VND: Stable Outlook But Trade Deficit Still A Concern
Selling pressure on the Vietnamese dong, which traditionally tends to escalate during the final quarter of the year, has been relatively mild in 2011. The usual surge in demand for US dollars as short-term US dollar debt matures at the end of the year did not result in the devaluation that various research houses had been expecting. In contrast, our view that waning inflationary pressures, a narrowing trade deficit, and government intervention to curb currency speculation, would be sufficient to prevent the need for a devaluation (at least in the near term), has play out nicely. We continue to expect the exchange rate to remain relatively stable at around VND21,000/US$ over the coming weeks.
Back in September, we mentioned that signs of cooling inflationary pressures and aggressive moves by the Vietnamese government to curb speculation and de-dollarise the economy would help underpin confidence in the Vietnamese dong (see 'VND: Keeping A Stable Outlook, But Risks RemainTitle Of Article', September 08, 2011). We remain optimistic that the Vietnamese government's focus on bringing down inflation, while accepting a lower but more sustainable growth path, will help bolster confidence in the currency in the medium term. In line with our outlook for headline consumer price inflation (CPI) to continue to ease towards 4.1% y-o-y by end-2012, we expect selling pressures on the Vietnamese dong to remain benign over the coming months.
However, although inflation is becoming less of a threat to the SBV's exchange rate regime, we remain concerned over the country's persistent trade deficit. Following the SBV's decision to devalue the currency by a significant 8.5% in February 2011, Vietnam's trade deficit has narrowed considerably from US$12.1bn in 2010 to US$9.3bn in 2011. However, our view that external demand will continue to cool on the back of slowing global economic growth means that the trade deficit could widen over the coming quarters. Indeed, we are seeing increasing risks of a recession across emerging markets in Asia as global economic growth continues to moderate. Should such a scenario play out over the coming months, Vietnamese exports could plummet, putting further pressure on the country's weak balance of payment's position.
A collapse in exports notwithstanding, the risk of a credit squeeze that is already beginning to unfold across emerging market economies in Asia, could severely undermine foreign capital inflows into Vietnam. We note that the country remains heavily reliant on foreign capital inflows to offset a persistent current account deficit. Thus, a decline in foreign capital inflows could result in a balance of payments deficit, eventually draining the country's dwindling foreign reserves. According to statement published by the by the National Financial Supervisory Commission (NFSC), Vietnam's foreign reserves are estimated to be at around 7.5 weeks of imports as of November 2011. Thus, we are increasingly concerned that the country's precariously low foreign reserves would put the SBV in a difficult position to defend the currency should capital flight occurs.
On a more positive note, we are seeing encouraging signs that the Vietnamese government is taking pressing ahead with reforms to de-dollarise the economy. Furthermore, the government has set a target to bring the trade deficit back to balance by 2020. These policies have so far helped to curb speculation and limit selling pressures on the currency. From our standpoint, these policies aimed at addressing imbalances in the economy will also underpin the currency's strength over the longer term. Thus, despite the short-term risks mentioned above, we expect the Vietnamese dong to remain relatively stable at around VND21,035/US$ throughout 2012. Over the longer term, we see a steady appreciation towards VND19500/US$ by 2013 and VND18,900/US$ by 2015.
Risk To Outlook
As mentioned above, Vietnam remains heavily exposed to a slowdown in external demand and foreign capital flows. Indeed, we note that the financial markets remain unconvinced that measures undertaken by the government will be sufficient to address the currency's decline. 12-month non-deliverable forward (NDF) on the Vietnamese dong continue to trade below the spot exchange rate, effectively pricing in a depreciation of 13.7%. This is not surprising given that the outlook for exports remains cloudy in the medium term. Should we fail to see a sustained improvement in the trade balance, we could see the dong come under further selling pressure over the coming months.