Risk drivers and outlook

Vietnam’s diversified economy continues to enjoy a strong momentum, driven by exports and FDI in the manufacturing sector, more specifically ICT. The country benefits from Asian multinationals relocating away from China in search of lower labour costs and also those attracted to Vietnam’s pro-trade position and multiple Free Trade Agreements (FTAs). As a result, economic fundamentals have strengthened over the past few years, from a comfortable balance of payments to moderate inflation and a rather stable currency in 2016. Under a new government guaranteeing political stability, the medium- to long-term (MLT) outlook is positive, with GDP growth forecast to remain above 6%. The level of financial risk is acceptable, with weak debt service on a moderate external debt that has nevertheless rapidly increased since 2015. However, certain downside risks cloud this otherwise bright picture. As an export-led and open economy, Vietnam is threatened by exogenous shocks, starting with the impact of Donald Trump’s protectionist trade policy from the potential end of the Trans-Pacific Partnership (TPP) to potentially higher US import tariffs on Vietnam’s important garment sector. Furthermore, the impact of a global context characterised by capital repatriation and depreciating pressures against a strong USD might not be neutral for Vietnam, which notably has a limited foreign exchange reserve buffer, though risks appear manageable. Internally, two persistent fragilities penalise the country, namely relatively poor public finances – including a relatively high and rising public debt – and a vulnerable banking sector. These risks contribute to keeping Vietnam’s political risk rating (4/7) for the MLT at a higher level than for the ST (3/7). In the future, maintaining macroeconomic stability will require not only progress on fiscal consolidation, but also the acceleration of ongoing reforms for banking sector and state-owned enterprises (SOEs), beyond the slight increase observed in 2016. The need for these reforms, together with issues such as corruption and political interference in justice, highlight Vietnam’s incomplete economic transition and explain its high commercial risk (C/C).

Facts & figures

Pros

  • Political stability
  • Economic openness and diversification
  • Attractive investment destination (dynamic workforce, competitive labour costs)
  • Moderate external debt

Cons

  • Dominant and mismanaged SOEs
  • Exposed to external shocks
  • Weak public finances
  • Vulnerable banking sector

General Secretary of the Communist Party (CPV)

  • Nguyễn Phú Trọng

President

  • Trần Đại Quang

Prime Minister

  • Nguyễn Xuân Phúc

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

  • 2021

Population

  • 91.7 million

Income per capita

  • USD 1,980

Income group

  • Lower-middle

Main export products

  • Phones and parts (16.7% of current account receipts), textiles/garments (12.6%), electronic and computer parts (8.6%), footwear (6.6%), private transfers (4.1%) and tourism (4.1%)

Country risk assessment

A stable political environment supports policy continuity

The election of Vietnam’s new leadership at the 12th National Congress of the Communist Party (CPV) in January 2016 made a clear choice for political continuity. The unexpected non-promotion of Prime Minister (PM) Dũng to General Secretary was due to internal criticism within the Party regarding his responsibility in mismanagement and corruption within SOEs, particularly Vinashin’s default in 2010. Therefore, the conservative General Secretary Nguyễn Phú Trọng was re-elected, while the more liberal Nguyễn Xuân Phúc was chosen as the new PM. Those choices will favour the medium- to long-term (MLT) status quo.

Political stability should also prevail given the rare protests – strengthened, however, by a tighter crackdown on political dissidents – against the CPV-driven political system. Protests of a social nature concerning labour conditions in the manufacturing sector, environmental degradation and contentious land acquisitions are more frequent, reflecting a heightened public awareness and the use of social media. Public protests are generally peaceful and take place on a small scale. An exception to this occurred in May 2014, when unprecedented violent attacks targeted Chinese factories and workers across the country following soaring tensions with China after a clash about the disputed Paracel Islands in the South China Sea.

Policy-making remains unchanged under the current government, with a positive stance vis-à-vis FDI and trade and the aim to imitate the Chinese model. Moreover, the government continues to take gradual steps towards long-standing reforms, notably concerning economic liberalisation and SOE restructuring. In this regard, caps on foreign ownership are progressively eased in a rising number of sectors, even allowing full foreign participation in a few areas. The reform process keeps moving forwards under the new PM, but is inevitably slowed by vested interests.

Opting for more balanced foreign relations

Vietnam’s foreign policy balances between its Chinese neighbour and western powers, particularly the USA. Relations with the latter have greatly improved over time, to the point of the country becoming a key ally. This is particularly true for defence and security cooperation, recently culminating in the historic lifting of the US arms embargo. Although these tightened bilateral ties are expected to continue under Trump’s presidency, Hanoi is likely to diversify its ties with the ASEAN as a counterweight to Beijing. Even though relations with Beijing have normalised since the intense tensions of 2014, in the future Hanoi should consolidate its army and navy after a rapid modernisation in recent years. Hanoi wants to have good relations with Beijing, firstly for obvious economic reasons. However, China’s potential moves in the coming years regarding the disputed islands will maintain a high risk of tension and escalation between two nationalist governments.

Vietnam’s economic openness and diversification boosts economic momentum

As one of the best-performing and most diversified in South-East Asia, Vietnam’s economy is again enjoying the strong momentum and promising position as it did prior to the 2008/2009 global crisis. Despite agricultural crops being harmed by historically severe droughts in 2016, GDP growth has picked up to reach 6.3% in 2014-2016 and is forecast to reach 6.2% in the MLT. The successful return to macroeconomic stability again happens on the back of strong exports in manufactured goods – amounting to three quarters of goods exports – and FDI.

This time, the current expansion was achieved through a transformed export structure, with a rapid shift to a rising hi-tech content in manufacturing: the electronic, computer and phone sectors account for the most substantial share of exports. In just a few years, the ICT industry as a whole has become the biggest source of export earnings, accounting for more than 25% of total exports of goods and services with 16% accounting solely for the phone sector, boosted by production from Samsung’s plants. This partly explains solid export performances despite a less supportive global demand.

The positive FDI evolution largely results from Asian multinationals relocating their activities from China and consequently benefiting from relatively lower and regionally competitive labour costs. In addition, acceptable infrastructure, a dynamic workforce and the general business-friendly environment explain why Vietnam is a favourite destination of foreign manufacturers for new investments. Today’s investor attractiveness also comes from the slight acceleration of the liberalisation process under the new government (see below) and Vietnam’s pro-trade and open economy, as shown by the multiple FTAs.

Strengthening macroeconomic conditions

Improved macroeconomic conditions translate into a robust balance of payments. On the one hand, Vietnam’s fast-growing exports allow the current account to be approximately balanced. Given Vietnam’s net fuel importer position, this positive result is strengthened, and likely to remain so by lower-for-longer oil prices. On the other hand, the balance of payments benefits from a constant upward trend in FDI, with net flows impressively up 60% between 2014 and 2016. MLT forecasts are positive for exports and FDI.

As a result, the Vietnamese dong (VND) has remained largely stable in 2016, even despite the shift to a more flexible exchange rate system (i.e. adjusted daily to a basket of foreign currencies and fluctuating by a maximum of 3% around a trading band with the USD). In addition, financial conditions are favourable towards consumers and domestic activity as lower oil prices allow inflation to be moderate and interest rates cut to lower levels in order to stimulate internal demand. This matters greatly for future GDP growth, as domestic demand keeps increasing alongside a dominant export sector (exports of goods and services weigh nearly 95% of GDP).

Trump’s protectionism might cloud the outlook

Trump’s protectionist trade policy is a downside risk to Vietnam’s positive outlook, as the USA is its primary export market. The announced US withdrawal from the TPP is bad news for Vietnam, as Asia was expected to be a major beneficiary. The potential TPP replacement by China’s Regional Comprehensive Economic Partnership, a less ambitious and more classic FTA, would still allow Vietnam to make some advances. A bigger risk – potentially mitigated by good bilateral relations – might come from potentially higher US import tariffs. This would harm Vietnam’s textile and garment sector, the country’s second-biggest source of export income, which relies on the USA (the top export destination) for 50% of goods.

Until now, Vietnam has barely been hit by capital repatriation and currency depreciation pressures following Trump’s election in November. A more volatile and uncertain international environment leading to capital outflows from emerging countries would certainly have the potential to affect Vietnam and its currency, especially if the RMB keeps depreciating. However, the country’s solid balance of payments, bright economic prospects and political stability might help it to withstand external pressures. In this context, an adequate government macroeconomic policy will be decisive. Moreover, the high number of bilateral FTAs, including the one with the EU, its second-biggest trade partner, is expected to stimulate exports and FDI in manufacturing and thus further support Vietnam’s strong growth potential.

Weak public finances and the banking sector remain two persistent risks

Despite an economic resurgence, Vietnam’s MLT outlook remains restrained by two persistent weaknesses, namely steadily deteriorating public finances and a vulnerable banking sector. Public debt (including guarantees amounting to 12% of GDP) is high at an expected 62% of GDP in 2016 after having soared by 35% since 2011. This is explained by tax cuts, weaker oil revenues and higher interest charges (from 4.1% to 9.3% of revenues in 2011-2016), which have led to an average 6.6% budget deficit. The public debt’s upward trajectory, also widened by bank restructuring costs, is mainly in local currency as its external share has decreased from 51% to around 36% over the period concerned. Public debt growth is forecast to slow down in the future, but this will depend on fiscal consolidation – which foresees gradually falling budget deficits – and hard-to-assess contingent liabilities from SOEs and SOCBs.

As for the banking sector, its health and NPL situations have improved on the back of strong economic performances, increased liquidity and the sale of a (small) share of NPLs to Vietnam’s ‘bad bank’ (VAMC) since 2013, thereby starting a clean-up process of banks’ balance sheets. Furthermore, regulation and supervision have made progress, several domestic banks have merged and foreign banks have been allowed to buy certain weak Vietnamese banks. However, NPLs are still large (estimated to be much higher than the official 2.6% rate), too slowly resolved by the VAMC and insufficiently provisioned, polluting the banking sector and clouding the economic outlook. In this situation and given budget limits for substantial recapitalisation, Hanoi has to attract more foreign capital in the sector, as highlighted by its recent decision to raise the 30% cap on foreign stakes. Moreover, the slightly better shape of banks has allowed for a faster expansion of credit (particularly to the financial and real-estate sectors) since 2015. This raises concerns of renewed risks of financial instability in a country where credit to GDP was expected at 121% of GDP in 2016, i.e. close to its pre-credit squeeze level in 2010. Therefore, in its restructuring of the banking sector, the government will have to focus on tackling the problem of NPLs, strengthening risk management, capital buffers and raising transparency.

Economic restructuring at a slow pace

Meanwhile, the economic transition is moving forward. Though the State continues to dominate the economy, the privatisation of SOEs has slightly accelerated under the new government after foreign investors were allowed to have a bigger stake in large SOEs active across a broad range of sectors (e.g. banks, telecoms, food, insurance, etc.). This development is good not only for FDI and public infrastructure plans (using privatisation earnings), but also for SOEs. The latter are likely to benefit from upgraded financial management and increased profitability, especially as they must be prepared to face greater foreign competition within the context of FTAs and the ASEAN Economic Community.

Moderate external debt, insufficient liquidity buffer

External debt has rapidly picked up over the past two years, with a jump of 26% in absolute terms and 17% of GDP to bring the debt-to-GDP ratio to around 45% in 2016, a record high this century but still a moderate level according to the emerging market standard. The surge is mainly due to the private sector on the back of strong SOCB credit growth. According to recent IMF forecasts, external debt ratios should stabilise in the MLT at this reasonable level. External debt service is constantly low at under 5% of export receipts, reflecting moderate external debt and proportionally longer maturities that mitigate repayment risks related to a strong USD. In any case, looking ahead, compared with several years ago, when concessional financing from international creditors dominated, Vietnam’s heightened share of private debt might at some point translate into higher refinancing costs for the country.

Foreign exchange reserves are at a historic peak after a strong 2016. Though they cover more than twice the ST debt, the import cover is for the most part (excluding 2007/2008) below the adequate three-month threshold (2.3 last September), due among other things to strong imports (from FDI-related capital goods imports) and the use of foreign exchange reserves to defend the VND in the face of depreciating pressures.

The latter risk, potentially exacerbated by a climate of capital outflows and regional currency depreciation, might ease with a slightly more flexible VND. In the meantime, the near absence of a foreign exchange reserve buffer leaves Vietnam vulnerable to a change in investor sentiment. Therefore, maintaining investor confidence will be of primary importance to Hanoi.