Moody's Investors Service raised Vietnam's credit rating for the first time in nearly two years on Tuesday to B1 with a stable outlook, citing improving macroeconomic stability and a stronger position in its balance of payments.
The communist country, which is still managing the fallout of bad loans and cash-draining state sector, was bumped up a level midway through a third year of macroeconomic stability, Moody's said, with inflation under 7.5 percent for 26 straight months until July and real GDP growth averaging 5.3 percent.
The upgrade will be a big boost for Vietnam at a critical time, as competition for foreign investment heats up among other regional manufacturing or export-led emerging market economies.
Vietnam has faced challenges on multiple fronts as a result of an overheating economy that grew on average 7 percent from 2001-2010, with inflation reaching 28.3 percent at one point in 2008.
Banks were now operating in a more stable environment, although the sector was still undercapitalised and non-performing loans (NPLs) remained a risk, Moody's said.
Export diversification towards cellphones and electronics, away from textiles and commodities had strengthened the external payments position, while exchange rates kept stable and foreign currency reserves reached a high of $35.9 billion.
"Combined with weak imports, this situation has resulted in the current account shifting from a deficit to healthy surplus," it said in its report.
"Vietnam's sovereign credit profile is still marked by important challenges. Capital levels in the banking system remain inadequate, especially in the context of the continued weakness in asset quality."
Many economists emphasise economic fragility from its failure to expedite long promised and urgently needed structural reforms, mainly in banking and its hundreds of State-Owned Enterprises (SOEs). State firms account for half the country's debt, but generate only a third of its GDP.
Lax oversight and a spree of easy lending left Vietnam with the region's highest ratios of NPLs, slamming the brakes on credit and retail growth and resulting in widespread bankruptcies. Some 68,000 companies were forced to close or halt trade in the first five months of 2014 alone.
Moody's downgraded Vietnam to B1 negative in August 2012, then B2 stable a month later after a major fraud scandal - the first of several to come - was uncovered in one of its biggest banks, Asia Commercial Bank .
The State Bank of Vietnam (SBV) is leading a banking shake-up, overseeing several mergers and acquisitions and allowing foreign investors to wholly buy banks considered weak, with total foreign shares in bigger lenders capped at 30 percent.
The central bank set up an asset management company a year ago to buy bad debt, but critics say its effectiveness has proved difficult to gauge in the absence of transparency and say the real level of toxic debt has been understated.
The SBV said NPLs were at 4.03 percent in April, up from 3.93 percent in March and 3.61 percent in December. Moody's said the NPLs and SOEs may continue to hamper progress.
"Risks from the SOE sector persist, posing important constraints to the improving health of the banking system and domestic demand," it said. "The re-emergence of macroeconomic instability ...could exert downward pressure on the rating."
Le Anh Tuan, chief economist at domestic fund Dragon Capital, which manages $1.4 billion, said the upgrade had been anticipated and could help boost the country's profile.
"This is a good signal for investors outside of the country and don't follow Vietnam so closely," he said. "Vietnam's economy has been following a good recovery path, but still contains issues that need to be tackled better."