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Banking & Finance

Pressure mounts

Released at: 08:41, 02/12/2017

Pressure mounts

Photo: Viet Tuan

Real issues are emerging from the government’s bid to use credit growth to support GDP growth.

by Duy Anh

Vietnam’s economic growth is the envy of Asia, as its neighbors struggle to keep up with its 7.4 per cent pace. Credit growth is surging 20 per cent year-on-year and pledged foreign direct investment (FDI) jumped 34 per cent in the nine months ended September. Long-time Vietnam observers, however, know how quickly sentiment towards the $220-billion credit-fueled economy can change. Investors’ views tend to swing wildly from irrationally bullish to implacably negative, with few stopping points in between. And with good reason, as Vietnam does indeed tend to boom and bust every five years or so, as in 2013, 2007, 2001, and 1997. The question is whether things will be different this time around or if investors should brace for an upcoming cyclical bust. 

Bad debt hangover

Just five years ago, the country was reeling under a mountain of bad debts, with non-performing loans (NPLs) at 17 per cent of the total. Past credit cycles, most recently 2008 and 2011, were characterized by large shares of credit directed to State-owned enterprises (SOEs) and to the real estate sector, leading to deteriorating quality of bank balance sheets and higher inflation. The souring debts of SOEs, together with a burst property bubble, left the country’s ill-managed and secretive banks in a mess.

Granted, Vietnam has done some heavy lifting to overhaul its banking sector. The State Bank of Vietnam (SBV) in 2013 created the Vietnam Asset Management Company (VAMC), which functions largely as a warehouse for bad debts. Though VAMC itself does not really fix the problem, as the cumulative NPL recovery rate has been low, at approximately 20 per cent, its program - zero coupon bonds amortized over five years - did enough to delay the impact on banks’ profit and loss and balance sheets, allowing them to at least gradually grow out of the problem.

The latest official NPL ratio stands at 2.46 per cent, as at end-August, and lending over the past three years has shifted towards the private and consumer sectors, both of which Credit Suisse believes still have further room to grow, and away from SOEs, thus reducing the government’s contingent liabilities. Even so, as Moody’s Investors Service warns, there are still few guardrails in place to avoid another credit binge that goes bad. In May, for example, Moody’s said Vietnamese banks “will face capital shortfalls over the next 12-18 months, and that such a situation continues to represent a key credit burden for the industry.”

Vietnam has been trying desperately to reach its 6.7 per cent GDP target this year and Prime Minister Nguyen Xuan Phuc’s call in August for the full-year credit growth target to be raised from the 18 per cent set by the SBV to 21 per cent was an attempt in the same direction. That came a month after the SBV shocked markets with its first official interest rate cut in three years. The one-quarter percentage point cuts in both the refinance rate, to 6.25 per cent, and the discount rate, to 4.25 per cent, were aimed at boosting economic growth and were carefully considered after the foreign exchange market in 2016 and the first half of this year was successfully managed and stabilized, SBV Governor Le Minh Hung told VET.

Few would question there was room to reduce rates. However, it comes at a cost of putting upwards pressure on prices going forward as well as potentially fueling a credit bubble. Given the country’s relatively recent run-in with bad loans and the rapid rate of credit growth, coupled with an over-dependence on banks for meeting borrowing requirements, this could quickly become a heady situation. “Credit booms on the scale that Vietnam is experiencing are not sustainable over the long term, and another sharp rise in NPLs looks inevitable,” Mr. Gareth Leather from Capital Economics noted. As a result, he concluded, “risks are building” and “we are increasingly concerned by the rapid increase in debt.”

Credit intensity

The preoccupation of policymakers with the economic growth target stems from the fact that another failure would make it the second year in a row that the government, which assumed leadership last year, has failed to achieve its stated goal of growing Vietnam’s economy at what is perceived to be a sufficiently swift pace. Unfortunately, the so-called “credit intensity” of Vietnam’s growth has deteriorated in recent years to the point where the country’s nominal GDP growth is now roughly half the rate of its system-wide bank credit growth rate, meaning that faster credit growth or additional interest rate cuts are unlikely to have much of an impact.

Yields on five-year government bonds have fallen about 90 basis points (bps) year-to-date, while short-term interbank interest rates fell from 5 per cent earlier this year to 1 per cent today. Nearly every weekly government bond auction since mid-July has essentially failed, signaling that interest rates in Vietnam have reached sustainable equilibrium. With the current credit-to-GDP ratio now at the 125 per cent level that has typically triggered macro-stability issues for the country in the past, Vietnam has gone excessively overboard from an 80 per cent credit-to-GDP level that the International Monetary Fund (IMF) believes is appropriate for the country, while others note that the increase in Vietnam’s credit-to-GDP ratio over the last decade from trough-to-peak is second only to China’s, further raising concerns that risks of future policy mistakes are rising.

An interesting aspect of the July rate cut is that although commercial banks have moved swiftly to reduce their lending rates, they have not done the same for their deposit rates, triggering concerns that the gap between credit and deposit growth rates will create liquidity and systemic issues. To make matters worse, a central bank directive that places limits on the maximum ratio of short-term funds used for medium and long-term loans will see this ratio decline to 40 per cent starting in 2018, making it nearly impossible for banks to reduce deposit rates as they will face liquidity issues.

Experts believe that the decline in lending rates with deposit rates remaining unchanged has a direct impact on bank profitability. “Banks need to see a marked increase in credit off-take in order to make up for the compressed spread between borrowing and lending rates,” banking expert Mr. Nguyen Tri Hieu said. “Failing to do so would be harmful to their own financial well-being.” Deposit growth in the first nine months of 10.08 per cent was far behind the 12 per cent in the same period last year, while interest rates on short-term loans have come down to 6-6.5 per cent and medium and long-term loan rates are in the 8-10 per cent range after the July rate cut.

Vietnamese banks have posted impressive profit figures of late. For instance, Vietcombank reported pre-tax profit of VND7.93 trillion ($349 million) for the first nine months, up 25.4 per cent year-on-year. Meanwhile, VPBank posted pre-tax profits of VND5.63 trillion ($248 million) in the same period, a 79 per cent increase from a year ago. However, all local banks may not be as healthy as their current profits may make it seem. Vietinbank, which hasn’t reported its financial performance for the first nine months of 2017 at the time of writing, will see their profits wiped out and turn into a loss as the bank must settle its bad debts at VAMC this year. 

Not a quick fix

Prime Minister Phuc recently set the wheels in motion to facilitate the implementation of the National Assembly’s resolution on bad debt settlement from August 15. Not only including measures to improve lenders’ ability to enforce collateral security, which already appears to have made banks more aggressive in seizing commercial property to foreclose bad loans, Resolution No. 42 also enhances the trading of bad debt in the secondary market. Bad debt can now be sold to any legal entity, including foreign investors, without them needing a license for debt trading. 

The attempt to involve foreign investors could increase the funds available for debt resolution, particularly given their recent strong interest in Vietnam, with net FDI inflows being among the strongest in Asia-Pacific in 2016, at 5.6 per cent of GDP. However, the sale of debt to foreigners could still be constrained by remaining uncertainties, including restrictions on foreign investors taking security over property. This is just one example of the problems that, in practice, are still likely to hinder bad debt resolution. “The new framework will only be properly tested when large cases are handled, and we expect remaining shortcomings to be addressed only slowly,” Fitch Ratings wrote in a September report.

Quicker debt resolution could also reduce banks’ capital charge burden, which would better position banks for the scheduled implementation of Basel II standards in January 2020. As it stands, banks’ reported capital adequacy ratios (CARs) meet minimum requirements, but these are based on official NPL ratios that understate problem loans in the banking sector. In fact, “capital adequacy in the banking system is poor because rapid credit growth is already outpacing internal capital generation and sources of external capital are limited.” Moody’s lead analyst Ms. Daphne Cheng told VET, adding that the government intends to rely on banks’ earnings to close their capital shortfalls, given its lack of fiscal resources to inject fresh capital.

Potential progress on resolving legacy bad loans should be weighed against asset-quality risks that could be stoked by recent rapid loan growth. Current asset-quality problems can be traced back to rapid credit growth and poor lending standards during the 2000s, when risks crystallized in 2011-13 and caused significant stress in the financial sector. And as Fitch Ratings noted, “another extended period of rapid credit growth to meet GDP targets could eventually trigger another wave of defaults.”

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