How to Drive the Economy by Reforming State-Owned Debt
The more Viet Nam’s state-owned enterprises can access capital through the strength of their own balance sheets, the more they can help fund infrastructure, social development and COVID-19 response.
The ratio of government debt and guarantees to gross domestic product (GDP) peaked in Viet Nam in 2016 at 64%. Government lending to and guaranteeing the loans of state-owned enterprises helped drive this fiscal expansion. Intent on not breaching the statutory debt limit of 65%, Viet Nam introduced several fiscal reforms, including pushing state-owned enterprises to raise debts against the strength of their own balance sheets without relying on the government.
As a result, many state-owned enterprises are no longer borrowing through the government, but they are still using debts sub-optimally. That is a big deal. State-owned enterprises accounted for 29% of GDP as of 2016 and comprised seven out of Viet Nam’s 10 largest corporations in 2018. They are dominant in infrastructure and other sectors that are key to improving Viet Nam’s productivity.
If state-owned enterprises struggle, Viet Nam will struggle. This is truer now than before the outbreak of the COVID-19 pandemic because government resources are needed more than ever for public health and economic recovery.
To help clarify these issues, the Asian Development Bank undertook a study to identify financially sound state-owned enterprises. A secondary outcome was the identification of broader themes that, if addressed, would better position state-owned enterprises to borrow more effectively. The following are priority areas for future action that we identified as part of the unpublished study.
Better structuring: Symptomatic of the bank loans that are available domestically in Viet Nam, state-owned enterprises rely heavily on floating-rate debt that often carries tenors that are shorter than the economic life of the assets being financed. This introduces interest rate and refinancing risk.
The bond market offers state-owned enterprises the best opportunity to secure better structured financing, but state-owned enterprises have underutilized it despite the corporate bond market’s rapid growth since 2017.
A related structuring issue, particularly for infrastructure, is project finance. This loan structure relies on the creation of a special purpose vehicle and ring-fenced cash flows.
In many cases, it gives borrowers the comfort to lend for longer maturities than loans to a parent company. Its greater use would also help Viet Nam’s state-owned enterprises to better match loan tenor with the economic lives of assets.
There is a stereotype that state-owned enterprises have too much debt. Although there are certainly some highly leveraged state-owned enterprises in Viet Nam, over-indebtedness is not universal, and paradoxically, too little debt can be a problem.
Yes, more debt increases financial risk, but it also boosts the government’s returns on its invested equity. Moreover, debt can introduce discipline. With cash going to pay interest, there is less temptation to prioritize discretionary expenses. We found quite a few state-owned enterprises that can afford a higher proportion of debts, which would free cash for new investments, or for dividends to the government.
State-owned enterprises accounted for 29% of GDP as of 2016 and comprised seven out of Viet Nam’s 10 largest corporations in 2018.
Accessible and compatible financial statements: For many state-owned enterprises, there is a need to strengthen their financial reporting. Out of the 11 state-owned enterprises in the study, not all published their financial statements on their websites and five had qualified audit opinions. The former inhibits transparency. The latter prompts questions, and in some cases, a qualified audit will lead lenders to invest elsewhere.
State-owned enterprises financial statements could also do more to attract international lenders. All the enterprises sampled reported only under Vietnamese accounting standards as opposed to the more globally accepted International financial reporting standards, and to the extent that foreign borrowing is a priority, financial statements need to be available in English. Few in the sample were.
Credit ratings: Another limitation to effective capital raising is the scarcity of credit ratings. Perhaps more state-owned enterprises would be rated if there were a well-established domestic credit rating agency.
Currently, Viet Nam has licensed to two domestic agencies, but neither has yet itself in the market yet. The sooner one of these two or some later entrant can establish itself, the easier and less costly it will be for state-owned enterprises to be rated.
Sovereign ceiling: Our study focused only on financial data and did not consider subjective criteria that would require more intensive interactions with management and a better understanding of the particular industries.
Nonetheless, a surprisingly high number of state-owned enterprises – based exclusively on their financials – were positioned for credit ratings that could exceed Viet Nam’s country rating. In other words, these state-owned enterprises would have higher ratings if Viet Nam had a higher rating.
The potential of these state-owned enterprises and other corporates in Viet Nam to have better ratings underscores the importance of raising Viet Nam’s credit rating, which will require less leverage in the banking sector and continue the reduction of the stock of public debt and guarantees.
Divestment: Another drag on the sovereign credit rating, as consistently flagged by rating agencies, is the implicit obligation that the government might have to assist a state-owned enterprise in financial difficulty. To reduce these potential liabilities, the government needs to reduce its ownership of state-owned enterprises.
Equitization (reducing ownership below 100%) and divestment (reducing ownership below 51%) have other merits too. Multiple studies have confirmed their benefits in Viet Nam (as elsewhere) of boosting state-owned enterprises’ efficiency, profitability, and revenues.
Unfortunately, equitization and divestment have slowed. According to statistics from Fiin Group, between 2014 and 2016, 197 state-owned enterprises in Viet Nam were either equitized or divested. Between 2017 and 2019, the total fell by over half.
In August 2019, the government identified 93 state-owned enterprises for equitization or divestment by 2020. It is critical that these reforms continue, particularly for sectors like manufacturing and agriculture where the rationale for state ownership is unclear and the competition from the private sector fierce.
Identifying a handful of state-owned enterprises that have strong underlying financials will not usher in a halcyon era of state-owned enterprises reform. Yet, it is a step.
The more Viet Nam’s state-owned enterprises can access new and better-structured sources of capital through the strength of their own balance sheets, the more they will benefit from market discipline, the more they can fund infrastructure and other key development needs, and the more the government can prioritize resources for COVID-19 and other exigencies that only it can address.
A version of this blog post originally was published in the Vietnam Investment Review.