Vietnam: authorities must keep in tune with growth

Asiamoney, March 2008

Vietnam isn’t in the mainstream of Asian investment markets yet, but its economy stands shoulder to shoulder with any of its more closely-watched neighbours. GDP grew by 8.5% in 2007, the third consecutive year in which it topped 8%. According to HSBC, industry grew by 12%, construction by 12% and retail sales by more than 20%. That’s a booming market.

Accession to WTO is integrating Vietnam with the rest of the world, a development that has been welcomed and lobbied for in Vietnam for years. But it is, in some ways, an unfortunate time to be doing so. “When Vietnam becomes more integrated with the rest of the world, through WTO, it brings growth,” says Thuy Dam at ANZ. “But as exports increase significantly, Vietnam will also become more vulnerable to external shocks.” International trade is equivalent to 150% of GDP, according to Citi, which gives some indication just how much impact a global slowdown would have.

While growth is admired, there is a growing sense that the economy needs some more finesse in its policy for the years ahead. The pace of growth from here, says Thuy, “very much depends on other macroeconomic policies the government wants to put in place, to make sure we are not going to sacrifice all other things just for the sake of having very high growth. I believe 2008 will be the year that we see a lot more macroeconomic policy implemented by the government to manage growth more effectively.”

Key to this debate is what the government does about inflation. This hit a 12 year high of 12.6% year on year in December, although the full year average was a less alarming 8.3%. “We do not feel entirely comfortable with the government’s inflation policy,” wrote UBS economist Duncan Wooldridge in a recent note. But inflation is difficult to get a handle on. Dominic Scriven at Dragon Capital points out that Vietnam’s CPI price indicator makes the situation look particularly bad since it includes food and energy, which would not appear in a US index of core inflation, for example. UBS considers two versions of core CPI, one excluding food, and the other excluding food and foodstuffs (that is, including processed foods). CPI ex-food appears to be expanding rapidly; CPI ex-food and foodstuffs is easing. As Wooldridge says: which measure should you believe?

“Some level of inflation is unavoidable in a place like this because of the inherent inefficiencies in real and financial infrastructure,” says Scriven. “The worst has probably been had but it’s a subject of considerable concern to politicians in a country with a big proportion of its population in the countryside.” Nevertheless, it is talked about constantly in Vietnam and intervention is considered more and more likely. “Given the high social cost of runaway inflation, we believe the government will continue to undertake fiscal type measures such as reducing import taxes and increasing control on monopolies,” says economist Prakriti Sofat at HSBC, who also hopes the National Assembly will give more autonomy to the State Bank of Vietnam, “which should give policymakers the leeway to tighten policy.”

This slightly trickier economic outlook than recent years has been reflected in a fall in Vietnam’s stock market, which had gained more than 200% in two years up until March 2007 but has since lost roughly a third of its value. By early January this did at least mean the price earnings ratios had fallen, but only to 19 times, still expensive by Asian market standards.

Tom Nguyen, a director in Deutsche’s global markets division in Vietnam, says foreign investors are reconsidering what they’ll pay for Vietnamese assets in an illiquid market. “The question at the forefront of foreign investors’ minds is, in the context of a global economic slowdown, would you pay 20 times [earnings] for 20-30% consensus earnings growth?”

The structure of Vietnam’s stock markets are still working themselves out. There are separate stock exchanges in both Hanoi and Ho Chi Minh City, which in some measure compete with one another. Most people expect that eventually Hanoi will be the centre for the bond market and Ho Chi Minh City for equities, but that’s not the case today, and Hanoi has the advantage of having less stringent requirements for listing. “That’s why many people use it,” says Thuy at ANZ. “If you want to get to the market quickly you go to Hanoi first, then Ho Chi Minh later.” Several big stocks, such as SSI, have done exactly this, starting in Hanoi and switching south afterwards.

It’s probably only a matter of time before a more practical distinction is made. “It’s not the right answer but it will have to do for now,” says Kelvin Lee, CEO of VinaSecurities. “I’m a firm believer that the marketplace will sort itself out.”

Another thing that needs to sort itself out is the over-the-counter market. Prior to the opening of Ho Chi Minh City’s stock market in 2002, this was how most trading was done; it is reasonably liquid, but far from transparent, and does quite literally involve giving one’s orders and picking up certificates over a counter. Gradually the increasing number of stocks listed on the main boards in Vietnam is reducing the need for institutions to take the OTC route. “The government is very clearly trying to move the unofficial market towards the official public market,” says Dominic Scriven at Dragon Capital.

But it remains popular at a retail level. “The OTC market is just waiting and waiting to disappear, and we wish it would,” says Lee. “It is far better for the marketplace, and for Vietnam’s development in the capital markets, to migrate everything to the formal exchange.”

And Lee thinks there is no challenge in doing so. “It’s a stroke of the pen. You say: though shalt move and thou shalt have 18 months to do so. It’s almost as simple as that.”

There is an argument that shutting the OTC markets reduces the access to capital for smaller companies. “But accessing capital is not a birth right, you have to earn it,” says Lee. “You have to do something to earn investors’ trust. The time has come when you need a higher level of compliance to access the markets.”

The eccentricities and valuations in the public stock markets make many believe that the way to go in Vietnam is private equity. “I was in Hanoi recently,” says one banker, “and of every 10 foreigners in suits in the room, nine of them were involved in principal finance in some way. That’s where the opportunity is, not the capital markets.”

Mekong Capital has focused in this area: two of its three existing funds are private equity, and the next one will be too, moving from growth equity to buyouts. “Private companies can have much better top line growth, and much better true growth in net profit, because they’re expanding their organisations faster than state-owned companies would. In the really good ones you can have 50 to 100% revenue growth per year.” Now that really is boom territory.

BOX: DEBT MARKETS

One of the more exciting developments in Vietnam is the gradual move towards functioning debt capital markets. Scriven says the debt markets are in some ways more interesting than the equity markets: “more meaningfully interesting, in terms of the development of the financial system and nerve centre of this economy, in particular the government bond market.” He describes the development of the market as “on the cusp, which doesn’t mean immediately. But the next step forward is a market where there will be development of the right sort of instruments, the right sort of transparency, the right sort of communication to determine what the risk free rate is in this country.”

These are early stages, but the trend is clear. Dealogic tracked no corporate bonds in Vietnam in 2005; four, worth $268 million, in 2006; and 17, worth $1.304 billion, in 2007. There isn’t, yet, a meaningful level of issuance at a sovereign level domestically, which presents a challenge for others to price off, but nevertheless corporate issuance is developing, with the banks now beginning to join the party. “The economics of it are becoming a bit more attractive as reserve requirements on deposits go up to 11%, and also there’s the element of asset liability management,” says Charly Madan at Citi. “Going to the capital markets allows you to fix those potential gaps you may have on your balance sheet.”

One problem for the debt markets is inflation, which has pushed up the government benchmark. But there’s certainly a willing audience. “The investors we continue to speak to, predominantly overseas, would dearly love to hold Vietnamese paper, whether it’s corporate, government or semi,” says Kelvin Lee at VinaSecurities. “But the problem is two things: you don’t have the supporting institutions to do a total return swap; and the foreign guys continue to watch but are staying away because there’s no Euroclear or Cedel.”

A new group called the Vietnam Bond Forum is gaining momentum, led by the treasurers of the large state owned banks and the big foreign banks active in this area such as Citi, HSBC and Standard Chartered. The idea is to discuss views and present to the authorities some advice gleaned from overseas experience.

Vietnam very obviously needs infrastructure spending, which should also boost the bond market. “Everything you see touch or feel here is in short supply,” says Madan. “And as Vietnam catches up on its infrastructure investments a lot of these will need to be financed through debt. Having a robust capital market with established benchmarks and tradability and transparency is going to be very important.” Buyers are numerous: banks and insurers, wanting long term paper for liability management; private sector funds domestically; and foreign investors, who like the high yields and the generally stable currency.

At a sovereign level, Vietnam launched in the dollar markets two years ago and had been planning to do another offer, but global market conditions have postponed the plans. When it reconsiders, its scarcity may prove to be an asset. “There’s very limited supply of Vietnamese paper in the markets,” says Madan, “so it is trading well below the risk premiums that equivalent risk weighted countries are paying.”