May 29, 2008 / 10:24 AM / 12 years ago

Vietnam may be first domino among Asian economies

SINGAPORE (Reuters) - Fitch’s lowering of its outlook on Vietnam’s sovereign rating on Thursday could be a sign of more weakness to come for many of Asia’s economies and currencies, as record oil prices complicate their efforts to control inflation.

Workers erect steel structures at a construction site in Hanoi May 27, 2008. REUTERS/Kham

Fitch Ratings lowered the outlook on Vietnam’s BB-minus rating to negative from stable, saying that authorities had not dealt quickly or strongly enough with inflation, potentially posing risks to banking system’s stability.

The agency cited the delicate position the government is now in, riding a fine line between containing price rises and setting off a sharp economic slowdown.

Some observers are even pointing to a potential currency crisis, given Vietnam’s growing current account deficit, weakening fiscal position and limited foreign exchange reserves, on top of 25 percent annual inflation, the second-worst in Asia.

Some of Asia’s largest economies are also grappling with the same risks. Although none look as vulnerable as Vietnam, some are set for their sternest test since the Asian financial crisis of 1997.

“I think (we could see) a much deeper and more prolonged slowdown than people are currently anticipating that lasts until the end of 2009, rather than being done shortly,” said Bill Belchere, regional economist with Macquarie in Hong Kong.

The Philippines, South Korea and India share some of the problems that pushed Vietnam into its downward spiral.

In all three expensive oil imports are eroding their current accounts and dragging down currencies. Weak currencies are fuelling inflation, piling pressure on central banks to raise interest rates. Higher rates would hurt economic growth and stock markets, triggering a flight of capital needed to finance the trade gap.

“Then you can see a fairly sharp reversal in expectations around the behavior of the currency,” said Peter Redward, head of rates strategy at Barclays Capital.

“The currencies’ weakness then starts feeding on itself in terms of pushing inflation up. That’s a significant risk.”

GROWING DIVERGENCE

The Korean won KRW= has fallen 9.4 percent this year as the country prepares to run up its first current account deficit since the Asian crisis. The Philippine peso is down nearly 5.7 percent and the Indian rupee INR=IN 7.9 percent.

By contrast currencies of economies with solid trade surpluses have fared better. The Singapore dollar has risen 5.2 percent, the Malaysian ringgit 1.7 percent and the Taiwan dollar about 6.6 percent.

“I think divergence will be a theme moving forward,” Belchere said. “Southeast Asia is losing its policy flexibility.”

Nowhere is that threat more pronounced than in the Philippines, said Peter Redward, head of rates strategy at Barclays Capital.

With countries such as the Philippines coming under increasing fiscal stress from their oil and food subsidies, they will likely have to issue more debt, which could lead to a higher likelihood of default, Redward said.

Redward said he observed a “domino effect” working through Asia, as currency weakness spread from countries with the most exposure in their balance of payments to oil prices, such as Korea, India and the Philippines, to those with trade surpluses such as Singapore, Malaysia and China.

OIL PRICES KEY

Key to the extent of the spread will be the price of oil.

“If oil prices were to come back down to $100 a barrel, then I think a lot of the pressure that these countries are under would dissipate very quickly,” Redward said.

“If it was to go up to $150 a barrel, then we would find that more dominoes would fall,” raising the risk of a harder landing for the region, he said.

Mirza Baig and Dennis Tan, strategists with Deutsche Bank in Singapore, expect most Asian currencies, apart from the Chinese yuan, the Malaysian ringgit and Singapore dollar, to weaken this summer, particularly if oil prices extend their rise.

“We think the broader macro backdrop has reached a tipping point, where the cushion on balance of payments and scope for policy makers to retain a ‘watch and wait’ stance on monetary policy has worn out,” they said in a note to clients.

While stronger economies in the region would probably see their currencies, and exports, hit to some extent by the weakness in other countries, Belchere said he thought the region would avoid anything like the 1997 financial crisis.

“It comes down to the old Mark Twain saying: ‘Virtue untested is not a virtue.’ It’s going to be tested now. The policy guys are going to have to respond,” he said. “I think Asia will get to the right place. Will it be a straight line? I’m not so certain.”

Reporting by Jason Subler; Editing by Dayan Candappa

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