Amid the myriad booms
and bubbles the asset world has witnessed in recent months, one stands out, at
least for originality: Vietnam.
It is awash in more money than it can handle.
In mid-March, a
thousand portfolio investors, investment bankers and fund managers crowded into
Hanoi’s Melia Hotel for an investment conference that coincided with a flurry
of announcements about new funds being formed to invest in Asia’s latest
miracle economy. Here was the successor to China
of the past decade, Thailand-Malaysia of the 1985-1995 era, Taiwan and Korea
of 1975-1985 and Japan
during the post-1965 boom. Vietnam
is the latest to fly in the Asian geese formation.
Although a handful
of pioneers have dabbled there since 1994 after its doi moi reform (which began in 1986) gradually moved in the
direction of capitalism, the past few months have seen a foreign feeding frenzy
that has caught the imagination of local punters, who have rushed to the stock
market in unprecedented numbers. Although the market has come off 15 percent or
so since an index peak of 1170 in early March, it is still double its level
when the latest bull run began in November 2006 and four times the level of
early 2006 when the markets began to wake up. (There are separate markets in Ho
Chi Minh and Hanoi
but the Ho Chi Minh one is the most active and the preferred listing location).
More remarkable,
perhaps, than the rise in the index has been the increase in market
capitalization from around a year ago to today’s US$15 billion plus ‑ around 24
percent of GDP. That has been the result of a flood of new listings thanks to
tax changes that have forced many companies whose shares were once traded only
on an over-the-counter basis to list. Hitherto many had preferred to avoid the
reporting and regulatory requirements of a listing, but now they are finding
that listing can bring share prices as well as tax benefits. (Altogether there
are about 2,800 OTC companies but most seldom trade.)
New markets are
particularly prone to speculative excesses and Vietnam is no exception. This has
been a money-and-momentum driven market with scant regard for such niceties as
price-to-earnings or price-to-book ratios. They are there for quick profits and
an improvement on the modest yields of bank deposits. As for the foreigners,
they say they are there for the long term, which is mostly true.
But what can they do
other than buy stocks when they have fast-growing funds dedicated to doing just
that, sometimes almost regardless of price? There are now some 20 foreign funds
with money to invest in Vietnam,
compared with only four a year ago. This is in addition to investment by
foreign individuals or through participating certificates sold by investment
banks, including HSBC and Merrill Lynch, which hold baskets of major stocks.
The fact is that Vietnam
is being swamped with foreign money, adding to a credit-driven surge in local
speculation. Combined, this could have destabilizing macro-economic effects as
well as an equities bubble in danger of bursting. Some of the money earmarked
for investment will remain on the sidelines for the time being. Some will find
its way into OTC shares or new equitizations ‑ the process of state companies
becoming tradable, which in most cases also means issuing shares to private investors,
managers and employees.
In one case, Dragon Capital,
the oldest of the foreign funds, has used cash to buy control of a
Canadian-listed company, Tiberon Minerals, whose main asset was a Vietnamese
wolfram deposit.
But the estimated $2
to 3 billion of new foreign portfolio money waiting in the wings is a huge
amount for this market to absorb. It may not seem so big relative to a $16bn
market capitalization but it is huge relative both to the free float of those
listed and bearing in mind that foreign holdings for some counters, mainly
banks, are close to their limits (30 percent in the case of banks).
This is money
earmarked for Vietnam.
There is more discretionary foreign money that may still want to come in, for a
long term punt on Asia’s latest star.
Meanwhile foreign direct investment into businesses is running at around $10
billion in promised projects and around $2 billion in actual disbursements.
Even if the
foreigners decline to buy with an index trading at some 50 times earnings,
there is no guarantee that locals will not continue to pile in as the market is
fuelled by rapidly growing money supply, itself partly driven by the foreign
cash inflow. There are plenty of examples. Big institutions had mostly exited
Nasdaq well before its small investor-driven 2000 peak. Closer to home, the Bangladesh
market continued to boom long after foreigners exited.
There has been talk
that the government might try to dampen the market and money supply excesses by
imposing new controls on foreign portfolio capital. The mess that Thailand
made of this has probably been a deterrent. So, too, is the knowledge that the
government should be able to take this opportunity to speed up the equitization
and new listing processes.
The issue for Vietnam
now is whether enough new large state companies can come to the market, or at
least be made available during the equitization process, to absorb the excess
of foreign and local money. There are several major companies planning to do so
this year but whether that can happen quickly enough is debatable given that
bureaucracy moves slowly. It also faces genuine problems in determining asset
values of state companies, particularly those with large but unutilized land
banks and the lack of any meaningful market in land.
The foreigners would
like to use the current weight of money waiting to invest to persuade the
authorities to increase foreign ownership limits – 30 percent for banks and 49
percent for most other companies. But the government fears that this would
simply drive prices further and use up funds which it would prefer to see
deployed in the new listings.
The market could
anyway lose momentum of its own accord before the new listings arrive, in which
case the authorities may face the choice of slowing them down or even halting
them – as happened in the past in China – or seeing the weight of new
paper collapsing the market, a result that could have political consequences.
Among foreign fund
managers, the optimists do not expect a correction of more than 30 percent.
They argue that accelerating earnings will soon show up in results and make the
PE ratios look less inflated. They note, too, that the Vietnam stock
index is capitalization-weighted and that though several of the heavyweight and
liquid stocks are expensive by most measures, the smaller companies usually trade
on much lower ratios. It is also argued that as new large stocks come to the
market at IPO prices kept to moderate levels by the regulatory authority, the
overall index valuation will come down without the necessity of a crash.
Others are less sanguine
and suggest that once the domestic momentum goes out of the market, small
punters will head for the exit in droves and the foreign money will only be a
palliative. If that is the case, the market could easily go back to the 600
level or worse and, like its Chinese precursors, go through a long period of
inaction with both PE and earnings falling. A worst case scenario could see the
index back to 300 which would itself slow reform and bring new listings to a
halt.
The theory is that
the current average PE ratio is around 45 and could come down to 30 assuming
(perhaps optimistically) earnings growth of 30 percent in 2007. But that would
still leave it at about double what might be expected for a market with great
growth potential but erratic corporate governance, a heavy presence of banking
stocks and huge demands on capital if current 7-8 percent GDP growth is to be
sustained.
Some of the biggest
demands for capital will come from the power sector and Vietnam plans to use the market to
raise capital for separately listed power producers under the Electricity
Vietnam umbrella. Such capital intensive ventures are seldom the stuff of
market booms.
For now the financial
markets look promising only in parts. Participants mostly praise the structure
and management of the stock exchanges which have had few trading problem –
though abuses by brokers are believed widespread, as in other markets where
profits come more from proprietary trading books than from commissions.
A bond market, too,
is emerging to which foreigners have access. Thus far it trades mainly
government bonds. But public debt issues will continue to grow – outstanding
government bonds are only equal to about 10 percent of GDP compared with as
much as 40 percent in Thailand
and Malaysia.
Corporate bond issues will also likely expand as investors become more
confident of their accounts.
Generally speaking, Vietnam’s institutional financial development is
more advanced than China’s
was at a similar stage. However, there
is one major problem which is being exacerbated by the current credit boom: the
banking system. Its health is not only critical for macro-economic stability,
it is also a key to stock prices: eight of the top 20 stocks by market
capitalization are banks, and new ones are coming to the market soon
As the banking system
is largely state-owned it may not be in danger of the kind of meltdown suffered
in many countries during the Asian financial crisis of 1997-1998. However,
credit has almost certainly been growing too fast even for an economy with 13
percent nominal growth and still in the process of monetization. Large state-owned
enterprises still get the lion’s share of credit and although the official figures
for nonperforming loans have been falling and are now around 5 percent, many foreign
observers are skeptical. They suggest that a realistic 15 percent NPL for state
banks is realistic.
Many banks could be
technically insolvent and in need of new capital. To make matters worse, there
are far too many banks and lately some are said to have been using their excess
liquidity to play in the stock market. There are four large SOE banks and 36
joint-stock banks. Of the latter, four have 60 percent of Vietnam’s loans
so the rest are very small. The whole banking sector is changing for the better,
including the central bank. But it looks to have lagged behind credit growth
and thus exposes the economy to potential dangers.
For an increasingly
open economy ‑ foreign trade is now equal to 80 percent of GDP –foreign
exchange reserves are a modest US$13 billion. Although up from $9 billion at
end-2005, it is barely satisfactory relative to foreign trade – it is not quite
equal to three months of imports and it is only a quarter of the fast-growing
monetary base.
Complicating matters
is that some 25 percent of bank deposits are in foreign currencies. While banks
hold significant liquid assets offshore, local borrowers of foreign currency
could present the banks with major problems if the dong were to fall sharply or
the local economy experience a major downturn. Despite the success of farm,
footwear and textile exporters, oil still accounts for 25 percent of exports.
In short, Vietnam
has probably not done enough during this period of easy money to reduce risk by
increasing its forex reserves. So it will need to be on guard so that today’s
inflow excesses do not become tomorrow’s outflow flood and drain those
reserves. The sooner the government can get new listings to market while the
foreign cash is available the quicker it can build its reserves and bring
market prices to levels which make a future bust less likely.
For now the dong
looks stable enough. Inflation has come down and with it the controlled
depreciation. The current account deficit is only 2 percent of GDP and capital
controls remain in place. However, looking ahead, the banking system will have
to manage a transition to a more open economy. Foreign banks’ access to dong
deposits will increase and foreign ownership of local banks will be permitted
from April 1.
By 2011 Vietnam
aims to abolish most capital controls. These are ambitious targets and are
requirements built into bilateral agreements linked to World Trade Organization
accession. They carry opportunities for the modernization of a socialist-era
banking system and for amalgamations to reduce the number of players. But all
financial sector liberalizations carry risks either of credit excess or the
privatization of entities which lack sufficient capital and expertise to
survive tougher times.
The best argument
for Vietnam
is a macro one. But even the best macro performance – as in the case of China – can be
ignored by the market for years. There are several reasons why this could
happen in Vietnam.
The price of capital, now at an all time low, could rise, putting a strain on
financial markets in an economy with huge growth potential but also huge
capital requirements. Another possibility is that, as happened in Vietnam in the mid-1990s and in China
more recently, easy access to capital results in over investment, excess
capacity and a sharp fall in profits.
Vietnam’s economy has been growing at a fast yet
quite steady pace for more than a decade. However, three events over the past
years have served to underwrite confidence that this will continue and that
Vietnam will take its place among the more successful and prosperous east Asian
nations, perhaps catching Thailand in a generation and Taiwan by mid-century.
First, entry into
the World Trade Organization. This was no surprise after years of negotiations
during which Vietnam
acquired trade access to the EU, US and other major markets. However,
membership and related bilateral agreements, especially with the US, are
set to force continued reform and opening up of the economy, including much of
the service sector, to foreign entry and competition.
The Party Congress
in 2006 which saw not only another smooth transition of leadership but the
promotion of younger figures who came to prominence in the postwar years and are
associated with economic reform and the continued shift to a market economy.
The party remains highly authoritarian and will come under pressure for
political change as the economy develops. But Vietnam
has achieved more internal democracy and decentralization than its communist
peers and never subjected the people to the violent ideological swings
experienced in China.
Reform has been slow but steady and seemingly well thought through.
However, as in any
transition economy where the borders between the state and private sector are
blurred, corruption is rife. It is closely associated both with the normal
obstructionism of the bureaucracy and now with the spoils that can come from
equitization. More equitization is needed – 40 percent of the economy is still
in SOE hands – but ill-gotten gains are a seemingly inevitable part of the
process.
Meanwhile foreign
investors, though often admiring the Vietnamese work ethnic, find the
bureaucracy a source of interminable delays and sometimes chauvinist attitudes,
a sense that it is wrong for foreigners to be able to profit from the labor or
resources of the Vietnamese. However, nationalism seems to have waned somewhat
as opening up has come to be seen as a success. In any event, economic
nationalism was never as entrenched in freewheeling Ho Chi
Minh City and the south generally, as in Hanoi.
The third, already
mentioned, was the tax decision which resulted in the dramatic development of
the stock market and hence of foreign interest, which also spilled over into
the bond and real estate markets.
The macro bull story
is easy enough to understand. Firstly, Vietnam
is playing catch-up with China
and most of Southeast Asia. Its shift of
manpower from agriculture to manufacturing is relatively recent. It could
certainly be slowed by adverse global conditions or a shortage of capital but
it is probably no more vulnerable than other Asian economies.
Second, it has among
the best demographics in Asia if not the
world. Population growth is slowing. The workforce is still expanding by 2
percent a year but that will gradually slow to less than 1 percent by 2020. The
percentage in the working age 15-59 group will soon reach 66 percent and remain
close to that very high level for the next fifteen years.
The macro story is
enhanced by a high savings rate – currently 35 percent of GDP and still rising,
which may be behind China
but is up to the levels enjoyed by earlier fast developers like Taiwan and Thailand. And the fiscal position
is stable enough with a deficit of less than 2 percent of GDP and government at
45 percent of GDP. The foreign debt proportion is high (27 percent of GDP) but
most of it is long term, low interest loans. Short term debt is modest.
Vietnam lacks China’s
economies of scale and there is no equivalent to Taiwan
or Hong Kong to provide instant access to
capital and markets. But Vietnam
does enjoy some compensating advantages. Most of its population is concentrated
in two delta regions which keeps down infrastructure costs. And those regions
are close to the sea and hence the markets of Asia
and the world.
A combination of geography
and domestic politics has also served to limit income imbalances, at least
compared with China.
The social, health and educational safety nets of socialism have not all been
sacrificed on the altar of GDP growth. Vietnam is probably right to look
for 8 percent growth, not 10 percent. It has a good record in tackling issues
such as avian influenza and education is making progress albeit from a low
base. Although the rural/urban income gap is, as everywhere, large at a ratio
of two to one it is far less severe than in China. Pollution is not yet a very
serious problem and reliance on gas and hydro for the majority of its power
needs is an advantage.
But make no mistake,
Vietnam
has literally little room for maneuver. Population density per hectare of cultivable
land is higher even than Bangladesh.
But is a tribute to its productivity that despite this it remains among the top
world exporters of rice, coffee, rubber and (mostly farmed) seafood and farm
output continues to grow by 3-4 percent a year.
It may be that Vietnam
is arriving at the maximum growth stage too late – as the export-driven model
of development looks likely to be under severe pressure from global trade
imbalances. But Vietnam can
probably gain market share at the expense both of higher cost China and low cost but low efficiency Indonesia and south Asia.
But whatever happens
to global conditions it needs to beware of getting carried away by easy money,
which inevitably ends not in a great leap forward but a crash of markets and
hopes.