Of the perceived ‘second tier’ emerging markets in Asia, Vietnam is increasingly viewed as a net beneficiary of the trade spat between the US and China. The deteriorating relationship between the two has forced companies to rethink their global supply chains and the dominant role that China occupies within these. Moreover, China is gradually losing its competitiveness versus other Asian economies as labour costs rise and the intense focus on manufacturing recedes.
Vietnam appears to be the biggest beneficiary of the trade wars to date. It produces many of the goods affected by the tariffs, instantly increasing the competitiveness of its products if/when particular tariffs come into force. This, combined with an increasingly liberalised economy, consistently growing at a rate of 6-7% per annum even before these recent tailwinds, has turned the country into an exporting powerhouse. Much of this initial growth in exports came from China partially vacating certain low-value export markets such as textiles to move into higher value exports such as electronics. Vietnam was a beneficiary of this trend and is now looking to transition to higher value export markets itself.
China Plus One Model
While single countries such as Vietnam could not hope to replace China entirely, a ‘China plus one’ model is increasingly being adopted by companies with a high exposure. According to a recent article by the Washington post, more than fifty multinational companies have announced plans to move production away from China or are considering doing so. Backing this up is a July survey from the quality control and supply chain auditor QIMA. The findings showed that demand for China-based inspections from US companies had fallen 13 percent in the first half of 2019. In the same window, overall demand for inspections in South Asia jumped 34 percent.
For example, Apple recently began production trials in Vietnam for its wireless earbuds, AirPods, one of Apple’s fastest growing products. The trials, which are normally a precursor to mass production, are designed to test the manufacturing capabilities of the Vietnamese economy. Should the trials be successful, Apple is considering moving up to 30% of its Chinese production to Vietnam, consistent with the aforementioned China plus one strategy that many companies are looking to adopt.
In addition to the well-established export model, there is also a thriving domestic economy. Significant reform has seen the domestic private sector rapidly taking over from formerly State Owned Enterprises (SOEs). As recently as 2014, SOEs as a share of GDP were higher than the private sector, however, that has now flipped, with productivity rising as a result. Renewed infrastructure spending has also had a positive impact, with Vietnam spending more of its GDP on infrastructure than other Asian emerging markets.
Demographics are also favourable. The population is large and young – nearly 45% of the population is under the age of 26 and the median age is 31. Urbanisation is also growing fast (from a low base). Once one of the poorest countries in the world, GDP per capita – at approximately $2,700 – is growing rapidly but remains well below that of some neighbours. Thailand for example has a figure closer to $7,300.
Foreign Direct Investment
Despite being a one-party communist state, Vietnam has made itself increasingly attractive to foreign investment. The country is seen as politically stable, partly due to a consensus government, absent a controlling ‘strongman’ type figure. It is a member of The Association of Southeast Asian Nations (ASEAN) and is a signatory to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which evolved from the now defunct Trans Pacific Partnership Agreement (TPP). Like other Asian countries, Vietnam has learned the lessons of the Asian financial crisis and has tried to encourage foreign capital of the longer-term variety, largely immune to capital flight. The currency is stable, inflation is low, the current account is in a healthy surplus and foreign exchange reserves are at a record high.
Inclusion in the MSCI indices?
At present Vietnam is classified as a frontier market, despite its stock market enjoying more scale and trading volumes than many countries classified as emerging (the next band up). The country recently missed the chance for a status upgrade to an emerging market; however, the government is determined to achieve this target in the next few years, as it seeks to attract further foreign capital into the country.
One of the sticking points has been foreign ownership limits, which are currently 30% for banks and 49% for others. However, recent amendments to securities laws are helping create a fairer market between domestic and foreign investors and further changes may see limits lifted – for non-strategic sectors initially.
Dangers of economic success
The recent tailwinds to the Vietnamese economy do come with potential pitfalls however. Vietnam’s exports to the US have been growing rapidly (up 40% from last year) and now account for a quarter of its GDP. The trade surplus with the US has now reached $40bn annually. A growing trade surplus may draw the ire of the US – it narrowly avoided the label of currency manipulator recently. Therefore, like China, Vietnam could become a victim of its own success, with much more scrutiny of its trade practises than before. In addition, there have been accusations of Chinese companies routing goods through Vietnam in order to circumvent tariffs, with accusations that the Vietnamese authorities have not done enough to crack down upon it.
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