October 2008 - In his 2005 book Unconventional Success: A Fundamental Approach to Personal Investment,Professor David Swensen of the Yale University Endowment Fund suggested a key characteristic of core asset classes should be that they derive from broad, deep, investable markets.

Emerging markets, by their nature, don’t usually fall into the ‘broad and deep’ category. The proportion of available investor capital put into them and the ‘stickability’ of that capital-regardless of whether aimed at core or non-core assets-tends to be reduced in times of adverse or bearish trading conditions.

In Asia the markets most likely to get squeezed first and squeezed hardest are those perceived to have the weakest or most problematic economic and political management or those without the saving graces of variety of opportunity, domestic demand and structural scale found in China and India. Among Asia’s emerging markets, Vietnam currently seems to be playing the role of the fall guy.

Vietnam’s difficulties appear real and are not simply the growing pains associated with a rapidly expanding economy facing rising commodity prices and the global credit squeeze. Overlaid are domestic factors that have become promoters of 25.2% inflation year-on-year to May and an estimated 30% over valuation of the Vietnamese Dong. They are the sort of economic indicators that are public enemy number one and two of investors everywhere. The World Bank says the inflation rate is the highest experienced in the country since 1992, and that it may get worse before it gets better.

A report issued by Goldman Sachs on 3rd June stressed it is unlikely Vietnam is in the sort of trouble seen during the 1997 Asian financial crisis. The report indicates that Vietnam’s short-term foreign debt is only 8.6% of GDP, as compared to Thailand’s debt in 1996, which stood at 26.3% of GDP. GS economist Helen Qiao said a decline in the dong was essential in order to improve things. “We are thinking that this is the direction policy makers are moving toward,” she stated.

The European Union Green Book report for 2008 also points out the country’s fundamentals are strong on the output side. The economy grew rapidly in 2007, spurred in part by Vietnam’s accession to the WTO. GDP growth in 2007 was 8.48%, while committed FDI capital totalled US$20.3 billion. Exports grew at 21.5% reaching US$48.4 billion.

Despite this good performance, structural weaknesses in the economy and bad luck or bad timing on monetary policy have contributed to the country’s problems. Easing of restrictions on the domestic credit market late last year occurred at precisely the moment when liquidity in the world banking system was coming under severe pressure.

The fall out from the policy included an increase in company and personal debt and an acceleration of the existing trend for a large balance of trade deficit. Companies and consumers spent the credit mainly on Chinese-made goods. The latter accounted for US$9.15 billion of the US$12 billion deficit in 2007. The World Bank says the trade shortfall for the first five months of 2008 is expected to surpass US$15 billion, and may exceed US$30 billion for the full year.

The dong, non-convertible on international exchange markets and subject to state control of its valuation against other currencies, has seen a much-needed depreciation of 7.3% on its unofficial valuation since January. Workers are becoming frustrated at a reduction in their spending power and their demands for higher pay threaten to feed the inflationary cycle. In the first two weeks of 2008 alone, there were 50 strikes according to Vietnam’s Ministry of Labour. Companies with foreign direct investment are being affected disproportionately suggest some local media reports. In March 10,000 workers making products for Nike were said to have downed tools at a South Korea-owned footwear factory on the outskirts of Ho Chi Minh City.

Despite these difficulties Vietnam remains a major exporter and the European Union’s second biggest trading partner with a trading volume of US$14.23 billion and a trade surplus in Vietnam’s favour of US$5.66 billion last year, according to an EU report published on 30th May.

Speaking at the Vietnam Business Forum in Hanoi on 2nd June, Michael Pease, chairman of the American Chamber of Commerce in Vietnam, said he was confident the central government would act prudently to restore macro-economic stability. “It is safe to say that all of us gathered here today are only too aware of the spiralling costs and the negative effect that inflation is having on the business environment in Vietnam,” said Mr Pease, general director of Ford Vietnam.

Don Lam, Chief Executive Officer for VinaCapital Investment Management Limited, puts a positive slant on the country’s trade deficit with China. In a note to investors he said: “Much of the equipment being imported is building the factories and infrastructure needed for the country’s development. For example, today Vietnam is a net importer of steel, but it will soon produce and refine sufficient amounts to satisfy domestic consumption.

“It is also worth noting that unlike most countries, Vietnam is self sufficient in terms of crude oil production, but unfortunately in the absence of an oil refinery it has to export 100% of production and then re-import it as refined fuel. This will also change very soon as the first refinery will come on-stream in 2009,” he added.

VinaCapital operates a number of vehicles for investment in Vietnam, including: the Vietnam Opportunity Fund, which has about 30% of its net asset value in the Vietnam listed market; VinaLand Limited, a real estate portfolio with 41 assets spread across all property sectors in Vietnam; Vietnam Infrastructure Limited, with 20% of its NAV in listed stocks, 5% in over-the-counter stocks and 11% in private equity investments.

Lam says it is unlikely Vietnam’s trade deficit will rise to US$30 billion in 2008 because of government steps including a restriction on imports of non-productive and non-essential goods and lower quotas and higher import tariffs. He said market factors, including a rapid rise in the cost of debt, would also reduce business activities and thus reduce imports.

“The country’s medium and long term fundamentals have not changed in the slightest way,” adds Lam. There does, though, appear to be divided opinion among foreign investors about whether the government should stick to monetary management as the best method of tackling the crisis, or get more involved with market mechanisms as Lam suggests. Alain Cany, chairman of the European Chamber of Commerce, suggests, “As monetary issues are largely at the root of the current inflation problem, we feel the government’s focus should remain on monetary policy to resolve this issue domestically.”