Strategy: Whither the VND? Endogenous support, but external risks
07/06/2019 - 08:20
The Vietnamese Dong looks fundamentally well-supported, but watch the RMB. Investors have recently expressed concern about the potential downside risks to the VND, especially given the currency’s high historical volatility and the moderate softening that was evident in May. We believe the domestic economic fundamentals are broadly supportive. We expect 2% depreciation annually going forward, which we think is more or less in line with consensus. However, a key downside risk to our moderate “Goldilocks” depreciation outlook is the potential for RMB devaluation.
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Themes and catalysts
- Strong fundamentals: persistent foreign investment inflows, subdued inflation, sufficient reserves.
- A sharp depreciation of the RMB could trigger downside risk for the VND (albeit probably less downside than that of other ASEAN currencies).
Supportive macroeconomic factors include strong FDI and portfolio inflows (still), relatively low inflation despite food and energy price volatility, and reasonable levels for both VND rates and FX reserves. Historical current account instability results in our global macro team pegging the VND at 10% overvalued (see chart at left) but we think a more stable trade account will gradually emerge from the FDI focus on export manufacturing and, longer term, the development of a comprehensive domestic supply chain that allows greater capture of export value.
RMB is perhaps the key risk. The US-China trade war has resulted in increased and likely persistent FDI inflows for Vietnam, but also increases the risks for global growth. That said, Vietnam appears well placed to enjoy a larger slice of the overall export pie. We think a more cogent risk from the trade war is the possibility of a sharp decline in the RMB from here. Although the VND would not likely fall as much as the RMB (or regional currencies) in this scenario, depreciation could certainly be more dramatic than our base case expectation of 2% annually going forward. We discuss the sector-by-sector impact of a sharp devaluation in this note.
Our call: Fed easing in 2H19 is more likely than a sharp drop in the RMB. Last week’s dismissal (by an ex-PBOC governor) of the idea that 7 RMB to the dollar has any particular importance has driven expectations of further RMB depreciation. However, China also faces food price inflation, banking system troubles, and the potential for renewed capital flight. In our view, the RMB is likely to find support at this level. By contrast, we believe a reversal of previous Fed policy is far more likely to occur in 2H19. This should ease pressure on emerging market currencies such as the VND and is a key driver of our expected stock market recovery in 2H19.
Yuanta Vietnam Strategy — VND Outlook