March 07, 2016
Disclaimer: The opinions expressed herein are that of RongViet Securities and not of VietnamAdvisors. This is NOT a solicitation to buy or sell securities.
WORLD MACRO: A PERFECT STORM FROM CHINA
A slower growth outlook, a low inflation environment, the dovish stance of central banks will dominate global macro drivers in 2016. With China’s growth remaining under pressure, commodities are likely to decline further and uncertainty about the RMB depreciation is expected to persist. We believe the key driver for exchange rates, so far this year, has been the RMB, not the US dollar. In addition, weak growth in China can influence the rest of the world where developed economies have been resilient while developing economies have struggled.
2016 will not wander far from 2015
According to the IMF’s forecast, the global economic growth is expected to rebound a little in 2016, supported in part by a modest recovery in developed countries (US, ECB and Japan). Four economies among the BRICS countries are expected to contract while India should remain robust. In particular, China continues to slow and its rebalancing has weighed negatively on global trade, commodities, and asset prices.
Because of the sharp drop in oil prices in early 2016, inflation should remain lower for longer, strengthening the case for monetary policy to stay loose in many advanced economies. In 2016, the Fed will focus on the pace of economic recovery. According to the CME Fed Watch tracking tool, the market-implied probability of a rate increase in March was only 14%. In addition, markets are broadly pricing two hikes this year. If the Fed hikes are gradual, US dollar gains should be slow.
Concurrently, other central banks (ECB, BOJ and POBC) are looking towards more easing. At the end of January, the BOJ joined the club of negative policy interest rates. In China, there is room for the PBOC to implement further easing by injecting RMB liquidity or cutting reserve requirements ratios and benchmark interest rates to stimulate growth. Under this circumstance, RMB weakness may not be over yet despite the string of macro-prudential measures introduced. Based on the currently prevailing forecasts, there is a 55% probability that the RMB may depreciate against the dollar by 5-10% in 2016 while the probability of a larger than 10% depreciation is estimated at 15%.
Commodities: Supply cut could bring prices to balance
In 2015, the world started to feel the economic repercussion of China’s slowing, as growth shifted from focusing on investments and exports) to services and internal consumption. Demand for energy products and commodities for industrial production took the first hit. Along with the drop in China’s demand, the appreciation of the USD has reduced the costs of production of major global exporters. In addition, the significant decline in energy prices due to prolonged oversupply have led to decreases in input prices for heavy industries. This combination of factors has pushed global commodity prices further downwards.
Overall, commodity prices are facing challenges in order to reach a new equilibrium level as the market is fraught with over supply. A drop in supply could still be the decisive factor to bring commodity prices back to equilibrium. In 2016, agricultural products, fertilizers and raw materials are expected to remain stable or decrease marginally due to El Nino. For energy and industrial metals, the downtrend should continue due to the strong denomination by ample supply and high inventories. Regarding to crude oil, oversupply is expected to last to the end-2016, there was ~65% fall in US oil rigs and OPEC have yet to give a clear opinion about cutting supply. Thus, oil price could decrease further.
The impact of China’s slowdown and US rate hikes on Vietnam
Risks related to China’s slowdown mainly come from the negative movements of commodity prices.
Recently, Vietnamese exports to China still showed positive growth and there is no explicit sign of decline. In 2015, exports to China increased by 15% yoy, and the proportion in total value of exports slightly improved to 10.6%. Among 10 exporting sectors to China, agricultural products; crude oil, rubber, textiles, and electronics have the highest proportion in terms of exporting to China and surged significantly last year. Textiles and electronics are mainly participated by FDI companies while domestic enterprises account for the major proportion of agricultural products, crude oil and rubber exports to China.
Foreign exporting companies are usually better integrated in global supply chains and are better equipped for international trade. In contrast, domestic exporting companies are often competing solely on price. Therefore, falling commodity prices at home may make imports of Vietnamese commodities less attractive to Chinese buyers.
Vietnam consistently runs a trade deficit with China. In 2015, the total value of imports increased by 13% yoy. The decline of Chinese goods price could negatively affect the production of similar domestic goods such as steel and metal, plastic, and automobiles. These products compete on price and pose the greatest risks to companies with high production costs. In contrast, commercial activities as textiles, garments, footwear, and chemicals could benefit greatly from a drop in commodity prices.
The Fed’s rate hike in 2016 should not pose much negative risk on Vietnam. Currently, the difference between Vietnamese and US deposit rates is approximately 6%. We believe the spread could narrow to 5% this year if the Fed increases rates by 1% and the State Bank of Vietnam follows suit. The SBV’s new, more flexible exchange rate policies should help to ease speculation against the dong and volatility of the currency. We could potentially see more capital flowing into the local currency for a carry trade despite its devaluation risk. Furthermore, the signing of many free trade agreements (TPP, FTA VN – EU, FTA VN – Korea) combined with low inflation and high consumer confidence make Vietnam an attractive place for investors.
VIETNAM OUTLOOK: CLIMBING THE GLOBAL LADDER
Growth could slow slightly but the momentum should remain intact
We forecast Vietnam’s real GDP to grow 6.5% in 2016, lower than the market consensus of 6.7%and 2015’s growth rate 6.68%. The key rationales are:
- We expect to see expansion in manufacturing, construction and consumption this year. However, after a strong year, growth rates should stabilize in the industrial and construction sector.
- Consumption should grow further thanks to low oil price and strong consumer confidence.
- The mining industry should contribute less to the GDP in 2016. At current prices (~30$/barrel), there is high probability that oil production will be cut down further. Lower crude exports should negatively affect GDP growth.
- Foreign direct investment should continue to enter the country on the back of the newly signed trade agreements. Rapid growth in inflows could offset the decline in state investment. The growth in private-sector investment should remain stable as banks increase financing for private firms.
Inflation is not a big concern
2015 inflation was mild (~0.6% yoy), driven mainly by the drop in fuel and gas prices. In 2016, we expect headline CPI accelerate and reach around 3%. Most of this increase should occur in the second half of the year and coincide with an increase in expected inflation. There may be divergence in the price movements of various items in the CPI basket, but overall, inflation should not be much of a concern this year.
- Food prices (36% of the CPI basket value), are expected to be stable given low commodity prices. The weights for accommodation and construction materials in the CPI has just been adjusted upward to 15.7% from 10%. Although housing prices has been on a gradual rise, a drop in building material prices could offset part of the upward pressure on headline inflation.
- Core inflation was about 2% last year despite lower prices of energy. In 2016, prices of public services, which include education and healthcare, will be raised. However, the weights of these items in the CPI (base year 2014) have been reduced from 11.3% to 11%. We believe the upside risk for core inflation is minimal given the reduced influence of these items.
- Given low base of oil prices and the high probability of a crude market recovery in 2H2016, there could be an increase in inflation expectations. However, we do not expect strong rebound of oil prices such that expected inflation should be in line with the below-five-percent target of policy makers.
Trade: strongly diverged
We see a strong growth momentum in exports, especially from the FDI sector. Considering the weak prospect for global trade and the issues in Vietnam’s trade structures, the divergence in trade growth between local and FDI companies is here to stay. We expect exports to grow at 11% yoy in 2016 while imports expanding a bit faster at 13% yoy, which would result in a trade deficit of USD7 billion.
- FDI vs domestic: The FDI sector now dominates 68% of Vietnam’s total exports. While the foreign companies posted exports and imports growth rates of 17.7% and 15.0%, respectively, local companies saw a decline of 8% in both respects. Under many free trade agreements, the number of foreign direct investors in Vietnam is increasing quickly as global companies trying to take advantages of the country’s cheap labour. This mean the divergence should continue and have an even stronger impact on Vietnam’s trade balance. Nonetheless, we do not think the trend will be sustainable for growth.
- Trade product divergence: Vietnam has three primary product groups: processing and assembling (electrics), processing using imported material (textile, leather, footwear
- Regional divergence: Vietnam exports is pivoting away from some developing markets (Russia, ASEAN, India) and toward developed markets (US, EU, Korea) in correspondence with the slowdown in emerging economies and their weakening currencies. We notice Vietnam has large trade surpluses with TPP countries and the EU. Yet the deficits with other ASEAN countries have increased year by year. The trade deficit with China should also increase considering the country’s slowing economy.
- The 12th National Party Congress, which ended in late January 2016 with the incumbent Party leader being reappointed. From the result, it is expected that Vietnam’s policies will continue to be skewed toward a “safe” foreign policy. On the other hand, with the country’s signing into the TPP, its new leadership could employ the agreement to push through radical economic reforms. Even so, changes may not happen quickly.
- A lot of turbulences from the outside happened in the last quarter of 2015, affecting both Vietnam’s economy and its currency. Considering that Vietnam is still undergoing a reform and there is much uncertainty regarding the global economy, monetary and fiscal policies should remain to be growth-supportive this year.
- Rising public debt is eroding fiscal policy buffers and leaving Vietnam more susceptible to external shocks. Although inflation has been low, interest rates have bottomed out and the State Bank of Vietnam (SBV) has limited space for additional rate cuts.
Monetary policy: little room for more easing
- As many nations have adopted expansionary monetary policies, it may not be desirable for the SBV to raise its policy rates. However, deposit rates and government bond yields have started to increase. This could drive the lending rate higher. We expect a 25-50 bps increase of interest rates in 2016 to reflect the US rate hikes and the SBV’s desire to protect the stability of the local currency.
- The main driver for credit growth should continue to private consumption and real estate. However, we notice strong growth of lending in the agriculture and technology sectors, which may be attributable to the orientation by policy makers.
- 2016’s credit growth guidance is higher than that of 2015 and is between 18% and 20%. However, we do not think this is an easy target. Assuming a GDP growth rate of 6.5%, we forecast credit growth to reach 16% in 2016.
Exchange rate policy: enhance creditability
- In 2016, exchange rates should be subject to: (1) the strengthening of the US dollar as opposed to the weakening of RMB; (2) the dynamism of capital flows and the level of current account surplus; and (3) the market’s faith in the efficiency of the SBV’s policies and its creditability.
- We believe number (1) & (3) will determine whether Vietnam’s FX policy will see a good end. In early 2016, the SBV changed the exchange rate regime from a peg to the US dollar and benchmarking the VND against a currency basket. Following the action, the volatility of the VND has declined, proving that the SBV still has some control over the exchange rate.
- Under the new exchange rate scheme, the dong’s movement will be closely linked with trade deficits and net capital inflows. We expect the VND to weaken to VND23,200/USD or 3.2% by year-end 2016.
- The risk to our view is the uncertainty of the RMB devaluation especially when considering the transparency of the calculation method of central exchange rates. If pressures rise, using the FX reserves is the only way that the SBV can reduce the impact. Since the current FX reserve is as low as two months of imports, the SBV faces a big challenge in managing the exchange rate volatility.
Fiscal policy: between a rock and hard place
- Despite the high level of public debt (~61.3% by year-end 2015), we believe the risk of default is nowhere near. However, from the fiscal point of view, Vietnam is constrained in launching any stimulus to boost growth. Not only the debt ratio but the payment of principle and interests is also a problem. Total principle and interest payment is targeted at VND155,100 bn in 2016, a 5%-increase yoy.
- The Vietnamese government wants to maintain fiscal deficit at 5% of GDP. It should noted, however, that the budget is planned on the assumption that crude oil trades at $60 per barrel. Considering the decrease of oil export revenue, we expect a higher deficit for the government budget this year.
- Economic stimulation by increasing the State’s investment and supporting companies and consumers: The government’s expenditures for development did not increase last year (~83% of the annual guidance) because of a significant decline in oil revenue. Although the expenditure target for 2016 is significantly higher, it should still depend largely on the level oil price. In addition, a cut in the corporate income tax rate from 22% to 20% and a five-percent increase in the minimum-wage are in the pipeline.
FY2016 opens many opportunities for Vietnam to take a deeper and wider integration to the global value chain. Vietnam could take advantage of those opportunities to climb up the global ladder and improve its competiveness. In this context, we consider a top-down strategy which developing in the two following themes: Moving up the global chain and a shining light in consumption. The last theme is the progress of current economic reform, implying the most challenging remains ahead.
THEME 1: Move up the global chain and beneficial industries
Vietnam’s integration into the world has progressed steadily thanks to many free trade agreements (FTA). In 2016, the AEC (Asia Economic Community) and the Vietnam-Korea FTA come into force. The Trans-Pacific Partnership (TPP), one of the largest trade deals, was signed in early-Feb, and this trade pact will now undergo at least two years of ratifications before becoming reality. Besides the TPP, another important FTA (Vietnam-EU) is likely to take effect in two years’ time, probably in 2018.
There are three key determinants to enhance the effectiveness of Vietnam trade, including: (1) Regulatory Procedures; (2) Supply chain and (3) Transportation & Logistic Services. To capture the benefits of regional and international integration, Vietnam has to made changes in aspects related to these pillars.
- Hard infrastructure: Vietnam’s infrastructure has improved significantly over the last five years, however, it still ranked below most countries in the region and lagged far behind TPP partners. At the moment, Vietnam performs the lowest in terms of quality of roads and second lowest in quality of airport infrastructure. As the traffic volumes continue to increase, additional widening of the roads will be required in the near future. In addition, the increasing proportion of electronic products that Vietnam exports will require improving airport infrastructure. It could be favourable for construction and building materials industries which have posted the strong recovery recently.
- Soft infrastructure: In 2015, Vietnam ranked 99th out of 189 for trading across border index, its performance is below that of ASEAN countries. While Vietnam’s cost to export is lower than other countries in the region, the time it takes to export and import is among the longest in the region. Lengthy administrative procedures have been widely cited as a major problem in Vietnam, there are a lot of opportunities to cope with the process of international standard by using more IT applications, and diversifying financial services. Regarding financial services, Vietnam lags far behind its regional peers and TPP countries. Even though most of the bad debts have been cleared over the past 3 years, the financial soundness indicators in Vietnam still rank the lowest in the region. In addition, the availability and affordability of financial services are weak and there are room to improve.
- Supply chain: As a part of three pillars of competitive international trade, the development of supply chains is important for Vietnam. The change in the supply chain structure could impact positively to economic growth and specific industries. For garment, textile and electrical equipment industries, Vietnam’s competitive advantage derives from the availability of low-cost and semi-skilled labour. In order to increase the value of those manufacturing products’ export, Vietnam has to improve input supply chains to adapt to the rule of origin in the TPP (textile, garment) and develop the supporting industries (electrical equipment). This progress is happening with a greater role played by FDI companies. For agriculture products, domestic companies are increasingly investing large-scale industrial farming. However, the lower agricultural products prices and a much deeper integration to global trade will create challenges these companies have to overcome.
- Institutional framework: An effective development cannot exist without equally robust supporting institutional framework including legal framework and management system. By signing onto the TPP, there is now strong support from the authorities to undertake major institutional framework changes. In 2014-2015, the changes focused on an improved legal framework, important laws (Enterprises and Investment, Housing, Bidding
Finally, Vietnam has to implement a wide range of commitments on regulatory quality, intellectual property rights, investor protection, SOE management, labour and environmental standards, public procurement and liberalization services to adapt the TPP’s standard. There should be a long process to climb the global chain for Vietnam. However, in this process, we could expect there are the first beneficial industries: (1) construction and building materials, (2) logistics services, (3) technology and (4) supportive industries. Financial service and agriculture are in the context of boosting growth while face many challenges in the integration process.
THEME 2: Consumption is a silver lining
Vietnam domestic consumption grew by 6-9 % on average per year (after deducting price factors). That growth is based on the population structure of Vietnam with approximate 60% of the population under the age of 30. In addition, the rapid pace of expansion of the middle class in Vietnam (average increase by 2 million people per year) contributes significantly to the growth of retail sector.
Besides the favourable population structure, retail activity in 2015 was also more exciting due to low oil prices and low inflation. According to our estimates, domestic consumers saved about VND15,000 billion in 2015 thanks to the sharp decline in gasoline prices (down 30 % compared to 2014). The World Bank forecasts oil prices will continue to fall to an average of ~ 37 USD barrel this year. Based on this assumption, Vietnamese consumers could save about 8,000 billion VND in 2016. This should increase disposable income as well as enhance consumer confidence.
Besides the favourable population structure, retail activity in 2015 was also more exciting due to low oil prices and low inflation. According to our estimates, domestic consumers saved about VDN15,000 billion in 2015 thanks to the sharp decline in gasoline prices (down 30 % compared to 2014). The World Bank forecasts oil prices will continue to fall to an average of ~ 37 USD barrel this year. Based on this assumption, Vietnamese consumers could save about 8,000 billion VND in 2016. This should increase disposable income as well as enhance consumer confidence.
Demographics and consumer demand have recently led to the divergence among product categories. Vietnam’s Millennials (ages from 21-34) are now more connected than any generation before them. They are also willing to spend on more branded fashion, electronics, automobiles and travel. According to Nielsen, among major industries (beverage, food, milk, personal cares, family cares, tobacco, childcares), beverage shows the brightest prospect in both short and long-term. Because health concerns have been top-of-mind for Vietnamese consumers right now, healthy food and health products are expected to become a new, fast-growing consumption trend. This might offer great growth opportunities for companies that can run ahead of their peers in exploiting the new demands.
While Vietnam’s consumer goods stand out as the most attractive sector, it faces competitive pressure from FDI companies. According to the Ministry of industry and trade, the FDI sector have only 90 retail stores out of the 750 stores nationwide. However, with regard to size and revenue, FDI-invested retail stores are 3-4 (even 7-8) times bigger than local stores. FDI companies account for about 1/3 of Vietnam’s retail market. In fact, they have been aggressive in capturing market power through M&As with domestic producers and major local retailers (Table 3). This has posed tall challenges to domestic companies.
Domestic companies will face even more competition as Vietnam partakes in the various free trade agreements. Those with financial strength and logistic capacity should be the ones with the highest chance to prevail.
THEME 3: Reform – the most challenging remains ahead
SOE: privatization continues with more listed companies
- From 2016-2020, the government targets to equitize 123 SOEs, divesting over VND15.6 trillion from non-core operations, mainly in banking and real estate.
- 2016 big IPOs include: Song Da, HUD, IDICO, VICEM, Mobifone, Vinalines, Vietnam Expressway Corporation (VEC), and Vietnam Rubber Group (VRG).
- The drawback of these IPOs is that the size of the actual offerings to the public is not large enough to attract strategic investors as the State remains the dominant shareholder. This might not change in the near-term.
- The listing within one year of the equitization means that hundreds of companies will be listed on Upcom in 2016.
Banking: cleaning up NPLs is likely a long process
- Cleaning up bad debts is likely a long drawn-out process as (1) there is still no real market for collected bad debts, (2) special bond is not a method to recapitalize insolvent banks.
- As the economy continues to improve, banks will be able gradually to work off their NPLs. This this will be a slow process however.
- Raising foreign ownership of domestic banks above 30% could be a viable expectation, but caution remains.
- BASEL II will be a big step for the banking system in 2016.
- Despite the increasing number of M&A, the target of reducing the total number of commercial banks to 15 -17 by 2017 remains a challenging task.
Public investment: enhancing budget’s discipline
- Given constraints in the State budget, enhancing government budget’s discipline will be the most important goal.
- Because of high demand for public investment, especially in transport infrastructure, government considers to use PPPs (Public-Private Partnership) as a tool for managing public infrastructure.