Vietnam's Ticking Debt Bomb

By Elisabeth Rosen

August 19, 2014

For Vietnam, the debt problem serves as a reminder that the state should have limited influence in business. 

Vietnam may find it hard to reach its goal of 5.8 percent growth this year if bad debt continues to hold back the economy.

The central bank has made moves to bring down the debt ratio, but structural changes are also needed to ensure the health of the economy in the long-term.

“The bad debt problem can’t be resolved if there is no disclosure and transparency to prevent corruption and crony capitalism,” influential economist Vu Dinh Anh told me.

The bad debt ratio at Vietnamese banks was estimated at 4.84 percent at the end of June, continuing a steady rise since the beginning of the year. And these are only the official numbers. Moody’s Investors Service estimates that non-performing loans (NPLs) account for 10-15 percent of the total–more than double the central bank estimate.

Unlike the central bank’s figures, Moody’s takes into account special mention loans and other weak assets that should technically be classified as non-performing. While banks were told last year to categorize their loans in line with these standards, the deadline was delayed three times after banks expressed concern that the abruptly higher totals would cause businesses to fold; implementation is currently set for the first quarter of 2015.

“This lack of data is a major issue. Without knowing the real NPL ratio and structure, we can’t understand the problem,” Anh said.

The debt problem has already taken a toll on the economy as banks have been forced to set aside more capital rather than issue loans. Despite the central bank slashing interest rates on a number of occasions, lending in Vietnam only increased a scant 3.5 percent in the first half of the year.

“The bad debt in Vietnam is not huge enough to cause an economic crisis. But it prevents the economy from making a fast recovery,” said Dinh Tuan Minh, a former economic analyst at the Military Bank.

Roots of the problem

As in the U.S. and China, Vietnam’s debt problem is due in large part to the real estate asset bubble of the late 2000s. State-owned banks readily handed out loans to investors and developers, prompted by the government’s desire to boost the economy. When the economy faltered in 2010 and housing prices tumbled, many borrowers were unable to repay the loans.

Many of these developers were affiliates of state-owned enterprises (SOEs) that had little experience in the real estate sector. Since Vietnam gained independence, the government has viewed SOEs as the pillar of the economy, a point of view echoed in the constitution as well as in other key government documents. In the early 2000s, as the country opened to the outside world, the government encouraged SOEs to expand outside their core areas into other business activities in an effort to compete with foreign rivals.

“The Party and State will create favorable conditions for State-run corporations like Song Da to surmount difficulties and develop more efficiently,” State President Nguyen Minh Triet said during a visit to that company in 2009.

One of the cornerstones of this plan was shipping company Vinashin. Amid rising global demand for shipping, the government expanded its own company, convincing state-run commercial banks and local authorities to provide Vinashin with loans and resources.

“The government’s strategy was to build this company quickly into a shipping superpower by pumping money into it. In the first few years, that strategy worked,” said Le Duy Binh, managing director at consulting firm Economica Vietnam. “We got a lot of orders from other countries. For the government, that initial success confirmed that they were going in the right direction.”

But as the government poured more money into Vinashin, it became increasingly clear that the company’s senior management was not experienced in handling such large financial resources. Executives’ poor investment decisions triggered major losses. In 2010, Vinashin collapsed with more than $4 billion in debts; two years later, the company’s executives were imprisoned for violating economic management regulations. The following year, in 2013, the former chairman and general director of fellow state-run shipper Vinalines both received death sentences for embezzling $474,000 each through a scheme by which they deliberately overpaid for an old dock, then pocketed the million-dollar kickback.

“Corruption is part of it, but it’s more about management capacity,” Binh said. “You can’t manage huge companies using the old style of management. They didn’t know what to do with all the resources they had, so they invested in many sectors: banking, property, hotels, even taxis.”

In 2012, the government announced that SOEs had engaged in $1.5 billion of “wrongful spending.” The oil and gas monopoly PetroVietnam alone was found to be responsible for roughly $8.5 million in losses. Similarly, the government said that Song Da Group had “misused” more than $500 million by embezzling money and making poor investments through its 85 affiliates, many of whom incurred significant losses building cement and steel factories, hydropower plants and other types of infrastructure.

“A huge amount of Vietnam’s economic problem is connected with the political system,” the economist Anh said. “Like China, Vietnam lacks the developed derivatives market that you have in the U.S. and other countries. As a result, economic growth significantly depends on banking credit and the state-owned sector, which has seen major losses. The connections with the state-owned sector are major reasons for Vietnam’s bad debt.”

State-owned enterprises remain the largest segment of borrowers in Vietnam’s banking system and account for a huge percentage of the NPLs. Therefore, reforming SOEs is integral to solving the debt problem.

“The SOEs’ record of poor operational results and unprofitable asset expansion is discouraging. Vietnamese banks are not likely to see a return to healthy loan growth unless the health of the SOEs is revived,” said Gene Fang, a Moody’s Vice President and Senior Analyst.

Solving the problem

In 2013, Vietnam attempted to tackle the problem by launching the Vietnam Asset Management Company (VAMC). Under this scheme, banks trade their NPLs to the VAMC in exchange for special bonds that they can use to obtain central bank loans. By early July, the VAMC purchased $2.4 billion of NPLs.

However, this is not a complete solution: while the debts leave the banks’ balance sheets, the asset management company has yet to devise a way to resolve them. There are plans to sell the debts to outside investors, yet little progress has been made on that front.

“The number of NPLs is almost the same as two years ago, and the attitude of the government and state bank hasn’t changed either,” said former analyst Minh. “They think that when the economy recovers, the NPLs will go away. The government doesn’t want to spend money. Vietnam simply doesn’t have enough resources.”

One solution would be to sell the NPLs to foreign investors. Nguyen Quoc Hung, chairman of the VAMC Members’ Council, told Banking Times that the company had received interest from several foreign organizations and individuals. However, most of the loans have real estate as collateral, and Vietnamese law prohibits foreigners (or anyone else for that matter) from owning land.

Moreover, the VAMC buys the debt from the banks for as much as 80-90 percent of its value, which is far more than investors would be willing to purchase it for.

“They [the foreign investors] tend to offer market price for such assets, as low as 20-30 percent of par value. VAMC considers such offers quite inadequate considering the asset values,” said Andy Ho, chief investment officer at VinaCapital. “VAMC can be an effective instrument to resolve bad debts only if it is willing to put debts on sale and accept the best offers that can be obtained from the market.”

While there is talk of changing these regulations, the government is reluctant to do so. As deputy head of the National Assembly’s Economic Committee, Nguyen Duc Kien, has said, “Right now, everyone seems to be afraid of taking responsibility for creating losses to the state, so no one dares to make decisions to sell any debt at very low prices.”

This hesitance on the part of authorities isn’t just about financial losses. It’s about a symbolic loss of control.

“The government recognizes that only foreign companies have enough resources to buy bad debt. But there’s a group in the government that doesn’t want to do that,” Minh said. “They’re afraid that when the government sells bad debt to foreign companies, major sectors of the economy will be under the control of foreigners.”

This would threaten the country’s national interest. And changing the property laws would mean allowing private investors to enjoy the same rights as the state — which would be unthinkable.

“We can’t expect that the government will change the land law. Even Vietnamese are not allowed to own land. All the land belongs to the state,” Binh said.

Making progress

Tackling bad debt is a good first step. There is also encouraging progress on enacting SOE reforms. Some laws currently being considered would force state-owned companies to operate under market principles and restrict them from investing in risky areas. However, the government also needs to address the underlying problems of both SOEs and the banking sector by increasing transparency and loosening foreign ownership restrictions.

This year, the government has stepped up the pace of SOE reforms as well as equitization (i.e. privatization). Non-banking SOEs are required to divest from risky areas like insurance, securities and real estate by 2015; almost one-fifth of this target was reached by the end of 2013, according to a World Bank report.

The government has also set the goal of offering more than 400 SOE IPOs by 2015, although the success of these remains uncertain. In this year’s first round of IPOs, listed SOEs – most of which belonged to unprofitable sectors like property and public works – sold less than one-third of available shares. On the other hand, investors are expected to vie for shares in profitable SOEs like Vietnam Airlines and telecom giant MobiFone when they are listed this year.

However, transparency should also be a key element of the reform process. Operating in an environment without outside oversight, SOE executives made decisions that resulted in huge amounts of debt. A state audit report published this year revealed “flagrant abuse of regulations” by SOEs in 2012. While regulations now require SOEs to publish financial results online every year, these disclosures are lacking in both accessibility and useful information.

This lack of transparency is also a critical problem in the banking sector, where cross-ownership and interbank lending pose major risks. The recent arrest of three former officials from the Vietnam Bank for Construction for fraudulently procuring $311 million followed a state audit report that singled out several lenders for “dubious operations,” the latest in a series of scandals at major banks. Many of these are caused by cross-ownership: there are 35 private commercial banks in Vietnam, but Binh estimated that in one-third of these, stakeholders with other interests owned more than permitted by law. Another economist compared the tangled relationships between banks to a “spaghetti bowl.”

Creating a new legal framework that loosens foreign ownership restrictions can also solve problems in both sectors. Progress was made in this area earlier this year with the raising of foreign ownership caps in banks, but more can be done, especially when it comes to resolving bad debt. While the government may fear the loss of control that would result from allowing foreign investors to participate in key economic areas, the economic consequences of not doing so could be even more damaging. Ho from VinaCapital pointed out that after the 1997-1998 Asian financial crisis, foreign buyers played an “indispensable” role in resolving NPLs for the countries involved.

For Vietnam, the debt problem serves as a costly but important lesson that the state should have limited influence in the business sphere, particularly when it comes to lending decisions by credit institutions.

“If someone working at a bank looked at Vinashin’s balance sheet and appraised it on a purely commercial basis, they would not have lent to Vinashin,” Binh said. “But banks didn’t do the calculation. They blindly followed the government’s decision to make Vinashin a superpower in the shipping industry. When Vinashin collapsed, banks collapsed overnight.”

Elisabeth Rosen is a journalist based in Hanoi.