FX Alert Vietnamese Dong Analysts Callum Henderson*, +65 6530 3282 Standard Chartered Bank, Singapore Head of FX Strategy Callum.Henderson@standardchartered.com Thomas Harr, +65 6530 3617 Standard Chartered Bank, Singapore Senior FX Strategist Thomas.Harr@standardchartered.com Tai Hui, +65 6530 3464 Standard Chartered Bank, Singapore Regional Head of Economic Research, SE Asia Tai.Hui@standardchartered.com *Edited by VND to Depreciate Gradually in 2009 06:15 GMT 19 September 2008 A Vietnamese BoP crisis is unlikely given smaller 2009 trade deficit, stable inflows We compare the situation of Vietnam now with China in 1993-1994 Vietnam is a much more open economy than China in 1993 Near term, Vietnam prefers a stable VND due to focus on inflation VND depreciation pressure will increase not decline as inflation comes off Summary We assess the risk that the Vietnamese dong (VND) will devalue against the USD. We judge that the risk of a fully-fledged balance of payment (BoP) crisis is limited as the trade deficit is likely to narrow while FDI and remittances provide stable capital inflows. However, in 2009, the weaker growth environment and weaker regional currencies could weigh on the VND. We compare the situation of Vietnam now with China in 1993-1994 where the latter devalued its currency by nearly 50%. Vietnam is a much more open economy now than China in 1993 and hence the trade deficit and the prospects of slowing export growth pose a much larger threat for Vietnam s growth now than it did for China. However, in contrast with China in 1993, Vietnam s exports are holding up well so far and the VND on a Real Effective Exchange Rate (REER) basis has depreciated since 2001 vs. its key competitors. Near term, the Vietnamese authorities main priority is to deal with inflation, which implies that they prefer a stable currency. As the policy priority moves from inflation to growth, which is likely to come in mid-2009, the authorities could opt for a weaker VND. We have adjusted our forecasts accordingly. Table 1: Standard Chartered Bank Revised VND Forecasts Exchange rate End-Q3 End-Q4 End Q1-09 End Q2-09 End Q3-09 USD-VND (Old forecasts are in brackets) 16,800 16,900 (17,300) 17,000 (17,100) 17,300 (16,900) 17,600 (16,800) EUR-VND 23,714 24,336 (24,912) 23,120 (23,256) 22,490 (21,970) 23,584 (22,512) CNY-VND 2,474 2,522 (2,582) 2,519 (2,533) 2,544 (2,485) 2,607 (24,912) JPY-VND 153.21 157.94 (161.68) 155.96 (156.88) 154.46 (150.89) 158.56 (151.35) Source: Standard Chartered Bank Important disclosures can be found in the Disclosures Appendix.
VND: A Strange Safe Haven in Turbulent Times Over the last two months, all major Asia ex- Japan (AXJ) currencies, except from the Vietnamese dong (VND), have weakened against the USD. The VND was leading the AXJ currency weakness in the spring, but it has since stabilized as foreign investors have all but eliminated Vietnam exposure and risks of a balance of payments (BoP) crisis appear to have moderated for now. However, with other AXJ currencies now devaluing against the USD and thus against the more stable VND the risks of further VND weakness in 2009 to catch up need to be closely considered. We assess here the risks that Vietnam will face a BoP crisis. Next, we access the risks that the Vietnamese authorities could opt for a weaker currency when growth slows and inflation is defeated. For this purpose, we compare the current Vietnamese situation with China s in 1993-1994 where the latter opted for a big one-off devaluation of the Chinese yuan (CNY). FDI, Remittances to Limit BoP Crisis Risks The fundamental drivers of the crisis of confidence in the spring were that inflation and the trade deficit. The CPI rate rose to an average of above 3% m/m in the first five months of 2008, while the monthly trade deficit rose to an average of USD 2.7bn. This, coupled with a lack of policy response from the Vietnamese authorities, led to significant USD demand onshore, in turn causing foreigners to dump their Vietnamese local market positions. Going forward, we believe the risk of a fully-fledged BoP crisis in Vietnam is low. Over the last three months, the monthly trade deficit has improved to less than USD 1bn. On the import side, higher tariffs on imported cars have resulted in a decline in automobile imports whereas the import of steel products has dropped from USD 1bn in March to less than USD 0.5bn in June-August. If the recent trend continues, the government s trade deficit forecast of USD 20bn looks less unreasonable. In 2009, we expect the trade deficit to narrow on slower domestic demand, some import substitution towards local refineries and lower global commodities. Meanwhile, Vietnam is likely to continue to attract capital inflows from foreign direct investment (FDI) and overseas Vietnamese worker remittances, which should cover the trade deficit. From June-August, CPI fell to an average 1.60% m/m rate and we expect overall CPI to fall to 15% in 2009 from 25.50% in 2008 on base effects and lower commodities. There is clearly a risk of a new sell off in Vietnamese markets on inflation and slowing growth, but that risk should not be sufficient to trigger a BoP crisis. Table 2: Balance of Payments - The risks of a balance of payments crisis are small 2007 2008, Estimates 2009, Estimates Trade deficit, USD bn -12.44-20 -10-15 FDI, USD bn 8 11 5-8 ODA*, bn 4.4 4.5 2 Overseas remittances, bn 5 8 8-10 Net portfolio flows, bn 5.5-2.5-2.5 *Official development assistance, Sources: CEIC and Standard Chartered Bank China 1993 vs. Vietnam 2008 On 01 January 1994, the Chinese authorities unified its exchange rate system by abolishing the official rate. Overnight, China s currency fell 50% - though this partly reflected convergence between the official and market rates. Export data suggested that China lacked export competitiveness ahead of the devaluation as the value of exports grew 8% in 1993 despite CPI of around 25%. In 1993, China had a trade deficit of USD 11.77bn, which amounted to -1.84% of GDP. China was then a much more closed economy with exports to GDP of only around 15%. The steep devaluation clearly helped to improve China s export competitiveness as the value of exports grew 32.90% in 1994 and the trade balance shifted into a surplus where it has been ever since. More broadly, the devaluation contributed to China s export-led growth in the years ahead. 2
By comparison, Vietnam recorded a trade deficit of USD 12.44bn in 2007 or around -13.44% of GDP. In 2008, the trade deficit has reached USD 15.97bn and is likely to reach USD 20bn for the year. Exports to GDP are around 68% and hence Vietnam is a much more open economy than China in 1994. Therefore, the widening trade deficit and the prospects of slower export growth pose a much greater threat to Vietnam s growth in 2008/09 than they did for China in 1993/4. However, one key difference is Vietnamese export growth has been holding up well so far. From June-August nominal exports grew 49.72 % y/y, partly reflecting soaring prices. However, textile and garment exports grew 19.7% y/y in the first seven months, footwear by 18% and computer/electronic components by 30%. These are low-margin sectors which one should expect will slow sharply if Vietnam loses export competitiveness. Instead, the ballooning trade deficit is more due to rapid credit growth, fuelling an import boom of goods such as machinery and steel. From 2005-2007, M2 money supply grew 47%-66% y/y. Going forward, this suggest that the key focus of the Vietnamese authorities should be on slowing credit growth, reducing import growth and narrowing the trade deficit. Table 3: China 1993 vs. Vietnam 2008 - Vietnam is more open but also more competitive China 1993 Vietnam September 2007 - August 2008 Export growth 8% 35.70% Trade balance as % of GDP* -1.84% -13.44% Exports to GDP* 15% 68.02% *Vietnam 2007 data, Source: CEIC A closer look at the performance of the VND Real Effective Exchange Rate (REER) indicates that Vietnam has not lost export competitiveness over the last years. In Table 4, we compare the performance of the VND vs. the USD with the currency performance of Vietnam s competitors in key export markets. In 2008, the VND has depreciated less against the USD than AXJ currencies such as the Malaysian ringgit (MYR), Indian rupee (INR) and Philippine peso (PHP). Moreover, adjusted for inflation, the VND has appreciated massively vs. its key competitors. Hence, Vietnam has lost competitiveness in 2008. However, since 2001, the VND is one of the very few currencies to have actually depreciated against the USD. Moreover, key competitors such as the Thai baht (THB) and the Chinese yuan (CNY) strengthened significantly against the USD in that time. Vietnam has experienced higher inflation rates than its competitors, eroding some of the nominal currency depreciation. Still, on a REER basis the VND has depreciated vs. its main competitors since 2001. Hence, this does not rationalize why Vietnam should opt for a significant one-off devaluation. If anything the key concerns for Vietnamese export competitiveness is not that the VND has depreciated less than other AXJ currencies in nominal terms, but rather that high inflation rates have eroded real competitiveness. Table 4: The Performance of the VND Compared to its key Competitors - The VND has appreciated in 2008 Appreciation vs. USD since 2001 Appreciation vs. USD 2008 ytd. Average CPI since 2001 Average inflation in 2008 CNY 21.04% 6.80% 2.30% 7.30% INR 0.64% -13.47% 5.70% 8.86% IDR 3.67% -0.13% 8.6%* 11.59%** MYR 10.03% -4.11% 2.24% 4.40% PHP 6.22% -12.30% 5.50% 8.80% LKR -30.62% 0.94% N.A 24.60% THB 27.41% -3.11% 3.00% 6.70% Vietnam -14.73% -3.89% 8.47%*** 22.24% * 2003 - May 2008; **June 2008 - August 2008; ***Average since July 2002, Sources: Bloomberg and CEIC 3
That said, whether Vietnam will opt for devaluation in line with the rest of the region remains a political decision. We believe the current policy priority of the Vietnamese authorities is on price stability. The crisis of confidence in the spring, which was fuelled by rapid credit growth, was a warning for Vietnam of what can occur if economic policies do not deal swiftly and credibly towards rising inflation threats. Clearly, the battle against economic overheating is not won yet. We expect that CPI will rise to above 30% y/y in Q4-08. This gives the authorities limited room to focus on anything else than inflation for now. However, we do expect inflation will drop to 8.40% y/y in Q4-09 on base effect, slowing domestic demand and lower commodity prices. Meanwhile, the government is targeting 7% GDP growth in 2008 and 7-8% in 2009. This looks ambitious given that Q2-08 GDP growth slowed to 6.5% y/y from 7.4% y/y in Q1. Going forward, rising inflation together with high domestic interest rates are likely to have a dampening effect on domestic demand. Moreover, export growth is likely to slow on lower global demand. We expect that GDP growth will slow to 6% y/y in 2009 from 6.70% in 2008 and the risk to this is on the downside. In an environment where the economy is slowing and inflation is coming off, we believe the Vietnamese authorities could opt for a weaker VND. One needs to remember that except from a brief period from September-07 to March-08, where the economy was still growing fast and inflation was rising, Vietnam has always had a preference for a weaker currency to support export-led growth. The risk that Vietnam will go back to a policy of currency depreciation will increase if the currencies of Vietnam s key export competitors continue to weaken. Vietnam most significant export competitor is China. We expect the CNY to weaken against the USD in H1-09, from 6.70 to 6.80, as the Chinese authorities shift its focus from inflation concerns towards growth focus. As USD-CNY moves higher, USD-VND is likely to follow extend higher. 4
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