The Vietnamese economy expanded 8.3 per cent in the first nine months of the year, or 9.1 per cent year-on-year in the third quarter of 2007 by our calculation, up from 7.9 per cent in the second quarter of 2007.

The acceleration in growth is unsurprising as the government continues to pursue a pro-growth policy in order to achieve its 8.5 per cent growth target for this year.

Recent comments from the authorities suggest that this drive could become even more aggressive in 2008 as policymakers hope to achieve a GDP per capita of $1,000 by 2008, ahead of its original target of 2010. We remain cautious about this ‘super growth’ approach, particularly with inflation running high at 8.8 per cent year-on-year in September.
 
Although we believe it is reasonable to expect the Vietnamese economy to expand by 6-8 per cent in the medium term, allowing inflation to stray is a risky strategy that could undermine the long term balance of the economy.

We reiterate our GDP growth forecast of 8.5 per cent for 2007 and 2008, but revising our 2007 and 2008 inflation forecasts up to 8.0 per cent and 8.5 per cent respectively, from 7.6 per cent and 8.2 per cent before.

Picking up momentum

While the GDP breakdown by expenditure is not immediately available, we believe much of the growth came from domestic drivers. Exports expanded by 19 per cent year-on-year in the third quarter of 2007, and there is no sign of slowdown just yet, partly due to the higher energy prices.

That said, this impressive performance was more than offset by the growth in imports, which rose by 29.3 per cent year-on-year in the same period. The resulting trade deficit hit $3 billion in the third quarter of 2007, twice the $1.5 billion deficit in the third quarter of 2006. We expect this trend to continue in coming quarters given strong import demand from consumers and manufacturers. However, as manufacturing capacity expands and supports higher export growth, the trade deficit may gradually switch into a surplus.

Meanwhile, retail sales continue on its strong momentum. Total retail sales (including sales to business, individual and household) grew by an average 23.6 per cent year-on-year during June to August. While this is partially a result of higher inflation, the underlying strength of demand should not be underestimated.

Another source of growth is foreign direct investment. Government figures stated that the country has attracted $9.6 billion worth of investment in the first nine months of the year, up 38 per cent year-on-year. This is likely to surpass our forecast of $10 billion for the year (see OTG on Vietnam: High Growth, High Inflation, released on July 30 2007) and may hit $13 billion. Tourist arrivals also reached 3.2 million during the period, representing a year-on-year growth of 18 per cent.

Watchful over inflation

Much of the increase in inflation can be explained by the surge in food prices and rise in housing and construction material costs, which rose 13.3 per cent year-on-year and 9.5 per cent respectively in September. In addition, both are likely to remain elevated at least for the coming months.

While we believe the current high level of energy prices is not sustainable, the near term pressure on inflation should not be overlooked. Furthermore, recent weakness in the US dollar implies that the Vietnam dong, which moves closely with the US dollar, has its effective exchange rate depreciating also. This again could add to Vietnam’s inflation risk.

Another important determinant is inflation expectation, which is much more difficult to gauge but could have significant impact on business decisions and wage negotiation, hence feeding into future price increases. Despite the hefty inflationary pressure, the authorities have set an ambitious growth target of more than 9 per cent next year in order to achieve its $1,000 GDP per capita target by 2008, two years ahead of schedule. This could prompt even greater inflation risks in the local economy.

On the monetary front, the central bank is relying on money market operations to absorb excess liquidity, rather than hiking reserve ratios or interest rates to cool growth. The longstanding directive of allowing an orderly depreciation of the dong against the dollar is also unlikely to change, especially with the country still running a moderate trade deficit.

As a result, we have raised our inflation forecasts for 2007 and 2008 to reflect the upside risk to inflation. We now expect inflation to average 8.0 per cent in 2007 and 8.5 per cent in 2008, compared with our previous forecast of 7.6 per cent and 8.2 per cent respectively.

Source: VIR.