13 March 2008 Economics Research

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Emerging Markets Economics Research

Emerging Markets Economics Asia
Contributors Joseph Lau +852 2101 7427 joseph.lau@credit-suisse.com

Vietnam: Time to be very nervous

The following is an unedited extract from our Emerging Markets Quarterly Q2 2008 report, published on 12 March 2008. Inflation and the repercussions of excessive liquidity are Vietnams prime concerns. Record net capital inflows and rapid economic expansion are fuelling price pressure across a range of sectors, much being focused in the food and energy sectors. But the effect on CPI is widening and reflected in rising wages, asset price and credit growth, plus emerging supply-side constraints. Februarys CPI inflation hit a 13-year high of 15.7% year on year, but may exceed 18% year on year during H1 2008. Currently, we think the government is wary about how to approach this problem, but macro policy should turn more aggressive. Authorities want to cool inflation, but have a desire to maintain the pace of economic growth and development. Four rounds of monetary tightening measures in recent months have led to severe domestic VND shortages and overnight rates spiking to 41%, but these have yet to prove effective. In our view, hyperinflation and a bubble-bust cycle is a clear risk in the next 12 months. The government will probably try maintaining its mixed policy focus, and hoping some relief from inflation will come from the anticipated global slowdown. However, a slowdown in net influxes of foreign liquidity is still needed, and the aborted debate over restating capital controls in early 2007 looks increasingly like a missed opportunity. Debate may be resurrected in the coming months, but we still believe that the authorities are reluctant to risk undermining investor confidence with such extreme measures. One option is FX policy and we target 4% to 5% appreciation in $/VND by the year-end, targeting a level of about 15,200. The second widening of the daily trading band in three months is a signal of intent and a further departure from the longstanding policy of near 1% annual depreciation. In our view, substantial FX appreciation probably represents the least bad option left to the government. But as much as 12% appreciation may be required to correct the structural imbalances in the short term, although the terms of trade adjustment could also worsen the current account deficit. Additional policy action is expected, including selected price controls and hikes in policy interest rates and reserve requirements by Q3. Banks are already under pressure to raise their own commercial interest rates, but we think the discount rate could rise by another one percentage point to 7%, with another hike in Q1 2009.

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13 March 2008

Despite the financial problems, Vietnam should still post strong real growth over the medium term if the economy can be kept on an even keel. The private sector remains very robust, stimulated by fixed investment and an emerging consumption sector. Substantial infrastructure spending should also contribute increasingly towards GDP, as planned public projects get up to speed in the coming years. However, we have revised down our 2008 GDP growth forecast from 9.1% to 8.5%, as peak potential is affected by the measures to cool inflation. Exports continue to expand, up 30% yoy in Q1. WTO accession and the developing export base should benefit long-term growth, but high demand for capital imports and high commodity prices are hitting the trade deficit, which is projected to hit 20% of GDP this year from 14% in 2007. This might ease after new petroleum refineries come on-line from 2009, but Vietnam is likely to see sustained deficits for the next five years. Capital market development will likely be weak for a second year, as Vietnam concentrates on financial deepening and improving the quality of its banking and intermediation systems. We expect the pace of state enterprise listings to remain lackluster and the planned $10 bn listing of Vietcombank being shelved for now. The oftdelayed $1 bn sovereign bond will also be postponed again, though this should not undermine fiscal funding. Moodys is poised to upgrade Vietnams sovereign rating by one-notch to Ba2, but economic conditions probably defer any decision beyond this year; actions by other ratings agencies are unlikely in 2008.

Emerging Markets Economics Research

13 March 2008

Exhibit 1: Recent financial and monetary policy actions by the government

Date Current~ 8 Mar 2008 7 Mar 2008 Event/policy action $/VND trading almost 2% below official rate of 15,865, as local VND demand remains high. Foreign investment limit on unlisted non-bank stocks raised from 30% to 40%; limit on listed non-bank stocks still 49%, while 30% limit applies on banks. $/VND daily trading band widened to 1% from 0.75%. Interbank VND interest rates to have ceiling of about 9-10%. Compulsory T-bill sales to go ahead, but execution will be flexible and can be adjusted according to specific institutions and conditions. State Bank of Vietnam (SBV) commits to ensuring emergency liquidity. The governments VND 20tn State Capital Investment Corporation (SCIC) will buy local stocks to support market. Compulsory T-bill auction to be phased in, rather than issued once. SBV to review reserve requirement ratios (RRRs) further and widening the daily trading limit on $/VND to 2%. $1 bn sovereign bond to be delayed. SBV injects funds to ease liquidity constraints. SBV requests bans to cap lending rate at 12% after severe volatility in the money market. Finance Ministry also indicates tighter regulation on property lending. SBV to launch compulsory auction of VND 20.3tn in 1-year T-bills on 17 March to drain liquidity. Bank stock lending ceiling revised to 20% of registered capital from previous 3% of total assets, representing an effective squeeze on margin trading. Plans to allow usage of USD in IPO purchases and scrap limits on VND conversions into FX (notably for trade). SOEs to be more freely able to raise FX debt. RRR raised by 1% to 11% and 5% for short-term and long-term VND and FX deposits. Discount rate raised by 1.5% to 6.0%; long-term lending rate to 8.75% from 8.25%. SBV will limit credit growth to 30% this year from 37.8% in 2007. $/VND daily trading band widened to 0.75% from 0.5%.

6 Mar 2008 4 Mar 2008 3 Mar 2008 27 Feb 2008 14 Feb 2008 3 Feb 2008 1 Feb 2008 30 Jan 2008 9 Jan 2008 24 Dec 2007

Possible future measures: Q2/Q3 2008 Q2 2008 Q2 2008 H2 2008 2009 Another 1% hike in policy interest rates. A 1% hike in RRRs. Tighter credit controls on non-infrastructure sectors. Accelerated $/VND appreciation; limitations on inward foreign capital, but formal capital controls likely avoided unless the situation becomes critical. Further hike in policy rates.

Source: Ministry of Finance, State Bank of Vietnam, various media agencies, Credit Suisse

Exhibit 2: Policymakers have been behind the curve on inflation

Reining in inflation will dominate policy this year, as administrative measures should supplement efforts on monetary, credit and FX policy. The government has tried to squeeze hard, but the countrys underdeveloped financial system creates operational problems and market risk.
16 14 12 10 8 6 4 2 0 2003 2004 2005 2006 2007 2008 CPI inflation (% yoy) Long term loan rate (%) Discount rate (%)

Exhibit 3: Recent measures have been disruptive to sentiment...

25 20 15 10 5 0 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08
Source: SBV, Credit Suisse

Overnight call rate (%)

Source: SBV, Credit Suisse

Emerging Markets Economics Research

13 March 2008

Exhibit 4: ... and markets have fallen

1,200

Exhibit 5: Problem capital inflows

12 10 8 6 4

Private capital inflow s (% of GDP)

Confidence has ebbed, though SCIC will start buying into domestic stocks shortly. Despite the poor markets, the scale of continuing foreign capital inflows remains problematic for Vietnam to absorb.

1,100 1,000 900 800 700 600 500 400 Ho Chi Minh City stock index

2 0 2007E 2008F
2007

-2

Source: Ho Chi Minh Stock Exchange, CEIC

Source: MoF, CEIC, Credit Suisse

Exhibit 6: We see $/VND as the easiest policy option to swallow

2003 2004 2005 2006 2007 2008 15,400 15,500 15,600 15,700 15,800 15,900 16,000 16,100 16,200 16,300 $/VND exchange rate (Inverted scale)

Exhibit 7: BoP stability despite record current account deficits

Current account (% of GDP) Capital account (% of GDP) Balance of payments (% of GDP)

We see a more substantial appreciation trend emerging, as $/VND targets 15,200 by year-end, in our view. Huge financial inflows mean Vietnam has to run massive current account deficits to maintain some degree of BoP stability.

40 30 20 10 0 -10 -20 2000

Projection 2002 2004 2006 2008F

Source: SBV, Credit Suisse

Source: MOF, Credit Suisse

Exhibit 8: Commodity prices put the trade deficit under more pressure
Data are smoothed for the lunar new year effect

Exhibit 9: GDP growth stays fast, but likely moderates this year
9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 2000 2001 2002 2003 2004 2005 2006 Real GDP (% yoy)

The focus on imported inflation and big deficits masks a structurally improving export base. Peak growth will be capped by tighter monetary policy, but trend GDP growth should still be at the 8% to 9% yoy level.

80 70 60 50 40 30 20 10

Exports (% yoy) Imports (% yoy)

0 -10 -20 2002 2003 2004 2005 2006 2007 2008

Source: General statistics Office, Credit Suisse

Source: GSO, Credit Suisse

2009F

2000

2001

2002

2003

2004

2005

2006

300 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

Emerging Markets Economics Research

13 March 2008

Vietnam: Selected economic indicators

2001 National accounts, population and unemployment Real GDP growth (%) Growth in real private consumption (%) Growth in real fixed investment (%) Fixed investment (% of GDP) Nominal GDP ($bn) Population (mn) GDP per capita ($) Prices, interest rates and exchange rates CPI inflation (%, December over December) CPI inflation (% change in average index for the year) Exchange rate (VND per USD, end-year) Exchange rate (VND per USD, average) Nominal wage growth (% year-on-year change, average) Discount rate (%, end-year) Fiscal data General government fiscal balance (% of GDP) General government primary fiscal balance (% of GDP) General government expenditure (% of GDP) Gross general government debt (% of GDP, end-year) Money supply and credit Broad money supply (M2, % of GDP) Broad money supply (M2, % year-on-year change) Domestic credit (% of GDP) Domestic credit (% year-on-year change) Balance of payments Exports (goods and non-factor services, % of GDP) Imports (goods and non-factor services, % of GDP) Exports (goods and non-factor services, % increase in $ value) Imports (goods and non-factor services, % increase in $ value) Current account balance ($bn) Current account (% of GDP) Net FDI ($bn) Scheduled external debt amortization ($bn) Foreign debt and reserves Foreign debt ($bn, end-year) Public ($bn) Private ($bn) Foreign debt (% of GDP, end-year) Foreign debt (% of exports of goods and services) Central bank gross FX reserves ($bn) Central bank gross non-gold FX reserves ($bn) 12.6 10.5 2.2 38.9 70.9 3.7 3.6 12.4 11.4 1.0 35.3 63.1 4.1 4.0 13.4 11.7 1.6 33.7 57.0 6.2 6.1 14.6 12.7 1.9 32.1 48.1 7.0 6.9 16.7 13.3 3.3 31.5 45.5 9.1 8.9 18.9 13.2 5.7 31.0 42.0 13.4 13.2 21.6 14.0 7.6 30.4 39.0 27.5 27.2 23.6 14.7 8.9 26.4 33.8 36.3 36.0 25.7 15.1 10.6 23.8 29.5 44.1 43.8 54.8 54.7 4.0 2.3 0.7 2.1 1.3 1.4 56.0 61.1 10.2 20.7 -0.7 -1.9 2.0 1.0 59.2 67.7 19.2 24.8 -1.9 -4.9 1.9 1.2 66.7 73.7 29.6 25.1 -1.6 -3.4 1.9 2.0 69.1 72.8 20.6 15.1 0.2 0.4 2.0 1.8 73.7 78.3 22.7 23.7 -0.4 -0.6 2.4 2.0 77.8 90.4 23.2 34.8 -6.4 -9.0 14.8 1.8 78.1 96.0 26.3 33.6 -13.4 -15.0 20.0 1.8 80.8 97.3 24.6 22.1 -15.4 -14.3 22.0 1.8 46.3 25.5 39.7 23.2 52.2 17.6 44.8 25.5 53.6 25.0 51.8 32.4 57.5 30.4 58.2 31.0 63.9 28.8 69.8 40.6 70.9 28.9 75.0 24.7 82.2 36.0 88.0 37.8 90.1 34.0 95.1 32.0 100.1 29.0 104.1 27.0 -6.1 -3.5 27.0 41.1 -5.3 -3.3 27.7 43.2 -6.3 -4.5 29.5 44.9 1.8 2.8 29.9 37.5 -0.3 0.5 27.0 33.7 -5.0 -4.1 33.0 34.0 -4.4 -3.5 33.7 34.5 -4.3 -3.6 34.5 32.5 -5.0 -4.1 35.7 32.3 0.8 0.9 15,072 14,796 6.5 4.8 4.0 3.9 15,393 15,265 6.1 4.8 3.0 3.2 15,634 15,503 18.0 3.0 9.5 7.9 15,762 15,728 15.3 3.0 8.4 8.3 15,900 15,843 15.7 4.5 6.6 7.5 16,055 15,984 16.0 4.5 12.6 8.3 16,015 16,072 16.5 4.5 10.7 14.7 15,200 15,608 19.9 7.0 7.0 8.9 14,896 15,048 17.8 8.0 6.9 4.5 10.7 29.2 32.5 78.7 413.4 7.0 7.6 12.9 31.1 35.1 79.7 440.2 7.3 8.0 11.9 33.4 39.6 80.9 489.1 7.8 7.1 10.4 33.3 45.5 82.0 554.4 8.4 7.3 9.8 32.9 53.0 83.1 637.4 8.2 7.5 8.6 32.8 60.9 84.1 724.3 8.5 9.0 9.5 32.9 71.1 85.3 834.5 8.5 9.2 9.5 33.4 89.5 86.4 1035.7 8.2 8.8 9.0 33.9 107.7 87.6 1230.0 2002 2003 2004 2005 2006 2007E 2008F 2009F

Source: General Statistics Office, Ministry of Finance, State Bank of Vietnam, CEIC and Credit Suisse

Emerging Markets Economics Research

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