Vietnam Economy: The Odds Favor the Bold Macro Outlook

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VIETNAM MACRO OUTLOOK: ENSURING CONTINUOUS STABILITY

Vietnam’s macroeconomic challenges have been rising this year. There are 3 factors that constrain economic development at the moment, including a high public debt/GDP ratio, an over-reliance on the FDI sector as a growth driver in manufacturing and trade, and the slow progress in SOE and banking reforms. More recently, the risks of protectionism have cast an additional shadow on Vietnam’s economic outlook. At the beginning of this year, investors appeared most concerned about the risks of VND devaluation and there has been greater skepticism on whether Vietnam’s policy makers can ensure a stable business environment for domestic enterprises. However, we take a positive view that Vietnam will be able to navigate these challenges:

1. We view the risk of a large devaluation of the dong as low because of the specific characteristics of Vietnam’s exchange rate mechanism. Investors are concerned that the strength of the USD will continue through 2017 because of Trump’s policy and the Fed rate hike. However, there are three risk mitigating factors at play. First, from a macro stability management perspective, the starting point of a position in the form of current account surplus and the lack of significant inflationary pressure does mean that the SBV will be able to manage the exchange rate and thus avoid the sharp devaluation of the dong. Secondly, recent intervention of the SBV to build FX reserves has been commendable. A historic high level of FX reserves could provide adequate buffers against external currency shocks, smoothing periods of substantial volatility. Finally, pressure from psychological elements and market expectations has been mitigated since the new exchange rate mechanism was applied in early-2016. During 2017, we do recognize that there will be a manageable, moderate currency depreciation ahead. We project that the year-end exchange rate will be 23,500.

2. Notwithstanding higher inflation in the years ahead, a spike in interest rates is the less likely outcome. In the context of the commodity bull market, investors have expressed reservation regarding higher inflation. Although the headline inflation has risen, reflecting the administered price changes and the recovery of oil prices, core inflation is still benign. We forecast a 2017 headline CPI of 6.0% YoY, while we expect that core CPI will be around 2.5-3.0%. We think the SBV will maintain the current policy interest rates, given that higher headline inflation reflects non-monetary factors. If core inflation picks up due to second-round effects, a tightening monetary policy could be considered.

Recently, the SBV issued many circulars regulating the operations of credit institutions, especially Circular 39/2016/TT-NHNN on credit activities of credit institutions and foreign bank branches regarding the new lending regime. It is still too early to fully access all the implications of this regulatory, although we think it is a step in developing prudential macroeconomic measures, and tightening of regulations on lending in some sectors (consumer loans, revolving loans, rollover of loans), while channeling capital through policy directives to productive and special sectors based on the health of individual banks. In addition, the SBV has a desire to control short run volatility in the monetary market to strengthen macroeconomic stability, by removing the available lending rate cap stipulated under the Civil Code of 2015 and applying the short-term lending rate cap.

3. Trade protectionism is not likely to hurt Vietnam’s economy in the medium term. Vietnam’s export performance has been supported by FDI sectors in recent years. In 2016, the FDI sector’s share in Vietnam’s total exports reached 70%, which displays how Vietnam’s trade outlook will depend mostly on the FDI sector. We think the ongoing investment trend in Vietnam will not be reverted easily after the failure of the TPP. According to survey conducted by JETRO on business conditions of Japanese companies in Asia, a total of 66.6% of the surveyed firms selected “Expansion” as their approach to future business challenges in the next one or two years, up 2.5 pp from the 2015 survey. Comparing China with Vietnam, the proportion was higher, as Vietnam (66.6%) overtook China (40.1%). It should be noted that only 15.4% of the surveyed firms answered that the TPP will impact their businesses while 60.1% answered “Unknown”. According to the result of this survey, we think the TPP is not one of the key criteria for FDI investors considering whether they want to expand their businesses in Vietnam. According to the survey, high receptivity for high-value added products and sales increase have been the key reasons for business expansion, so FDI investors are mainly interested in wholesale/retail and electric machinery sectors. Domestic exporters will benefit from the recovery of commodity prices. Moreover, companies who take advantage of the rising trade protectionism between China and the US might see some improvements in the medium-term.

Bull Market in Commodity Prices and its Impacts on Domestic Enterprises
The commodity bear market ended in 2016, which was especially led by an increase in the prices of base metals and energy. Based on the policy objectives that aim to keep inflation low and the outlook for domestic demand, we do not think output prices could increase significantly enough to offset the increase of input prices. In the short-run, only companies who opportunistically built stocks at low prices will benefit during the recovery of commodity prices. Companies that did not prepare for the hike in input prices will experience a decline in their profit margins. Domestic demand will continue to support companies operating in the consumer and healthcare industries, and an increase in selling prices could lead to earnings growth.
In the beginning of this year, investors have been interested in whether stock returns of companies whose primary business is in commodities actually reflect changes in the prices of the underlying commodities (rubber, oil & gas). It is common to think that investing in commodity stocks to be an alternative to investing in commodities themselves. Furthermore, we have observed that commodity prices have followed a super cycle for a decade, while the bull phase of individual stocks is shorter. At the moment, we believe that there should be hope for investors who are interested in commodity-linked stocks, as some areas are still trading at a low. However, the recovery in business results will occur significantly after the rise of commodity prices.

Risks:
• Vietnam’s high credit to GDP ratio reflects the dependency of the economy on bank lending, However, most of the increase in credit was due to the real estate, financial and personal sectors. This raises concerns over the productivity of new credit. If the authorities fail to use appropriate measures (both market and administrative) to control over excessive credit growth, Vietnam financial stability will be negatively affected.

• Due to high public debt, the government has to enhance budget revenue to reduce fiscal deficit. We think that the temporary solution is to take steps further to use equitization profit to finance the deficit. At the end of 2016, the new cabinet raised further hope on the prospects of selling the State’s stakes in big SOEs. If the Government fails to put their promises into action, market sentiment will be not as good as before.

• External shocks could trigger domestic risks. More volatilities in the global market could create more pressure on the exchange rate and domestic interest rates. The lack of resources to mitigate external shocks could undermine Vietnam’s macroeconomic stability.

In conclusion, we believe that the macro environment is shifting from low inflation to slight reflation in 2017. We expect more prudence in public expenditure, sound monetary management to improve bad debts and pro-business policies through improving administrative procedures. Macroeconomic policy will focus on preserving stability in interest rates and exchange rates. Credit growth might not be as high as last year as credit to real estate and other potential risky sectors will be monitored closely. On the other hand, monetary authorities will channel prioritize credit for productive sectors such as manufacturing, agriculture, technology, logistics and SMEs.

Based on the above rationales, we think that domestic enterprises can continue to do well in this environment as long as the underlying driver is macroeconomic stability. Improved business sentiment in supporting sectors could ignite the confidence and willingness to invest in the private sector. Stronger economic growth and moderate inflation could support revenue-driven earnings growth. In addition, some companies that have competitive advantages in the domestic market will continue to grow when income increases. Exporters are hardly to expect a sharp depreciation in the dong, but their business situation will be less difficult thanks to the recovery of commodity prices. They are even better if they can take advantage of the opportunities when trade protectionism between the US and China rises.

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