Vietnam: Corporate governance

Wednesday, September 10

HSBC and Standard Chartered on September 9th gained approval to open wholly owned units in Vietnam.  As the first overseas banks to secure the right of local incorporation, they have gained a first-mover advantage in a fast-growing economy. However, the news comes amid indications of serious weaknesses in corporate governance, which threaten investor interests.

After a decade as one of the world's fastest-growing economies, Vietnam has experienced a marked deterioration in macroeconomic conditions this year. At 28% year-on-year, the inflation rate is the highest in Asia and Vietnam's worst since 1992. Lower consumption and investment growth have slowed the pace of expansion, while the trade deficit has ballooned to more than one billion dollars per month on average.

Corporate governance weaknesses. This adverse change in the macroeconomic environment has dented the profitability of both state-owned and privately owned companies. It has also brought mounting evidence of weaknesses in management and corporate governance, which will concern foreign investors.

State enterprise sector. As part of a larger campaign to dampen inflation by cutting public expenditure, the government has publicly appealed to state-owned firms to bring their investments in non-core business activities to below 30% of total assets.

In itself, such an appeal is not surprising, but as the sole equity holder in such state corporations, the government might be expected simply to instruct the firms to focus on their strategic roles through private, boardroom channels. The resort to a public appeal highlights deeper problems of incoherence, patronage and blurred authority in the management of state enterprises.

Private sector. The downturn in domestic corporate sector performance may also have exposed further poor governance practices.  An instructive case is that of Bach Tuyet Cotton, a relatively high-profile listed company that has found itself facing accusations of financial irregularities and misreporting.

As a listed company, Bach Tuyet Cotton is subject to stricter auditing requirements. Yet according to local media reports, Bach Tuyet's 2006 and 2007 financial accounts were incorrect and the company may now be facing bankruptcy. A declared profit of 2.25 billion dong (136,000 dollars) in 2006 and 3.0 billion dong in 2007 should have been reported as a 17.0 billion dong loss across the two years, according to the reports. 

While the recent rise in stock market indices indicates that local investors consider the Bach Tuyet Cotton incident to be a one off, accounting firms will be under increased pressure not to allow a repeat of this episode. auditing season will be tougher next time, potentially exposing lax practices and hidden problems among other firms.

Banking implications. Having taken out loans with at least one local bank, it is likely that the assets Bach Tuyet pledged as collateral will be seized. This points to wider ramifications for the financial sector if further problems emerge:

• Bad loans. After unsustainably high loan growth during 2006 and 2007, exceeding 35% both years, the banking community seems destined to face more loan defaults in 2008, as corporate sector clients struggle with a much less benign macroeconomic backdrop.
• Interest rates. The State Bank of Vietnam effectively caps the interest rate at which banks can provide loans at 1.5 times the prime-lending rate. That prime rate is currently 14%, thereby limiting the maximum interest rate that a commercial bank can impose on a loan to 21%. To be profitable, banks must therefore offer a rate of interest on deposits that is below the interest rate on loans, adequate to at least offset all their operating costs. However, with inflation running at 28%, any deposit rates below that level effectively result in negative interest for depositors.
• Thin margins. Banks have been offering around 18-19% interest on deposits, leaving just a slender 2-3% interest rate margin. Even so, many depositors have been withdrawing their money from banks, and thereby removing one of the cheapest and long-term sources of funding for the banks.