Author: Suiwah Leung

So far, Vietnam has weathered the global financial crisis surprisingly well. The following chart from the latest IMF World Economic Outlook indicates that Vietnam is likely to outperform most of its Southeast Asian neighbours in terms of growth rates for 2009.

A number of factors contributed to this pleasant surprise. First, Vietnam was not sufficiently integrated with the world financial system for the crisis in the United States to have had significant impact on its banking sector. Second, Vietnam was at the early stages in its participation in the regional production networks in electronic and household durable goods. Hence, the collapse in demand for these goods in the West, coupled with the destocking of inventory, whilst impacting negatively on exports and foreign direct investment, did not have the same devastating effect on Vietnam as it did on other small export oriented Asian economies. Finally, and perhaps more importantly, the Vietnamese government rapidly reversed its tight monetary policy of mid 2008 (lowering official interest rates from 14 per cent to 7 per cent), as well as embarking on a large program (announced at around US$8 billion) of fiscal stimulus. This latter program involves a mixture of tax relief, spending on social programs, and a four-percent interest rate subsidy to enterprises.

With the ‘green shoots of recovery’ now appearing to be taking root more firmly in Asia, the immediate policy question for the Vietnamese authorities is whether the monetary and fiscal easing should now begin to be wound back in order to maintain macroeconomic stability and hence improve the investment climate. Furthermore, at a time when the authorities are mapping out development plans for the next decade, medium-term issues of structural reform and institutional development need also to be kept firmly on the agenda.

The immediate policy question of winding back monetary easing is likely to be driven by developments in the foreign exchange market. For the past six months since April 2009, there have been signs of over-valuation in the dong as the rates in the ‘grey’ and the parallel markets have consistently fallen below the weaker end of the official exchange rate band. This has led to outcries of ‘dollar shortage’ on the part of businesses. A New York Times article of 12 October reporting on the difficulties of Ford Vietnam in securing enough US dollars to pay its overseas suppliers on time has highlighted this issue.

However, an analysis of the balance of payments accounts indicates that the current account deficit in the first half of 2009 is below that for the same period in 2008, and that this deficit is easily covered by official inflows and foreign direct investment inflows. Portfolio outflows are not significantly out of line either. The pressure on the exchange rate seems to be coming from a large item of capital outflow labelled ‘gold and errors and omissions’ (a jump to $US3.3 billion for the first half of 2009 compared with an estimate of $US3.7 billion for the whole of 2008, and $US1.6 billion for 2007). By definition, the components of this item are hard to pin down, but past experience, for example in the Asian financial crisis a decade earlier, points to the likelihood of these outflows being associated with informal capital transfers from private residents fearful, inter alia, of large devaluations of the local currency. It appears, therefore, that the risks of holding the dong are putting the pressure on the foreign exchange market. Of course, the exchange control regime in place means that the available dollars are being rationed, but the underlying pressure comes from a disinclination to hold the dong.

One policy implication is to raise the dong interest rate vis-à-vis the dollar interest rate in order to compensate residents in part for the risk of holding dong. This, combined with measured progress towards devaluing the official exchange rate, could ward off the need for large and disruptive devaluations later on. At the same time, the interest rate subsidy which caused a rapid growth in credit could now be phased out so as to avoid a repeat of the asset price inflation of 2008 when non-performing loans, amongst other factors, put the banking system at risk. Finally, a comprehensive estimate of the fiscal stimulus, together with the sources of funding, needs to be clarified. With lower economic activity and, until recently, falling oil prices, budget revenue is expected to fall. Hence, it is important for investor confidence to ensure that the authorities improve fiscal sustainability. On the expenditure side, government spending on projects (social or otherwise) needs to be subjected to a process of technical supervision, including cost-benefit analyses, so that public resources are not being inefficiently allocated.

In recent years, Vietnam has been consistently falling in the Global Competitiveness Index (from a ranking of 68th place in 2007 to 70th in 2008 and to 75th in 2009). Concerns over Vietnam’s macroeconomic management seem to be a major factor in this fall (its ranking for macroeconomic stability fell from 51st place in 2007 to 112th in 2009). This overrides improved perceptions on factors such as ‘efficiency enhancers’ and ‘innovation and sophistication factors’. Therefore, while Vietnam’s growth performance in 2009 has been better than many of its Asian neighbours, it is now time to reassess the stimulus package in the light of its potential impact on macroeconomic stability, and hence on longer term competitiveness in the eyes of foreign and domestic investors.

This leads to the need, in the medium term, for the professional strengthening of public institutions, starting with macroeconomic institutions such as the State Bank of Vietnam (SBV) and the Ministry of Finance (MOF). The recent SBV announcement that official interest rate would remain at 7 per cent for the remainder of the year, as well as its blanket refusal to lift the interest rate cap on commercial banks of 1.5 times the official interest rate, gives an impression of an institution more comfortable issuing government edicts rather than policy making based on serious analyses of market developments. Likewise, the apparent failure by the MOF to recognise the importance of fiscal sustainability and its impact on the investment climate could, if left unchanged, hinder Vietnam’s competitiveness for foreign investment and trade once global recovery gets underway.

In summary, short term macroeconomic policy making needs to go hand-in-hand with a medium term focus on building world class public institutions capable of promoting a dynamic and entrepreneurial private sector. In an important sense, success in this area is needed if Vietnam is to achieve its stated goal of attaining middle income country status within the coming decade.