Vietnam: One of Asia’s best proxies to Emerging Market growth

Vietnam has come a long way since the mid-2000s; a period characterised by double-digit inflation rates and large current account deficits. The economy is expected to grow 6.6 to 6.8% in 2019, one of the fastest in Asia. Inflation is also likely to hover around the government’s 4% target¹. While the strength of the US dollar in 2018 refocused investor attention on current account deficits, it is encouraging to note that Vietnam’s current account balance is in positive territory (2.2% of GDP²). In fact, the economy has been enjoying current account surpluses since 2011 as its export-oriented manufacturing sector took off.

For an economy that had been largely dependent on agriculture, economic growth is now being led by services and industrial activity³.

At a time when trade protectionism in some parts of the world appears to be on the rise, trade has been key in transforming the Vietnamese economy. Exports have grown 129x since 1986 with electronics and footwear accounting for more than 40% of the country’s total exports. See Figure 1.

Figure 1. Vietnam’s exports of goods and services (USD billions)

Source: World Bank. December 2018. In constant 2010 US$.

Given the importance of exports to its economy, Vietnam is, not surprisingly, a big advocate of free trade. Since signing a trade deal with South Korea in 2015, it is now South Korea’s fourth-biggest trading partner. Vietnam was also a founding member of the Trans Pacific Partnership (TPP). Following the withdrawal of the United States from TPP, Vietnam is now party to the new Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), along with 10 other Asia-Pacific countries.

Meanwhile, the signing of the EU-Vietnam Free Trade Agreement (EVFTA) in October 2018 is set to deepen Vietnam’s relationship with the European Union (EU). The EU is already one of Vietnam’s biggest trading partners, accounting for nearly a one-fifth of the country’s exports⁴. The EU-Vietnam deal will potentially eliminate 99% of custom duties on bilateral goods trade worth €47 billion a year. The impact of the FTA is expected to significantly increase trade flows between Vietnam and the EU. Vietnam’s exports of textile, clothing and footwear to the EU are expected to more than double in 2020 because of the EVFTA⁵.

Vietnam may also be a beneficiary as trade tensions continue to loom between the US and China. 70% of the companies surveyed by the American Chamber of Commerce in South China had indicated that they were considering switching sourcing or assembly of supplies out of China. 64% were considering relocating some manufacturing elsewhere⁶. The rise of trade protectionism from the US could potentially hasten China’s exit from the labour-intensive light manufacturing sectors. Given its competitive labour costs and business infrastructure, Vietnam may end up being a winner if this scenario materialises. Sectors that will potentially benefit include the industrial parks, ports, textile and garments, as well as fisheries and seafood.

Beyond trade, Vietnam has also liberalised its economy in other ways. After Vietnam joined the World Trade Organisation in late 2006, registered Foreign Direct Investments (FDI) grew six-fold two years later. By 2017, Vietnam’s FDI has reached 6% of GDP⁷, more than double the level achieved by other economies in the region. Stable FDI inflows, together with the trade surpluses, have boosted Vietnam’s balance of payments over the years. See Figure 2.

Figure 2. Stable FDI inflows and trade surpluses have supported Vietnam’s Balance of Payments

Source: VCSC, GSO, Eastspring Investments Vietnam.

Nguyen Xuan Phuc, the current Prime Minister wants the private sector to account for 50% of Vietnam’s GDP by 2020, up from 43% currently. Since taking office in 2016, he has sought to dispose government stakes in various industries - not an easy task as many state-owned companies are under the management of different ministries. However, progress is picking up. The government sold a majority stake in the biggest state-owned brewer, Sabeco, to a foreign firm in 2017. The government has also set up a committee in February 2018 to oversee the sale of US$220 billion worth of state-owned assets.

In line with this privatisation drive, more than 100 Initial Public Offerings (IPOs) are planned before 2020, potentially giving investors greater options when allocating capital to the Vietnam market.

Rapid growth nevertheless brings about other challenges. Vietnam’s non-financial corporate sector debt rose to 131.3% of GDP in the first quarter of 2018, up from 122.7% in the corresponding period the year before. Government debt service costs as a percentage of GDP has also risen marginally to around 2% of GDP.

In addition, rapid economic growth has resulted in pollution and deforestation. With a high percentage of its people living along its 3,260-kilometre coastline, Vietnam is vulnerable to climate changes. As such, Vietnam has incorporated environmental targets into its 2030 Sustainable Development Goals (SDGs).

In the 2017-2018 Global Competitiveness Report, areas of improvement cited by the World Economic Forum (WEF) include enhancing infrastructure and institutions as well as developing an educated workforce. The report also suggests that Vietnam boosts its competitiveness by closing gaps in innovation and sophistication factors with countries at a similar stage of development, such as the Philippines.

On balance, Vietnam has made huge strides in its development and its transformation has not gone unnoticed. Vietnam was Asia’s top performing market in 2017, up 47%. It was one of the only two stock markets (besides China) in Asia in 2018 to enjoy net foreign portfolio inflows⁸. The Vietnamese market is currently trading at 16.8x 12-month trailing Price to Earnings Ratio, marginally above its historical long-term average⁹. See Figure 3. Earnings are expected to grow 12 to 15% in 2019¹⁰.

Figure 3. VN-Index 12-month Trailing price to earnings ratio

Source: Eastspring Investments. Bloomberg. December 2018.

Looking ahead, Vietnam’s proposed amendments to its securities law can accelerate its ongoing State Owned Enterprise (SOE) reform agenda and boost its chances of MSCI inclusion in June 2020¹¹. Proposed changes include allowing 100% foreign ownership for public companies that are not deemed strategically important as well as incorporating G20/OECD principles of corporate governance into Vietnam regulations. The draft law is expected to be submitted to the National Assembly for approval in 4Q19. As a sign of what could be in store, FTSE Russell, in September 2018, identified Vietnam as a potential candidate to be reclassified as a secondary Emerging Market in September 2019.

With Vietnam poised to be one of Asia’s fastest growing economies in 2019 and potentially in the coming years, it is one of Asia’s best proxies to emerging market growth. Sectors that can benefit from this strong growth include the energy, power, utilities, banking and consumer sectors. For long-term investors with higher risk appetite and access to the relevant expertise, Vietnam can potentially offer attractive returns that are less correlated to more developed markets.