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|Michael Kokalari, Chief economist, VinaCapital|
The Fed effectively prints money and uses it to acquire bonds and other securities. In doing so, it increases the amount of US dollars in the global economy, and thus the Fed’s quantitative easing (QE) programme is essentially (but not exactly) a form of money printing that pushes up stock prices around the world.
For that reason, some investors are worried about the possibility of another “taper tantrum” like in 2013. At that time, the Fed’s announcement that it would reduce its monthly QE purchases from $85 billion to $65 billion prompted major corrections in several emerging market (EM) stock markets.
Most analysts expect the Fed to begin its QE tapering in December. As such, some investors are concerned about the possibility that another taper tantrum could prompt a correction in the VN-Index, which has surged by more than 20 per cent on-year despite the lockdowns.
We are not overly concerned that another taper tantrum will trigger a stock market correction in Vietnam. The EM countries that were the most impacted by the 2013 tantrum were those that had too little USD reserves and/or had too much US dollar-denominated debt.
Vietnam was not overly impacted in 2013 because it was still benefiting from the State Bank of Vietnam’s restructuring plan as well as other positive developments at that time. The country is also not likely to be affected by the Fed’s imminent tapering, according to new research published by the Fed last month.
The Fed’s new research compared which frontier and EM countries were most impacted by the 2013 tantrum to those that emerged relatively unscathed by comparing the impact on the foreign exchange (FX) rates of EM countries that did not have sufficient FX reserves to those that did.
The exchange rates of countries that did not have sufficient FX reserves, according to the International Monetary Fund (IMF), depreciated by over 10 per cent during the taper tantrum, while those with sufficient FX reserves were relatively unchanged. The sudden, steep depreciations of the exchange rates of countries with insufficient FX reserves prompted stock market corrections in those countries.
Vietnam currently has an estimated $100 billion of USD reserves, which is nearly 10 per cent above the IMF’s minimum recommended level. Furthermore, Vietnam’s USD-denominated debt is fairly modest, which is the other major vulnerability for EM countries during QE tapering, according to the Fed’s research.
Companies in EM countries borrow in foreign currencies, especially in USD, because the interest rate expense of such borrowing is usually much lower than the interest rates on loans denominated in their own currencies. Vietnam’s one-year deposit rates are currently around 5-6 per cent versus 0.05 per cent in the US.
However, in times of financial distress, it can become very difficult for companies to access the US dollars they need to make payments or to re-finance the debt. This explains why EM countries that had high external debts and low FX reserves suffered most in 2013.
The IMF estimates that Vietnam had $138 billion of foreign currency debt at the end of 2020, which equates to 38 per cent of GDP. But it is important to note that a substantial portion of Vietnam’s external debt is essentially soft loans that are owed to supra-national lenders, such as the World Bank, on concessionary terms. As such, this debt does not increase Vietnam’s vulnerability to tighter global monetary conditions.
EM countries are advised to maintain sufficient FX reserves to cover their US dollar-denominated liabilities for one year without having to borrow more from overseas lenders and investors. That’s because the availability of US dollars in the international markets can dry up at times, which would likely happen if-and-when the Fed aggressively reduces its monthly money printing.
We estimate that the total amount of Vietnam’s foreign currency debt owed to foreign lenders by private sector businesses and state-owned enterprises equates to 25 per cent of GDP. However, the State Bank of Vietnam has about 30 per cent of GDP worth of USD reserves, which is more than enough to repay the country’s most pressing liabilities to foreign investors and lenders, and which explains why Vietnam does not need to fear the Fed’s imminent QE tapering.
The Federal Reserve is under pressure to reduce its QE because its monthly money printing has fuelled a US real estate bubble of epic proportions, and propelled stock markets around the world to unfathomable heights. In addition, the European Central Bank recently announced it would begin reducing its monthly asset purchases, putting further pressure on the Fed to announce the timing of its QE taper.
Meanwhile, US house prices went up 19 per cent on-year and the S&P500 is 40 per cent above its pre-pandemic level, despite the fact that the pandemic has damaged the country’s future economic prospects.
We expect the Fed to start reducing its monthly asset purchases in November. However, we do not expect its tapering to last for more than a few months, because economic growth in the US is slowing precipitously. A plethora of poor economic data, including falling retail sales and much weaker-than-expected new job creation, prompted Morgan Stanley to slash its Q3 US GDP growth forecast from 6.5 per cent to 2.9 per cent two weeks ago, and the Fed’s economists also reduced their growth forecasts in recent weeks.
The current situation is reminiscent of both 2018 and 2019, when the Fed began tightening monetary policy despite slowing US GDP growth. In both cases, the Fed was quickly forced to reverse course, and we expect a similar scenario with its current plan.
Now, the US economy is slowing because of the spread of the Delta variant as well as the fact that the US government gave an enormous amount of COVID aid money to citizens over the last 18 months. Those benefits have now ended and much of the money the government handed out has already been spent. Incidentally, the US consumer spending fuelled by this aid has resulted in a surge of exports from Vietnam to the US.
In conclusion, while analysts have concerns about the potential impact of US QE tapering on EMs, Vietnam stands apart and should not be negatively impacted because it is in a different and better position than many other markets. Furthermore, the Fed is unlikely to taper for a significant amount of time due to the weakening economic growth in the US.