| On the Ground |
Analysts
Tai Hui , +65 6596 8244
Thomas Harr, +65 6596 8247
Jennifer Kusuma, +65 6596 8250
Standard Chartered Bank, Singapore
Regional Head of Res earch, South East Asi a
Tai.Hui@sc.com
Standard Chartered Bank, Singapore
Head, Asian FX Strategy
Thomas.Harr@sc.c om
Standard Chartered Bank, Singapore
Rates Strategist
Jennifer.Kus uma@sc.c om
Vietnam – Implications of rating downgrade
05:00 GMT 16 December 2010

Latest downgrade by Moody’s to reinforce market worries over VND depreciation

Central bank will need to consider hiking rates and to allow orderly VND depreciation

We do not expect contagion to the rest of the region from Vietnam’s financial turbulence

We expect further VND devaluations on BoP dynamics, rising CPI inflation and policy

We reiterate our bearish outlook on the local-currency government bond market
Summary
Rating downgrade to reinforce market concerns over VND depreciation
On 15 December, Moody’s downgraded Vietnam’s foreign-currency rating from Ba3 to B1, with a negative rating outlook.
This follows Fitch’s downgrade to B+ in July 2010. S&P’s foreign-currency rating for Vietnam is now BB, two notches
above those of Moody’s and Fitch. With S&P’s rating outlook at negative, the risk of a downgrade in the near term has
risen considerably following Moody’s latest action.
The Moody’s downgrade is likely to reinforce the prevailing negative sentiment towards the Vietnamese dong (VND). The
distressed debt situation at a state-owned enterprise, cited by Moody’s as one of the reasons for the downgrade, will also
affect market sentiment in the near term . We expect the authorities to continue to opt for further one -off devaluations of
the VND o ver the next 12 months, with the official USD-VND exchange rate reaching 20,800 by end-2011. The latest
Moody's action underlines our bearish outlook for VND bonds. Foreign interest in the onshore bond market has waned
significantly, and the downgrade underpins our view that foreign demand will remain poor. With inflation on the uptrend
and further rate hikes expectated in 2011, we expect 2Y yields to climb to 11.25% in Q1-2011 and 12.00% in Q2-2011,
from 10.8% currently.
It is important to stress that Vietnam’s currency stress is unlikely to spill over to the rest of the region. While Vietnam
suffers from a shortage of foreign exchange reserves, other South East Asian economies have a large stock of reserves,
at a combined USD 646bn for Singapore, Malaysia, Indonesia, Thailand and the Philippines. In fact, several central
banks, including those of Thailand and Indonesia, are trying to manage sizeable foreign inflows and the resulting
currency appreciation pressure. These countries are also running healthy current account surplus es, whereas Vietnam
has been running a trade deficit to support economic development and rising consumption.
Important disclosures can be found in the Disclosures Appendix
All rights reserved. Standard Chartered Bank 2010
Ref: GR10AU
http://research.standardchartered.com
On the Ground | 16 December 2010
A shortage of foreign-currency reserve s and confidence
Even before the rating downgrade, the VND was already in a position of weakness in terms of investor confidence.
Higher gold prices (Chart 1) and rising inflation, which breached 10% y/y in November (Chart 2), have prompted local
investors to switch from the VND to gold and USD. (In the absence of a better reflection of the parallel USD-VND
exchange rate, we use the USD-VND 12M non-deliverable forward, or NDF, to illustrate market perceptions; however,
we note that the liquidity in this market is thin.) The inflation surge in recent months has been led by food and
transportation costs. Due to the erosion of the value of the VND and competition from gold and USD, Vietnam’s FX
reserves have stabilised at around 1.8 months of imports, according to the IMF. B y our calculation, this translates into
around USD 12bn of reserves, based on the average monthly import value for the first 11 months of 2010. The low level
of FX reserves does little to support confidence in the VND.
Chart 2: Inflation is on the rise again in Vietnam
4.0
24000
30
3.5
23000
25
3.0
22000
20
2.5
21000
2.0
20000
1.5
19000
%
VND/chi
Chart 1: Higher local gold price puts downward
pressure on VND
15
10
5
1.0
18000
Nov-08 Mar-09 Jul-09 Nov-09 Apr-10 Aug-10 Dec-10
0
Jan-08
Domestic gold price (Grade 99)
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
CPI Inflation y/y
USD-VND 12M NDF (RHS)
Sources: CEIC, Standard Chartered Research
Sources: CEIC, Standard Chartered Research
While market sentiment is clearly fragile, one needs to put Vietnam’s balance-of-payments position in perspective. The
trade deficit is likely to reach USD 12bn in 2010, compared with projected overseas remittance inflows of around USD
7bn. Meanwhile, disbursed foreign direct investment (FDI) was reportedly USD 10bn for the first 11 months of the year,
and overseas development assistance (ODA) will total around USD 4.3bn. So while Vietnam’s external position is in a
delicate balance, it is not necessarily in crisis mode.
The Moody’s downgrade is justified by factors beyond the rise in inflation and the country’s balance-of-payments position.
Rapid lending growth in 2009 and 2010 to support economic expansion has led to a possible deterioration of credit
quality in the banking sector. The lack of public data on this front makes assessing such risks a challenge. Meanwhile,
Moody’s also cited the distressed debt situation at a state-owned enterprise as a factor that could weaken the
government’s ability to support other SOEs in meeting their external debt obligations. This could in turn undermine
international investor confidence in debt raised by the Vietnamese government or SOEs.
Policy response – higher rate s and orderly currency depreciation are needed
Given that Vietnam’s inflation is likely to remain elevated in the short term due to year -end and Tet (Lunar New Year)
spending, the VND is likely to remain under pressure. While the easing of gold prices may have provided some relief, this
is an exogenous factor rather than a domestically determined one (though the government has tried to cool gold prices
by rela xing restrictions on gold imports). The government could allow the currency to depreciate in steps, as it has done
in the past 12 months, or raise interest rates to make the VND more attractive to hold. The State Bank of Vietnam (SBV)
capped the deposit rate at 14% on 15 December. While this could be adjusted higher, the central bank’s action can be
interpreted as a desire to keep interest rates at reasonable levels without allowing them to spike.
Ref: GR10AU
2
On the Ground | 16 December 2010
Chart 3: SBV has devalued the VND in steps
Chart 4: Base rate may need to rise further
20000
16
14
19500
12
19000
10
%
18500
8
6
18000
4
17500
17000
Jan-09
2
May-09
Sep-09
Jan-10
May-10
0
Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10
Sep-10
USD-VND
Base rate
Sources: Bloomberg, Standard Chartered Research
Sources: CEIC, Standard Chartered Research
Implications for the region – an exceptional case
We believe the current financial stress in Vietnam should have a limited impact on the rest of the region. Some of the
root causes of Vietnam’s problem are unique to the country. Other South East Asian economies have much larger FX
reserves (Chart 5) and current account surplus es (Chart 6), while Vietnam has low FX reserves and a current account
deficit. Moreover, these economies have seen considerable capital inflows and , subsequently, currency appreciation. In
fact, Thailand and Indonesia have implemented measures to stem short-term capital flows and limit currency
appreciation, albeit with limited success. International investors are fully aware of these differences. Moreover, foreign
participation in local markets has been low in Vietnam since the bond-market crash in 2008, and VND depreciation has
been largely driven by domestic inves tor sentiment, in our view. As such, the risk of contagion to other South East Asian
countries from further VND devaluations is limited, in our view.
Chart 5: FX reserves in South East Asia (USD b n)
Chart 6: Current account balance in 2010 (% of GDP)
20
250
15
200
10
150
5
100
0
50
-5
0
-10
Singapore Thailand Malaysia Indonesia Philippines Vietnam
Malaysia Singapore Philippines Thailand Indonesia Vietnam
Sources: Bloomberg, Standard Chartered Research
Ref: GR10AU
Sources: CEIC, Standard Chartered Research
3
On the Ground | 16 December 2010
FX economics
We forecast that Vietnam’s GDP growth will accelerate to 7.2% in 2011 from 6.7% in 2010 due to robust domestic
demand. We e xpect CPI inflation to rise to 10.5% in 2011 from 8.9% in 2010 on rising commodity prices ; the SBV is
likely to raise interest rates in Q2, with rates peaking at 11% in Q3 (versus 9% currently). While the trade deficit has
stabilised since H1-2008, the risk is that the deficit will widen again in 2011 amid strong domestic demand and higher
commodity prices. Inflows from FDI, inward remittances and ODA may cover the shortfall, but overall balance-ofpayments dynamics are likely to turn less favourable in 2011 than in 2010. We note that Vietnam’s ratio of estimated FX
reserves to average monthly imports is very low, at 1.8 months.
FX outlook
We have short- and medium-term Neutral FX ratings on the VND; this largely reflects the fact that USD-VND forwards
(both deliverable and non-deliverable) already factor in substantial VND depreciation. We forecast further one-off VND
devaluations throughout 2011 on deteriorating external balances, higher CPI inflation and FX policy. We see balance-ofpayment dynamics turning less favourable for the VND in 2011 than in 2010, which is a concern given the low level of FX
reserves. Moreover, there is a substantial risk that the market will perceive the SBV as falling behind the curve in raising
interest rates. This recalls the experience of late 2007 and early 2008 , when the SBV was slow to react to a sharp rise in
CPI inflation, which triggered a sharp sell-off in local asset markets and the VND. Finally, the SBV’s credibility is low, as
the central bank has on a number of occasions devalued the VND immediately after pledging to keep USD-VND stable.
We forecast that the official USD-VND exchange rate will rise to 20,800 at end-2011.
Table 1: Standard Chartered Bank USD-VND forecasts
End- Q4-10
End- Q1-11
End- Q2-11
End- Q3-11
End- Q4-11
USD-VND
19,900
20,000
20,400
20,500
20,800
Forward (mid)
20,974
21,600
22,147
22,620
23,185
Source: Standard Chartered Research
FX strategy – corporates
Transaction risk
USD-VND onshore forwards are currently indicated at 21,600 at end-Q1-2011, 22,147 at end-Q2, 22,620 at end-Q3 and
23,185 at end-Q4 (mid), respectively. These levels are substantially above our USD-VND forecasts, especially for longer
tenors. However, risk-averse corporates may want to factor in the risk of sharper VND devaluations than we forecast. As
such, risk-averse Vietnamese importers should maintain high hedge ratios on USD payables. The same is the case for
euro (EUR) and Japanese yen (JPY) payables. For Vietnamese exporters, the opposite conclusions apply.
Translation risk
With respect to translation risk, we expect the VND to continue to depreciate versus the USD over the coming year, and
the risk is for sharper depreciation than we anticipate. As such, we advise USD -based clients to maintain high hedge
ratios for VND-denominated assets. EUR-, GBP-, AUD-, NZD- and JPY-based corporates should also maintain high
balance-sheet hedges of VND-denominated assets. Only when Vietnam’s balance of payments has become more
favourable and the SBV has stopped repeated devaluations will we advise global corporates to lower their VND balance sheet hedges. Similarly, Vietnamese corporates with G10 subsidiaries should maintain low balance -sheet hedges on
G10 currencies.
Ref: GR10AU
4
On the Ground | 16 December 2010
Rates – Upward pressure on government bond yields to continue through H1 -2011
We reiterate our bearish outlook for the VND government bond market through H1-2011. We expect heightened market
expectations of further rate hikes (on the pick-up in inflation, the widening trade deficit and increasing pressure on the
currency) to undermine the local-currency bond market. The Moody’s rating downgrade will not have a direct impact on
bonds, as foreign participation in the market has been minimal since 2008. The market reaction was similarly muted
following Fitch’s rating downgrade in July 2010, although domestic sentiment then was well supported by the SBV’s
accommodative monetary policy, still-benign inflation, and the strong economic growth outlook. The impact of the
Moody’s downgrade on the bond market will instead take the form of heightened pressure on the VND, leading to a
greater pick-up in imported inflation. The SBV is already at risk of falling behind the curve, as CPI inflation has gained
pace in Q4-2010.
Further rate hikes by the SBV will add upward pressure on bond yields and money market rates. Against its earlier
rhetoric, the SBV hiked the base policy rate in November 2010, triggering a rise in bond yields across the curve and a
spike in interbank overnight rates. Liquidity conditions have remained tight, with the SBV having to push the outstanding
open-market operations (OMO) amount to above VND 100trn (see Chart 7). The SBV also increased the 7-day OMO
funding rate to 10% from 7% in October. While the requirement for banks to hold government bonds as the underlying
asset for repos with the central bank is providing support to the bond market, the pick-up in the OMO rate has narrowed
spreads between bond yields and the OMO rate. To illustrate, the 2Y bond yield to the 7 -day OMO rate is now only
80bps, versus 320bps in June (see Chart 8). Money market rates may remain elevated until the Tet holiday in early
February 2011. With CPI inflation on the uptrend, further rate hikes expected, and tight liquidity, we forecast that 2Y
yields will rise to 11.25% in Q1-2011 and 12.00% in Q2-2011, from 10.8% currently.
Chart 7: SBV has provided liquidity through OMOs
13
130
12
110
12
11
90
70
9
10
7
Interbank
O/N
6
Jan-10 Mar-10 May-10
Jul-10
CPI YOY
9
50
8
2Y yield
%
Outstanding
OMO (rhs)
%
10
13
VND trn
11
Chart 8: Upward pressure on VGB yield
8
30
7
10
6
Jan-10
Sep-10 Nov-10
Sources: Bloomberg, Standard Chartered Research
OMO rate*
Mar-10
May-10
Jul-10
Sep-10
Nov-10
* This rate is constructed from both 7-day and 14-day OMO rates;
Source: Bloomberg
Ref: GR10AU
5
On the Ground | 16 December 2010
Disclosures Appendix
Analyst Certification Disclosure:
The research analyst or analysts responsible for the content of this researc h report certif y that: (1) the views expressed and attributed to
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issuers and/or other subject matter as appropriate; and, (2) no part of his or her compensation was, is or w ill be directly or indirectly
related to the specif ic recommendations or views contained in this research report. On a general basis, the effic acy of recommendations
is a factor in the performance appraisals of analysts.
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