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Thursday, 30 October 2014

Not so Fonda any more

Vietnam is a bad example to newly emerging markets

(This column appears in the Oct. 1 edition of Newsweek magazine.)

Almost exactly two years ago this week, Christine Gregoire, the governor of the U.S. state of Washington, was in Vietnam handing out French fries made from potatoes grown in her state at a Kentucky Fried Chicken outlet in Ho Chi Minh City. Gregoire, accompanied by representatives of more than 50 companies from home, was in Vietnam trying to drum up business with America’s former military adversary. But the most important stop on Gregoire’s itinerary may have been a ribbon-cutting ceremony for a new deepwater shipping terminal at Cai Mep.

Things looked hopeful then. But now the venture, like so many others in Vietnam, is plagued by red ink and scandal. It’s sadly not an unusual story. The country looked on track to take its place as an Asian tiger economy, a smaller version of its giant neighbor to the north, China. The nation boasts a large youthful population, a very high literacy rate, abundant natural resources, agricultural self-sufficiency, a stretch of coastline to rival California’s or Thailand’s, and a strategic position amid the trade routes of the Pacific. Instead, Vietnam is now looking increasingly like a basket case - and an example for just-emerging countries such as Myanmar of exactly how not to manage the opening-up of an economy.

The Cai Mep facility in Ba Ria-Vung Tau province, on the southern coast about 50 miles from Vietnam’s commercial capital, Ho Chi Minh City, seemed ideal - a joint venture between Seattle-based Carrix’s SSA Marine unit and Saigon Port, a division of state shipping complex Vietnam National Shipping Lines, known as Vinalines. After six years of preparation by SSA, the $160 million port christened by Governor Gregoire promised to fill a huge gap in Vietnam’s infrastructure. Fast forward, though, and it is suffering from a double whammy familiar to many foreign investors: the global economic slowdown coupled with local corruption.

The number of container ships calling at the port and two other foreign joint ventures operated by Vinalines plunged by half in the second quarter amid a price war among other port operators struggling with unused capacity. And Vinalines is foundering under a huge load of debt and an embezzlement scandal that led to the arrest in July of six of its executives. After a three-month Interpol manhunt, Chairman Duong Chi Dung, once the head of the country’s maritime administration, was arrested abroad and extradited to Vietnam last month.

Vietnam, in short, has gone from global investment darling to poster child for mismanagement. Too much money flowed into the country over the past decade, particularly following its admission to the World Trade Organization in January 2007. Foreign direct investment that year surpassed the dollars going to Indonesia, the Philippines, Thailand, and the rest of the region combined, according to the World Bank. The country’s creaky communist institutions couldn’t absorb all the funds, leading to a textbook instance of what economists call capital misallocation. On Friday, Moody’s downgraded the creditworthiness of eight Vietnamese banks and cut the country’s credit rating to B2, the lowest ever.

“Vietnam offers a classic case of a small country that had greatness thrust upon it,” according to Ruchir Sharma, author of Breakout Nations and head of emerging-market equities at Morgan Stanley Investment Management in New York. “Its rulers were neither prepared nor competent to handle the huge inrush of foreign capital in the last decade.”

At first, the cash went to building what seemed like useful infrastructure, such as the Cai Mep port, roads, bridges over the Red River and the Mekong, and highways –though many show little sign of upgrades since the Americans left in 1973. Then it flowed into apartment buildings, including luxury residences. Many of these, particularly around Ho Chi Minh City, stand vacant or unfinished. And there were the industrial parks meant to house all those foreign manufacturers, built on the outskirts of cities by displacing rice paddies and pomelo farmers. Indeed, 20 of these parks covering some 3,645 hectares of former farmland were built in the Mekong Delta province of Cuu Long alone. Yet as of July, only 810 hectares of that space had been leased, according to a report in the official Vietnam News.

This overinvestment would have created a hangover on its own. But when the global financial crisis dented world trade and slowed foreign capital flows starting in 2008, Vietnam’s banks, prodded mightily by the government, stepped in to keep the money flowing. By HSBC’s reckoning, credit has grown fourfold over the past six years. Worse, the bulk of the money flowed to inefficient state-owned enterprises like Vinalines, led by political apparatchiks and the well-connected beneficiaries of a party spoils system. Vietnam’s 100 largest state enterprises are now indebted to the tune of about $50 billion, or more than one third of the country’s GDP, Reuters calculates. Should some of these conglomerates collapse - which hardly seems farfetched–it could trigger a huge banking crisis.

The arrest in August of one of the country’s richest businessmen, Nguyen Duc Kien, further exposed Vietnam’s shaky financial system. Kien was seized for alleged fraud and economic mismanagement arising from efforts to shore up the bank he founded, Asia Commercial Bank. The news had depositors lining up to pull out their money, sent stocks plunging, and caused a surge in the retail price of gold, the traditional refuge for Vietnamese savers.

Vietnam’s banking troubles are by no means confined to Asia Commercial Bank, whose founder’s ties to Prime Minister Nguyen Tan Dung sparked speculation that the Communist Party is redoubling efforts to crack down on corruption within the government. Central bank governor Nguyen Van Binh shocked the country in July when he warned that nonperforming loans constituted almost 9 percent of all lending - contradicting official data that had reported duff loans amounting to just 4 percent a few months earlier. The real number is likely to be far higher, foreign bankers say.

So banks need an injection of capital. The National Assembly’s economic committee estimated on Sept. 4 that around $12 billion would do it - but that’s probably just the start. With international reserves of only some $14 billion, according to the International Monetary Fund, that won’t be easy. The government could run the printing presses, but that would batter the country’s currency, the dong, and fuel inflation, which the authorities have tried with mixed success to tame.

Another way to improve matters would be to attract foreign capital back to Vietnam. But the once enthusiastic foreigners are shy now that they’ve been bitten. The country has managed only one international bond offering this year - a $250 million deal for Vietnam Joint Stock Commercial Bank for Industry and Trade, or VietinBank. That happened in May before things looked as bad as they do now, and even so the bank raised only half as much as it hoped despite paying an 8 percent yield. It was the first attempt to raise money after state-owned Vietnam Shipbuilding Industry Group, or Vinashin, defaulted on a $600 million loan.

All this, it might be argued, could stem from shaky economic fundamentals. But foreign investors are also now leery of trusting the government, and with reason. In the bankruptcy of Vinashin, for instance, Hanoi didn’t make good the debts of what was patently a state-controlled enterprise, sparking lawsuits by bondholders including New York investment firm Elliott Associates.

And if that sounds like the gripe of a sharp-elbowed U.S. hedge fund, there are other situations that cast doubt on Vietnam’s commitment to the rule of law. In one of these, International Textile Group (ITG), owned by U.S. private equity mogul Wilbur Ross, is battling with Phong Phu, its partner in a clothing joint venture set up six years ago in Da Nang. Phong Phu is controlled by state-owned enterprise Vietnam National Textile and Apparel Group, known as Vinatex. The dispute, over financial commitments, is supposed to be resolved through arbitration in Singapore. But government parties sympathetic to Vinatex have pressured a Vietnamese court to rule on certain matters between the two companies. Such involvement by the Vietnamese court directly contravenes the parties’ agreement to arbitrate in Singapore.

The combination of scarce domestic financial resources and a near-boycott of the country by international investors leaves Vietnam with few options. A bailout of some sort can’t be excluded. While China has the capital, it’s hard to imagine the Vietnamese surrendering even a glimmer of sovereignty to their historic adversary. The United States, which is diplomatically snuggling up to Vietnam and other Southeast Asian nations as a bulwark against increasing Chinese power in the region, is rich but also has financial problems of its own. Washington could, however, easily assist in helping put together an IMF funding package. Such a deal might even lay the groundwork for a return of American naval ships to Vietnamese ports like Cam Ranh Bay.

Either way, the current disillusionment suggests that any money that flows to Vietnam will come with strings attached. Deep reform, including privatization, of the country’s lumbering state-owned enterprises and greater adherence to the rule of law will be required. Both would upset the ruling elite, whose Porsches and Bentleys vie with bicycle rickshaws in the clogged streets of old Hanoi. The justifiably proud Vietnamese won’t want to cede much, if any, influence to the likes of the IMF. But if they can find ways to change things cautiously for the better, they could yet offer a more positive example to Myanmar and other emerging economies.

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Context News

Moody’s downgraded Vietnam’s foreign- and local-currency government bond ratings to B2, its lowest rating ever, on Sept. 28 citing a weak banking sector likely in need of “extraordinary support”, dealing another blow to a country once tipped as Southeast Asia’s next emerging market star even as many of its neighbors prosper.

Moody’s said the cut in its credit assessments of state-controlled Vietnam Bank for Industry and Trade and the Bank for Investment & Development of Vietnam, plus six joint stock banks, “reflects the increased probability that the eight banks will need extraordinary support to avoid economic insolvency,” Moody’s said.

Over the period from 2007 to 2011, average domestic credit growth of 33.7 percent far exceeded average annual nominal GDP growth of 21.3 percent and average annual real GDP growth of 6.6 percent, according to Moody’s.

The other downgraded banks include: Asia Commercial Bank, Military Commercial Joint Stock Bank, Saigon - Hanoi Commercial Joint Stock Bank, Saigon Thuong Tin Commercial Joint-Stock Bank, Techcombank, Vietnam International Bank.

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