Inflationary pressures weigh on Vietnam's prospects

KUALA LUMPUR: The Vietnamese government’s Ba3 foreign and local currency bond ratings are supported by the progress made in externally oriented policies and state enterprise restructuring and reform, according to Moody's Investors Service global sovereign report issued on Monday, Dec 21.

Prospects that Vietnam can continue on a path of relatively rapid economic growth seem favorable, if policies are supportive. Public finances are manageable, even though the deficit has swelled as a result of a robust stimulus package and the adverse effects of the global financial crisis and recession.

Difficulty in balancing pro-growth with stabilization policies is allowing inflationary expectations to regain hold while balance of payments weaknesses persist. The global recession has also exacerbated Vietnam’s external imbalances. Measures taken recently have yet to stem downward pressure on the exchange rate or arrest the drain of official foreign exchange reserves according to available information.

Credit challenges are considerable enough to justify a negative rating outlook, but Vietnam’s credit fundamentals still support its Ba3 rating. The efficacy of the authorities’ policy tightening and the extent to which the global economic recovery provides uplift to Vietnam’s very open economy will be key determinants to the outlook for the rating.

Vietnam’s relatively weak institutional strengths, transparency and rule of law, constrain the rating as well, despite improvements in policy formulation and communication. Although the economy grew rapidly in the decade following the Asian financial crisis, per capita income remains low among its Ba-rated peers.

A record of strong growth, but with inflationary pressures and somewhat dimmed prospects

Vietnam’s record of 7.2 percent per annum real GDP growth in the decade after the Asian financial crisis has more than doubled the country’s per capita income. Yet at about US$1,100, it remains low relative to Ba-rated peers.

Growth performance was similar to India’s and placed Vietnam among the front ranks of rapidly growing emerging market economies. This was a direct result of the external orientation of the economy. Total foreign trade amounted to about 170% of GDP in 2008, up from about 90% a decade ago.

Yet Vietnam’s US$100 billion economy remains relatively moderate in scale. While the downturn in global trade dims somewhat Vietnam’s prospects for continued rapid economic growth, the country’s growth model may remain relatively vigorous.

Like Thailand and Indonesia, Vietnam’s export-led manufacturing sector is balanced by a sizable commodity sector. Vietnam is the world’s second largest exporter of rice, and other agricultural and fishery products are also important exports.

Oil production was brought on stream in the late-1980s but output peaked at 400,000 barrels a day in 2004 and has since declined to about 300,000 barrels a day. Natural gas production has, however, risen steadily and coal is a growing but modest part of the country’s energy mix.

A challenge to macroeconomic stability, however, is the rise in inflation since 2007, which peaked at almost 30 percent in mid-2008. Although the moderation in commodity prices since 2008 and the collapse in demand from the global recession have dampened inflation, underlying pressures are evident. If left unchecked, such pressures threaten to aggravate the country’s external balance of payments imbalances, which had moderated in 2009. Inflationary pressures in Vietnam readily create a negative feedback loop on the exchange rate.

Fiscal and monetary measures taken by the government to support the economy in the wake of the global financial crisis and recession have been successful in reversing the sharp slowdown in economic activity in early 2009.

We expect real GDP growth to recover to between 5% and 6% in 2009 and 2010. This assumes that growth in exports of goods will bounce back into the double-digit range in 2010 after the sharp contraction in 2009. This would take up slack from a scaling back of fiscal stimulus measures.

Long-term growth prospects will also hinge on balancing growth with price and exchange rate stability. In addition, economic resiliency would be enhanced by the advancement of structural reforms. A new budget law intended to be introduced in 2010 is to develop a medium-term fiscal framework, and perhaps it will also simplify complicated budget and off-budget transactions.

Although the private sector has expanded rapidly, the pace of state-owned enterprise (SOE) reform has slowed in the wake of the global economic crisis. Some SOEs, including the third and fourth largest banks, have been listed on the stock exchange and more will be in the future. The State Capital Investment Corporation was established in 2006 to shepherd equitization (partial privatization).

The government does, however, intend to speed up the equitization and listing on the stock exchange of the remaining non-strategic SOEs. But large SOEs will continue to dominate the economy.


Slow progress in reform

Vietnam’s transition from a centrally planned to an export-led, more market-based economy has achieved much in boosting output and employment since the “Doi Moi” reform policy began more than 20 years ago. Institutional reforms, however, have in some respects lagged developments in the real economy.

In its most recent Article IV Consultation Staff Report, the IMF notes that Vietnam lacks effective public communication which is needed especially to bolster confidence in turbulent times. Clearer communication of policies to the public and timelier and higher quality data would allow for a more informed and improved analysis of fiscal, monetary and external liquidity developments—most importantly for the authorities themselves, but also for the international financial community.

The IMF cites a perception gap between the public and the authorities on financial soundness, for example. And Moody’s notes that the lagged provision of timely information on the country’s international liquidity, compared with Vietnam’s rating peers, hampers its credit analysis.

The World Bank’s Government Effectiveness and Rule of Law governance indicators rank Vietnam in a relatively low position globally, although the country’s rankings have been on a gradually improving trend over the past decade.

Moreover, relative to its global income category (10th-25th percentile), Vietnam’s governance indicators for these two areas are higher—in the 25th-50th percentile. Vietnam’s governance rankings are ratings more or less consistent. It ranks above its B1 near peers (Belarus, Fiji, Mongolia and Papua New Guinea) but below its Ba3 peers (Philippines, Turkey and Uruguay) for both categories. A notable exception is Vietnam’s Rule of Law ranking, which is higher than that of a regional near peer, Ba2-rated Indonesia.

Vietnam’s integration into the global trade and financial systems has been facilitated by a number of key international agreements. Trade agreements came first, and now investment agreements are being negotiated. These will help improve the country’s economic institutional strengths in the areas of investment protection and dispute arbitration, the free transfer of capital and non-tariff trade barriers.

The first major trade agreement was the Framework and Cooperation Agreement signed with the EU in 1995. Next was the bilateral trade agreement with the US in late 2001, and which was followed by the establishment of Permanent Normal Trade Relations in 2006.

The latter set the stage for Vietnam’s accession to the World Trade Organization (WTO) in early 2007. The Japan-Vietnam Economic Partnership Agreement, which came into force in October 2009, will help further boost Vietnam’s foreign trade.

Investment agreements are currently being negotiated with the US and EU. Vietnam concluded a Trade and Investment Framework Agreement (TIFA) with the US in 2007 and the two countries are currently negotiating a Bilateral Investment Treaty (BIT). Moreover, Vietnam and the EU are negotiating a similar Partnership and Cooperation Agreement.


Ample finance-ability helps withstand pressures

Vietnam may be the first emerging market economy in Asia to exit from both fiscal and monetary stimulus measures. In response the rising inflationary pressures and ongoing balance of payments weaknesses, the State Bank of Vietnam raised its policy rate 100 basis points and devalued the exchange rate by five percent in December 2009.

Moreover, the Ministry of Finance announced that it will halve its interest rate subsidy scheme in 2010 and will also seek to contain investment spending.

Such demand management measures may help lower the budget deficit from an estimated 8% of GDP in 2009 to 5% of GDP in 2010. The adjusted general government deficit has tended to fluctuate between 2% and 5% of GDP in the past five years. This includes development spending on education and infrastructure. The official government budget, in contrast, shows a rather narrower deficit of 4.5% of GDP for 2009 and 3.9% for 2010.

The gap between the two budgetary classifications is due to large capital spending which, however, is necessary to remove infrastructure bottlenecks and to build up the country’s industrial capacity, which is still highly dependent on imports, although the country’s first petroleum refinery was completed in 2009.

Trend revenue performance has improved. Total revenues rose to around 28 percent of GDP before the onset of the global financial crisis from less than 20 percent in 1999. The rise in tax revenues had been in part due to oil-related revenues, which accounted for about one-third of total revenues at the peak. Buoyancy in non-oil revenue generation has come from a relatively sound value-added tax base, real estate taxes and improved administration. Foreign grants provide less than one percent of total revenues.

The government is relying more on domestic debt to finance its deficits. The country’s high savings rate, about 30 percent, is adequate to help shift financing to domestic from foreign sources. Less than one-fifth of the narrow government deficit (excluding development spending) is to be financed externally in 2009.

As a result, foreign currency government debt has declined – as a share of total government debt – to an estimated 60 percent in 2009 from a peak of 85 percent in 2000. Including government guaranteed debt, however, the share amounted to about 70 percent at the end of 2008.


Roughly 90 percent of long-term external debt is highly concessional official development assistance loans (ODA). Confounding previous expectations of a decline in ODA, in December 2009 the Consultative Group of donors, mainly consisting of the World Bank, ADB, EU and Japan, announced a hefty increase in commitments to US$8 billion from the US$5 billion pledged in 2008.

The affordability and finance-ability of Vietnam’s general government debt are adequate and consistent with a Ba rating range. The ratio of interest-to-revenues is in the single digit range, and the trend was stable before the onset of the global crisis. General government debt to GDP will likely remain comfortably below 40% of GDP in 2009 and 2010, and the ratio of debt-to-revenues may hover around 150%. All three metrics place Vietnam in a slightly favorable position when compared with the broad Ba rating cohort.

Moreover, the IMF considers that Vietnam’s public debt, including wider public sector entities, is sustainable. Such may rise gradually but level off at around 50% GDP over the medium term. This assumes annual real GDP growth of around 7% and further banking and enterprise reforms.

Low risks have supported placement in the Ba range

Vietnam’s political, economic and financial event risks are low. This constellation places the country in a relatively favorable position when compared with its rating peers and near pears, especially B1-rated countries which are generally more fraught with underlying vulnerabilities that could prompt an abrupt, multi-notch rating downgrade or default. Our assessment of event risk is supportive of maintaining Vietnam’s ratings in the broad Ba rating category, despite underlying economic and financial pressures.

Vietnam’s social and political system is characterized by stability. The Communist Party’s support and credibility are founded on its nationalist credentials in freeing the country from colonization and more recently in promoting economic development as a national priority rather than ideological orthodoxy.

The 10th Party Congress held in April 2006 affirmed a reform strategy focused on expanding the role of the private sector, while retaining a strategic role for the state sector. Government ministerial-level agencies were restructured and new deputy prime ministers named in August 2007 with a further emphasis on accelerating economic reform. The next Party Congress will be held in 2011.

Balance of payments (BOP) risks are of most concern and have prompted us to maintain a negative rating outlook. The downturn in global trade and collapse in Vietnam’s export performance, coupled with fiscal stimulus driven imports, have widened the current account deficit.

The large ramp-up in the current account deficit in 2008 and 2009 exceeded financing that had previously been amply provided by FDI inflows. Although ODA-driven net external financing has continued to support the BOP, this has been overwhelmed by other capital outflows as reflected in the sharp increase in negative errors and omissions.

The external imbalances are reflected in the depreciation of the official VND exchange rate and the emergence of a spread on the parallel rate.

As a result, official foreign exchange reserves have steadily declined since the onset of the global financial crisis in the third quarter of 2008, in contrast to the rise in reserves with Vietnam’s rating peers.

Although the run down in reserves has not stabilized according to information available at the time of this report, the level remains in the comfort zone—the External Vulnerability ratio of debt maturing within one year to official foreign exchange reserves is lower than 100%.

The government expects reserves to bottom out at US$16 billion by the end of 2009, down from a peak of US$24 billion at the end of 2008.

A reduction in half of the current account deficit in 2010 to around five to six percent of GDP from the 2008 level would stabilize the BOP and the government’s international liquidity position. A dampening of inflationary expectations and a restoration of confidence in monetary and exchange rate policy seem necessary to stem further deterioration.


Regarding external support, Vietnam does benefit from official creditor financing which tends to be long-term project related. Net annual disbursements of around US$1-2 billion are considerably lower than pledged commitments–although net inflows are expected to increase to US$3 billion for 2009. In contrast, Vietnam’s ability to obtain liquidity support from the IMF is not as readily at hand.

An IMF support program would require a change in Vietnamese law to allow for an independent, external audit of the State Bank of Vietnam’s external accounts.

Strains will likely emerge on the banking system from the combined effects or previous rapid credit expansions, especially in 2007, and the effects of the global recession. But the most important banks are liquid and capitalization may be adequate enough to forestall systemic stress which would require large-scale government intervention.

While the Vietnamese regulators consider that all commercial banks’ capital adequacy ratios (CAR) meet Basel 1 standards, Moody’s assessment is not as sanguine. Taking into account stress scenarios, we find that asset quality and loan loss reserves make for borderline capital adequacy for the system as a whole.

However, the joint-stock banks are in better health, in general, than other banks in the system, including the four large state-owned commercial banks.

The system-wide intrinsic financial strength of rated banks is a modest, “D-.” This is below the global system average of C- whose scale ranges from A to E, with the latter suggesting very weak fundamentals which may require the extension of government support.