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Vietnam's Economic Malaise and Lessons for China, Part I

Recent economic turbulences in Vietnam – high inflation, tumbling stock markets, a depreciating currency and more – have not just attracted worldwide attention in their own right. Due to its proximity to China and its similarly "socialist" market economy, Chinese have been keenly following the developments in Vietnam.

The EO sent two reporter to Hanoi and Ho Chi Minh City in early June to investigate the situation on the ground, and consulted experts on the economies of both countries.

The findings, which appeared on the EO's Chinese print edition dated June 16, have been rewritten and updated here in the form of a two-part series. In this first part we focus on the ground situation in Vietnam. We will follow up with comparative studies between the macro-economic challenges facing it and China.

Vietnam's Economy: Surfing Through Stormy Waters
Once the CEO of a securities firm in Ho Chi Minh City (HCMC) making buckets of gold; Nguyen Dung (pseudo name) contemplated the twist of events over cups of coffee on a rainy afternoon.

"I have never imagined money could come so easily; no matter what stock you bought, you gained; money was like raining down on you.

"Once, I thought I had made money that could last me a lifetime," said the 34-year-old. Yet, the fortune he made vanished along the bursting of Vietnamese stock market's bubble.

About three months ago, when the HCMC stock market index dropped 5% everyday for 10 consecutive days, Nguyen could no longer take the pressure and tendered his resignation letter to his securities firm's shareholders.

However, to quit the tumbling stock market was not so easy. The stock market index continued spiraling and by the second week of June, it had fallen below 400 points. Compared to the height of 1170 points in March last year, the market had shed over 60% of its value, and turned from the best performing Asian market to the worst.

In the process, Nguyen and his family lost some two million dollars. He then looked for a job in the credit department of a bank, a much more modest salary but a stable income nonetheless. Ironically, he was weighed down with debts accumulated from days when banks were giving out loans almost too easily, when liquidity was not channeled to productive sectors but mainly to the bubbling stock markets and real estate.

The bad news did not stop with the diving stocks. What followed was high inflation – especially in food, a depreciating Vietnamese currency, the dong, and contracting credits controls, leading the new middle class like Nguyen to tighten their belts. Meanwhile, the labor class began to convulse, staging protests and strikes to demand for higher wages.

Panic over Non-Crisis
"Though the Vietnamese economy has underlying weaknesses, the catalyst for a sudden spread of panic was indeed several reports by international investment consultancies and rating institutions," claimed Gu Yuanyang, member of Chinese Academy of Social Sciences' academic committee.

Gu was also once the Academy's world economy and politics research center director, specialized in East Asia's economy.

The first to sound the alarm was a Morgan Stanley report in late May, warning that Vietnam was heading for a "financial crisis" similar to that of Thailand in 1997, as the Vietnamese central bank over-valued the dong while inflation soared and the trade deficit widened.

What followed were several pessimistic reports, including one from Standard & Poor's, Moody's Investors Service and Fitch Rating in early June.

Gu disputed the objectivity and intention of such reports, saying that Vietnam was not in "crisis", and that the Vietnamese capital market was not entirely opened, thus limiting "attacks" by foreign manipulations to deliver the deadly blow.

He summarized the fundamental weakness in the Vietnamese economy as too eager to catch up economically with neighboring countries, thus the government policies were overly tilted to create impressive growth.

"Yet the years of high growth rates were not supported by strong foundation, which left Vietnam with a lack of infrastructure, inefficient investments that led to money flooding the stock markets, lack of quality human resources and training, and low value-added productions," he said.
The German development bank, KFW Bankengruppe, regional office in Hanoi also doubted that balance of payment crisis that happened in Thailand would repeat in Vietnam. Its director, Christian Richter, stated two major factors differentiating the two countries.

"First, foreign direct investment (FDI), foreign indirect investment (FII, especially transfers), Official Development Assistance (ODA) flow, investment capital invested in the security market, and in spite of Vietnam's falling security market, foreign investors still seem to continue to buy stocks. Accordingly, the trade deficit could be made up with these resources.

"Second, Vietnam's short-term loans from foreign countries are limited, differing from the situation of Thailand when the country fell into financial crisis in 1997. Due to the strict stipulations of the SBV about foreign debts, Vietnam's short-term debts are usually small and relate to export credits," he said.

External debts at the end of 2007 tolled at 23.2 billion dollar, of which 206 million dollar were short-term debts.

In comparison, when Thailand was hit financially in 1997, its total outstanding debts were over 100 billion dollars with over 20 billion in public debts, according to its central bank data. And as its currency was then pegged to the US dollar, the government spent about 90% of its some 30 billion foreign reserves to defend the bath from depreciating in the initial months of meltdown.

Counter Measures by Vietnam's Government
The buzzword "crisis" appeared to be slowly waning as the Vietnamese government announced counter-measures with the priority placed on taming inflation after the CPI index hit 25.2 in May, the highest level since 1992.

By the second week of June, the HCMC stock exchange index even inched up after months of declines, albeit marginally, and some market observers viewed it as indication that the market was "starting to correct".

One of the first moves the Vietnamese government did was withdraw liquidity from the market by tightening credit controls. This year alone, the government had upped the interest rate three times, the latest being in June when the prime rate was raised to 14% from 12%, thus the highest permissible lending rate jumped to 21% from 18%. The high rate aimed to discourage loans while promoting savings.  

The government also adjusted the dong's exchange rate against the dollar; as of June 24, the state bank reference rate was set as 16,451 dong to 1 dollar, allowing a trading band of plus or minus 1%. The rate at the beginning of this year was around 15,000 dong to 1 dollar.

The country's securities regulator had also upped the trading band for the stock markets to plus or minus 3% from the initially 2%, in an attempt to boost trading. The trading band was imposed to avoid dramatic rise and fall of the markets.

Government-wide spending would also cut by 10%, such as suspending purchases of expensive assets like vehicles, cutting unnecessary overseas working or conference trips, and more stringent checks on tax evasion.

In addition, the government would boost local supplies of industrial and agricultural materials, including fuel, steel and fertilizer, to cut dependency on imports. According to an official from the Vietnamese embassy in Beijing, the country would stop exporting coal by 2010 to ensure domestic supply.

Vietnam's oil fields lacked refinery facilities, and thus it exports crude oil and import processed oil. However, the country's first oil refinery is expected to begin operating mid-next year in Quang Ngai Province.

Ground Reality
Vu Man (pseudo name) came from a farming village in central Vietnam. When the HCMC city dwellers were scrambling to hoard rice in April due to fears of shortage and rising global food prices, he was puzzled.

"At one point, prices shot up to 20,000 dong (1.2 dollar) per kg. I could not understand, Vietnam is one of the biggest producers and exporters of rice, how could we be short of supply?

"My parents back home told me: "Don't be silly and join the buying rush. Just tell us if you have run out, we'll send you bags of supplies, we have plenty here'," Vu recalled. By mid June, the prices had stabilized around 12,000 dong (0.72 dollar) per kg but cost of living, such as food and fuel, remained high.

In fact, the Vietnamese government announced on June 19 that the country would expect a good harvest this year, and mulled over lifting the freeze of rice exports.

Though not troubled by rice supplies, Vu was depressed by rising gold prices.

Gold plays an important role in Vietnamese life, while only 5% of the country's 86 million population have a bank account according to public data, many Vietnamese keep keep savings in gold. Purchases of fixed assets, such as houses, could be made in gold payments.

When the economy outlook appeared to be gloomy, Vietnamese also tend to buy gold to avoid holding cash that could devalue.

That was not the reason for Vu to seek gold though. He had persuaded relatives to lend him about 5 million dong (about 300 dollar) worth of gold last year to invest in the stock market during its boom time. His investment failed and payback time came.

But the weigh of gold worth 5 million dong then would cost more to acquire, while it used to cost about 17 million dong for one tael of gold, by mid June the price had reached 18.43 million dong per tael. Some feared the suspension of gold imports would further drive up prices due to a reduced supply.

"The prices changed by the day, it made a huge difference to buy earlier than later," Vu sighed.

The same applied to the value of the dollar. The state bank set the reference rate, but another much higher rate prevailed in the black market, namely gold and jewelry shop operators who traded currencies. Legally, they could buy dollars from individuals but not sell them. Though that law was reinforced by the authorities recently, the ruling was widely disregarded. One could easily approach jewelry shops and inquire about the rate.

When the EO checked the black market rate on June 10, the official rate was around plus or minus 16,300 dong to a dollar. But the black market was quoting around 17,300 for selling and 17,900 for buying dollars. Subsequently, the government adjusted the official rate, though the black market asking remained higher.

One HCMC based investment analyst told the EO that in analyzing data, he referred to the inter-bank or the black market exchange rate, which was more reflective of the real demand and supply situation.

Another foreign banker, who requested anonymity, told the EO in second week of June that there was a shortage of dollars in the market. He said clients, mainly businessmen, were looking for dollar and he had to help sourcing the money.

"Shortage pushed up the price. Even when sourcing amongst banks, the asking rate was always higher than the official ones. On paper, no one is using the reference rate, but there are many ways to drive up the prices, such as charging higher commissions or processing fees," he said.

Opinions from Market Observers
In assessing the Vietnamese government's responses to the economic challenges so far, Mekong Securities' head of investment research Cheah King Yoong said the shift of focus from pro-growth to anti-inflation was a sound move.

In addition, he said the Government might continue to maintain its subsidies and price control policies which could cool down the inflation rate in the medium term.

"Nonetheless, we expect the country to record double digit inflation rate in 2008 and 2009 before slowing down to single digit rate in 2010.

"The dong will continue to depreciate gradually against US dollar in nominal term but appreciate in real term. We do not expect a sharp devaluation in Dong. Our year-end target for it is VND17,000," he said.

He expected the market would remain volatile with downside risk triggered by the expiration of the repurchase contract, unwinding of proprietary trading position by the securities firm and continued selling by retail investors.

Vietnam Investment Group (VI Group) set up its HCMC base late last year, however, it was still at an early stage of scouting for worthwhile projects. Its investment analyst Chu Hoang Viet said the company would hesitate to enter the market unless four factors improved, namely the CPI dropped back to one digit, the dong stabilized around 16,500 to a dollar, the trade deficit fell, and there were effective monetary policies.

He was pessimistic over inflationary pressure, as it depended largely on external factors such as prices of commodities in the global market, such as oil, food, and gold. As for the trade deficit, he said about 30% of the bills were chalked up by investors needing imports of equipment for setting up plants, the cost was in fact borne by the latter.

A source from the banking industry expected the percentage of non-performing loans to go up, adding the loose lending in the past that was channeled into speculating on real estate would likely turned into bad debts by next year, and by then, a spate of property auction might take place.

Another high level official from a foreign development bank, who requested anonymity, said the current economic turbulence might be a blessing in disguise, as it would readjust an over-inflated market, investors would become more realistic in their future expectations, and the government would prudently look into more effective ways to channel investment.

Moreover, he pointedo ut that in the past, the Vietnamese government was not that keen in utilizing funds made available through Official Development Assistance (ODA) due to high FDI.

He said of the 5.4 billion-dollar fund presently made available by six banks, including the Asian Development Bank and the World Bank, the disbursement rate was only between 13% and 20% depending on projects. He added the current situation would push the government to utilize these fund more effectively.

ODA-supported projects come under stringent monitoring and assessment throughout the implementation process. Its focus is mainly infrastructure construction and developmental projects, such as road and railway, which commercial banks usually unwilling to undertake due to low returns.

In fact, tapping the ODA had also become a strategy of survival for private businesses. Chinese businessman Kong Xiongfei, who is stationed in Hanoi, said he now focus on tendering for projects sponsored by the World Bank to ensure guarantee of payment.

"We are currently working on a waste water treatment project. In the past, who would have paid attention to this kind of contract? But, I fear there will be a lot of competitors in the near future," he said.


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