The State Bank of Vietnam (SBV) is gathering feedback on a draft circular to replace Circular 12/2014/TT-NHNN, which stipulates conditions for enterprises to take out foreign loans without Government guarantees. This is aimed at tightening control over the arrangement of foreign loans by credit institutions and businesses, as this activity has been increasing rapidly in recent years.
Whose external debt is rapidly growing?
As interest rates have fallen to their lowest in years, credit institutions and businesses have taken advantage of this situation to step up the application for loans from international financial institutions. For example, there have been quite a few deals on trade finance and loan syndication with domestic banks and securities companies, international bond issues by domestic firms, and the borrowing of capital from parent companies by foreign-invested enterprises in an attempt to enhance their internal financial resources and competitive advantages.
This trend leads to the risk of the annual level of external debt under the self-borrowing and self-repayment modality and national external debt safety indicators exceeding the prescribed thresholds. This is the reason why the SBV has to come up with stricter regulations concerning loan conditions in order to (i) prudently manage this activity, (ii) ensure compatibility with the relevant, newly promulgated legal system that comprises the Investment Law 2020 and the Enterprise Law 2020, and (iii) facilitate the roadmap of capital account liberalization, in line with the IMF’s recommendations on liberalizing capital controls on foreign debt.
Statistics show that Vietnam’s external debt to GDP ratio has risen from 2016 to 2020, mainly due to the self-borrowing and self-repayment loans arranged by credit institutions and businesses, stemming from their burgeoning demand for capital to meet their growth requirements.
Specifically, foreign loans borrowed by the Government inched up 5.6% per year, whereas those taken out with a government guarantee rose 7.1% during this period. “External debt under the self-borrowing and self-repayment modality run up by enterprises has increased rapidly in recent years: in 2016, it picked up 25.7% against 2015, and in 2017, it surged 39.6% against 2016. This is the main reason for a higher ratio of the country’s foreign debt to GDP,” said then Minister of Finance Dinh Tien Dung at the National Assembly session in 2018.
Foreign loans arranged by the Government and government-guaranteed ones constitute an increasingly modest proportion of the national external debt structure (from 59.6% in 2016 to some 43.5% in 2020).
Since 2011, external debt has been growing at an annual rate of 17%, faster than nominal GDP, making up 46% of GDP in 2018. This is mainly ascribed to the debt run up by private borrowers with a growth rate of 24% a year, with foreign-invested enterprises accounting for most debt from abroad (72% of the short-term and 78% of the medium- and long-term debt in 2018). Vietnam’s external debt to GDP was 47.2% at the end of 2020, but it sometimes approached the limit of 50%, exerting pressure on the indicators of national external debt safety (1).
The major changes
In the draft circular mentioned above, first, the SBV has added a new regulation stipulating a ceiling on the cost of borrowing from foreign sources. With this, the foreign currency lending rate will be equal to the reference interest rate, plus a maximum margin of 8% per year. In case the reference interest rate is not touched upon, the “6-month CME Term SOFR Reference Rate”, calculated based on the Secured Overnight Financing Rate (SOFR) published by the New York Fed, will be opted for.
For loans in the Vietnamese dong, the rate will be equal to the interest rate on Vietnamese Government bonds with a 10-year term, plus a maximum margin of 8% per year.
With central banks worldwide tightening their policies, according to the SBV, the aforesaid regulation on the borrowing cost ceiling has taken into account the average lending rates in the greenback and the dong at home, considering the tendency of major central banks in the world to raise their interest rates. Besides, the author of this article believes such a ceiling is probably necessary to control a situation wherein businesses borrow foreign currency from the parent bank with too high a defined loan interest rate to transfer profits back to the country.
Second, major currencies such as the U.S. dollar have risen sharply recently, with the USD Index ascending to its peak in 20 years, with no end in sight as the trend of tightening policies to combat inflation is still ongoing. In light of this, the SBV has added a requirement that borrowers must conduct foreign currency derivatives transactions to help businesses avoid losses due to exchange rate risks. They must also limit the negative impact on the exchange rate management and the foreign currency market of the central bank due to the sudden demand for foreign currency buying/selling in the event of loan withdrawal and foreign debt repayment.
Specifically, for short-term loans worth more than US$500,000 or of an equivalent value in another foreign currency, borrowers must carry out foreign currency derivatives transactions before or at the time of loan withdrawal, at least equal to 30% of the withdrawal value. For medium- and long-term loans, such transactions must be conducted for installments of principal payment with a value of over US$500,000, at least three months before the payment date, with a minimum value equal to 30% of the amount paid.
Third, conforming to Decree 219, which specifies that borrowers must be responsible for settling external debt under the self-borrowing and self-repayment modality and bear all the risks of raising foreign loans, to which the Government has no obligations, this draft amends the regulation concerning secured transactions. It also stipulates that the main handlers of collateral must be credit institutions, foreign bank branches or other legal entities established and operating under Vietnamese law.
Is it against the trend?
The SBV applies different conditions to credit institutions and foreign bank branches, with additional limits on the value of foreign loans.
Specifically, the limit on short-term loans based on the maximum ratio of the total outstanding short-term foreign loans to the level of equity on the last working day of the year preceding the time a foreign loan agreement is signed is as follows: (i) 25% for credit institutions and 100% for foreign bank branches in 2023, and (ii) 20% and 80%, respectively, from 2024 onward.
As for medium- and long-term loans, borrowers must ensure the total net withdrawal (withdrawal value minus repayment value) of their medium- and long-term foreign loans in the year does not exceed 10% of their equity. This is applicable to commercial banks, whereas a ratio of 50% is set out for non-banking credit institutions, foreign bank branches, cooperative banks, and policy banks.
Looking at the trend of domestic banks stepping up the application for medium- and long-term foreign loans to boost their tier 2 capital and enhance their financial strength and competitiveness, stricter control on their arrangement of foreign loans will pose more challenges for this group of borrowers. This is especially considering their goal of expanding their equity and international sources of medium- and long-term capital in the coming time.
As for the group of businesses, their foreign loans make up 70-80% of the total external debt on the self-borrowing and self-repayment basis in the economy, as per data from the SBV. Given the socio-economic development orientations in the period from 2021 to 2030, the tendency of enterprises to borrow more from foreign sources is inevitable. For this reason, it is necessary to select and determine the priority of which sectors and businesses are allowed to borrow money overseas.
Therefore, the draft makes it clear that the arrangement of foreign loans must focus on the goal of supporting the capital needs for production and business activities of enterprises, limiting foreign loans for potentially risky areas, which not only builds up outstanding foreign loans but also compromises the chance of enterprises helping with production and business development in the economy to obtain finance.
To be specific, the draft provides that enterprises may borrow short-term capital from abroad to pay off short-term debts arising within 12 months from the time of signing a foreign loan agreement, which, however, do not include debts arising from loan agreements with residents, payables arising from trading securities, the purchase of contributed capital or shares from other entities, the purchase of real estate for investment and project takeovers.
This is also the issue that has captured the most attention these days, especially when the stock market is experiencing its biggest correction in two years. Investors are afraid that such a regulation will further limit capital inflows in the market. Still, according to the SBV, the “overheated” and “spontaneous” growth of the stock and real estate markets entails great risks since it may give birth to “virtual” capital and “bubbles” of assets, the root of macroeconomic instability.
In the context that Vietnam is actively engaged in free trade agreements, deepening integration and opening the doors to invite foreign investors into the country, some may think the more stringent regulations on international borrowing are going against the aforesaid trend.
Certain businesses have been very active in borrowing from international financial institutions to acquire land projects everywhere, including those located in sensitive areas. This is in addition to some enterprises with foreign entities involved recently playing a role in pushing up land prices during auctions, leading to market instability. These are reasons enough for the operator to tighten its control over the borrowing of capital from foreign sources in these potentially risky sectors.