Vietnam: Risk Assessment

Country Rating¹

Rating: C

Business Climate Rating¹

Rating: C

Risk Assessment²

Significant deterioration in the country's financial position: high exchange-rate and liquidity risk
The Vietnamese current account deficit has widened substantially in the past four years, from -0.3% of GDP in 2006 to -9.0% in 2010, due to the opening up of the economy (marked by membership in the WTO), the dynamism of investment, which has necessitated massive imports of capital goods and repatriation of profits by foreign companies operating in Vietnam. And amid the rise of food and energy prices in 2011 the current account deficit could grow even deeper. 80% of the financing need will be covered by foreign direct investment and the rest by bank debt. In that context of insufficient capital inflows and high inflation, the downward pressure on the dong (fixed exchange-rate regime) has been strong, prompting the authorities to devalue the dong six times since June 2008. While the devaluations carried out in 2008-2009 were of marginal proportions, in 2010-2011 they were both more frequent and sharper (8.5% in February 2011). Despite the devaluations, exchange-rate risk has remained high. Anticipating further devaluations residents have been converting their portfolios into gold and dollars. On the grey market, the dong has been trading at a considerable discount. Over the rest of the year, the substantial current account deficit and the strong growth of monetary aggregates (credit expanded by 45% 2009 and 35% in 2010) could cause another sharp decline in the currency.
However, capital outflows could ease thanks to capital controls (restricted dong convertibility) limiting the possibilities for speculative attacks against the dong, the introduction of restrictions on imports of gold - a traditional refuge used by residents to protect against dong depreciations - and to the large rate differential between contracts denominated in dong and those denominated in dollars (underpinning the carry trade).
But foreign-exchange reserves have fallen to precariously low levels (estimated at between six and eight weeks of imports), limiting Vietnam's capacity to cope with a sudden flight of capital.

A weak - undercapitalized and highly dollarized - banking system
Banks remain very vulnerable to exchange rate risk as a result of their high degree of dollarization: 16% of domestic loans are denominated in dollars and 22% of the deposits are denominated in foreign currencies. Moreover, credit has grown significantly (+150% at constant prices since 2005), reaching 120% of GDP in 2010 (vs. 48% in 2003). Moreover, despite recent progress (with the economy opened more decisively to foreign capital and a process initiated to privatize state-controlled banks), the banking system has remained  highly exposed to risk due to low capitalization, a high rate of nonperforming loans (10% according to the consensus compared to 2% officially), and a lack of transparency and oversight.

Significant sovereign risk: high public-sector debt and a lack of transparency
The public debt is expected to grow and with half denominated in foreign currencies it will be vulnerable to exchange rate risk. And the practice of classifying some spending as off-budget has made public accounts opaque with default risk increasing in consequence.
Late January 2010, the government nonetheless successfully issued a 10-year $1°billion sovereign bond with 6.95% yield on international markets. This success suggests that the markets remain confident in Vietnam's capacity to meet its commitments. Although the bonds were fully subscribed, the 333 basis-point spread on the Vietnamese issue compared to American treasury bonds was much higher than spreads on recent issues by Indonesia (228 basis points) or the Philippines (184 basis points on a $1.5 billion issue in January 2010.).

A growth slowdown is expected
After rebounding in 2010, driven by the recovery of domestic demand and exports, economic growth could weaken somewhat in 2011 (5% growth expected compared to 6.7% in 2010) with domestic demand expected to suffer from the high inflation expected in 2011 (13.4%) and the tightening of monetary policy. Foreign direct investment inflows are nonetheless expected to remain firm with Asian companies continuing to set up production facilities in Vietnam in the framework of a broad delocalization movement. This phenomenon is exemplified by delocalizations from China prompted by the gradual strengthening of the yuan and recent wage growth: the $96 monthly average wage of Vietnamese workers represents about two thirds of the average wage in China. Export sectors (textiles shoes, electronics) are expected to be very dynamic. Similarly, the services sector (tourism, transport, communication, financial services) will outperform. And the growth of the primary sector -which provides 74% of rural employment - is expected to remain dynamic thanks to do the better weather conditions forecasted.

Persistent shortcomings in the business environment
The Communist Party continues to exercise total control over political, economic, and social life in Vietnam. Although the 11th National Congress scheduled in January this year was marked by changes in party leadership, they did not, however, jeopardize economic policy continuity. But governance problems, especially corruption, remain the country's Achilles' heel as attested by the scandal over the bankruptcy of the state-controlled Vinashin naval shipyard group.

Strengths

• The economy benefits from a quality and low-wage workforce attractive to foreign investors
• Solid agricultural and natural resources development potential
• Successful development strategy based on strengthening the tertiary sector, opening and diversifying the economy
• Skilled, low-cost workforce

Weaknesses

• Vietnam's specialization too focused on price competitiveness and low value-added products
• Persistent deficiencies in the business environment
• Lack of infrastructures
• Public sector reform unfinished
•  Growing inequality