By Steve Garton
Soaring inflation and a 46% drop in share prices in the first three months of 2008: all eyes are on Vietnam’s policy response as Asia’s star performer grapples with overheating
Early last year, talk in Vietnam turned to surfing. Not the water sport, but the practice by retail investors of riding the high wave of the country’s burgeoning young stock market. The term seemed to capture the sense of abandon about a market whose main index rose by 100% in 2007. Tall tales of 150% returns from stock market funds became commonplace and fed a feeling that Vietnam’s economy was booming.
But as all surfers know, every wave eventually breaks: this year, the market has already sustained serious losses. By March 25, the benchmark VN index had fallen 21% since the start of the month and 46% since the beginning of the year. Disgruntled investors protested outside the State Securities Commission headquarters in central Hanoi.
Many cite inflation as their main concern, while confidence in the government’s fiscal policy has ebbed.
The collapse was so worrying that the commission had to narrow the share trading bands on both the Ho Chi Minh City and Hanoi exchanges, stopping rises or falls of more than 1% a day and 2% a day respectively. The State Capital Investment Corp also had to buy up stock in an unspecified number of listed companies to calm investors.
Rising prices
Although international investors remain optimistic about the country’s long-term economic prospects, high inflation and weak banking regulations will cause more problems in the immediate future, they say. Price movements on the young stock market will only affect a small fraction of the population, but inflation is hurting everyone. “The first order of business is to bring inflation under control,” says Ifzal Ali, chief economist at the Asian Development Bank in Manila. “If Vietnam cannot bring inflation under control, it will seriously undermine the stability of its growth process.”
Consumer prices rose by 16% in the year to February 2008, and by 19.4% in the year to March, pushed up by rocketing food and commodity prices. Domestic food prices in Vietnam – a net exporter of rice – increased by 31% a year in March, and the potentially dangerous social consequences have ensured that the government’s full attention is now focused on combating further price rises.
Inflation has risen so sharply that it is endangering economic growth. “The government has had to lower its growth target for the year from 9% to 7.5%,” says Amber Rabinov, an economist at ANZ in Melbourne. “They have realized that they can’t push for such strong growth while inflation is running so high, which we think is a sensible decision.”The IMF recently warned Vietnam that its economy was in danger of over-heating, pointing to rapid credit growth as a cause of inflation, and policy-makers in Hanoi are now fighting the problem. But that does not necessarily mean the price rises will be reined in quickly. “The government began taking steps to combat inflation in December, widening the dollar/dong trading band, raising reserve requirements and increasing interest rates, but these measures have not flowed through yet,” says Rabinov. “These things take time.”
It also limited securities lending to 3% of total outstanding loans, which quickly took the edge off speculative investment in the stock market and contributed to the share price correction. Monetary policy was further tightened at the end of last year, raising reserve requirements for banks and increasing interest rates.
The wrong direction
These anti-inflationary measures have been broadly welcomed, although some believe the government’s focus has been misplaced. “So far the government’s toolkit has been focused on monetary measures to slow credit growth,” says Dominic Scriven, a director of Dragon Capital, a Vietnamese-based investment bank which manages four foreign funds. “We accept these are useful in combating inflation, but the government needs to address its foreign exchange policy and consider the balance between export competitiveness and imported inflation.”
Vietnam closely manages its foreign exchange rate, with the central bank promoting a weak dong policy since the late 1980s to make the country’s exports more competitive. In recent years, however, that has contributed to the build-up of domestic liquidity, adding to inflationary pressures.
The State Bank of Vietnam has only recently shifted this focus, allowing the dong to gradually appreciate against the US dollar from the last quarter of 2007. The dong/dollar trading band has been widened twice since December 2007, and spot rates are free to range 1% from an official rate set daily, compared to just 0.25% in late 2006. A 2% trading band has now also been approved in principle.
“Other countries in Asia, including India and China, have allowed their currencies to appreciate 9–15% against the dollar, whereas Vietnam has allowed a move of less than 1%,” says Charly Madan, chief operating officer for Vietnam at Citi in Ho Chi Minh City. “We would have liked to see faster dong appreciation, given that a large amount of Vietnam’s inflation is imported.”
High domestic liquidity and rising asset prices are not the only reasons for rising inflation. Food prices, which account for 40% of Vietnam’s sole consumer price index, rose 31% over the year to March 2008, because of rising global commodity prices. In late March the government tried to ease some of that pressure, introducing a tax on rice exports and limiting total exports for the first 10 months of the year to reduce domestic prices of the grain.
Vietnam also imports inflation by buying capital equipment to fulfil the country’s public works projects. That, too, is being addressed through curbs on public-sector investment announced at the end of March as part of a seven-point plan to combat inflation. “Price-based inflation is the biggest concern, and Vietnam has little control over global commodity prices,” says Scriven. “Only in the last few weeks has the government acknowledged the need for a stronger currency that may need to strengthen by more than it is officially allowed.”
The banking system itself has now come under examination. Monetary policy was tightened after credit growth reached an estimated 50% last year, but there are growing calls for the sector to consolidate. Vietnam already has more than 80 banks, and tougher rules on minimum capitalization requirements do not come into force until the end of 2009. “There are concerns given that many banks are very small,” says Citi’s Madan. “A number of new banking licences were issued in the last year or two when really we should be looking for consolidation to strengthen the industry.”
Opening up
Foreign banks have a market share of 10–12% by assets, and are limited to 15% stakes in Vietnamese lenders. Madan and other international bankers are calling for those restrictions to be lifted, although he admits that the topic is not yet on the table. “Allowing foreign banks to lead the consolidation process would be good for the industry,” he says.
Spiralling inflation remains the biggest short-term worry for policy-makers and money managers alike, but international investors remain convinced that Vietnam is going through no more than a short blip on an otherwise positive growth curve. “Vietnam has been the second fastest-growing economy in Asia for the past decade, and the long-term prospects for growth are still very good,” says Rabinov at ANZ. “It’s growing from a very low base, and per capita GDP is still under $1,000. The potential upside is massive.”
Economic growth remains fast, with real GDP growth consistently above 7.5% since 2000, and at 8.5% for 2007. Foreign direct investment (FDI) reached $2 billion in 2007, with commitments for new and existing projects in the same period totalling $20 billion. “I am not surprised FDI growth is running so high,” says Scriven. “Vietnam has improved its terms of trade dramatically and is one of the most export-competitive destinations in the world, and opportunities in the infrastructure sector are growing fast.”
BIG opportunities
Vietnam’s natural resources, growing consumer base and abundance of cheap labour still attract some investment from manufacturers despite the short-term malaise. Once inflation is under control, foreign investors will target the infrastructure sector, where international build-operate-transfer projects are likely to be the next big opportunity. Vietnam needs to invest heavily in the power and transportation sectors, as well as meet rising demand for residential and commercial property – private investors hope to play a role. Private finance has already been tested on some small power projects.
“The next big opportunities will come in the infrastructure and natural resources sectors,” says Alex Hambly, the former chief executive in Vietnam of Prudential. “Both require massive investment and hold huge potential but are very tightly held in state hands, and opportunities are hard to access.”
There is even an argument that the slide in the financial markets could have distant benefits. “From a long-term point of view, the dip in stock prices is a positive, absolutely,” says Scriven. “People who participate in these markets need to know they can go down as well as up.”
Retail investors were not the only ones surfing at the start of 2007. The same could be said of Vietnam itself, riding a wave of unbridled economic optimism. That wave has now broken, but if Vietnam can convincingly combat inflation, there could be many more to come.
“There are internal and external problems that come with a very young banking system and a country that has close trading ties to the US,” says Hambly. “But are they serious enough to derail growth? I don’t think so. Vietnam has 85 million consumers, a stable political party and no real social unrest – on a five- to 10-year view, it’s still a compelling story.”