Having Tamed Inflation, Vietnam Tackles Overleveraged Banks…

Despite hosting a few interesting consumer stories such as Vinamilk, Vietnam has been from my top down perspective a highly risky investment destination, plagued by sustained macro instability. Having been touted by Asian brokers as a ‘mini China’,  perhaps it’s finally living up to that name as it undergoes a painful deleveraging process and local tycoons get hauled away in handcuffs amid political uncertainty. It’s positive that the authorities have followed through on stabilising the macro environment as reflected in falling inflation and a becalmed VND. However, the country’s overextended banks and their fast deteriorating loan quality (with NPLs already probably well over 10%) have been the trigger for recent headline grabbing events, which have seen the local market slump over 20%.

The chief executive of Vietnam’s Asia Commercial Bank (ACB), Ly Xuan Hai, was arrested last week and he could face up to 20 years in prison if found guilty of the rather quaint sounding charges of “deliberately acting against state regulations on economic management and causing serious consequences”. Moody’s lowered Asia Commercial Bank’s credit rating to B2 from B1 last week in the wake of these developments and put the company on review for future downgrades.

Annual GDP growth averaged more than 7% in the decade leading up to the inflation crisis of 2008, but has slowed to just 4.7% in Q2 2012 as the government tightened credit in an attempt to restore confidence in the currency, and dissuade its citizens from hoarding gold and USD. Slower inflation has created room for the State Bank of Vietnam to try to boost economic growth by cutting policy interest rates, but having cut rates by five percentage points already this year, the bank may have reached the point where further easing has limited impact, until bank nonperforming loans are dealt with, so they can boost lending. In any case, slashing rates much further risks reversing retail flows back out of the VND and into gold and the USD.

The State Bank of Vietnam’s Governor told the national assembly recently that the non- performing loan ratio is now at 10%, although the bank’s official figure as at the end of June was only 4%. The bank expects 5.1% growth in 2012, which looks ambitious as the slowdown reflects weak domestic demand. With consumer credit tight, most Vietnamese are taking a conservative approach to consumption, as wage growth slows and unemployment rises, while some of the highest gold holdings as a share of total household wealth in the world are no longer generating a spending windfall. Reflecting this, import growth on a YTD y/y % growth basis has slowed from 24-26% a month throughout 2011 to under 7% in August.

Business in Vietnam has long been characterised by a lack of transparency, weak corporate governance, and rampant fraud/corruption far exceeding anything seen even in less than exemplary Indonesia or China.  The corruption clampdown amid widening economic inequality and popular discontent at the politically connected business elite (sound familiar?) is long overdue, and has gone far beyond celebrity tycoons. For instance, eight executives at Vinashin received prison sentences of up to 20 years in April after the shipbuilder nearly collapsed in 2010, having run up around $4.4 billion in debt. With the boom unravelling, the rise of hardliners such as Communist President Truong Tan Sang, may pull the country from a reform path (and the shift in oversight of the anti-corruption governing body from the Prime Minister to the Secretary General of the Communist party is telling) but privatisation revenues remain crucial and regaining the confidence of foreign portfolio investors will be a priority. I concluded in that note last February that: ‘By the beginning of Q4, we should know if they have the stomach for this fight; if so, Vietnam will finally become a sensible long-term investment destination for portfolio investors rather than that ‘mini China’ investment sound bite.’

After a series of missteps, Vietnamese authorities have showed impressive resolve to restore policy credibility, and if they can now reform the banking sector and manage its NPL issues, the country can belatedly aspire to graduate from frontier market status later this decade. Although the local market remains largely a retail driven casino (with price trends correlating inversely with VND gold prices, a factor driving this year’s Feb-May rally), resumption of the delayed privatisation program would be a positive sign of intent and local consumer, pharmaceutical and infrastructure plays look thematically attractive longer term, while property and construction materials remain exposed to a prolonged downturn.

Banks may deliver a ‘dead cat’ rebound, but with acknowledged NPLs having gone from 2% at end 2010 to 10% now, and with a series of corruption scandals from the credit boom coalescing, they will be a volatile ride. The benchmark equity index has fallen 21% from its high this year on May 8th, and is now trading at a 9.4x PER, or about a 33% discount to the MSCI South East Asia Index. If for no other reason, events in Vietnam are worth watching as a precursor to policy changes facing China’s Communist party, where many of the same economic and social stress points as well as a loss of political authority are evident, albeit on a vastly greater scale. Furthermore, it’s not at all inconceivable that the two countries, with a historically uneasy and sometimes violent relationship, will come to blows in the not too distant future as domestic pressures drive geopolitical posturing.