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Mekong Delta Frontier Offers Investor Opportunities

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Investors looking to frontier markets for broader diversification opportunities might want to review trends in the Mekong Delta region, where a number of factors are providing an atmosphere for growth.

According to Oliver Bell, portfolio manager, Middle East and Africa and global frontier markets equities strategies for T. Rowe Price, there’s plenty of potential for rewards in the Greater Mekong Region, a development project formed by the Asian Development Bank in 1992 that has united the six states that make up the region: Cambodia, Laos, Myanmar, Thailand, Vietnam and China’s Yunnan Province. In particular, Vietnam, Cambodia and Myanmar have benefited from a substantial increase in inflows of foreign direct investment.

While Vietnam experienced a slowdown a few years ago, more recently, stabilization in its economy has stimulated not just greater business confidence but renewed interest by investors. At the end of 2014, the country’s General Statistics Office said that fourth-quarter GDP increased 6.96% from a year ago. Its currency was upgraded and a recent bond market offering was so much in demand that it was 10 times oversubscribed.

Bell said in research that banks in Vietnam are being forced by the government and the central bank to recognize nonperforming loans properly, and that state-owned enterprise reforms are also being enacted. In an e-mail interview, he expanded on that.

“Vietnam is emerging from a credit boom and bust of its own making and the legacy of that is a nonperforming loan (NPL) problem,” Bell said. “Hence stability of the banking system is key; there’s a greater focus on inflation and conservative credit growth, the government is encouraging mergers between strong and weaker banks, as well as opening the door to foreign banks to acquire more than the current 30% foreign limit in the weaker banks.”

Improvement in the property market could push that NPL problem to the back burner, however. Bell pointed out, “There is continued optimism that the property prices have stabilized and are indeed slowly picking up. This is crucial for the banking system as it allows them to get their arms fully around the NPL problem, and may even reverse some if property prices continue to escalate.”

Vietnam, and its neighbor Cambodia, also have low labor costs in their favor. That’s something that has not only attracted business from neighboring China as its own manufacturing costs rise, but also could play a major role in bringing benefits from free trade agreements (FTAs). For the moment, China’s move to invest in manufacturing facilities in Vietnam, Cambodia and elsewhere within the Mekong Delta region is coming not just from companies but also from their customers. It’s understandable; in Vietnam wages are about half the cost of those for Chinese workers, and in Cambodia they’re a quarter as much.

When you add in the fact that corporate income taxes in both countries can provide advantages for certain sectors as well—in Cambodia, garment manufacturers pay no corporate income taxes at all for the first five years, while in Vietnam manufacturers in high-value-added industries, like healthcare, environmental and energy efficiency technology, education and electronics, pay just 10% instead of the standard rate of 22%—it’s hardly surprising that many industries are looking to take advantage of what they see as a friendlier business climate.

Vietnam is looking higher than low-tech manufacturing, hence the corporate tax rate favoring higher-tech companies. That shows in the fact that the country’s biggest export is no longer textiles but mobile phones.

Of course, it’s not necessarily as easy as adjusting corporate tax rates. Bell said, “Vietnam has had significant success already in recent years in attracting electronic manufacturing due to government incentives and lower wages. Building on this success to attract more investment will require a mix of things though the most important would be continuing to secure FTAs (especially the TPP—Trans-Pacific Partnership), maintaining a predictable investment environment and providing adequate infrastructure. Longer term development of the sector will depend on improving the skill level of the workforce so that Vietnam can manufacture and export increasingly high value added products.”

Vietnam already has an FTA with the European Union, its second-largest trading partner and South Korea, its fourth largest, concluded at the end of the year. According to Bell, that “will continue to support Vietnam’s export growth. The EU is an important and growing trade partner for Vietnam with 18% of its exports going there (up from 13% in 2010).” That said, Bell added that the “TPP remains the trade deal that would have the most significant effect on Vietnam.”

One thing investors should remember when considering investments in the region, said Bell, is liquidity. “Hence taking a long-term view is important, as is having the ability to get in to these stocks early and get out early as well,” Bell said. “Having dedicated resources on both the equity and fixed side enable us to do this. However, we do expect the liquidity of the market to improve as [foreign ownership limits] rise and the opportunity set increases.”