ANALYSIS

Turmoil in Vietnam's Bond and Real Estate Markets - Ways Out of the Crisis

In recent years, there has been an increase in overall corporate bond issuance in Vietnam. However, starting in 2022 and continuing into 2023, there was a decline in bond issuance along with a general market turmoil that affected all market participants. Mainly due to a weakening credit environment triggered by factors such as interest rate hikes, speculative real estate cycles, tightening bank credit, and unprepared retail investor participation in the corporate bond market a high number of corporate bond defaulted. In numbers: Alone in March 69 issuers were unable to meet their debt obligations, resulting in a total value of defaults of VND 94.43 trillion, or about 8.15% of the total value of outstanding bonds. But default rates have not stopped instead they increased significantly, reaching 11.74% in May 2023.

Property market as main driver

A closer look at the property market is essential to fully understand the impact of bond defaults in Vietnam, as the two markets are strongly linked (almost 25% of real estate bonds defaulted as of May 2023). In fact, a significant share of the increase in bond default rates can be attributed to property developers, as this sector has driven the corporate bond market and attracted a significant number of investors.

Throughout the Covid-19 pandemic, Vietnam's property sector faced challenges such as rising interest rates, regulatory bottlenecks, inflation, slow construction progress and reduced bank lending. To overcome liquidity problems, developers turned to the bond market with professional bonds that could be issued easily and quickly. The regulator tried to protect retail investors from this type of risky investment by restricting access to professional bonds, which do not require any regulation or transparency, as early as 2020 (Decree No. 153/2020/ND-CP).

However, retail investors found ways around the restriction and bought mainly these professional bonds - sometimes with knowledge, sometimes not. As default rates rose, retail investors lost money and investor anger grew, the regulator reacted with the new decree No. 65/2022/ND-CP. However, the strict rules led to a stark decline in bond issuance, which affected the liquidity of developers and caused a temporary halt to ongoing real estate projects. To overcome the liquidity shortage and the impact of the previous decision, the regulation was withdrawn (Decree No. 08/2023/ND-CP) - meaning that the challenges and risks for most retail investors remain the same.

Although the current situation can be explained by short-term indicators such as the credit environment, inflation or rising interest rates, the solution to the problem is more fundamental and therefore should be addressed in the long term to prevent Vietnam from experiencing a similar setback in the future again.

Pillars on which to build a solution - starting with the financial sector

One of the pillars is the improvement of the financial sector, which is also reflected in the Global Financial Centres Index (GFCI), where Ho Chi Minh City is the only listed financial center in Vietnam ranked last in the Asia-Pacific region. In order to create a robust framework for the development of the financial sector, it is crucial to focus on several key aspects.

These include the enhancement of the financial infrastructure, the fostering of fintech efforts, and the strengthening of the banking sector. By nurturing these elements, a stronger sense of confidence in the financial market can be cultivated, thereby attracting more investors. It is equally important to foster synergy between the public and private sectors. This synergy serves as an important catalyst for driving innovation and inclusiveness across the financial sector. Collaborative partnerships have the potential to catalyze the creation of inventive solutions, extend the reach of financial services to marginalized populations, and ultimately promote inclusive economic development.

It is also important to open up access to a wide range of financial products and international markets to the general public, so that they can invest in a variety of assets. At present, investment opportunities for Vietnamese investors (especially for retail investors) are limited and may lead to speculation in other forms such as the real estate sector.

Financial knowledge as second pillar

Another pillar is the spreading of financial knowledge and ensuring understanding among the general public about the basic workings of the economy and finance can provide Vietnamese private investors with invaluable resources (which is already taking place by “television” education). This empowerment equips them with the ability to carefully analyze investment decisions and more effectively assess the intricacies of financial undertakings, including real estate transactions in the current context, along with their associated risks.

Over time, this proactive educational approach has the potential to reduce harmful behavior within the Vietnamese financial framework and holds the prospect of improving the allocation of financial assets. It also ensures that investors are independent in their decisions and that no legislator is pressured to impose excessive regulations on financial institutions, which can be a constraint on their development. In the long run, retail investors could build a portfolio based on their own risk adverse and attain financial independence at all stages of their lives without relying on large social security systems.

Institutions as crucial foundation

Last but not least, improving institutions is the beehive of Vietnam's economy, particularly its financial sector. In achieving long-term prosperity, innovation and growth are the key drivers of success. Institutions can be seen as the "rules of the game" (as defined by Douglass North, an American economist and Nobel laureate) in a society, which can be formal, such as laws and constitutions, or informal, such as social norms and customs.

According to this theory, in countries where legal systems enforce, for example, (good) private property rights, support contractual agreements and protect investors' rights, investors are more willing to invest and the financial market performs better than its counterparts. An examination of Vietnam's (legal) institutions reveals room for improvement over the past 25 years. The control of corruption, the quality of regulation, the rule of law and, not least, the effectiveness of the judiciary have remained at the same level for many years.

However, there have been positive trends, particularly in the areas of property rights and government integrity, which have clearly had a positive impact on the Vietnamese economy (particularly in attracting foreign direct investment). However, to bring Vietnam closer to its vision of becoming a developed, high-income country by 2050, it is crucial to strengthen its overall institutions.