Vietnam: First domino in asia?

Rating agency Fitch has lowered its outlook on Vietnam’s sovereign rating last week, which can be a sign of more weakness to come for many of Asia’s economies and currencies, as record oil prices complicate their efforts to control inflation. Fitch Ratings lowered the outlook on Vietnam’s BB-minus rating to negative from stable, saying that authorities had not dealt quickly or strongly enough with inflation, potentially posing risks to banking system’s stability.

The agency cited the delicate position the government is now in, riding a fine line between containing price rises and setting off a sharp economic slowdown. Some observers are even pointing to a potential currency crisis, given Vietnam’s growing current account deficit, weakening fiscal position and limited foreign exchange reserves, on top of 25% annual inflation, the second-worst in Asia. Some of Asia’s largest economies are also grappling with the same risks.

Although none look as vulnerable as Vietnam, some are set for their sternest test since the Asian financial crisis of 1997. “I think (we could see) a much deeper and more prolonged slowdown than people are currently anticipating that lasts until the end of 2009, rather than being done shortly,” said Bill Belchere, regional economist with Macquarie in Hong Kong.

The Philippines, South Korea and India share some of the problems that pushed Vietnam into its downward spiral. In all, three expensive oil imports are eroding their current accounts and dragging down currencies. Weak currencies are fuelling inflation, piling pressure on central banks to raise interest rates.

Higher rates will hurt economic growth and stock markets, triggering a flight of capital needed to finance the trade gap. “Then you can see a fairly sharp reversal in expectations around the behaviour of the currency,” said Peter Redward, head of rates strategy at Barclays Capital. “The currencies’ weakness then starts feeding on itself in terms of pushing inflation up. That’s a significant risk.” Oil prices are another factor.

“If oil prices were to come back down to $100 a barrel, then I think a lot of the pressure that these countries are under would dissipate very quickly,” said Peter Redward, head of rates strategy, at Barclays Capital said. “If it was to go up to $150 a barrel, then we would find that more dominoes would fall,” raising the risk of a harder landing for the region, he said.

Mirza Baig and Dennis Tan, strategists with Deutsche Bank in Singapore, expect most Asian currencies, apart from the Chinese yuan, Malaysian ringgit and Singapore dollar, to weaken this summer, particularly if oil prices extend their rise.

“We think the broader macro backdrop has reached a tipping point, where the cushion on balance of payments and scope for policy makers to retain a ‘watch and wait’ stance on monetary policy has worn out,” they said. While stronger economies in the region will probably see their currencies, and exports, hit to some extent by the weakness in other countries, the region will avoid anything like the 1997 financial crisis.

Vietnam: First domino in asia?- Investors Guide-Specials-The Economic Times

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