Despite myriad reassuring market signals, namely improved dong sentiment (evidenced by the absence of premium on unofficial USD/VND and an expected continued surplus of over USD2bn in the country’s balance of payments despite a likely [petrol fueled] customs trade deficit widening given an improving structural flow [i.e. FDI/remittance] to leakage dynamic), declining 5yCDS premiums (~530bp in October 2011 to ~270 last month) and annualized inflation projections now well below August’s 23 percent peak and last year’s 18.6 percent average (triggering a reverse repo cut in March, followed by refinance and discount rate cuts this month), the central bank’s (SBV) monetary tightrope act remains treacherous given ongoing commercial bank consolidation and moderating credit extension (11 percent last year [versus a 22 percent government target] and average annual growth >35 percent from 2006-10) that comes against the backdrop of slowing growth.  A mooted about plan to remove deposit rate ceilings by July, for instance, and thus adopt a more efficient market-oriented paradigm contrasts with the IMF’s opinion that lower deposit rates make it more difficult for weak lenders to attract funds (though in theory at least capped deposit rates may also pressure further dong depreciation) and is indicative of the slippery slope the SBV current navigates in trying to weed out weak lenders and bolster the dong’s credibility while concurrently lowering lending rates.

Yet while looser monetary policy feeds M2 growth (total money supply up ~1.06 percent in 1Q2012) and presumably fuels liquidity (local papers cited an unnamed SBV Deputy Governor in March, for instance, as saying that it was both “unfeasible and unnecessary to impose a cap on lending interest rates as [they] will automatically go down on surplus liquidity and easing inflation expectations”) interbank market health–which on its face appears healthier YTD–looks to also be correlated with the efficiency and speed of consolidation as falling rates, rather than a function of confidence, could be symptomatic of risk aversion as growing NPLs make stronger balance sheets within the sector less rather than more likely to lend to weaker ones.  As has been pointed out the vast discrepancy between how loans are classified may be a roadblock to reform as it tends to vastly understate the country’s climbing (since 2006) non-performing loan (NPL) trend (2012 sector NPL forecasts from Fitch, for instance, are more than 2x those provided by the state) given differences in loan classification between two accounting systems.

At present, per the Vietnam Accounting Standard (VAS) banks classify amounts of NPLs that cannot be paid in lieu of  the gross outstanding loan, while per the International Accounting Standard (IAS) method the entire loan amount is the basis (as an aside, a further reason underlying the country’s NPL gap may also relate to the inability of most Vietnamese banks to build out or adapt their internal risk management/credit rating strategies to the herein linked 2005 directive).  Larger than acknowledged NPLs would theoretically magnify risk and also threaten to accelerate a negative feedback loop which I’d argue strikes at the foundation of the very sector consolidation efforts deemed so integral to the country’s macro stability in the first place.  One proxy for this thesis, and the extent to which a liquidity crunch is already or may soon be underway is the velocity of interbank loans as bad debts and subsequent recollections between banks rise.

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