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    Southeast Asia
     Feb 10, 2010
Vietnam as Asia's first domino
By Shawn W Crispin

BANGKOK - While global markets fret about European sovereign debts, could Vietnam be Asia's first over-stimulated economic domino? With a wobbly currency, fast and loose bank lending and an absence of local confidence in the government's economic management, Vietnam stands out as the region's prime candidate for a sudden market re-evaluation of the financial impact of recently ramped and frequently misallocated fiscal spending.

On the back of massive government pump-priming, Vietnam last year outperformed several of its regional peers with 5.5% gross domestic product (GDP) growth. To counteract the global economic downturn, the government pledged economic stimulus packages amounting to a whopping 8% of GDP. Although less


than half of that amount has actually been disbursed, on-budget spending and off-budget state bank lending propelled the economy through the global crisis.

With emerging signs of global recovery, the communist party-led government has signaled its intention to rein in the stimulus and return the economy to export-oriented growth. But a lack of policy coordination across state agencies and enterprises has further eroded local confidence in the government's ability to control future inflation and to a significant degree has undermined central efforts to contain pressures on the currency and an overheating property market.

The disconnect between central command and peripheral resistance was made apparent last year when many export-oriented industries refused to cash in their export receipts at the official exchange rate for the dong against the US dollar. As of October, there was a 9% spread between the official and black market rates, and that gap drove the government's decision in November to devalue the dong by 5% by expanding its permissible trading band. Even with that depreciation, financial analysts monitoring the situation say there is still a 5% spread between the official and black market rates.

One factor driving the distortion is the government's interest rate subsidies, which were implemented last year as part of the stimulus package to encourage more local lending. The policy effectively reduced lending rates from 10% to 6.5% and drove huge new lending worth around $24 billion, or nearly 23% of GDP. According to Standard & Poor's, a credit rating agency, Vietnam's year-on-year loan growth was up 37%.

Financial analysts say that because there was virtually no underlying demand for working capital among state-owned enterprises (SOEs) and export-oriented private companies that received the bulk of the new credits, much of the money was recycled into the local stock market. The footloose liquidity contributed to making Vietnam's stock market one of the world's best performers during the first half of 2009; it then fell dramatically in the second half.

It's unclear to financial and sovereign analysts how much of last year's US$24 billion in new lending was lost to stock market speculation. Kim Eng Tan, a sovereign and public finance analyst at Standard & Poor's, expressed his preliminary concerns about last year's 37% loan growth rate. He said that the balance sheets of major Vietnamese banks were in "reasonable shape" at the end of 2008, but that "we'll need to see what has changed after the new surge in lending".

From the government's perspective, the easy money aimed to forestall a spike in unemployment at a time when labor-intensive export industries faced a near collapse in global trade. The Communist Party leadership clearly wanted to avoid a repeat of the social instability witnessed in 2008 when inflation topped out at over 25% and labor unrest spread in both foreign and locally owned factories across the country.

Galloping inflation also contributed to a ballooning current account deficit as companies built up large inventories of imports to arbitrage anticipated higher prices and demand. The loss of economic control is known to have undermined the position of liberalizing Prime Minister Nguyen Tan Dung, whom some analysts estimate was only spared full-blown hyperinflation by the global economic downturn and its associated commodity price collapse. Some analysts believe that party conservatives could regain the upper hand at the 11th National Party Congress scheduled for January 2011.

Carlyle Thayer, a Vietnam expert at the Australian Defense Force Academy, points to reports that party conservatives had called for Dung's resignation at a central committee meeting in 2008 over his perceived mishandling of the economy. The main policy divide between party conservatives and liberalizers concerns the pace and scope of Vietnam's integration with the global economy and its impact on domestic stability and state control over the economy, according to Thayer.

"Conservatives seek to preserve one-party rule, maintain order and stability and state control over key sectors of the economy, which they regard as their 'milk cows'," Thayer wrote in e-mail correspondence with Asia Times Online. "It is clear that reform of state-owned enterprises has stalled, for example. Those [like Dung] pushing for increased global integration would like to see market forces play a greater role."

While Dung's broad economic and financial liberalization program is still on track, there are signs that conservative elements are asserting more influence over economic management. The State Bank of Vietnam (SBV) has required that small banks, which contributed to inflation through rampant lending in 2008, triple their underlying capital by year's end or face closure. The government has also ordered closed gold exchanges across the country - a restriction that will come into full force in March in a bid to stop local dumping of dong for gold.

Pressures and distortions
New technocratic tests are emerging with signs of inflation, a rising trade deficit and sustained downward pressure on the dong vis-a-vis a globally weak US dollar. Even with last November's 5% devaluation of the dong and a hike in baseline interest rates from 10% to 12%, state-owned enterprises and private companies continue to hoard dollars over dong, underscoring the lack of local confidence in the SBV's ability or willingness to check inflation.

"The central bank needs to send a fairly stiff signal to the market that it is willing to defend the currency band, most likely by raising interest rates further," said Sriyan Pietersz, head of research at J P Morgan in Bangkok. "Without that, they risk losing potential FDI [foreign direct investment] inflows due to a shaky currency."

A $1 billion dollar-denominated bond issue was fully subscribed by foreign investors in January but analysts say that's not enough to alleviate the new pressures building around the dong. The currency should get a short reprieve from Tet holiday-related remittance inflows this month, but many analysts believe the SBV needs to raise interest rates by at least another 3% to put a punitive local tax on those who convert dong to dollars.

As the SBV is the only official source of foreign exchange inside the country, the government maintains strict capital controls in defense of the dong. By law, companies and enterprises are allowed to hold only enough foreign exchange to pay debts and settle current trade transactions. Yet as of the third quarter of last year, 27% of all liquidity in the local financial system had fled dong for dollars, according to J P Morgan.

Despite the currency controls, SOEs are estimated to hold around $10 billion worth of mainly dollar-denominated foreign exchange. Notably, they have recently defied a government-issued circular decree addressed specifically to 10 large SOEs, including Vietnam Oil and Gas Group, Vietnam National Coal and Mineral Group and Vietnam National Chemical Corporation, requiring them to cash in their dollars for dong.

According to the circular, SOEs were to have turned over $3 billion of their foreign holdings to the SBV by the end of last year; as of early February, they had only released $300 million, according to analysts tracking the situation. The defiance, the same analysts say, has contributed to the SBV's reluctance to inject more liquidity into the market to defend the currency. According to official statistics the SBV currently holds around $16 billion worth of foreign reserves.

While Vietnam clearly cribbed from China's extraordinary fiscal response to the global economic downturn, Hanoi comparatively lacks the top-down controls that have allowed Beijing to put a more authoritative brake on its stimulus. As the recent tug-of-war over foreign exchange indicates, Vietnam's big SOEs are still often run as the personal fiefdoms of politically powerful Communist Party members with enough clout to defy central directives.

Some analysts contend it is reassuring that Vietnam's perennial loss-making SOEs are finally prioritizing profitability over state policy. To others, it underscores the sustained lack of transparency and accountability of big SOEs and raises worrying new questions about how the billions of dollars worth of bank loans they received last year were put to use. State-motivated lending that was last year funneled into stock market speculation now appears to be fast pumping up property prices, particularly in Ho Chi Minh City.

What's clearer is that Vietnam still lacks effective policy coordination across state agencies and enterprises at a time economic authorities need to show the market a renewed commitment to maintaining macroeconomic and price stability. The lack of control also resurrects questions lingering about the central bank's patchy handling of 2008's inflationary surge and its technocratic capacity to head off new emerging inflationary pressures, including in the property market.

J P Morgan's Pietersz says the relevant authorities are "very bright and committed", but still "learning by doing" in managing the economy. Others say it is not clear that the internally divided government has the political will to roll back last year's stimulus measures in the politicized run-up to next year's National Party Congress.

"Ultimately, the government can't close down the whole economy ... but inflation expectations will have to be anchored somehow," said Tan of Standard & Poor's. "If inflation is kept high for a long time, it could be a serious vulnerability."

A research analyst with a European investment bank estimates that Vietnam's "day of reckoning" is "inevitable due to the government's inability to raise revenues" and that the country will face more "convulsive devaluations" until the central bank is allowed more independence from party heavies.

Despite the recent pressure on the dong, Tan says Vietnam does not exhibit symptoms of a "classic currency crisis" because "external borrowing is still largely under control" and "FDI has held up well". Unlike in the debt-binged countries hit by the 1997-98 Asian financial crisis, he notes, Vietnam's debt burden is comparatively modest because it is wrapped up largely in low-risk, long-term concessionary loans.

But as market scrutiny over public finances intensifies in Europe, country-by-country risk in Asia will increasingly be determined by investor perceptions of how governments have managed and spent recently ramped fiscal measures. Locals in Vietnam have already made clear their mistrust of the government's management and history shows foreign sentiment often lags but eventually follows indigenous leads in high-risk emerging markets.

As fears of state-led financial contagion rise in Europe, Vietnam seems the leading candidate for a parallel crisis of confidence in Asia.

Shawn W Crispin is Asia Times Online's Southeast Asia Editor. He may be reached at swcrispin@atimes.com

(Copyright 2010 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

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