Vietnam: an emerging Tiger

Country risk specialist Christine Shields makes the case for the fast-growing frontier economy, and John Hughman looks at a few investment options

Ho Chi Minh City photo by Tron Le

Vietnam is an immensely exciting economy that has for some time been overlooked by many. Yet its recent economic record is impressive, as is its performance through the pandemic. And it has ambitious aspirations – to become a high-income economy by 2045. This would require annual GDP growth of some 5% a year for the next 25 years, not something feasible for many economies.

Vietnam, though, is likely to deliver, but with a risk perhaps of some blips on the way. Encouragingly, there are also risks to the upside – it could reach its target sooner – indeed, it’s Five-Year Plan is targeting GDP growth of 6.5-7% a year between 2021 and 2025. Here we dig deeper into why we think it’s likely to get there, but also the risks that may hold growth back.

The power of reforms

After the years of conflict, that Vietnam decided in 1986 to embark on reforms – known as doi moi – was remarkable. Neighbouring China began its reform journey in 1978 and to some extent, this provided a welcome precedent for Vietnam to enable its own policy. The aim was to lift one of the world’s poorest economies onto a rapid growth path. By couching the programme as one within a socialist market economy, political legitimacy was achieved, as was the case in China. Over the next decades, per capita incomes rose almost threefold while poverty rates fell from around a third to below 2% of the population, underpinning growth of domestic consumption that now accounts for nearly two-thirds of the country’s economic activity.

Indeed, its economic performance has been resilient since. Partly because Vietnam was able to learn from China, but also because the political backdrop was so stable, policy makers pursued an export –led strategy that played to domestic strengths. It joined groups such as ASEAN and the WTO, boosting trade liberalisation. Meanwhile, infrastructure was modernised and upgraded. By improving health and education provision as well as general welfare standards, the quality of the labour force was pushed higher. This is now enabling a shift out of a lower-value, labour-intensive manufacturing base into higher-value products, a strategy that will in the short-term help to overcome the temporary labour shortages that resulted from the pandemic supply disruptions. One example: 60% of Samsung handsets sold in 2021 were manufactured in Vietnam.

One advantage of the stable political situation, of course, is that a long-term perspective is possible, unlike in western democracies where policy is guided more by short term political cycles than real economic need. So, while the 2045 aspiration may slip over time, the direction of travel is set so that slippage is not significant – and it is quite likely that the target will be exceeded.

Challenges being overcome

Compared to most other countries, economic performance in 2020 was good, with GDP growth of 3%, one of the few positive outcomes globally. This despite woeful preparedness but thanks to a swift vaccination programme – 75% of the population are now double jabbed. However, the April 2021 wave of the virus provoked a tight shutdown that hit both incomes and employment, both not fully recovered from the first wave. The loss of tourism trade was very damaging, especially for the service sector. Though monetary forbearance helped, there was limited fiscal support and in the first half of last year, the fiscal stance was actually contractionary. This is now changing as new fiscal packages are introduced, most recently equivalent to 4% of GDP. Implementation often falls short of rhetoric, though, a tendency evident for some time, but one which the authorities are now seeking to change.

The growth outcome for 2021 is now estimated to be 2.6%, below the previous 6% plus average enjoyed for many years. For 2022, some 7.3% is expected, exceeding 8% annually thereafter.

Though less than a fifth of GDP, agriculture still provides 40% of employment and was little affected by the pandemic. Services, though, were hard hit, up by just 1% in 2021. Manufacturing – which accounts for a fifth of GDP - contracted as many factories closed but rebounded sharply in Q4, as exports jumped by almost 20%. Retail sales fell each month from May, dropping by a third in September 2021 alone. Over 2 million jobs were lost, and unemployment reached a record 3.7% of the labour force. Though most have now been regained as the autumn reopening brought a swift recovery - with GDP up by over 5% in Q4 and retail sales surging 30% from Q3 to Q4 - output remains below pre-shutdown levels.

Solid fundamentals

A strong external balance is one of Vietnam’s strengths. Until the pandemic, the current account was in regular surplus, of the order of 5% of GDP, though this shifted to small deficit in 2021 when exports fell. Reserves cover imports for over 3 months, comfortable. This helps to limit vulnerability to rising US interest rates, a blight on the outlook for other emerging markets.

Foreign direct investment has been resilient, up over 33% in 2021, attracted in part by a growing caution about investing in China but also as a means to diversify supply sources. Moderate public debt is another attraction, though fiscal policy is, if anything, not active enough to spur development, implying a rise in future. The budget tends to be in surplus. And inflation has remained in check, though this year will be driven higher by energy costs.

Some downside risks

China’s slowing economy may bring headwinds, although Vietnam is well positioned to pick up manufacturing business being moved out of the country – that’s showing up in its PMIs, where a building export backlog lifted the measure to 53.7 in January, the highest level in ten months. Exports grew 8% in January and 7% growth in FDI disbursements is a positive leading indicator for the manufacturing sector.

And in the past, the banking sector has been a source of weakness. While now much stronger and better regulated, one pandemic legacy will be rising bad debts. These so far have been accommodated but at some point will have to be addressed. How well this is handled is key.

Likewise, higher environmental standards are imposing costs on businesses, requiring new investment. Hints of more protectionist trade policies will also impact. While the move up the value chain should help offset these, providing sufficient employment opportunities may become more difficult, especially as trends to more automation advance. Collectively these factors are likely to drive up costs and erode Vietnam’s relative cost advantages.  

An emerging tiger

But overall, despite these risks, Vietnam has solid prospects, both short term and medium term. As the world reopens post-pandemic, its tourist trade will resume and the sector will likely develop further – foreign visits rose 11.2% in January ahead of a full reopening of its borders planned for Q2. That in turn should boost consumption spending – pre-Covid, foreign visitors accounted for around 10% of consumer spending.

Similarly, disposal of state-owned enterprises should boost productivity, as will further investment in infrastructure funded by a $15bn fiscal stimulus package. An ample resource endowment is additional security, helping lock in foreign investor interest, and inflation in the country is well under control, currently under 2%, which means a low likelihood of interest rate rises that could weaken the country’s currency, the Dong.

And as the policy backdrop tightens, regulatory standards lift and workforce quality improves further, this should persist into the medium term, likely helped by improving credit ratings which will further attract foreign interest.

Investment options

Source: SharePad

The UK has plenty of good options to choose from when it comes to investing in Vietnam, which in itself is reflective of the extent of the country’s recent economic development. As well as dedicated Vietnam-focused trusts, emerging Asia generalist Baillie Gifford’s Pacific Horizon holds 6% of its trust in Vietnamese assets, although other broader Asian trusts have no exposure at all. All three generalists have significantly underperformed Vietnam-only trusts in the past year, largely the result of serious weakness in the Chinese and Hong Kong markets that are among their largest exposures.

The Vietnam Index outperforms the S&P 500 and FTSE 100

Source: tradingview.com

Vietnamese indices, by contrast, have performed extremely well, with the headline VN index climbing 29% in the last year and doubling in the last 5. As you’d imagine for a country still in the foothills of economic development, its markets are dominated by ‘old economy’ sectors such as banking (financials make up 37% of the index), real estate (23%), consumer staples (10%) and materials (9%).

Alongside limitations on foreign ownership of some companies, which does limit the choice for investors – and means overlapping holdings in the three dedicated trusts - but they’re also sectors that will benefit as the country makes its way to full emerging market status, and regulatory reforms could be coming that open the market up to more foreign ownership.

As the country locked down for a Covid outbreak at the end of last year, concerns over credit quality at its banks did weigh on their share prices. However, full year results have been strong, with continuing credit growth across the sector and low levels of loan impairments. And economic risks – along with the threat of Chinese hostilities towards Taiwan in the neighbouring South China Sea and potential fallout from the Chinese property slowdown – are reflected in the wider-than-usual discounts at which the three trusts trade at.  

All three trusts are attractive routes into an exciting growth economy, and of the three VinaCapital’s Vietnam Opportunity Fund is currently trading at the widest discount, a reflection of its higher allocation to private and unlisted equity and underperformance versus peers over the last year. But it’s also the cheapest in terms of charges and is the only one to pay a dividend.

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