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Vietnam Trip Takeaways: Growth Sustainability Is Key United States Consumer Spending: Slow Growth - Not No Growth - Ahead View GEF Archive

		The Global Economics Team

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Takeaway 1: Policy-Driven Macro Rebound Underway; Sustainability Is Key

Policymakers and corporates sounded more sanguine about macro prospects as well as prospects for sectors such as steel, property and banking compared with six months ago, attesting to the effectiveness of the policy response. We understand that around 60% of the ~US$7 billion first stimulus package will be disbursed this year. Specifically on the US$1 billion loan subsidy program, which is one of the key parts of the first stimulus package, around VND413 trillion in subsidized loans had been disbursed in the first 10 months. As a result, new loan creation by end-3Q09 stands at around 24% of 2008 GDP (versus China's 29% of GDP). Indeed, this underpins the recovery seen in Vietnam. As a comparison, new loan creation in non-China Asia had been in a relatively tepid range of -2.6% of GDP to +4.4% of GDP for this year so far. Loan growth in Vietnam between January and September 2009 stands at around 28% (versus a 2009 target ceiling of +30%).

We believe that a policy exit strategy would need to be delicately managed, both politically and economically. From a political perspective, there is likely to be pressure to support economic conditions ahead of the National Party Congress planned for early 2011. From an economic perspective, policymakers are of the view that recovery is in the initial phase. Hence, there is a need for balance between passing on the growth baton to exporters, asset inflation from leakage of the stimulus measures, external balance and currency dynamics. A gradual phasing out of policy measures is favored. As the removal of the 4% loan subsidy (introduced in early 2009) would entail a one-off step-up in terms of an effective loan rate, this is likely to be the reason why the government has announced a second stimulus package, which extended the loan subsidy program for medium- and long-term projects until 2010 but reduced the interest rate subsidy from 4% to 2%. We think that policy rate normalization could be kick-started in 1H10. A hike in the reserve requirement ratio could potentially serve as a prelude to actual monetary policy rate normalization.

Takeaway 2: The Usual Pressure Points in Twin Deficits and Market Liquidity Conditions

The policy-driven macro rebound is leading to familiar pressure points from the balance of payments such as trade deficits, fiscal deficits and market liquidity conditions. On the balance of payments front, reduced foreign net selling in Vietnamese asset markets means that funding pressures are increasingly coming from the trade deficit front. Indeed, the 30D trailing sum for foreign net selling volume in Vietnam equities (HCM) has slowed from -45.8 million shares in November 2008 to -9.0 million shares in October 2009. However, on the trade front, while exports remained in negative territory at -16.1%Y (3MMA) in October 2009, imports have rebounded back into positive territory at +6.5%Y (3MMA). This has widened the trade deficit to -22.7% of GDP (on a three-month trailing sum, annualized basis).

Separately, the government's ability to fund the stimulus programs also appears to be facing pressure. Market participants pointed out that government bond sales this year have had a poor reception due to the low targeted yields.

Meanwhile, while interbank market conditions still appear orderly, the 3M interbank rate has moved up from around 8% in 1Q09 to around 9.6%. Tighter liquidity conditions are also evident in the rising loan-to-deposit (LDR) ratios of state-owned commercial banks (SOCBs), which are typically deposit-rich. Anecdotally, we understand that the VND LDR in SOCBs has increased from around 65-75% at the beginning of this year to 80-90% currently. VND deposit rates for SOCBs have also risen by 110-130bp since early 2009 and stand at 8.1-8.7% for 3-12 months tenure. As a result, NIMs have compressed, falling below 2%, given the lending rate ceiling. This could place added pressure on the government's financing ability, given that banks and insurance companies are typically the major players in the sovereign bond market.

Takeaway 3: FX and the ‘Triangle of Impossibility'

Indeed, the pressures facing Vietnam could be characterized as a type of ‘triangle of impossibility'*, where there is only a certain degree to which policymakers can control interest rate policy and exchange rate policy in an open economy. (Under the ‘triangle of impossibility' theory, policymakers can choose to manage only two out of the three corners of the triangle: a managed currency, open economy or independent interest rate policy.) Indeed, a loose monetary policy is currently leading to weak external balances, thereby putting stress on the managed exchange rate policy. Although VND non-deliverable forwards remain below the worst point seen in mid-2008, the depreciation pressures on the VND can be seen by the persistent gap between the official rate (~17,860) and the black market rate (~18,200-18,600). The policy to support the VND within a designated range has led to a decline in foreign reserves from around US$24 billion in 4Q08 (as per CEIC database) to ~US$16 billion currently (based on government officials' comments that reserves can cover three months of imports). Interestingly, USD supply domestically remains ample, given that the 4% loan subsidy is applicable only for VND loans. However, USD liquidity is tight. The central bank rations USD liquidity only for key activities such as petroleum, fertilizers and medicine. As a result of the tight USD liquidity, corporates and investors are switching out of VND via third currencies such as the euro and yen, rather than via the VND/USD cross.

The USD depreciation could by default reduce some depreciation pressures on the VND. The US$500 million loan from the Asian Development Bank (ADB), ~US$700 million ODA (Official Development Assistance) loan from Japan, US$425 million for the poverty reduction program from the World Bank and ADB and another planned US$1 billion loan each from the World Bank and Japan will also help to boost the foreign reserves base to support the VND. However, offsetting factors are pressure points from the trade deficit and from foreign investment. A sizeable portion of sovereign bond positions are due to mature next year and there is uncertainty with regards to whether such bond investment will return to the same degree, given the likelihood of monetary policy tightening and potential inflation pressures.

Indeed, with pressures from external imbalances venting themselves via the currency channel, Vietnam's FX policy remains caught in a vicious circle. One could argue that a one-off devaluation could create expectations of further devaluation, leading to more local holdings of USD and resulting in the central bank needing to hold more reserves to support the currency.

However, not weakening the currency means external balance pressures will persist and depreciation tendencies will continue. To this point, some argue that Vietnam is a country facing a structural trade deficit, which obviates it from the necessity to use FX to close the gap. In our view, however, sustainability remains the key. Today's structural trade deficits have to be balanced by structural trade surpluses in the future. The crux lies in whether strong import growth today translates into future export production capacity, which boosts exports in line with imports. It appears to us that the current loose monetary policy may not be translating into the most optimal productive capacity expansion for exports, as it tends to be biased towards real estate, hotels and construction rather than factories and infrastructure. Moreover, while other countries in the initial phase of development have also had trade deficits, Vietnam's trade deficits have been persistently high for the past seven years or so. Also, underlying deficits could be understated due to remittances, which reflect income generation from elsewhere. In this regard, we believe that a combination of further weakening FX and tighter monetary policy will have to be in the pipeline to rein in external imbalances. 

Takeaway 4: Real Estate Market Is Reviving in Certain Segments

Our conversations with corporates and banks suggest that a significant part of the loan subsidy program went into the real estate/construction market. Indeed, import data show that the bulk of the incremental growth contribution since April 2009 was attributed to segments such as steel. Six months ago, there were concerns regarding possible consolidation in the property sector, as transaction volumes had dried up and some property developers had financed projects with part loan and part equity and were hoping to make up for the funding shortfall with sales transactions. Our sense now is that consolidation has not been as widespread as expected, owing to the government stimulus program and the turnaround in global asset markets.

Indeed, real estate projects that were halted during the trough of the downturn were re-started and new ones were kick-started. Transaction volumes and residential prices for 3Q09 picked up mostly at the low-to-mid end, though some demand was also seen for the high-end market. According to CBRE, residential asking prices in the secondary market in Ho Chi Minh City (HCM) rose by 1-4%Q in 3Q09. Interestingly, due the shorter supply, property prices in Hanoi have been rising faster than in Ho Chi Minh City, which is traditionally the speculative market. Anecdotally, we understand that marketing and research activities are now running at full capacity again, suggesting that interest in property is returning.

Separately, the office space segment remains under pressure from the expected huge increase in supply since corporates with core businesses outside of real estate had also been undertaking investment in real estate during the boom years. Indeed, in HCM, CBRE forecasts supply to increase by a further 134% by end-2010 across all grades. In this regard, with the previous undersupply being corrected, a downward adjustment of office rents in Vietnam seems likely to us.

Takeaway 5: Longer-Term Issues Remain

In our view, policymakers appear to have adopted a short-term approach rather than a long-term strategy in this last macro cycle of overheating-global-downturn-stimulus response from 2007-09. Coming from a previously centrally planned system means that policymakers still have a number of additional levers (administrative measures such as import control and SOEs) in terms of macro management. To a certain extent, this may have shielded Vietnam from more severe macro/market consequences which would have pushed policymaking towards a more long-term strategy. For example, import controls can temporarily help to assuage trade deficit pressures, but undertaking structural measures to improve export production capacity could be the more sustainable long-term option, in our view.

Undoubtedly, some reforms have taken place as market access opened with the entry into WTO and with relatively more market/data transparency. Anecdotally, we also heard of some isolated examples where the export value-added production chain has broadened. For example, where export production was previously seen in garment-making, there is now vertical integration into knitting, weaving, buttons and zippers production as investors wanted to ensure the longer-term viability of their businesses and reduce relocation costs.

Yet, we believe that other reforms are still required. More technocrats are needed to spearhead institutional reforms. Infrastructure bottlenecks (we experienced power blackouts while there), SOE efficiency and human resource bottlenecks are some of the well-known longer-term issues requiring attention. Additionally, while Vietnamese corporates have got more attuned to what investors look for in terms of accounting and disclosure, corporate efficiency and the level of market-orientation are still playing catch-up compared with some other emerging markets in ASEAN, in our view. 

Bottom Line: Growth Sustainability Is Key

While a macro rebound is underway, we believe that policy management will remain critical for Vietnam. The way we see it, policy measures have helped to engineer a macro turnaround but, at the same time, opened up familiar pressure points in terms of trade deficits, fiscal deficit funding and market liquidity. Indeed, pressures from external imbalances are also venting themselves via another outlet, i.e., the currency channel. We believe that policymakers have a delicate balancing act to carry out in terms of policy management, one which balances three needs:

•           To support macro conditions ahead of the National Party Congress in 2011;

•           To transition seamlessly from a policy-driven recovery to an export-driven recovery; and

•           To manage the pressure points and ensure the short-term and long-term sustainability of this policy-driven macro rebound.

In our view, a policy-driven turnaround has to give way to a more market-based export-led recovery in the short term for the growth path to be sustainable. In the bull case scenario, a stronger-than-expected global demand recovery would help Vietnam to export its way out of the pressure points to a certain extent and find a balance between its three objectives. In the bear case scenario, a macro double-dip would add to the existing pressure points.

For details, see ASEAN MacroScope: Vietnam Trip Takeaways: Growth Sustainability Is Key, November 4, 2009.

United States
Consumer Spending: Slow Growth - Not No Growth - Ahead
November 05, 2009

By Richard Berner | New York

Following a summer splurge, consumer spending is slowing dramatically.  We estimate that real growth in consumer spending will slow to under 2% annualized in 4Q, following a temporary boost to nearly a 3.5% clip in 3Q.  It's widely understood that the use-it-or-lose-it ‘cash-for-clunkers' purchase incentives that began late in July and ended on September 1 fueled more than 40% of that spending gain.   With consumer fundamentals still under pressure, therefore, many investors regard September's 0.6% decline in real consumer spending as the start of renewed retrenchment.  We disagree.  Consistent with our long-standing view, slow growth, not no growth, is likely.  Tailwinds are starting to offset still-significant headwinds, and we continue to forecast modest (2%) spending growth over the next several months.

Three key consumer tailwinds are poised to strengthen in coming months.  The first: Real, after-tax ‘core' income - income from wages and salaries, the critical driver for consumer spending - is likely to rise modestly in the coming months.  Although wage gains won't likely improve much until later in 2010, a rising workweek and slower declines in payroll employment finally seem likely to pull core wage and salary income out of its two-year tailspin. 

The evidence for such improvement is so far fragmentary, but timely and forward-looking data suggest that it may be for real.  For example, initial and continued claims for unemployment insurance benefits have declined steadily since peaking in June, and the decline in the latter over the last four weeks accelerated to 315,000; that's the fastest pace since an atypical July surge in motor vehicle output reduced continued claims.  The employment components of the two ISM indices and stability in the private job openings rate over the past three months seem consistent with smaller declines in payrolls.  Surveys of hiring and hiring plans such as those from our own Business Conditions Survey (the MSBCI) in early October improved noticeably.  The hiring series, which tracks the number of analysts whose firms have employed more workers over the previous three months, nearly doubled in October to 17% - a 13-month high.  Moreover, the hiring plans series, which captures the number of respondents whose companies intend to expand payrolls over the next three months, rose an additional three percentage points to a similar 17%.  As in the hiring series, this value was the highest mark for this indicator since the intensification of the recession last fall. 

After-tax income also is likely to get a boost from a final installment of tax cuts and rebates early next year.  While many observers believe that fiscal stimulus has peaked, they ignore the fact that some of the tax cuts from the stimulus plan don't hit consumer spendable income until the spring of 2010.  That's because the ‘making work pay' tax credit is just that - a credit - for which consumers got a down-payment with the reduction in withholding rates on April 1, 2009.  Indeed, we expect a 10% rise in tax refunds in the 2010 refund season that will begin in February, accruing to those who did not adjust withholdings for the 2009 tax year.  That increase will offset the modest 3% gain we expect in taxes withheld on income received early in 2010, and would leave overall individual income taxes essentially flat.  As a result, real after-tax wage and salary income may grow at a 4.5% annual rate over the first half of 2010.

Tailwinds 2 and 3.  A second, more modest tailwind comes from the rise in equity values, plus debt paydowns and write-downs, which have ended the slide in household net worth.  Household and non-profit equity holdings have retraced about a third of their US$11 trillion plunge over the 18 months ended in March.  In addition, gross housing wealth has declined by US$3.9 trillion since early in 2007, and there is so far no sign of an upturn.  Without question, households will be adjusting to this breathtaking decline in wealth for some time.  But the recent upturn in asset values means that the pressure on balance sheets is abating.  And consumer deleveraging is also helping balance sheets and discretionary income: The US$270 billion decline in consumer and residential mortgage debt over the past year has reduced debt in relation to income by 700bp.  Combined with lower interest rates, that decline has trimmed the household debt service ratio by about 90bp over the past two years, which has added around US$100 billion to consumer discretionary spending power (for details, see Recovery Myths, October 19, 2009).  Finally, lenders seem to be easing their lending standards slightly as the rise in delinquencies slows and both funding and ABS markets have improved.  Evidence for that improvement may come in the Fed's November Senior Loan Officer survey, likely to be released on November 9. 

Headwinds still linger.  We hasten to add that consumer headwinds remain strong.  Past weak income and job performance has kept consumers cautious.  Real ‘core' income declined by 2.3% over the past year, the steepest rate since 3Q80, while hours worked have declined by 7%, a record yearly decline.  Ditto for household assets: As noted above, the shock to wealth over the past two years will foster a long period of adjustment to patterns of consumer spending and saving.  And while deleveraging has trimmed household debt service, some of the decline in debt is clearly involuntary, as it is the product of defaults and foreclosures.  Over time we believe that this tough aspect of cleaning up balance sheets will produce healthier, more resilient consumers, but while it is underway, it leaves them reluctant to spend.

Saving rate decline a poor guide to consumer behavior.  Some observers view September's rise in the personal saving rate to 3.3% as an indication that renewed retrenchment is underway.  Likewise, they believe that the sharp decline from 5.9% in May to 2.8% in August signals that consumers have exhausted their resources.  But short-term movements in the saving rate are a poor guide to consumer behavior.  While the rise in the saving rate from 1% early in 2008 to just over 3% recently reflects consumers' response to falling next worth, most of the movements in 2009 reflect lumpy tax refunds, policy changes and plunging property income.  The saving rate began the year at 4.4% and then jumped to 5.9% as consumers received extra tax rebates, transfers, tax cuts and one-time OASDI payments.  It fell again as the one-time payments vanished.  Declines in interest and dividend income, amounting to US$217 billion, accounted for 92% of the decline in overall personal income, and for as much as 180bp (more than all) of the decline in the saving rate, as such income tends to be saved rather than spent.  Smoothing the rate for those changes since 2008 suggests that a sea change in consumer behavior is underway - one that will take the savings rate to 7-10% over the next several years.

Three key risks to this modest consumer spending growth scenario.  First, hours worked and core income could be either stronger or weaker than we expect, accentuating the payback from the summer splurge.  We think that payrolls might turn positive in 1Q10 - perhaps in January or February.  But we also think there are two risks to this view from a policy perspective, one positive and one negative.  The mooted employment tax credit that is now being drafted could be a plus (if enacted quickly).  But the uncertainty around healthcare reform could well be a minus, especially if would-be employers who do not currently offer healthcare benefits to their employees are required to choose between introducing a plan and paying a hefty tax.  Why hire until the dust settles on those proposals?  Employers needing more labor input could respond by boosting the workweek and avoiding hires (that will probably happen over the next couple of months anyway).  While the press has highlighted this risk for small businesses, it actually applies to any business that does not currently offer healthcare benefits, including many in services industries. 

Second, rising energy quotes, especially for gasoline, could add to the near-term downside squeeze on real disposable or discretionary income.  Reflecting the renewed global growth and a weaker dollar, crude oil prices have risen roughly US$10/bbl over the past month.  Wholesale and retail gasoline prices have followed, the latter to US$2.72/gallon (average all grades) in the latest week.  If gasoline prices peak at about US$2.85, we estimate that this price rise might drain about US$44 billion, or 0.4%, from disposable income between September and December. 

Finally, renewed mortgage foreclosures and home price declines may again pressure wealth and credit availability.  We are not sure if the famous ‘shadow inventory' of yet-to-be-foreclosed homes is as high as the most pessimistic estimates have it.  But even if the number of pending foreclosures is half the size of the pessimistic estimates, they will add to a looming supply overhang of unoccupied houses, and such additions may promote renewed declines in home prices as they come on the market in the spring.

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