative prices from StoneX, implying a yield of 35.5% on a mid-price basis (though pricing is highly uncertain given illiquidity).  

As a landlocked country with a relatively underdeveloped economy, Laos has relied on megaprojects from China’s Belt and Road Initiative (BRI) to sustain robust growth in recent years. Meanwhile, reserves have remained low at only US$1.3bn, compared to short-term external obligations of US$1.1bn annually over the next 4 years.

Further, with its future economic prospects hinging almost entirely on Chinese built and financed hydropower and transport prospects, it makes little sense to mortgage its future status as a regional power and transit hub to China by relinquishing ownership of its assets merely to repay the US$150mn facility.

However, given negative PR surrounding BRI and debt transparency, China could be keen to prevent a messy restructuring that will attract unwanted international attention on a strategically important neighbour (à la Sri Lanka’s Hambantota Port in 2017). With almost half of its external debt due to China, bilateral debt relief (either through the G20’s debt service suspension initiative – DSSI – or directly from China) would likely be sufficient to avoid a bond default.

While Laos is eligible for DSSI, it is not clear if it has requested relief under this initiative and to date it hasn’t benefited from Paris Club debt service suspension. DSSI currently allows suspension of debt service due to official bilateral creditors from May-December 2020, although an extension is under consideration (possibly by a year).

Private creditors are encouraged to participate in DSSI on a voluntary basis at the request of the borrower, but until Zambia last week it seems none had (see here). With private sector involvement (PSI) now on the table for Zambia, it may be similarly mooted as a requirement for debt relief under DSSI for Laos.

In addition, to benefit from relief under DSSI, countries must be “benefiting from, or have made a request to IMF Management for, IMF financing including emergency facilities (RFI/RCF).” At this stage, there is no evidence that Laos has begun engaging with the IMF. With these points in mind, Chinese debt relief outside the auspices of DSSI may be the most likely route to avoid defaulting on its bonds (à la Angola – see here).

It is also possible that Laos will seek to refinance its eurobond. We understand from broker comments and market chatter that the authorities have organised a non-deal roadshow this week, which may have supported bond prices after having dropped as low as 75 on a mid-price basis, although we haven’t seen details or the presentation. However, with yields currently above 35% it is unclear if there would be appetite for a new issuance, and if so at what level it would price. As such, refinancing options in practice may be limited, and with market access already restricted the incentive to avoid defaulting on its bonds may be lower.

We think the risks are relatively balanced, with significant haircuts unlikely to occur but moderate downside to current prices if a DSSI-like suspension is pursued. Meanwhile, there is significant upside if the eurobond is refinanced and/or PSI is avoided, but this would likely require a Chinese bailout for Laos to continue meeting its external obligations, for which appetite is difficult to gauge.

We therefore assign a Hold recommendation for LAOSIN 21s based on the current mid-price of 82.5, and will revisit if market pricing drops below our conservative target price of 70 and/or we receive more clarity on progress (or lack thereof) with negotiations on bilateral or multilateral relief efforts, or a potential refinancing exercise.

Macro background: “The Battery of Asia”

Laos has a population of c7mn people, GDP of cUS$19bn, and has sustained a consistently high real rate of growth, averaging 6.6% since 1980 and 7.2% over the past decade. However, it remains relatively underdeveloped, with GDP per capita of cUS$2,500 and a Human Development Index rating of .604 (140th out of 189 globally and versus an East Asia & Pacific average of .741).  

Laos is landlocked, nestled between Thailand, Vietnam, Cambodia, Myanmar, and China. Laos began to transition away from a Soviet-style planned economy in 1986 but remains politically centralised under the ruling LPRP and does not have a functioning opposition.

Laos is particularly vulnerable to natural disasters, with GDP growth falling from 6.8% in 2017 to 6.3% in 2018 and 4.7% in 2019 amid flooding from tropical storms and the tragic collapse of Xe-Pian Xe-Namnoy dam. That said, long-term prospects remain favourable and growth is expected to rebound from 0.7% in 2020 to 5.6% in 2021 and 7% over the medium-term per IMF estimates.

Growth has been driven by large private investments into the mining and hydropower sectors since the mid-2000s, but there have been minimal linkages to the rest of the economy and the contribution of human capital has remained limited despite a young and growing labour force.

Laos’ 5-year economic plan aims to transform Laos into a “land-linked” country and position itself as a regional transport hub for its high-growth, export-oriented neighbours. The centrepiece of this drive is the US$5.9bn (c30% of GDP) Kunming-Vientiane railway, built and financed by China and expected to be completed in December 2021.

Laos also plans to become the “Battery of Asia” by boosting its power capacity, with 23,000 MW of exploitable hydropower potential. In light of fiscal constraints the government placed a temporary ban on new hydropower projects in August 2018, but there is 2,200 MW of new capacity expected by year-end, another 1,440 MW under construction, and 9,580 MW in the planning stage that will still proceed.

However, transport and hydro projects have both stoked harsh criticism from environmentalists, and a series of feasibility studies have reportedly called into question the viability of the railway. Laos has allegedly borrowed US$3.5bn (nearly 20% of GDP) from China Exim to fund the project, with several multilaterals and think tanks citing concerns over heightened fiscal vulnerability, dependence on China and a potential lack of real economic benefits for Laos stemming from the project (see here).

From the mid-2000s, mining sector exports drove the economy (mainly copper and to a far lesser extent gold). However, in recent years electricity exports have increased sharply while mining activity has slowed (due largely to a ban on new mining projects in place since 2016), with mining and electricity now each making up around a quarter of exports.

Despite this, megaproject- and disaster-related imports have kept the current account deficit high, averaging 8.8% of GDP over the past five years per official estimates (or 12.7% per IMF). That said, much of this has been offset by megaproject-related FDI inflows, which have averaged 6.6% of GDP over the past 5 years per official estimates (or 7.9% per IMF).

Much of this has come from the government’s extensive use of PPPs, with Laos as one of the top three IDA-eligible countries by PPP use through 2017, according to the World Bank. The stock of PPP investment totals nearly 39% of GDP, with the government’s equity share ranging from 15-25% (though it is closer to 60% for two projects).

The authorities have also increasingly accessed the Thai capital market since 2013, with an outstanding stock of US$1,115mn of THB-denominated bonds and another US$182mn of US$-denominated loans (likely private placements with commercial banks) per Bloomberg data.

External imbalances are acute but improving

The World Bank expects the current account deficit to increase from 8% of GDP in 2019 to 11.1% this year due to lower exports, tourism, and remittances. Tourism contributed an estimated 4% of GDP of FX earnings in 2019, with Covid-induced travel restrictions prompting a forecast 2.7% of GDP loss. Meanwhile, the return of more than 100,000 migrants from Thailand could result in a 0.7% of GDP loss in remittances.

However, per official data, the current account deficit actually declined to 0.7% of full-year GDP in H1 20 from 2% in the same period last year. While exports have declined 1.6% yoy in H1 (-15.1% in Q2), this has been more than offset by an 11.1% drop in imports (-21.5% in Q2).

Extrapolating the Q2 run rate through year-end, and assuming a 60% drop in tourism, 20% drop in remittances, and 20% elasticity of FDI to imports (which is the historical average), we forecast a halving of the current account deficit from 4.5% of GDP in 2019 to 2.4% in 2020 (based on official data, which may underestimate the magnitude of the deficit but is nonetheless indicative for the direction of change).

While power and manufacturing exports are still subject to demand-side risk due to the contraction of the Thai economy (the key importer for both sectors), over 90% of electricity exports are under 25-30 year intergovernmental power purchase agreements (PPA) which minimise the downside demand risk.

Over the longer-term, FX flexibility will be required to promote non-electricity or mining exports. The BOL’s objective is to limit fluctuations of the kip (LAK) against the US$ within ±5% per annum, with associated REER appreciation leading to overvaluation. The IMF estimated in August that the REER was 14-23% overvalued, while the LAK currently trades c10% wide of the official rate on the parallel market.

Nonetheless, reserve buffers remain alarmingly low, dropping to US$864mn (1.5 months of import) by June. While the World Bank forecasts a further drop to between US$500-800mn in 2020, reserves jumped by US$429mn (+50%) in July to nearly US$1.3bn (2.3 months of import). The source of this increase is not clear, but we think it is likely due to megaproject-related FDI inflows.

However, reserves remain low relative to Laos’ external debt service profile, with cUS$500mn of external debt service payments due during the remainder of 2020 and a further US$1.1bn annually over the following 4 years (85% of reserves and 55% of government revenue).

In Fitch’s recent report, it highlights repayments of US$200mn to commercial banks in September and US$100mn in THB-denominated bonds in October, plus an additional US$165mn of THB bonds in 2021 and the US$150mn eurobond amortising in June.

Concerns over debt distress have narrowed Laos’s financing options, with the government abandoning a June rollover exercise in the Thai market. If market access remains limited in 2021, Laos could quickly be pushed into default absent bilateral relief (more on this later) or new multilateral funding (with no evidence so far that IMF or other multilateral negotiations are underway).

Debt solvency not so dire, but heading in the wrong direction

The solvency outlook is not so dire, with public debt totalling an estimated 58.9% of GDP in 2019 (51.7% external, 7.2% domestic). However, the World Bank forecasts an increase to 65-68% of GDP this year, with the budget deficit set to rise from 5.1% of GDP in 2019 to 7.5-8.8% of GDP in 2020 amid a 3-4% of GDP revenue loss and a 1.9% of GDP Covid relief package (less than the peer average of 5%).

As of end-2018 (the latest date for which official data is available), c75% of public external debt is on concessional and semi-concessional terms. However, concessionality has declined amid recent issues in the Thai capital market, while exposure to China has increased to 47% of external public debt.

About one-third of public external debt is on-lent to the power sector, with the liabilities of state-owned Électricité du Laos (EDL) reaching US$7.2bn (40% of GDP) in 2018 per IMF estimates. Private external debt is also estimated to be 41.5% of GDP, driven mainly by PPPs. In all, the IMF estimates contingent liabilities at 38.9% of GDP in 2018, a significant source of vulnerability.

Overall, the IMF’s August 2019 DSA rated Laos’s debt as sustainable but with a high risk of distress – and the economic situation has worsened since then. However, with over 90% of electricity exports under long-term PPAs, it estimates that more than 20% of the external debt stock is “self-sustaining”, ameliorating some of the risk.

Laos’ policy priority as of the August 2019 Article IV was to reduce the fiscal deficit to about 2% of GDP and public debt below 50% of GDP by 2025. While recent setbacks may push back the timeline, the target seems achievable and will be supported by existing policy efforts to improve revenue administration, reduce the civil service headcount, and suspend major capex projects.

Cashflow relief more essential than haircuts

Given the debt outlook, we do not think Laos would need to push through significant nominal haircuts (if any at all) to bring debt back to sustainable levels. If the government succeeds in consolidating the deficit to its 2% of GDP target, debt will stabilise c71% of GDP and the concessional nature of its existing stock will keep debt service below 20% of revenue at 11% of exports (from 14% and 7% now).

However, debt will continue to rise in the absence of further consolidation. In our base case, debt will rise to 76% of GDP by 2024. If Laos wants to reduce public debt to 50% of GDP, this would require a nominal haircut of 45-50% on all external debt. If Laos hits its 2% of GDP deficit target, however, this number drops to 35-40%, and it is even lower if debt is measured in PV terms (25-35%) or if the IMF’s indicative 70% is used instead (0-10%).

However, external liquidity constraints make the BOP a more relevant lens from which to approach the issue of debt sustainability. With short-term external debt service reaching c85% of reserves, cashflow relief will likely be necessary if Laos is unable to rollover its external obligations in 2021.

Without cashflow relief, we think reserves will fall to US$860mn by year-end and US$960mn by the end of 2021. However, the US$150mn eurobond maturity in June is just a small portion of the total debt service bill. It is therefore unclear whether private creditors will need to be included in any relief plans.

If bilateral debt relief was provided under an extended version of DSSI (we assume here it will be extended through the end of next year – see below), it would push reserves to 2.7 months of import by end-2021. However, with around two-thirds of official bilateral commitments owed to China, it could choose to provide relief outside the auspices of DSSI or to augment DSSI with additional support (either by widening the scope to include non-official debt or expanding the deferral beyond its DSSI commitments, like it did in Angola).

However, with the IMF citing 4-6 months of imports as a more appropriate threshold for Laos, PSI would be required to reach that level. While debt relief through either an extended DSSI program, or directly from China (or both), could potentially stave off eurobond default, PSI may therefore still be required.

The menu of options: Chinese bailout, DSSI and/or PSI

The menu of debt relief options for Laos is therefore fairly clear. On the one hand, Laos may choose to push for bilateral relief from China. While potentially insufficient to restore external balance on its own, it would free up enough financing to allow Laos to meet the June 2021 eurobond maturity.

However, Laos may be keen to avoid a direct Chinese bailout, which would reduce the likelihood of market refinancing or further issuance and push Laos more firmly into China’s orbit. And if the bailout comes with onerous terms (like a Hambantota-style debt-to-equity swap) it is unlikely that Laos would be willing to mortgage its hydroelectric future, on which much of its future economic prospects are based, simply to be able to meet its Eurobond obligations.

That said, given the negative PR garnered for BRI from China’s annexation of the Hambantota Port and associated criticism of its “debt-trap diplomacy”, it may see debt relief as a relatively low-cost option to minimise international scrutiny and preserve its strategic relationship. From this lens, it may make sense to offer relief on relatively favourable terms and without the threat of annexation. 

If either Laos or China are unwilling to pursue a direct bailout, pursuing DSSI may be a more appropriate route. While nearly two-thirds of bilateral debt payments due between now and the end of 2021 are due to China, participation in DSSI would provide some extra juice and lend an added degree of credibility and transparency to the process.

While DSSI is due to expire at the end of the year, the G20 will discuss in October the prospect of extending it further. Early indications are that the G7 will back an extension, and a further suspension of payments through end-2021 seems likely. However, the G20 and IMF have increasingly stressed the importance of PSI to address the free-rider problem whereby bilateral relief simply flows to private creditors.

Until recently there had been no private sector participation in DSSI, but Zambia became the first DSSI recipient to initiate PSI last week (see here). Given its distressed status, it seems likely that PSI came at the behest of the official sector. As Laos appears to have fallen into similar distress, we think it would likely be subject to similar requirements, especially since the June maturity would fall squarely within the time frame of an extended DSSI. They also have a coupon due on 30 December, so could signal PSI ahead of that rather than wait for the bond maturity, but we note they paid the June coupon.

That said, the threshold for “distress” is not clear, with Angola (whose debt is projected to exceed 122% of GDP this year) recently agreeing to DSSI relief from its bilateral creditors and renegotiating its oil-backed loans with China (which owns 45% of its debt stock, similar to Laos’ 47%) while emphasising its intention to continue honouring eurobond obligations within the context of its existing IMF program. While preserving market access is far more important for Angola than it is for Laos, it is curious that the G20 – and IMF – didn’t push harder for PSI.

With a lone eurobond of US$150mn and market access already restricted, maintaining future access probably isn’t a high priority and Laos is therefore less likely to push back against requests for PSI. However, with limited financing options Laos will need some way to finance deficits in the coming years, and a default on US$ obligations would likely impact negatively its ability to issue in the Thai market (which it seems to be currently locked out of also given the abandoned issuance in June).

As such, Laos likely wants to avoid a wholly market-unfriendly solution, even if prospects for future eurobond issuance remain limited.

Valuation scenarios: Restructuring likely, but probably not severe

This leaves several scenarios for Laos:

  • DSSI with PSI: This is our base case, and could take several forms (see below). An IMF programme would likely be required.

  • DSSI without PSI: Gives space to pay or refinance June maturity, but we think is less likely given the Zambia precedent. An IMF programme would likely be required.

  • Chinese bailout: Gives space to pay or refinance the June maturity, but likely requires further adjustments down the road.

  • Full restructuring: If solvency concerns remain or bilateral relief is not secured, Laos may try to impose haircuts in addition to cashflow relief. However, as we said before, they probably would not have to be large (we use a conservative 30% and 50% for illustrative purposes below).

Under DSSI, deferred amounts (principal and interest) are supposed to be repaid over four years with a one-year grace period and are meant to be NPV neutral (implying some sort of charge such as penalty interest and/or principal enhancement, but no details have been made public). We use this structure, minus the NPV adjustment, for our conservative DSSI case.

Alternatively, the Zambia example shows us that PSI relief need not necessarily be on the same terms as DSSI, with Zambia opting to suspend interest payments on its Eurobonds from 14 October to 14 April, at which point it will pay all deferred interest. However, the suspension is merely a prelude to a wider restructuring (which would not necessarily be the case for Laos), so the light treatment could be reversed when negotiations start in earnest.

However, it is likely that DSSI participation would need to be preceded by a request for emergency funding from the IMF, and there is no evidence that the government has yet launched discussions to that end. That said, Zambia was recently granted DSSI relief without IMF funding in place and seemingly before negotiations have reached an advanced stage, showing that the definition of a "request" for funding can be interpreted loosely and that relief is still possible before IMF funding is formally agreed as long as there is some assurance that government is working towards it.

Meanwhile, Ecuador’s recent consent solicitation shows that commercial creditors may also be willing to agree to light cashflow relief without an IMF program or funding in place, though in this case too Ecuador was in the process of replacing its previous EFF with a new emergency RFI facility (here). Without some assurance that Laos has at least engaged with the IMF, DSSI or commercial cashflow relief are therefore both unlikely and Laos may be forced to either launch IMF negotiations or seek relief from China.

Lastly, it is possible that Laos will try to refinance its eurobond before it matures in 9 months. While unlikely to durably resolve Laos’ liquidity constraints, this could still provide a profitable path to exit for existing bondholders without having to parse the likelihood of a Chinese or DSSI bailout. However, with yields currently above 35% (and potentially higher, due to the uncertain nature of pricing) it is unclear if there would be appetite for a new issuance, and if so whether it would price at a level acceptable to the authorities. While it is possible that a new issuance would cause bonds to reprice, we would not count on this as a sufficiently viable route out of distress. 

We present the potential scenarios and their impact on bond prices below, assuming a conservative exit yield of 12% across the board:

In our conservative base case of PSI on the exact same terms as DSSI, there is c17% downside relative to our assumed mid-price of 82.5 (which, again, is uncertain). However, if a China and/or DSSI bailout is secured without PSI being enforced and the proceeds are used to settle the June 2021 maturity, there is upside of c17%.  Meanwhile, the tail scenarios where haircuts are involved (which we deem unlikely, but certainly possible), suggest downside of c40-60%.

Conclusion: Hold Laos 21s

All things considered, Laos’ external liquidity crisis is acute but not intractable. Given the nine-month horizon and small size, restructuring of the Laos 21s could easily be avoided if relief is obtained from elsewhere (ie China and/or DSSI), and/or if policies are adjusted and the economy turns around.

That said, Laos is essentially a China bailout trade. If relief is obtained from China (and China doesn’t seek to enforce PSI), Laos will be able to pay its 2021 maturity. If not, it will have to seek support through DSSI, or beyond, which will likely (but not necessarily) include PSI as a requirement, and probably an IMF programme too.

While bilateral debt relief would help paper over short-term liquidity constraints, significant fiscal consolidation (c4-5% of GDP) would still be required to stabilise the debt burden and Laos could quickly find itself back in distress.

Given the opacity of Chinese debt relief, it is hard to gauge their appetite for a bailout. And while Laos’s eurobond is small relative to its total external obligations and would be easy to pay off in concert with bilateral relief, preserving market access is unlikely to be a high priority for the administration.

Risks seem to be relatively balanced, with material upside if restructuring is avoided and symmetric downside if cashflow relief is required but a long tail if an aggressive restructuring is pursued.

We therefore assign a Hold recommendation for LAOSIN 21s based on the current mid-price of 82.5, and will revisit if market pricing drops below our conservative target price of 70 and/or we receive more clarity on progress (or lack thereof) with negotiations on bilateral or multilateral relief efforts, or a potential refinancing exercise.