Vietnam has descended from heaven to hell in a matter of weeks. The chorus of praises still echoes in the fund raising circles: Asia's hidden dragon, the one in the China-plus-one strategy among multinationals, and the next China. Then, its stock market collapsed like a house of cards. While its officially controlled exchange rate, the dong, remains stable, its 12month forward price in the offshore market is already 30% lower. Vietnam's crisis bears eerie resemblance to the Thai bath crisis that heralded the Asian Financial Crisis in 1998. Are we headed for another emerging market crisis?
Yes, we are entering another wave of emerging market crisis that seems to occur every ten years. Several prominent economies may experience collapsing asset prices and weakening exchange rates. But, this wave wouldn't spread like wildfire like the one ten years ago. Emerging economies have been running over half a trillion dollars of trade surpluses per annum (mainly attributable to China and oil exporters) in contrast to the aggregate deficits ten years ago. Dollar shortage would inflict only a few economies like Vietnam, India, or some East European economies. Further, the economies with massive foreign exchange reserves could help those with dollar shortage. Hence, this wave of crises would be more limited in scope.
Vietnam's crisis is self-inflicted. It didn't handle the hot money well and allowed it to supercharge its money supply. The resulting credit surge went into stock and property speculation. Inflating asset prices exaggerated the economic growth rate, which supported the hype behind the hot money inflow. The resulting overheating triggered accelerating inflation. As the government took action in early 2008 to rein in inflation, hot money began to flee. The resulting currency weakness worsened inflation and forced further tightening. The virtuous cycle turns into a vicious one.
Most bubbles start with a good story. Vietnam has averaged 7.5% GDP growth rate in the past decade. Its poverty rate has been halved since 1993 to 24%. Since China began to appreciate its currency in 2005, Vietnam gained extra attention as an alternative production base to China. To attract export manufacturing businesses, Vietnam promised them to keep its exchange rate low and pegged it to the US dollar. The policy did work wonders and attracted many businesses (mainly in garments, shoes, and furniture) from Pearl River Delta. Even though Vietnam runs a large trade deficit, it is largely financed by foreign direct investment ('FDI'), i.e., its trade deficit or investment surge is FDI-led and self financing.
Its currency policy then laid the seed for today's trouble. Vietnam's economic successes began to attract the attention of international capital. While Chinese retail investors view big international fund management houses with awe, thinking they have secret recipes for making money, they are actually run by their marketing managers who sell funds rather than fund managers who invest money. The marketing managers want to sell funds that are hot and, hence, easy to sell. When a country gains prominence in international media, it is easy to sell funds in its name. But, it is exactly the wrong time to invest, as the media attention usually means overvaluation. Hence, international capital, pushed by big fund management houses, adds fuel to fire and amplify the economic overheating. Vietnam is just the latest example in the long history of 'from rags to riches and to rags again' for emerging markets.
Vietnam registered 10% of GDP in current account deficit in 2007. There is no doubt that it partly resulted from overheating. Excessive optimism drove some of the investment growth. But, Vietnam does need investment to build up its industry. Despite the hype over its export success, it remains a backward economy. Primary commodities like oil, rice, fish, and wood account for half of its exports. On value added basis, these commodities probably account for three quarters of its exports, as manufacturing exports have value added of about 50% or less. Vietnam is still a primary producer in global trade. As China's production cost rises, it is a golden opportunity for Vietnam to repeat East Asia's export-led development success. Indeed, the total FDI last year was quite close to its current account deficit, i.e., its imports were probably driven by foreign businesses.
The current account deficit didn't stop Vietnam's foreign exchange reserves from rising by $10 billion (or 12% of its GDP), mainly due to portfolio investment inflow, i.e., hot money. The money came from retail fund investors in Asia, Europe, and the United States. They heard about Vietnam and, egged on by their brokers, bought into various Vietnam funds. The inflow was going to push up Vietnam's currency value. To maintain its export competitiveness, Vietnam's central bought up the inflow to keep the currency from appreciating. It led to massive money growth. The government didn't stop the money growth from turning into credit growth. Bank lending rose by 50% in 2007 and above 60% in early 2008.
Anytime you see massive credit growth, the chances are that the money is flowing into stock and property market, regardless of what government data say. Other economic activities are not structured to absorb such rapid credit growth. Vietnam has set up 19 small joint stock banks. Of course, they would grab any opportunity to expand at the expense of large state banks. The easiest areas to lend money into are for stock trading and property development. The lending results in rising stock and property market. The rising asset prices increase the value of collaterals-land and stocks, which boosts lending.
The overheating led to high inflation. By the end of 2007, Vietnam couldn't ignore inflation on the ground that it was due to food and energy only and mostly imported. Inflation spread into all areas. In February 2008, the government acted with a package to cool demand, mainly by downsizing government investments and issuing bonds to decrease liquidity. The tightening, of course, led to diminished economic growth expectation. The strong funds inflow on growth optimism began to leave as growth outlook declined. The withdrawal of liquidity amplified the stock market decline that was already under way.
After rising by seven times in the previous three years, the stock market index began to dive in the fall of 2007, as the government restricted lending for market speculation. The fleeing hot money turned the decline into a total collapse. It has lost two thirds over the past seven months. While tightening is the immediate trigger for asset deflation, it was a bubble to begin with and would burst sooner or later. The mistake is not tightening but tolerating the bubble for so long.
When a bubble bursts, it is difficult to maintain order regardless of how good policies are. By definition, bubble bursting is a disruptive even. It is too late to stop a painful adjustment after a bubble has formed. It is just not possible to avoid pain after tolerating an asset bubble. Good policies, however, could keep the disruption short, say, less than one year. For example, China's tightening in 1994 restored stability relatively quickly. Korea's adjustment policy in 1998 brought the economy back in the following year. Bad policies could throw a country into a prolonged turmoil. For example, Indonesia's turmoil after 1998 lasted for five years.
Good policies must be internally consistent. There are two common mistakes that governments make in trying to restore macro stability: (1) fighting inflation without cooling demand and (2) depreciating currency to maintain competitiveness. Globalization has complicated inflation fighting, as more and more factors that affect inflation are determined by world markets rather than at home. Whatever excuses one may have, limiting money growth is a must for fighting inflation. Without some sort of quantitative control of money supply during high inflation, stabilization policy is likely to fail.
In Vietnam's situation, it must stabilize the deposit base and control credit growth. The former requires interest rate to be set above inflation rate. The surging demand for physical gold in Vietnam is a dangerous sign that inflation expectation is high. As paper money is exchanged into gold, it boosts money velocity and, hence, inflation. To stop this vicious dynamic of high inflation from taking hold, the government must ensure that the value of bank deposits is protected.
Controlling credit growth is the other side of the coin in stabilizing money supply. The government may have to set quotas for credit growth for the banks. The targets should decline relatively quickly to low double digit growth rate from the peak of over sixty percent. As the government restricts credit expansion, it has to eliminate many investment projects. Probably, many buildings have to remain unfinished, similar to what China experienced after 1994.
The bout of high inflation has eroded Vietnam's competitiveness. The market is betting that it has to devalue to protect its export-led development strategy and has priced in 30% devaluation in the forward market. Currency devaluation is not always bad. But, it doesn't work for Vietnam. Devaluation works best when an economy has excess capacity. For example, Korea had massive overcapacity in heavy industries in 1998 and devaluation played an important role in its economic recovery. Vietnam, however, hasn't built up its industrial capacity. Devaluation leads to more inflation, which then requires more devaluation to maintain competitiveness. The vicious dynamic can plunge the country into prolonged instability. Vietnam's per capita income is below $1,000. There is plenty of scope to improve competitiveness via improving efficiency.
Vietnam should defend its currency as a core strategy for fighting inflation. It should obtain dollar liquidity lines from its neighbors and the international financial institutions like the IMF, World Bank, and Asian Development Bank. If it can demonstrate a credible policy for currency stability, it would decrease demand for dollars and gold at home, which would cool inflation by slowing down money velocity. Of course, supporting the currency is not effective without controlling money supply and curtailing investments.
Vietnam is quite similar to China in 1992-93. The country already possesses the necessary elements for an economic takeoff. International investors see the potential and pile in. The government has trouble controlling itself and tries to satisfy all the interest groups by tolerating investment projects and credit expansion. In 1992, China's monetary excess was due to rampant and voluntary money printing out of ignorance about its inflationary consequence. Hot money inflow was the most important driver in Vietnam's monetary excess. The similarities between the two are an optimistic and inexperienced government that wanted to look from bright side whenever possible and tolerated excessive credit expansion for too long.
Once its economy stabilizes, Vietnam has a great future like China fifteen years ago. It has a good labor force and a pro-growth government. It needs to build up its infrastructure and industrial base. It needs to be patient in building up the economy, not trying to do everything at once. What is occurring is a lesson to its government and its economic management would improve in the future due to the lesson learnt. While international capital is pulling out of the stock market en masse, its market is probably worth investing now on low valuation. Of course, as foreign money continues to pull out, the market may sink further. The recovery would take time like China's market in 1994.
The contagion effect of Vietnam's crisis has been limited so far. Dollar abundance among developing economies is the reason. In 1998, most developing economies had short-term dollar debts. Debt investors tend to run as soon as they feel uncertainty, as their upside is interest income but the downside is losing principal. The contagion effect today could come from hot money in stock and property market pulling out. When one pulls money out of stock or property market, their prices fall. Hence, the quicker the outflow, the less the outflow. This self-balancing dynamic makes the contagion less serious than ten years ago.
Limited contagion effect doesn't mean that the international community shouldn't help Vietnam. As a neighbor, China may have to assume a special responsibility. Any crisis has unpredictable consequences. Cambodia and Laos, for example, are vulnerable to what's going on in Vietnam. The stability of Indochina is important to China's Southwest. It is in China's interest to lend a hand. If Vietnam asks China for help, China should say yes.
Limited contagion doesn't mean that other emerging economies can carry on like before. What's affecting Vietnam is affecting others. The bottom line is that, after years of fast monetary expansion, inflation is affecting everyone. Almost all the developing economies need to limit demand growth to contain inflation. As many, if not most, emerging economies have overvalued asset markets, containing inflation means asset deflation, which is painful.
India has been a superstar in the current growth cycle. Unlike the other three in the BRIC group, it has trade and fiscal deficits. Hence, it is vulnerable to a turbulent adjustment like Vietnam. Its inflation may climb to double digit rate soon. Its social consequences could lead to political instability. The fiscal constraint may force the government to stop fuel subsidy. The resulting inflation surge may lead to instability and frighten away hot money. As the massive amount of hot money flees its stock market, it could further destabilize the country. If India enters turbulent adjustment, it would have serious consequences through eroding confidence for emerging economies as a whole. So much of the faith in emerging economies comes from optimism over China and India. If one star dims, the optimism would come under the severest test since 1998.
While we are not witnessing a repeat of 1998, many emerging economies may encounter turbulence in 2008. Some may experience full blown crisis.
2 comments:
又一场新兴市场危机
谢国忠/文 《财经》杂志 总第214期 [06-23 00:00]
导致越南危机的问题，其他新兴市场国家也存在。但这次危机不会像十年前那样大范围蔓延，印度则可能是个例外
短短数周，越南就从天堂坠入了地狱。越南股市就像纸扎的房子一样迅速崩塌。虽然越南官方的控制使越南盾汇率暂时稳定，但在离岸市场，越南盾12个月远期价格已低于现价30％。这样的情形，与1998年引发亚洲金融危机的泰铢危机有惊人的相似之处。那么，我们是否将进入另一场新兴市场危机呢？
是的。这种危机似乎每十年爆发一次，一些主要新兴市场可能经历资产价格下跌和汇率走弱。但是，这次危机不会像十年前如野火般蔓延到其他国家。与十年前总体上存在贸易赤字相比，如今新兴市场每年有超过5000亿美元的贸易盈余（主要是中国和石油出口国的贡献）。美元短缺只会困扰为数不多的国家，例如越南、印度和一些东欧国家。此外，有巨大外汇储备的新兴市场国家，可以援助那些美元短缺国。因此，这场危机的范围可以进一步得到控制。
危机链条
越南的危机是其自身造成的。它没有很好地控制“热钱”规模，造成对货币供给的压力。货币供给过剩导致信贷扩张，增加的贷款又转而投向股市和房市，进行投机。虚高的资产价格使经济增长速度被高估，而高速增长支撑了推动“热钱”流入的炒作。结果是，经济过热加快了通货膨胀。由于2008年初越南政府采取措施控制通胀，“热钱”开始撤出越南。由此导致的汇率走弱加剧了通胀，迫使政府进一步紧缩。良性循环变成了恶性循环。
大多数泡沫的开端都有一个精彩的故事。
过去十年，越南GDP平均增速是7.5％；自1993年，贫困率下降了一半，减至24％。由于2005年起，人民币开始升值，作为中国生产基地的替代，越南格外引人瞩目。为了吸引出口制造业，越南承诺将汇率维持在一个较低水平上，并且盯住美元。这个政策确实生效，并从珠三角吸引了大量企业，主要是服装、制鞋和家具企业。越南主要是通过外商直接投资（FDI）来为巨大的贸易赤字（意味着国内储蓄小于国内投资）融资，即贸易赤字和投资浪潮是由FDI引导的。
一方面，越南的货币政策为今日的麻烦埋下了种子。另一方面，越南的经济成功吸引了国际资本的注意。
在中国，个人投资者对大型国际基金怀有敬畏之心，认为他们有挣钱秘诀。但这些基金其实是由销售基金的市场经理运作，而非由真正做投资的基金经理运作。市场经理希望销售的，是那些抢手、好卖的基金。当一个国家在国际媒体报道中占据主要位置后，以该国命名的基金就很好卖。但这恰是投资的错误时机，因为媒体的关注通常意味着估价过高。大型基金管理公司推动国际资本涌入越南，无异于火上浇油，加剧经济过热。
2007年，越南经常项目赤字约占GDP的10％。毋庸置疑，这部分是因为经济过热，过度乐观推动了投资增长。不过，越南确实需要投资来兴建工业体系。尽管对越南出口的成功存在大量炒作，越南仍然还是一个落后的经济体。越南出口的制造业商品附加值较低，不超过50％，而初级商品出口占越南出口的四分之三。在全球贸易链中，越南仍然是初级产品生产商。中国生产成本上升对越南是个黄金机遇，使其可能重演东亚出口导向型经济成功的一幕。
经常项目赤字并没有妨碍越南外汇储备上升（增加了100亿美元，占GDP的12％）。这主要是由于短期资本的流入，即“热钱”。这些“热钱”来自亚洲、欧洲和美国的个人投资者。他们听说越南高速增长，受到经纪商的鼓动，买入各种越南基金。短期资本流入推高了越南盾的价格。为保持出口竞争力，越南中央银行买入大量外汇，以避免本币升值，从而带来大量货币供给。重要的是，越南政府没有阻止货币供给增长演变为信贷增长。2007年，越南银行贷款增加 50％，2008年初增幅更超过60％。
不管政府的数据怎么说，任何时候出现大量信贷增长，都很可能是资金正流向股市和房市。其他经济活动都不会吸收如此快速增长的信贷。越南已经设立了19 家小型股份银行。它们将抓住任何机遇扩张。最先需要贷款的就是股票交易和房产投资，从而导致了股市和房市走高。资产价格走高又推动了抵押品——土地和股票的价格，增加了贷款需求。
经济过热导致高通胀。到2007年底，越南无法再忽略通货膨胀。由于通胀仅由食品和能源价格引起，而且主要是因为进口商品价格上涨，2008年2月，越南政府采取一系列措施给内需降温，主要是通过减少政府投资和发行国债减少流动性。当然，这些紧缩政策会引起经济增长放缓的预期。当增长前景看淡，原本对越南经济增长持乐观态度的基金开始退出，这加速了股市下跌。
调整之痛
过去三年七次大涨之后，2007年秋天，越南股市开始跳水，这是因为越南政府为防止市场投机而限制信贷。“热钱”逃走，使得股市下跌变成了彻底的股灾。过去七个月里，越南股市缩水三分之二。尽管紧缩政策导致资产贬值，但是泡沫迟早会破灭，错不在紧缩政策，而在于容忍泡沫存在如此之久。
当泡沫破灭时，不管政策多么好，都很难保持一切井然有序。从定义上讲，泡沫破灭就是一个引起混乱的事件。泡沫形成后，就无法避免调整带来的痛苦。不过，好的政策可以缩短破坏时间，例如一年内。1994年中国的紧缩政策，就相对很快地使经济恢复到稳定增长路径；1998年韩国的调整政策，也使经济在下一年回到了正常轨道。不好的政策会使一个国家陷入长时间的混乱。例如，1998年之后印度尼西亚的混乱持续了五年。
好政策必须逻辑一致。通常，政府为恢复宏观经济稳定会犯两个错误：治理通胀，却没有冷却内需；为保持竞争力使本币贬值。全球化使得治理通胀变得复杂，因为越来越多导致通胀的因素是由全球市场决定。但无论如何，限制货币供给增长是治理通胀的必要手段。在高通胀时期，没有货币供给数量的控制，意图实现经济稳定增长的紧缩政策很可能会失效。
对于越南来讲，它必须稳定存款，同时控制信贷增长。前者需要提高利率到通胀率以上的水平。越南出现的黄金需求是通胀预期很高的危险信号。由于纸币换成黄金，加快了货币周转速度，进一步推动了通胀。为阻止通胀攀升，政府必须确保银行存款的价值受到保护。
控制信贷增长是稳定货币供给的另一种方式。政府可能会对银行实施信贷配额。其目标应该是迅速降低两位数的信贷增长率，从逾60％的峰值落下来。由于政府控制信贷扩张，许多投资项目会被削减。其间很可能会出现“烂尾楼”，就像1994年之后中国经历的那样。
这次高通胀会削弱越南的竞争力。市场认定越南为保证出口导向发展战略，必须使本币贬值。在远期市场上，市场已经预期越南盾会贬值30％。货币贬值并不总是坏事。但对越南肯定不是好事。当一个国家产能过剩，贬值会发挥很好的作用。如，1998年韩国重工业产能过剩，而贬值在其经济复苏中起了重要作用。但越南还没有建立起工业体系。贬值会导致更严重的通胀，而通胀又要求越南盾进一步贬值，以保障出口商品的竞争力。这种恶性循环会使一个国家陷入长期不稳定。事实上，越南人均收入低于1000美元，还有很大的空间通过提高效率来增强竞争力。
越南应将稳定币值作为治理通胀的核心战略。它应从邻国或国际金融组织，例如国际货币基金组织、世界银行和亚洲发展银行，借入美元。如果越南可以发布一项可信的稳定币值的政策，国内美元和黄金需求就会减少，这可以减慢货币周转速度，从而降低通胀率。当然，不控制货币供给、压缩投资，稳定币值就不会有效。
有限危机
当前，越南的情况很像1992年－1993年的中国。越南已经具备了经济起飞的必要因素。国际投资者看到了它的潜力，并投入大量资本。越南政府无法独立制定政策，并试着满足所有利益集团，允许项目开工和信贷扩张。当然，1992年，中国的超额货币供给是因为肆意印刷钞票，却没有考虑到通胀后果；而“热钱”流入是越南货币超额供给最重要的驱动因素。越南和中国的相似之处在于，政府都乐观、没有经验，一旦有可能，政府都会看好的一面，并且容忍过度信贷扩张太久。
一旦经济着陆，越南就像15年前中国那样，面临非常好的机遇。它有很好的劳动力和倾向经济增长的政府。它需要修建基础设施和建立工业基础。修建经济金字塔需要耐心，而不是立即尝试做每件事。现在发生的事情对越南政府是一个教训，未来越南政府的经济管理方式会因这次危机而有所改善。当国际资本集体从越南股市退出，股市跌到低点，这时的越南更值得投资。当然，由于外国资本持续撤出，市场会进一步下跌。越南股市复苏需要时间，就像1994年中国股市那样。
越南危机目前影响范围较小，原因是发展中国家有充足的美元。1998年，大多数发展中国家有短期美元债务。一旦债权人感到前景不确定，他们会抽逃资金。这是因为当发展中国家经济形势好，他们可以获得利息收入；形势不好，他们就要亏本。目前传播效应来自股市和楼市的“热钱”撤离。当资金从股市和楼市中抽出，资产价格会下降。因此，资金流出越快，流出量越小。这种自我平衡的调节过程，使得这次危机的传染性没有十年前严重。
传染效应有限，并不意味着国际社会不该给越南提供援助。作为邻国，中国应该担负特殊的责任。任何危机都有意想不到的后果。例如，柬埔寨和老挝很容易受到越南危机的影响，而中南半岛的稳定对中国西南的安定非常重要。因此，援助也是从中国的利益考虑。如果越南请求中国帮助，中国应该同意。
传染效应有限，也不意味着其他新兴经济体仍能继续原来的发展模式。越南遇到的问题，其他国家也存在。实际上，经过数年高速货币扩张，通胀正在影响每一个人。几乎所有的发展中国家都需要冷却内需来控制通胀。大多数新兴国家，至少是很多新兴国家的资产价格已经高估，控制通胀意味着资产价格下调，那是一个相当痛苦的过程。
印度是这轮增长的超级明星之一。但与“金砖四国”（巴西、俄罗斯、印度和中国）中的其他三国不同，印度有贸易和财政赤字。因此，它更容易像越南这样陷入剧烈调整。它的通胀率可能会很快攀升到两位数。其财政约束可能迫使政府停止石油补贴，由此推高通胀，可能引发不稳定，并吓退“热钱”。当大量“热钱”从股市撤离，这会进一步导致不稳定。如果印度开始剧烈调整，将打击投资者对所有新兴市场的信心，后果非常严重。对新兴市场的信念，主要来自对中国和印度经济的乐观。如果一颗明星坠落，投资者信心将跌到自1998年以来的最低点。
Déjà vu
Andy Xie
2008-06-26
Vietnam has descended from heaven to hell in a matter of weeks. The chorus of praises still echoes in the fund raising circles: Asia's hidden dragon, the one in the China-plus-one strategy among multinationals, and the next China. Then, its stock market collapsed like a house of cards. While its officially controlled exchange rate, the dong, remains stable, its 12month forward price in the offshore market is already 30% lower. Vietnam's crisis bears eerie resemblance to the Thai bath crisis that heralded the Asian Financial Crisis in 1998. Are we headed for another emerging market crisis?
Yes, we are entering another wave of emerging market crisis that seems to occur every ten years. Several prominent economies may experience collapsing asset prices and weakening exchange rates. But, this wave wouldn't spread like wildfire like the one ten years ago. Emerging economies have been running over half a trillion dollars of trade surpluses per annum (mainly attributable to China and oil exporters) in contrast to the aggregate deficits ten years ago. Dollar shortage would inflict only a few economies like Vietnam, India, or some East European economies. Further, the economies with massive foreign exchange reserves could help those with dollar shortage. Hence, this wave of crises would be more limited in scope.
Vietnam's crisis is self-inflicted. It didn't handle the hot money well and allowed it to supercharge its money supply. The resulting credit surge went into stock and property speculation. Inflating asset prices exaggerated the economic growth rate, which supported the hype behind the hot money inflow. The resulting overheating triggered accelerating inflation. As the government took action in early 2008 to rein in inflation, hot money began to flee. The resulting currency weakness worsened inflation and forced further tightening. The virtuous cycle turns into a vicious one.
Most bubbles start with a good story. Vietnam has averaged 7.5% GDP growth rate in the past decade. Its poverty rate has been halved since 1993 to 24%. Since China began to appreciate its currency in 2005, Vietnam gained extra attention as an alternative production base to China. To attract export manufacturing businesses, Vietnam promised them to keep its exchange rate low and pegged it to the US dollar. The policy did work wonders and attracted many businesses (mainly in garments, shoes, and furniture) from Pearl River Delta. Even though Vietnam runs a large trade deficit, it is largely financed by foreign direct investment ('FDI'), i.e., its trade deficit or investment surge is FDI-led and self financing.
Its currency policy then laid the seed for today's trouble. Vietnam's economic successes began to attract the attention of international capital. While Chinese retail investors view big international fund management houses with awe, thinking they have secret recipes for making money, they are actually run by their marketing managers who sell funds rather than fund managers who invest money. The marketing managers want to sell funds that are hot and, hence, easy to sell. When a country gains prominence in international media, it is easy to sell funds in its name. But, it is exactly the wrong time to invest, as the media attention usually means overvaluation. Hence, international capital, pushed by big fund management houses, adds fuel to fire and amplify the economic overheating. Vietnam is just the latest example in the long history of 'from rags to riches and to rags again' for emerging markets.
Vietnam registered 10% of GDP in current account deficit in 2007. There is no doubt that it partly resulted from overheating. Excessive optimism drove some of the investment growth. But, Vietnam does need investment to build up its industry. Despite the hype over its export success, it remains a backward economy. Primary commodities like oil, rice, fish, and wood account for half of its exports. On value added basis, these commodities probably account for three quarters of its exports, as manufacturing exports have value added of about 50% or less. Vietnam is still a primary producer in global trade. As China's production cost rises, it is a golden opportunity for Vietnam to repeat East Asia's export-led development success. Indeed, the total FDI last year was quite close to its current account deficit, i.e., its imports were probably driven by foreign businesses.
The current account deficit didn't stop Vietnam's foreign exchange reserves from rising by $10 billion (or 12% of its GDP), mainly due to portfolio investment inflow, i.e., hot money. The money came from retail fund investors in Asia, Europe, and the United States. They heard about Vietnam and, egged on by their brokers, bought into various Vietnam funds. The inflow was going to push up Vietnam's currency value. To maintain its export competitiveness, Vietnam's central bought up the inflow to keep the currency from appreciating. It led to massive money growth. The government didn't stop the money growth from turning into credit growth. Bank lending rose by 50% in 2007 and above 60% in early 2008.
Anytime you see massive credit growth, the chances are that the money is flowing into stock and property market, regardless of what government data say. Other economic activities are not structured to absorb such rapid credit growth. Vietnam has set up 19 small joint stock banks. Of course, they would grab any opportunity to expand at the expense of large state banks. The easiest areas to lend money into are for stock trading and property development. The lending results in rising stock and property market. The rising asset prices increase the value of collaterals-land and stocks, which boosts lending.
The overheating led to high inflation. By the end of 2007, Vietnam couldn't ignore inflation on the ground that it was due to food and energy only and mostly imported. Inflation spread into all areas. In February 2008, the government acted with a package to cool demand, mainly by downsizing government investments and issuing bonds to decrease liquidity. The tightening, of course, led to diminished economic growth expectation. The strong funds inflow on growth optimism began to leave as growth outlook declined. The withdrawal of liquidity amplified the stock market decline that was already under way.
After rising by seven times in the previous three years, the stock market index began to dive in the fall of 2007, as the government restricted lending for market speculation. The fleeing hot money turned the decline into a total collapse. It has lost two thirds over the past seven months. While tightening is the immediate trigger for asset deflation, it was a bubble to begin with and would burst sooner or later. The mistake is not tightening but tolerating the bubble for so long.
When a bubble bursts, it is difficult to maintain order regardless of how good policies are. By definition, bubble bursting is a disruptive even. It is too late to stop a painful adjustment after a bubble has formed. It is just not possible to avoid pain after tolerating an asset bubble. Good policies, however, could keep the disruption short, say, less than one year. For example, China's tightening in 1994 restored stability relatively quickly. Korea's adjustment policy in 1998 brought the economy back in the following year. Bad policies could throw a country into a prolonged turmoil. For example, Indonesia's turmoil after 1998 lasted for five years.
Good policies must be internally consistent. There are two common mistakes that governments make in trying to restore macro stability: (1) fighting inflation without cooling demand and (2) depreciating currency to maintain competitiveness. Globalization has complicated inflation fighting, as more and more factors that affect inflation are determined by world markets rather than at home. Whatever excuses one may have, limiting money growth is a must for fighting inflation. Without some sort of quantitative control of money supply during high inflation, stabilization policy is likely to fail.
In Vietnam's situation, it must stabilize the deposit base and control credit growth. The former requires interest rate to be set above inflation rate. The surging demand for physical gold in Vietnam is a dangerous sign that inflation expectation is high. As paper money is exchanged into gold, it boosts money velocity and, hence, inflation. To stop this vicious dynamic of high inflation from taking hold, the government must ensure that the value of bank deposits is protected.
Controlling credit growth is the other side of the coin in stabilizing money supply. The government may have to set quotas for credit growth for the banks. The targets should decline relatively quickly to low double digit growth rate from the peak of over sixty percent. As the government restricts credit expansion, it has to eliminate many investment projects. Probably, many buildings have to remain unfinished, similar to what China experienced after 1994.
The bout of high inflation has eroded Vietnam's competitiveness. The market is betting that it has to devalue to protect its export-led development strategy and has priced in 30% devaluation in the forward market. Currency devaluation is not always bad. But, it doesn't work for Vietnam. Devaluation works best when an economy has excess capacity. For example, Korea had massive overcapacity in heavy industries in 1998 and devaluation played an important role in its economic recovery. Vietnam, however, hasn't built up its industrial capacity. Devaluation leads to more inflation, which then requires more devaluation to maintain competitiveness. The vicious dynamic can plunge the country into prolonged instability. Vietnam's per capita income is below $1,000. There is plenty of scope to improve competitiveness via improving efficiency.
Vietnam should defend its currency as a core strategy for fighting inflation. It should obtain dollar liquidity lines from its neighbors and the international financial institutions like the IMF, World Bank, and Asian Development Bank. If it can demonstrate a credible policy for currency stability, it would decrease demand for dollars and gold at home, which would cool inflation by slowing down money velocity. Of course, supporting the currency is not effective without controlling money supply and curtailing investments.
Vietnam is quite similar to China in 1992-93. The country already possesses the necessary elements for an economic takeoff. International investors see the potential and pile in. The government has trouble controlling itself and tries to satisfy all the interest groups by tolerating investment projects and credit expansion. In 1992, China's monetary excess was due to rampant and voluntary money printing out of ignorance about its inflationary consequence. Hot money inflow was the most important driver in Vietnam's monetary excess. The similarities between the two are an optimistic and inexperienced government that wanted to look from bright side whenever possible and tolerated excessive credit expansion for too long.
Once its economy stabilizes, Vietnam has a great future like China fifteen years ago. It has a good labor force and a pro-growth government. It needs to build up its infrastructure and industrial base. It needs to be patient in building up the economy, not trying to do everything at once. What is occurring is a lesson to its government and its economic management would improve in the future due to the lesson learnt. While international capital is pulling out of the stock market en masse, its market is probably worth investing now on low valuation. Of course, as foreign money continues to pull out, the market may sink further. The recovery would take time like China's market in 1994.
The contagion effect of Vietnam's crisis has been limited so far. Dollar abundance among developing economies is the reason. In 1998, most developing economies had short-term dollar debts. Debt investors tend to run as soon as they feel uncertainty, as their upside is interest income but the downside is losing principal. The contagion effect today could come from hot money in stock and property market pulling out. When one pulls money out of stock or property market, their prices fall. Hence, the quicker the outflow, the less the outflow. This self-balancing dynamic makes the contagion less serious than ten years ago.
Limited contagion effect doesn't mean that the international community shouldn't help Vietnam. As a neighbor, China may have to assume a special responsibility. Any crisis has unpredictable consequences. Cambodia and Laos, for example, are vulnerable to what's going on in Vietnam. The stability of Indochina is important to China's Southwest. It is in China's interest to lend a hand. If Vietnam asks China for help, China should say yes.
Limited contagion doesn't mean that other emerging economies can carry on like before. What's affecting Vietnam is affecting others. The bottom line is that, after years of fast monetary expansion, inflation is affecting everyone. Almost all the developing economies need to limit demand growth to contain inflation. As many, if not most, emerging economies have overvalued asset markets, containing inflation means asset deflation, which is painful.
India has been a superstar in the current growth cycle. Unlike the other three in the BRIC group, it has trade and fiscal deficits. Hence, it is vulnerable to a turbulent adjustment like Vietnam. Its inflation may climb to double digit rate soon. Its social consequences could lead to political instability. The fiscal constraint may force the government to stop fuel subsidy. The resulting inflation surge may lead to instability and frighten away hot money. As the massive amount of hot money flees its stock market, it could further destabilize the country. If India enters turbulent adjustment, it would have serious consequences through eroding confidence for emerging economies as a whole. So much of the faith in emerging economies comes from optimism over China and India. If one star dims, the optimism would come under the severest test since 1998.
While we are not witnessing a repeat of 1998, many emerging economies may encounter turbulence in 2008. Some may experience full blown crisis.
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