VND Weakness Not Over Yet The SBV devalued the VND by 1%; expect another 2-3% decline. After a long period of stability and despite a moderate intervention by the State Bank of Vietnam (SBV), the VND was devalued by 1% last week. We and other local market observers initially viewed this as a one-off devaluation prompted by developments in Vietnam’s gold market, but additional factors are also driving local demand for USD (FX speculation by the banks and foreigner selling of VGBs). That said, the domestic economy is not overheated, so the market is probably not entering a period of high currency volatility. Weak 2Q13 economic statistics. Recently-released data indicate that Vietnam’s economy is still bouncing along the bottom in a U-shaped recovery. There are some positive signs, but in general, the numbers show clearly that GDP will grow by less than 6% in 2013, after 2012’s sluggish 5% increase. Weak credit growth of just 3% YTD remains the main constraint on the economy, although slowing external demand, especially from China, is also starting to bite. The government’s recently-approved VAMC solution to the domestic banks’ NPL problem should reignite credit growth, but we do not think it will encourage banks to lend until year-end or the beginning of next year due to the time needed to get the programme fully active. A weak economy means less pressure on the VND. The current pressure on the VND stems from specific factors in the banking system, in our view. This contrasts with major VND devaluations in recent years, which were caused by an overheating economy and rampant inflation, which sent savers scrambling to take their money out of the VND and put it into gold and USD. During 2009-2011, the ‘Errors and Omissions’ item in Vietnam’s balance of payments averaged about 8% of GDP each year, evidence of funds leaving the VND. Inflation is expected to come in at around 7% this year because of the weak economy. But this figure is the lowest in 10 years, which means that inflation is not a factor in the current bout of VND weakness. Local gold market the main catalyst for VND weakness. Vietnamese banks bought gold to close out their approximately USD5b short gold position before the SBV’s deadline of 30 Jun 2013. Some of that short position was bought back last year but the central bank spent about USD1b of its reserves this year to buy gold on the world market, which was in turn auctioned off to local banks. Purchases by local banks led to gold prices in Vietnam being at a 15-20% premium over global prices, encouraging arbitrageurs to illegally import the metal and causing further outflow from the VND. Gold prices in Vietnam are currently 15% above world prices but as banks have closed their short gold positions, this spread is likely to drop over the next few months. Specific developments in the banks are negative for the VND. Vietnam is in the midst of a classic liquidity trap: loan growth is weak and money has been pouring into government bonds. The resulting increase in bond prices has prompted foreign investors to take profits on the estimated USD3b worth of VGB’s they hold, which they then need to convert back into USD. The prevailing negative sentiment towards emerging markets also encouraged foreigners to sell VGBs. In addition, excess VND-denominated bank deposits have given local banks spare cash to speculate on the FX market – and they are using it to sell VND and buy USD. Banks will need those trading profits, as core NII growth will likely be low this year while provision expenses will be high as Vietnam continues to clean up its banking system. Michael Kokalari, CFA [email protected] (84) 8 3838 6647 Hang Vu [email protected] (84) 8 44 555 888 (x8087) 3 July 2013 Page 2 of 12 2Q Strategy Vietnam devalues the Dong After a long period of currency stability, Vietnam’s central bank, the SBV, lowered the reference rate for the VND by 1% to 21,036 last week. The last major depreciation of the VND was a 9.3% adjustment to the reference rate in Feb 2011 (followed by a total of 1.1% of gradual depreciations in the reference rate before last week’s 1% devaluation). The official trading band for the VND is +/- 1% around the official reference rate. The VND had unofficially been trading around 21,350 at the time of the devaluation and is currently trading at around 21,480. The VND devaluation was also coupled with a surprise 50bp interest rate cut, which is discussed below. The main catalyst for the recent VND weakness is a series of developments in the local gold market, but these developments will only have a temporary impact on the currency, for reasons that are explained below. Negative sentiment towards emerging market currencies (especially towards the South African Rand and Indian Rupee) also hurt sentiment towards the VND. When the SBV intervened to support the VND two weeks ago the central banks of India and Indonesia also intervened to support their respective currencies that week. Finally, a moderate increase in the trade deficit also hurt sentiment towards the VND, although trade deficits do not have a significant supply and demand impact on the currency over time because trade deficits in Vietnam are a byproduct of FDI inflows. The trade deficit has been growing recently because a gradual pick-up in the economy has led to the increased import of production raw materials, and because of increased gold imports. Further depreciations likely because of VGB profit-taking We expected the VND devaluation last week to be a one-off event for the reasons discussed above. However, when we began gathering our thoughts in order to write a short note on the devaluation, our bank analyst pointed out that there was more to the story than the widelydiscussed issues in the local gold market outlined below. A substantial holding in Vietnam Government Bonds (VGBs) by foreign investors make further, moderate depreciations likely over the next few 3 July 2013 Page 3 of 12 2Q Strategy months – although Vietnam is not headed for a period of high currency volatility because large currency depreciations in Vietnam are typically caused by rampant inflation. We infer from FII statistics that foreign investors bought about USD1b of VGBs in each of 2010 and 2011, and USD400m of government bonds in 2012. The market consensus is that total foreign investor holdings of VGBs are about USD3b or c.10% of the total stock of outstanding VGBs. Foreign profit-taking on VGBs Foreign investors are sitting on handsome gains on their bond positions due to a dramatic fall in inflation since 2011 and because the ongoing liquidity trap in Vietnam’s banking system prompted banks to pour money into bonds instead of making loans. Because of concerns about Vietnam’s 12-15% NPLs problem, banks only grew their loan books by about 6% last year (although credit growth shot up to 9% in the last two weeks of the year). In contrast, deposit growth was 16% in 2012 and M2 growth was 22%, so a large amount of excess liquidity was created that ended up in government bonds. A similar situation persists this year, with system-wide deposit growth of about 7% YTD vs VND loan growth of about 3%. The net result of falling inflation and aggressive bank purchases of government bonds is that bond prices soared, yields collapsed by 600bps, and foreign investors are sitting on handsome gains. However, in order to repatriate their profits, foreign investors need to exchange the proceeds of their VGB bond sales back into USD. Note that the recent spike in 2-year VGB yields from 6% to 7.5% (depicted in the price chart above) was caused by foreign profit-taking worth about USD200m. Sentiment towards VGBs has also been impacted by general negativity towards emerging markets due to the tapering of QE, and the widespread discussion about the USD4t of inflows into emerging markets since the global financial crisis. 3 July 2013 Page 4 of 12 2Q Strategy Banks’ short gold positions Vietnamese banks were short about USD5b worth of gold at the beginning of 2012, an industry-wide position that was built up over a few years. Banks had accepted gold-denominated deposits on which they paid savers a 2-3% interest rate, but then exchanged some of those gold deposits into higher-yielding VND to play the carry trade between gold and the VND (the gold deposits that were not changed into VND were lent out in gold-denominated loans, much of which was used to fund property speculation). Banks stopped making gold-denominated loans more than a year ago and stopped accepting new gold deposits at the end of 2012. The SBV required all gold-denominated deposit accounts to be closed out by 30 Jun 2013. The banks returned physical gold to the original savers, who must pay warehousing fees to have that gold held for them. Gold market the catalyst for weak VND sentiment Vietnam’s banks intensified their purchases of gold over the last few months to close out their short gold positions in advance of the SBV’s 30 June deadline, which in turn put pressure on the VND (VND needs to be sold to buy USD, which is then used to buy gold). Local banks bought 100 tonnes of gold in 2012 and over 30 tonnes of gold in 2013, which pushed the price of gold in Vietnam to 15% above world gold prices. Earlier in the year, local gold prices were as much as 20% above world gold prices. Part of the reason for the large spread between local and world gold prices was that the SBV had estimated at the end of 2012 that banks would need to buy 20 tonnes of gold in 2013 to square their short positions, but in the end they purchased more than 30 tonnes of gold. This large gap between local and world gold prices has put pressure on the VND in two ways: first, it has encouraged illegal smuggling of gold into Vietnam by black market arbitrageurs (prompting the sale of VND and purchase of USD), and second, the SBV spent about USD1b of its reserves importing gold, which it then auctioned to the banks. The SBV’s gold imports were the main catalyst for the current bout of Dong weakness, even though the central bank’s FX reserves are probably over USD25b at the moment, and more than 3 months’ worth of imports (the SBV does not clearly disclose its FX reserves). The trade deficit is damaging sentiment The trade deficit is also putting pressure on the VND, although we think this is more of a sentiment issue than a factor putting significant supply/demand pressure on the currency, as discussed below. The trade deficit in the first half of this year was USD1.4b, and the trade balance has been deteriorating each month as Vietnam’s economy starts to show some signs of recovery, because an increase in businesses’ optimism about the economy boosts the rate of import growth due to the increased import of production materials. 3 July 2013 Page 5 of 12 2Q Strategy Export growth has also been slowing as China and world economy begins to slow a bit, as evidenced by weak PMIs around the world. Looking at the numbers, Vietnam’s import growth surged from 6% YoY at the beginning of 2013 to about 17% at present, while export growth has fallen a bit from nearly 20% YoY in the beginning of the year to about 16% now. The opposing trajectories of these numbers explain why Vietnam’s trade balance deteriorated from a USD155m surplus in 1H12 to a USD1.4b deficit in 1H13. Declining export growth is clearly not a favorable development, but export growth at FDI companies remains robust at about 25% YoY and the outlook for continued FDI inflows is very bright. In 1H13, disbursed FDI was USD5.7b, up about 6% YoY, with nearly 90% of newly pledged FDI earmarked for manufacturing (vs 50% during the property bubble years around 2010). But the trade deficit is not a significant issue at present… The reason we are not overly concerned about Vietnam’s trade deficit is that the country faces a structural trade deficit due to large FDI inflows. Money comes into Vietnam via the capital account but then goes back out via the current account/trade deficit because FDI-funded factories need to import the machines and materials required for production. In general, the flows of money in and out of Vietnam have been fairly well balanced over the last years. For example, this year, the balance of payments will probably come in at a surplus of about 2-3% of GDP. The real issue for the VND is the internal capital flight that occurs during times of rampant inflation when local savers move their money from VND to gold and USD held inside the country. Notwithstanding the last point, trade deficits do cause negative sentiment towards the Dong and those deficits are likely to persist for the next few years because tertiary industries in Vietnam are generally weak; so many basic materials, like the textiles used to make garments, and the PVC used to make packaging and plastic pipes need to be imported. The development of tertiary industries will help close the gap, but the real improvement in trade deficit will come as the country’s exports move up the value chain – we expect Vietnam to run persistent trade 3 July 2013 Page 6 of 12 2Q Strategy surpluses starting in about three years due to an explosion in the manufacture of high-tech Japanese and Korean products such as electronics and cell phones. Mobile phone exports are on track to reach USD20b this year, up from just USD2.5b in 2010. …unlike currency speculation by banks The liquidity trap in Vietnam’s banks described above (on page 3) has left commercial banks sitting on an excess of VND-denominated deposits. The accumulation of VND deposits this year is due to weak credit growth of c.3% YTD vs a 7% system-wide increase in VND deposits. According to the central bank (and anecdotal evidence), banks are using some of those excess deposits to speculate in the currency market. The banks are well positioned to do this because they understand foreigners’ desire to take profit on their VGB positions, which in turn generates a need for those foreign investors to buy USD. We estimate that the entire banking system has the capacity to short about USD4b worth of VND and that banks have already sold over USD1b worth of VND to buy USD. Recall from above that foreign VGB holdings are estimated at about USD3b, and it becomes clear that local banks are essentially front-running foreigners’ eventual need to buy USD to repatriate their VGB profits. SBV governor Binh is well aware of this and has threatened to increase reserve requirements to mop up excess VND deposits in order to curtail the current selling pressure on the currency. No help from the carry trade Another reason for VND weakness is that the currency is not receiving much help from the VND/USD carry trade because interest rates have fallen more than 800bps since the beginning of 2012. Last year, a record USD11b of overseas remittances flowed into Vietnam, most of which are thought to have ended up in bank deposits. That was one reason why the currency has been stable since the beginning of 2011, but now, based on anecdotal evidence, it seems that an increasing proportion of those remittances are flowing into real estate, where rental yields are around 8%. However, deposit rates are still 700bps and the prospects of a VND depreciation of more than 5% is quite low, so we do not foresee an aggressive unwinding of the carry trade. We just do not expect a lot of new inflows into the VND to play the carry trade, which was a big factor that helped support the currency last year. Inflation differential means structural depreciation of c.3% per year Although the SBV’s gold imports were the main catalyst for the current negative sentiment towards the VND, Vietnam’s currency needs to depreciate about 3% a year because of the inflation differential between the USD and the VND. The inflation differential is greater than 3% but the VND is supported by the fact that USD and gold worth about 40- 50% of GDP are held in the country outside the formal financial system 3 July 2013 Page 7 of 12 2Q Strategy (in the past the nominal VND rate has depreciated by about half the inflation differential between the USD and VND). At the end of last year, central bank governor Binh said that he expected the VND to depreciate about 2-3% in 2013. The fall in the currency will itself add slightly to the increase in the CPI but this effect is negligible compared to money supply growth, which is well under control at present. On the other hand, the economy is weak The VND typically has large depreciations when the economy is overheating and inflation is rampant. A series of recently-released economic statistics show that Vietnam’s economy is weak, but gradually recovering. In our view, the three most important recentlyreleased figures are 2Q13 GDP growth, June CPI, and the June HSBC PMI. GDP growth of 5% YoY in 2Q13 was a slight pick-up from the 4.76% growth rate in 1Q13, and resulted in a 4.9% GDP growth rate for 1H13. June CPI came in at 6.69% YoY, up slightly from 6.36% in May. The steady fall in inflation that has taken place throughout 2013 has probably come to an end, as evidenced by a modest acceleration in most of the sub-indexes, but we do not expect a dramatic pickup in inflation for the rest of this year. It looks like inflation in 2013 will probably be the lowest in 10 years because of weakness in the economy. Finally, the HSBC PMI dropped from 48.8 in May to 46.4 in June, and the PMI sub-indices showed a fairly strong pickup in companies’ inventories, which is disappointing because inventories had been falling more or less steadily for the last year and a half. These weak figures led to a surprise 50-bp cut in the VND deposit rate ceiling to 7%, and a 75-bp cut in the USD deposit rate ceiling to 1.25%. Vietnam not entering another period of high currency volatility Despite all the negative factors for the VND discussed above, we do not believe that investors need to worry much about the VND. We think that the current period of currency weakness will pass quickly once the gold market stabilises and foreigners finish taking profits on their bond positions. Although we think the VND will depreciate more this year, four things make us believe that we are not headed for another period of high currency volatility: 1) The central bank bought USD18b of reserves last year and about USD3b in 1Q13. Even after the reduction in reserves due to SBV’s purchases of gold on the world market, Vietnam’s FX reserves are above the traditional safety threshold of 3- months’ worth of imports. 2) Bouts of currency weakness in Vietnam are usually caused by high inflation – which prompts local savers to take their money out of VND and into USD and gold. Inflation in Vietnam is 3 July 2013 Page 8 of 12 2Q Strategy currently running at just under 7% YoY, and is likely to stay around these levels the foreseeable future. 3) Despite investors’ preoccupation with the trade deficit, we actually think this is a non-issue as far as the VND is concerned. 4) Our main reason for believing that the VND will depreciate more is the likelihood of increased foreign profit-taking on their VGB positions. However, the recent sale of just USD200m worth of government bonds, coupled with a shift in sentiment, caused yields to rise by 150bps. This suggests to us that foreigners will be constrained from selling too much of their VGBs lest they significantly diminish the profits that they are currently sitting on. research.maybank-ib/pdf/documentrg/20130703_MBKE_VND_Depreciation_V6_2496.pdf
Posted on: Fri, 12 Jul 2013 02:01:07 +0000
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