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.