Political Risk Analysis - Tensions With China Running High But No Armed Conflict - NOV 2017


BMI View: Tensions between Vietnam and China have soared to a three-year high after a series of maritime spats in the South China Sea which started in June 2017 . While we see no end to the maritime dispute between the two countries, and neither side is likely to tone down their tough rhetoric over the near-term, an escalation of tensions into an armed conflict is unlikely in the foreseeable future. Both sides are likely to prioritise economic cooperation, which have grown considerably in recent years.

Tensions between Vietnam and China in the South China Sea appear to have flared up again since June 2017 after a three-year hiatus (although there were sporadic episodes in between). In the latest development on September 5, Hanoi issued a strong condemnation of Chinese military live-fire exercise in the disputed Paracel islands which reportedly ended on September 2. This incident followed after Vietnam suspended an oil exploration project operated by Spain's Repsol in offshore waters in July when Hanoi came under pressure from Beijing, while a scheduled meeting between the foreign ministers of China and Vietnam was also cancelled on the sidelines of the ASEAN Foreign Ministers' summit in August. While we expect rhetoric to remain heated between the two countries over the near-term, and a limited skirmish cannot be entirely ruled out, we do not expect tensions between China and Vietnam to escalate into an armed conflict, similar to the scale seen in the 1970s and 1980s. Vietnam and China have developed deep economic ties over the last three decades, and we believe that both sides will prioritise trade and investment over going to war.

A Geopolitical Tinderbox
Map Of South China Sea Territorial Claims
Source: Center for International and Strategic St udies, Wall Street Journal, BMI

Area And Source Of Renewed Tensions

The South China Sea is the most hotly contested territorial flashpoint in South East Asia, with several nations claiming rights over parts of the 3.5mn square kilometre (1.4mn square mile) resource-rich sea, through which an estimated USD3.0trn in international trade passes each year. China claims sovereignty over most of the sea, as demarcated by its long-standing 'nine-dash line', but its neighbours reject these claims. Beijing has become more assertive in its maritime claims since 2010, leading to tensions with Vietnam and the Philippines. However, since July 2016, Vietnam has emerged as the key contender of China's claims in the South China Sea after fellow claimant, the Philippines, adopted a much more conciliatory tone towards Beijing under the Duterte Administration.

Since June 2017, a sequence of maritime spats between the two neighbouring communist countries has resulted in tensions soaring to a three-year high.

  • In June, Talisman-Vietnam, a subsidiary of Spanish energy firm Repsol, commenced gas-drilling operations in an area about 400 kilometers off Vietnam's coast near Vanguard bank. However, following alleged threats by China to attack Vietnamese installations in the Spratlys Islands in response to the drilling, Hanoi called off the operation in July.

  • In early-August, during the ASEAN Foreign Ministers Summit, Vietnam urged other member nations to take a tougher stance against Chinese militarisation in the South China Sea. This likely irked Beijing and prompted a cancellation of the meeting between the foreign ministers of China and Vietnam, although no official response was given.

  • On August 31, the Vietnamese foreign ministry protested against Beijing's announcement of a military drill in the Gulf of Tonkin. Nevertheless, the exercise went ahead according to Beijing's plan and Hanoi subsequently issued a sharp rebuke on September 5 stating that the move was a 'serious violation of Vietnam's sovereignty' and that it will 'defend its sovereignty and legitimate rights and interests in the East Sea by peaceful means'.

Tough Rhetoric To Stay But Tensions Unlikely To Escalate To Armed Conflict

We believe that there continues to be no end in sight to the ongoing maritime dispute between China and Vietnam in the South China Sea, and that it is unlikely for either country to back down on their rhetoric over the near term as they look to exert their sovereignty claims and develop energy and military installations in the disputed waterway. However, given Vietnam's close economic ties with China, we believe that Hanoi will not want to further strain relations with its larger neighbour by escalating these disputes into an armed conflict. Indeed, China is Vietnam's largest trade partner with total trade turnover amounting to USD54.7bn (20.3% of total trade) in the first eight months of 2017, and also the fourth largest foreign investor with a registered capital of USD1.3bn over the same period.

Instead, we believe that Hanoi will maintain its strategic non-alignment foreign policy, and continue to foster closer ties with the US, Japan, and more recently India to counterbalance China's overarching maritime claims in the South China Sea ( see ' Vietnam and Indonesia To Boost India Ties To Counterbalance China ' , December 16 , 2016). At the same time, Hanoi will strive to achieve a delicate balance at home by talking tough against Beijing in order to appease the population, which has become more concerned and wary of China. In 2014, when Beijing moved an oil rig into the waters claimed by Vietnam, the move sparked two weeks of deadly anti-Chinese protests across Vietnam. This has likely served as a reminder to the communist party that nationalist sentiment runs high in Vietnam, and that they will not be able to compromise on territorial sovereignty.

Macroeconomic Forecasts (Vietnam 2013-2019)
Indicator 2013 2014e 2015e 2016e 2017f 2018f 2019f
National Sources/BMI
Population, mn 91.50 92.54 93.57 94.57 95.54 96.49 97.43
Nominal GDP, USDbn 170.4 185.8 191.3 201.3 219.2 241.1 265.6
GDP per capita, USD 1,862 2,007 2,044 2,128 2,294 2,498 2,726
Real GDP growth, % y-o-y 5.4 6.0 6.7 6.2 6.3 6.3 6.2
Industrial production, % y-o-y, ave 5.9 7.6 8.4 8.6 8.6 8.5 8.5
Consumer price inflation, % y-o-y, ave 6.6 4.1 0.6 2.6 5.0 4.9 4.8
Consumer price inflation, % y-o-y, eop 6.0 1.8 0.6 4.7 5.2 4.9 4.8
Central bank policy rate, % eop 7.00 6.50 6.50 6.50 6.25 6.25 6.25
Exchange rate VND/USD, ave 21,029.04 21,198.86 21,919.28 22,366.16 22,930.50 23,250.00 23,500.00
Exchange rate VND/USD, eop 21,095.00 21,388.00 22,485.00 22,761.00 23,100.00 23,400.00 23,600.00
Budget balance, VNDbn -236,768.0 -249,362.0 -263,135.0 -254,000.0 -239,331.3 -270,302.5 -281,790.0
Budget balance, % of GDP -6.6 -6.3 -6.3 -5.6 -4.8 -4.8 -4.5
Goods and services exports, USDbn 142.9 161.5 173.6 193.8 223.1 254.1 286.7
Goods and services imports, USDbn 103.9 114.2 128.8 142.4 168.5 195.9 223.2
Current account balance, USDbn 9.5 9.1 0.9 4.6 4.7 5.1 7.0
Current account balance, % of GDP 5.6 4.9 0.5 2.3 2.1 2.1 2.6
Foreign reserves ex gold, USDbn 25.5 34.2 28.3 44.2 60.0 76.6 95.5
Import cover, months 2.5 3.0 2.2 3.1 3.6 4.0 4.5
Total external debt stock, USDbn 65.5 72.4 77.8 74.8 72.3 70.0 67.7
Total external debt stock, % of GDP 38.4 39.0 40.7 37.2 33.0 29.0 25.5
Crude, NGPL & other liquids prod, 000b/d 342.5 355.5 329.8 313.4 289.2 272.4 262.0
Total net oil exports (crude & products), 000b/d -25.7 -39.4 -88.3 -126.8 -170.9 -210.7 -244.5
Dry natural gas production, bcm 8.8 9.4 9.8 10.6 10.1 9.8 9.5
Dry natural gas consumption, bcm 8.8 9.4 9.8 10.6 10.1 9.8 9.5