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$25 Billion Up for Grabs: Will Vietnam's Communist Grip Hinder its Emerging Market Dream?

Vietnam, accounting for 27.12% of the MSCI Frontier Markets Index as of January 31, 2024, seeks an upgrade to emerging market status, aiming to attract up to $25 billion in stock market investment by 2030. While the transition promises benefits like increased market liquidity and foreign capital inflows, challenges remain, including same-day settlement procedures hindering foreign investor participation and industry-specific foreign ownership caps. Addressing these concerns and implementing reforms are crucial for Vietnam to convince relevant organizations of its readiness to join the ranks of established emerging markets.



Benefits of Vietnam's Upgrade to Emerging from Frontier Market


Vietnam has been on a prolonged charm offensive to convince foreign equity managers (i.e., FTSE, MSCI) to upgrade the status of Vietnam to emerging from frontier market. The motivation is high for Vietnam as the emerging economy stands to gain up to $800 million from passive funds alone, and $25 billion in stock market gains from foreign investors by 2030, according to the World Bank's Ketut Ariadi Kusuma.


A specific timeframe hasn't been confirmed by relevant organizations, but Vietnam signals it hopes the upgrade occurs in 2025. Before that happens, Hanoi has much to accomplish. For starters it must relax its stock market settlement procedures for foreign investors, one of the most critical and necessary reform to foreign equity managers. Of all the roadblocks slowing the upgrade, this is perhaps the one irking foreign investors the most.


Progress is occurring, albeit slowly. In October 2023, representatives from FTSE visited Vietnam and were positive about the progress they observed Hanoir making to break the years-long deadlock preventing the upgrade. Le Thi Le Hand, chief strategist at Viettna's leading broker SSI, had this to say about the process and progress:


"Last week's meetings with FTSE were positive and could lead to a possible upgrade to the secondary emerging market status by September 2025."

Vietnam's Frontier Status


Vietnam accounts for around one-third of the frontier indices' total capitalization, and at the same time has one of the smallest bourses of the main Southeast Asia exchanges. As of January 31, 2024, Vietnam accounted for 27.12% of the MSCI Frontier Markets Index. Second is Romania holding a market share of 11.5%, followed by Morocco with a 10% share.


Moving to emerging market status would put Vietnam in the category of the Philippines, Qatar, Argentina, Kuwait, and Indonesia which have all recently made the jump and benefited. The primary downside for those upgraded nations has been increased volatility. Emerging market capital flows are greater but also more finicky and face greater fluctuations due to greater sensitivity to broader economic trends. Frontier market flows are smaller and the investments tend to be a bit "stickier".


 

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Changes Hanoi Must Fasttrack to be Upgraded


Vietnam plans to adopt a mechanism permitting easier settlement of shares. More advanced markets permit a two-day (T + 2) settlement period, whereas in Vietnam the cash must be available the same day (t + 0) causing higher costs and risks to foreign investors. The challenges stem from time zone differences and banking regulations making it burdensome to ensure cash is available in time.


Forex is also an issue since same-day settlement requires same-day forex conversion which may not always be possible at favorable rates.


To solve the funding challenges, Vietnam plans to copy China's model where local securities firms guarantee foreign funds payments. The result is effectively a two-day line of credit with the securities firms being on the hook if something goes wrong. The primary risk the security firm guaranteeing the transaction faces is non-payment by the foreign counterparty.


In a way, it makes sense for the securities firms to bear these risks since they stand to benefit the most from the massive increase in capital flows that would occur after the upgrade. Bank loans are not an option to offer short-term lines of credit due to a prohibition in Vietnam of banks extending credit to foreigners.


To entice more foreign capital, the communist nation should also increase or eliminate foreign ownership caps for stocks. Many stocks have no caps, but the ones most desired do, and the caps range in value based on the industry and perceived strategic importance to Hanoi and business elite.


Foreign ownership stakes are required to be disclosed to the authorities in many cases. While not a technical impediment to investment, it adds a layer of complexity to owning shares in Vietnam which isn't present in other nations with friendlier business and investment climates.


Lastly, Vietnam as a communist nation has a plethora of state-owned companies that are primed to be privatized and many of these would be attractive to foreign investors. Giving up control of the companies would create more investment options in the country, and benefit the country's economy. But it would also mean Hanoi giving up some control which could negatively impact well-placed communist politicians in Hanoi and their allies. This final point may explain the relatively slow pace of changes the markets have seen from the Vietnamese government to affect these relatively easy-to-make changes.


In summary, Vietnam now stands at a critical juncture in its pursuit of emerging market status, with foreign fund managers closely watching developments. As the process drags on, the responsibility now falls squarely on Hanoi's shoulders to enact necessary reforms. Despite recent setbacks like corruption scandals denting Vietnam's reputation, decisive action from the government could offer a positive story for foreign investors to focus their attention. A successful transition holds the promise of augmented market liquidity, expanded access to capital, and targeted growth across all sectors.

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