Risk drivers and outlook

Vietnam’s economic performances have gradually recovered from a difficult period some years ago. Imbalances have been progressively repaired as shown by the current account surplus, controlled inflation, a stabilised dong and rising FDI, while external debt is at a sustainable level. Therefore, macroeconomic stability appears to have returned, as does, to some extent, investor confidence. However, the export-driven economy’s overall positive outlook faces downside  risks. The weaker global environment, the Chinese slowdown and the potential negative impact from renewed tensions with China about maritime disputes are external risks to consider carefully. Domestically, the sluggish credit growth continues to undermine a moderate internal demand whereas weak public finances prevent countercyclical measures.

Moreover, looking long-term, the resulting lower growth trajectory is hindered by structural impediments. The banking sector reform and the large privatisation plan for inefficient state companies – two key government priorities – are under way but are implemented too slowly, notably due to political resistance from vested interests within a powerful communist party. In consequence, though the economy has regained momentum and stability, it is vulnerable to materialising domestic and external risks, which explains Vietnam’s high medium-to-long-term political risk rating that is likely to linger in category 5 (out of 7). In the short term, political risk is assessed much more favourable (2/7) thanks to good liquidity indicators boosted by historic foreign exchange reserves while short-term debt is rather low.

Facts & figures

Pros

  • Political stability
  • Attractive and competitive location for FDI,notably in manufacturing
  • Diversified export sector
  • Dynamic and consumerist young population, rising middle-class

Cons

  • Poor public finances
  • Bank credit shortage hinders economic growth
  • Inefficiency and mismanagement undermine state enterprises
  • Lack of transparency and reliability of financial accounts and official data

Main export products

  • Textile (11.4% of current account receipts), crude oil (6.4%), rice (6.1%), electronics & computers parts (5.9%), private transfers (5.9%), footwear (5.5%), tourism (5.2%), fishery (4.6%)

Income group

  • Lower-middle income

Per capita Income (USD)

  • 1,730

Population

  • 89.7 M

Elections at the National Congress of the CPV (five-year cycle)

  • Next in 2016

Prime Minister

  • Nguyen Tan Dung

President

  • Truong Tan Sang

General Secretary of the Communist Party (CPV)

  • Nguyen Phu Trong

Country risk assessment

Political stability prevails despite a weakened government

Political developments over the past years have been characterised by a weakening of Nguyen Tan Dung’s government authority resulting from macroeconomic mismanagement and a succession of corruption scandals. Although the dominance of the single-communist-party system remains so far uncontested, the Communist Party (CPV) faces deepening fragmentation between conservative and reformist party factions. Moreover, since 2013, for the first time ever, the country’s top officials are subject to an annual vote of confidence from the National Assembly. This does not (yet) threaten medium-term political stability and continuity as proved by the absence of sanctions for the ruling cabinet.

Nevertheless, elites face heightened pressure – PM Dung was poorly assessed by the Assembly – to launch structural reforms, improve economic policy and governance in order to keep confidence from the CPV by the next assembly election in 2016, and particularly to preserve legitimacy under the CPV rule. To that end, a revision of the constitution allowing more economic liberalisation was voted at the end of 2013 but failed to address the need of political reforms as it only reiterated the CPV political leadership. Factors of domestic instability lie more in social unrest due to working conditions and protests against land seizure, which have become frequent and are a matter of concern for the CPV.

Conflict with China in South China Sea has eased, temporarily…

Vietnam’s foreign policy was marked last year by the worst deterioration in decades of the relations with its large neighbour China. Indeed, in a strained regional climate around the South/East China Sea, Sino-Vietnamese tensions intensified in May after Beijing allowed state oil group CNOOC to drill in waters in an area close to the disputed Paracel Islands (seized by China 40 years ago and claimed by Vietnam). Boosted by Hanoi’s nationalist stance following clashes between vessels, anti-Chinese riots erupted against Vietnam-based Chinese (and assimilated) businesses, damaging more than 200 factories, mostly Taiwanese, killing a few ethnic Chinese and leading to the repatriation of thousands of workers.

Since then, tensions have abated as Vietnam has been trying to rebuild bilateral ties. Last October, both Prime Ministers met while a Vietnamese military delegation visited Beijing, where both sides pledged to establish direct communication, to work at military cooperation and to refrain from any provocative activities in disputed areas.

Vietnam has an obvious interest in maintaining good relations with its first trade partner, which, in addition, has a huge military superiority. However, China’s rising military power and Vietnam’s strengthened security and military cooperation with the US do not bode well for their future relations. Therefore, escalated tensions and new clashes in the South China Sea are likely in the future with possibly unintended consequences.

Prolonged subpar economic growth albeit in slow recovery

Vietnam’s economic growth – which was at more than 8% before the country was hit by balance of payment difficulties in 2008-2011 and a banking crisis in 2011-2012 – has slowly recovered and its macroeconomic stability has been restored. Nevertheless, as a consequence of economic adjustment in a context of weaker global environment, Vietnam has seen its average growth trajectory fall to a more moderate 5.5-6% per annum, i.e. below the 7.6% rate recorded in 2000-2007.

As one of the most export-oriented economies (the country has Asia’s highest merchandise trade ratio at 75% of GDP), Vietnam’s manufacturing sector (textile, electronics) is understandably hit by a weaker demand from advanced countries, notably the EU. Improved US forecasts could however benefit the demand for Vietnamese goods in the future as the US market accounts for 17% of them. Tourism (5% of total exports) was performing well until maritime tensions occurred and had a sharp negative impact on Chinese tourist arrivals (20% of total visitors). It remains to be seen to what extent last year’s tensions will weigh not only on future tourist receipts but also on FDI inflows as China accounts for 10% of total FDI (many through relocation of the textile industry).
Although bilateral links have recently improved, the fact that China temporarily banned its state-owned  enterprises (SOEs) to conclude contracts with Vietnam after anti-Chinese riots, shows looming economic risks as tensions in the South China Sea could resume in the medium term. This adds to the structural economic slowdown of China, its first trade partner. Still, despite downside external risks and a subdued domestic demand – notably due to a lower credit supply – clouding the outlook, exports record overall strong growth thanks to a  high diversification (including many commodities from oil to rice and fishes) and contribute to a great deal to keep GDP growth at a high level.

Improved fundamentals on the back of strong exports and FDI

Those domestic and foreign developments combined with policy adjustments have allowed Vietnam’s current account to be in surplus since 2012. This surplus is forecast to gradually decrease over the years and turn into deficit as internal demand picks up. However, the recent sharp drop in oil prices is expected to have an overall favourable positive impact on Vietnam’s economy and current account as the country is a (small) net fuel importer. Its balance of payments is more robust today with strong FDI and rising inflows (especially in manufacturing and electronics/computer parts from Korean and Japanese groups given Vietnam’s many competitive advantages) as investor confidence in Vietnam improves together with the country’s fundamentals. Investors, especially Japanese, are attracted by the ‘equitisation’ process, namely the new privatisation wave (limited to the sale of minority shares) of SOEs in sectors like garment, infrastructure or transport.

The US monetary tightening, expected in the second half of 2015, could affect Vietnam’s economy through trade, indirectly via China, Japan and the EU, and some capital volatility as in mid-2013 when short-term capital  outflows were recorded. This is nevertheless a low risk to medium-term stability given the current account surplus and low amounts of portfolio investments. Macroeconomic stability has indeed been strengthened. Inflation has left the double-digit area since 2012 as a result of slower growth, weaker domestic demand, Hanoi’s monetary tightening significantly squeezing credit supply, and lower imported commodity prices. Much reduced oil prices have exacerbated the decline of the consumer price inflation rate to a decade-low around 2% according to recent national official data. In the coming years, it is expected to remain on average under 5%. Those developments have contributed to the dong stabilisation, a sign of enhanced confidence after constant currency pressure that  led to several devaluations between mid-2008 and 2011.

Vietnam_Graph1EN

Forex at a record level

External liquidity, Vietnam’s usually biggest financial concern, has improved on the back of historically high  foreign exchange reserves. In the first half of 2014, they soared by 38% from their end-2013 level thanks to  strong exports and workers’ remittances, and a stabilised dong without requiring central bank intervention (despite a small devaluation last June to further support exports). This increase allows foreign exchange reserves to cover 2.5 months of imports, which still keeps Vietnam chronically under the 3-month threshold. This fares poorly with regional peers, but the higher volume of foreign exchange reserves makes future debt service payments, stable around 3% of export receipts, more comfortable.

A low debt service is explained by an external debt that remains mainly concessional – but this share is going down with Vietnam’s middle-income status – and is judged sustainable with manageable debt ratios. The foreign debt-to-GDP ratio is expected to remain stable around 38% in the medium term. The mostly positive economic outlook is likely to keep the debt profile largely unchanged.

Public debt further widens

Yet, Hanoi is faced with many challenges. One is related to budget conditions that had worsened with the post- 2008 expansionist policy aimed to boost economic growth. Given the absence of consolidation, increased public investment spending and much lowered structural fiscal revenues, the budget deficit persists at record levels and is to remain above an average 6% of GDP in 2012-2015 before slowly decreasing towards 4% by 2019. Therefore, sharply lowered oil prices, considering also the negative impact on state oil revenues, offer an ideal opportunity to cut heavy fuel subsidies (2.5% of GDP in 2012). The government plans to take this necessary step, as witnessed in other Asian countries (e.g. India, Indonesia, Malaysia…), without fuelling much inflation.

Meanwhile, public debt remains on a rising trend to reach one of the region’s highest levels, expected at 54.8% of GDP in 2014 from 46.7% in 2011, and up to 60% in 2017, with a mainly growing domestic share, though. Moreover, it is burdened by contingent liabilities from weak SOEs and state-owned commercial banks whose amounts are estimated at around 10% of GDP, but the implicit state support has become all but guaranteed since the Vinashin scandal1 in 2010.

Vietnam_Graph2EN

1 Faced with the near bankruptcy of a major state-owned conglomerate (Vinashin), the government initially refused to bring its financial support to repay foreign creditors.

Two government priorities: an ongoing but difficult banking sector reform…

In addition to budget constraints, two other challenges for the country correspond to the government’s top priorities: reforming the banking sector and the state-owned sector. The process is under way but has to proceed at a faster pace to put the economy on a sustainable long-term path. The banking sector crisis, fuelled by years of sustained credit growth, has been overcome but underlying difficulties have not gone. Heavy non-performing  loans (NPLs), estimated at around 15% of total loans (i.e. far above the officially reported 4%), are still on the rise (notably as a result of tighter classification criteria for bad debts), harm confidence, penalise credit supply and so undermine the private sector development. Credit growth has indeed sharply slowed down to a low 3.5% in the first half of 2014, together with GDP growth. The lingering credit shortage is indeed an important factor to Vietnam’s subpar economic growth.

Vietnam_Graph3EN

In July 2013, the central bank decided to set up the Vietnam Asset Management Company (VAMC) to purchase bad debts from the banks’ balance sheets and swap those with VAMC bonds of 5-year maturity. This means that the NPL problem will linger for several years. The partial and temporary cleaning up of many banks’ balance sheets is welcome but does not resolve structural problems. Not all debts can be purchased and further regulatory changes and bank restructuring are required to prevent credit risks from reaching new highs.

Though banks – the largest are state-owned – have become more liquid, they would need a capital injection to cope with poor asset quality, but that is not part of the government plans. Moreover, the planned consolidation (from 40 to less than 20 banks) is complex – because of lacking risk management skills – and hindered by political resistance within the CPV. Therefore, even though the recent prison sentence for the Asian Commercial Bank’s founder highlights Hanoi’s pledge to change bad practices in the banking system, reform implementation remains a hard task, especially with a weakened government.

…and a possibly accelerating privatisation process

The second key structural reform, namely the large partial privatisation of SOEs, seems to accelerate momentum since 2014, as evidenced by the national carrier Vietnam Airlines’ recent IPO. The SOEs’ inefficiency and bad financial situations were to some extent also to blame for the banking crisis, so that the banking sector might benefit from better managed SOEs. The state is not to give up its majority in SOEs, particularly in strategic sectors, but will rather reduce its participation in 40% of about 1,000 existing SOEs, while generating extra public revenues. Still, the ‘wait and see’ attitude is the best one to adopt given mixed past experience of a similar process and persisting lack of transparency of SOE financial accounts.

Those structural problems, the state’s persisting economic dominance and interference remind us that Vietnam’s transition to a fully free market economy is not completed. An amendment of the constitution at the end of 2013 promoting a Chinese-like model with a socialist-oriented market economy in which the state plays a leading role, has not contributed to entirely rebuilding investor confidence as it tends to preserve the status quo.

Analyst: Raphaël Cecchi, r.cecchi@credendogroup.com