How Vietnam can avoid the middle-income trap

Will Vietnam’s growing domestic private sector help or hinder it to avoid a middle-income trap?

How Vietnam’s domestic private sector evolves over the coming decade will mould the country it becomes for generations to come. “It’s what we discuss internally all the time,” said Chad Ovel, a partner at domestic private equity firm, Mekong Capital. “It predicates where our investment goes.”

What is very clear is that Vietnam has reached a crucial tipping point. The domestic private sector accounted for 43.3% of GDP in 2018 and has outstripped both state-owned industries (SOEs) and multinationals as the economy’s dominant force. By 2020, the government wants it to contribute 50% and in recent years has been much more proactive about directing capital its way.

“It’s also been highly supportive of foreign investment,” said Jeffrey Perlman, head of Southeast Asia at Warburg Pincus. “That’s been very positive in aiding efficient capital allocation.”

That represents a complete about-turn from a decade ago when the government’s prime focus was on state-owned entities like Vinashin and Vinalines. However, their mismanagement created a banking crisis in 2012, prompting a re-think.

So now it is entities like Vingroup that tend to hog the headlines and capture more of the capital flows – and increasingly from foreign institutions and private equity investors.

In 2018, the ever-expanding conglomerate swept into the ranks of the top-10 Vietnamese companies by revenue for the first time. Its founder, Pham Nhat Voung, is Vietnam’s richest man according to Forbes.

All of which presents a conundrum, because Vietnam does not want to follow the same path that led other Asian countries into a middle-income trap.

As Southeast Asia decolonised after World War 2, one country’s government after another handed over large swathes of the economy to a few lucky businessmen who just happened to be in the right place at the right time.

The resultant nexus of politics and business means that families such as the Sophonpanichs of Thailand, Kuoks of Malaysia and Liems of Indonesia have held onto those trading concessions ever since, passing the wealth down from one generation to the next.

And as we all know, monopolies are not good for productivity in the long-run.

In Northeast Asia, the South Korean government subsidised entrepreneurs who invested in technological innovation, creating world-class brands like Samsung and Hyundai. They made the country rich but the wealth ended up similarly concentrated in family-run chaebol dominated by third- or fourth-generation Chungs, Koos, Lees and Parks.

China looked like it was heading down a similar path of politically connected conglomerates until President Xi Jinping’s corruption crackdown and de-leveraging campaign took the economy in another direction.

So is Vietnam in danger of seeding future discontent among its emerging middle class if later generations of Ngyuens, Phams and Trans inherit a large slug of the nation’s wealth? Right now, that is still a few decades off.

When it comes to the present, the consensus is that the first generation’s entrepreneurialism is benefitting an economy stymied by SOE inefficiency. The leading private sector groups fall into three distinct camps (see table 1).

One group were sent to the former Eastern bloc for their higher education after the Vietnam War and cut their entrepreneurial teeth as the USSR collapsed around them. Local observers believe this bred a determination to scale-up quickly as a survival mechanism against the Mafiosi-style business conditions they faced before they returned home.

Founders of the second and third groups are both homegrown. The former typically started off at SOEs before fledging their entrepreneurial wings, while the latter often cut their teeth in real estate then diversified.

The Vietnam War (1955-1975) and related crippling US sanctions, which were only lifted in 1994, are the main reasons why Vietnam’s private sector is just over 20 years old.

As Techcombank’s chief financial officer (CFO), Bang Trinh, puts it: “We’re behind but that gives us an opportunity to leapfrog and learn from other countries’ mistakes.”

Local observers believe there are three factors that could aid that: a less incestuous relationship between industry and government, a heavier reliance on foreign capital and more female founders who could foster a different spirit to the patriarchy that created Southeast and Northeast Asian Inc.

Yet, clearly, the most important factor will be whether the government acts as an enabler for productive growth (positive) or state capture (negative).

On the debit side, Vietnam has consistently scored badly in Transparency International’s Corruption Perception Index. It currently ranks 117 out of 175 nations.

So far that corruption has largely involved SOEs. Dragon Capital’s chief investment officer, Bill Stoops, also notes that: “There aren’t any leading private sector groups founded purely on political connections.”

It did not look like it would stay that way until Nguyen Phu Trong, general secretary of the Communist Party of Vietnam, won a power struggle in 2016. Before then associates of former prime minister Nguyen Tan Dung gained prominent roles in business and politics.

Nguyen has pledged to uphold the Communist Party’s legitimacy and Vietnam’s economic development by sweeping the corrupt away. “As Uncle Ho taught us, we must catch mice without breaking the vase,” he famously commented.

To date, hundreds of officials have been ensnared. It is not yet clear whether the driving force behind this is structural reform or a general desire to dismantle of a rival’s patronage network. But local observers err towards optimism based on Nguyen’s known ideological purity.

The second area where Vietnam scores more highly than regional peers at a similar juncture in their history concerns its banking system.

During the 1990s Indonesia had 240 banks, mostly tied to individual tycoons who treated them as personal piggy banks. Thanks to prodigious domestic savings rates across the region, there was plenty of capital to misappropriate in the run up to the Asian financial crisis of 1997.

Vietnam’s banking sector is different. Techcombank’s Trinh says the country does not suffer from connected lending. “Vietnam had its banking crisis in 2012 and really learned from it,” he told FinanceAsia. “The top banks here are exerting a good influence on corporate development.”

Others agree. One is Jonathon Waugh, co-founder of Wardhaven Capital and a financial backer of one of the country’s most successful high-end brands, Marou chocolate. “When the private sector banks were set up in the 1990s, no-one had enough money to go it alone so most were established by clusters of entrepreneurs,” he said.

This is a familiar refrain, cutting across other sectors. “There was never enough capital so anyone with a vision needed friends to make it happen,” explained Masan Group deputy chief executive and CFO, Michael Nguyen. “Vietnam is different because many companies have diverse shareholding bases.”

Mekong’s Ovel backs this up. “We often find that we can invest 30% and become the single largest shareholder,” he noted.

Multiple founders mean Vietnamese companies may develop along similar lines to Western corporations with their fragmented and institutionalised shareholder bases. They are also more likely to favour consensus-based decision-making, much like the ruling party, which adheres to the concept of democratic socialism: multiple internal views coalescing into a single decision that everyone then follows.

Vietnam is also developing at a time when both international capital markets and the private equity arena offer plentiful sources of finance. The two have been ardent suitors, but come with strings attached.

“Private equity has made a big difference here providing capital but also governance,” HSBC’s Vietnam CEO, Pham Hong Hai, said. Masan’s Nguyen agrees and has first hand experience, having working alongside KKR & Co. before it made a profitable exit from Masan in 2018.

“Private equity turns over every stone during due diligence,” he commented. “And then there are ongoing key performance indicators (KPIs), which professionalise standards and keep everyone on their toes.”

Nguyen is typical of the new manager class. Having been born in the US and educated at Harvard he barely spoke Vietnamese when he decided to move back to his parents’ home country.

He considers himself part of a second wave. “The first wave were business founders who saw how other countries made money and then applied it here,” he said. “But they know that if they want their companies to stay competitive or move to the next level, then they need people with the right skill set, rather than family members or someone with a government relationship.”

Masan’s senior managers are all incentivised with stock options and Nguyen says the focus is as much about governance as growth. HSBC’s Pham says more companies are moving in this direction.

“Some founders don’t see why they need to change because they’re still benefitting from the economy’s fast growth,” he said. “But the smart ones realise they need to put controls and better oversight in place.”

The International Finance Corporation’s (IFC) Vietnam corporate governance lead, Nguyen Nguyet Anh, says the country has made significant progress to improve its Association of Southeast Asian Nations Corporate Governance Scorecard rankings by an average of almost 50% between 2012 and 2017, although more effort is needed since it ranked last among the big six.

She is currently working with the government on a corporate governance code for listed companies and hopes it will move to a ‘comply or explain’ regime after a few years of voluntary adoption. She also cites positive steps such as the Vietnam Corporate Governance Initiative (VCGI), which links the government, public and private sector. In 2018, this spawned a Vietnam Institute of Directors to help train the new upcoming management cadre.

Nguyen says listed companies have made strides making English-language disclosures over the fast five years, with the number of companies jumping from 30 to 70. PXP Vietnam Asset Management’s CEO, Kevin Snowball, cites Vinamilk as a standout in this regard.

However, Nguyen says more work is needed, particularly around audit committees and independent directors. Vinamilk, for example, became one of the first listed companies to appoint independent directors and set up an audit committee in 2017, but did not fully adhere to international best practice by appointing its CFO to the latter.

The Enterprise Law, revised in November 2014, allows two models for non-credit institutions: one where the audit function is conducted by a supervisory board reporting to shareholders rather than the board of directors and one where it is an independent committee under the board of directors.

Masan uses the former model, but excludes its CFO from checking himself. Trinh is also excluded from Techcombank’s audit committee, which reports directly to the board.

Where independent directors are concerned, many companies “don’t adhere to international standards in appointing them because the law isn’t clear enough,” IFC’s Nguyen said. “Someone can classify as an independent director simply because they work for the holding company rather than the operating company.”

Techcombank’s Trinh and Masan’s Nguyen agree that this is an area that needs strengthening in law and in practice.

Trinh’s bank has one independent director but is nominating more to “contribute expertise as the bank continues to grow,” he said. Masan, meanwhile, has recently conducted a corporate governance audit to see what it can improve, Nguyen told FinanceAsia.

Both groups are also well ahead of Vietnamese legal requirements in adopting IFRS accounting standards.

Trinh further flags that Techcombank’s “strong management and leadership training programme” is helping to strengthen management expertise across the wider banking sector – something VinaCapital chief economist, Michael Kokalari, thinks Hanoi could reinforce by persuading the country’s resident multinationals to boost their training.

Does all this mean that Vietnamese companies will have sufficiently professionalised their management and widened their equity bases before they have to face the challenge of succession at the top?

Vietnam’s second generation is certainly less wedded to Confucianism (following in father’s footsteps) than many Asian peers at a similar point in their corporate trajectories. Credit Suisse’s Vietnam coverage head, Le Hoai Anh, highlights the competing attractions of a thriving startup scene for those who want to prove they can make it on their own.

Those entering family businesses will also face the full force of domestic and foreign competition, unlike previous second-generation Asians. “Vietnam is coming of age in a far more complex era and that will dictate who runs businesses,” Trinh said.

“As ever, it’s a balancing act between keeping the first generation’s entrepreneurialism alive, while introducing professional managers and controls into the mix,” he added. “You can be successful here but there’s an understanding that it needs to be for society’s benefit.”

The government is trying to ensure that the benefits filter down to the wider population by starting to create domestic institutions that mobilise savings and invest them into the stock market, giving everyone a stake in the country’s financial future.

One aspect that needs a lot more improvement is tertiary education to bridge the country’s skills gap and keep social mobility flowing.

“Half a century ago, the East Asians very clearly understood how important universities were for their development,” Thuy Dam Bich, president of the newly established Fulbright University Vietnam, said. “We now need to educate students who are, at the very least, capable of competing on a regional basis.”

So far, the government has outsourced the job to the non-profit sector led by Fulbright and the ever-present, Vingroup, which is collaborating with two American universities to establish the VinUni group.

It has done a better job (recently at least) of reining in the kind of debt-fuelled imperial overreach that felled some Southeast Asian companies in the 1990s, its own SOEs last decade and some Chinese companies so far this one. For while it is widening bond market participation, it is also increasing the regulatory hoops that companies must jump through to access it and refinance their bank loans.

A number of private sector groups have also called on the government to let them to partner with the state in the kind of big infrastructure projects Vietnam desperately needs to keep pace with, and help sustain, its 7%-plus growth. If it learns from other countries, Vietnam will make sure they do so on the basis of open tenders.

Visiting Vietnam, the sense of optimism about the country’s long-term economic prospects is palpable. The monopolies and the clan curse remain on the distant horizon, for now. Dragon Capital’s Stoops, for one, believes that as far as Asia is concerned, “Vietnam could yet be the exception that proves the rule.” 


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