economics

March 21, 2010

April 1, 2010 Gains From Devaluation To Quickly Eroded

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Business Monitor International (BMI)
Vietnam Business Forecast Report

BMI View: We are of the view that the devaluations of the dong in November 2009 and February 2010 have done little to address Vietnam’s underlying balance-of-payments problems. We are therefore expecting a further devaluation, this time coupled with a tightening of fiscal and monetary policy. This should help Vietnam contain its trade deficit in 2010 to US$12.4bn, or roughly 13.1% of GDP, after an estimated US$12.2bn (13.4%) shortfall in 2009.

We believe that the latest devaluation of the dong, by 3.4% to VND19,100/US$ on February 11, will only have a temporary effect on Vietnam’s balance-of-payments. Indeed, the benefits will largely be reaped in the form of the release of foreign currency inflows held up by the expected devaluation increasing the availability of greenbacks in the local market. However, we reiterate that the devaluation will do little to address the fact that domestic demand is still markedly stronger than external demand for Vietnam’s key exports. Moreover, accelerating inflation will continue to erode public confidence in the value of the dong, raising pressure for further devaluations.

Indeed, macroeconomic data for December and January support our view that the 3% devaluation effected by the Vietnamese authorities on November 25 would only serve to narrow the trade deficit temporarily. Indeed, the upward revision of the December trade deficit from US$1.3bn to US$1.9bn shows that the improvement from the US$2.1bn shortfall in November was only marginal. The estimates for January saw the trade deficit fall to US$1.3bn on the back of a 16% m-o-m fall in imports to US$6.2bn while exports fell 11% to US$4.9bn. However, we believe these figures may well be revised to reflect a higher trade deficit (as has been the case with trade data releases in Q409) for January.

Inflation And Input Costs To Wipe Out Gains From Devaluation

The cumulated 7.3% devaluation between November 2009 and February 2010 has improved Vietnam’s competitive position vis-à-vis China and other rivals. However, we expect these gains to be short-lived as the reduction of labour costs in real terms will be quickly eroded by demands for higher wages as inflation reaches double digit territory. Moreover, the garment and footwear industry, Vietnam’s main export items after oil, requires a high degree of imports of fabric and other input goods, the cost of which will not have been affected by the devaluation.

We have not made any change in our export forecast (as it already factored in expected devaluations), which sees overseas shipments increase 13.0% to US$63.9bn in 2010 on the back of an improvement in demand conditions in G3 markets. The Vietnam-Japan Economic Partnership Agreement (VJEPA) has given Vietnamese enterprises increased access to the Japanese market, which should support exports, especially if the Japanese yen maintains its recent strength. This should mitigate the more troubled outlook for shipments to Europe and the US.

Our import forecast for 2010 stands at US$76.3bn, 10.9% up from an estimated US$68.8bn in 2010. However, this forecast assumes that the Vietnamese government will embark on a fairly sharp tightening of fiscal and monetary policy during the year, taking the base rate to 12.00% and reducing the fiscal deficit (including off-budget spending) from an estimated 8.9% of GDP in 2009 to 6.2% in 2010.

A failure to sufficiently tighten monetary policy, or indeed a delay in doing so, poses upside risks to our forecast of a US$12.4bn trade deficit in 2010, marginally higher than the US$12.2bn shortfall estimated in 2009. In GDP terms the trade shortfall is projected to fall from 13.3% in 2009 to 13.1% in 2010. We expect the domestic policy tightening to gain more traction in 2011, at the same time as global economic growth rises from 2.9% to 3.2%. This positive dynamic should see the trade deficit remain stable in dollar terms (US$12.3bn compared to US$12.4bn), but fall to 11.6% of GDP.

The devaluation should have a stronger effect on the services export component of the balance of payments. We are expecting service exports to rise by 15% in 2010 to US$7.1bn on the back of a recovery of the tourism sector as Vietnam’s allure as a cheaper alternative to Thailand gets a boost from the devaluations of the dong and the recent strength of the Thai baht. Conversely, the weaker dong should hold back service imports. We expect the service trade deficit to decrease to US$1.3bn in 2010 from an estimated US$1.5bn in 2009 and US$2.3bn in 2008.

Remittances Resilient, Risk From Housing Market

Remittances from abroad have proved fairly resilient through the global downturn on spite of Vietnamese workers being laid off in Taiwan and other regional economies. We have estimated that remittances fell 7.7% in 2009 to US$6.3bn, from US$6.8bn in 2008 with the resurgence in the housing market in the latter part of the year drawing in inflows from overseas Vietnamese. We expect remittances to increase by 11.2% in 2010 to US$7.0bn on the back of a continued rebound in global economic growth. Moreover, government policies aimed at encouraging overseas Vietnamese to invest in the Vietnamese housing market should add to the remittance inflows. However, we see a risk that a protracted slump in the housing market, which is not our core scenario, could have a dampening effect on remittances.

We expect the resilience in remittance inflows to be a key factor in driving down the current account deficit, in spite of the upward pressure they add to import demand. We are forecasting the current account deficit to fall to US$8.3bn in 2010, 8.7% of GDP, from an estimated US$9.2bn in 2009, 10.1% of GDP. For 2011, we see the current account deficit at US$7.9bn, or 7.4% of GDP. This is still a sizeable shortfall and is, together with the large fiscal deficit, a key factor in Vietnam’s poor score of 44.0 in our short-term economic risk rating. However, while we recognise the risks, we do not expect Vietnam to fall prey to the same market pressure as for instance Greece, another high twin deficit country, has in recent months.

This is primarily because Vietnam’s external debt position is highly secure ( see ‘Limited Risks To External Debt Position’, February 4 2010). In addition, the far-reaching capital controls in the Vietnamese market, which is virtually off-limits for international investors without a presence in the country, eliminates the risk of capital flight.

We expect the outflow in Vietnam’s current account to be covered by inflows in the capital and financial account. Vietnam raised US$1bn in a foreign bond issue in January and has secured financing from multilaterals such as the Asian Development Bank and the World Bank and bilateral donors such as France and Japan. As a consequence, we see no greater risks for Vietnam’s balance-of-payments even if foreign direct investment inflows were to be stalled due to continued uncertainties about the economic policy and the value of the dong. We expect Vietnam’s foreign exchange reserves to rise from an estimated US$15.5bn at the end of 2009 to US$17.5bn by end 2010, approximately 2.8 months of imports.

Business Monitoe International (BMI)
Vietnam Business Forecast Report

April 1, 2010 Thursday

Policy-Induced Slowdown Of Overheating Economy Needed

Our outlook on Vietnam has essentially not changed since early Q409 when it became increasingly clear that the economy was overheating. We are still expecting a double-dip scenario with real GDP expansion dipping to 4.4% in 2010 after a forceful economic recovery in the three last quarters of 2009, which brought full-year growth for the year to 5.3%. Our 2010 forecast is based on our expectations that fiscal and monetary policy will have to be tightened sharply in H110 in order to rein in the widening trade deficit and halt inflationary pressures. With Vietnam having effected yet another devaluation of the dong in February, less than three months after the previous devaluation in late November, we have been reinforced in this view.

The 11th National Congress of the Communist Party in January 2011 will serve to keep the political barometer high. We expect some criticism of the government’s handling of the macroeconomic turbulence Vietnam has undergone in recent years from more conservative party members, but no major changes to the current leadership and government policy. However, fears of criticism have led to a certain degree of policy paralysis in the run-up to previous National Congresses. There is a risk that this pattern is repeated, and that the needed steeps to tighten fiscal and monetary policy to address accelerating inflation and the widening trade deficit are not taken.

The strong domestic demand-driven recovery in Vietnam brought real GDP growth to 6.9% y-o-y in Q409. We believe a sharp tightening of fiscal and monetary policy will be needed in 2010, and thus maintain our below-consensus forecast of real GDP growth dropping to 4.4% as domestic demand suffers. Tighter fiscal and monetary policy conditions are likely to stay in place until the end of 2011, when inflation is firmly in single digits again. We are consequently forecasting real GDP growth of 5.5% and 6.0% in 2011 and 2012, respectively, as the global economic environment is expected to be less conducive than in the 2003-2007 boom years.

Vietnam is making headway in improving its dilapidated infrastructure with construction on a number of ports, power plants and road projects being commenced in 2009. Nonetheless, it will take a number of years, if not decades, until Vietnam’s infrastructure rating of 37.2 comes anywhere near the 68.0 China scores in the same area. On the economic reform front, the government’s privatisation process is gaining pace again with the listing of Vietcombank , VietInBank and Eximbank in 2009. We are also expecting improvements in the business environment from the Vietnam-Japan Economic Partnership agreement and a free trade agreement currently under negotiation with the European Union.

Political

Strengths

  • The Communist Party government appears committed to market-oriented reforms, although specific economic policies will undoubtedly be discussed at the 2011 National Congress. The one-party system is generally conducive to short-term political stability.
  • Relations with the US are generally improving, and Washington sees Hanoi as a potential geopolitical ally in South East Asia.

Weaknesses

  • Corruption among government officials poses a major threat to the legitimacy of the ruling Communist Party.
  • There is increasing (albeit still limited) public dissatisfaction with the leadership’s tight control over political dissent.

Opportunities

  • The government recognises the threat that corruption poses to its legitimacy, and has acted to clamp down on graft among party officials.
  • Vietnam has allowed legislators to become more vocal in criticising government policies. This is opening up opportunities for more checks and balances within the one-party system.

Threats

  • The slowdown in growth in 2009 and 2010 is likely to weigh on public acceptance of the one-party system, and street demonstrations to protest economic conditions could develop into a full-on challenge of undemocractic rule.
  • Although strong domestic control will ensure little change to Vietnam’s political scene in the next few years, over the longer term, the one-party-state will probably be unsustainable.
  • Relations with China have deteriorated over the past year due to Beijing’s more assertive stance over disputed islands in the South China Sea and domestic criticism of a large Chinese investment into a bauxite mining project in the central highlands, which could potentially cause widescale environmental damage.

Economic View

Strengths

  • Vietnam has been one of the fastest-growing economies in Asia in recent years, with GDP growth averaging 7.6% annually between 2000 and 2007.
  • The economic boom has lifted many Vietnamese out of poverty, with the official poverty rate in the country falling from 58% in 1993 to 20% in 2004.

Weaknesses

  • Vietnam still suffers from substantial trade, current account and fiscal deficits, leaving the economy vulnerable as the global economy continues to suffer in 2010. The fiscal picture is clouded by considerable ‘off-the-books’ spending.
  • The heavily-managed and weak dong currency reduces incentives to improve quality of exports, and also serves to keep import costs high, thus contributing to inflationary pressures.

Opportunities

  • WTO membership has given Vietnam access to both foreign markets and capital, while making Vietnamese enterprises stronger through increased competition.
  • The government will in spite of the current macroeconomic woes, continue to move forward with market reforms, including privatisation of state-owned enterprises, and liberalising the banking sector.
  • Urbanisation will continue to be a long-term growth driver. The UN forecasts the urban population to rise from 29% of the population to more than 50% by the early 2040s.

Threats

  • Inflation and deficit concerns have caused some investors to re-assess their hitherto upbeat view of Vietnam. If the government focuses too much on stimulating growth and fails to root out inflationary pressure, it risks prolonging macroeconomic instability, which could lead to a potential crisis.
  • Prolonged macroeconomic instability could prompt the authorities to put reforms on hold, as they struggle to stabilise the economy.


Business Environment View

Strengths

  • Vietnam has a large, skilled and low-cost workforce, that has made the country attractive to foreign investors.
  • Vietnam’s location – its proximity to China and South East Asia, and its good sea links – makes it a good base for foreign companies to export to the rest of Asia, and beyond.

Weaknesses

  • Vietnam’s infrastructure is still weak. Roads, railways and ports are inadequate to cope with the country’s economic growth and links with the outside world.
  • Vietnam remains one of the world’s most corrupt countries. Its score in Transparency International’s 2008 Corruption Perceptions Index was 2.7, placing it in 20th place in the Asia-Pacific region.


Opportunities

  • Vietnam is increasingly attracting investment from key Asian economies, such as Japan, South Korea and Taiwan. This offers the possibility of the transfer of high-tech skills and knowhow.
  • Vietnam is pressing ahead with the privatisation of state-owned enterprises and the liberalisation of the banking sector. This should offer foreign investors new entry points.

Threats

  • Ongoing trade disputes with the US, and the general threat of American protectionism, which will remain a concern.
  • Labour unrest remains a lingering threat. A failure by the authorities to boost skills levels could leave Vietnam a second-rate economy for an indefinite period.

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