abc Vietnam at a glance More needs to be done Global Research Economics Macro - Vietnam Starting with a stronger foundation 2 January 2013

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1 Global Research Vietnam at a glance Starting with a stronger foundation The economy slowed as expected to.% in 212 from.9% the previous year, but the sacrifice was not in vain From a macro perspective, 213 will likely be a better year than 212 amid slowly improving domestic and external demand and the initial results from Vietnam s recent reform efforts Watch out for further concrete reforms, especially those that reduce bad debt in the financial system and improve the business environment to make Vietnam more competitive Trinh D Nguyen Economist The Hongkong and Shanghai Banking Corporation Limited trinhdnguyen@hsbc.com.hk View HSBC Global Research at: Issuer of report: The Hongkong and Shanghai Banking Corporation Limited Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it More needs to be done For a country with great potential such as Vietnam, the % growth of 212 is nothing to cheer about, as this is not fast enough to allow the country to leap to a new level of development. But this number should be interpreted in the context of Vietnam s past, current and future challenges. Since transforming the country into a more market-oriented economy from a centrally planned one in the late 198s and early 199s, Vietnam has grown on average 7%. Thanks to reforms such as strengthened property rights, market liberalization and opening to foreign investment, Vietnam boosted productivity significantly in the 199s. But this burst of total factor productivity gradually slowed in the 2s as state investment rose significantly. And much of this state investment was not in efficiently run state-owned enterprises, which required more capital to subsidise their operations. As such, the strong growth rates in the past decade were not sustainable, as the costs were macroeconomic instability and lower productivity. Therefore, the government s actions in 211 and 212 to prioritise sustained over rapid growth were considered positive for Vietnam s long-term outlook. But further reforms are needed and the sooner they come, the better. The bad debt overhang still needs to be resolved. The business environment and supportive infrastructure should be improved. Vietnam, while attractive for its burgeoning market and cheap wages, is either stagnating or worsening in major competitiveness rankings. Although the contraction of registered FDI inflows is partly due to sluggish global growth, it also reflects Vietnam s gradual loss of competitiveness.

2 Chart 1. Growth slowed in 212; the industry sector saw the biggest decline (% y-o-y) Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Agriculture Industry Manufacturing Services Despite a challenging year, some bright stars of the economy shone in 212. Exports expanded almost 2% despite weak external demand. There was a trade surplus. The December HSBC PMI employment sub-index rose. Investment from Japan increased, reflecting the still attractive workforce and location. But whether these will stay strong depends on how soon reforms come. We remain watchful of the concrete actions the government takes. Chart 2. But on a quarter-on-quarter seasonally adjusted basis, the economy is stabilizing and on track for a recovery, albeit a modest one (% q-o-q sa) Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Agriculture Industry Services A better but still bumpy year With cautious optimism, we expect 213 to be a better year than 212. Across the globe, monetary officials are doing what they can to shore up domestic demand. Japan, an important market for Vietnamese exporters, will likely see upside risks to GDP growth thanks to Prime Minister Abe s accommodative stance as well as the BOJ s aggressive easing. Data from the US also suggests that the housing recovery is real, which means that consumer confidence will likely be supported (though watch the lingering fiscal cliff concerns). Coupled with this, the FOMC is doing what it can to help the US economy. China is on track for an economic recovery and bumps in the road will Chart 3. The manufacturing sector is recovering, thanks to slowing inflation, stabilization of domestic demand and a China recovery Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Source: CEIC, Markit, HSBC HSBC PMI Index (% 3m/3m) Official GDP Manufacturing (% QoQ sa) Chart 4. Sluggish growth in the developed world, especially the EU, caused demand for goods such as textiles and footwear to slow; but new foreign investment in electronics helped boosted exports to double digits (% y-o-y) Electronics Textile & Garments Crude Oil Total 2

3 Chart. Since June 21, export growth has exceeded import growth on a quarterly basis (% y-o-y), allowing the trade deficit to narrow Dec-8 Sep-9 Jun-1 Mar-11 Dec-11 Sep-12 Exports Imports Chart 6. thanks to a refocus on manufacturing; manufacturing FDI inflows in 212 (% of total registered FDI) Electricity, Gas, Air Con Supply Human Health Construction Transportation Information, Communication Wholesale, Retail Trade, Motor Repair Real Estate Activities Manufacturing likely be smoothed out with fiscal policy. The EU, the biggest market for Vietnam, may have bottomed out in Q This means that from an expenditure perspective, external demand for Vietnamese goods is expected to improve. Exports, while still strong at 18.3% growth, slowed from 34.2% in 211. Most of the slowdown was in textiles, garments and footwear, which dropped significantly due to weaker demand in the EU. But thanks to new foreign investment in electronics, which raised electronic exports, the total export level remained robust. The growth rate of electronics will likely slow, although should still remain strong, as the one-time burst of new investment wears off. The acceleration of non-electronic exports should offset the negative effect of both slowing electronics and likely decline in crude exports due to increased capability in oil refinery that raises domestic demand for crude oil (and limits import needs of refined products). From a sector outlook, manufacturing is poised to benefit from firmer demand from abroad as well as contained inflation, which gives scope for manufacturers to employ price discounting strategies. The sector had a tough year in 212, as domestic demand was subdued and external demand weakened. But moving forward, we expect the global landscape to improve. Even domestically, after two years of tightening their purses, consumers are gradually easing. Chart 3 shows that the HSBC PMI manufacturing index tracks well with the official GDP breakdown of manufacturing growth, although the HSBC PMI Table 1. HSBC Vietnam Manufacturing PMI and its sub-indices Dec-12 Nov-12 Oct-12 Long-Term Average PMI Index Output New Orders New Export Orders Backlogs of Work Stocks of Finished Goods Employment Output Prices Input Prices Suppliers' Delivery Times Stocks of Purchases Quantity of Purchases Source: Markit, HSBC; Note: Less than and falling Less than and rising or same Greater than or equal to and falling Greater or equal to and rising or same 3

4 Chart 7. Activity is stable but still very bumpy due to... Chart 8....still weak global conditions and sluggish domestic demand (PMI-based index) Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 PMI Index Output Source: Markit, HSBC Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 New Orders New Export Orders Source: Markit, HSBC shows a sharper contraction in 3Q. Since 3Q, activities have been bolstered by improved domestic credit conditions as well as a gradual recovery of China. But with the global recovery process still fragile as well as the unresolved fiscal compromise in the US, 1Q could be a bumpy ride. The December HSBC PMI sub-indices show that manufacturing activity stabilised at close to but has yet to take off, being held back by cautious consumption abroad and domestically. New export orders show a continued deterioration of external demand, which will likely persist into early 1Q. Note both the stabilisation of output as well as the expansion of employment despite persistent weak export demand. This reflects a gradual improvement of credit conditions domestically as well as slowing inflation (Chart 9), which gives room for manufacturers to discount output prices to boost demand. But a continued contraction of inventory suggests that de-stocking measures are ongoing and managers are waiting for stronger signs of growth to ramp up production. While preparing for an expansion with increased employment, they are proceeding cautiously. The service sector, on the other hand, continues to be robust (Charts 1 and 2), albeit expanding by a slower pace of 6.4% in 212 versus 8.2% in 211. This resilience is derived from Vietnam s strong demographics and rising income, which necessitate a range of services from financials, transport, health, education and electronics repair. At the same juncture, the real estate sector is Chart 9. Output prices continue to drop thanks to slowing inflation (PMI-based index) Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Source: Markit, HSBC Output Prices Input Prices Chart 1. Employment continues to expand due to expectations of a recovery but manufacturers are still cautious and continuing to destock (PMI-based index) Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Source: Markit, HSBC Stocks of Finished Goods Employment 4

5 Chart 11 Slowing GDP growth has hurt revenue collection, although lower public spending helps the budget balance to narrow % y-o-y VND bn Current spending Budget balance (RHS) Revenue: Tax Chart 12. Inflation is expected to be relatively contained in 213 with a modest pickup due to improved demand and an unfavourable base effect Nov-7 Oct-8 Sep-9 Aug-1 Jul-11 Jun-12 May-13 Headline CPI (% y-o-y) HSBC Forecasts Core CPI (% y-o-y) particularly affected by the slowdown domestically as bad debts have not been cleared. As such, the sector is relatively frozen as the process for recovering insolvency is cumbersome and banks prefer to roll over bad debts. This means is that unless the issue of bad debt is resolved, a recalibration of prices, in which the supply of real estate would reflect demand, is unlikely to happen. The State Bank of Vietnam (SBV) hopes to address this by setting aside VND2-trn to lend to home buyers in 213 to boost the property market. Should it be successful at boosting demand for real estate, the issue of existing bad debts would be largely untouched, which means systemic risks would remain if not become larger. Given that banks are more cautious and are quality credit-driven, any new lending would be contingent upon the availability of credit-worthy borrowers. As such, we do not anticipate a huge upsurge of credit growth in 213. The SBV estimates that credit growth will accelerate to 12% in 213 from 6.4% in 212, which is close to our forecast of 13%. Taking inflation into account, real credit should only give a marginal boost to growth. The fiscal prints for the year reflect weak domestic demand; the budget deficit declined to VND16trn from VND4.4trn in 211 largely due to a decline in revenues and expenditures. Revenues from land and housing dropped 24.7% in 212 while revenue from VAT imports Chart 13. The global slump and Vietnam s slowing growth affected inflow FDI, although Japanese inflows remain strong (% y-o-y) Japan South Korea Hong Kong Singapore Chart 14. Japan is the largest FDI investor in Vietnam totalling USD4bn (% of total; top five FDI countries) China Singapore Hong Kong South Korea Japan

6 Chart 1. The slowdown of investment from top countries (except Japan) reflect deteriorating competitiveness; a higher number indicates a worse ranking Doing business (WB) Infrastructure (WEF) Global competitive (WEF) Source: The World Bank, World Economic Forum, HSBC Chart 16. Still has a lot of advantages, including strong population growth which could expand to 1m people in the mid 22s (% working population growth rate) Source: UN, HSBC JP TW KR CH TH VN ID 199s 2s 21s 22s contracted 3.2%. With the economy slowing down across the board, revenue collection from corporate income tax slowed to 16% from 24.% in 212; and VAT tax collection slowed to 1.4% from 26.1% in 211. This translates into total revenue collected reducing to 1.8% from 24.3% in 211. To carry out its fiscal consolidation policy, the government reined in public spending, which slowed to 18.9% from 3.% in 211. Capital expenditure saw a modest contraction. This is to lower the budget deficit as well as a cutdown on wasteful public spending. We expect this trend to continue next year with import growth still constrained by relatively weak domestic demand, albeit with some improvement in revenue collection as imports are expected to stage a modest recovery. With revenue collection slowing and expenditure reduced to lower the budget balance, a fiscal stimulus to spur growth is unlikely in 213, with the government having neither the funds nor the appetite to do so. As a whole, although growth slowed, five major developments were considered positive in 212 that will eventually build a foundation for more sustainable growth: 1) the trade balance is in surplus thanks to weaker import growth and strong exports; 2) inflation slowed to 6.8% in December 212 from 17.8% in January 212; 3) the budget deficit is narrowing, lowering Vietnam s debt burden; 4) FX reserves have risen significantly; and ) FDI inflows surged from Japan, which is considered positive for Vietnam s industrialization process. Chart 13 shows that registered FDI inflows into Vietnam from Japan surged. The amount of Japanese FDI inflows into a country can also be a proxy on whether that country would ultimately raise its level of productivity and move up the value chain. Generally speaking, Japanese FDI has been more trade oriented than US FDI, meaning Japanese firms in Asia tend to build overseas production zones as an extension of their domestic base. This results in Japanese firms having a role of being an initiator and coach in the industrialization of less-developed countries. In Vietnam, the top-five FDI countries are from Asia, which reflects an ongoing trend of multinational firms relocating out of China to reduce costs. Countries, such as Vietnam and Indonesia, are poised to gain from this restructuring as labour costs are relatively lower and the population is dynamic enough to support robust domestic demand (Chart 16). However, Vietnam could do more to attract foreign investment to support its development. As shown, with the fiscal space constrained, more foreign investment is needed to pick up the slack of domestic investment. Additionally, the 6

7 Table 2. HSBC main Vietnam forecasts Q1 212 Q2 212 Q3 212 Q4 212 Q1 213f Q2 213f Q3 213f Q4 213f f GDP (% y-o-y) CPI, average (% y-o-y) Trade balance (% GDP) *.2* -2.2* OMO rate, end quarter (%) VND/USD, end quarter ; Note * denotes USDbn infrastructure needs are immense, ranging from shortages of electricity to public transportation systems, which would benefit from world-class technology that foreign firms bring. But to do this, Vietnam would need to improve its business environment, most notably reducing red tape and creating clearer laws on how to resolve insolvency. Without doing so, firms are entering Vietnam only to take advantage of the wage costs rather than to take advantage of the dynamic domestic market. This shows in the contraction of registered FDI (with the exception of Japan) as they have other attractive markets such as Indonesia and Thailand to enter. As such, for Vietnam to realize its ambitions, reforms need to be carried out to not only eliminate the bad debt but also improve the efficiency of the economy. 7

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