Vietnam Battles Dark Side of Boom
By James Hookway

HO CHI MINH CITY, Vietnam—At a time when many emerging markets are trying to stem a destabilizing rise in their local currencies against the dollar, up-and-coming Vietnam is grappling with a rather different problem: Residents can't get enough of the U.S. greenback, as their own currency, the dong, threatens to spiral lower.

Moody's Investors Service signaled the extent of the problems Wednesday, downgrading its rating on Vietnamese government debt to B1 from Ba3 in part because of the downward pressure on Vietnam's currency and worsening inflation. It also maintained a negative outlook on the country's ratings, citing the mounting debt problems at state-run Vietnam Shipbuilding Industry Group as another reason for the downgrade.

Call it the dark side of Vietnam's economic boom. In recent years, Vietnam has established itself as a major production hub for the global economy, luring big names such as Canon Inc. and Intel Corp. to its shores and racking up some of the fastest growth rates in Asia after China.

But the Communist-run government's determination to hit persistently high growth targets, coupled with state-directed lending growth of more than 30% annually in recent years, have flooded Vietnam's economy with money and created a raft of problems for the local currency. The excess capital has triggered a sharper uptick in inflation than has been seen in other emerging markets, stripping confidence in the dong as residents doubt their government can manage rising costs in the months ahead.

Meanwhile, unlike many Asian countries, Vietnam runs a substantial trade deficit, which adds further downward pressure on the dong. Officials here expect a deficit of $12 billion this year, little changed from 2009.

The dong has already lost about one-fifth of its value against the U.S. dollar since mid-2008, and black-market rates for dollars are currently 10% or more above the official exchange rate. That is fueling speculation that the government will be forced to devalue the dong again in the next few months to bring official values closer in line with street rates.

Vietnam's currency woes serve as a reminder that not all emerging markets are the same at a time when investors are pouring money into frontier economies worldwide.

Most of Vietnam's neighbors, including Thailand, Malaysia and South Korea, are seeing their currencies shoot up in value as investors bet on stronger growth in Asian markets while the U.S. and Europe slog through slow recoveries from the latest global recession, sending the dollar and the euro lower.

Stronger currencies are a problem for many Asian countries because they make those countries' export sectors less competitive on global markets.

But that isn't an issue for Vietnam. Instead, residents are now hoarding dollars and other stores of value because they consider just about anything to be better than the dong.

The gold and jewelry stores along Ho Chi Minh City's Le Loi Street are doing a roaring trade most mornings, selling everything from U.S. dollars to South Korean won to residents desperate to unload their dong. The biggest trades often are made by vendors who also hawk goods like shirts, shoes and dried mangoes at the cavernous Ben Thanh market nearby. On a recent Tuesday, Nguyen Thi Phuong placed several bricks of Vietnamese dong on the glass table at Thuy Van's kiosk and asked how much to convert it into gold. The answer: 36.7 million dong per tael, or $1,447 per ounce, about 2.3% higher than international prices that day.

"It's worth it for the peace of mind," Ms. Phuong says.

This loss of faith in the dong also presents a challenge for Vietnam's Communist leaders who, until now, have relied on rapid economic growth to keep the country's 85 million people satisfied. As the dong weakens, it is driving up the cost of imported goods and ratcheting up fears of higher inflation rates to come. The consumer-price index hit 11.1% in November, virtually assuring that the full-year inflation rate will hit double figures. Economic growth overall is expected to reach 6.7%.

Economists say the country has also used up much of its foreign reserves supporting the dong. Vietnam keeps the precise level of its foreign reserves secret, but the International Monetary Fund recently estimated it had enough to provide for 1.8 months of imports— a dangerously slim amount and well short of the three months that multilateral agencies consider adequate.

One problem is that Vietnamese have long been used to dealing in foreign currencies, and sometimes buy land and other expensive goods with gold instead of bank notes. People here consume 10 times more gold on a per capita basis than people in China, according to data collected by the World Gold Council, and about twice as much as Indians.

Government economists also estimate that as much as $5 billion in U.S. bank notes are held outside the banking system in Vietnam, stuffed into mattresses or hidden under creaky floorboards—enough to cover Vietnam's projected balance-of-payments deficit this year.

Hanoi's economic planners in recent weeks have flagged their intent to do more to combat their currency problem instead of focusing relentlessly on bolstering headline gross-domestic-product growth figures, as they have in past years.

Last month, the central bank pushed up its benchmark lending rate to 9% from 8% to help support the dong and contain prices, while the government has slapped a 10% tax on gold exports to help sustain the supply of the metal and avert any potential panic.

Officials at Vietnam Shipbuilding Industry Group, or Vinashin, also are scrambling to reschedule some of its $4.4 billion in debt after the company almost collapsed during the summer. Several top executives have been arrested for allegedly masking the extent of the firm's problems, and new government-appointed managers have told creditors that the shipbuilder might not be able to make a $60 million initial repayment on a $600 million syndicated loan arranged by Credit Suisse in 2007—a failure that could badly tarnish the country's international reputation.

Vinashin officials didn't respond to requests for comment. A Credit Suisse spokesman said the investment bank had no comment.

"An unwillingness to support a seemingly strategic company…raises questions on the health of the public enterprise sector at large, and the adequacy of official holdings of foreign-exchange reserves," Moody's said in a statement Wednesday.

Prime Minister Nguyen Tan Dung has ordered government ministries to set prices on goods such as coal and petrol to keep price rises in check. Among his tools, so far unused, are new rules enabling the government to impose price controls on goods and services produced by foreign and private companies in addition to those of state-owned enterprises.

"All the authorities should take strong measures to control gold prices and stabilize the foreign-exchange rates and interest rates, and punish speculation in gold and foreign currencies," Mr. Dung said earlier this month.

It is unclear whether the current policies are enough to stop the rot. In a research note to clients this month, Capital Economics asked whether Vietnam is heading for a crisis in 2011.

The answer, said economist Kevin Grice, is "yes" unless Vietnam moves more aggressively to let interest rates rise further and does more to tackle state-enterprise spending that, while encouraging growth, also contributes to a large budget deficit.

The International Monetary Fund last week warned that Hanoi needs to tighten monetary policy and also do more to cut public debt. "Further reforms are needed to safeguard a financial system that is robust, efficient and market-based," the IMF's Asian-Pacific chief, Masato Miyazaki, said in a statement.

The Communist Party Congress in January might determine how far Mr. Dung and other leaders are willing to go—and even whether they survive to push through policy changes. The congress, held every five years, will determine whether Mr. Dung will be appointed to a second term as premier and will likely set the scope of any reform plan.

If Hanoi's policy makers act decisively by tightening monetary policy, analysts said, they could restore confidence in Vietnam and its financial markets and gradually revive the flagging dong.

Stock market analysts said equity prices here have retreated to a level at which they now look attractive, with only those in Pakistan rated cheaper on a price-to-earnings basis. On Wednesday, the VN Index closed 0.8% higher at 493.47 points amid heavy trading volumes driven, brokers said, by speculation that the government's change in focus might help stabilize prices.

Some analysts, though, said it will be difficult for Vietnam to shake off its old ways. Already, the government is projecting an inflation rate of at least 7% a year for the next five years, far higher than its neighbors, in a sign that it intends to pursue its target-driven, growth-at-all-costs policies.

"This isn't a sustainable way to run an economy," says Nguyen Quang A, an economist who ran Vietnam's only independent economic think tank until its founders opted to close it amid tightening government censorship.
Vietnam Battles Dark Side of Boom - WSJ.com

Can the Vietnamese Communist Party keep things together?