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VAM Note to Investors ( Nov 26, 2009)
Yesterday (25 November 2009) was a big day for the State Bank of Vietnam (SBV), as they announced a raft of policy measures designed to combat perceived emerging macroeconomic imbalances. Already for the last several weeks the SBV has been devaluing the VND/USD base rate used as the reference rate for official forex traders, albeit at a crawling pace, to signal to the market its intention to change from a growth to exchange rate management policy...
The policy was not yielding the desired results to bring the black market exchange rate inline with the official exchange rate, and thus the SBV yesterday announced three drastic policy measures:
· A one off VND devaluation of roughly 5.4% in the VND/USD reference rate from 17,034 to 17,961 effective on 26 November 2009, combined with a reduction in the official forex trading band over the reference rate from ±5% to ±3
· A 1% base rate hike from 7% to 8% effective on 1 December 2009
· Potential mandatory purchases of USD from State-Owned Enterprises (SOEs) and other exporters
The VND devaluation serves two primary purposes. First, it is a signal that the SBV is moving towards a more free floating currency regime as the new rate should theoretically allow the official forex traders to come inline with rates in the black market easing USD demand concerns. Second, devaluing the VND will help ease potential balance of payment issues as the trade deficit in October is estimated to have reached nearly USD 2bn.
The interest rate hike is an effort to ease credit growth, which stood at 33% ytd through October, 3% higher than the Government’s full year 30% target. High credit growth, increasing commodities prices, and base effects led to an increase in the YoY inflation rate from 3% in October to 4.4% in November, and the Government does not intend to make the mistake of allowing runaway inflation again.
While hard data is not available, it is generally believed that Vietnamese companies, particularly exporters, are often guilty of hoarding USD, undermining confidence in the local currency. The third measure (if more than just rhetoric) will get tough on SOEs thus improving USD liquidity and alleviating forex concerns.
The market reacted negatively to the news, being virtually limit down on Wednesday. However, the initial consensus view is applauding the SBV’s aggressive action, and although a short term market correction is to be expected, in the long term the actions put Vietnam on a much more sustainable growth path.
The Fund impact and strategy going forward
It is not the first time we have seen this kind of hiccup along Vietnam’s path of development, and thus the fund was largely well prepared for the announcement. The fund is holding a large cash position in mainly non-VND currencies, which alleviates the one off devaluation.
Inline with the consensus view, we see the policy response as highly beneficial to the long term return potential of Vietnamese equities. The double headed inflation/trade deficit problem is one that needs to be permanently addressed in order to eliminate the biggest threat to Vietnam’s high growth story. Historically, the SBV has used patchwork policy responses to address emerging imbalances, and our opinion is that the current proactive response is necessary for the long term health of Vietnam’s economy.
The market correction, in such panic mode, means great value is emerging in Vietnamese equities. It must be noted that Vietnam is still in the midst of a strong economic recovery, and the fund will continue to invest in companies that are levered to that growth. Thus, the fund will continue to target domestic plays, in companies that continue to be the primary beneficiaries of the Vietnam growth story. Furthermore, there will be an added emphasis on export companies who will now see their profit margins improve as their costs have been reduced in relative terms due to the Dong devaluation.
Our view on current investment potential
One reminder is that investing in Vietnam should always be done with a long term view, and in that sense, our opinion is that potential for high market returns in the long term has improved as a result of the 25 November policy measures. In the next week or two, it is likely the market will continue to correct, which will give us ample opportunity to use up its large cash balance to enter into good companies at increasingly attractive valuations.
The final word is this: we should be willing to accept a short term sacrifice in market returns as a result of the SBV actions as long as it improves long term return potential, and the current response really demonstrates a maturing SBV, one that looks increasingly likely to lead Vietnam’s high growth AND sustainable growth path moving forward.