Vietnam: new leadership needs to continue structural reforms
Vietnam’s economy expanded by almost 7% last year, but worrying public debt dynamics could put future growth at risk. Ongoing commitment to structural reforms by its new leadership is needed.
Strengths (+) and weaknesses (-)
(+) Strong growth potential
A relatively young and motivated population, relatively low wages and an abundance of natural resources underpin Vietnam’s growth potential.
(-) Low level of development
Vietnam’s level of development and income per capita are low and its institutions relatively weak.
(-) Weak economic and monetary policy framework
Politically motivated and unsustainable economic and monetary policies have led to major economic instability in recent years. Policymaking remains highly centralized and opaque.
(-) Weak external liquidity position
Although external liquidity is no longer critical, it remains very weak with FX reserves barely covering three months of imports.
1. Ongoing economic transformation despite leadership change
Notwithstanding Vietnam’s positive economic development in recent years, incumbent Prime Minister Nguyen Tan Dung was ousted at the 12th Party Congress of Vietnam’s Communist Party (CPV) held in late January. Policy continuity should be ensured, however, as the decision seems to mainly reflect the CPV’s top leaders’ preference for a balanced Politburo that is not dominated by strong personalities rather than disagreement with Mr. Dung’s policies aimed at economic liberalization. While CPV General Secretary Nguyen Phu Trong will remain in office for up to two years, Mr. Dung will be replaced by Deputy Prime Minister Nguyen Xuan Phuc, who is widely seen as a competent leader with considerable administrative experience. Though not being known as major reformers, they will likely continue Mr. Dung’s policies and the implementation of various free-trade agreements (FTAs), including the Trans-Pacific Partnership (TPP) or the EU-Vietnam FTA, as Vietnam strives to diversify its trade partners to avoid strong dependency on China. Implementation requirements related to the various FTAs should ensure a certain structural reform momentum, leading to a gradual improvement of Vietnam’s business climate and a continuing reduction of anti-competitive measures to support state-owned enterprises (SOE). Still, progress on SOE privatization will remain sluggish amid resistance from vested interests and challenges in finding strategic investors, which weighs on the prospects for sustainable banking sector cleanup. On a more positive note, owing to more consensus-driven policies, rising concerns about recent years’ marked increase in public indebtedness should lead to more cautious fiscal planning, possibly at the cost of weaker public infrastructure investments.
2. Economy continues to expand strongly despite external headwinds
Vietnam’s economy proved resilient to the Chinese economic slowdown, as solid domestic demand and strong manufacturing exports boosted economic growth from 6% in 2014 to 6.7% last year (according to recently-published official data). While low inflation and rising consumer confidence supported private consumption, investments rose on the back of surging foreign direct investment (FDI), strengthening credit growth and rising government spending. In spite of accelerating manufacturing exports, net exports weighed on growth due to the concurrent rise of intermediate goods imports (reflecting high import content of exports), growing imports of capital goods and a major decline in commodity exports. Reflecting this trend, Vietnam’s current account surplus declined from 5.1% of GDP in 2014 to 2.2% last year. Also due to solid FDI inflows, foreign exchange reserves rose to about USD 40bn last year, but remain relatively low at about 2.5 months of import cover. This brings with it lingering risks of a balance-of-payments crisis, particularly if the central bank was forced to defend the dong under the managed float regime to avoid foreign-currency denominated debt from rising too sharply in local currency terms. Economic growth next year is expected to come in at about 7% on the back of resilient domestic demand and strong FDI inflows attracted by TPP-membership and ongoing liberalization of business regulations. The risks to the outlook are tilted to the downside, given relatively weak growth in key export markets, the need for sizeable fiscal consolidation and slow progress on banking sector cleanup and SOE reform.
3. Public finances continue to deteriorate amid sizeable contingent liabilities
Vietnam’s public debt dynamics remain worrisome, as recurrent sizeable budget deficits incurred since the country’s economic crisis in 2011 contributed to a 15-percentage point increase of Vietnam’s public debt ratio to 62% of GDP in 2015, a mere 3 percentage points below the country’s statutory debt limit. Meanwhile, contingent liabilities from the financial sector and state-owned enterprises remain sizeable. Amid rising debt sustainability concerns, Vietnam’s government strives to improve fiscal discipline by means of strengthening tax administration, broadening of the tax base as well as reining in recurrent spending growth and capital investments. Moreover, its seeks privatizations of hundreds of state-owned enterprises. Still, given administrative weaknesses and a likely prolonged period of low global hydrocarbon prices weighing on oil revenues, reining in budget deficits could prove challenging, even if economic growth remains strong. Meanwhile, Vietnam’s public finances remain exposed to considerable contingent liabilities and a weakening of the country’s currency, as 50% of public debt is denominated in foreign currency. Contingent liabilities mainly stem from government guarantees on SOE debt (12% of GDP) and costs related to the cleanup of the banking system. Reflecting years of connected lending to state-owned enterprises, Vietnamese banks’ balance sheets have been weighed down by large amounts of non-performing loans (NPLs), which international rating agencies estimated to amount to about 15% of total lending in 2014. Even though some progress could be achieved through loan restructuring, the forced merger of ailing banks with state lenders, and the transfer of NPLs worth about USD 10bn (5% of GDP) to the Vietnam Asset Management Company (VAMC), last year’s loan growth of around 12% raised concerns about reemerging asset quality problems at banks. Pending meaningful privatization of SOEs and banks, connected lending problems between (state) banks and SOEs remain unsolved. Consequently, bank recapitalizations and additional NPL-transfers that burden public finances might be needed, whereas VAMC losses could be sizeable as a mere 7% of transferred bad loans could be resolved so far.
In 1986, the “doi moi” (renovation) policy, aimed at modernising the Vietnamese economy and developing competitive, export-driven industries was implemented. The policy has modernised the country’s economic structure and has led to rapid economic growth. Even so, income per capita remains far below the global average (both in nominal and PPP terms). Vietnam joined the WTO in 2007, which helped to more than double total trade since. With total exports and imports of goods and services amounting to about 160% of GDP in 2015, Vietnam is a very open economy. Exporting mainly to the US, China, Japan and South Korea, the country is vulnerable to economic downturns in these markets. 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.
Since 1975, Vietnam has maintained one-party rule by the Communist Party of Vietnam (CPV). Corruption remains a major problem. Freedom of expression is limited in Vietnam, as is freedom of press, and criticism on the government is not tolerated. In international relations, Vietnam will continue to work on improving relations with the US and the EU. Vietnam is a member of the US-backed Trans-Pacific Partnership (TPP). However, the country will also have to remain on relatively good terms with its large neighbour, China and thus walk a fine balance, also with regards to conflicts on sea borders.