Wednesday, April 14, 2010

Vietnam in Economic Turbulence

Some bright spots, some not so bright
Vietnam is flirting with a significant downgrade in foreign perception of its potential and prospects. But not all the news is bad at a time when the world economy is picking up and foreign investors are looking to diversify away from an over-hyped China. Vietnam currently has two perception problems which are seen as linked, albeit indirectly, to next year's Communist Party Congress and the change in leadership that will bring. The first is that loose fiscal and monetary policy driven by a desire to maintain economic growth of 6 percent at all costs is re-igniting inflation, weakening the currency and weakening Vietnam's credit standing. Rating agency Fitch last month put Vietnam on negative watch, suggesting that it could be downgraded from an already none too appealing BB-. It cited
inflation and a two-step decline which saw the dong fall 7 percent between November and February and the black market rate indicates fears of further falls.

The second is the apparent rise of economic nationalism, at least as far as the resource sector is concerned. This has focused on two important projects, both now stalled. The result is likely to be that when eventually they get re-started they will do so with majority local ownership in place of the foreign majority which has in principle at least been allowed. The biggest is the Tiberon Minerals project at Nui Phao in northwest Vietnam, which promises to be one of the world's largest wolfram (tungsten ore) mines and to also produce fluorspar, silver and other minerals. Tiberon was originally a Canadian company listed in Toronto but control was acquired in 2007 by Vietnam Resources Investments, a closed-end foreign fund, and other funds managed by Ho Chi Minh based Dragon capital.

The project first hit trouble when financing fell through as a result of the global credit crisis and a sharp fall in metals prices. It was further set back when the government suggested the venture might lose its mining license because of failure to complete the project on time. This made financing even more difficult. Some resolution of the issue is likely which would involve a state entity taking a controlling interest and the funds writing down the value of their investment. But debt finance could still be a problem and the episode has discouraged other foreign investment in Vietnam's potentially abundant resource sector.

Even more politically sensitive than the Nui Phao project is a Chinese majority-owned bauxite venture in central Vietnam. This has become the focus of government critics and even caused war hero General Giap to voice his opinion that it will bring an influx of Chinese workers, increase China's already strong economic leverage, displace local minorities and generally undermine national security. The issue has also become the focus of apparent official attempts to hack into the emails and websites of critics of the project.

The bottom line of all this is that Hanoi is going to take a much more restrictive attitude to foreign investment in mining, probably limiting it to minority equity participation. That will slow development of mines and the economy. Although it is not thought likely to extend to other sectors, these two issues have had some impact on foreign perceptions and a very negative one on some investment fund valuations. The jury is still out on the inflation/weak currency issue and will probably stay that way till later in the year. Inflation is likely to hit double digits for the year but given the composition of the index, heavily weighted to food, transport and building materials, it is not clear how far the government can influence it other than via the exchange rate. Interest rates and government spending make limited impact on aggregate demand. Further sharp currency falls now look less likely.

Foreign reserves should begin to recover after a sharp decline last year in a vain official attempt to avoid devaluation and financial sector reform has recently been given a quiet but important push forwards.

The current account had deteriorated very sharply but much of this seem to have been due to precautionary importing, and including of gold, which remains a key part of the Vietnamese monetary system. Export volumes and prices are now mostly looking positive. Garment exports exceeded forecasts and oil output and prices have risen significantly. Remittances are holding up and dong devaluation should have helped stem imports from China which remain a constant thorn in the side of local industries. Despite pressures from some within the party to halt market-oriented reforms and continue to give priority to state enterprises, the latest measures suggest that the central bank has won an important victory in its struggle to free up interest rates. Interest subsidies introduced in 2009 as an anti-recession measure are to be withdrawn and there is a move towards negotiated rates.

So even if state banks continue to be accommodative towards the state sector, private banks, which have 50 percent of the market, will be freer to lend to a private sector which can afford to pay higher rates but cannot offer the same security as asset-rich state enterprises. The lead-up to the party elections and congress may see official caution on issues such as further equitization. But there appears to be no deep ideological divide between contestants for the future top jobs. The global crisis and failure of several foreign invested projects to proceed as promised does not appear to have caused any major retreat from liberalization. The party continues to need to balance various interests and loyalties,
regional, sectoral and personal which can make for conflicts, corruption and slow progress. But apart from the resource sector there is little to suggest that problems have gotten worse.

As for Vietnam's external position, its currency is vulnerable to a hyper-sensitive local market and the low level of official foreign reserves. However, most external debt is state-backed and long term. Meanwhile dollars and gold continue to play huge roles in the local financial system, a factor which can sustain purchasing power even through sharp dong declines. The long-term need is to wean Vietnam away from dollars and gold, which will require a sustained period of relative currency stability backed by market-driven interest rates. The evidence is that despite the inflation and currency setbacks of recent months, it is now moving in the direction of market-oriented rates which is time should make for a more stable dong. By Philip Bowring for the Asia Sentinel

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