A banking system saddled with non-performing loans. Political power struggle. Rising inequality and massive corruption. Inflation that was stubbornly rising until recently. Currency under pressure. Unwillingness to privatize or genuinely cede control of public sector. No, we are not talking of India. We are talking of Vietnam. But Communist Vietnam holds lessons for both Communist China and democratic India.

Vietnam appeared to be stabilizing in 2012 simply because things could not get much worse than they did in 2011. Then, inflation was in double digits. The current account was in deficit and the sword of depreciation/devaluation hung over the currency. Vietnam had more than doubled the bank credit/gross domestic product (GDP) ratio to 136% of GDP by 2010 in three waves of credit expansion. One was before the global crisis in 2008. There were two after the crisis and both were deliberate policy decisions by the government. The first one was largely due to massive capital inflows. The State Bank of Vietnam did not sterilize the inflows enough. Domestic liquidity exploded. So did inflation. Bad debts had begun to rise. Credit expansion, therefore, slowed. As liquidity became tight, inflation began to come down.

A 22 August photo of investors at the Asia Commercial Bank’s securities trading floor in Hanoi, Vietnam. Hoang Dinh Nam/AFP

In April and May, a series of articles appeared in financial media that acknowledged the emerging macro-economic stability in Vietnam. The government had announced the privatization of Vietnam Airlines and had even drawn up a privatization timetable after cost reduction of 10% and divestiture of non-core assets. However, one commentator wisely cautions against the use of the word, “private" in the Vietnamese context. There were only State and non-State actors. Where cronyism and favouritism are rampant, private talent that can take over State assets and turn them productive and profitable is not easily found.

In November 2011, the Prime Minister’s son had joined the government as its youngest vice-minister. That came close on the heels of the Prime Minister’s daughter joining the management board of the re-named Viet Capital Bank. Concerns over rampant corruption and nepotism have combined with rising inequality. At the same time, the quality of the workforce is not rising fast enough for employers, operating on thin margins, to boost wages beyond a certain point. On paper, Vietnam has a highly educated population. The literacy rate is high. But the quality of the workforce and private sector management talent is thin. Millions pumped into capacity building in the economy by multilateral institutions have not yet achieved their stated objectives. Consequently, economic productivity and the quality of political and economic institutions leave a lot to be desired. After few years of 7% growth, there is the real risk that the economy is unable to recapture those heights for a very long time.

Fast forward to August 2012. The steep reduction in interest rates in the wake of falling inflation has left many bank depositors unsatisfied. Vietnam has the world’s highest per capita holding of gold. The government is determined to push more credit into the economy to achieve at least a 5% growth rate this year. Growth targets have been pegged back from around 6% to 6.5% to little over 5%. But the determined government directed allocation of credit, in the absence of underlying capacity in many respects, has only allowed non-performing assets to rise. The governor of the State Bank of Vietnam acknowledges that non-performing assets could be as high as 10%. The official figure is 8.6% as of end-March. Fitch Ratings puts the figure at 13%. In some select banks, non-performing assets could be as high as 60% of book value.

All of these have now resulted in the “climatic" arrest of one of the banking tycoons (Nguyen Duc Kien), the founder of the Asia Commercial Bank. Later, his chief executive, too, was arrested. The arrested tycoon was said to be close to the Prime Minister. Hence, this arrest could be seen as a reflection of the internal power struggle in the communist party between the President and the Prime Minister. Or, it could be a genuine detention of a businessman with powerful business connections that demonstrates that cronyism is about to be dealt with. It is hard to know. Emerging markets are known not just for opacity of economic data. Internal power arrangements, struggles and dynamics are hard to know for foreign investors. That need not deter investments as long as they know how to demand a premium for such risks. But zero interest rates have sedated them into accepting all risks with no compensation.

It is debatable if Vietnam stocks are priced cheaply enough yet, especially if recent developments raise questions on the ability of the country to re-scale high growth rates ever.

V. Anantha Nageswaran is an independent financial consultant based in Singapore. Comments are welcome at baretalk@livemint.com

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