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Global Research 20 April 2015

Vietnam Potentially one of the most exciting markets in Asia

Young, competitive, industrialising and tech savvy Vietnam has a large, young population—almost 50% of Vietnamese are under 30. GDP per capita is comparable to India and the Philippines, with a similar potential for rapid growth. Competitive wages are attracting significant new FDI, notably in electronics. Internet penetration of 40% should support growth in 'disruptive' companies, which can boost productivity. The country is investing heavily in infrastructure.

Market cap-to-GDP is the lowest in Asia, at only 30% Unsustainable credit growth before 2012 led to runaway inflation. Internal capital flight exacerbated the problems and strained the currency and foreign reserves. The central bank was forced to raise rates, leading to a property crash and rising NPLs. However, we believe this is fully discounted in share prices. Over the past five years, Vietnam has been the worst-performing market in Asia. It is trading at a large discount to other markets in Southeast Asia against both income and asset values.

Why now and what are the risks? Macroeconomic stability was restored in 2012 and interest rates have fallen proportionately. Foreign reserves are at an all-time high, and in July 2014 Moody's upgraded Vietnam to B1. While restructuring of the banking sector and state-owned enterprises remains a work-in-progress, banks are lending again and Q115 GDP growth was above expectations at 6.0%. Furthermore, important new legislation taking effect in 2015 regarding foreign ownership of property, bankruptcy and enterprises should help restructuring and support growth. Risks include rising public debt, a repeat of high inflation and a political transition in the next 12 months.

Potential catalysts: changes to foreign ownership and MSCI "emerging" status The biggest deterrent for foreign investors is not value, but supply, in our view. There are almost 700 listed companies in Vietnam, but 90% have a market capitalisation below US$100m. Of the remaining 10%, we estimate the total available room to be only US$3.2bn, concentrated in a small number of financials. If the authorities were to launch a structure similar to Thailand's Non-Voting Depository Receipts, it could significantly increase demand for Vietnamese equities. Secondly, Vietnam is the only Southeast Asian market MSCI classifies as a "frontier" market. In cases where MSCI has announced it is considering upgrading a market to "emerging" status (eg, the UAE) there has been a sharp rally in share prices. In this report, beyond highlighting the largest locally-listed companies, we identify several overseas-listed companies with exposure to Vietnam. These include Amata, CP Foods, Dongbu Insurance, Samsung Electronics, Sembcorp Industries, Semen Indonesia, Siam Cement and Yue Yuen.

Equity Strategy

Asia

Ian Gisbourne Analyst

[email protected] +662-613 5758

Vietnam 20 April 2015

2

Contents

Executive summary .......................................................................... 3

Key highlights for investors ............................................................ 7

Vietnam has many of the building blocks for rapid growth ...... 19

And yet, Vietnam has been the biggest laggard over the past five years. Why? ............................................................................. 25

What has changed? ........................................................................ 29

Looking forward, what should we expect and where are the risks? ............................................................................................... 38

Ian Gisbourne Analyst

[email protected] +662-613 5758


3

Executive summary Vietnam has many of the building blocks for rapid growth

A large, young population.

At a similar stage to India and the Philippines in terms of GDP per capita.

An emerging consumer class: penetration of household goods, while rising sharply, is still only equivalent to Thailand's approximately 20 years ago.

Tech savvy—the highest Internet penetration among ASEAN members excluding Singapore and Malaysia.

Industrialising. This should lead to cluster benefits over time.

Competitive. Wages are half those in China and Thailand, for example.

Figure 1: Population by age, 2015F ('000 people) Figure 2: Internet penetration, 2014

Source: United Nations Population Division Source: Internet World Stats, UBS

Figure 3: Car penetration versus Thailand, 1990-2010 Figure 4: Inward FDI 1994-2013 (US$ bn)

Source: The Vietnamese Household Living Standards Survey 2012, The General Statistics Office of Vietnam, Thai National Statistics Office, UBS

Source: The General Statistics Office of Vietnam

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And yet, Vietnam has been the biggest laggard in Asia over the past five years. Why?

Unsustainable credit growth. The ratio of credit-to-GDP rose from 35% to 125% from 2000 to 2010.

Inflation has twice exceeded 20% over the past 10 years, and there has been excessive investment in non-productive assets, namely real estate.

Internal capital flight exacerbated the problems and put a significant strain on the currency and reserves (which fell to less than two months of imports at one point).

The central bank was forced to hike rates to restore macroeconomic stability…

…at the expense of a property bust and a sharp rise in NPLs.

Figure 5: Index performance over the past five years and versus 10-year highs

Figure 6: Vietnam's credit-to-GDP ratio, 2000-12 (%)

Source: Bloomberg, UBS estimates Source: Haver, UBS estimates

Figure 7: CPI, YoY % change (annual data) Figure 8: Exchange rate and international reserves

Source: Haver, UBS Source: Haver, UBS

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What has changed?

Inflation has declined from 19% at the end of 2011 to less than 1%.

A sharp improvement in the terms of trade. Since 2012, Vietnam has enjoyed a current account surplus for the first time since the early 1990s.

Interest rates have fallen from 15% to 6%.

A recovery in the property sector. In Q115, condominium launches in Ho Chi Minh City and Hanoi were up 160% and 80%, respectively.

Banking sector restructuring and a 'clean up' of NPLs has commenced. The approach offers only a partial solution but has got banks lending again. In 2014, credit growth for the system was 13%.

Reform of SOEs. Progress has been mixed, but is being mitigated by strong inward FDI and high levels of entrepreneurship in the private sector.

Investment in infrastructure has provided a counter-cyclical boost to growth.

Figure 9: CPI: 2010 to February 2015 Figure 10: Exports and current account, 2005-14

Source: Haver, General Statistics Office of Vietnam, UBS Source: Haver, UBS

Figure 11: Sovereign bond yields 2006-15 Figure 12: Ho Chi Minh City condominium launches and sales

Source: Bloomberg Source: CBRE Vietnam

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Looking ahead, what to expect and where are the risks?

Landmark trade initiatives. A study has identified Vietnam as potentially the largest beneficiary of the Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership (RCEP), which are being negotiated.

On-going restructuring of SOEs and the banking sector.

Important new legislation to take effect in the areas of property ownership, bankruptcy and enterprises.

Supportive fiscal stance, but concern over rising public debt.

Beyond wages, improving overall competitiveness remains a work-in-progress.

Economically stable, but inflation fears remain given Vietnam's recent history.

Politically stable, but senior political figures expected to retire in Q116.

Figure 13: Estimated boost to Vietnamese exports, 2025F (US$ bn)

Figure 14: Estimated boost to GDP from the Trans-Pacific Partnership (as a % of baseline GDP)

Source: Peter A. Petri, Michael G. Plummer and Fan Zhai, "The Trans Pacific Partnership and Asia-Pacific integration: A quantitative Assessment"

Source: Peter A. Petri, Michael G. Plummer and Fan Zhai, "The Trans Pacific Partnership and Asia-Pacific integration: A quantitative Assessment"

Figure 15: General government debt (as % of GDP) Figure 16: World Economic Forum's global competitiveness Index 2014-15, ASEAN rankings

Source: IMF World Database, IMF Chapter IV Report on Vietnam, October 2014 Source: World Economic Forum's global competitiveness Index 2014-15

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Key highlights for investors We compared Vietnamese equities relative to: 1) the country's total annual

income, 2) peers in the rest of Asia (especially in the ASEAN region), and 3) their own history.

As a percentage of GDP, the total market cap of Vietnamese equities is currently 30%. By comparison, Thailand and the Philippines are trading at 116% and 95% of their GDP, respectively. The forward PE ratio for Vietnam is the second lowest in Asia, behind only Korea.

By number, more than half of all listed stocks are industrials and materials companies. However, in terms of market capitalisation, financials and real estate companies represent in excess of 40% of the VN-Index.

There are almost 700 listed companies, but many are extremely small. More than 90% of listed companies have a capitalisation below US$100m.

Sixty-two Vietnamese companies are covered by at least one securities company, according to Bloomberg. Of these, 13 are covered by 10 or more companies. The difference between current share prices and consensus price objectives varies from -10% to +53%, resulting in an average upside of 19%.

The biggest deterrent to buying Vietnamese equities is supply, not price, in our view. The foreign ownership limit on Vietnamese companies is 49%, and for many popular companies the limit is already full. The absence of a foreign board where companies can trade at a premium to the local shares makes finding stock difficult.

Beyond the foreign ownership limit, a number of companies have small free floats. In the case of PV Gas, the largest publicly-traded company in Vietnam by capitalisation, the free float is only 3%. We estimate the effective value of shares available for foreign investors among those companies with a market cap greater than US$100m at only US3.2bn. And much of this is in financials.

A proposal by the stock exchanges to raise the foreign limit to 60% was blocked in early 2014; we understand by the government. However, a number of investors and securities companies we spoke with believe it is possible Vietnam could adopt a structure similar to Thailand's Non-Voting Depository Receipts. If it were to do so, it could unlock potentially significant additional foreign demand, and lead to a re-rating of Vietnamese equities. However, there is no indication of when, or if, Vietnam will adopt such a structure.

Vietnam is currently classified as a "frontier" market for the purposes of MSCI investment indices. The amount of money tied to Frontier Indices is very small compared to emerging markets. Previously, where countries have been upgraded from frontier to emerging status, we have seen a significant increase in demand for equities, and share prices have risen sharply. However, the increase has tended to precede the actual upgrade. In the case of the UAE, between the announcement that the MSCI classification was under review and the actual upgrade (approximately 11 months) the market rose more than 100%.


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Other ways to gain exposure to Vietnam include acquiring shares in an existing closed-end fund. The five largest close-end funds have AUM of about US$2bn. Many share similar holdings and they tend to be very concentrated, with the top 10 holdings representing an average of 63% of AUM.

Over the next several years, the number of companies from elsewhere in the region deriving a meaningful proportion of earnings and/or growth from Vietnam seems likely to increase. The list of companies with an existing exposure (albeit still relatively modest) includes: Amata, Berli Jucker, the Central Group of companies, CP Group, Dongbu Insurance, Hyundai Mipo Dockyard, Samsung, Sembcorp Industries, Semen Indonesia, Siam Cement and Yue Yuen.

Market capitalisation-to-GDP of only 30%…

Vietnam has two stock exchanges, one in Ho Chi Minh City (established in 2000) and one in Hanoi (established in 2005). Together, they have almost 700 listed companies. By number this is comparable to Thailand; by value it could not be more different. The total market capitalisation of publicly-traded companies in Vietnam is US$57bn compared to US$443bn in Thailand. As a percentage of GDP, market capitalisation in Vietnam is 30%, in Thailand it is 116%.

Figure 17: Asian indices market capitalisation as a % of GDP

Source: Bloomberg, IMF, UBS

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Market capitalisation-to-GDP of only 30%; the lowest in Asia


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…second-lowest forward PE ratio in Asia…

Of the two indices, the Ho Chi Minh City Stock Exchange has more listings and is the more liquid. The VN-Index is on a forward PE of 12.4x, based on current consensus estimates. This is the second lowest in Asia, after Korea.

Figure 18: Asian indices' forward PE ratios

Source: Bloomberg

… a discount to historic trading range

Vietnamese equities are also trading at a significant discount to their historic trading range. At the peak of the euphoria surrounding Vietnam, in 2007, the VN-Index was priced as high as 45x earnings.

Figure 19: VN-Index PE 2005-15

Source: Bloomberg

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The peak PE was 45x, in 2007


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We compared the performance of Vietnamese equities to Indonesia and Thailand following the Asian financial crisis. You see a similar de-rating in the 12-18 months following the crash, but in the case of Vietnam, we have so far failed to see the sharp 'lift off' seen in other Asian markets approximately five years after the event. We attribute this in part to the structure of the market (specifically, the lack of foreign liquidity) and the failure to aggressively tackle NPLs in the banking sector. Conversely, however, it does illustrate the potential gains if either or both of those issues were to be resolved.

Figure 20: Comparing Vietnam 2007-15 with the experience of Indonesia and Thailand after the Asian financial crisis 1997-2005

Source: Bloomberg, UBS

If we fast forward another 10 years, the post-crisis gains in Thailand, and particularly in Indonesia, have been significant.

Figure 21: Comparing Vietnam 2007-15 with the experience of Indonesia and Thailand after the Asian financial crisis 1997-2015


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...no 'lift off after approx 5 years. We attribute this to mkt liquidity contraints and failure to resolve NPLs

Similar reaction to the Asian financial crisis, but...

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Composition of indices

The greatest weightings by value are: financials (ex-real estate) 32%; consumer staples 18%; utilities 13% and real estate 10%. By simple number of companies, it is industrials and materials.

Figure 22: Composition of the Vietnamese exchanges by value and simple number of publicly-traded companies


Of the almost 700 companies listed on the Ho Chi Minh City and Hanoi stock exchanges, more than 600, or 90%, have a market capitalisation below US$100m. Conversely, only nine have a market value in excess of US$1,000m. There are similarities with Thailand in 2001, following the Asian financial crisis. Since its low, the SET Index has risen seven-fold.

Figure 23: Market cap distribution, by number of companies


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By capitalisation, financials and real estate companies represent more than 40% of the VN-Index

Almost 700 listed companies, but 90% have a market cap below US$100m


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In all, 46% of publicly traded companies in Vietnam are currently trading on trailing PE multiples of below 10x, and 58% are below 1.0x book value. Balance sheets in most cases appear relatively healthy (as far as one can tell from a simple screen of net gearing), but profitability is relatively low. The latter is particularly true of many financials (broadly defined to include both banks and real estate).

Figure 24: PE dispersion (number of companies) Figure 25: P/BV dispersion (number of companies)

Source: Bloomberg, UBS Source: Bloomberg, UBS

Figure 26: ROE dispersion (number of companies) Figure 27: Net debt/equity dispersion (number of companies)

Source: Bloomberg, UBS Source: Bloomberg, UBS

Consensus trading data for Vietnamese companies

Of the almost 700 listed companies in Vietnam, 62 are followed by at least one local securities company according to Bloomberg. Of these, 13 are covered by 10 or more securities companies. We show the results for the largest of these below. The difference between current share prices and consensus price objectives varies from -10% to +53%, resulting in an average estimated upside of 19%.

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Financial health; Net debt:equity, by number of companies

46% of Vietnamese companies on a trailing PE of below 10x; 58% have a P/BV below 1x

62 Vietnamese companies are covered by at least one broker and 13 companies are covered by 10 or more


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The median forward PE for the 62 companies is 9.4x. The dispersion of earnings estimates for the companies is very wide. The company forecast to grow the fastest in 2015 is a contractor at 300%. Conversely, a number of companies are forecast to report a contraction in earnings this year. The median P/BV for the same group of companies is 1.5x against a median actual return on equity of 16.9%. The dividend yield is 4.0%.

Figure 28: Consensus estimates for Vietnam's largest publicly-traded companies

Price Mkt cap PE fwd EPS gwth P/BV ROE Div yld Gearing

Company Industry (VND) (US$ m) (x) (%) (x) (%) (%) (%)

PV Gas Utilities 67,500 5,920 12.3 (23) 3.6 40.7 8.1 (48)

Vietnam Dairy Packaged Foods 108,000 5,001 14.9 20 5.5 32.6 3.4 (37)

Vietcombank Financials 37,300 4,602 24.0 (17) 2.3 10.7 2.8 (157)

Vingroup Real Estate 48,100 3,239 21.0 (7) 3.2 18.1 3.0 72

Vietinbank Financials 18,400 3,172 13.2 na 1.2 10.5 5.4 101

Masan Group Packaged Foods 79,500 2,708 27.4 (883) 3.9 7.3 na 65

BIDV Financials 19,600 2,551 13.7 (19) 1.7 15.2 4.3 248

Hoa Phat Grp Steel 44,900 1,016 8.9 (23) 1.8 29.5 2.9 35

Sacombank Financials 18,400 973 10.3 (8) 1.3 12.6 na (40)

FPT Corp Technology Distributors 48,800 777 9.3 11 2.1 21.6 na 12

HAGL Multi-Sector Holdings 20,700 757 8.3 34 1.1 10.9 na 111

PV Drilling Oil & gas 53,500 751 6.7 (1) 1.4 22.7 na 9

Military Bank Financials 13,700 735 6.4 na 1.0 15.6 5.1 (128)

EXIM Bank Financials 12,800 729 24.9 na 1.1 0.4 3.1 (2)

Asia Comm Bank Financials 16,500 685 14.6 8 1.2 7.6 4.2 (8)

Mobile World Retail 107,000 554 12.9 32 8.1 58.7 na 27

PV Fertilizer Chemicals 30,800 542 7.4 16 1.3 12.1 na (56)

PV Tech Services Oil & gas 25,500 527 7.3 (12) 1.2 20.6 4.7 (52)

Kinh Do Corp Packaged Foods 45,000 490 21.4 (10) 1.8 9.7 3.7 (42)

Saigon Securities Financials 21,200 419 14.7 (18) 1.6 13.6 3.9 (8)

Kinh Bac City Dev Real Estate 16,700 363 13.7 34 1.2 6.9 na 62

DHG Pharma Pharmaceuticals 85,500 345 10.7 32 3.3 25.0 1.8 (25)

REE Conglomerates 26,300 328 6.7 (3) 1.2 19.1 na (9)

Hatien 1 Cement Construction Materials 21,000 309 11.7 na 1.8 8.8 na 187

Danang Rubber Tires & Rubber 61,000 235 12.0 20 3.3 24.2 3.3 69

Ho Chi Minh City Financials 31,700 187 10.0 na 1.7 16.3 na (64)

Hung Vuong Corp Packaged Foods 20,400 179 7.9 na 1.4 12.4 7.4 148

Phu Nhuan Jewelr Apparel, Accessories 49,500 173 11.7 32 2.9 18.5 4.4 77

Vinh Hoan Corp Packaged Foods 39,000 167 7.8 11 1.9 26.3 2.6 64

Hoa Sen Group Steel 37,300 166 7.8 na 1.4 17.9 4.0 233

Binh Minh Plastics Building Products 78,000 164 7.6 24 2.1 23.5 2.6 (38)

Becamex Infrastr Construction & Engineering 12,000 152 17.0 (16) 1.1 7.6 5.0 61

Gemadept Corp Marine Ports & Services 27,800 149 13.5 (56) 0.7 11.3 4.3 7

Coteccons Jsc Construction & Engineering 75,500 147 8.4 16 1.3 13.6 1.3 (41)

Khang Dien House Real Estate 23,800 139 12.2 na 1.2 8.3 na 56

Vinh Son - Song Renewable Electricity 13,500 129 11.6 (36) 0.9 12.9 11.1 5

Southern Rubber Tires & Rubber 40,400 126 8.2 0 2.0 25.6 5.7 106

Nam Long Investm Real Estate 20,000 124 15.1 58 1.3 5.9 1.5 11

Jap Viet Med Ins Healthcare 21,600 113 7.8 48 0.9 14.9 na 3

Petrolimex Petro Commodity Chemicals 34,000 111 7.8 63 2.2 23.9 12.0 24

Vietnam Sun Corp Trucking 38,500 101 7.4 na 1.7 25.6 4.6 34

Hoang Huy Invest Construction Machinery 19,500 100 5.8 48 1.6 21.8 4.7 (128)

Above data as of 16 April 2015. Source: Bloomberg


14

Foreign limits and low free floats in some cases limit supply of stock

In addition to the relatively small size of most companies, there are two other impediments to investing in Vietnam as a foreign investor. The first is low free float; in a small number of cases it is below 5%. Secondly, a limit on foreign ownership of Vietnamese shares of not more than 49%. Together, we estimate the effective value of shares available for foreign investors among all those companies with a market cap greater than US$100m totals only US$3.2bn. Of this, more than three quarters is in financials. Most large consumer companies have no foreign room available.

Figure 29: Available foreign room for Vietnam's largest publicly-listed companies

Effective

Price Mkt cap Free float Fgn limit Fgn own. Fgn. room

Company Sector (VND) (US$m) (%) (%) (%) (%)

PV Gas Utilities 67,500 5,920 3.2 49.0 2.2 1.0 Vietnam Dairy Packaged Foods 108,000 5,001 49.9 49.0 49.0 0.0 Vietcombank Financials 37,300 4,602 22.9 49.0 20.8 2.1 Vingroup Real Estate 48,100 3,239 49.8 49.0 15.7 33.3 Vietinbank Financials 18,400 3,172 35.5 49.0 29.3 6.2 Masan Group Packaged Foods 79,500 2,708 34.9 49.0 34.7 0.2 BIDV Financials 19,600 2,551 4.2 49.0 1.4 2.8 Hoa Phat Grp Steel 44,900 1,016 45.8 49.0 41.1 4.7 Sacombank Financials 18,400 973 90.4 49.0 5.5 43.5 FPT Corp Technology Distributors 48,800 777 67.2 49.0 49.0 0.0 HAGL Multi-Sector Holdings 20,700 757 54.8 49.0 25.8 23.2 PV Drilling Oil & gas 53,500 751 49.4 49.0 36.4 12.6 Military Bank Financials 13,700 735 64.9 49.0 10.0 39.0 EXIM Bank Financials 12,800 729 75.1 49.0 25.6 23.4 Asia Comm Bank Financials 16,500 685 93.1 30.0 30.0 0.0 Mobile World Retail 107,000 554 47.7 49.0 49.0 0.0 PV Fertilizer Chemicals 30,800 542 33.4 49.0 24.3 9.1 PV Tech Services Oil & gas 25,500 527 48.4 49.0 23.9 24.5 Kinh Do Corp Packaged Foods 45,000 490 37.6 49.0 28.9 8.7 Saigon Securities Financials 21,200 419 70.3 49.0 35.2 13.8 Kinh Bac City Dev Real Estate 16,700 363 63.3 49.0 28.6 20.4 DHG Pharma Pharmaceuticals 85,500 345 48.4 49.0 49.0 0.0 REE Conglomerates 26,300 328 58.6 49.0 49.0 0.0 Hatien 1 Cement Construction Materials 21,000 309 99.8 49.0 8.1 40.9 Danang Rubber Tires & Rubber 61,000 235 35.2 49.0 38.4 0.0 Ho Chi Minh City Financials 31,700 187 38.0 49.0 49.0 0.0 Hung Vuong Corp Packaged Foods 20,400 179 65.5 49.0 16.0 33.0 Phu Nhuan Jewelr Apparel, Accessories 49,500 173 69.0 49.0 48.7 0.3 Vinh Hoan Corp Packaged Foods 39,000 167 44.2 49.0 26.4 17.7 Hoa Sen Group Steel 37,300 166 32.3 49.0 41.9 0.0 Binh Minh Plastics Building Products 78,000 164 47.0 49.0 49.0 0.0 Becamex Infrastr Construction & Engineering 12,000 152 21.2 49.0 12.7 8.5 Gemadept Corp Marine Ports & Services 27,800 149 84.8 49.0 32.8 16.2 Coteccons Jsc Construction & Engineering 75,500 147 59.9 49.0 49.0 0.0 Khang Dien House Real Estate 23,800 139 45.0 49.0 49.0 0.0 Vinh Son - Song Renewable Electricity 13,500 129 34.3 49.0 26.5 7.9 Southern Rubber Tires & Rubber 40,400 126 35.7 49.0 19.2 16.6 Nam Long Investm Real Estate 20,000 124 47.6 49.0 45.8 1.8 Jap Viet Med Ins Healthcare 21,600 113 67.9 49.0 49.0 0.0 Petrolimex Petro Commodity Chemicals 34,000 111 19.8 52.9 3.7 16.1 Vietnam Sun Corp Trucking 38,500 101 33.4 49.0 49.0 0.0 Hoang Huy Invest Construction Machinery 19,500 100 68.2 49.0 7.3 41.7 Note: For the purposes of calculating the available foreign room, we have deducted the current foreign holding from the lower of: 1) the foreign limit; and 2) the free float. Where foreign holders are classified as strategic investors this would understate the actual available room. Above data as of 16 April 2015. Source: Bloomberg, UBS estimates

The biggest deterrent to buying Vietnamese companies is supply, not value, in our opinion


15

In the table above, we calculate available foreign room by deducting the current foreign holding from the lower of: 1) the foreign limit; and 2) the free float. Where foreign holders are classified as strategic investors this would understate the actual available room. However, we believe the difference is not material enough to affect the key takeaway that stock available for foreign investors is limited.

If a foreign investor wished to buy shares in a company where the foreign limit is already full, what can they do? The broker in Vietnam would approach an existing foreign holder to negotiate a block purchase. The premium obviously varies based on demand, but from speaking with VinaCapital, a local securities company, these blocks are more often priced at the upper trading limit for that day (that is at a 7% premium to the previous day's close). These transactions are put through the exchange.

It is possible to acquire stock from an existing holder at a premium greater than 7% to the prevailing market price. However, because Vietnam does not have a 'foreign board' these purchases must be negotiated 'off exchange' between the two parties. They would both enter into a sale-and-purchase agreement and then must seek permission from the State Securities Commission of Vietnam. Again, from conversations with VinaCapital, this can take two to four weeks to conclude.

Twelve months ago, the authorities guided that the foreign limit would be raised to 60%. At the time, this was a powerful catalyst for equities; the expectation being that it would attract greater foreign liquidity and cause share prices to rise. Foreign limits were not raised, and people we spoke with on the ground were not hopeful this would change anytime soon.

However, it is possible the Vietnamese authorities could utilise a structure similar to Thailand's NVDRs. This would allow the legal ownership of the shares to remain in local hands while the beneficial ownership is held by foreign investors. There is no visibility on when, or even if, a similar structure would be introduced. However, it is believed to be a possibility.

Vietnam's "frontier" status

Vietnam is currently classified as a "frontier" market for the purposes of MSCI investment indices. The amount of money tied to Frontier Indices is very small compared to emerging markets. Previously, where countries have been upgraded from frontier to emerging status, we have seen a significant increase in demand for equities, and share prices have risen sharply. However, the increase has tended to precede the actual upgrade. In the case of the UAE, between the announcement that the MSCI classification was under review and the actual upgrade (approximately 11 months) the market rose more than 100%.

Vietnam closed-end funds

The largest Vietnam closed-end funds, by AUM, are managed by VinaCapital, Dragon Capital and Deutsche AM. Combined, the five funds set out in the table below have total assets under management of just under US$2bn. Three of the funds are equity only; two are multi asset. Based on latest prices, the average discount to NAV is 19%. The oldest fund was established in 1995 by Dragon Capital. The others were launched between 2003 and 2006. No significant closed-end fund has been established since, ie in the past nine years, to the best of our knowledge.

Foreign investors can acquire stock from existing foreign holders but can be time consuming if sellers demand a premium above 7% to the previous days close

Foreign limits unlikely to be raised anytime soon; however, some observers think a structure similar to non-voting depository receipts could be a possibility

The five largest close-end funds have AUM of circa US$2bn; many share similar holdings, and they tend to be highly concentrated


16

Several funds have recently been 'opened up'. This includes one fund managed by PXP Vietnam. Because of the still relatively significant discounts to AUM it is possible that other closed-end funds will follow suit.

Figure 30: Closed-end funds in Vietnam

Inception Pricing AUM Price NAV Prem/(Disc)

Ticker Manager Type Date date (US$) (US$) (unit) (%)

VinaCapital Vietnam Opportunity Fund VOF LN VinaCapital Multi Asset 30-Sep-03 27-Feb-15 743 2.46 3.25 -24%

Vietnam Enterprise Inv. VIETENI KY Dragon Capital Equity only 21-Aug-95 7-Apr-15 495 2.78 3.34 -17%

DWS Vietnam Fund DWSVIET KY Deutsche AM Multi Asset 8-Dec-06 27-Feb-15 348 na 0.72 na

Vietnam Growth Fund VIETNGF KY Dragon Capital Equity only 15-Sep-04 7-Apr-15 266 18.10 21.45 -16%

Vietnam Holding VNH LN Vietnam Holding Equity only 14-Jun-06 3-Apr-15 133 1.71 2.00 -14%

Average

-18%

Source: Bloomberg

The most recent reported holdings for the funds are set out below. Perhaps not surprising given our comments above about the limited number of large listed companies in Vietnam, many of the funds share similar holdings and are very concentrated.

For all five funds, Vinamilk and Hao Phat Group are among the 10 largest holdings. PV Drilling features in four funds and DHG Pharma and FPOT Corp both feature in the top 10 for three of the funds.

Across the funds, the average weighting in the top five holdings is 42% and for the top 10 it is 63%.

The mixed-asset funds also own shares in other closed-end funds. DWS has invested 11% of its AUM in funds managed by Dragon Capital and another 7% in its own funds. We understand that DWS has also allocated some money to be managed by PXP Vietnam.

Figure 31: Largest reported holdings of Vietnam closed-end funds

VOF LN

VIETENI KY

DWSVIET KY

VIETNGF KY

VNH LN

(31 January 2015) (%) (16 March 2015) (%) (27 Feb. 2015) (%) (26 March 2015) (%) (31 Dec. 2014) (%)

Vinamilk 10.7 Vinamilk 15.9 Greenfeed 15.2 Vinamilk 17.8 Hoa Phat Group 8.8

Sofitel Metropole Hotel 9.0 Asia Comm Bank 9.1 Vinamilk 8.6 Masan Group 10.6 DHG Pharma 8.3

Hoa Phat Group 7.8 Hoa Phat Group 8.9 DWS Vietnam Fund 6.7 Hoa Phat Group 6.8 Traphaco 7.0

EXIM Bank 5.4 Masan Group 8.1 Vietnam Enterprise Inv. 5.9 FPT Corp 6.2 Binh Minh Plastics 6.4

Intl Dairy Product 4.8 Saigon Securities 6.2 Hoa Phat Group 5.7 HCM City Infra. 5.4 Thien Long Group 6.0

Khang Dien House 3.9 FPT Corp 6.0 Vietnam Growth Fund 4.9 VinGroup 4.2 PV Drilling 5.6

DHG Pharma 3.7 REE 5.7 Corbyns Intl 4.4 REE 3.9 Vietnam Container 5.5

PV Services 3.6 Khang Dien House 4.0 FPT Corp 4.0 Southern Rubber 3.8 Vinamilk 5.4

PV Drilling 3.4 Khun Bac City Dev 3.7 PV Drilling 3.6 PV Drilling 3.7 Danang Rubber 5.3

NYSE Century 3.3 DHG Pharma 3.2 PV Gas 3.0 Jpn Vietnam Medical 3.6 Phun Nhuan Jewelry 4.7

Top 5 37.7 Top 5 48.1 Top 5 42.0 Top 5 46.8 Top 5 36.6

Top 10 55.6 Top 10 70.6 Top 10 61.9 Top 10 66.1 Top 10 63.0

Source: Bloomberg


17

Overseas-listed companies generating revenue in Vietnam

Around the region, a number of companies have exposure to Vietnam. In most cases it is relatively small at the moment, but is growing.

Vietnam has become an increasing focus of attention for Thai companies:

Amata currently operates one industrial estate in Vietnam and is developing two more. In 2014, Vietnam represented 11% of its land sales by area and 7% of total revenue. This should increase further as the new estates come on line. Amata is considering spinning-off all three developments into a separate listed vehicle.

Bangkok Bank has a full banking licence in Vietnam. Lending to local SMEs is approximately 20% of BBL's total Vietnamese loan book.

Berli Jucker has manufacturing and distribution businesses in Vietnam. In 2014, it provisionally agreed to spend €655m to acquire 19 wholesale stores in Vietnam from Germany's Metro Group. The deal ultimately did not happen, partly due to concerns about valuation, but it was a significant statement of intent.

CP Foods has a long-standing presence in Vietnam. In 2014, it represented approximately 12% of total revenue.

PTTEP has investments in oil and gas exploration offshore of Vietnam.

Robinsons has opened two department stores in Vietnam in the past 12 months, one in Hanoi and one in Ho Chi Minh City. Robinson's parent, the Central Group, also recently acquired 49% of electronics retailer Nguyen Kim.

Siam Cement's Vietnamese investments already include cement, building materials, chemicals and paper businesses. Investment in a new US$3bn petrochemical cracker is under consideration. Currently 6% of Siam Cement group revenue is derived from Vietnam (including exports from Thailand).

A number of Korean companies have significant manufacturing operations in Vietnam, but as a percentage of revenue it is still relatively small. Samsung is one of the largest foreign investors in Vietnam; by the end of 2015 approximately half of all Samsung phones will be manufactured in Vietnam. LG Electronics has also recently announced plans to relocate TV production from Thailand to Vietnam. Beyond these companies:

The Korean E&C company most exposed to Vietnam is GS E&C with 3.9% of its backlog from Vietnam. It is followed by Daelim (3.0%), Daewoo E&C (1.0%), Samsung Engineering (SECL) (0.6%), Samsung C&T (0.4%) and Hyundai Engineering & Construction (HDEC) (0.3%).

Hyundai Mipo Dockyards owns 55% of Hyundai Vinashin Shipyard. It is fully consolidated and comprises about 10% of revenue and 17% of its net loss in 2014 (not adjusted for consolidation).

POSCO's Vietnam exposure was 1.2% of its revenue in 2014 with very little contribution on a net profit basis (actually a Won2bn loss). But that exposure should increase to 1.5% of revenue in 2015 given completion of its 1mt EAF in 2015. Profit contribution will likely still be small, however.

Overseas companies with interests in Vietnam include: Amata, Berli Jucker, the Central Group of companies, CP Group, Dongbu Insurance, Hyundai Mipo Dockyard, Samsung, Sembcorp Industries, Semen Indonesia, Siam Cement and Yue Yuen


18

Orion and Lotte Shopping have some exposure to Vietnam. For Orion, Vietnam sales accounted for about 5.4% of total sales in 2014.

All Korean listed banks have a branch in Vietnam. However, they target large Korean corporates and SMEs with production facilities in Vietnam. Shinhan Vietnam Bank is the largest with US$1.9bn of assets (slightly over 0.5% of consolidated assets).

In January 2015, Dongbu Insurance acquired a 37% stake in the fifth largest P&C insurance company in Vietnam—Post & Telecommunication Insurance—and became the largest shareholder. The acquisition price was around Won50bn.

From Singapore, Sembcorp Industries currently operates five projects in Vietnam under Vietnam Singapore Industrial Park (VSIP). They total 6,000 hectares of gross land area, with industrial saleable land of 2,357 ha and residential saleable land of 1,409 ha. Keppel Corp, CapitaLand and Mapletree Logistics Trust also have interests in Vietnam, but they are small relative to total group revenue.

From Malaysia, Gamuda, IJM and SP Setia have property interests in Vietnam. SapuraKencana is in process of buying some upstream oil and gas assets in Vietnam. Public Bank is moving to 100% ownership (from 50%) of VID Bank in Vietnam (currently seven branches).

From Indonesia, the biggest exposure is Semen Indonesia, which owns Thanglong Vietnam Cement. This represents 2.3m tonnes out of the group's total installed capacity of 30m tonnes.

From Hong Kong, Yue Yuen Industrial Holdings, a manufacturer of footwear for Nike and Adidas among others, has approximately one third of its capacity in Vietnam.


19

Vietnam has many of the building blocks for rapid growth A large, young population

Vietnam is the fourteenth most populous country in the world, with a population of 93m (by comparison, Germany has a population of 81 m). It is also an extremely young population, with 49% currently aged under 30. As the country's demographic profile changes, and a greater proportion of Vietnamese enter peak earning and spending years (typically 35-54) it should provide a boost to growth.

Figure 32: Vietnam population by age, 2015F ('000 people)

Source: United Nations Population Division

GDP per capita comparable to India and the Philippines

GDP per capita in purchasing power terms is currently 5,621 international dollars, according to the IMF World Database. This is similar to India and the Philippines. Compared to other emerging countries in Southeast Asia, it is 39% of the level in Thailand and 55% of that in Indonesia, for example.

Figure 33: GDP per capita in purchasing power terms, 2014E

Source: International Monetary Fund, World Economic Outlook Database, October 2014

0 2,000 4,000 6,000 8,000

0-45-9

10-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-7980-8485-89

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Almost half of the population is currently under 30 years of age

Incomes coming from a comparatively low base


20

An emerging consumer class

Disposable incomes are at the point where we should witness rapid growth in the penetration of key consumer goods. Today, motorbikes fill the streets of Ho Chi Minh City, but car ownership remains very low. According to the latest official data, The Vietnamese Household Living Standards Survey 2012, 80% of Vietnamese households possess a motorbike but less than 2% own a car. The proportion of households that possess a refrigerator has risen almost fourfold since 2002, but this still leaves another 50% who do not own a refrigerator. Less than a quarter of households have a washing machine and less than 10% have air conditioning.

Figure 34: Motorbike and car ownership (% of households)

Figure 35: Refrigerator ownership (% of households)

Source: The Vietnamese Household Living Standards Survey 2012, The General Statistics Office of Vietnam, UBS


Figure 36: Washing machine ownership (% of households)

Figure 37: Air conditioner ownership (% of households)



0.1 0.1 0.1 0.4 1.2 1.7

32.3

44.2

52.7

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80.0

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Expecting rapid growth in penetration of consumer goods such as cars, refrigerators and air conditioners


21

Penetration of consumer goods is similar to Thailand between 1990 and 2000

To gauge the potential demand for consumer items we compared current household penetration for the four items with the experience in Thailand. From the Thailand Population and Housing Census, conducted every 10 years, we have data for Thailand from 1990, 2000 and 2010.

In the case of penetration of refrigerators, washing machines and air conditioners, Vietnam is at levels of penetration similar to Thailand between 1990 and 2000. In the case of motor vehicle penetration, Vietnam is not yet at the 1990 level in Thailand.

Figure 38: Motor vehicle penetration in Thailand 1990-2010, versus Vietnam in 2012

Figure 39: Refrigerator penetration in Thailand 1990-2010, versus Vietnam in 2012

Source: The Vietnamese Household Living Standards Survey 2012, The General Statistics Office of Vietnam, The Thai Population And Housing Census, National Statistical Office, Office Of The Prime Minister, UBS estimates


Figure 40: Washing machine penetration in Thailand 1990-2010, versus Vietnam in 2012

Figure 41: Air conditioner penetration in Thailand 1990-2010, versus Vietnam in 2012



10.6

24.7

36.4

1.7

0

5

10

15

20

25

30

35

40

1990 2000 2010 Vietnam 2012

Motor vehicle penetration in Thailand

1990 2000 2010 Vietnam 2012

33.2

72.4

84.5

49.0

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Refrigerator penetration in Thailand

1990 2000 2010 Vietnam 2012

5.6

27.8

57.4

22.5

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1990 2000 2010 Vietnam 2012

Washing machine penetration in Thailand

1990 2000 2010 Vietnam 2012

3.4

10.3

19.8

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0

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20

25

1990 2000 2010 Vietnam 2012

Air conditioning penetration in Thailand

1990 2000 2010 Vietnam 2012


22

Tech savvy

Despite low levels of computer ownership, Internet penetration in Vietnam is extremely high. It ranks ahead of Indonesia, the Philippines and Thailand, for example. Based on data as of June 2014, Vietnam had 41m Internet users, representing 44% penetration.

Figure 42: Internet penetration, June 2014

Source: Internet World Stats; UBS

Electricity consumption reflects rising industrialisation

In terms of development indicators, Vietnam's per capita consumption of electricity is, again, approximately half that of Thailand, but it is significantly more than that for either Indonesia or the Philippines, which have a higher GDP.

We believe this reflects: 1) historically heavily subsidised electricity prices; and 2) significant FDI in manufacturing. Vietnam is industrialising.

Figure 43: Electricity consumption 2012 (Kwh/capita) Figure 44: CO2 emissions 2012 (tonnes CO2/capita)

Source: International Energy Agency Source: International Energy Agency

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Higher levels of Internet penetration than ASEAN peers excluding Singapore and Malaysia

Electricity consumption above levels suggested by current incomes; this is consistent with increasing industrialisation


23

Inward FDI equivalent to 6% of GDP

Inward, implemented FDI into Vietnam has been relatively steady at US$11bn per annum. This is equivalent to approximately 6% of GDP. Including supplemental capital to previously licensed projects, the record for FDI approved in a single year is an astonishing US$72bn, in 2008.

Vietnam has been increasingly successful in attracting new investment into electronics and electrical products—50% of all Samsung phones are now manufactured in Vietnam. Samsung now has a total capacity of 240m units, and is investing another US$3bn to increase this to 270m units by the end of 2015.

Figure 45: Inward FDI 1994-2013 (US$ bn)

Source: General Statistics Office of Vietnam

The competitive cost of labour is illustrated by the most recent survey of Japanese affiliated companies by The Japan External Trade Organisation (JETRO). The total annual cost of general manufacturing employees in Vietnam is US$2,989. This compares to US$4,481 in Indonesia and US$7,120 in Thailand. For a Vietnamese engineer, the cost is US$5,800. This compares to US$7,215 and US$12,444 in Indonesia and Thailand, respectively.

Figure 46: Manufacturing worker (US$) Figure 47: Engineer (US$)

Source: Japan External Trade Organisation, UBS Source: Japan External Trade Organisation, UBS

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Inward FDI flows averaging US$11bn pa; Vietnam has been particularly successful in attracting electronics companies

Wages and the price of electricity are extremely competitive


24

Vietnam also has cheap electricity because of government subsidies. However, these are being gradually reduced; a necessity if Vietnam wishes to attract investment crucial to preventing power shortages.

We note that during our recent stay in Ho Chi Minh City we received a typed note from our hotel warning of power outages for a total of five hours on 27 March and two hours on 28 March. The note went on to say that guests should not worry because the hotel was equipped with generators. It all gave the appearance that this was a regular occurrence and supports the argument for significant additional investment in infrastructure.

Figure 48: Electricity rate for general use (per kWh)

Source: Japan External Trade Organisation, UBS

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Cheap electricity boosts demand and reduces the incentive for new supply; this is not sustainable and the government has been gradually increasing the price


25

And yet, Vietnam has been the biggest laggard over the past five years. Why? Over the past five years, Vietnam's stock market has risen only 12%; the lowest for any Asian market

Notwithstanding the positive environment described in the previous section, Vietnam has been a standout laggard. Over the past five years, the stock market has risen only 12%. This is the lowest growth of any Asian market. By comparison, Indonesia, the Philippines and Thailand have doubled over the same period. The Vietnam Stock Index (VN-Index) is still 51% below its 10-year high. (The next worst performer is China at -29%.)

Figure 49: Current index levels vs. 10-year highs, and over the past five years


Figure 50: VN-Index 2005-15


150%

102% 93%

63% 41% 37% 32% 27% 22% 22% 12%

0%

-4% -2% -3% -2%

-29% -9% -3% -1% -7%

-51%

-100%

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Performance 2010-2015

Current level vs 10-year high MAX

0

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A standout laggard over the past five years


26

Where did it go wrong?

In essence, from 2000 to 2010 Vietnam enjoyed a prolonged period of rapid credit growth due to unsterilised FDI inflows, exacerbated by government stimulus in response to the global financial crisis. This led to a sharp rise in inflation and excessive investment in non-productive assets—principally real estate. The country was already running twin deficits (fiscally and in trade with the rest of the world) and this put a significant strain on the currency. This was made worse by internal capital flight. By this we mean Vietnamese choosing to convert their local currency into gold and US dollars. At the time, this was so prevalent that banks were paying interest of 3-4% on gold deposits. In an attempt to reduce inflation and protect the currency, the State Bank of Vietnam (SBV) was forced to raise rates significantly. This successfully cooled the domestic economy but at the expense of a collapse in property prices and a sharp rise in banks' non-performing loans. In conjunction with various scandals this led to deposit runs at even some of the largest banks. By the standard of the previous decade, credit growth collapsed.

A prolonged period of rapid credit growth

Between 2000 and 2010, the YoY percentage change in credit averaged 33%, with the ratio of credit-to-GDP rising from 35% to 125% over the same period.

Figure 51: Credit growth and credit-to-GDP 2000-12

Source: Haver, UBS

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Credit-to-GDP increased from 35% to 125% from 2000 to 2010


27

Inflation and excessive investment in non-productive assets

Between 2002 and 2012, credit growth consistently exceeded growth in nominal GDP, on several occasions by 20 percentage points. During this period, inflation twice spiked to 20% (in 2008 and 2011).

Figure 52: CPI percentage change YoY, 2002-12 (annual data)

Source: Haver, UBS

Internal capital flight exacerbated the problems and put significant strain on the currency and reserves

Between 2000 and 2007, the Vietnamese Dong depreciated approximately 10% versus the US dollar. Over the subsequent four years it fell another 30%, from 16,000 to 21,000 VND/USD. Over the same four years, Vietnam's foreign reserves fell from 4.8 months of imports to 1.6 months.

Figure 53: Vietnamese exchange rate and foreign currency reserves 2000-12

Source: Haver, UBS

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Exchange rate - VND/USD Intl reserves (mths of imports)

Inflation exceeded 20%, in 2008 and 2011

Reserves fell to less than two months of imports, and the currency depreciated 30%


28

The SBV was forced to raise rates…

Nominal short-term interest rates rose from 12.0% to 16.4% between 2009 and 2011.

Figure 54: Nominal short-term interest rates (period end)

Source: IMF, UBS

…at the expense of a collapse in property prices and sharp rise in NPLs

Property prices were vulnerable to a correction even before 2011. At one point, prices in Ho Chi Minh City were more expensive than New York City. As the central bank raised rates and the authorities introduced macro-prudential measures to cool the property market, commercial banks' lending slowed and the property bubble collapsed in spectacular fashion. The aforementioned measures included higher taxes, limiting speculation on unfinished units, requiring that payment instalments from buyers be placed in escrow prior to transfer (and hence could not be used to finance construction) and guidance to banks to reduce property exposure.

While most end purchasers were not highly geared (in 2011, mortgages were rare), property developers were. These included both professional developers and those companies for whom property was not a core business but who had been seduced by the apparent significant profits to be made. Most loans were collateralised against land and as capital values fell, many loans became non-performing.

Several factors make an accurate assessment of non-performing loans and capital adequacy difficult. To quote the IMF these include: "weak balance sheets, regulatory forbearance, connected lending and cross ownership, weak risk management, and the presence of special interest groups…". At a recent conference we attended, hosted by Viet Capital, one speaker referred to a possible range of 15-25%, although his sense was it was likely to be towards the lower end of this estimate.

This estimate is consistent with an estimate from Moody's rating agency in early 2014. They estimated non-performing loans to be at least 15% of total assets. At the time, the SBV estimated NPLs at 4.7%. While it disputed Moody's assessment, the SBV simultaneously raised its own estimate to 10-11%. Levels of capital adequacy appear to be insufficient to absorb potential losses, in our view.

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To restore stability, the central bank raised the policy rate to more than 16%; interbank rates exceeded 30%

Higher rates and macro prudential measures had a significant cooling effect on the property market

Moody's estimated NPLs in the banking system at 15% as of Q114


29

What has changed? Macroeconomic stability has been restored

First and foremost the authorities have been successful in stabilising the macroeconomic environment. Inflation has declined from 18.7% at the end of 2011 to only 0.3% in February 2015. This is the lowest level of headline inflation since 2001. Obviously, lower energy prices in recent months have helped, but even adjusting for this the record of the authorities has been impressive. Core inflation for February was only +2.3%.

Figure 55: Vietnam CPI, 2010 – February 2015

Source: Haver, General Statistics Office of Vietnam, UBS

Vietnam has succeeded in stabilising the economy while continuing to expand at more than 5% p.a. in real terms. The authorities recently released the GDP number for Q115—at 6.03% it was above consensus.

Figure 56: Vietnam real GDP growth, 2009-Q115

Source: Haver, UBS

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The lowest rate of inflation for more than a decade

Inflation has been brought under control while the economy has continued to grow at more than 5% pa


30

A sharp improvement in the terms of trade

Vietnam acceded to the WTO in 2007. Since then, exports in US$ terms have almost trebled, to US$150bn in 2014. This is equivalent to approximately 80% of GDP. Initially, rising FDI post 2007 sucked in imports of capital goods—as well as raw materials—which contributed to the negative current account. However, with a weaker currency and soft domestic demand, the current account, which was negative every year between 2002 and 2010, turned positive.

Figure 57: Vietnam exports and current account, 2005-14

Source: Haver, UBS

Foreign direct investment has been a significant contributor to the strength in exports. In 2014, 68% of total exports were attributed to foreign investors, compared to 32% to domestic companies. By value, exports of telephones and parts were Vietnam's top export in 2014. Exports of electronics, computers and parts were third. While exports of textiles and footwear have declined as a share of total exports, they remain substantial, reflecting the still relatively low cost of labour and electricity.

Figure 58: Vietnamese exports by item, 2014 (US$ bn)

Source: General Statistics Office of Vietnam

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spor

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ts

Cof

fee

Rice

For the first time in a generation, Vietnam is running a current account surplus

In 2014, 68% of total exports were attributed to foreign investors


31

By region, North America is the largest export destination for Vietnam. It has also been the fastest growing. Between 2000 and 2013, Vietnamese exports to North America grew 30-fold. This is relevant in the context of discussions on the proposed Trans-Pacific Partnership.

Figure 59: Vietnamese exports by region/country, 2000-13

Source: General Statistics Office of Vietnam, UBS

One of the fastest growing tourism destinations in Asia

In addition to exports of goods, Vietnam has been successful in growing its tourism industry. Since 2000, the compounded annual rate of visitor arrivals has been 9.8%. In ASEAN, this is behind only Cambodia and Laos.

Figure 60: Visitor arrival CAGR 2000-14 (%)

Source: CEIC, UBS estimates

Looking ahead, the potential for growth in tourism appears significant in the context of: 1) the many attractions Vietnam offers (including 3,260 km of coastline); 2) increasing investment in tourism infrastructure (eg expansion of airport capacity, growth in low-cost air carriers and investment in new resorts); and 3) comparison with its peers in the region (visitor arrivals to Vietnam are currently only one third of the number to Malaysia and Thailand).

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Vietnamese exports to North America have grown 30-fold since 2000; the TPP, if concluded, should provide a further boost

Expect significant growth in tourism receipts

We expect tourism to be a significant income generator; expect to see significant investment airport capacity, new airlines and resorts


32

Figure 61: Most recent visitor arrivals to ASEAN ('000)

Source: CEIC, UBS

The improvement in Vietnam's external accounts has contributed to a sharp rise in international reserves. As of May 2014 these had risen to US$35.9bn, the highest on record. The IMF projects them to rise to US$48.8bn by the end of 2015.

Figure 62: Vietnam's international reserves

Source: Haver, IMF, UBS

Interest rates have more than halved

This has enabled the SBV to lower interest rates. Vietnam's key interest rate is the refinancing rate. From a peak of 15% at the beginning of 2012, it has declined to 6.5%.

27,437

24,780

15,087

9,435 7,874

4,833 4,503 3,779

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Vietnam's international reserves are at an all-time high

Vietnam's refinancing rate has fallen from a peak of 15% at the beginning of 2012 to 6.5%


33

Figure 63: Vietnam refinancing rate

Source: State Bank of Vietnam, UBS

Market interest rates also started to decline in tandem. The yield on Vietnamese sovereign bonds has fallen from 12.8% in February 2012 to 4.8%. Yields on 10-year sovereign bonds have also fallen, to 6.6%.

Figure 64: Vietnamese sovereign bond yields 2006-15

Source: Bloomberg

A recovery in the property sector

The property sector has stabilised and is now recovering. In 2014, condominium sales in Ho Chi Minh City were the highest on record, with approximately 17,000 units sold. In Q115, the number of launches was up 160% YoY, to 5,150 units in 17 projects in Ho Chi Minh City, and 80% to 4,880 units in Hanoi. Year-to-date, more than half of the newly-launched 'affordable' units have been sold. Stronger demand is also having a positive effect on prices across the market, from 'affordable' to 'high-end' units.

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In Q115, the number of new condominiums launched in Ho Chi Minh City and Hanoi rose 160% and 80%, YoY, respectively


34

Figure 65: Ho Chi Minh City condominium launches and sales, Q115

Figure 66: Hanoi condominium launches and sales, Q115

Source: CBRE Vietnam, UBS Source: CBRE Vietnam, UBS

The recovery was prompted by a number of factors:

Rising affordability as interest rates declined.

Rising affordability as developers changed their product mix to offer smaller, more reasonably priced units.

Greater availability of mortgages. Buyers previously paid predominantly with cash. Based on a survey by Ehome of more than 2,000 home buyers, 81% in the 'affordable' segment plan to apply for a bank loan to finance the purchase.

Infrastructure. Construction of Ho Chi Minh City's first urban mass transit (similar to Bangkok's Skytrain) can clearly be seen coming out of the ground, and work on a second line is just starting. Developments near the new railway are proving particularly popular.

Figure 67: Change in condominium types—first-tier units Figure 68: Change in condominium size—first-tier units (sq m)

Source: CBRE Vietnam, UBS Source: CBRE Vietnam, UBS

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35

Across all property segments in Ho Chi Minh City (office, retail, residential, hotels and serviced apartments, and industrial) both prices and absorption rates should be either stable or improve in 2015, according to CBRE Vietnam. In Hanoi, that is true for absorption rates, but they still see some weakness in pricing for office, non-CBD retail and serviced apartments.

Banking sector restructured and a 'clean up' of non-performing loans

Lower interest rates and a recovery in the property sector provide a more supportive environment for Vietnamese banks. However, it is widely estimated that system-wide NPLs could still be as high as 15% of total assets.

In 2013, having taken advice from foreign banks and supranational agencies on the experience in financial crises elsewhere, the Vietnamese authorities launched the Vietnamese Asset Management Company (VAMC). The VAMC would 'acquire' non-performing loans from banks in exchange for VAMC bonds. The bonds do not carry any interest but banks can use them as collateral to borrow from the SBV, capped at a theoretical maximum of 70% of the face value of the bonds. In so doing, the banks essentially obtain fresh liquidity where previously they had a non-income generating asset.

To say the banks are selling the NPLs to the VAMC is not strictly correct; they are really swapping them, on a 'with-recourse basis'. Banks swap the NPLs at face value minus any collateral. The VAMC will then attempt to sell the NPLs, or the underlying collateral. Any proceeds are then returned to the banks in exchange for the bonds and the banks must account for any gain or loss.

In the meantime, banks are required to amortise the bonds over five years. If the VAMC is unable to sell the NPLs or the underlying collateral during that period they are returned to the banks, but by then they will have been written off in any event. Banks are currently required to swap any NPLs in excess of 3% with the VAMC.

This approach, as we discuss in the next section, has a number of drawbacks. However, it has had the effect of increasing liquidity in the system (through lending money to banks backed by the VAMC bonds the SBV has essentially printed fresh money) and loan growth is accelerating again. It has also prevented a potential fire sale of assets that could have further depressed asset prices.

Reform of SOEs

SOEs have historically played a leading role in the economy. In 2005, they represented one third of workers employed in the formal sector and more than half the invested capital. However, they have low asset turnover and crowd out private sector investment.

Vietnam's policy is to reduce the role of the SOEs and increase efficiency though restructuring and equitisation (a precursor to subsequent listing of the companies on one of the local stock exchanges).

The government has also introduced a series of improvements to the legal framework. To quote from the latest IMF Chapter IV report: "the government has issued new regulations to enhance SOEs' financial reporting and transparency, improve internal controls by defining different government agency responsibilities, and improve corporate governance."

Approach to dealing with NPLs in the banking sector is only a partial solution, but it has restored confidence in the system as a whole and boosted liquidity

Government goal is to reduce the role of the public sector; progress has been mixed, but mitigated by FDI and high level of entrepreneurship in private sector


36

To date, the government has failed to meet its own very ambitious targets to reform SOEs. However, while clearly a drag on productivity within the economy this has not stopped Vietnam achieving relatively high levels of growth because of significant FDI and the high level of entrepreneurship in the private sector, in our opinion.

The number of non-state owned enterprises more than trebled between 2005 and 2012, while the number of SOEs declined 20%. The capital within private enterprises rose 10-fold over the same period.

Figure 69: Number of businesses by type of enterprise Figure 70: Average capital by enterprise (VND trn)

Source: General Statistics Office of Vietnam, Statistical Yearbook of Vietnam 2013, UBS


Figure 71: Net turnover by enterprise (VND trn) Figure 72: Fixed asset turnover by enterprise (x)



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37

Investment in infrastructure

Throughout the period of economic adjustment the government has supported growth through continued tax and tariff adjustments and spending on infrastructure. The latter includes investment in new bridges and tunnels, and construction of urban mass transit networks for Hanoi and Ho Chi Minh City. Construction on both is already underway. The tax changes include a cut in the corporation tax rate from 25% to 22%, with a further cut to 20% planned for 2016. The flipside of this approach, however, is that public debt is increasing (more on this in the next section).

Figure 73: Vietnamese government finances (% GDP)

Source: IMF, UBS

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Government has been firm on the need for a counter-cyclical fiscal boost to growth, including infrastructure spending and tax cuts


38

Looking forward, what should we expect and where are the risks? Potential landmark trade initiatives

Vietnam is currently party to several trade and investment initiatives. The most significant, if successfully concluded, would be the Trans-Pacific Partnership and the Regional Comprehensive Economic Partnership. The full list is as follows:

Trans-Pacific Partnership (TPP)

Regional Comprehensive Economic Partnership (RCEP)

ASEAN Economic Community (AEC)

EU-Vietnam Free Trade Area

Korea-Vietnam Free Trade Area

US-Vietnam Tax Treaty

The TPP is a trade agreement being negotiated by 12 countries in the Asia-Pacific region. Together these 12 countries represent 37% of global GDP and 19% of global exports. Beyond including some of the world's largest economies, the TPP is different in that it seeks to go beyond simple commerce; it covers areas such as the environment, government procurement and labour rights.

The US has described the TPP as "a trade agreement for the 21st century". It is also intended to be a "living agreement". In other words, it lays open the possibility of further trade reform and additional members in the future.

Figure 74: TPP negotiating countries, 2013

Population GDP GDP/capita Exports % world % world % world

(m) (US$ bn) (US$) (US$ bn) Population GDP Exports

Australia 23.3 1,506 64,578 252 0.3% 2.0% 1.1%

Brunei 0.4 16 39,659 11 0.0% 0.0% 0.0%

Canada 35.1 1,827 52,037 456 0.5% 2.4% 2.0%

Chile 17.6 277 15,776 77 0.2% 0.4% 0.3%

Japan 127.3 4,899 38,468 715 1.8% 6.6% 3.1%

Malaysia 29.9 313 10,457 229 0.4% 0.4% 1.0%

Mexico 118.4 1,261 10,650 380 1.7% 1.7% 1.6%

New Zealand 4.5 182 40,516 39 0.1% 0.2% 0.2%

Peru 30.9 202 6,542 42 0.4% 0.3% 0.2%

Singapore 5.4 298 55,182 410 0.1% 0.4% 1.8%

United States 316.4 16,768 53,001 1,578 4.4% 22.4% 6.8%

Vietnam 89.7 171 1,902 132 1.3% 0.2% 0.6%

Total 799.0 27,719

4,322 11.2% 37.1% 18.5%

Source: IMF, UNCTAD, CEIC, UBS

Vietnam is simultaneously a party to several pending landmark trade and investment initiatives

The Trans-Pacific Partnership is unique in several respects; the negotiating member countries represent more than a third of global GDP


39

What are the prospects of the TPP materialising? US President Barack Obama has made the TPP core to his Asian economic policy and the supposed 'tilt towards Asia'. However, the process has stalled because of the administration's inability to get approval for 'Fast Track' negotiating rights from Congress. It is still by no means certain that Congress will deliver 'Fast Track', or that other hurdles and resistance to the TPP will be overcome, but the Republican Congress might offer more support to the President on this issue than the last Congress, and the TPP did feature prominently in the 2015 State of the Union address.

In addition to administrative obstacles, there are a number of contentious substantive issues to be resolved. Most pertinent to Vietnam would be:

Labour provisions that would include rights of association and collective bargaining. These would be inconsistent with current Vietnamese law.

More stringent intellectual property protection.

Rules "to promote a competitive business environment, protect consumers and ensure a level playing field" would limit the ability to support SOEs.

A provision that would enable corporations to challenge government rulings in international tribunals if they contravene the TPP rules.

Simultaneous with negotiations on the TPP, albeit less well advanced, are discussions to establish a Regional Comprehensive Economic Partnership (RCEP). It centres on the ASEAN region but includes the Plus 6 ASEAN dialogue partner countries: China, South Korea, Japan, India, Australia and New Zealand. The RCEP is intended to extend, and to some extent harmonise, existing bilateral Preferential Trade Agreements between ASEAN and its six dialogue partners.

The RCEP would create a trade block of 16 countries. It does not include the US, but would still capture 48% of the world's population, 29% of global GDP and 23% of global exports.

Figure 75: RCEP negotiating countries, 2013

Population GDP GDP/capita Exports % world % world % world

(m) (US$ bn) (US$) (US$ bn) Population GDP exports

Australia 23.3 1,506 64,578 252 0.3% 2.0% 1.1%

Brunei 0.4 16 39,659 11 0.0% 0.0% 0.0%

Cambodia 15.1 16 1,028 9 0.2% 0.0% 0.0%

China 1,360.8 9,469 6,959 2,209 19.0% 12.7% 9.5%

India 1,243.3 1,877 1,509 337 17.4% 2.5% 1.4%

Indonesia 248.0 870 3,510 183 3.5% 1.2% 0.8%

Japan 127.3 4,899 38,468 715 1.8% 6.6% 3.1%

Korea 50.2 1,304 25,975 560 0.7% 1.7% 2.4%

Laos 6.8 11 1,594 2 0.1% 0.0% 0.0%

Malaysia 29.9 313 10,457 229 0.4% 0.4% 1.0%

Myanmar 51.0 57 1,113 11 0.7% 0.1% 0.0%

New Zealand 4.5 182 40,516 39 0.1% 0.2% 0.2%

Philippines 97.5 272 2,791 54 1.4% 0.4% 0.2%

Singapore 5.4 298 55,182 410 0.1% 0.4% 1.8%

Thailand 68.2 387 5,676 229 1.0% 0.5% 1.0%

Vietnam 89.7 171 1,902 132 1.3% 0.2% 0.6%

Total 3,421 21,647

5,382 47.8% 29.0% 23.1%

Source: IMF, UNCTAD, CEIC, UBS

Obstacles to a successful conclusion are substantive; in Vietnam, for example, the TPP would require changes to current labour laws

The Regional Comprehensive Economic Partnership involves negotiations between 16 countries representing almost half the world's population


40

What could these trade deals mean? Economists Peter A. Petri, Michael G. Plummer and Fan Zhai have attempted to model the impact on income and exports. They estimate the TPP and the RCEP could boost Vietnam's baseline exports and GDP by $83bn and US$43bn, respectively.

Figure 76: Boost to Vietnamese GDP, 2025F Figure 77: Boost to Vietnamese exports, 2025F

Source: Peter A. Petri, Michael G. Plummer and Fan Zhai, "The Trans Pacific Partnership and Asia-Pacific integration: A quantitative Assessment", UBS


In percentage terms, based on their models, Vietnam comes out as the largest beneficiary in terms of both trade and overall GDP. This in part reflects that the other negotiating countries are all high or middle- to high-income countries. Vietnam should benefit through greater FDI and exports of manufactured goods, cheaper imported consumer products, productivity gains and momentum for reform (for more on this, see below).

Figure 78: Estimated boost to GDP under the TPP (as a % of baseline GDP)


15

34

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0

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In percentage terms, one study estimates Vietnam would be the biggest beneficiary in both trade and overall income


41

Beyond the direct boost to trade and income, UBS economist Ed Teather noted in Asian Economic Perspectives: ASEAN Linkages—Trans Pacific Potential, published 1 November 2013, that one of the most positive aspects of the TPP is that it is indicative of the mind-set of policy makers. In Vietnam's case, this suggests it is serious about reforming its SOEs and reducing the barriers to doing business. This could well prove to be the most important takeaway from the TPP, and is key, in our opinion, to taking advantage of the building blocks to growth we discussed at the start of this report.

Ongoing restructuring of SOEs and the financial sector

The government has, for the first time, announced plans to publish the list of enterprises to be equitised; the belief is that this will increase the pressure on managers. Thereafter, enterprises are also now required to seek a listing within 12 months of being equitised, and managers have been threatened with losing their jobs if they fail to achieve this. To facilitate this process, enterprises are now permitted to sell assets below book value with the approval of the government.

The government's objective was to equitise 280 SOEs in 2015. These new initiatives should help, and are consistent with the intention to participate in the TPP. We believe there is a general consensus among the authorities on the need to reform. However, practice has often disappointed, and we suspect that for the foreseeable future diluting the role of the SOEs through expansion of the private sector and growing FDI will prove more important.

Arguably more urgent than reform of the SOEs are the banking sector and outstanding NPLs. They represents a constraint to lending, and hence to economic growth. As highlighted in the previous section, independent commentators have estimated NPLs to be about 15%. The State Bank of Vietnam has previously acknowledged them to be at least 10%.

In 2014, the VAMC acquired VND96trn (approximately US$4.5bn) of NPLs from the banks, increasing the total NPLs acquired to VND135trn, or 3.4% of total loans outstanding. This year, the VAMC plans to acquire another VND100trn, or another 2.5% of outstanding loans.

Initially, transferring NPLs to the VAMC was not compulsory; we understand this has changed. It was recently reported that the credit institutions were required to swap at least 75% of the NPLs they had registered to sale to the VAMC by 30 June 2015, and the deadline for swapping all NPLS is 30 September 2015.

New bankruptcy legislation (see below) should help the VAMC with resolution of the bad debts, but it remains to be tested. We understand the government has also asked the VAMC to tighten links with banks to facilitate the recovery and restructuring of bad debts.

Beyond NPLs, however, further reform is required:

Vietnam is arguably overbanked. There are currently five state-owned banks and 33 private joint stock banks. According to a Vietnamese bank at the conference we attended, the SBV wants to reduce this to 20 through merging strong and weak banks. This represents a risk to minority investors in the strong banks.

An aspiration to be part of the TPP is symbolic of a reformist mind set among Vietnamese leaders; this is key, in our opinion

The government is increasing transparency as part of its strategy to expedite reform in the SOEs

More immediately, the challenge is to restructure the financial system so banks resume lending

Beyond NPLs, wide ranging reforms are required to the financial system and regulatory regime

https://neo.ubs.com/shared/d1VyU3zIkkASw


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Classification of loans. Banks have significant flexibility in classifying loans. This has enabled them to understate the true extent of credit impairment. The SBV plans to introduce tighter loan classification, but this has been delayed several times.

Low profitability. The industry structure and high levels of historic impairment are affecting bank profitability. Return on equity, even for the best banks, is only in the region of 10%.

Undercapitalised. Viet Capital estimates the total capital adequacy for Asia Commercial Bank and Vietcombank at 13.1% and 11.5%, respectively. However, in meetings with bank management, they suggested that if you were to apply the Basel II framework, the ratios would be much lower; possibly half of the current stated numbers. The deficit for the smaller banks, we understand, is even greater.

Connected lending, directed lending and cross ownership. Private banks historically often lent to related companies, frequently companies engaged in real estate development. State-owned banks could be told to lend money to unprofitable and unproductive SOEs. The SBV still sets target loan growth for the system; the risk is that this might be at odds with credit quality or the capital adequacy of the banks.

The IMF, as noted in its October 2014 Article IV Consultation report, has recommended that the SBV use the breathing space provided by improved liquidity conditions to undertake more comprehensive reform: "…a more expeditious recognition of NPLs, supported by bank diagnostic assessments and legal and SOE reforms; restructuring and recapitalisation of viable banks; and orderly exit of insolvent institutions, supported if necessary by a stronger safety net. A revamped VAMC, with ability to buy and sell impaired loans at market value as is currently under consideration, could play a significant role. The crisis management framework and supervision should be strengthened, and use of administrative measures gradually eliminated."

The IMF went on to comment that the authorities agreed with the ''thrust" of the recommendations, but argued for more time to increase banks' ability to absorb losses and support the economic recovery. To reiterate, we do expect some progress, and improved liquidity conditions and recovery in the property sector are certainly positive, however for the immediate future, the banking sector remains a constraint on Vietnam achieving its growth potential.

Important new legislation takes effect in the areas of property ownership, bankruptcy and enterprises

The government has passed a number of significant new laws and regulations coming into effect this year. They include:

New property laws (effective 1 July 2015)

New Bankruptcy Law (effective 1 January 2015)

New Law on Enterprises (effective 1 July 2015)

Resolution 19/2015—Improvements to business environment (March 2015)

New Public Investment Law (effective 1 January 2015)

The IMF has outlined a package of reform measures; we view these more as the IMF's wish list than a genuine action plan likely to be adopted by Vietnam at this point


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The new laws have been described as "a long awaited breakthrough". They are expected to have a positive effect on the property market to the extent they establish a more transparent framework and remove a number of obstacles to foreign buyers. Key details are as follows:

New categories of buyers permitted to buy property. 1) Overseas Vietnamese; 2) a broader group of foreign organisations; and 3) any foreign individual with a three-month entry visa.

Property type. Previously, foreign investors were only allowed to own condominiums. Under the new law this has been broadened to all types of residential property—condominiums, townhouses and even landed property.

Number of properties. Previously limited to a single condominium, there is now no limit on the number of properties an individual or company can acquire, although the total number of foreign-owned condominiums in a single building should not exceed 30%, or the total number of foreign-owned separate houses in a ward should not exceed 250.

Ownership period. Overseas Vietnamese are permitted to purchase property in the same way as if they were actually resident, without limits on the number, type or tenure of homes they can acquire. The same applies to foreign organisations. Under the new law, the definition of foreign organisations permitted to own land has been broadened to include foreign investment funds and branches or representative offices of foreign enterprises (including banks). For foreign individuals, they are permitted to acquire a 50-year lease on property, with the right of extension (we are still waiting on regulations regarding the length of the permitted extension). However, if you are married to a Vietnamese citizen you are permitted to own freehold.

Property rights. Previously, foreign investors were not permitted to sublease, mortgage or inherit property, among other things. These restrictions have been removed under the new law, with the exception that any mortgage for foreign organisations must be with a credit institution in Vietnam, and any mortgage for a foreign individual must be with an "economic organization" in Vietnam.

The 2014 Bankruptcy Law replaces a 2004 law that was deficient in a number of areas. Key changes include:

For the first time, it allows for the role of "a receiver", a private company with certain professional qualifications, to manage the bankruptcy process. Under the old regulations, it would be the courts themselves.

Jurisdiction over all but the most complicated bankruptcy cases is transferred to the District Court where the enterprise has its headquarters. This avoids delays in Provincial Courts that are overloaded with cases.

Insolvency status is defined as the inability to pay overdue debt for three months instead of the inability to pay overdue debt when due. The revised definition could help to reduce abuse of the bankruptcy process to settle individual disputes.

The new law provides clear steps for declaring an enterprise insolvent. This includes providing that a quorum for a creditors' meeting is lowered to 51% of the total unsecured debt. Under the previous law, a quorum required at least two thirds of the unsecured debt by value.

New property laws relax the restrictions on foreign ownership

A new bankruptcy law aims to protect creditors and make it easier to liquidate assets


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Interest can continue to accrue from the time of the decision to commence a bankruptcy process to the time of the decision to declare bankruptcy. Under the old regulations, interest ceased to accrue as soon as there was a decision to commence a bankruptcy process. The new provision is more protective of creditors, as the bankruptcy process could well last for a couple of years.

The new law provides that bankruptcy procedures shall also be applicable to credit institutions that are not under the special control regime by the SBV. While this was theoretically the case under the old law, no guidelines had been issued to enable this.

The new Law on Enterprises is a further step towards meeting Vietnam's commitments when it acceded to the WTO. Key changes are as follows:

The law defines a foreign enterprise for the first time as an enterprise in which a foreign individual(s) or organisation owns at least 51% of the shares. (Note, it remains to be seen whether this will translate to slightly higher foreign ownership limits for publicly-traded companies, currently set at 49%.)

Change of business activities or founding shareholders need not be registered to update the Enterprise Registration Certificate as required under current law.

Lower quorum and voting thresholds. For example, to obtain a quorum for a shareholding meeting under the current law, in the first instance, holders of 65% of total shares outstanding must be present. This has been reduced to 51%. For "important decisions" a quorum has been reduced from 75% to 65%.

Fewer restrictions on founding shareholders in a joint stock company and simplified procedures for issuing new shares.

A State-Owned Enterprise is now defined as being wholly owned by the state, ie 100%, as opposed to more than 50% under the previous law.

Increased public disclosure requirements for SOEs.

The context for Resolution 19/2015 is Vietnam's relatively poor rating in terms of the ease of doing business (see below). The government's objective is to raise the country's business environment indicator above the average for ASEAN. Details include:

State agencies to review administrative procedures to reduce paperwork, saving time and costs for businesses, specifically regarding the import/export of goods and taxes.

To reduce the average tax-filing time to 121.5 hours per year (from 872 hours in 2013 and 537 hours in 2014) and raise the number of businesses that complete online tax applications to 95%.

A commitment to more restructuring of SOEs. And specific policies and mechanisms to be introduced to level the playing field between large SOEs and small-to-medium-sized enterprises. (Is this a nod to Vietnam's commitment under the TPP?)

Privatisation of a number of public services.

New Law on Enterprises is a further step towards meeting Vietnam's commitments under the WTO

Resolution 19/2015 is designed to help raise competitiveness


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More autonomy for key sectors such as education, health care and technology. This could include potential public-private partnerships (PPPs). There is already one pilot scheme in the area of procurement of medical supplies for two public hospitals.

More capital into research and development, including in agriculture. The sector should enhance product quality and competitiveness, while ensuring food security and sustainable development.

Ministries, sectors, cities and provinces have been instructed to take steps to improve their investment and business environments, and resolve any impediments to the implementation of administrative procedures.

The new Public Investment Law aims to improve the effectiveness of public investment management in line with international practices.

It governs the management and use of public investment funds and defines rights, obligations and responsibilities of agencies, units, organisations and individuals related to public investment activities.

Most importantly, the law is designed to encourage private organisations and individuals to invest in infrastructure. This could include through PPPs.

Ongoing fiscal stimulus, but concerns over rising public debt

As growth has slowed, Vietnam has pursued a 'counter-cyclical fiscal policy', with tax cuts and increased public spending on infrastructure. This has led to an increase in the fiscal deficit (the IMF is projecting 6.25% for 2015), and rising public debt as a percentage of GDP.

Tax stimulus includes a reduction in the corporate tax rate from 25% to 22%, and to 20% in 2016. Other tax reductions and exemptions include a halving of the VAT rate for affordable housing projects. The authorities have tried to mitigate this through reducing tax evasion and requiring profitable SOEs to pay dividends in 2013-14. However, the impact of these measures has been relatively limited.

Compared to other developing countries, the IMF believes public employee compensation as a proportion of GDP is very high and should be reduced through wage and hiring freezes, and deep efficiency improvements. They are also recommending the government delay further cuts to the corporate tax rate and introduce a new property tax.

In addition to on-balance sheet liabilities there is also worry about potential contingent liabilities surrounding the resolution of NPLs in the banking sector and reform of the SOEs. The IMF has recommended the government build a buffer into public finances against this, and potential shocks in the future.

From the government's response these recommendations seem unlikely to be followed in the foreseeable future because of the need to support growth and competitiveness. According to the IMF's October 2014 Chapter IV report, the authorities are, however, "…fully aware of public debt risks. They expect the debt-GDP ratio to peak around 2016 and decline afterward with a gradual consolidation, and emphasised that the government's ceiling of 65% of GDP would not be breached".

New public investment law should facilitate more PPPs

Expect the government to continue to support growth through running a sizeable fiscal deficit for the foreseeable future

IMF has medium-term concerns on the level of public debt, especially if you fully account for potential contingent liabilities in the banking sector and SOEs


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In the immediate future, rising public debt does not appear to pose a risk to macroeconomic stability, and on 29 July 2014 Moody's upgraded Vietnam's sovereign credit rating to B1, with a stable outlook. However, were we to witness another shock, the rising level of public indebtedness would limit the flexibility of the authorities to respond. For that reason, and while challenges in the banks and SOEs have not been fully addressed, it remains something to monitor.

Figure 79: General government net debt (% GDP)

Source: IMF World Database

Beyond wages, improvement in overall competitiveness remains a work-in-progress

Despite the relatively low cost of labour and electricity in Vietnam, overall competitiveness remains a problem. In the World Economic Forum's Global Competitiveness Index (GCI) for 2014-15, Vietnam ranked 68th out of 144 countries. This represented a slight improvement on its ranking the previous year of 70th, but remains below that for the Philippines, for example, and significantly below the rankings for Thailand and Indonesia, at 31 and 34, respectively.

Figure 80: World Economic Forum's Global Competitiveness index 2014-15, ranking of ASEAN countries

Source: World Economic Forum's Global Competitiveness Index 2014-15

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Nevertheless, Moody's upgraded Vietnam's rating in Q314, the first upgrade in more than 10 years; it remains below investment grade

Weak infrastructure to blame for poor overall competitiveness rating, despite low wages


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Vietnam's poor ranking reflects poor physical and 'soft' infrastructure. The latter refers to the strength of Vietnam's institutions, corporate governance, poor tertiary education and training, and limited supply chains.

The good news is that the government recognises many of these challenges. It is precisely for that reason, we believe, that it has embarked on reform of the SOEs, introduced ground breaking new legislation and is negotiating to join the TPP (with all the new commitments this entails). As Vietnam addresses these bottlenecks, we would expect growth to accelerate. The government's own plan targets compounded real GDP growth of 6.5-7.0% with single digit inflation through to 2020. If achieved, this would be one of the fastest rates of growth in Asia.

Economically stable, but inflation fears remain given Vietnam's recent history

Twice in the past 10 years, Vietnam has suffered from spikes in inflation fuelled by excessive credit growth. It is notable that the government's response to resolving the NPLs from the previous credit cycle was to establish the VAMC structure, which is arguably a vehicle to print more money.

However, the consensus view of everyone we met—a view repeated in the IMF's latest Article IV Consultation paper—is that the government is committed to ensuring macroeconomic stability, and certainly does not want to see a repeat of the previous inflationary spikes. The test of this will be the attitude of the authorities, and the SBV in particular, if the recovery in the property market were to pick up speed. This is possible in the context of new rules to enable foreign individuals, and most importantly overseas Vietnamese, to acquire property after 1 July 2015.

Politically stable, but senior political figures expected to retire in Q116; relations with China also merit attention

The Vietnamese Communist Party’s 12th Congress will convene in January 2016 to renew the nation’s leadership. By then, 10 of the Politburo's 16 members will have reached retirement age. At a time when the country is still addressing structural challenges on a number of fronts, not least corporate governance, the role of the SOEs and restructuring the banking sector, the composition of the new Politburo and their policy orientation matters.

Particular attention will be paid to the role of Prime Minister. The Prime Minister wields significant power in Vietnam, and the current Prime Minister, who has held the post for the past 10 years, is deemed to have been one of the country's most powerful. The consensus appears to be that the current Prime Minister will stand down, but by taking up another role, possibly Secretary General of the Party, he will continue to be influential. If so, it could reduce concerns about a significant change of course in policy after January 2016. However, like fiscal policy, SOE reform and the banking sector, it is another area which merits close attention.

Geo-politically, the biggest risk would be a deterioration in Sino-Vietnamese relations. There was an example of this in 2014, when a Chinese deep-sea oil rig was placed in disputed waters in the South China Sea. This led to anti-Chinese protests in Vietnam, including attacks on Chinese businesses. This had a negative impact on FDI and Chinese tourist arrivals to Vietnam, albeit only temporarily. The oil rig was subsequently removed and the issues of relations between the two countries did not come up at all during the recent conference we attended in Vietnam. One factor we would hope reduces the likelihood of a serious confrontation between the two countries is the degree of economic linkage between them. That said, it remains a risk.

The good news is the authorities appear to 'get this'—hence the initiatives surrounding the SOEs and recent, long-awaited legislation

Given Vietnam's history over the past 10 years, inflation remains a fear among a number of people we spoke to on the ground

Keys will be policy consistency, and the position of the current Prime Minister


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Statement of Risk

Although there are many uncertainties with equity investing, generally economic and policy surprises pose the most consistent and continuous risks. Economic growth can be volatile, leading to earnings uncertainty. Inflation volatility can likewise lead to interest rate uncertainty. The direction and level of policy rates has a substantial impact upon equity valuations. This has happened twice in the past 10 years. For foreign investors in equities, the lack of liquidity is a significant additional risk. The available foreign room for foreign investors is currently very low. As a result, at times when large numbers of foreign investors wish to own or sell Vietnamese equities, they can have a significant impact upon price.


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EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece.

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