Country Report Vietnam
With improved economic policies the government has been able to stabilize the economy since early 2011, which has resulted in some return of confidence in the economy. However, growth has fallen to 5% in 2012. Further reforms of the state-owned sector and the banking sector are badly needed. However, these reforms will be difficult to implement. Moreover, the banking sector is coping with a large amount of bad debt stemming from the 2009 stimulus effort. The external liquidity position has improved, but remains weak and is difficult to determine as data on Vietnam’s level of FX reserves is no longer published regularly. In case confidence in the economy falters once again, improvements could be undone quickly.
Economic structure and growth
The Socialist Republic of Vietnam is a country in South East Asia, bordering China, Cambodia and Laos. Since 1975, the country has been under communist rule. Until the implementation of the “doi moi” (renovation) policy in 1986, the country economy was more or less stagnant. The “doi moi” policy was aimed at modernizing the Vietnamese economy and producing competitive, export-driven industries. As a result, the country’s economic structure has modernized, although the contribution of agriculture to GDP remains high at 22% and the sector employs a very high percentage (around 48%) of the working population. The secondary sector is also relatively large, at 41% of GDP, reflecting the country’s comparative advantage in the manufacturing industry, as a result of its labor abundance and, hence, comparatively low wages. The fact that the services sector accounts for 38% of GDP, far less than is the case in more developed countries, indicates that the country still has significant development steps to take.
Nonetheless, the “doi moi” policy has been successful in the sense that GDP has grown rapidly since its implementation. Nominal GDP in USD terms has more than quintupled since 1986, from USD 26bn then to USD 147bn in 2012. GDP per capita has also risen sharply from USD 438 (USD 510 in PPP terms) in 1986 to USD 1,650 (3,585 in PPP terms) last year. Even so, income per capita remains far below the global average (both in nominal and PPP terms) and the country is classified as a lower middle-income country by the World Bank.
Vietnam joined the WTO in 2007, which helped to more than double total trade from USD 109bn in 2007 to USD 235bn in 2012. With total exports and imports of goods and services amounting to 170% of GDP in 2012, Vietnam is now a very open economy. Vietnam mainly exports to the US, China, Japan and South Korea and, as a result, the country is vulnerable to economic downturns in these markets and to international oil price fluctuations. Imports are largely related to Vietnam’s industry and, in spite of it being a crude oil exporter, the country needs to import refined fuel products, as it lacks sufficient refining capacity.
The global economic crisis in 2008 and 2009 hit Vietnam hard. Real GDP growth slowed from above 8% in the period 2005-2007 to 6.3% in 2008 and 5.3% in 2009, as external demand plummeted. On the back of a rebound in export growth and economic policies aimed at stimulating growth, real GDP growth recovered to nearly 7% in 2010. However, in the years thereafter, economic growth slowed again, as economic confidence was lost as a result of severe economic instability and a near balance of payments crisis. As a result, fixed investment contracted by 10% in 2011. In addition, the economic instability forced the government to shift away from its strong growth oriented policies towards policies aimed at stabilizing the economy, which subdued economic growth. In 2012, the economy largely stabilized, and confidence started to return. As a result, private consumption and investment growth accelerated, although remaining relatively weak compared to the preceding years (except 2008). As external demand was relatively weak as well last year, Vietnam’s economy grew by only 5% in 2012, the slowest pace in 13 years.
In the years ahead, an improving external environment and a responsible easing of growth constraining policies should lead to an acceleration of growth. Growth is expected to increase to around 5.4% this year and around 6% in 2014. However, downside risks are present. For one, the external environment could underperform, resulting in weaker than anticipated export growth. Secondly, domestic downside risks are large as well.
In this regard, especially an overly rapid and irresponsible return to pro-growth policies, undoubtedly followed by renewed macroeconomic instability. Economic confidence that has been slowly returning could evaporate quickly in such a scenario. Moreover, failing to adequately address the issues in the banking sector (see next paragraph) could have the same effect. If so, economic growth will turn out lower than projected.
Between 2001 and 2011, Vietnam’s economic growth has been supported by strong credit growth, averaging 31% a year, and peaking at 49% in 2007. The financial sector, as measured by total credit-to-GDP, has increased to around 120% of GDP in 2011. In 2009 and 2010, strong credit growth of 45% and 31% respectively was part of the government’s strategy to support economic growth.
It is clear that not all loans extended had a sound commercial rationale. Rather, industries favored by the government were the first to receive financing. Monetary tightening in 2011, with policy interest rates being hiked by 600bps, and a slowdown of economic growth reduced the creditworthiness of many debtors. NPL’s began to rise as a result and now pose a significant risk to the banking sector. The State Bank of Vietnam puts the overall NPL ratio at around 9% of total loans, but some independent analysts put this figure as high as 30%. The costs of adequately recapitalizing Vietnam’s financial sector could be high and pose a large contingent liability for the government. Moreover, the banking sector is currently being shaken by arrests of high-level bank officials, mostly on charges of corruption or fraud. Since the first arrest of the founder of Vietnamese bank ACB in August last year, which then led to a bank run on the bank, more arrests have been made, but no bank runs have taken place since. Both increased financial stress and more arrests of banking officials carry the risk of undermining economic confidence and could turn into macroeconomic risks quickly.
Political and social situation
Since 1975, Vietnam has maintained one-party rule by the Communist Party of Vietnam (CPV) and the political climate is stable as a result. In July 2011, the CPV’s National assembly confirmed the country’s new leadership for five years. The presidency, a largely ceremonial function in Vietnam, went to Truong Tan Sang and Nguyen Tan Dung was reappointed to the far more powerful position of prime minister (PM). A number of corruption scandals and slowing growth following the government’s adoption of pro-stabilization policies in 2011 have led to increased criticism on the PM from both within the CPV and outside. In October last year, Dung survived a leadership challenge by the Communist Party Central Committee (CPVCC) (an important governing body in which Vietnam’s military leaders and leading businessmen are assembled). Only weeks later, he dismissed a unique call to resign by the CPV-dominated legislature (only 42 out of 500 members are non-CVP members). Although it is still expected that Dung will complete his term in office (until 2016), his position has weakened in favor of the more conservative faction within the CPV. There is a positive side to this; as the conservative faction is more concerned about the stability of the economy, policies aimed at achieving this are likely to be maintained, as long as economic growth does not fall below 5% a year.
Corruption remains a major problem in Vietnam, as indicated by the country’s poor ranking on Transparency International’s corruption perception index (123 out of 176). In January this year, Nguyen Ba Thinh was named head of the Central Internal Affairs Commission, a body set up in December last year. His no-nonsense image and the fact that fighting corruption has been given a higher priority should lead to results. This is important, as many Vietnamese have not been able to profit evenly from the country’s strong growth and income inequality has been rising. If not addressed, this could prove a source of dissatisfaction with the government. Freedom of expression is limited in Vietnam, as is freedom of press, and criticism on the government is not tolerated. This, of course, is a problem in the country’s aim to improve relationships with the West. Some 15% of the country’s population consists of minorities that are often economically disadvantaged, are intimidated, while issues over land rights lead to further dissatisfaction.
Regarding international relations, Vietnam will continue to work on improving relations with the US and the EU. As the country is one of the stakeholders in the South China Sea dispute, partly centered on the Spratly Islands, with China, relations with the US are cherished. Vietnam is a supporter of the US-backed Trans-Pacific Partnership (TPP). However, the country will also have to remain on relatively good terms with its large neighbor, China and thus walk a fine balance.
In the past decades, Vietnam’s economic policies have been geared towards achieving high growth rates through industrialization and modernization of the economy. Highly expansionary fiscal policies and supportive monetary policies have indeed helped to achieve a high average growth rate of 7.1% from 1990-2012. However, this success came at the cost of periods of macroeconomic instability and a high public debt level. After years of budget deficits, Vietnam’s public debt level has risen from 31% of GDP in 2001 to roughly 45% of GDP in 2012, which is high for a developing country. Even worse, Vietnam’s policy framework is not fit for modern times, as information and data availability are substandard and policies are not predictable or transparent.
Pro-growth policies following the global economic downturn and some erratic and unpredictable attempts to prevent the economy from overheating had a major destabilizing impact in 2010 and 2011. Confidence in Vietnam’s economy plummeted as a result, leading to a drop in FDI inflows and capital flight, the government was forced to change tactics. Early 2011, the policy focus shifted towards stabilizing the economy. Monetary policies were tightened through a number of interest rate hikes, and, as monetary policies are not very effective in Vietnam, credit controls were introduced to further lower credit growth. Between March and May 2011, the discount rate was raised by a total of 600bps to 13% and the re-financing rate was raised by 600bps to 15% between February and November 2011. As a result, inflation decreased from a staggering 23% year-on-year in August 2011 to 5% in August 2012. On the fiscal front, government spending growth was reduced from over 12% in 2010 to around 7% a year in 2011 and 2012. The policy shift has paid off, as the most acute balance of payment problems have eased, as has inflation, and economic confidence has been slowly returning.
It will now be key to maintain stabilization oriented policies in the years ahead, even in the face of slower growth. At the moment, it seems that this is indeed the government’s aim, although growth remains important. The fact that interest rates were lowered again the moment inflation started to fall – the State Bank of Vietnam lowered the two policy interest rates by 500bps between March 2012 and July 2012 - and the fact that the prime minister urged banks to lend in December are testimony to this. Public spending will also grow steadily in the coming years, leading to a budget deficit that will come in at between 4% and 5% of GDP, as was the case in 2012, which implies the government’s debt level will remain more or less equal as a percentage of GDP (around 45%). However, contingent liabilities in the financial sector could weigh heavily on the government’s financial position in case a bailout is needed. In case of a severe scenario, these liabilities could amount to as much as 30%-60% of GDP. Moreover, when such a scenario would unfold, evaporating economic confidence and capital flight will aggravate the government’s headaches, as tax revenues will plummet and the dong will expectedly have to be devalued following balance of payment pressures stemming from capital flight. As a large part of the government’s debt is denominated in USD, a lower value of the dong will increase the government’s debt burden.
The effectiveness of monetary policies is hampered by the dong’s peg to the USD, Vietnam’s underdeveloped financial system and the lack of credibility of Vietnam’s monetary policy makers due to years of volatile inflation and, at times, the implementation of contradictory policies. The dong has been devalued multiple times in the past years in order to cope with pressures resulting from capital flight, largely due to locals exchanging their dongs for USD. On average, the dong has lost nearly 30% of its value since early 2008.
Reforming state-owned enterprises (SOEs) is the government’s key priority regarding structural reforms. A plan to overhaul the state-owned sector, in order to increase profit margins and the competitiveness of the sector, was approved in July 2012. It aims to make SOEs more transparent by listing them on the stock exchange. SOEs that are considered important for national security are excluded though. Implementing the plan, however, will be hampered by the high debt burden of most SOEs and political opposition.
Balance of Payments
Vietnam’s trade balance has been in deficit for 11 out of the past 12 years due to strong, government supported, growth and, hence, strong demand for imports. Relatively weak domestic activity on the back of the government’s efforts to rein in credit growth and a devaluation of the dong reduced import growth in 2011 and 2012. From nearly -5% of GDP in 2010, the trade balance improved to -0.4% of GDP in 2011 and registered a small but rare surplus of 0.2% of GDP last year. With many foreign companies operating in Vietnam, the services and income accounts have been in deficit at least since 1995. In fact, the current transfers account has been the only component of the current account that has structurally been in surplus. It has shown a wide surplus of between 6 and 9 percent of GDP each year until 2011 .
Normally, the current account shows a deficit of up to 12% of GDP (in 2008). However, as the trade balance improved in recent years, the current account showed rare surpluses of 0.2% of GDP and 1.4% of GDP in 2011 and 2012 respectively. In the coming years, however, mainly on the back of a widening trade deficit, the current account is expected to once again slip into a deficit, estimated at around 1% of GDP this year and 1.2% of GDP in 2014.
To cover the shortfall on the current account, Vietnam mainly relies on foreign direct investment inflows (FDI), which hovered between six and ten percent of GDP in the past years. In 2011, as foreign investors lost confidence in the Vietnamese economy, FDI inflows fell sharply to USD 7.4bn. As the domestic economy stabilized, foreign investors regained confidence and FDI increased as a result to nearly USD 11bn in 2012. FDI inflows are expected to remain strong in the coming years as well, rising to an estimated USD 14bn (equal to 8% of GDP) in 2014. However, this projection is based on the assumption that Vietnam will be able to maintain investors’ confidence. In case macroeconomic instability returns or if Vietnam fails to address the issues in the banking sector, it is likely that a rapid loss of confidence will translate into a quick decrease of FDI inflows.
 Current transfers account data is not available from 2012 onwards.
External position and liquidity
Vietnam’s total external debt is manageable at nearly USD 42bn in 2012, although at around 30% of GDP relatively high for a developing country. Some 25% of the country’s total external debt is short-term, mostly trade related debt and owed by the private sector. Vietnam’s medium-to-long-term debt is all owed by the country’s public sector, some 90% of which to official creditors. As a result, debt service is manageable, amounting to only slightly more than short-term debt repayments of the year before.
Notwithstanding some improvement in the past year, Vietnam’s external liquidity remains one of our main concerns and continues to pose a key risk following a sharp deterioration in 2010. Vietnam’s liquidity ratio, which hovered around 100% until 2011 , is only barely sufficient. Accurate data on the level of FX reserves are no longer published regularly by the country’s central bank, a worrisome development in its own right. However, estimates put the level of FX reserves between USD 21bn and USD 24bn end-2012. At the low end, this implies that total foreign exchange (FX) reserves cover only around 2 months of imports, which is insufficient. Even when taking into account the high end of the FX reserves estimate, the import cover is only 2.3 months and thus still inadequate. Taking into consideration that a loss of economic confidence will not only translate into less FDI but also to capital flight, such a scenario would quickly put unsustainable pressures on the balance of payments, as happened in late 2010 and early 2011, and lead to a rapid depletion of FX reserves once again. In spite of the currently seemingly sound debt service cover figures (see graph and table), there is thus a risk that as a result of insufficient foreign currency reserves, Vietnam’s ability to service external debt could be jeopardized in a severe downside scenario. In this respect, we note that Vietnam has rather good relationships with multilateral institutions, which should allow for emergency liquidity support becoming available if needed. Nonetheless, the government needs to continue to commit to upholding responsible macroeconomic and reform policies in order to prevent this key economic risk from materializing.
 Due to non-availability of data it is not possible to calculate the liquidity ratios from 2012 onwards.