Macro Update – Devaluation of Dong Warranted

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August 2015

Devaluation of Dong Warranted

Macro-Update1-1-1

  • August witnessed global financial turmoil triggered by the unprecedented Yuan devaluation and its spillover effect on other Asian currencies. Vietnam’s economy, with export turnover equivalent to 80% GDP, was unable to escape these external turbulences – the SBV had no choice but to break their commitment and devalue the Dong for the third time this year (mid-point up 1%, trading band widened to 3% from 1%). Yet, the action was framed as necessary from a trade perspective (see page 6).
  • On the bright side, Vietnam-EU FTA was inked after more than 2 years of negotiation. Under the circumstance that recent depreciation of Asian export-oriented economies is intensifying cost competition in international trade, tariff elimination stipulated by this trade deal will give Vietnam’s exports a much needed boost.
  • Meanwhile, domestic activities cooled off, partly as 3Q is the low season. Real retail sales and auto sales sped up but consumer confidence lagged after increasing for three consecutive quarters and industrial production slowed on mining activities.

Price levels down on pump price cuts

  • August CPI slid 0.07% vs. July, an expected result of falling fuel prices. Year-on-year reading retreated to 0.61% while average inflation through Jan-Aug was muted at 0.83%.
  • We forecast September CPI to inch up 0.1% as cheaper pump prices is expected to dampen the impact of tuition hikes

Retail sales remained strong amid waning consumer confidence
Real retail sales growth reached 9.1% after flat lining at around 8% over the last 4 months. Auto sales surged 59% in 7M15 vs. 7M14. However, consumer confidence was reported to drop to 104 in 2Q15 from 112 in 1Q15. The latest report by AC Nielsen cited concerns over short-term personal finances as the reason for the drop.

Industrial production slowed as oil production eased in August
IIP growth weakened to 9.0% in Aug-15 vs. Aug-14 (cf. 11.3% in Jul-15 vs. Jul-14). However, manufacturing expanded at a respectable rate of 10.6% yoy.

Vietnam and EU ink free trade deal

  • On August 4, Vietnam – EU FTA was concluded, agreeing on elimination for nearly 99% of tariff lines over 7 to 10 years. EU is one of the biggest trading partners of Vietnam, accounting for 11% of total trade.
  • The trade pact should give a boost to Vietnam’s key shipments to EU including electronics (current tariff 0%-5%, immediate elimination), apparels (current tariff 12%, reduced to 0% within 7 years with fabric-forward requirement), and fishery (current tariff 5%, immediate elimination). Consequently, VN-EU FTA incentivizes oversea capital into these sectors to enjoy tariff edges.
  • Vietnam’s manufacturers will also benefit from cheaper inputs made-in-EU with 0% import duties on machinery and appliances (current tariff 0%-25%), yarn & fabric (current tariff 5%-12%), or meat and poultry (current tariff 15%-30%). However, F&B industry would face headwinds with tariff elimination for confectionery (current tariff 15%-40%), alcoholic drink (current tariff 30%-50%).

Trade deficit widened to USD 3.6b with a slight deficit of USD 100m in August

  • Export turnover in 8M15 vs. 8M14 grew 9.0% to USD 106b. Export growth has lingered at this level over the past three months. FIEs (now contributing 70% of Vietnam’s export), continue to account for nearly all the growth with cell phones remaining the top export item.
  • Import turnover in 8M15 vs. 8M14 soared 16.4% to USD 110b – imports of machinery accounted for 17% (the largest) of the import turnover in the first eight months of 2015. Of note, imported cars (CBUs) reached USD 2b YTD.

FDI: Korean electronics giant continues to expand production in Vietnam

  • Monthly registered FDI in August reached the new height at USD 4.5b, as Samsung received license for an additional USD 3b investment to expand LCD production at Samsung Display Bac Ninh. The diversification into other types of hi-tech manufacturing is a positive signal for Vietnam exports in light of the fact that Samsung accounts for nearly one-fifth of export turnover, most of which comes from their smart phones business line, which is experiencing slowing sales globally.
  • As such, YTD register FDI touched over USD 13.3b (up 30.4% vs. 8M14). Disbursed FDI stayed robust at USD 8.5b in 8M15 (+7.6% vs. 8M14).

The Macro Picture

Consumer Price Index

Cheaper pump price pushed down prices in August
Macro-Update1-3

  • As expected, price of transportation category witnessed the sharpest declined, down 2.12% vs. July due to the 5.3% pump price cuts within the tracking period for August CPI. Housing and construction material was the runner-up in dragging August CPI since construction activities normally slowed in the month of rainy season.
  • Meanwhile, the back-to-school season boosted price of education to inch up 0.87%

September inflation outlook – Price levels could reverse to an uptrend due to tuition hikes but persistent cheap fuel prices will curtail the pace.

  • As selected state universities are allowed to apply new tuition scheme for 2015 school year (which is on average 12% higher than the former) while private universities normally lift up their tuition fees from 5% to 10%, we expect price of the education sub-basket to surge 5% in September.
  • However, the 4% pump price cut on August 19 and another 6.5% drop on September 3 would mitigate the impact of tuition lift-off on the September reading.
  • Furthermore, we believe that housing and construction material will continue to stay on a downtrend, as the rainy season is not over.
  • Meanwhile, we continue to anticipate stable pricing for food and foodstuff as well as household goods basket because most retailers nationwide will hold the annual promotion campaign in September.

As such, we estimate September inflation to be up 0.1% vs. August.

Domestic Activity

Real retail sales growth picked up in August but consumer confidence slowed with concerns on personal finance in short-term
Macro-Update1-4-1

Auto sales

According to Vietnam Automobile Association (VAMA), auto sales in July totaled 20,349 units, growing nearly 9% vs. June. Total sales in 7M15 reached 123,841 vehicles, implying a growth of 59% vs. the same period of last year.

GSO also estimated Vietnam imported more than 73,000 CBUs in 8M15 valued at nearly USD 2b. Both quantity and value are more than double those of the same period in 2014 but the growth pace has cooled off over the past three months after peaking in May.
Macro-Update1-4-2

Industrial Production

Manufacturing gained more momentum but slowdown in crude oil production curb IIP growth in August
Macro-Update1-5

Event of the Month

Dong devaluation – Tit-for-tat in the global currency game

What happened in August?
On August 19, the SBV devalued the Dong 1% – the third devaluation within this year. Trading band was also widened to 3%, only one week after the expansion to 2% from 1% on August 12.
This is the first time since Feb 2011 when the Dong was allowed to swing with such flexibility and the first time since Feb 2008 that the SBV resorted to a combination of an outright devaluation and trade band widening.

Macro-Update1-6

What triggered these consecutive adjustments? – We believe the adjustments are a must rather than a choice to the unforeseen devaluation of the Yuan, which also sent most currencies tumbling afterwards.

Dong devaluation affects trade balance between Vietnam and China. China is among one of the most prominent trading partners of Vietnam, accounting for nearly 20% of Vietnam’s total trade turnover. However, Vietnam is sitting on a concerning large deficit with China (nearly USD 30b in 2014 and 17b in 1H15) and major Vietnam’s exports to China such as agriculture commodities or fishery are those clinging towards price competition with low production cost.

Meanwhile, aside from machinery or electronic spare parts imported for final industrial production, Vietnam purchases a great amount of made-in-China steel and garments for final consumption, which dominate locally-produced products in terms of price. As such, the SBV’s move is well-grounded in the wake of further broadening trade deficit with China from a weaken Yuan.
Macro-Update1-7

Vietnam is in a head-to-head competition with China in international trade markets. Both countries rely on cheap labor-intensive manufacturing and hence, any cost-related factors would have significance on price competition. The latest PMI report for Vietnam indicated that Yuan devaluation has indeed put pressure on Vietnamese manufacturers to curb output price in a bid to hold on to market share.
Macro-Update1-8

The Dong devaluation also came as Yuan devaluation kicked off a domino effect on other emerging export-oriented economies in Asia to depreciate. As for a country with exports equivalent to more than 80% GDP, this de-facto currency war called for pre-emptive policy moves to protect Vietnam’s export competitiveness and beyond that, to maintain growth.
Macro-Update1-9

The looming Fed rate hike was also one stimulus behind the third as the SBV framed the move as proactive in anticipation of forex rate volatility caused by this event. Though the surprise Yuan devaluation triggered turmoil in the financial market which some believed would force the Fed to rethink, recent data revealing better-than-expected 2Q GDP growth in the US nurtured the possibility of the rate hike in September.

Devaluation forced SBV to tap into the forex reserves, in the process, pushing it under safe levels. Several media reports circulated news that the SBV floated USD 600m on August 11 and USD 500m on August 18 to the market in preparation of the outright devaluation on August 19. Year-to-date, the SBV may have sold USD 3b to the market. Although the State Bank Governor made a recent statement that Vietnam’s forex reserve is at the all-time-high of roughly USD 37b as of 1H15 (which could at this point of time track around USD 35b since the SBV has been net seller in the forex market within July and August), the surge in imports so far this year has shaved the reserve-to-import ratio to less than the standard comfort level of 12 weeks.

What’s next?

The devaluation on August 19 marked the breaking of the SBV’s vow to limit devaluation to 2% in 2015. However, it was well justified by the need to offset the negative effects of the surprise Yuan devaluation and China’s shift to market-oriented currency policy.

After the third devaluation, the State Bank Governor again reassured the market that there would be no further VND devaluation until 1Q16, citing that the move on August 19 has created sufficient flexibility for the Dong (a likely reference to trading band of 3%) to cushion the imminent Fed rate hike.

Nonetheless, the risk that further weakening of the Yuan or a stronger-than-expected USD movement resulting from the Fed lift-off remains. The SBV has shown that it stands ready to respond to market forces in particular these external ones and we expect the manipulation of the trading band to feature more prominently in the future. Remember that the trading band was 5% around the reference rate back in 2009. With that said, the SBV can again technically hold their pledge to not devalue (by resetting the reference rate) from now until the end of the year but could let market forces (by further expanding the trading band) dictate the exchange rate.

Macro Indicators

Macro-Update1-10

VCSC Information

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Valuation Methodology: To derive the target price, the analyst may use different valuation methods, including, but not limited to, discounted free cash-flow and comparative analysis. The selection of methods depends on the industry, the company, the nature of the stock and other circumstances. Company valuations are based on a single or a combination of one of the following valuation methods: 1) Multiple-based models (P/E, P/cash flow, EV/sales, EV/EBIT, EV/EBITA, EV/EBITDA), peer-group comparisons, and historical valuation approaches; 2) Discount models (DCF, DVMA, DDM); 3)Break-up value approaches or asset-based evaluation methods; and 4) Economic profit approaches (Residual Income, EVA). Valuation models are dependent on macroeconomic factors, such as GDP growth, interest rates, exchange rates, raw materials, on other assumptions about the economy, as well as risks inherent to the company under review. Furthermore, market sentiment may affect the valuation of companies. Valuations are also based on expectations that might change rapidly and without notice, depending on developments specific to individual industries.

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