Morning in Vietnam?

Politics and the economy in Vietnam both look bleak. The political leadership is divided and an economy which ought to be able to grow at 6-7 percent is struggling to reach 4 percent.

The stock market has the cheapest rating in all of Asia, the banks are awash in non-performing loans and it is sure guesswork how deep are the problems of the state-owned enterprise. Yet could Vietnam could be enduring its darkest hour before dawn.

The biggest problem as of now is the uncertainty of politics – an unusual condition for a Communist one-party state. The power distribution between president and prime minister and with the chairman of the National Assembly and the general secretary of the party all playing important roles, and with the constant attempt to balance North, Central and South, were once seen as strengths of Vietnam’s system compared to China’s rigidly hierarchical model. However, they have become a source of discord and indecision rather than consensus, obstacles to good government. The balance is now upset by a struggle for power and policy between long time Prime Minister Nguyen Tan Dung and President Truong Tan Sang.

Dung is under fire because of his association with the corruption and huge losses racked up by SOEs which had been given easy access to cash from the state banks which they proceeded to squander. Major SOEs came directly under Dung as the prime minister sought to boost growth in 2009 by using Chinese tools of massive lending to SOEs. That policy is proving costly in China but in Vietnam management was worse and the financial system too fragile and exposed to the outside world to cope.

The SOE problems stem from a mixture of large scale corruption, over-ambitious but inexperienced management, trophy office buildings, and political pressure for projects to appease regional and provincial interests. Dung is seen as an obstacle to taking an axe to the SOEs whose investment spree, aimed at raising Vietnam’s growth rate to China’s level, ended in disaster and bed debts which will be a burden for several years.

Yet some of the forces aligned against Dung are reactionary, looking less to improve Vietnam’s version of mixed state and private capitalism than return at least of the way to the socialist values of the past. Hence those who have been arrested in the ongoing clean-up campaign include not merely corrupt and incompetent SOE bosses but the chairman of Asia Commercial Bank, Vietnam’s largest private bank.

As always in Communist party power struggles, ideology is far less important than personal and group rivalries and access to spoils. But the opacity of such struggles in a closed system makes predictions of the outcome and of the policy consequences impossible to predict.

Meanwhile, as in China, power struggles result in a crackdown on media, blogs and anyone else who draws attention to what is going on under the blanket, let alone suggest that it is time for the party to reform itself or active popular opposition rather than just public cynicism.

Divisions at the top are an obstacle to decision-making on many issues, not just SOEs. They are compounding the delays and compromises that the need for balance between regions and power centers has long created. That balance did not optimize growth but did at least ensure a more even distribution of economic progress than in China. More recently the scale of SOE-linked corruption has undermined that benefit.

However, it is also the case that, despite the usual communist party secrecy, almost all the bad news is already in the public arena and the markets. The party will not fall apart, the people will grumble about corruption and the government will make vain efforts to stifle dissent. But it is unlikely that Vietnam is on the cusp of radical change for good or bad.

The tendency to compromise between factions and interest groups will reassert itself and hopefully lessons will have been learned about the dangers of SOEs trying to run before they can walk, and of the dangers to stability when high inflation and banking crises follow such attempts.

Indeed, looking at recent economic management suggests that the lessons have been learned. The currency has been stable for the past eight months, the trade balance has improved dramatically, inflation is down to 6 percent from 19 percent and credit growth has fallen very sharply as real interest rates remain very high. Indeed the slow growth of credit in the wake of SOE disasters accounts for most of the other improvements – and for a fall in GDP growth to at best 5 percent this year and only a little more in 2013, even assuming that global conditions do not deteriorate further. SOE investments has fallen from 19 percent of GDP to 11 percent.

But slow steady growth is to be preferred to the booms and busts of the past two decades. So the issue is whether the SOEs can stay reined in, bad debts gradually cleared up and failed ones liquidated. NPL provisions at the state banks will remain a drag on credit growth at least for the state sector which should mean a bigger share of the economy for the private banks and private sector generally.

Banks have been slow to foreclose on failures and dispose of the large overhang of properties. Much quicker recognition of losses would speed recovery but is unlikely to happen. But meanwhile the fact that some SOEs have not been bailed out by the state has meant that costs of capital for private firms have improved relatively.

Corruption and SOE inefficiency are not going to stop, but exposure of their failings is acting as a brake. The SOE share of investment has fallen sharply. Meanwhile much of the export sector has been unmoved by the turmoil in the domestic one. Foreign direct investment has fallen but at around US$7 billion a year in disbursements is still higher as a proportion of GDP than anywhere in Asia and is now concentrated in manufacturing industries and infrastructure, not real estate as companies from Japan, Taiwan and Korea continue to see it as an attractive, lower wage alternative to China.

Commodity price declines, particularly for coal and rubber, will hurt export values but even so Vietnam might even achieve current account balance in 2013, or at least come close enough to enable interest rates to fall without compromising the currency.

For portfolio investors the underlying outlook is promising if they can see beyond the justifiable nervousness following the ACB and other arrests which seem more an outcome of political infighting than genuine clean-ups. On a price/earnings ratio basis it is the cheapest market in Asia at around 9 times for 2012 and a prospective 8 times for 2013 according to investment house Dragon Capital, and one of the few market in the world where interest rates in real terms are high at a time when real rates almost everywhere are low to negative. So the prospect for re-rating as local rates fall or foreign ones rise is very substantial.

The market itself remains too thin for comfort and privatizations have stalled both for political reasons and because potential issuers are too big to be easily absorbed at present. But lower interest rates should raise interest in equities and there remains the possibility that the government will raise foreign shareholding limits. As several of the best regarded shares are at their foreign limits and foreign sellers can attract premiums. At the same time however, foreign closed end funds listed overseas trade at significant discounts. This anomaly is unlikely to last forever.

In short, dawn may be delayed but the risk/reward equation relative to other Asian markets now looks favorable, and the politics no worse than most others.