VinaCapital Economic Report

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October 2014

FLATTENING OF VIETNAMS YIELD CURVES: SOME IMPLICATIONS

I.BACKGROUND AND ANALYSIS

In an economy, the yield curves can give a snapshot picture of its interest rate levels. They

show government bond rates across maturities. Government bonds are chosen (versus

corporate securities) because of their uniform features and wide availability for trading on

capital markets. This makes for easier comparison of bond yields across maturities and

changing economic conditions.

In recent months, the yield curves in Vietnam have shifted down continuously with rates on

benchmark 5-year VGB declining from 6.33% YOY to 5.38% YOY from July to September.

Meanwhile, yields on 15-year bonds declined from 8.90% to 7.23%1. The downshift is more

substantial among longer maturities. The consequence is a flattening of the yield curve starting

in July, and it has accelerated over August-September.

Bond yield curves are normally upward-sloping reflecting the higher risk of lending for longer

maturities. The shape also implies that investors expect more inflation in the future and

demand an additional premium to bear that risk.

YIELD CURVES HAVE BECOME FLATTER IN 2014

1 SBV - State Bank of Vietnam

5.27

6.63

8.55

8.90

5.11

6.39

7.86

8.44

4.67

5.38

6.63

7.23

4.00

5.00

6.00

7.00

8.00

9.00

1Yr 2Yr 3Yr 5Yr 10Yr 15Yr

Jul-14 Aug-14 Sep-14

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In the current Vietnam context, a flattening of bond yield curves carries some important

implications.

Faced with a lower yield-configuration offered to them at periodic government

bond auctions, banks are moving strongly to lengthen the duration of their

fixed-income portfolios. They are in search of higher yields as low inflation has

pushed down coupon rates on 2-year bonds to 4.67%2, much lower than their

cost of funds estimated at 5-6%3. This behavior is in accordance with the

location-preference-theory by which banks are searching for their preferred

location at the long end of the yield curves, bidding up long-term bond prices

and simultaneously depressing the yields. Over the past 2 months, yields on 10-

and-15 year bonds have declined by 1.90% and 1.70%4 respectively. This trend

is projected to continue as expected low inflation leads to further declines in

bond coupon rates across maturities, and yield pressures will keep causing

banks to reach for longer maturities.

As yield curves become flatter, the gap between yields on short-term and long-

term bonds decreases. In effect, banks are accepting lower premiums than

before for taking on the same extra amount of risk (say, by moving from 10-

year to 15-year along the yield curve).

Banks (or bond investors in general) are projecting lower inflation in the near

future. Therefore, they are asking for less protection against this risk in the

form of lower yields. Since the yield curves reflect market expectations of future

economic developments, a flattening yield curve translates into market

opinions that near-term inflation will be kept low by government policies. Such

a belief would tend to drive bond markets higher and provide better support for

fixed-income portfolios.

BOND YIELDS AND INFLATION HAVE TRENDED DOWN - YTD 2014

BOND YIELDS (%) IN 2014 CPI

2Yr 5Yr 10Yr 15Yr YOY %

January 6.90 8.21 9.00 9.07 5.45

February 6.50 7.90 9.00 9.07 4.65

March 5.75 7.25 8.73 8.85 4.39

April 5.60 7.15 8.72 8.97 4.45

May 5.88 7.26 8.75 8.93 4.72

June 5.70 7.16 8.75 9.03 4.98

July 5.27 6.63 8.55 8.90 4.94

August 5.11 6.39 7.86 8.44 4.31

September 4.67 5.38 6.63 7.23 3.62

Source: SBV & General Statistics Office

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SBV 3

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A flattening yield curve also implies expectations of weak economic growth

ahead. This may be one reason why the WB has recently issued its GDP growth

forecast of 5.4% and 5.5% for this year and next, as versus GVN goals of 5.8%. In

such environment, capital absorption capacity of business is limited and interest

rates will be kept low to moderate. Financial needs for new investments or

expanding current operations will be quite restrained.

II. CONCLUSION

In summary, a flattening yield curve implies lower long-maturity risk-premiums, subdued

future inflation, and weak economic growth in the near future. All these features seem to

characterize fairly well the current economic situation in Vietnam. We think that yield curves

are an instructive statistical construction: they can compound in their shape a lot of

information about the economy as well as the market.

With inflation steadily declining and bank deposit rates falling pari passu, many investors with

idle funds have migrated to more profitable channels e.g. stocks and real estates. This move

can be considered a no-brainer when the VN Index delivered 22% in CY 2013 and circa 25%

YTD 2014. The flow of liquidity into real estate has been confirmed by SBV numbers: by end

August, overall credit growth was at 5.82% but lending to the property sector was up 9.75%.

Stock prices of many RE companies (especially those operating in the affordable housing sub-

sector) have benefited significantly. We think investors should channel more capital into

equity and property. These two channels will continue to deliver above-average returns in the

current market uptrend.

One final note on a possible change-in-shape of the yield curves: when they begin to steepen,

it can be taken as signaling an opposite set of developments, i.e. the forces operating

previously are now unwinding. The implications include: higher risk premiums for long- term

securities, potential revival of inflationary pressures, and more robust GDP growth to be

unfolding. In such environment, bond investments would become more risky and appropriate

steps are in order to restructure all fixed-income portfolios.

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