Donald H. Straszheim 06.12.08, 6:30 PM ET
Vietnam’s government has been working hard in recent years to reform its economy in ways reminiscent of the successes of her neighbor to the north, China. I have been bullish on Vietnam for many years, and remain so for the long term. But, in the short term, real economic trouble is brewing that threatens a major economic disruption.
Here is the essential background. After the American war (as they call it), and years of internal conflict, the Vietnamese government launched a so-called “doi moi”–economic revival–in 1986. The economy was opened up, in steps, to foreign investment, Vietnam joined the Association of Southeast Asian Nations in 1995, a U.S.-Vietnam trade pact was signed in 2000 and Vietnam became a member of the World Trade Organization in 2007. Selected state-owned enterprises are being privatized, and new equity markets were launched, letting market forces start to work in the economy.
The very positive results are no surprise to those of us that believe in free enterprise. Vietnam has been the second-fastest growing economy in the world the last half-decade, behind only China. The people have never been better off. All they want to do is work, earn and consume. But too much of a good thing is turning into a bad thing.
Inflation is surging. In May, Vietnam’s prices were 25.2% higher than a year earlier. This was up from 16% in March, 13% in December 2007 and 8.4% in May 2007. The economy has gotten overheated. With commodity and energy prices spiking everywhere, Vietnam’s inflation rate is likely to go even higher. The history of developing economies in Asia over the last quarter-century is that they rarely come back from inflation this high without experiencing a severe economic setback. That is exactly what I see.
Hanoi is trying to slow inflation via a series of little steps–limits on key exports, tariff reductions on some imports, public-sector construction cuts and more. Really, only tighter monetary and fiscal policies will work, and Vietnam has no track record here.
In addition to inflation, Vietnam has a trade deficit and a budget deficit that are both in the range of 6%-7% of gross domestic product. These are also reliable signs of spreading economic trouble.
The most visible sign is a young equity market that is plunging. The Ho Chi Minh Stock Exchange (HOSE index; $11 billion market cap) is down 67% from its March 2007 peak and down 60% year-to-date. Volumes are down 95% over the last year. Domestic investors are dispirited, and foreign investors can’t get their money out of the market fast enough.
In an effort to slow the market’s decline, daily trading-band limits were imposed on all stocks of 1% in March of this year. This was the wrong step by a government that knows little about markets. Those limits were raised to 2% in April. But what has been happening? The market opens–and the price of virtually every security traded on the exchange opens down the daily 2% limit. Trading essentially stops at that level, and the next day the market opens limit-down again in a perfect stair-step fashion, now repeated for 23 days in a row. That’s really ugly.
Vietnam’s currency, the dong, has been gradually depreciating against the dollar in recent years. Just this week, Hanoi announced a 2% depreciation of the currency as part of its basic economic repair medicine. But with inflation currently at 25% and headed higher, a mere 2% depreciation on the currency is far from sufficient to keep Vietnam’s export industries competitive. And the declining currency has the added feature of making equity market participation uneconomic for foreign investors. It also makes foreign imports of essential commodities more important, aggravating the inflation problem.
Vietnam’s rapid economic ascent over the last decade has been impressive indeed. But the near-term outlook is not so rosy. The government has recently reduced its 2008 economic growth forecast from 8.5% to 7.0%, a figure I think is unrealistically optimistic. It will take months of unambiguously better statistics on trade, the budget deficit and inflation to convince investors that Vietnam is back on the right track. A significant devaluation on the order of 33% is also an ingredient in Vietnam’s economic rebound. But until that time, the current slow-motion crash in Vietnamese equities is likely to continue unabated.
Don’t get me wrong. The country is beautiful. The people are well-educated, entrepreneurial and energetic. Vietnam is positioned in the middle of the fastest growing portion of the world, right next to China. But when an economy gets off the track, due to bad luck or bad policy, it usually takes a fresh start to get it back on the track. In that circumstance, the first round of investors often loses out, and the second or third round of investors get to pick up the pieces and capitalize most profitably.
Donald H. Straszheim is vice chairman of Roth Capital Partners in Los Angeles, former global chief economist at Merrill Lynch, a visiting scholar at the University of California-Los Angeles Anderson School of Management and a longtime China specialist. He previously served as president of the Milken Institute and joined Roth in 2006 to spearhead the company’s China initiatives.
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