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Addressing the confidence crisis in Vietnam’s capital markets... In order to restore confidence, several measures are proposed:- a Establishing central buying agri-bodies and implement d

IF NOT NOW, THEN WHEN?

Addressing the confidence crisis in Vietnam’s capital markets

EXECUTIVE SUMMARY

(A) CONTENTS OF THIS PAPER

1 How Perceptions change – The Then (2007) and the Now (2008)

2 Analysis of various aspects of Economy - Fundamentals Remain Strong – Export, FDI, industrial production, agriculture production, consumer spending, remittance and tourism

3 Analysis of various aspects of Economy - On currency scares and NDF and Government Response

4 Analysis of Measures put in place so far to gain confidence

5 Investor’s Perspective and Proposal - The Now and Possible Measure for regaining confidence – Equity Performance

6 The time is NOW

(B) SUMMARY OF PAPER AND RECOMMENDATIONS

The crisis, if it is a crisis, is a crisis in confidence In other words, it is the perception

of the market or consumers which is driving this crisis

Vietnam’s fundamentals remain strong In order to restore confidence, several measures are proposed:-

(a) Establishing central buying agri-bodies and implement domestic subsidy mechanisms for basic essential goods for Vietnam

(b) Use of administrative measures rather than monetary policies e.g to control inflation

(c) Use of other measures to improve confidence and participation in capital markets to jump-start confidence in a crucial funding platform for Vietnam

(C) CONCLUSION

Vietnam’s fundamentals are strong It is just a perception issue which needs to be addressed Some proposals are contained in this paper, for consideration Chief among the proposals is the formation of a fund which due to it being a joint investment with others will cost less but will potentially reap significant rewards for the government, if the investment is timed properly

I PERCEPTIONS – THE THEN AND THE NOW (HOW THINGS DON’T CHANGE BUT PERCEPTIONS DO)

1.1 THE THEN - Success story of Vietnam in 2003 - 2007, focusing on 2007:

Vietnam is considered as the fastest growing economy of ASEAN GDP achieved growth at 8.48% in 2007, and considered to continue at least 8% for the next 5 years 2008-2012

In 2007, export jumped 21% to US$48.4 bil with import growth 35% to US$57.8 bil This made Vietnam as one of most open trading countries in the world No of foreign tourists exceed 4.2 mil, up by 16% compared to 2006’s

FDI continued to make a record with actual disbursed amount of US$6.5 bil in 2007, more than 3 times higher than 2006’s US$1.8 bil, mostly for industrials and real estate FDI commitments also reach new height with US$20.3 bil at the end of 2007, compared to only US$12.0 bil of 2006

Real GDP growth (% change)

2 3 4 5 6 7 8 9

2003 2004 2005 2006 2007 2008 2009

Source: Economist Intelligence Unit

All the analysis about perspectives of Vietnam economy, except for rising inflation of 12.63% in 2007, has made the world view Vietnam as the next Asian Tiger Vietnam became the dream destination for investments, tourism development, and all sources

of capital inflow were trying to get a piece of the action

Stock market continued to develop strongly with market cap about 44% of GDP at over US$30 bil Interest in Vietnam was so strong, asset managers’ assets under management increased multiple times! Even the pace of stock market development was unable to catch up with the asset managers Assets under Management (AUM)

These asset managers, given the shortage of free float in the stock market, became the market

Market Capitalization / Nominal GDP

0%

50%

100%

150%

200%

250%

300%

350%

400%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Source: Economist Intelligence Unit

1.2 THE NOW - Vietnam in controversy in 2008:

GDP growth slowed down to 7.4% in Q.1 2008 Inflation jumped 25% in May 2008, caused primarily by food prices which increased over 42% Oil prices are now above US$130 per barrel, even when Vietnam is a net exporter of energy products

Sharply tightening policies, focusing on monetary and later on public finance, has been implemented to curb inflation In Feb 08, interest rates rose above 40%!

As a result, Vietnam stock market continued to fall sharply from Jan-08 at 924 to May-08 at 414 or loss 55%, the heaviest loss in Asia Vietnam’s first asset bubble has burst and now it is cascading to land and house prices, with high end real estate developments’ prices decreasing 50%-60% in many areas

Trade deficit of US$14.4 bil (16% of GDP – up till May 2008) has caused serious concerns about a possible balanced of payments crisis These factors resulted in fluctuations of USD/VND forex rate, shortage of USD in commercial banks, high yield

in bond market up to 24% in late May 2008 Anecdotal evidence is that the trading or purchases of gold and foreign currencies has reached alarming proportions Many foreign commentators draw parallels to the current Vietnam crisis of confidence with that of Thailand’s 97 crisis The Thailand crisis more than 10 years ago snow-balled into the Asian Financial Crisis, affecting many, many countries of Asia

The questions have been raised about whether Vietnam has strong economic fundamentals to sustain its high rate of economic development or will fall into same crisis as Thailand did in 1997-98?

The equity market stumbles

0 200 400 600 800 1000 1200

HCMC Stock INDEX

Source: CEIC, Merrill Lynch calculation

II ANALYSIS OF VARIOUS ASPECTS OF ECONOMY – FUNDAMENTALS REMAIN STRONG

But who is watching the positives?

However, positive developments in last 5 months are recorded as (i) export growth of 27.2% is amongst the best in Asia, (ii) industrial production expanded 16.7%, (ii) consumer spending reached growth at 29.7%, (iv) FDI approval of US$23 bil until now, more than the entire 2007’s, and (v) no of foreign tourists up by 16%

If it is a crisis, it is a crisis in confidence, no more

 Vietnam in 2008 is still the same Vietnam as the Vietnam in 2007

 The fundamentals have not changed with further development of export, FDI, industrial production, agriculture production, consumer spending, remittance and tourism

Stock Markets and signals about the economy Many retail observers around the world use the stock market indicators as a representation or proxy of economic growth Whilst that may be somewhat appropriate in the developed markets/economies context, this is inappropriate in

an emerging market like Vietnam The relevance between GDP growth and stock market share index is one of little or low correlation Please see the charts and correlation figures on emerging markets in general and how they contrast with S&P, the stock indicator for the US in Appendix I In our view, the stock market is

a sentiment indicator for Vietnam, nothing more

Sources: ADB, Bloomberg, GSO Data from the Vietnamese capital market’s short history also shows a weak relationship between share price volatility and real economic performance as stated in GDP growth and Industrial production growth

Conflicting Advice from Reputed Economists Although many say that Vietnamese policy makers were instrumental in creating the current worrisome situation, our sympathies go out to them It is very difficult

to identify the appropriate macro-economic policy responses when leading observers (such as global economists, global institutions and NGOs) continue to make (in our view) erroneous pronouncements on what should and should not be done This is because their analysis is often made in an environment of incomplete and/or inadequate analysis When reputed economists/analysts make comments and seemingly provide knowledgeable advice, has anyone closely analysed if those comments are well informed, relevant, or appropriate? Who should the government of Vietnam listen to? There is such a sea of noise!

Policy Measures to manage inflation - Need for subsidy mechanisms Take for instance the policy measures to manage inflation So far, many people talk about using monetary policy In our view, the instruments of monetary policy

do not yet function well in Vietnam Thus, we are worrying that even if the interest rate rises to 50% pa that would not stop inflation from reaching 30% pa (especially when more than 60% of CPI is accounted for by food and energy prices’ sharp inflation)

- 50% 0% 50% 100% 150%

0%

5%

10%

15%

20%

2001 2002 2003 2004 2005 2006 2007 Q1 2008

Growth in GDP vs Equity Market Performance

Nominal GDP Growth Real GDP Growth Change in VNINDEX

Indeed, if there is a 50% pa interest rate, there will probably be a run on the banks and all Vietnamese people will take money out and shift to hard assets, e.g rice, gold, petrol and cause an even more dangerous spiral in inflation in domestic Vietnam

We thus highlight the urgent need to set up central buying agri-bodies, and implement domestic subsidy mechanisms for these basic essential goods for Vietnam We encourage all to review our Research Paper, “Recommendations from

a Friend”

CONFIDENCE MY FRIENDS, IS SO LACKING

The only thing that differs from 2007 and 2008 is confidence, or to be precise, a lack of confidence No confidence that this time, Vietnam is not a Thailand, no confidence that the government can manage inflation, no confidence that Vietnam will not collapse as a result of inaction by its people

Unfortunately, policies need time to be more effective, and inflation needs time to

be curbed; that means, this crisis of confidence from both local and foreigners is not going away so soon

Why Vietnam’s situation is different from Thailand – Please learn from history There is little evidence that Vietnam’s situation is bad like the Thailand of 1997, or

in anyway similar

Even whilst Vietnam’s state budget has remained in high deficit, foreign debts have decreased to the current 33% of GDP (as compared to Vietnam’s 40% in

2000 or 73% in Thailand in 1997) Most of Vietnam’s debts are from ODA which if need be can be rescheduled by long term decision makers For Thailand and the rest of Asia’s affected countries during the Asian financial crisis, the key issue was the dominance of short term capital flows to fund their current account deficits These significant current account deficits were in turn driven by a combination of high investment growth, and wasteful investments into speculative activity like real estate and large state backed projects E.g Thailand created a monster petrochemical and refinery complex which was meant to produce more than was required for domestic usage They wanted to be a petrochemical giant for Indochina and Asia When the providers of short term funding got nervous, the pulled out, and left a sea of destruction and anguish for Asian countries involved Here, these providers of short term capital were primarily behaving a little like

“retail investors”

As referred to in the paper “Vietnam and its Myths”, there is no balance of payment issues for Vietnam Indeed, Vietnam is in a very enviable position with much of its infrastructure projects supported by very long term funding flow, including significant FDIs This is very positive for Vietnam

III ANALYSIS OF VARIOUS ASPECTS OF ECONOMY – ON CURRENCY SCARES 3.1 On Currency scares

In addition, the VND is not a freely convertible currency However, everyone believes in market forces, and this obviously applies to exchange rates: From the non-deliverable forwards (NDF) market, where 12m contracts are at above 21,900VND/$ against an official rate of 16,200, recently adjusted to 16,459; people translate it into devaluation of nearly 30% in next 12 months But the NDF market is very illiquid and it does not reflect the true demand against supply in Vietnam So when observers review this attention grabbing figures of the extremely illiquid Non-Deliverable Forwards (NDFs) played by foreign speculators, they immediately draw the conclusion that VND is going through a nose dive

“Vietnam is going to have a currency crisis!” goes the newspaper headlines! Nothing can be further from the truth! Why did the Malaysia move towards M$ currency capital controls during the 97-98 crisis? Vietnam is already there, whereas because M$ was under attack during the 97-98 crisis, Malaysia had to move to a model similar to Vietnam’s, and consequently, none of the speculators managed to speculate against Malaysia M$

3.2 Recent government response

After speaking publicly that there are no plans to devalue the currency, the Vietnam government/SBV 2 days later adjusted the VND by a 2% devaluation and raised interest rates! This has seemingly stabilized the markets and received positive feedback in both Vietnam and overseas

We however, feel that the flip-flop nature of official communication may damage the credibility of the anyone in its resolve to manage the current confidence crisis

In other words, investors may lose confidence in the institution if they think that what the institution says may not be what it means Who will believe the announcements again? Explanations of actions are required and communication of not carrying out the same mis-management of expectations must be made to all, domestic and foreigners

And in succumbing to the inappropriate pressures to raise interest rates further, and depreciating the currency, this may signal a lack of understanding of the key issues involved and that Vietnam does not have the appropriate solutions to handle this confidence crisis It is our view that Vietnam does not need high interest rates, it is high enough now Many businesses, even good, will fail and be

in trouble in this high interest rates environment Furthermore, Vietnam needs an appreciating currency to manage imported inflation as well as control domestic liquidity growth

IV ANALYSIS OF VARIOUS MEASURES PUT IN SO FAR

Measures put in place so far to gain back confidence:

- During the last 4 months, the management of inflation has been implemented with monetary policies such as central bank rate increases, compulsory rate

increase, strong control on credit growth at 30%, revitalising the basic central bank rate to monitor closely market moves; public finance policies as 10% decrease in government regular spending; and VND4 trillion has been cut from investment spending

- Fiscal administrative action has become one of the tools for the State to control inflation of certain key economic sectors such as fuel, cement, power and to delay price increases But are the market participants adhering to these price controls? We think not The issue is not so much strategy, but implementation, and adherence to the measures Just like managing the SOEs, the government needs to implement very, very stern measures

V INVESTORS PERSPECTIVE AND PROPOSAL – PROPOSALS FOR REGAINING CONFIDENCE

5.1 Summary

5.1.1 In this paper we have set out the background noting that the key issue is

change in perception or market sentiment as the fundamentals for Vietnam’s economy in key sectors has not changed or in fact has even improved In this section we also include prognosis of how these sectors will perform and what may need to be done

5.1.2 Thus to address the issue of confidence or market perception, a very fast

means could be to “jump-start” the capital markets In the nature of markets,

we can encourage greed to replace fear as the driving force and participants will then again jump into the market and carry on the momentum The timing

of this activity should be carefully timed and preferably take place soon

5.1.3 We produced papers titled “Actions required for Vietnam Capital Markets”, and

“Q&A: Can Market Stabilisation Funds work? Yes, if there is total commitment” We highlighted a possible avenue to address the confidence issues in the capital markets may be done through a fund

5.1.4 The details of a plan which we consider workable is summarised below

5.2 Prognosis – “Focus and be steady”

5.2.1 With detailed analysis, we expect that the economy will improve and continue

to perform well from Q.3, forecast of GDP at over 7.0%-7.5%, export over US$60 bil (up 25%), import over US$80 bil (up 40%), record FDI approval of aprox US$40 bil (up 100%) Balance of Payment at surplus in excess of US$1 bil

5.2.2 Strong FDI, remittance (expected over US$8 bil in 2008), and continued

inflows of capital will be the key factors to support the economy to overcome current difficulties and make it stable from 2009

5.2.3 The government is slowly but surely coming round to see that they need to

implement administrative measures to control inflation CPI will in the short term slow down to 22%-24% When the administrative central buying bodies