In a previous article I emphasised the urgent need to address the risks to macroeconomic stability in Vietnam.

Indeed, action was taken after the Party Congress and the Tết holidays in January this year, beginning with a large devaluation (9 per cent of the central rate plus reduction of the band around the central rate from 3 to 1 per cent). This was followed three weeks later by a new resolution (Resolution 11) to re-balance the economy away from growth and toward macroeconomic stabilisation. This is to be achieved by tightening monetary policy, cutting back on fiscal spending, continuing with reform of the state-owned enterprises (SOEs) and building social safety nets.

The initial reaction to the large devaluation (the fourth in the past 18 months) was a further weakening of the dong as expectation of an inflation/devaluation spiral fuelled further capital flight into gold and US dollars. Subsequent administrative edicts to ban trading of gold and dollars in the open market, whilst emphasising the determination of the government, could have served to drive such activities underground. Still, raising the policy interest rate (four times in four months) from 9 to 14 per cent, and reducing the target credit growth to below 20 per cent per annum, did seem to have some impact, and the exchange rate began trading close to the official band. But the battle is far from over, as evidenced by yet another interest rate rise (to 15 per cent) last week. With one of the highest credit–GDP ratios in the region (Vietnam’s stock of credit is over 120 per cent of its GDP compared with around 50 to 80 per cent of GDP in the ASEAN 4 at similar stages of economic development in the mid-1990s), and an expected inflation rate of around 17 per cent (driven partly by rises in the administered prices of fuel and utilities), it would take greater and more sustained efforts to tame inflationary expectations. A clear mandate from the government to the State Bank of Vietnam to attain certain targeted-levels of inflation and international reserves would be a good start.

On the fiscal front, it has been reported that public investment is to be cut by 7.4 per cent this year, but guidance is badly needed on a trajectory of future government spending that would be consistent with macroeconomic stability. Furthermore, the key ministries of finance and planning need to have independence from political interference to conduct unbiased cost–benefit analyses of public investment projects, and to weed out those which are backed by powerful political interests but are economically wasteful.

As for the SOEs, the Ministry of Finance is currently attempting to set quotas on their foreign borrowings which would require them to seek approvals from the State Bank of Vietnam on a case by case basis. This move is no doubt a reaction to the near collapse and US$600 million debt default late last year of Vinashin (a huge state-owned shipbuilding, financial and real estate conglomerate) reportedly with political links to the Prime Minister Nguyen Tan Dung. Any increase in public oversight and improved governance of the large SOEs is a step in the right direction, but the authority and operational independence of the State Bank will be put to the test.

It is in this climate of macroeconomic weaknesses that Vietnam faced on 22 May an election of its 500-seat National Assembly. While there is no question that the Vietnamese Communist Party will continue to dominate, and Prime Minister Dung is widely expected to be re-elected, it is also clear that macroeconomic stability and continued rapid growth in living standards are key to the regime’s legitimacy. Support for strong public institutions (including the State Bank, the Ministry of Finance, and the Ministry of Planning and Investment) is an effective way of re-building public confidence in the macroeconomic foundations of the country.

So far, Vietnam still has the confidence of international investors, and has climbed onto the Asian production network gaining a foothold in parts and components manufacturing and assembly in electronics and related industries. (Samsung began mobile phone manufacturing in Vietnam in 2009. Intel commenced operations in Ho Chi Minh City in 2010, and Nokia set to open a factory in 2012). With wage rates climbing in China, significant opportunities are opening up for further investments in Vietnam. But much depends on the ability of the government to restore and re-build the public’s confidence in the country’s macroeconomic foundations before foot-loose foreign investors begin to sense trouble.

Suiwah Leung is Adjunct Associate Professor of Economics at the Crawford School of Economics and Government, Australian National University.

1. Vietnam: Macroeconomic challenges and the road to prosperity
2. The problems of success in Vietnam
3. Managing the risk of inflation during economic recovery – the case of Vietnam

A new generation of leadership is expected to emerge from the 11^th national congress of the Vietnamese Communist Party in January 2011. Both the President and the Secretary-General of the Vietnamese Communist Party are expected to be stepping down, and a question mark hovers over the re-appointment of the current Prime Minister, Mr Nguyen Tan Dung.

After leading the country into the WTO, amongst other market-oriented reforms, Mr Dung’s personal standing within the Party has been tarnished in recent months by the near-collapse of the large state-owned shipbuilding conglomerate, Vinashin. Whether the new leadership is reformist or conservative, it will be confronted with the issue of balancing short-term growth with macroeconomic stability.

Vietnam survived the GFC in better shape than most other countries of its size in the region, with a growth rate of 5.3 per cent in 2009. Throughout much of 2010, pro-growth policies resulted in estimated growth rates of around 6.7 per cent. However, with credit growth exceeding the (already high) official target of 25 per cent for the year, and Vietnam’s headline inflation rate looking to be in double-digits year-on-year, the State Bank of Vietnam had to reverse gear and raised official interest rates from 8 to 9 percent in November 2010.

More needs to be done, however, in order to ease the pressure on the dong, which has been devalued three times since November 2009. The official exchange rate is again about 10 per cent above the current ‘black market’ rate.

The 2010 current account deficit (excluding gold) is projected to be just under 7 per cent of GDP which is relatively high for an emerging Asian economy. International reserves, although stabilised, are at an uncomfortably low level, covering about 1.8 months of imports.

A more comprehensive package of macroeconomic policies, including fiscal consolidation, is needed to convince the market that the government is aware of the risks to macroeconomic stability and is managing those risks appropriately. In the medium-term, greater flexibility in the exchange rate regime is also needed to enable the private sector to manage exchange rate risks more effectively. Once confidence is re-established, households and enterprises are likely to cease hoarding US dollars and gold as a hedge against inflation and devaluations of the dong, and the so-called ‘dollar shortage’ (in reality, unwillingness to hold dong assets) should disappear.

The likelihood, however, of such a comprehensive package being adopted in 2011 is slim. Even with most stimulus measures having expired by end-2009, a reduction in the budget deficit to substantially below the level in 2009 of 9 per cent of GDP is unlikely, due to (often inefficient) spending on infrastructure and social welfare programs.

Without significant fiscal consolidation, Vietnam’s public debt to GDP ratio could well exceed 50 per cent, making it more costly for the government to borrow internationally, and further limiting the fiscal space. Furthermore, perhaps not surprisingly, the transition from direct to indirect monetary policy instruments is not unproblematic, and recently announced price controls to fight inflation, if implemented, could further undermine confidence amongst domestic and foreign investors.

It is in this context that the forthcoming Party Congress in January is important. Two decades of economic reforms and globalisation have made Vietnam a middle-income country with a rapidly growing domestic private sector. A return to a more dirigiste style of economic management on the part of the conservative elements in the Party is likely to dampen the domestic private sector, with negative consequences for economic growth in the medium term. Whilst there is perhaps no serious chance of a return to central planning, a ‘stop-go’ approach to economic policy-making could prevail.

If the reformist elements of the Party continue their ascendancy, fairly rapid reforms in key macroeconomic institutions could take place in the next 2 to 3 years. This could improve Vietnam’s macroeconomic policy-making and the government’s ability to communicate its policy stance to the market. In time, reforms could spread to other public institutions, assisting in the development of a dynamic and innovative private sector, and enabling Vietnam to achieve its long-term growth potential.

Suiwah Leung is an Adjunct Associate Professor of Economics at the Crawford School, ANU.

1. Vietnam: a switch from growth to stability
2. Vietnam sails through the crisis but needs reform to sustain the growth
3. The problems of success in Vietnam

With an estimated GDP growth of 5.3 per cent in 2009 and a forecasted growth rate by the ADB of 6.7 per cent for 2010, Vietnam has not only survived the GFC in better shape than countries of comparable size in Asia, but has joined the ranks of middle-income countries by having its per capita GDP in excess of USD 1,000. This is certainly a remarkable achievement in two decades of economic reforms. With the leadership setting its sights on having Vietnam develop into an industrialised market economy by 2020, there are expectations in some quarters that foreign investors will again find Vietnam a very attractive investment destination after Brazil, Russia, India and China (BRIC).

Vietnam is no stranger to foreign investors. During the last two decades, the country has had an average FDI/GDP ratio of 5.9 per cent; the highest among many ASEAN countries during their respective periods of rapid growth from the mid-1970s to mid-1990s. Yet it was not until 2006 that foreign investors were able to link Vietnam to the parts and components/assembly trade in electronics and IT equipment (the so-called production networks of East Asia, and arguably the most dynamic aspect of manufacturing trade in the late 20^th and early 21^st centuries).  This was a result, firstly, of two new laws in 2006 and Vietnam’s accession to the WTO in 2007 which made it possible for foreign investors to purchase more than 30 per cent of a Vietnamese enterprise, thus enabling foreign firms to exercise the coordination necessary for production network trade. Secondly, the costs of doing business in addition to labour costs (for example, transport, customs clearance, telephony, electricity) were lowered significantly in 2006 and became competitive with similar costs in the region. These two developments made it possible for Vietnam to join the first ‘rung’ of this global supply chain, providing another example that domestic reforms were needed for the country to reap the benefits of international integration.

In the short term to have a resurgence of FDI which would take advantage of the production network trade, the market  needs to be more confident in the government’s ability to maintain macroeconomic stability. The recently announced prime ministerial initiative to target the growth of the IT sector would certainly add to the optimism of investors. On the other hand, recently reported intentions of the government to use price controls to fight inflation is a negative. In the medium term, in order to progress up the value chain, Vietnam’s domestic private sector would need to be significantly more developed and given substantially better access to credit.

After two decades of reforms, the very large state-owned enterprises (conglomerates called ‘General Corporations’) still constitute a quarter share of Vietnamese industry and command over half of the country’s investible funds. The move by these General Corporations into real estate and finance in 2007/8 provided another channel of funding to these corporations while destabilising the macroeconomy. The recent failure of Vinashin, the large state-owned shipbuilding conglomerate, is having reverberations at the highest political levels. And yet, as the country is about to implement its ninth socio-economic development plan in 2011, there seems little appetite to address directly the role of the State in the economy vis-à-vis the private sector.

Given Vietnam has experienced significant macroeconomic turbulence in the past three years, with current account deficits hitting the ‘safety threshold’ of 10 per cent of GDP, the dong under attack, and inflationary pressures expected to re-emerge with resumption of rapid growth; the building of strong macroeconomic institutions (central bank, ministry of finance, ministry of planning and investment) is an important and necessary goal in the medium term future. In due course, institution-building could spread to other areas of the civil service. A strong set of public institutions could act as a bulwark against politically-driven and wasteful public spending, leaving more room for social spending on health and education – essential ingredients supporting a dynamic private sector. In time, this would help to redefine the catch phrase, ‘A market economy with socialist orientation’, that is more in consonance with an industrialised market economy. With this framework in place, Vietnam has the potential to sustain rapid growth in the coming decade, and continue to be regarded favourably in the eyes of international investors.

Suiwah Leung is Adjunct Associate Professor of Economics at ANU. She consults regularly with AusAID, the Australian Department of Foreign Affairs and Trade, the Australian Centre for International Agricultural Research, the UN Development Program, and the Vietnamese government on macroeconomic and economic development issues.

1. Vietnam: back from the brink?
2. Vietnam: Macroeconomic challenges and the road to prosperity
3. Vietnam: Balancing growth and stability in a more market-oriented economy

As the Productivity Commission in Australia deliberates the pros and cons of Preferential Trade Agreements (PTAs) for Australia, Vietnam is entering into active talks with the EU. These follow the failure of the earlier trade discussions, often referred to as the EU-ASEAN FTA talks.

During this same period, Vietnam joined the Trans Pacific Partnership (TPP) at its first meeting in March. The TPP’s announced aim is to promote trade cooperation among its eight disparate members (Brunei, Singapore, Peru, Chile, the US, Vietnam, New Zealand and Australia).

Economists point out the majority of so-called Free Trade Agreements (FTAs) are in fact PTAs as they give tariff preferences to participating countries to the exclusion of other countries. There are potential costs associated with diverting trade away from non-participating countries towards the countries with preferential tariff arrangements. Furthermore, Vietnam is in the assembly and simple component manufacturing stages of the East Asian production networks. These tariff arrangements could be detrimental, as often it is not possible within these networks to determine where a product or component is made.  This ‘establishment of origin’, so as to satisfy the ‘rules of origin’, is generally stipulated in such preferential trade agreements. Accordingly, there is a risk such arrangements may prevent participation in cross-national supply chain systems.

There can be little doubt that PTAs involve trade diversion. Vietnam is a signatory to the IT Agreement under the WTO and, given this agreement covers some 60 per cent of the trade in parts and components in East Asia, the impact of PTAs on Vietnam may not be significant as concerns these networks. However, there are other sectors in which production networks are important to Vietnam, including garments, footwear, furniture, and automotive parts. A PTA between Vietnam and the EU could well mean that these industries would need to move to export processing zones where producers might be protected from the rules of origin problem.

Trade diversion costs notwithstanding, Vietnam is likely to conclude a PTA with the EU for the following reasons:-

Firstly, it would mean that the EU confers ‘market economy’ status to Vietnam. Vietnam joined the WTO in 2007 under the status of a ‘non-market economy’. Subsequently, other members of ASEAN, as well as Australia, New Zealand and India accorded Vietnam market economy status, yet the EU, US and Japan still maintain that Vietnam is a non-market economy. A PTA between the EU and Vietnam would reverse that situation, at least as far as the EU is concerned and could strengthen Vietnam’s case vis-a-vis the US and Japan. In practice, this would mean that anti-dumping suits become more difficult. With market economy status, only the production costs within Vietnam can be considered in anti-dumping cases, whereas under a non-market economy status, Vietnam’s production costs could be compared unfavourably with those of an arbitrarily-chosen third country. In the more protectionist post-GFC era, where anti-dumping suits against Vietnam have tripled in the past year, the benefits of being awarded ‘market economy’ status could be very real.

Secondly, the PTA talks with the EU include investment agreements which would give better protection to foreign investors, improve dispute resolutions and court procedures, and facilitate investment in general. All these are likely to promote foreign direct investment inflows and have a consequently positive effect on economic growth. These highly significant structural changes would potentially meet fewer domestic political difficulties when presented as part of an EU-PTA.

Finally, a continuing consideration is the perception of Vietnam as a small country that needs to consider the balance of its strategic interests between the EU, US, China and Japan.

So long as the PTA talks are seen to be more than just trade agreements, Vietnam is likely to add to the proliferation of this particular ‘noodle bowl‘ in the region.

1. Preferential trade agreements and the WTO
2. Multilateralising Regionalism: Australia’s Role in ‘Taming the Tangle’ of Preferential Trade Agreements
3. The Japan-Thailand economic partnership agreement: Utilization and implementation issues from the perspective of Thailand

Vietnam weathered the global financial crisis surprisingly well. Real GDP growth of 4.6 per cent year-on-year for the period January-September 2009 is below that of China, but well above growth rates in most East Asian economies.

One factor behind this unexpected result is the still early stages of integration into the global economy. This has cushioned Vietnam from the immediate impact of the US financial crisis and from the more devastating effect of reduced manufacturing exports. The turnaround in monetary policy (from monetary tightening in mid-2008 to halving the official interest rate from 14 to 7 per cent per annum by November the same year) and the large program of fiscal stimulus (announced at around US$8 billion) also contributed to maintaining growth.

Since April 2009, however, there have been signs of over-valuation of the Vietnamese currency, the dong. Along with rapid credit growth throughout the year, this has caused concern about overheating and macroeconomic instability akin to the 2008 episode when inflation reached 28 per cent. Fears of large and disruptive devaluations, manifested in large informal private capital outflows, have put pressure on the balance of payments. In November 2009 a reassessment of the stimulus package became necessary.

Since then authorities have devalued the dong by a further 3.4 per cent and raised official interest rates from 7 to 8 per cent. The government has also announced that its program of subsidising interest rates for working capital will be terminated, as scheduled, by the end of 2009. The subsidy element of the scheme for medium and longer-term investments will also be cut from 4 to 2 per cent and phased out completely by the end of 2010. International donors showed support for these measures in early December by pledging a further $8 billion of assistance to Vietnam in 2010.

As a relatively small, open economy, with a population of around 86 million, Vietnam has little choice but to embrace increased globalisation as a longer term development strategy. Its immediate challenge is to improve its international competitiveness in trade and investment.

In recent years Vietnam has fallen consistently in the Global Competitiveness Index, from a ranking of 68^th in 2007 to 70^th in 2008, and to 75^th in 2009. Concerns over Vietnam’s macroeconomic management seem to be a major factor in this fall. Its ranking for macroeconomic stability fell from 51^st in 2007 to 112^th in 2009.

The recent pullback in the stimulus package, together with strong show of support from the donors, is a promising start. Continued skilful management of the macroeconomy on the part of the Vietnamese authorities will be crucial in 2010.

Related to this is the need for professional strengthening of public institutions, especially macroeconomic institutions. In addition to formulating and implementing monetary policy, the State Bank of Vietnam also needs to supervise the banking system effectively. The initiation of large-scale onsite supervision of banks and the coalescing of all supervision activities into a single department of the State Bank is a good start, but more must be done. The Ministry of Finance needs to focus on fiscal sustainability. In order to better target government spending they should utilise technical assessments of large infrastructure projects and other areas of public expenditure. The program of reforming state-owned enterprises, including reform of state-owned banks, also needs to be revitalised.

In short, the strengthening of public institutions in order to manage the macroeconomy and to pursue microeconomic reforms needs to be high on the agenda in 2010 as Vietnam prepares for its next five year development plan. Success in these areas will enable Vietnam to attain its goal of becoming a middle-income country in the coming decade.

This is part of the special feature: 2009 in review and the year ahead.

1. Vietnam: dangers and opportunities
2. Vietnam: Balancing growth and stability in a more market-oriented economy
3. Vietnam: a switch from growth to stability

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.

1. Managing the risk of inflation during economic recovery – the case of Vietnam
2. Vietnam: dangers and opportunities
3. The problems of success in Vietnam

The year 2008 was testing for Vietnam. Between March and August of 2008, with inflation running at some 28 per cent p.a., fuelled by significant capital inflows the year before, the Government had to implement strong stabilisation policies in order to cool the overheated economy (see my analyses from last year).

By November 2008, these policies had to be reversed in order to support economic growth in the face of deteriorating global conditions. And yet, Vietnam still posted real growth of 6.25 per cent for the year, albeit at the slowest pace since 1999. Perhaps more encouragingly, the authorities showed a degree of flexibility in policymaking that needs to be maintained, and enhanced, for Vietnam to face the near-term challenges posed by the global recession.

For 2009, the IMF and the World Bank are forecasting growth rates between 4.75 to 5.5 per cent — well below the historical average of 7.5 per cent, and lower than the official government target of 6.5 per cent. Even though imports are falling faster than exports, narrowing the trade deficit, Vietnam’s current account deficit is still expected to be around 8 per cent of GDP this calendar year. With international reserves covering only around three months’ of imports and an expected weakening of capital inflows (FDI, portfolio and private remittances inflows), vulnerability on the balance of payments front is constraining the degree of monetary easing and fiscal stimulus available to the authorities.

This calls for particular attention to be paid to the financing of government budget deficits. The fiscal stimulus needs to be well-targeted, to alleviate poverty and enhance efficient infrastructure projects, rather than piecemeal tax and interest-rate relief for small-medium enterprises. Pushing on with state-owned enterprise reform (particularly state-owned commercial banks reform) would also add to fiscal sustainability. On the monetary side, the authorities devalued the dong against the US dollar by 2.4 per cent in June 2008, and then by a further 3 per cent more recently. There is, however, renewed pressure on the dong, and continued flexibility on the exchange rate is needed to enhance the effectiveness of monetary policy for any given reduction in official interest rates.

Vulnerability of the banking sector has already been discussed in an earlier piece. It is encouraging that the State Bank of Vietnam has since then initiated large-scale onsite supervision of banks and in general, tightened its prudential supervisory functions which are now brought together within a single department of the Bank. In addition, conditions for granting bank licenses have also been tightened so that perhaps there will not be a continuation of the trend towards large SOEs moving into the financial sector for quick profits.

In short, there appear to be some indications that the crisis of mid-2008 in Vietnam and the current global recession are resulting in moves towards significantly improving the country’s macroeconomic institutions. A start has already been made with the State Bank, and hopefully this will continue through to the Ministry of Finance in order to deal with longer-term fiscal sustainability.

Vo Tri Thanh talks of a new development paradigm based on strong national and international institutions. Perhaps the current crisis could result in political will committed to institution strengthening, both in Vietnam and more broadly un the region.

1. Vietnam sails through the crisis but needs reform to sustain the growth
2. Vietnam: back from the brink?
3. The problems of success in Vietnam

After Pakistan and Sri Lanka, Vietnam is reported to be the third country in Asia at risk of a credit-rating downgrade by Standard & Poor as global recession deepens, and the country’s banking system is cited as being the major concern. In May this year, Standard & Poor lowered Vietnam’s BB long-term foreign currency ratings outlook to negative as macroeconomic turbulence intensified. Since then, tight monetary and fiscal policies, as well as administrative measures and falling world demand, have managed to cool the overheating of the economy, but now, the country’s banking system is coming under scrutiny.

From a situation where the banking system was overwhelmingly dominated by a few state-owned commercial banks, Vietnam’s banking sector has diversified quite rapidly. Currently, Vietnam has four major state-owned commercial banks (plus a fifth, smaller one) which control around 55 per cent of banking sector assets; 37 joint stock banks occupying another 30 per cent of the market share, with the remaining 15 per cent spread amongst 37 foreign bank branches and five joint-venture banks. Whilst credit growth last year amongst the state-owned commercial banks was relatively modest (a little over 20 per cent), credit growth amongst the joint stock banks reached almost 100 per cent, raising concerns about credit quality.

A State Bank report at end-July, 2008, indicated that the exposure of some banks to the real estate sector was uncomfortably high, with two banks having over 50 per cent of total loans in the real estate sector, another nine banks having an exposure of 30 per cent, and a further nine banks an exposure of over 20 per cent. Given that real estate prices have dropped by about half, the amount of non-performing loans would already be worrying. To make matters worse, the lack of hard data, particularly on the joint stock banks, is making assessment difficult, and tends to undermine investor confidence. Vietnam still has not enforced the internationally-accepted standard of measuring non-performing loans; that is, when a loan service is in default, the entire loan (rather than just the interest component) is counted as non-performing. The Vietnamese measurement therefore can grossly understate the amount of non-performing loans.

Documented information shows that foreign banks have minority interests in nine of the 37 joint stock banks. These foreign banks include HSBC, Standard and Chartered, and ANZ Banking Corporation all of whom have recently been granted 100 per cent foreign-owned subsidiary status. It is therefore not clear what will happen to the minority interests in their three joint stock banks. In any case, it is the other 28 joint stock banks without foreign interests that seem to have largely escaped public scrutiny. At least nine of these are so small that they will probably fail to meet the necessary capital requirements to continue operating beyond the end of this year. Consolidation through mergers and acquisitions will therefore be inevitable.

In addition to non-performing loans in the banking system, an equally worrying development is the trend towards large state-owned enterprises (in fact, conglomerates) obtaining banking licenses. Experience in a number of countries (including Japan, Chile, and Indonesia) has shown that conglomerates in these situations are inclined to make loans to companies within their business group without due regard to the risks posed by these loans, tending to undermine the potential stability of the banking system. According to an assessment by the Ministry of Finance dated May 31 this year, state owned conglomerates have invested in about 1.30 per cent of total equity, and 0.50 per cent of total assets of joint stock banks. On the face of these numbers, the involvement of state-owned conglomerates in the joint stock banks is not high, but as at the start of 2008, there were reportedly 15 new applications for banking licences by major enterprise groups, and the government has been under pressure to grant at least some of these. Indeed, three have already been granted this year. These comprise the FPT Bank (earlier known as the Tien Phong Bank) with large stakes held by the Corporation for Financing and Promoting Technologies, Mobiphone, and the State Capital Investment Corporation; the LienViet Bank owned mainly by the Him Lam Ltd, the Saigon Trading Group, and the Southern Airport Services Company (a state-owned entperprise); and the most recently established Bao Viet Bank which is controlled by the state-owned insurance company.

The dangers of related-party transactions, in addition to non-performing loans, could be really serious in an environment where published information on joint stock banks is already scarce, and the regulatory regime is not well-established.

In March this year, the National Financial Supervision Committee was set up to advise the Prime Minister and to function as an overall supervisor of the financial sector. However, the professional capacity of this Committee is lacking and its relationship with the prudential supervisory role of the State Bank of Vietnam is unclear. Unless and until more data are systematically published on Vietnamese banks and greater transparency obtained, investor confidence will continue to be undermined, and rating agencies will continue to look with increasing scepticism at Vietnam’s banking sector.

1. Vietnam: dangers and opportunities
2. The problems of success in Vietnam
3. Vietnam sails through the crisis but needs reform to sustain the growth

The economic policy authorities in Vietnam seem to have had some success in pulling the economy back from the brink. The latest month-on-month inflation rate has begun to slow down and the economy may have passed the point of macroeconomic danger, though it is too soon to declare victory yet.

Vietnam’s problems are different from those of the rest of Southeast Asia in the Asian financial crisis. They are more like those of Southeast Asia in the early 1980s or China in the early 1990s: the darling of international investors and an ill-disciplined policy response to all the attention. The tough policy choices required have been nowhere to be seen until the last few months.

The turnabout now seems in train. Since May the Vietnamese policy authorities have sharply tightened monetary and fiscal policy while the Vietnamese dong has been allowed to adjust down, and recent measures on the part of the State Bank of Vietnam may have eased the otherwise continuously downward trend. There is still a looming bad loan problem in the banking sector about which there is a national state of denial. And, with the first signs of economic slowdown, there is a danger that the authorities will back off before inflationary expectations have been tamed. But the battle has been joined and it feels as if the point of maximum danger has been passed.

However, the recent macroeconomic turbulence (in addition to continued problems of corruption) has taken its toll both on growth forecasts for 2008 and 2009 as well as on the credibility of reform-minded fractions of the Vietnamese Communist Party, including Prime Minister Nguyen Tan Dung. The implementation of scheduled cuts to electricity supply in August highlights the grave weaknesses in infrastructure, although raising the necessary funds for new plants would not be easy if electricity prices were continued to be subsidized. At the same time, localized protests (albeit small scale) against escalating food and fuel prices emphasize the important link between economic and social stability. The margins of error for economic policy-makers from hereon could have been narrowed considerably.

1. The problems of success in Vietnam
2. Vietnam sails through the crisis but needs reform to sustain the growth
3. Vietnam: dangers and opportunities

With an inflation rate running at 27% pa, current account deficit forecast at 9.2% of GDP, and a widening of the dong/dollar exchange rate between the official and informal markets (at times in excess of 7-8 percent), the Vietnamese government, whose emphasis had traditionally been on stability, is facing its first significant macroeconomic turbulence since opening the economy to international trade and investment almost 20 years ago.

Paradoxically, Vietnam’s success in attracting capital inflows over the last couple of years is behind the current problems. This has revealed some of the limitations of its reform process over the past five years.

The origins of the current macroeconomic problems stem principally from the failure of the State Bank of Vietnam (SBV) to sterilize the surge of capital inflows (which took the form mainly of foreign direct investment and remittances from Vietnamese living abroad) whilst keeping a rigid exchange rate peg in 2007. This left the banking system awash with liquidity, fuelling credit growth of over 50% by the end of last year. Macroeconomic management has been complicated on the one hand, by a ‘young’ banking system inexperienced in pricing risks and, on the other hand, easy access to bank credit on the part of state-owned enterprises (SOEs) eager to expand investments into real estate, financial services, and other non-core activities. Easy credit, coupled with a nascent and poorly regulated stock market, also fuelled a spectacular boom and then bust which is currently dampening investor sentiments.

To make matters worse, 10 days ago, the SBV banned third currency trading by banks (the so-called ‘grey market’) in an effort to curb arbitrage and enforce the official exchange rate. This has incited fears that, unless exporters and others could be persuaded to sell dollars at the official exchange rate, the SBV could be left as the only legal supplier of foreign exchange, and would have to be prepared to use the country’s international reserves to back what is perceived to be an over-valued official exchange rate.

This is unfortunate as moves in the past month to broaden the exchange rate band and allow for some official depreciation of the dong were welcome, and still greater flexibility is needed in the management of the exchange rate in order to give greater effectiveness to monetary policy, without excessive reliance on capital controls which, over time, can become porous. At the same time, a much-needed reining in of the SOEs seems to be occurring and must be continued. As much of the capital inflow is underpinned by foreign direct investments into the industrial and tourism sectors, a sudden reversal of inflows (a la Thai style) is unlikely in spite of the downturn in the world economy. However, the seeming inability of the authorities to put together a coherent package of monetary and exchange rate policy at present undermines investor confidence, and could impact negatively on Vietnam’s growth prospects. Furthermore, Vietnam’s future in expanding its industrial base and participating successfully in the production networks of East Asia depends crucially on its government’s ability to restore macroeconomic stability, and to convince domestic and foreign investors that it has the institutions capable of managing future financial turbulence.

In the medium term, a positive outcome of the present period of instability could be a significant deepening of reforms in key macroeconomic institutions such as the State Bank of Vietnam, in terms of increased independence and capability in managing monetary policy and in the regulatory oversight of the financial system. The ultimate aim should be to develop a public perception that these key government policy and regulatory institutions are run by people with professional integrity. Legislative independence of the central bank and significant increase in its professional capability would be a good start.

1. Vietnam: dangers and opportunities
2. Vietnam sails through the crisis but needs reform to sustain the growth
3. Managing the risk of inflation during economic recovery – the case of Vietnam