13-06-2008: Is Vietnam facing a currency crisis?
By Moody’s Economy.com

Investors have soured on Vietnam in recent months, sending the country’s benchmark stock index down nearly 60% and putting its economy increasingly at risk of foreign capital flight. Meanwhile, Vietnam’s year-to-date trade deficit in May — a whopping US$14.4 billion (RM47.52 billion) — exceeds the US$12.4 billion shortfall for all of 2007.

Is Vietnam headed for a currency and balance of payments crisis? A number of emerging market analysts have sounded the alarm, but currency speculators may get burned if they are betting on the kind of rout that brought down the Thai baht in 1997.

Though Vietnam’s black-market currency exchange rate has reportedly jumped to a record high of more than 18,000 dong (RM3.55) per US dollar — the official rate last week was 16,268 dong — Vietnam can still avoid a currency crisis if the government restores macroeconomic credibility by acting quickly and decisively.

It has done so before, from 1989 to 1992, when it launched bold and comprehensive reforms that squelched hyperinflation, drastically changing inflation expectations and increasing confidence in the domestic currency.

Granted, there is much to worry about: May CPI inflation soared to more than 25% year-on-year (y-o-y), driven largely by the sharp spike in food prices. A sense of déja vu and fears of skyrocketing inflation are causing individuals and merchants to hoard rice, cement and steel—a return to old habits formed back when annual inflation exceeded 60%.

This behaviour not only exacerbates inflationary pressure, creating intermittent shortages of key commodities, but it also has prompted a stampede into gold, the inflation hedge of choice. For this reason, the price of gold has tended to be a reliable proxy for the public’s assessment of the government’s ability to stabilise the economy.

Gold’s price in recent months underscores their stunning lack of confidence. Moreover, gold imports have risen sharply, aggravating the trade deficit. According to the World Bank, during the first four months of this year, Vietnam spent about US$1.2 billion to import 43 tons of gold.

The public’s mistrust is not surprising, given recent policy missteps. Even before putting in place the regulatory infrastructure needed for sound, stable development of the domestic financial market, the government accelerated the process of external liberalisation and failed to act quickly to prevent the economy from overheating. Instead, credit growth has shot up, and favoured state enterprises have been allowed to go on an investment spending spree. Consequently, the twin deficits in the balance of trade and fiscal budget have spun almost out of control. This year, the current account deficit as a share of GDP may rise to 7.8%, while the IMF projects Vietnam’s budget deficit to decline slightly to 6.6% of GDP from an estimated 6.9% in 2007.

The origins of Vietnam’s woes can be blamed in part on extreme swings in investor sentiment and the inexperience of Vietnamese policymakers who seem to not appreciate the dangers of a premature opening of the capital account. In 2006 and 2007, Vietnam was among Asia’s fastest-growing economies, and its stock market boom quickly acquired bubble dimensions. At its peak in March 2007, the combined capitalisation of the Ho Chi Minh City and Hanoi stock exchanges rose to nearly US$29 billion — more than 40% of GDP — from less than US$1 billion in 2005.

Investors were extraordinarily bullish in anticipation of Vietnam’s World Trade Organisation accession. The country was thought to be a prime investment destination and attracted huge flows of foreign capital. According to the World Bank, foreign direct investment inflows rose to an estimated US$6.7 billion, a little more than private remittances. To prevent this large inflow of foreign capital from driving up the value of the domestic currency, which would have undermined the country’s export competitiveness, the State Bank of Vietnam bought more than US$10 billion in 2007.

Unfortunately, the SBV’s effort to sterilise its interventions in the foreign exchange market were not successful, and the accumulation of reserves expanded the monetary base. The outcome was runaway credit growth, an overheating economy, surging inflation, and rapid deterioration in Vietnam’s external accounts.

An important indicator of the overheating has been the astonishingly sharp acceleration in import growth, especially relative to export growth. The latter has been curbed by the US downturn and subsequent slowdown in other developed economies. Import growth soared soon after Vietnam formally joined the World Trade Organisation in January 2007 and sought to contain inflationary pressures by accelerating the pace of WTO-mandated tariff reductions. Although this move was praised by the IMF, it not only failed to produce the desired results, it also contributed to a ballooning trade deficit.

The primary driver of import demand has been domestic enterprises, many of them state-owned. To analyse the sources of growth, Vietnam’s statistics office disaggregates import data by type of ownership. A distinction is made between imports by the FDI sector — enterprises that receive foreign direct investment and account for nearly 44% of industrial output and more than 50% of total exports — and imports by the domestic sector. The latest data show a sharp reversal in import share, with the domestic sector accounting for more than 70% of total imports in recent months.

Import costs have soared because of purchases of commercial aircraft and oil refinery equipment, as well as because of the sharp growth in imports of steel, machinery and equipment, petroleum, electronics, computers, and vehicles. During the first four months of this year, imports of iron and steel jumped by 153%, fertilizer by 165%, and automobiles by a whopping 333%.

To cool down the overheating economy, the government recently ruled that state-owned enterprises must obtain approval before investing in the financial and property markets. This is a step in the right direction to control overinvestment, and hence, the fast-growing trade deficit. Additional administrative measures may be needed to impose fiscal discipline. The central bank also should address the problem of negative real interest rates, which creates a strong incentive for domestic firms to borrow.

During the early 1990s, the Vietnamese authorities were able to bring down inflation and strengthen confidence in the currency by raising nominal interest rates sufficiently to ensure positive real rates of interest. It should do so again, quickly and decisively. In this regard, the SBV’s recent decision to raise the base rate to 14% from 12% is a positive step, although it is probably still not enough to restore faith in the currency.

A bitter lesson
Concerns are mounting about a currency crisis in Vietnam in the next 12 months. Yet the government should not have responded to these concerns by declaring that it has sufficient foreign reserves to defend the dong.

The bitter lessons of the Thais and Indonesians in 1997 are very clear: Even US$22 billion can be used up very quickly when the currency is under heavy pressure from determined and well-financed speculators. The only way to regain credibility is by employing serious tools to attack the roots of the problem, which are an overheating economy and excessive inflation.

Because the dong has been unofficially roughly pegged to the declining US dollar, Vietnam’s nominal effective exchange rate (NEER) has been declining, and the export growth rate has thus far risen appropriately. However, Vietnam’s inflation rate far exceeds that of its main trading partners, causing the real effective exchange rate (REER) to climb sharply, and, related to this, import growth has gone through the roof. The sharp divergence between the NEER and REER shows that it is the inflation rate that is hurting competitiveness, not the nominal exchange rate. The government should focus on attacking inflation by raising interest rates, a strategic move that would also blunt speculative pressure against the currency.

The central bank recently announced that the trading band of the dong will be widened and lowered the official exchange rate by 1.96% against the US dollar. Although greater exchange rate flexibility over the medium term may benefit the development of Vietnamese financial markets, it must be administered carefully during this difficult period.

The dong is set to weaken further in the near term, and a wider trading band would allow the currency to depreciate at a faster pace. This is a risky move, for it is likely to worsen inflationary pressures and lower confidence in the currency, setting off a self-reinforcing vicious cycle. The exchange rate depreciation could overshoot and cause greater harm to the economy.

To prevent a currency and balance of payments crisis, it is necessary that the government take a tough tightening stance. This could dampen growth in the near term, but the benefits outweigh the downside, as it would take an extended period for an economy to recover from a major crisis.

Monday July 21, 2008

Some businessmen's view on Vietnam, Laos and Cambodia

Many Malaysians do business with counterparts in the Mekong delta. Some of their views.

QUEK KAR LOON

Quek Kar Loon

CEO

GPRO Technologies Bhd

We have been in Vietnam since 2004 and I believe there is still tremendous potential for business growth in this country.

Despite the current inflationary pressure, sentiment among the local people remains strong.

We are not planning to venture into Cambodia and Laos anytime soon but we will gradually increase our workforce in Vietnam to cater to the growing textile industry.

As an information technology solutions provider for the textile and apparel industry, we grow in tandem with them.

Currently, about 20% of our net profit comes from Vietnam. Over the next few years, I see our activities there picking up.

I would say the main challenge of doing business in Vietnam is the language barrier.

TAN SRI MUHAMMAD ALI HASHIM

Tan Sri Muhammad Ali Hashim

Chairman

QSR Brands Bhd

Currently, about 30% of our revenue comes from overseas. It's quite substantial and, with Cambodia, it will definitely increase.

Tourism here is growing rapidly.

We hope to establish more Kentucky Fried Chicken outlets here to cater to the increasing number of foreign visitors.

Sales so far, have been very exciting.

James Chan

JAMES CHAN

Group managing director

Sumatec Resources Bhd

We are active in Cambodia and Vietnam, having secured contracts involving our oil and gas engineering, procurement, construction and commissioning (EPCC) division in these countries.

Currently, the Indochina operations contribute about 10% to our net profit. With the current high oil prices, we see much potential in the biofuel business.

TAN ANG MENG

CEO

Fraser & Neave Holdings Bhd

I believe the growth story of the Indochina economies is still very much intact despite current pressures on the economies.

The young population and increasing purchasing power will continue to drive demand. These markets are still relatively untapped in our view and our brands, although already introduced are not fully developed in these countries. We have plans to up our sales over the years.

Our glass manufacturing plant in Vietnam is doing quite well. So far, we have not felt any negative impact given the current inflationary pressure and weak currency there.

JIMMY CHEAH ENG CHUAN

Group MD

Furniweb Industrial Products Bhd

For now, our Vietnam operations are doing okay despite inflationary pressures.

Jimmy Cheah Eng Chuan

As a furniture-webbing manufacturer, labour forms a big part of our overall cost and as a result of high inflation, our labour cost has been on the rise.

Generally, labour cost in Vietnam is still relatively competitive as compared with other countries such as China but the government has to work on controlling the high inflation in the country or else things will get tougher.

There are plans to venture into upstream activities moving on as we still believe that there is potential for growth in Vietnam.

We have no plans to invest in Cambodia or Laos as this stage although we are already exporting some of our products from Vietnam to Cambodia. We think Laos is too small a market for a business like ours.

EDWARD YIP

Group corporate affairs senior manager

Kossan Rubber Industries Bhd

Given the current challenging environment in Vietnam, we believe we have to be extremely careful in our investment plans.

We remain open to the idea of venturing into Vietnam but are waiting for things to stabilise there.

Right now, inflationary pressure has caused costs such as labour and transportation to increase so much. We believe a correction should take place over the next couple of years after which the economy will start to grow at a steady pace again.

We plan to go into the technical rubber products sector there and ride on a possible construction and automotive boom thereafter