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Why bulls should not charge headlong into Vietnam

Nation has much to offer investors, but state interference still poses risks

| Vietnam
Prime Minister Nguyen Xuan Phuc must accelerate to open up the economy to validate investors' optimism.    © Reuters

Executives in Vietnam may see the prefix "+81" -- Japan's country code -- on a growing number of incoming calls this year.

The Southeast Asian economy has often been a favored destination for Japan Inc. Now out of all regional options, 36% of Japanese companies see Vietnam as the number one place to do business, says a December survey by Kyodo News-affiliated NNA. By a wide margin, too. Second-ranked India scored less than 18% of interest. China, less than 8%.

Vietnam has 7%-plus gross domestic product growth, a sizable consumer market and is working to become a central production hub, as an alternative to China. Quite a standout in a region being upended by the global trade war. Largely devoid of the currency gyrations and election intrigue afflicting neighbors from Indonesia to Thailand, Vietnam offers shelter from the coming global storm. Punters expect Ho Chi Minh City stocks to rally nearly 20% this year.

What could go wrong? Quite a bit, actually.

The bull case is evident. Even with its many boom-bust cycles, Vietnam's GDP has advanced on average by more than 5% annually since 2000. The government has worked steadily to create a cost-effective manufacturing power. In 2018, it attracted enviable foreign-direct investment inflows from Japan, South Korea and Taiwan. As of Dec. 26, actual FDI disbursements had risen 9% in 2018. The year ahead, Hanoi hopes, will see even more.

The benchmark VN Index appears cheap. Back in April, shares on average traded at roughly 20 times estimated earnings. Today, they are in the 14-15 range, compared with, say, 20 in the Philippines and 19 in Malaysia. Given that Vietnam's initial public offering market exceeded Singapore last year, with total proceeds of $2.6 billion, investors would seem to have plenty of targets. Hence the 18% rally analysts polled by Bloomberg expect this year.

Yet here are three risks that could easily upend optimism in the 12 months ahead.

First, Donald Trump's tariffs. For now, Vietnam is an obvious winner in Asia's "Plan B" beauty contest as conditions in China turn ugly. The U.S. president's taxes on $250 billion of mainland goods are imperiling China's export engine. Though President Xi Jinping's government is telegraphing 6.3% growth in 2019, almost no one believes it can achieve that.

As companies from Japan and South Korea to the U.S. look for an alternative, Vietnam's $241 billion of annual GDP feels comfortably familiar. A Communist government, openness to smokestack industries, a firm hand on public dissent, urbanization and 97 million-strong population can make the place seem Chinese enough without the Trump-Xi histrionics.

Yet no trade-reliant economy is immune to what might happen next. Trump's threat to impose 25% levies on imports of cars and auto parts, for example, would devastate the supply chains on which China and Korea rely. These, it is worth noting, are two of Hanoi's biggest markets.

Increased chaos on the trade front, and the specter of Trump starting a currency war, could mean fewer incoming +81 calls than expected. Japan Inc.'s 2019 will darken with each Trumpian outburst. No open Asian economy can wall themselves off from an erratic White House.

Next, government short-termism. Last week, Prime Minister Nguyen Xuan Phuc called on the Ministry of Finance to hasten reforms, focusing on more effective tax policies, simpler customs procedures, increased budget revenues and tighter corporate governance.

Investors could be excused for feeling a sense of deja vu. Twelve months ago, market watchers were forecasting a 20%-plus surge in VN shares amid hopes Phuc's team would accomplish much of what he discussed once again last week. The slower-than-hoped pace of reform helps explain why stocks lost 9.3% in 2018.

To validate investors' optimism, Phuc's team must accelerate steps to open up the economy more to financial investors and privatizing hundreds of state-owned enterprises. Given Vietnam's young population -- roughly 25% of which is under 15 -- punters are especially interested in greater access to consumer and health-care-related SOEs. Markets will cheer any progress on upping foreign-ownership caps in listed companies above today's 49%, something Phuc's team has proposed.

Yet efforts to strengthen the financial system have lagged Vietnam's ambitions. In a Dec. 4 report, Fitch Ratings noted that for all its progress building a consumer market, Vietnam remains highly dependent on state-directed industrial investments for growth.

In other words, it is more about stimulus than organic growth, a demerit that will sound familiar to China investors. As such, Fitch warns, bank capital "remains under pressure" thanks to overextending credit.

Finally, imperiling innovation. When trying to take on China, it is wise to avoid Beijing-like own goals. Hanoi's new cybersecurity law is a case in point. Daniel Bastard of Reporters Without Borders, the media freedom lobby group, minced no words on Jan. 1, deriding it as a "totalitarian model of information control."

Mark Zuckerberg of Facebook renown might agree. Last week, Hanoi picked a headline-grabbing fight with the world's biggest social network. Hanoi accused Facebook of allowing the posting of "slanderous content, anti-government sentiment and libel and defamation of individuals, organizations and state agencies."

Over the top? Zuckerberg's juggernaut can defend itself (and it does, claiming it has restricted illegal content in Vietnam). But this brawl might unnerve those investors, many in Japan, who believe Vietnam is destined to become an innovation powerhouse.

How Hanoi cultivates a Silicon Valley vibe while limiting the involvement of local entrepreneurs in the big conversations of the day is an open question. Google, too, is pushing back against demands that tech companies store data in Vietnam, fearing the government might want access.

All this works at cross-purposes with Hanoi's ambitions. One reason Vietnam "is not an investment market for the faint of heart," says global consultancy Control Risks, is its "complex political patronage networks, rampant corruption, 'evolving' infrastructure, low levels of transparency, and capricious policy initiatives. The ability to successfully navigate these challenges is critical to business success in Vietnam."

The fastest way to improve navigation is embracing global internet companies as allies in reducing opacity. Xi is going even further in bolstering censorship, imperiling China's development as a tech leader. Vietnam should not make the same mistake.

There is plenty that could go wrong for developing markets with Trump still on the prowl. So an ambitious country like Vietnam should take care to avoid making life even harder for itself. Now it is a clear favorite for CEOs from Tokyo to New York. But another year of disappointing investors betting on a modernized economy would cost the nation dearly.

William Pesek is an award-winning Tokyo-based journalist and author of "Japanization: What the World Can Learn from Japan's Lost Decades." He was given the 2018 prize for excellence in opinion writing by the Society of Publishers in Asia, for his work for the Nikkei Asian Review.

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