Vietnam downgrade adds to concerns about economy, reforms

SINGAPORE (Reuters) - Moody's downgraded Vietnam to its lowest rating ever on Friday citing a weak banking sector likely in need of "extraordinary support", dealing another blow to a country once tipped as Southeast Asia's next emerging market star even as many of its neighbours prosper.

Analysts said the downgrade of Vietnam and eight of its banks - including two controlled by the state - did not signal a full-blown banking crisis and that the slowing economy should return to form if the government takes action.

Still, the cut compounded concerns about bad debts and the pace of so-called "doi moi" reforms begun in 1986 to build a socialist-oriented market economy.

It also put Vietnam on a different track to Indonesia, which was raised to investment grade last December, and the Philippines, which could soon win the coveted status that lowers borrowing costs and opens the door to more foreign funds.

Moody's Investors Service cut Vietnam's sovereign credit rating by one notch to B2 - its all-time low for the country - and said the outlook was now stable, meaning that upside and downside risks were balanced.

"While there is little risk of a banking crisis, the main impact is on the government's fiscal position and economic growth," said Jonathan Pincus, dean of the Fulbright Economics Teaching Program in Ho Chi Minh City and a former Vietnam economic specialist at the United Nations.

"It is unlikely that Vietnam can simply grow out of its banking sector problems. Government action is needed and would be better if it is sooner rather than later."

Moody's said bank reforms being considered by the government would be positive if fully implemented, but cited a lack of speed and transparency. Restrictions on loan growth have eased overheating pressures in the economy but contributed to deteriorating asset quality, it said.

Vietnam's government fired back, saying Moody's was at odds with rival credit agencies. Moody's rating is now two notches below Standard & Poor's (BB-minus) and one notch below Fitch (B-plus), but all deem Vietnam's bonds as highly speculative.

"This rating will definitely affect Vietnam's borrowing costs," said Nguyen Thanh Do, director of the Finance Ministry's Debt Management and External Finance Department, calling on Moody's to reconsider its view.

"They seem to have focused on the negative sides while ignoring the Vietnamese economy's positive factors such as rising foreign exchange reserves, the banking system's good liquidity ... We are trying to curb inflation, so credit growth is limited and economic growth is affected."

Beyond government efforts to control inflation by tightening lending standards, banks battling bad debts have slowed loans to keep their books clean, putting pressure on businesses seeking funds for expansion.

IMPLICATIONS FOR THE ECONOMY

Moody's said the cut in its credit assessments of state-controlled Vietnam Bank for Industry and Trade and the Bank for Investment & Development of Vietnam, plus six joint stock banks, "reflects the increased probability that the eight banks will need extraordinary support to avoid economic insolvency.

"And we cannot ignore the risk that the banks may continue to restrain their lending, with potential feedback loop implications for the economy," Moody's said.

Vietnam has emerged over the past decade from the hangover of war to play a central role on Asia's factory floor, producing everything from footwear to computer parts, but in the past year its problems have overshadowed its promise - from stubborn inflation to creaking infrastructure and debt-choked banks.

The ruling Communist Party congress set policy goals in 2011 aimed at delivering economic growth of up to 7.5 percent a year for the next five years. Instead, growth has been nearly half that rate. The economy expanded 4.73 percent in the first nine months of this year, slowing from 5.77-percent in the same period of 2011, the government estimates.

Inflation, while far lower than the double-digit rates of last year, is still a concern. Prices rose 6.48 percent in September from a year earlier and 2.2 percent from August, their fastest growth since May 2011.

Vietnam may face at least one more downgrade over the next six to nine months, said Matt Hildebrandt, an economist at JPMorgan Chase Bank in Singapore.

"There's clearly a lot of bad debt. We don't know the breadth or depth of the problem but it is going to require some level of sovereign support," he said.

The government plans to restructure financial markets and consolidate state-owned businesses and investment but critics worry that, given entrenched interests, transforming the plans into action may prove difficult.

Vietnam's often-opaque policymaking is a big concern for analysts and investors. But Frederic Neumann, co-head of Asian economics research at HSBC in Hong Kong, said the government has begun to tackle structural issues.

"We believe Vietnam is now over the hump and, if officials stick with their reforms, growth should gradually pick up in the coming two years," he said.

(Reporting by Ngo Thi Ngoc Chau in HANOI and Martin Petty and Orathai Sriring in BANGKOK; Editing by Jason Szep and Alex Richardson)