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ABN AMRO - Vietnam research - June 6

ABN AMRO - Vietnam research - June 6



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Published by: Thuy on Jun 12, 2008
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Vietnam: not the 1997 crisis redux
In 2007 when Vietnam was already overheating, a surge in capitalinflows led to a sharp acceleration in import growth and, togetherwith surging food prices, to a sharp acceleration in inflation. ButVND and USD liquidity has been tightened sharply , import growth isalready slowing and inflation is bound to follow suit over the nextfew months. Onshore rates appear set to rise further which suggestgoing long the forward points. At the same time, a sovereign defaultappears unlikely in the next year or so, and the economicstabilization we expect will see sovereign risk fall, which suggestsselling the 5 yr CDS.
Investors concerns
Chart 1 : Headline inflation hasaccelerated on the back of foodprices (CPI, %, Y/Y)Chart 2 : A strong acceleration inimport growth suggests overheating(%, Y/Y)
0.0%5.0%10.0%15.0%20.0%25.0%30.0%35.0%40.0%45.0%Jun-03Jun-04Jun-05Jun-06Jun-07Headline Food Non food CPI
     J    u    n   -      0     5      O    c     t   -      0     5     F    e      b   -      0      6     J    u    n   -      0      6      O    c     t   -      0      6     F    e      b   -      0     7     J    u    n   -      0     7      O    c     t   -      0     7     F    e      b   -      0      8
Imports Exports
Source: ABN AMRO Source: ABN AMRO
Recent inflation and external trade data has generated market concerns over thepossible consequences of overheating and led Moody’s, S&P and Fitch to placeVietnam on negative outlook. Inflation has accelerated to 25.2% y/y in May 08,from 7.3% in May 07. However, this reflects largely an increase in food prices:food price inflation accelerated to 42.4% in May 08, against 9.2% in May 07 andthe weight of food and foodstuff in the CPI is .43 (.47 up to May 06). The nonfood CPI accelerated by 7.4% in May 08, from 4.8% in May 07.
Overheating and loss of monetary control
But the acceleration in food price inflation explains only about 80% of theacceleration in headline inflation over the past year, which suggests some spill-overs from food to the broader price index. Vietnam’s economy is experiencingresource pressures after years of fast growth: during 2003-07, Vietnam grew by8% a year on average, the fastest growing economy in Asia after China andIndia. And Vietnam’s current account deficit widened from nearly 0 to 10% of GDP in 2007.
Produced by: ABN AMROBank NV
Dominique Dwor-Frecaut
Singapore+65 6518 7382domi.df@sg.abnamro.com
Important disclosures can be found in the Disclosures Appendix.
Level 21, One Raffles Quay, South Tower, Singapore 048583, Singapore
Friday 6 June 2008
Local Markets Strategy - Asia
6 JUNE 2008
But the fast pick up in inflation suggests monetary accommodation. M2 growth isunlikely to have slowed from the 40% showed by the last available monetary surveyin June 07. A fairly stable ratio of M2 to reserve money up to mid-07 suggests M2growth may have been driven by reserve money growth. Reserve money growth inturn has been accelerating largely due to an acceleration in the growth of netforeign assets: during 2007 Vietnam’s FX reserves increased by USD9.4 bn or 13%of GDP.
Chart 3 : A rising ratio of NFA to reserve moneysuggests active sterilization
Chart 4 : Nevertheless, reserve money growth hasbeen accelerating (% Y/Y)
     M    a    r   -      0      0      S    e    p   -      0      0     M    a    r   -      0     1      S    e    p   -      0     1     M    a    r   -      0      2      S    e    p   -      0      2     M    a    r   -      0      3      S    e    p   -      0      3     M    a    r   -      0     4      S    e    p   -      0     4     M    a    r   -      0     5      S    e    p   -      0     5     M    a    r   -      0      6      S    e    p   -      0      6     M    a    r   -      0     7
     M    a    r   -      0      0      S    e    p   -      0      0     M    a    r   -      0     1      S    e    p   -      0     1     M    a    r   -      0      2      S    e    p   -      0      2     M    a    r   -      0      3      S    e    p   -      0      3     M    a    r   -      0     4      S    e    p   -      0     4     M    a    r   -      0     5      S    e    p   -      0     5     M    a    r   -      0      6      S    e    p   -      0      6     M    a    r   -      0     7
NFA growth reserve money growth
Source: ABN AMRO
Source: ABN AMRO
At the same time, the ratio of net foreign assets to reserve money has increasedfrom about 0.6 in March 2003 to 1.2 in June 07 which suggests active sterilizationby the SBV (for a given level of FX reserves, sterilization substitutes MSBs toreserve money). But with Vietnam’s highly open capital account, policy can eithercontrol interest rate or the exchange rate but not both. The spot USD/VND raterose during Q1-Q3 07 and subsequently fell up to end-Q1 08. The acceleration of inflation suggests VND flexibility has not been sufficient to limit the impact of thecapital inflows on money growth. With an open capital account and an overheatingeconomy, sterilization is likely to have pushed up onshore rates and brought in moreforeign inflows.Overheating has also pushed up import growth, that accelerated to a peak at 85%in April 08. By contrast, export growth has hovered around a trend of 25% y/y forthe past few years and even accelerated since Q3 07. With the sharp acceleration inimport growth, the trade deficit reached USD14.4 bn during January-May 2008,against USD10.4 for the whole of 2007. The combination of strong export growthand ballooning import growth suggests that, until recently, the sharp increase in thetrade deficit has reflected an intensification of overheating, rather than a loss of competitiveness.
Policy tightening
Faced with what is likely to have been spiralling money growth (unfortunately nodata is available after June 07), policy makers have implemented a number of measures to tighten liquidity and credit growth:
From December 06, restrictions on bank lending for equity investments
From June 07 onwards, increases in banks reserve requirements
in February and May 08, hikes in official interest rates: the refinancing rate nowstands at 13%, from 6.5% in January 2008
in March 08 compulsory purchases of SBV bonds by the banks
6 JUNE 2008
Chart 5 : A spike in interbank rates
Chart 6 : Government bonds have sold off sharply(1 yr bond yield)
     M    a    y   -      0     7     J    u    n   -      0     7     J    u      l   -      0     7     A    u    g   -      0     7      S    e    p   -      0     7      O    c     t   -      0     7     N    o    v   -      0     7     D    e    c   -      0     7     J    a    n   -      0      8     F    e      b   -      0      8     M    a    r   -      0      8     A    p    r   -      0      8     M    a    y   -      0      8
1m interbank rate overnight interbank rate02468101214161820
      O    c     t   -      0      6     D    e    c   -      0      6     F    e      b   -      0     7     A    p    r   -      0     7     J    u    n   -      0     7     A    u    g   -      0     7      O    c     t   -      0     7     D    e    c   -      0     7     F    e      b   -      0      8     A    p    r   -      0      8     J    u    n   -      0      8
Source: ABN AMRO
Source: ABN AMRO
These liquidity measures have seen bank liquidity tighten sharply and a spike in theinter-bank rate. Banks have scrambled to raise deposits, which saw the SBV initiallyimpose a cap on the deposits rates banks could offer. On May 19, SBV removed thecap and announced banks were free to set their own lending and deposit rateswithin 1.5 times of the base rate, to be announced monthly and raised to 12% from8.75% in April. Banks however have continued to struggle with the high cost andavailability of funding. Many banks are charging their clients an administrative feeabove the controlled interest rate in order to maintain positive margins of intermediation (see Reuters, Vietnam keeps 12 % base rate unchanged, 2 June2008).The tightening of bank liquidity has also led to a sharp fall in the equity index asbanks had lent large amounts to securities companies or had been directly fundingequity purchases. In addition, foreign portfolio inflows seem to have stopped (seebelow). Equity market weakness has been further compounded by the uncertaintyon the economic outlook caused by the ongoing liquidity squeeze. The main equityindex is down to 400, from a peak at 1100 in October 2007.In addition, the government is implementing a fiscal consolidation program. Thegeneral government deficit was 7.5% of GDP in 2007, up from 3.9% of GDP onaverage over the previous 5 years. According to the World Bank, the governmenthas postponed or cancelled public investment worth VND13 tn (1.1% of GDP).Moody’s estimates that the government deficit is likely to shrink to 5.2% of GDP in2008, which would help relieve demand pressures.While policy tightening seems to have led to a VND liquidity crunch, USD liquidityhas also become very tight, as shown by a sharp increase in the forward premium.This reflects the widening of the trade deficit mentioned above as well as:
Unmet demand for spot USD at the official exchange rate. The IMF classifiesVietnam’s exchange rate regime as a de facto peg. Under the peg, the StateBank of Vietnam (SBV) announces a daily reference rate, with a +/-2% band.But there are signs that securing USD at the official exchange rate for currentand capital account transactions has become difficult.
A loss of confidence: caused by rising inflation and import growth, a steep fall inthe equity market, a liquidity crunch and the compounding of economicuncertainty caused by a lack of availability of timely economic data, including FXreserves.

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