Emerging Markets Watch: Vietnam

Vietnam continues to be a major foreign direct investment (“FDI”) destination across diverse sectors. Overseas investors, particularly from ASEAN countries including Thailand and Singapore, together with longer established investors such as those from Japan and Korea, have increased their operational activity in the country as positive returns have encouraged further investments. Compared with other emerging markets in the region, Vietnam also enjoys stable macro-economic conditions, including low inflation and a well-regulated monetary policy. In addition, new free trade agreements, continuous legislative reforms together with political stability are also making the country an increasingly attractive investment destination. This is reflected in recent statistics, in the first 10 months of 2015, the country attracted $19.29 billion in new investments, a 40.8% year-on-year increase. Meanwhile, the implemented capital from existing FDI projects reached $11.8 billion, which was 16.3 per cent higher than the same period in 2014.¹

However, there remain a number of uncertainties and risks for inbound foreign investors in Vietnam. These include the geo-political situation around the South China Sea and limitations in obtaining information and disclosures which can present challenges to parties executing transactions.

Positive Economic Outlook
Vietnam started its economic transformation in 1986 under the banner of Doi Moi with the objective of creating a “socialist-oriented market-based economy”. This encouraged more private businesses to operate across a number of industries through decreased bureaucratic intervention. Over the last three decades, Vietnam has matured significantly in the way businesses are established and operate and recent economic growth rates have been strong. GDP growth was 5.2% in 2012, 5.4% in 2013, 6.0% in 2014,² and 6.7% in 2015³. The Vietnamese government has targeted a GDP growth rate of 6.5-7% and a trade increase of 12-15% per annum between 2016 and 2020.⁴

Market reform has enabled the process of equitization of State Owned Enterprises (“SOEs”) to commence, and the equitization program has taken place aggressively over the last two decades. Since the 1990s, more than 90% of approximately 12,000 SOEs have been equitized, and since 2011, Vietnam has equitized 350 SOEs and is now speeding up the restructuring of major state-owned groups and corporations, which have received significant international investment interest. For example, Vietnam’s current Prime Minister,⁵Nguyen Tan Dung (“Dung”), has announced that an increasing number of SOEs will be publicly listed⁶. At the same time, the government will also sell all of its shares in 10 large and profitable equitized companies, including Vinamilk and FPT, bringing further opportunities to investors.⁷

Dung has additionally vowed to reform public investment procedures to facilitate domestic and foreign investment, with an emphasis on Vietnam becoming a manufacturing hub for the regional electronics and IT industry. For example, in August 2015, Samsung increased its investment in a display module production project in the Bac Ninh province by four times to $4 billion, causing its cumulative investment in the country to reach $13.1 billion.⁸ On 10 April 2015, a new decree on public-private partnerships (“PPP”) became effective that is expected to attract increased foreign investment in the infrastructure sector.⁹ In June 2015, the government lifted restrictions on foreign ownership in listed companies which include former SOEs that have been equitized, allowing investors to take full ownership in specified sectors (from a prior maximum of 49% in some industries). These are all positive developments for foreign investors and, together with free trade agreements including the proposed Trans-Pacific Partnership, are expected to lead to further gains in the Vietnamese economy.¹⁰

Trans-Pacific Partnership (”TPP”)
The TPP is a much publicized free trade agreement between twelve countries bordering the Pacific Ocean and includes Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the U.S. and Vietnam¹¹. As of December 2015, the TPP was still undergoing legal review and expected to be signed and then ratified by all member parties’ legislatures within the next two years. The National Assembly in Vietnam will reportedly begin its review of the agreement in mid-2016,¹² with the Ministry of Industry and Trade and Ministry of Justice being in charge of identifying the gaps between domestic laws and TPP regulations. Analysts have noted that where there is a conflict between TPP regulations and domestic regulations, those of the TPP will prevail. A study by the Peterson Institute for International Economics estimates that Vietnam’s GDP could grow by an additional 10% by 2025 as a result of the TPP.¹³

If the TPP is adopted and enacted, Vietnam could be a significant beneficiary given its well established garment manufacturing industry combined with what would be an increased exposure to the US market to the detriment of this industry in other markets, such as China). This should also have a flow on effect that would potentially enable domestic manufacturing growth in Vietnam because the “yarn-forward rule” in the TPP requires most of the components of a garment product to originate from a TPP member country for it to qualify for duty exemption. As approximately 50% of Vietnam’s total annual import of fabric is currently sourced from China, which is not a TPP member, this may encourage Vietnam to establish a fabric and yarn industry of its own¹⁴, ¹⁵. It follows that other industries such as footwear, fisheries and agricultural products could also potentially benefit from the TPP, as well as general manufacturing, taking advantage of relatively cheap labor rates.

Vietnam’s political system appears largely united with regard to the TPP, which limits the political risk to its adoption and implementation emanating from upcoming leadership changes following the 2016 Communist Party Congress. During a historic visit to the United States in July 2015, the Communist Party of Vietnam’s (“CPV”) General Secretary Trong and President Obama highlighted the significance of the TPP as well as the need to deepen bilateral diplomatic and security relations.¹⁶ At the recently concluded 14th plenum of the CPV Central Committee, the Party has also voted to endorse the TPP.

Relative Political Stability
Vietnam’s current Prime Minister Dung was first appointed in 2006 and re-appointed for a second term in 2011. There will be a change in leadership in January 2016 when the CPV holds its 12th National Party Congress (“NPC”), and who will take on the leadership and maintain the greatest level of influence within the CPV has been the subject of intense speculation, and there has been a power struggle that pitted Dung against President Truong Tan Sang (“Sang”) and Party Secretary Nguyen Phu Trong (“Trong”). While Dung’s ‘Government Wing’ is seen as pro-market reform and anti-China in its policies, Sang and Trong’s ‘Party Wing’ has been focused on anti-corruption and increasing levels of transparency in Government. In that respect, Sang and Trong have challenged several of Dung’s close allies as part of an anti-corruption drive.

Dung himself has been subject to allegations of nepotism, and has had his position challenged by the Party Wing of the CPV.¹⁷ Dung has also made points of standing up to China in the South China Sea Conflict as well as denouncing what he called American “imperialism”, thus scoring points with both conservatives and reformists in the CPV.¹⁸

As Dung cannot seek a third term as Prime Minister, it has been rumored that he is going to seek nomination for the post of CPV General Secretary at the Party’s 12th NPC¹⁹. However he shall need the endorsement of the Central Committee. If Dung is appointed, Vietnam will continue to enjoy a high degree of political stability, especially compared with other countries in ASEAN which are enduring government transitions such as Myanmar and Thailand. That said, even if Dung fails in his bid and, for example, Trong remains in his position as General Secretary, Vietnam is unlikely to become politically unstable as Dung’s departure will have little impact on the country’s political structure, although the pace of reforms in the country may be slower than expected.

Geo-Political Issues
The Vietnamese economy and political environment have been subject to issues with China, with whom they have a shared historical, cultural and ideological heritage. Bilateral relations have traditionally been characterized by a power imbalance between the two countries: from a strategic viewpoint China regards Vietnam as part of its regional orbit; economically, Vietnam has a trade deficit with China that reached USD 32.3 billion in 2015.²⁰ Vietnam’s political and economic vulnerability towards its bigger neighbor has informed its foreign policy and led its leaders to engage in a balance of power strategy. Vietnam’s foreign policy towards China has therefore been to maintain close bilateral relations while simultaneously seeking to contain the latter’s ambitions through a network of informal and soft alliances.

Rivalry between China and Vietnam in the security sphere centers principally on opposing territorial claims in the South China Sea (or ‘East Sea’ in Vietnamese). Both countries claim territorial ownership of the Paracels and Spratlys. Sovereignty over either archipelago would give access to potential oil and gas reserves, fishing grounds, as well as a strategic base close to one of the world’s most important shipping routes. While the Paracels are disputed by Vietnam and China, the Spratlys are subject to claims by not only the two countries but also Brunei, Malaysia, Taiwan, and the Philippines. The arguments for the various countries’ territorial claims center both on historical records as well as on international law. While other claimant states, especially the Philippines, have shown a certain willingness to engage in dispute resolution under an international body, China has dismissed such proposals and fortified its hold on the features it occupies by engaging in land reclamation, construction works, and increases in civilian and military personnel.

Bilateral tensions over the South China Sea disputes can be expected to have a tangible effect on bilateral economic relations. Chinese foreign direct investment in Vietnam, while increasing, is still limited. By June 2015, for example, China was only the 9th largest foreign investor in Vietnam with $8.13 billion in registered capital, accounting for 3.15% of the total stock of FDI in the country.²¹ Rising anti-China sentiment among the Vietnamese may be one of the major reasons behind Chinese investors’ reluctance to invest in the country. In May 2014, when China placed an oil rig in Vietnam’s Exclusive Economic Zone, large anti-China protests broke out and turned into riots when Vietnamese demonstrators attacked enterprises that they thought were Chinese in the provinces of Binh Duong and Ha Tinh.²² China’s Foreign Ministry subsequently evacuated 3,000 Chinese nationals.²³

The more pronounced effect in bilateral relations will manifest itself in trade diversion. Whereas China remains Vietnam’s largest trading partner in 2015, this may change in the due course as Vietnam concluded free trade agreements with South Korea and the Eurasian Economic Union in May 2015, and the European Union in August 2015.²⁴, ²⁵ More significantly, if the TPP comes into effect, it may help diversify Vietnam’s import sources and reduce Vietnam’s import dependence on, and thus Vietnam’s economic vulnerabilities with respect to, China. At the same time, Vietnam’s increased economic integration with the United States and Japan through the TPP may also further impact Vietnam’s relations with China.

Investor Risks
While the many macro level indicators are encouraging – Vietnam has one of ASEAN’s largest populations at 90 million and a young, working demographic – it can still be a difficult region to navigate for both new investors and existing companies looking to expand their business.

Corruption remains a major issue at a local, regional and national level, with Vietnam currently ranked 119 out of 174 countries in the 2014 Corruption Perceptions Index published by Transparency International, behind the Philippines, Thailand and China.²⁶ The existence of patronage networks and requirement to maintain relationships with public officials is generally considered necessary for doing business in Vietnam, and many major companies are partially state-owned and have opaque holding structures. Transparency regarding beneficial ownership is also limited as the use of nominee directors is widespread and public records are not always available or current.

Navigating the risks of operating in Vietnam, whether at the investor’s local subsidiary or with a proposed joint-venture partner, requires detailed due diligence. Ideally, this should be conducted in a way where financial, legal and reputational elements are considered concurrently, together with the use of on-the-ground human intelligence to understand the reality of conducting business in the country.

If you would like to find out more, please contact our Managing Director of Southeast Asia, Richard Dailly ([email protected]).

Sources:
¹ Foreign Investment Agency, Tình hình đầu tư nước ngoài 10 tháng năm 2015 [Foreign investment in the first 10 months of 2015], 29 October 2015 http://fia.mpi.gov.vn/tinbai/3935/Tinh-hinh-dau-tu-nuoc-ngoai-10-thang-nam-2015
² http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG/countries/VN?display=graph
³ http://tuoitre.vn/tin/kinh-te/20160102/kinh-te-viet-nam-nam-2016-toc-do-tang-truong-se-vuot-trung-quoc/1031359.html
⁴ http://www.tradingeconomics.com/vietnam/forecast
⁵ The four most important political institutions in Vietnam are the Communist Party (led by a General Secretary), the President (a largely ceremonial role), the government rel="noopener noreferrer" (led by the Prime Minister), and the National rel="noopener noreferrer" Assembly (led by a Chairman).
⁶ http://en.baomoi.com/Info/Vietnam-prime-minister-encourages-foreign-investment-in-state-companies/3/580228.epi
⁷ http://www.reuters.com/article/vietnam-vinamilk-idUSL3N12D53L20151013
⁸ http://asia.nikkei.com/magazine/20150820-STICKER-SHOCK/Business/Fresh-Samsung-investment-good-sign-for-Vietnamese-electronics
⁹ http://www.financierworldwide.com/vietnam-new-decree-on-public-private-partnership-investments/
¹⁰ http://en.baomoi.com/Info/Vietnam-prime-minister-encourages-foreign-investment-in-state-companies/3/580228.epi
¹¹ http://money.cnn.com/2015/10/05/news/economy/transpacific-partnership-tpp
¹² http://tuoitrenews.vn/business/30919/vietnams-tpp-ratification-to-take-up-to-2-years-lead-negotiator
¹³ http://www.economist.com/news/finance-and-economics/21672330-negotiators-agree-ambitious-trade-deal-opposition-its-ratification
¹⁴ http://www.nytimes.com/2015/07/09/business/international/trans-pacific-partnerships-potential-impact-weighed-in-asia-and-us.html
¹⁵ http://www.wsj.com/articles/fabric-of-a-trade-deal-u-s-asks-vietnam-to-cut-out-chinese-textiles-1435125498
¹⁶ http://vietnamembassy-usa.org/news/2015/07/general-nguyen-phu-trong-held-talks-president-barrack-obama
¹⁷ The rel="noopener noreferrer" main fault line in Vietnamese politics has traditionally been between conservative and reformist forces.
¹⁸ http://thediplomat.com/2015/07/vietnam-after-2016-who-will-lead/
¹⁹ http://www.economist.com/news/asia/21656714-vietnams-new-friendship-america-reflects-political-drama-home-power-plays
²⁰ http://dantri.com.vn/kinh-doanh/viet-nam-chi-hon-49-ty-usd-nhap-khau-hang-hoa-tu-trung-quoc-20151226144706347.htm
²¹ http://thoibaotaichinhvietnam.vn/pages/kinh-doanh/2015-11-02/trung-quoc-dung-thu-9-ve-dau-tu-fdi-vao-viet-nam-25812.aspx
²² http://www.bbc.com/news/world-asia-27403851
²³ http://www.ft.com/intl/cms/s/0/251f27a2-de4c-11e3-9640-00144feabdc0.html
²⁴ http://www.reuters.com/article/2015/05/05/vietnam-southkorea-pact-idUSL4N0XW1ZX20150505
²⁵ http://www.bbc.com/news/world-europe-33787530
²⁶ https://www.transparency.org/cpi2014/results