Vietnam: The Asian dynamo loses power

Only five years ago, "Vietnam was the darling of foreign investors in search of the next hot emerging market", says Ben Bland in the Financial Times. It was widely seen as Asia's other Communist dynamo', benefiting from free-market reforms. It boasted a wide range of commodity exports, including coffee, tea and rice.

Its 86-million-strong population, rapidly-growing middle class and low wages a third of southern Chinese levels proved enticing for foreign companies. GDP soared by an average of 8% a year between 2003 and 2007. The country's main stockmarket index, the VN index, quadrupled between 2005 and 2007.

But over the past two years the VN has drifted downwards. It is grappling with a hangover from the government's aggressive growth policy after the 2008/2009 downturn. It encouraged a Chinese-style bank-lending spree, kept monetary policy easy, increased spending, and promoted the development of state-owned enterprises. The boom drove the annual inflation rate up to 20%, the highest in Asia.

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It also widened the trade deficit (undermining confidence in the currency, the dong) and fuelled fears of a wave of bankruptcies caused by careless lending. Credit has reached 120% of GDP. As a result, the government has been forced to combat overheating. Interest rates have risen sharply and targets for credit growth have tempered lending. Annual growth has fallen below 6% in the process.

The good news is that inflation has eased for four months in a row, while "the government has finally moved to begin restructuring some of the smaller, weaker banks", says Bland. Reforming wasteful state-owned enterprises is the crucial next step. That will be politically awkward, but policymakers have shown in the past that they can act when "their backs are against the wall", says Jonathan Pincus of Harvard University.

But while Vietnam is heading in the right direction, growth is unlikely to quicken while inflation remains high. The global backdrop is also discouraging. Vietnam ships a greater proportion of its exports to Europe than any Asian country apart from India and China, says consultancy Capital Economics. China is also a key trading partner. So Europe's recession and a possible hard landing in China will hit growth. It's too early to expect the stockmarket to make a sustained recovery just yet.