Despite its continued high economic growth rate, Vietnam's sovereign risk has risen sharply lately, as reflected by the five-year credit default swap (CDS) spread of 300 basis points compared to a high of 360 basis points two years ago.
Yet, Vietnam's credit fundamentals are improving in some areas and the economic outlook appears better, with the monthly trade deficits declining to just around $1 billion this year compared to almost $2.5 billion in the first five months of 2008.
In addition, inflation has stabilised in recent months below 10 per cent compared to a peak of 28.3 per cent in 2008.
However, a JP Morgan report suggests that a balance of payment (BOP) crisis is not yet in the offing for Vietnam despite its low import coverage ratio - thanks to the offsetting effect of large remittance and foreign direct investment (FDI) inflows, which have remained fairly steady in recent years.
The main BOP pressure in Vietnam comes from short-term portfolio capital flows, particularly domestic resident flows, which flee local-currency assets when inflation becomes worrying, according to the report.
JP Morgan thus noted that inflation can still be a key pressure point for BOP stability if it causes portfolio outflows that prompt the government to draw down the foreign exchange reserves to maintain its rigid exchange rate regime.
Since inflation is stabilising, the risk of inflation-led capital flight remains low at this stage.
In terms of creditworthiness, Vietnam is similarly rated to Indonesia and Philippines by Moody's and S&P, while Fitch Rating rates Vietnam one notch lower than the Philippines and two below Indonesia.
However, the market seems to see Vietnam as a weaker credit, as reflected by its 5-year CDS which is roughly 100 basis points wide of the other two countries.
According to the International Monetary Fund's informal mid-year report on Vietnam, the country is now on a sustained recovery path, but its macro-economic conditions remain fragile.
However, Vietnam's monetary policy is now tighter, as supported by the end of its subsidised loan scheme, while the fiscal policy is also more restrained in the wake of big stimulus measures.
GDP growth was sustained at 5.75 per cent in the first quarter, while the exchange rate appreciated back inside the official band, and reserves, which had been under pressure, have picked up by around $1 billion so far in the second quarter.
If these favourable conditions are sustained, Vietnam's GDP could grow 6.5 per cent this year, backed by continued recovery in private investment, consumption and non-oil export growth, according to the IMF.
While inflation would likely overshoot the target of 8 per cent, it should not exceed 10 per cent if food and fuel prices are stable.
In terms of the balance of payments, the rebounding of exports, the external current account balance (excluding gold) is projected to narrow to 9.9 per cent of GDP from 10.4 per cent in 2009.
At this level, the IMF is optimistic that foreign direct investment and official capital inflows will still be enough for coverage.