Vietnam could be excused for being fed up with Jerome Powell’s monetary exploits in Washington.
Chairman Powell has opened liquidity spigots that markets didn’t even know existed in restoring the quantitative easing regimen his Federal Reserve predecessors had scrapped.
Then he went on a Bank of Japan-like tear cornering the US Treasury debt market and Wall Street stocks via exchange-traded funds.
All that largess, arguably, helped put a floor under the world’s biggest economy as Covid-19 ravaged businesses and consumers.
Yet it also is generating risky side effects, not the least rising inflation, to which officials in Hanoi can attest.
Vietnamese Prime Minister Nguyen Xuan Phuc’s government expects a China-beating 6.5% gross domestic product (GDP) growth rate in 2021.
That reflects Vietnam’s relative success in battling the coronavirus, but also its place on the very front lines of trade dynamics returning from near-death conditions.
Just as Vietnam has been a trade war winner of former president Donald Trump’s China tariffs, it’s now the vanguard of emerging nations feeling the fallout from ultraloose Fed policies.
Case in point: an inflation rate many economists fear could hit 7.8% by year-end, a galaxy away from the 4% rate previously envisioned and the worst seen in Vietnam since 2012.
It is also arguably a bigger challenge considering consumer prices would be running 1.3 percentage points faster than GDP. So, could the “pendulum economics” problem of the past return in 2021?
The reference here is to the tendency of investor sentiment toward Vietnam to swing from intensely negative to wildly positive, with little middle ground between the extremes.
This was very much Vietnam’s reality in 2012 and many fear it might soon be again thanks to excess central bank liquidity.
The good news is that Phuc’s team is on the case. Since 2016, Hanoi worked to open the economy, simplify its notorious bureaucracy, raise its ease-of-doing-business score and build a more productive labor force.
The payoff: millions of Chinese manufacturing jobs rushing Vietnam’s way amid the trade war.
Trump hoped globalization’s biggest names would move production to the US. Yet Apple, Adidas, Nike, LG, Panasonic, Samsung and myriad others used Trump’s taxes as excuses to shift more jobs to Vietnam.
“Considering that Vietnam has been a major beneficiary of the supply chain relocation-diversification trend out of China over the past several years, we see large scope for growth in Vietnamese exports in the years to come,” say analysts at Fitch Solutions.
As such, Vietnamese growth in the 10% range is not out of the question should a global recovery from Covid-19 gain momentum, says Gareth Leather at Capital Economics.
“By the end of 2021, we think [Vietnam’s] GDP will be only 1.5% lower than it would have been had the crisis not happened,” Leather says. “This is one of the smallest gaps in the region.”
Yet everyone’s favorite emerging Asian economy faces an underappreciated overheating problem coming largely from the West. The gap between GDP and inflation is likely to tarnish the two-dimensional Vietnam-is-booming narrative.
One reason: the Vietnamese dong is often held below true market values by the central bank to juice exports.
The State Bank of Vietnam’s obsessive exchange-rate management earned a dreaded US Treasury “currency manipulator” label in December, as the Trump administration headed for the exit.
Even Trump’s arch-nemesis — China’s Xi Jinping — avoided that ignominy. Many saw it as sour grapes as Trump realized Vietnam gained more from his tariffs than America. Vietnam’s ability to hoover jobs didn’t cost Trump the election, but it sure didn’t help his sales pitch to manufacturing-heavy US states.
Now, though, Vietnam is navigating the dark side of US policies and with an undervalued dong that’s amplifying the inflation-related feedback effects.
As of March 24, calculates Thomas Wade at the American Action Forum think tank, the Fed’s balance sheet had swollen to an unprecedented $7.7 trillion worth of assets. That’s double the size of Germany’s annual output and 22.6 times Vietnam’s $340 billion economy.
And that’s just the Fed firepower that can be accounted for qualitatively. It’s near impossible to quantify both how much liquidity the Fed is actually deploying or where it’s headed.
The most likely destinations, naturally, are the hottest emerging economies in demand with multinational company CEOs and investors alike. The same goes for nations with monetary systems closely attuned to dollar transactions.
Vietnam is Exhibit A, notes economist Viet-Ngu Hoang at Australia’s Queensland University of Technology. “Any change in the international value of US dollars, for example initiated by an adjustment of the Fed funds rate, would directly affect the foreign exchange market in Vietnam,” Hoang says.
We’re not just talking about “hot money,” but long-term investment. In 2020, a devastating 12 months for economies everywhere, Vietnam managed to pull in $29 billion of foreign direct investment (FDI).
Overseas companies invested in at least 19 different sectors last year, particularly manufacturing and business processing, which together accounted for 47% of FDI.
What’s more, Vietnam’s General Statistics Office says another 300 international companies are eyeing big investments there. In the first quarter, pledged FDI jumped 18.5% year-on-year.
One reason the central bank hopes to cap the dong is to encourage even more factory investments. And that, says economist Francesco Pesole of Dutch bank ING, could be an intriguing test of President Joe Biden’s tolerance toward allies in Asia.
“Vietnam has been one of the key beneficiaries of the re-routing of Chinese products to dodge US tariffs,” Pesole says. “And the US stance on Vietnam and its currency can be considered as a good gauge of how much the US is willing to expand its tough trade stance on China to the broader Asian region.”
On April 1, Biden’s newly confirmed US Trade Representative Katherine Tai signaled that Hanoi won’t be getting a pass.
After speaking with Tran Tuan Anh, Vietnam’s minister of industry and trade, Tai said both governments plan to pursue “sustained dialogue” on exchange rates.
For now, though, Vietnam can probably breathe easy on the imposition of punitive tariffs. Trump’s team refrained from hitting Hanoi with new taxes; Biden’s will be loath to punish a key US ally just as it opens talks with China.
Yet the most acute pressure for now is coming from inflation. Nguyen Thu Oanh, who heads the General Statistics Office’s inflation department, points to the risks from higher oil prices, recovery demand and global credit trends.
Domestically, liquidity is only growing slightly. Vietnam’s bank lending rose 1.47% this year as of March 19 versus 0.68% in the year-earlier period.
And the “the risk of debt distress is low,” says economist Yuanliu Hu at the Institute of International Finance. IIF expects Vietnam’s debt as a percentage of GDP to reach a reasonable 57%.
Yet the capital zooming in from the West is swelling. Harvard University economist David Dapice finds great meaning in “inflation differential” dynamics. Vietnam’s GDP deflator, he says, grew 62% from 2010 to 2019 while the US deflator was up 17%.
If Vietnam’s currency had depreciated by the amount of Vietnam’s “extra” inflation, it would have depreciated by 38%. The dong currently hovers around 23,000 to the greenback.
Under purchasing power economic theory, he adds, “exchange rates reflect inflation differentials.”
One obvious risk: 2021 growth forecasts rely on “muted inflation,” says International Monetary Fund economist Era Dabla-Norris, meaning not far above the 4% mark. Should fears that prices may be rising nearly twice that come December be realized, all bets could be off.
If Prime Minister Phuc’s team is going to harness this year’s recovery to good effect — and keep inflation from getting out of control — there are three specific reform priorities.
One, mind the obsessive dong management. Over the last 20 years, the State Bank of Vietnam’s assertive efforts to weaken exchange rates have just as often provoked sudden shifts in investor sentiment, the very boom-bust cycles Hanoi wants to avoid.
An undervalued dong can lead to economic overheating that causes the pendulum to swing more widely. A rising dong would both communicate economic confidence and act as a vital bulwark against excess Fed cash and imported inflation.
Two, shrink the state sector once and for all. With its smokestack-heavy growth model, communist government, sizable population, low labor costs and geographical placement, Vietnam is often seen as a “mini-China.” This gives Vietnam a unique advantage in Southeast Asia as Trump’s tariffs and bans on companies caused a shakeup in production cycles.
Yet Vietnam also suffers from a sprawling and inefficient state-owned enterprise (SOE) sector. SOEs use their political connections to stymie shifts to more productive, innovative and startup-friendly growth models that create millions of office jobs and fresh wealth.
Three, make Vietnam more about tech unicorns than factories. That means shifting tax and regulatory codes to the advantage of new small-to-medium-sized enterprises. Manufacturing jobs are indeed important if Vietnam is to beat the “middle-income trap.”
But in today’s “unicorn” crazed world, generating more economic energy from the ground up is more impactful.
At the moment, Vietnam is learning the hard way what Hans Sennholz, former president of the Foundation for Economic Education, observed back in the days of US Fed chairman Alan Greenspan, the mid-to-late 1990s which marked the beginning of the internationalization of Fed policies.
The “country that provides the world reserve asset can, for a while, live comfortably beyond its means, enjoy massive imports from abroad while it is exporting its newly-created money in payment of such imports. In short, it can raise its level of living at the expense of the rest of the world.”
Welcome to Hanoi’s 2021, as the Powell-led Fed churns out unprecedented monetary stimulus that is fast leaking and overheating economies abroad. It’s making for some rough financial seas in far-off places.