There are quite a few people who take a doom and gloom perspective on Vietnam, particularly when it comes to its balance of payment outlook. You are more optimistic. Why?
I think people put too much stock in the headlines without really understanding how Vietnam’s economy works. While challenges exist, fears are overblown. Many focus on the trade deficit of about $12 billion for 2010, or 12% of gross domestic product (GDP), but few see that the deficit is more than compensated by inflows of about $11 billion in foreign direct investment, $8 billion in remittances and $2 billion in official development assistance, giving us in theory net inflows of roughly $9 billion, or 9% of GDP. These inflows are all expected to increase in 2011, while the trade deficit will likely decrease as export growth continues to outpace import growth. The same thing goes for base interest rates. The focus is on the official base rate of 9%, 300bp below the 12% inflation rate, but few people note that deposit rates at banks are in the 12% to 14% range and lending rates in the 18% to 20% range – not low by any standards. Finally, I would point out that in 2008, several major investment banks issued reports calling for an imminent Thai-style balance of payment crisis, citing similar reasons as those who are calling for one now. Soon after, global hedge funds sold their Vietnamese dong bonds at any price and yields reached 21%. Those who bought these did the best trade of the year, especially since that crisis never happened.
Back to the FX reserves number, can we be sure about the data? There are concerns that reserves aren’t actually accurately reported...
It is certain that net inflows into FX reserves are much smaller than the theoretical $9 billion due to what is called 'local leakages', basically the population selling dong to buy value stores, namely US dollars and gold. These flows are hard to estimate, but we suspect them to be unusually large, which denotes a lack of confidence in the dong. Some have speculated that they are so high that FX reserves have shrunk in 2010, pushing the country closer to a balance of payment crisis. On the other hand, the World Bank recently estimated FX reserves to have increased by $2.6 billion in 2010 and said it expects a higher number for 2011. Current FX reserves are not public information. Market consensus put current FX reserves at roughly $12 billion, but nobody knows for sure. There’s also chatter that Vietnam has two or three undisclosed FX reserves of roughly the same size, which is probably true to some extent.
Do you think the nation is too reliant upon imports?
Thanks to its low wages and hard-working people, Vietnam has been successful in attracting large amounts of FDI, especially manufacturing industries oriented towards exports. However, because the country is still at an early stage of industrialisation, it needs to import the machinery and raw materials that come in the production of these exports. For example, Vietnam is a major importer of textile -- the country’s largest non-energy import -- but a lot of it is re-exported in the form of garments, which is one of its top exports. The same goes for wood and furniture. This implies that should exports unexpectedly stop one day, imports would also fall drastically. It is short-sighted to draw a BOP crisis scenario without making adjustments for how much imports would fall should exports disappear overnight.
Ok, so the problems may not be as bad as they seem – and the FX reserves might be higher than some think, but there is a lack of confidence in the Vietnamese dong, don’t you agree?
Definitely. The real macroeconomic issue for Vietnam stems from the lack of confidence in the dong by its population, due to high monetary growth, high inflation and successive devaluations each time the USD/VND rate on the grey market move out of the official range sanctioned by the State Bank of Vietnam (SBV). The population still vividly remembers the 1980s – a time when triple-digit inflation was rampant and when a pack of cigarettes cost only 2 dong. The same pack of cigarettes today costs 7,000 dong. The country has come a very long way since, but the souvenir is still fresh in the mind of many Vietnamese, and so they hedge their savings.
On February 11 the USD/VND rate was adjusted by the state bank from 18,932 to 20,693 – a 9.3% devaluation of the official rate. But you’ve argued that’s not so important. Why is that?
The devaluation was largely expected and already priced in. You see, the interbank rate was already at 20,800 before the devaluation. So when it moved to 20,915 after the February 11 devaluation, investors were unmoved by what was in effect a 0.1% depreciation, not 9.3% as the headlines called for. The grey market rate also moved on that day to 21,405, a 0.28% depreciation, but again nothing alarming. The only ones to be shocked, it seems, are those who do not closely follow Vietnam. What the devaluation did change is that it made it easier for foreign fund managers and companies engaged in international trading to exchange currencies without having to pay what had become known as the ‘Vietnam tax’, i.e. selling US dollars at the official rate of 19,500 (prior to the devaluation), while buying US dollars at the effective rate of 20,800 (essentially 19,500 plus roughly 7% of “bank fees”).
The SBV recently hinted that it will pursue a more flexible currency management system – a quasi-floating currency regime, it seems. The dong is pegged to the US dollar and in theory the SBV should intervene in the market to maintain that peg. The reality is that the SBV hasn’t done so for a while now and has preferred to let the currency weaken rather than deplete its FX reserves. So, the mechanism works this way. First, the interbank market moves out of the band allowed by the SBV, stays there for a while, and then the SBV officially devalues the currency to the interbank market rate.
So, was devaluing the currency worthwhile?
While somehow necessary to make FX markets work properly, devaluating the currency will only exacerbate the problem by worsening the inflation (by perhaps no more than 1%) and by creating the expectation of future devaluation, both of which are root causes of the lack of confidence in the dong. The alternative to a devaluation would have been to hold on to the FX rate and maintain the so-called Vietnam tax, which I just explained. It wouldn’t be good for business, but in the end, perhaps the resolve would have showed the population that they should start selling their US dollars and gold, rather than hoarding them, and take advantage of the comparatively high interest rate in Vietnamese dong (14% vs 6% for US dollars). It is estimated that the country has 800 tonnes of gold in reserves and that about 28% of bank deposits are in foreign currency (mostly US dollars). That’s roughly 50% of GDP that is locked in so-called value stores. A reversal of flows could make the dong appreciate significantly in value.
In the meantime, we argue that the country needs to pursue a tighter monetary regime to successfully control monetary growth and inflation, stop the hoarding mentality and ultimately ensure sustainable economic growth. That being said, we suspect the government to be pro-growth and generally reluctant to tighten monetary conditions for macroeconomic stability's sake. It wants growth and it wants it now. The view is that an economic growth below 6% would result in fewer jobs being created than the number of workers entering the market, which could lead to greater social and political instability. When things get too hot however, the government does recognise that something must be done, even if it's late.
As a matter of fact, the SBV has just taken steps to tighten monetary conditions. Interest rates are already quite high (as explained prior) and loan growth did come down drastically in January, growing by only 0.35% month-on-month against 2.4% growth in December, but on February 17, the central bank announced an increase of 200bp to the refinancing rate, which is the rate it charges banks that still have outstanding demands for liquidity by the end of each day. This is nothing to be concerned about as most banks, except the smallest ones, do not use the refinancing window, but it is viewed as a step in the right direction. On February 18, the SBV also announced that it will seek to obtain government approval to lower the loan-growth target for this year, one of the main drivers of monetary expansion. It’s urgent for the government to act as the USD/VND rate in the grey market has moved to 22,500 since the latest devaluation due to a lack of policy action to fix the situation. We expect further policy action to take place in the following months, as we believe more is needed to control inflation.
So what’s next for Vietnam?
While Vietnam has definite macroeconomic challenges, the country remains underinvested by the global investment community. While 2010 was no doubt the year of emerging markets, and we’ve seen huge inflows and price-to-earnings expansion in these countries, Vietnam received only a tiny fraction of hot money flows. I roughly estimate that no more than 20% of the total inflows into the stock market came from hot money flows. Today, while most emerging markets are registering massive net outflows, Vietnam is one of the only countries in the region still receiving net inflows from foreigners into its stock market year-to-date. Moreover, valuations are still well below regional averages with price-to-earnings ratios of around 10 times, and some companies still find ways to boast 20%+ earnings-per-share growth.
