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Rating Action:

Moody's lowers Vietnam's rating to B1; maintains negative outlook

Global Credit Research - 15 Dec 2010

Singapore, December 15, 2010 -- Moody's Investors Service has today lowered the government of Vietnam's bond rating to B1 from Ba3 and maintained a negative outlook.

RATINGS RATIONALE

The main reasons for the decision are:

1. The heightened risk of a balance of payments crisis, arising from a widening trade deficit, capital flight, the reduced level of foreign exchange reserves, and depreciation pressure on the VN dong exchange rate;

2. The rise of inflation into double-digit territory, which will further increase pressure on the exchange rate and which results in capital flight in the external balance of payments;

3. Policies working at cross purposes have contributed to the rise in contingent liabilities on the government's balance sheet in the public enterprise and banking systems; and

4. Debt distress at the government-owned shipbuilder, Vinashin, which suggests a reduced ability or capacity on the part of the government to provide financial support to that, and perhaps other, large, state-owned enterprises.

The action lowers the government's foreign and local currency bond ratings to B1 from Ba3, Vietnam's foreign currency country bond ceiling to B1 from Ba2 and the foreign currency bank deposit ceiling to B2 from B1; all of which have negative outlooks. The local currency bond and deposit ceilings were lowered to Ba2 from Ba1. The short-term ratings and ceilings remain at Not Prime (NP).

The ceilings act as a cap on ratings that can be assigned to the domestic or foreign currency obligations of other entities domiciled in the country.

RATIONALE FOR THE DOWNGRADE

"Moody's considers that short-comings in economic policies have allowed pressures to remain unabated on the balance of payments and are resulting in ongoing macroeconomic instability," says Tom Byrne, a Senior Vice President in Moody's Sovereign Risk Group.

"Although strong stimulus measures taken during the global financial crisis buoyed economic growth and allowed Vietnam to rank as one of the better performers globally in 2009, an unwillingness to tighten effectively monetary policy and to allow the exchange rate to depreciate in line with market pressures have weakened the balance of payments and have elevated the risk of an external payments crisis," says Byrne.

"The rise in inflation to 11.1 percent in November compared with the same month a year ago highlights the weakness in policies, which remain biased towards growth rather than towards stability. While the food component of the price index was a large driver of inflation, so has been the investment component which is, in turn, driven by the declining, but still large fiscal deficit, as well as rapid growth in bank credit and in the monetary aggregates this year," adds Byrne.

The authorities have recently taken tightening measures, such as the 100-basis-point increase in the policy interest rate, but it is likely that a stronger stance will be necessary to contain inflationary pressures.

Moreover, the exchange rate remains overvalued despite the 2.1 percent devaluation in August, as is seen in the re-emergence of a sizable discount in parallel foreign exchange market rates. Coupled with overheating in the economy, the overvalued exchange rate has led to rapid growth in imports and the widening of the trade deficit this year.

Another result is that market expectations for a weaker dong exchange rate -- coupled with inflationary expectations -- led to a surge in capital flight (BOP errors and omissions) last year, and which apparently has continued this year according to available statistics.

These developments are putting significant pressure on the balance of payments and have weakened the external payments position, as is reflected in the rise in external vulnerability to external shocks (as reflected in the external vulnerability indicator, and the ratio of debt payments due within one year to holdings of official foreign exchange reserves).

Even though strong private remittance inflows and a rebound in foreign direct investment have provided additional support to the balance of payments this year, the current account deficit may also widen slightly to 7 percent of GDP according to the IMF. That, coupled with surging capital flight, reduced official foreign exchange holdings to $14.1 billion in September from a peak of $23.9 billion in 2008, according to the most recently available data. We expect reserves to decline further under existing policies.

Although an external payments crisis is probably not imminent--assuming that capital flight is staunched and the recent stabilization in holdings of official foreign exchange reserves continues--the absence of a timely release of official reserve data adds uncertainty and hinders analysis, especially during times of heightened global financial market uncertainty and risk aversion.

In addition, institutional and regulatory policy weaknesses raise concerns over a build-up in contingent liabilities on the government's balance sheet. One reason is that debt at large state-owned corporations has grown rapidly in recent years.

Another reason is the rapid growth in banking sector loans which will probably lead to deterioration in asset quality in a system that is not that well capitalized. And, greater reliance on offshore funding has eroded the international liquidity positions of the banks, resulting in a shift from a strong, net foreign asset position to a growing net liability position in June this year. This development increases vulnerability to an adverse shift in foreign creditor sentiment.

Lastly, the government's refusal to provide financial support to the distressed shipbuilder, Vinashin, may have unintended consequences. Although ring-fencing by the government of Vinashin's foreign liabilities from its balance sheet may seem to help protect official foreign exchange reserves, a default on Vinashin's foreign obligations would likely damage the ability of the country to raise foreign market financing at affordable rates for its still largely unmet infrastructure needs.

Moreover, an unwillingness to support a seemingly strategic company, which was the sole beneficiary of Vietnam's initial global bond issuance in 2007, raises questions on the health of the public enterprise sector at large, and on the adequacy of official holdings of foreign exchange reserves. Greater transparency in the communication of financial and economic conditions, as well as of policy intentions, would help to allay such concerns.

CREDIT TRIGGERS FOR A FUTURE RATING ACTIONS

These would include on the downside:

1. An inflationary cycle which further exacerbates capital flight,

2. A loss in foreign exchange reserves that threatens to remove the buffer to a sudden stop in foreign credit or to deleveraging of portfolio investment positions, or

3. Deterioration in the financial health of the banking or state enterprise system that threatens to weaken the country's external payments position or the sustainability of public-sector debt.

On the upside, a coherent and effective policy response that restores the prior strength of the balance of payments, contains inflation and ensures the continued manageability of public-sector finances would put upward pressure on the rating.

PREVIOUS RATING ACTION & METHODOLOGY

The last rating action on the Socialist Republic of Vietnam was taken on 4 August 2008, when Moody's placed Vietnam's government's ratings on negative outlook.

The principal methodology used in this rating was Sovereign Bond Ratings published in September 2008.

Press releases of other ratings affected by this action will follow separately.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings and public information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of maintaining a credit rating.

Moody's adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Singapore
Thomas J. Byrne
Senior Vice President - Regional Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Singapore
Christian de Guzman
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Moody's Investors Service Singapore Pte. Ltd.
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Singapore
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (65) 6398-8308

Moody's lowers Vietnam's rating to B1; maintains negative outlook
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