Save the Banks or Sink the Dong: Vietnam’s Financial Tightrope in 2025

Vietnam’s main macroeconomic indicators have had positive showings towards the tail end of 2024. While there have been slight increases in both Core and Headline Inflation to 2.89 and 2.77% respectively from October 2024, the general trend has been going down, as evidenced by the Exponential Moving Average. This is an indicator which places a premium emphasis on recent months to better capture immediate changes in CPI.

Fig 1. Both core and headline CPI decrease as general trend ticks downwards as well. Source: LSEG Workspace

The government’s target is to control inflation within the (4.0-4.5%) band.[1] Such promising data raises the possibility of further rate cuts, given that the last benchmark rate cut was in mid-2023.[2] This likelihood is further spurred by a need to consolidate the financial sector, plagued by Non-Performing Loans (NPLs), and weaker-than-expected credit growth (9.0% vs official target of 15.0%). Lower interest rates would stimulate greater loan volumes by increasing loan demand. This does not come at the possibility of reduced profit margins as short-term deposit rates have been recently capped at 4.75%.[3] The government’s recent decree likely signals a policy direction aimed at maintaining deposit rate stability. This approach would help ensure stable Net Interest Margins (NIMs) for banks, as the rising loan demand would not necessitate higher deposit rates to attract additional capital. With credit growth outpacing deposit growth (10.08% compared to 4.79%), Vietnamese banks are grappling with liquidity pressures exacerbated by the 2023 corruption crisis, which left the banking sector burdened with billions of toxic assets due to a massive issuance of fraudulent bonds.[4] It is therefore evident that this time, the politburo has prioritized the interests of banks over potential clients, likely resulting in increased earnings for these traditional financial institutions that remain heavily reliant on deposits for revenue growth.[5]

Additionally, cheaper loans would also indicate greater M&A activity within the financial sector, which is crucial for a reduction in systemic risk through the absorption of weaker banks with a higher proportion of Non-Performing Loans (NPLs) by banks with stronger balance sheets.[6] These NPLs seem to disproportionately affect smaller-sized banks (4-6% NPL) with strong ties to real-estate credit, which has experienced a severe downturn in 2023 and are highly illiquid in nature. [7] [8] Debt restructuring through M&A becomes crucial, and recent regulatory efforts to increase transparency are also likely to stimulate further investment banking activity to pull commercial banking out of the mud.[9]

It is probable that the refinancing rate will edge lower as the politburo seeks ways to further stimulate the financial sector. Current market risk premium—measured by the interest rate differential between the prime rate and the refinancing rate—stands at 4.50%, which is in parity with the NPL percentage in many small to medium sized banks that are facing short-term liquidity crunches. Therefore, the long-term financial health of these institutions can only be assured by widening the spread. Ultimately, the key lies in ensuring that prime rate reductions lag behind refinancing rate cuts, achieving a delicate balance between maintaining bank profitability and fostering adequate credit growth—both of which are crucial objectives for Vietnam's financial sector.

However, there are risks accompanying monetary policy adjustments. The most important one would be the dismal situation of the Dong, which has experienced rapid depreciation in 2022-2024.[10] This is exacerbated by dwindling Vietnamese foreign currency reserves following central bank efforts to stabilize the Dong after sudden U.S federal reserve hikes in 2022.

Fig 2.1 High correlation between Fed Fund Rates and USD/Dong exchange rate, indicating high dependence of the Vietnamese economy to the U.S economy.

Fig 2.2 Vietnam foreign reserves superposed to major monetary events in the US.

Further interest rate cuts would worsen the exchange rate, and central bank intervention becomes less likely as foreign currency reserves sink below the critical threshold of 3-month imports’ worth.[11] However, a dovish Fed in at least the first half of 2025 would likely alleviate the need for intervention. Additionally, relative stability in the Dong since June despite minimal government intervention, consistent export performance, and FDI inflows indicate less projected depreciation pressure. Recent government-led initiatives to shore-up the Dong, such as setting a 0% base-interest rate for any USD-denominated deposits in Vietnamese jurisdiction, are also likely to offset depreciation pressure.[12]

Combining the above insights, it is likely that the Central Bank would engage in tentative rate cuts before moving sideways. However, the manifest desire to stimulate the financial sector would be present through other means. For example, the Central Bank recently pledged a 20.695 trillion Dong capital injection to Vietcombank, a SOE that is concurrently the largest national bank to aid for acquisition and spillover debt restructuring efforts to struggling banks.[13] The development of large-scale infrastructure projects, alongside the revival of the real estate industry, is also expected to drive an increase in debt financing. Upsizing allocation to the financial sector would thus be a logical next step.

References

[1] Haiquan Online. (2023, December 31). Inflation increased by 4.16% in 2023.

[2] Dun & Bradstreet. (2024, December). Country Insight Report: Global economic outlook and country risk analysis. Dun & Bradstreet.

[3] Reuters. (2024, June 4). Vietnam expands massive bank rescue effort on deposit exodus, document shows.

[4] VietnamPlus. (2024, November 18). Central bank issues new decisions on deposit interest rates.

[5] Vietnam Investment Review (VIR). (2024, October 16). Acquisitions to help boost restructuring of weak banks.

[6] Vietnam Investment Review (VIR). (2024, April 15). Assessment of non-performing loans so far in 2024.

[7] Vietnam Investment Review (VIR). (2024, June 12). Rising NPLs under increased pressure.

[8] VietnamPlus. (2024, August 28). New regulations on mergers, consolidation of credit institutions proposed.

[9] The Investor. (2024, September 5). Vietnamese dong likely to depreciate 3% in 2025: VinaCapital

[10] Reuters. (2024, October 23). Vietnam plans capital injection into Vietcombank to support policy goals.

[11] https://theinvestor.vn/vietnamese-dong-likely-to-depreciate-3-in-2025-vinacapital-d13862.html

[12] https://en.vietnamplus.vn/central-bank-issues-new-decisions-on-deposit-interest-rates-post304162.vnp

[13] https://www.reuters.com/business/finance/vietnam-plans-capital-injection-into-vietcombank-support-policy-goals-2024-10-23/?utm_source=chatgpt.com