Clouds on the Horizon

The buzz about Vietnam's economic growth has turned sour over the past few months.  Inflation seems out of control -- people at the low end of the economic ladder are really hurting as their incomes fail to keep pace with inflation in key areas like food and fuel. 

Macroeconomics is not my strong suit, but my understanding is that official policies have kept the dong, Vietnam's currency, artificially high.  Also, the leadership's policy of encouraging state-owned conglomerates like PetroVietnam (the state oil company) to enter new industries like real estate and banking is not a good idea.  By definition, investment decisions by state enterprises often are dictated by political -- not economic -- considerations.  Due to the easy access to capital enjoyed by state enterprises, capital that otherwise would flow to projects with a high return on investment instead flow to projects that are favored for political reasons [read: easy money].  That in itself harms economic growth.  But if the dong declines precipitously in value, then the loans taken by state banks from overseas lenders suddenly will become much more expensive to repay.  Bank failures may result and the flow of investment capital to productive projects will seize up, severely impacting FDI and growth.  The exact same thing happened in Thailand in 1997.

Fortunately, we haven't seen any impact on our business at VietnamWorks yet.  But I expect any economic slowdown would lag a financial crisis by a few months anyway.  I've got my fingers crossed.

- charvey

Vietnam Inflation Crisis Is Feared

Government's Moves 
To Curb High Rate 
Deemed Inadequate

By JAMES HOOKWAY
May 30, 2008; Page A6

Vietnam's accelerating inflation is threatening to morph into a full-blown crisis, and it provides a warning to other Asian countries trying to tamp soaring prices.

The government said this week the inflation rate in May was 25.2% on an annual basis, up from 21.4% in April and 14.1% in January. A slow government response was in large part to blame. When oil and food prices began to rise late last year, the State Bank of Vietnam, hoping to sustain growth, was slow to rein in inflationary pressure by raising rates or clamping down effectively on irresponsible lending. Efforts to control inflation proved ineffective -- such as a loosening of the currency's dollar peg, which backfired largely because of lending practices.

So far, economists say there is limited scope for Vietnam's troubles to infect other Asian economies. But Vietnam presents a worst-case scenario of what could happen if the region's central banks don't act swiftly to curb rising prices at a time when their economies -- unlike those of the U.S. and Western Europe -- are still showing robust growth.

After a building boom amid low interest rates and an export boom because of a weak local currency pegged to the dollar, Vietnam's economy has reversed course. The stock market's main index is down 55% this year, and the prices of goods are rising sharply.

Morgan Stanley, in a report Wednesday, warned that loose lending had created a banking crisis. It forecast that Vietnam's currency, the dong, could weaken dramatically against the dollar in the coming year.

On Thursday, Fitch Ratings lowered its outlook for Vietnam's sovereign debt to "negative" from "stable." The country's policy response to rising inflation "has been both too slow and too small," the agency said.

Many Asian central banks have made controlling inflation their primary policy objective in recent years. But relatively few are genuinely independent, making them subject to political pressure to maintain economic growth.

Some, such as India and China, have opted to mop up excess liquidity in their financial systems by imposing new reserve requirements on their banks rather than raising interest rates to levels that might do more to stanch inflation. Others are waiting to see whether larger harvests will ease food bills, which are 40% or more of the consumer-price index in countries such as Indonesia and the Philippines.

Vietnam's experience shows the danger of waiting too long before taking decisive action to head off inflation. "What's happening here in Vietnam is the Asia of 10, 20 years ago," said Spencer White, a strategist and member of the board at Thien Viet Securities in Ho Chi Minh City. "There's not much financial integration with the other Asian markets at this point, but it could damage the broader appetite for frontier markets."

A year ago, Vietnam was the darling of global investors. International banks such as HSBC Holdings PLC bought into local banks. Property developers from South Korea and Taiwan began work on huge developments to build office space in Hanoi and Ho Chi Minh City.

Global manufacturers also streamed into the country, partly to escape rising wage and land costs in China but also to tap a young and industrious work force who saw a glimpse of prosperity after years of war and stagnation. Foreign companies sought approval to invest $20 billion in the country last year -- a third more than in nearby Thailand -- adding to the inflationary pressure by driving up land costs, skilled-worker wages and office rents.

The country's biggest state-run enterprises began diversifying, hoping to become powerful conglomerates to compete with the foreign firms that began arriving in Vietnam following its accession to the World Trade Organization.

Some of Vietnam's senior leaders questioned Prime Minister Nguyen Tan Dung's determination to build up these new businesses, often with cheap loans from state-run banks. A former prime minister, Vo Van Kiet, wrote a public letter to Mr. Dung last year saying these were precisely the mistakes South Korea, Malaysia and others made in the run-up to the Asian financial crisis of the 1990s.

As inflationary pressures began to rise last year, some government economists say, the central bank didn't want to cut off the low-cost loans. "Much of the central-bank policy was driven by the government's agenda of promoting as much economic growth as possible while at the same time making sure that state-run enterprises would play a bit part in the economy in the years to come," a Vietnamese economist said.

People familiar with the situation say that, earlier this year, as higher prices sparked protests and strikes, Mr. Dung instructed central-bank governor Nguyen Van Giau to act more aggressively to contain inflation.

The central bank widened the range in which the dong could trade against the dollar. The idea was to free the local currency from a sliding U.S. currency and to enable Vietnam to better absorb higher oil costs. Instead, the move triggered panic among a population that for years used the dollar as a convenient alternative to the unwieldy Vietnamese currency, whose largest bank note is the rarely seen 500,000-dong bill -- worth about $30.

Some local banks refused to exchange dollars, and local stock prices collapsed as banks held on to their dong and refused to lend money to buy shares. Mr. Dung in March lowered Vietnam's growth target for 2008 to 7% from 8.5% to help focus the drive against inflation.

Since then, a global spike in food prices and a poor rice harvest have made things worse. The central bank expects Vietnam's current-account deficit -- the difference between a country's import and export of goods and services -- to hit 7.5% of gross domestic product this year, up from 5% in 2007. The current-account deficit in Thailand was 6.5% of GDP when it was forced to devalue the baht in 1997, triggering the Asian financial crisis.

The Vietnamese, meanwhile, have been draining bank accounts and buying gold instead. Some have also started hoarding dollars as a hedge against inflation.

Apartment prices in Ho Chi Minh City, the country's commercial hub, have fallen by half so far this year, local media reports say. Morgan Stanley estimates loan growth has been expanding at over 35% a year and exposure to the property market is about 10% of total loans.

Write to James Hookway at [email protected]