In September last year, Moody’s downgraded Vietnam‘s credit rating to B2 – the country’s lowest rating ever – citing a weak banking sector in need of extraordinary support. The credit rating agency also downgraded eight Vietnamese banks, including two controlled by the state.

A weak financial system is one of the country's biggest economic problems. Vietnam, in short, has gone from global investment darling to poster child for mismanagement, said Rob Cox, a Reuters columnist, in Newsweek in October last year.

Foreign direct investment poured into Vietnam over the past several years, surpassing the money going to Indonesia, Thailand and the rest of the region combined, according to the World Bank. The country’s institutions struggled to absorb all the funds, leading to a severe misallocation of capital. And once the global financial crisis of 2008 crippled foreign capital outflows, Vietnam’s banks stepped in to keep the money flowing. The country’s total public debt is now more than $71.749 billion, equivalent to 49.4 percent of the country’s gross domestic product and an average debt load of $800 per person, The Economist calculates.

Vietnam’s credit downgrade stressed concerns surrounding its bad debts and the pace of economic reforms. However, analysts say this does not signal a full-blown banking crisis, and that the slowing economy should return to form if the government takes action. “The banking system is obviously in relatively poor shape,” says Tony Foster, Vietnam managing partner at Freshfields Bruckhaus Deringer. “The question is, what does the government do about it?” he adds.

A positive stride

The government has responded. In February this year, Vietnam’s Prime Minister Nguyen Tan Dung approved a broad plan to boost its economy, focusing on restructuring public investment, banks and state-owned enterprises, while controlling inflation and maintaining growth.

The move is not a surprising one, agree most lawyers. “Most people would agree with the principle that there is a lot to be done, and the government is just confirming this,” says Nguyen Quang Hung, a partner at Vietnamese law firm Vilaf.

The plan, which has already taken effect, seeks to accelerate economic growth this year to 5.5 percent while keeping annual inflation between 6.0 and 6.5 percent – down from 9.21 percent in 2012. Vietnam will aim to maintain total social investment at 30 to 35 percent of the country’s gross domestic product, the 29-page directive signed on Feb. 19 says, “maximising the scale and opportunity for private investment, especially the domestic private sector.”

The directive states that restructuring of state-owned enterprises will focus on businesses in the defence industry and those which have a monopoly or are providing essential goods and services. It also reiterated a policy on divestment by state-owned economic groups in their non-core businesses, while encouraging the establishment and development of domestic private economic groups.

Furthermore, banks will focus on dealing with the sector’s overall bad debts, a fast-growing problem gripping Vietnam. The Southeast Asian country has one of the highest bad debt ratios in the region, which rose to 8.82 percent of loans in September 2012 from 3.07 percent at the end of 2011, central bank data finds. However, in February this year, a Vietnamese government official said that the level of bad debt in its banking system has been cut to 6 percent, reports Reuters.

Among measures to tackle non-performing loans has been the proposed establishment of an asset management firm to buy bad debt from banks. “However, the funding for those purchases is not at all clear. So the ability to make it work is still very much in question,” says Foster.

As part of its plan to restructure lenders saddled with bad debt, the Vietnamese central bank is seeking to merge some of the weak banks together. Partly private Phuong Tay Bank, also known as Western Bank, plans to merge this year with Petrovietnam Finance Corp (PVFC), state oil and gas group Petrovietnam’s finance arm. The tie-up will turn Phuong Tay Bank and PVFC into a single mid-sized bank with combined equity of 9.16 trillion dong ($438 million), and should help rescue Phuong Tay Bank from its bad debts, raise PVFC's competitiveness, and cut the size of Petrovietnam's stake in PVFC.

Around 10 ailing banks will be restructured by the end of this year. So far, three small lenders in Ho Chi Minh City have been merged to form the Saigon Commercial Bank, while Habubank was acquired by Saigon-Hanoi Bank. Two leading partly private lenders, Eximbank and Sacombank, also plan to merge in the next three to five years despite not being involved in the central bank’s consolidation plan.

More foreign capital

One frequently discussed remedy to improve the situation in Vietnam is to attract foreign capital back into the country. Currently, foreign banks are allowed to own up to 20 percent of a Vietnamese bank as an individual investor – or group of related investors – with a 30 percent cap on all foreign investor ownership. The government, which owns a majority of all five state banks, is considering allowing foreign investors to take much larger positions in crisis-hit banks. Selling those stakes would help Vietnam attract the foreign capital and expertise it needs. However, the decree is still in its draft form, and is not effective legislation yet, says Nguyen.

“In the latest draft regulation, there is a clause that would allow foreign investors to take control of an ailing bank, but not a healthy bank,” says Foster. “If the government would allow foreign investors to take more than 50 percent ownership, it would be a very positive step,” says Foster.

But given the current economic climate and Vietnam’s wavering financial sector, many industry experts question whether there would be strong enough demand from foreign investors, even if the foreign ownership limit is relaxed. Any increase in the ownership limit would be a step forward. But allowing more than 50 percent ownership would greatly incentivise foreign banks, many of which are reluctant to increase their interest given new international banking regulations under Basel III, without taking a majority stake, adds Foster.

Despite sluggish demand, Foster notes that Asian financial institutions are still quite keen to enter Vietnam, ahead of their European and American counterparts. A report by the Ministry of Planning and Investment showed that Japan is the biggest foreign investor in Vietnam, while South Korea ranks the third in the list of 98 foreign investors in Vietnam. Last year saw two big investments from Japanese banks into Vietnamese financial institutions. Mitsubishi UFJ Financial Group took a 20 percent stake ($741 million) in Vietnam Joint Stock Commercial Bank for Industry and Trade, or VietinBank, at the end of last year, while Mizuho Financial Group bought a 15 percent stake in the Vietnam Bank for Foreign Trade for about $560 million in September 2011. Sumitomo Mitsui Financial Group is also currently in talks about buying a stake in Saigon Thuong Tin Commercial Joint Stock Bank, also known as Sacombank.

However, Nguyen states that the investments made by the Japanese banks did not relate to bad banks. “They are well-operating banks. For the banks struck by bad debts, we are not sure how much interest foreign investors would have,” he adds.

Reforming at the edges

Despite a more proactive stance by Vietnam’s government, several obstacles still stand in the way of a successful restructuring plan. “The focus of the economic restructuring programme is reallocation of resources. Inefficient allocation of economic, financial and land resources has become deep rooted and not easy to change,” Nguyen Dinh Cung, vice-president of the Central Institute for Economic Management, told the Saigon Times Daily.

For his part, Nguyen from Vilaf believes that the state of Vietnam’s banking sector is collateral damage from the real estate boom. “The government made a lot of mistakes in letting the real estate market boom at such a rate, and now the real estate market has frozen, causing the banking sector to feel the consequences. So, if a long-term solution is needed, they need to fix the real estate sector as well as the banking sector,” he says. The big question for the government now is how to fix the real estate sector, says Nguyen. In March this year, Vietnam’s central bank unveiled plans to inject 30 trillion dong ($1.4 billion) into the banking system to offer soft loans to home buyers in an attempt to revive the struggling property market and resolve bad debts. However, Nguyen believes that the size of the package is too small for the current market situation.

Foster agrees that while the government is pushing through more reforms, they are not necessarily central to the problem. “They are constantly reforming at the edges. The question is, can they introduce some of the fundamental reforms that would result in a much quicker solution, or are the vested interests strong enough to make that too difficult?” asks Foster.

Wait and see

Nonetheless, lawyers have observed increasing interest and inquiries from foreign banks about the government’s planned economic reforms. While it is too soon to gauge the effect of the restructuring plan, Nguyen states by the end of the year, it will be clear whether the reforms have been a success. “Six months should be enough for us to see if there are any positive developments in the banking sector, because some of the banks here are really in very desperate situations. If they cannot be rescued by the end of the year, there will be a big problem,” says Nguyen.

It is undoubtedly a testing time for Vietnam. While the proactive government attempts to pull the country away from the precipice of financial collapse, scepticism in the market still remains. Both the domestic public and private sectors will play key roles in the restructuring process, while foreign banks and law firms will keep a close eye on the easing of foreign ownership regulation. The next six to eight months will be crucial for Vietnam – only time will tell if the restructuring plan pulls the country out of its downward spiral.

Reuters

Vietnam's central bank plans to inject 30 trillion dong ($1.4 billion) into the banking system to offer soft loans to home buyers in an attempt to revive the struggling property market and resolve bad debts.

Banks will provide loans at 6 percent a year to low-income home buyers, state employees and the military for at least 10 years and to low-price property developers for five years, the central bank said in a draft circular last month. The plan is expected to take effect from Apr. 15.

Vietnam's property market has come to a standstill in the past two years after a long period of strong growth which was fueled by a lending spree by local banks. Robust demand encouraged many developers to invest in higher end housing.

An economic slowdown and soaring inflation exacerbated banks' problems with non-performing loans. Banks have dramatically cut lending, impacting property sales across the country and stalling many real estate projects.

The decreased demand has also affected unemployment, with many jobs lost in construction, an industry accounting for 3.3 million people, or 6.4 percent of Vietnam's labour force, according to parliament's economic committee.

The soft loans will be reserved for low-price property projects, the central bank said. The government will give developers permission to turn their commercial housing projects into social housing from this month until the end of 2014.

The State Bank of Vietnam will inject refinancing capital into five state-run and state-controlled banks, including Agribank, BIDV, Vietcombank, VietinBank and Mekong Housing Bank.

Loan rates in the local currency now range from 9 percent to 16 percent according to the central bank's reports, while small businesses have said they may be charged at 18 percent.

Total real estate-related loans amounted to 1,000 trillion dong ($47.8 billion) by the end of last August, or 57 percent of the banking system's lending, the Ministry of Construction has said.

An association of real estate developers in Ho Chi Minh City had been urging state support for the market and has asked the government and the central bank to instruct banks to tax deposits of more than 500 million dong ($24,000) to invest in the local economy, according to state media. That was widely interpreted as a move to spend on real estate instead.

The news had only a limited impact on Vietnam's benchmark Ho Chi Minh Stock exchange on Thursday, which was flat at 0420 GMT, with traders in a cautious mood.

Most property stocks, including Vingroup, the country's biggest listed developer, were unchanged. But shares in Thu Duc Housing Development Corp climbed 6.5 percent and shares of Songda Urban & Industrial Zone Investment and Development Co gained 1 percent.

"The move will help directly reduce inventories in the domestic property market, and it will also give a boost to the stock markets," says Quach Manh Hao of Military Bank Securities.

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