Following recent revelations of Malaysia’s  ballooning debt under Najib Razak, the ousted prime minister, there is a growing concern that south-east Asia’s infrastructure drive is pushing the region towards a debt crisis. Laos has been identified by the International Monetary Fund as being at high risk of debt distress and others could follow. 

There are parallels with south Asia, where Sri Lanka recently handed China a 99-year lease on a port to repay its debt. Malaysia and Laos are also shouldering multibillion dollar debt burdens for projects under China’s Belt and Road Initiative.

To reduce future spending, Malaysia’s new government is seeking to  renegotiate China-backed projects that were approved by Mr Najib’s government, including a  $14bn railway  to connect Port Klang, the country’s busiest port, located on its west coast, to the east coast. 

Laos, on the other hand, prefers to shrug off the pressure of Chinese debt, despite the fact that a $5.8bn project to connect Kunming in southern China to the Laotian capital of Vientiane will consume resources equal to nearly 40 per cent of the country’s gross domestic product in 2016.

We used the World Bank’s International Debt Statistics report for 2018 to assess the severity of debt in south-east Asia, excluding Brunei, East Timor and Singapore.

Debt piles

Based on ratios of external debt to gross national income, we have identified six south-east Asian countries where debt levels are above the average for the developing world. This is more than in south Asia, where only Bhutan and Sri Lanka have above-average levels of debt.

Laos has the highest level of external debt in south-east Asia with a ratio of 93.1 per cent, compared with an average of 26 per cent for all developing countries. In Malaysia, Cambodia and Vietnam, the ratios are 69.6 per cent, 54.4 per cent and 45.6 per cent respectively. Because about two-thirds of Laos’s debt is denominated in foreign currencies, a sudden depreciation of the Lao kip is the biggest risk to the country’s debt sustainability.

The six countries have been piling up foreign loans in the past five years, particularly Cambodia, Laos, and Vietnam. Cambodia recorded 142 per cent growth in its external debt, the most in the region. China is Cambodia’s largest bilateral creditor, with about 70 per cent of its external debt in 2016. It is also the largest creditor to Laos, according to the IMF.

Despite its rapid debt growth, we believe Cambodia’s risk of distress is 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.

Low foreign reserves and high short-term debt 

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 per cent greater than reported by Mr 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 favourable 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 per cent and 184.2 per cent respectively in 2016, well above the average for low and middle-income countries, of 107 per cent. Malaysia’s debt to export ratio was 94.5 per cent, but this may change given Mr 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.

The politics of Chinese loans

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 of office. 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 Mr Widodo: excluding loans from Hong Kong, they amounted to $16.7bn in April, 110.5 per cent more than when Mr Widodo took office at the end of 2014. China’s share of Indonesia’s overall bilateral loans has also doubled, from 4.5 per cent in 2014 to 9.2 per cent. Under Mr 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 per cent 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 any overdependence on China.

Moreover, since the 1997-98 Asian financial crisis, Indonesia has adopted a fiscal regime that favours capital markets over bilateral loans. This policy remains intact under Mr 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 per cent 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.

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 south-east 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.