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Global Research

Vietnam:  The government’s economic strategy


has propelled Vietnam to middle-income
Seeking Stability status – a major accomplishment

(Or why boring isn’t always bad)  However, macro instability – in the form
of bouts of inflation and trade deficits –
continues to concern investors

 To steady itself for the next growth


stage, key reforms are needed but are
unlikely to take place in the near term

Let it go & watch it grow


Since it began its transition from a communist economy
towards a market-oriented one in 1986, Vietnam has
experienced tremendous economic growth, so much so that
it has now entered the ranks of middle-income countries by
reaching a per capita GDP of more than USD1000 – an
impressive achievement. To press on to the next stage,
however, many market observers believe a more stable
macro environment is needed.

The incomplete transition to a market economy has left


Vietnam in a hybrid mode, where the state continues to retain
meaningful controlling tendencies over the functioning of the
economic system. Our analysis suggests that this could be
contributing to the trade deficit and inflation problems.

For instance, the state-owned sector remains dominant and


may be unintentionally keeping a lid on the growth of the
country’s nascent private enterprises, which have yet to
26 May 2010 command the resources to move up the value chain. As a
Wellian Wiranto result, export potential is crimped – at a time when the
Economist population is developing a taste for more imported goods.
The Hongkong and Shanghai Banking Corporation Limited
Singapore Branch Meanwhile, the government has yet to grant sufficient
+65 6230 2879 wellianwiranto@hsbc.com.sg
operational independence to the central bank for the latter to
have the necessary toolkit to start anchoring inflation
expectations and to minimize chances of runaway inflation.
View HSBC Global Research at: http://www.research.hsbc.com
Issuer of report: The Hongkong and Shanghai Banking As we have highlighted before, Vietnam’s economic
Corporation Limited Singapore Branch
potential remains exceptional. Achieving better macro
MICA (P) 177/08/2009 stability through market reforms would provide a steadier
Disclaimer & Disclosures platform to harness this potential. But investors should
This report must be read with the remain cautious on the near-term progress of reforms.
disclosures and the analyst certifications
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
Macro
Economics abc
26 May 2010

Diagnosing the issues


 Vietnam’s high growth has come with macro instability – bouts of
inflation and trade deficit problems
 The root of the problems may be the hybrid nature of its economy,
where the state sector still dominates over private enterprises
 Further liberalization and a more independent central bank can
help foster stability and set up Vietnam for the next growth stage

A strong start However, Vietnam’s admirable growth rate has


not come without any problems. The fast-growing
After embarking on reforms to move towards a
economy has exhibited a tendency to experience
market-based economy and away from its socialist,
significant macroeconomic instability, in the form
state-controlled model, Vietnam has succeeded in
of bouts of inflation and large trade gaps –
lifting the living standards of its people.
especially in more recent years.
1. It’s been a great ride up…
2. ...with a few bumps along the way
GDP per capita , USD
1200 % y -o-y USD bn, 3m ma
35 3.5
1000 30 3.0
800 25 2.5
20 2.0
600
15 1.5
400 10 1.0
5 0.5
200
0 0.0
0 -5 -0. 5
04 05 06 07 08 09 10
1993 1995 199 7 1999 2001 20 03 2005 2007 2009 -10 -1. 0
Inflation Trade Deficit - RHS
Source: CEIC, HSBC
Source: CEIC, HSBC

It managed to quintuple its GDP per capita in 15


In the period between late 2007 and early 2008,
years, from USD190 in 1993 to more than
for instance, the trade deficit ballooned to the tune
USD1100 by 2008 – a commendable feat.
of USD1-3bn per month. Around the same time,
Significantly, this achievement also elevated the
Vietnam registered outsized price pressures, with
country to the middle-income ranks, nominally
the year-on-year inflation rate running above 15%
defined as USD1000 of per capita GDP.
for 12 consecutive months.

2
Macro
Economics abc
26 May 2010

Although some semblance of order returned by Competitiveness Report by the World Economic
the start of 2009, inflation began trending up in Forum.
the last few months of the year, rising close to
So, why is Vietnam prone to episodes of
double-digit territory. The trade deficit embarked
macroeconomic instability?
on an unfriendly trajectory again, hitting USD2bn
by November 2009, and has lingered substantially Our analysis suggests that the country’s
above the USD1bn per month level since. In incomplete transition – from the state-controlled
response, the government has already depreciated economy that it was, towards a more market-
its currency twice in the past 6 months, as foreign based system – may be one of the reasons behind
exchange reserves are thought to have fallen. its macro volatility.

3. Trade deficit exerts pressure on the currency For instance, the still-large state sector may be
contributing to the country’s trade deficit. At one-
USD/VND, % y -o-y
2 third of GDP, state-owned enterprises still
0 command a dominant role in the economy and its
allocation of resources. As such, the country’s
-2 04 05 06 07 08 09 10
nascent private enterprises have yet to be given
-4
the resources to grow and move up the value
-6
chain – and become more competitive exporters.
-8
To increase the country’s export receipts (and
-1 0
help to turn around the trade deficit problem), one
Source: CEIC, HSBC option the government could pursue is to boost
the relative importance of private enterprises
While both the trade deficit and inflation in recent within the domestic economy.
months are better than in 2008, they nonetheless
paint a volatile macroeconomic picture – not least On another front, as the experience of some
because they have come barely two years after the countries which have moved towards central bank
previous episode, still fresh in the minds of many independence suggests, Vietnam may benefit from
investors. giving the central bank, the State Bank of Vietnam
(SBV), more operational independence as this
Tell me why could go some way to better anchor inflation
Finding the root cause of such volatility is a expectations and help minimize the frequency with
crucial first step towards creating macroeconomic which bouts of high inflation occur.
stability in Vietnam. This is especially important As a measure of the intertwined nature of these
considering the fact that the country has joined the factors, getting a better handle on inflation may
middle-income ranks – which means that Vietnam also encourage higher savings, which could in
will increasingly have to compete with better- turn help to finance domestic enterprises in their
positioned peers. drive to gain competitiveness on the global stage
As of now, Vietnam is low on the list in terms of – a positive for the trade position.
macroeconomic stability, at 112th out of 133 Such interconnectedness is best illustrated in the
countries, according to the 2009-2010 Global following stylized flowchart. The various causal
linkages will be detailed throughout the report.

3
Macro
Economics abc
26 May 2010

4. Many of the economy’s problems stem from the same source

In com p lete
T ra de D e ficit Tr a n s itio n to In fla tio n B o uts
M a rk e t E c on om y

S ta te S e ct or: C en tr al B a n k Au to no m y :
Im po rts
re m a in s d om ina n t a w o rk-in -p ro gre s s
>
Exp or ts H an d s are tie d in
P riva te Se c tor ’s pu rsui n g pro a ct iv e
c ro w d e d o u t m o n et ar y p o li c y

H ar d to m ove u p Ine ffic ie nt P o licy ra tes la g


th e Va lue C h ain H a rd t o an c ho r
In vest m e nt b eh ind in flatio n i nf la tio n
F ina ncing e xp e ct at io ns
Issues
U nc o m pe titiv e
I nsu f fic ient
Ex p ort er s S aving s
T e nd e nc y fo r
n e ga tiv e re al
+ ra te s
Affinity for H igh
H igh I m po rts F oreign G ood s:
Co n su m p t ion
e.g. iPh on e!

D e p re cia tion P re ssur e


Source: HSBC

The takeaway message will hopefully be clear: reform has also been the main force of attraction
lying at the root of the macroeconomic problems for foreign investors over the past years.
that Vietnam has been experiencing is the fact that
Though we remain hopeful that important reforms
the country is still very much in a hybrid stage –
will be carried out in due course, we believe that it
with the state-owned sector remaining dominant
may be premature to expect major steps to be taken
and the central bank still to gain enough
in the near term. The 11th Communist Party
operational independence to begin enhancing its
Congress to decide the country’s next leadership
inflation-fighting credibility.
cohort is due next year, making it less likely that
To establish stability on the macro front and to there will be a significant push for reforms at this
better position the country to compete against other juncture.
middle-income countries, the Vietnam economy
This means that the crucial next steps towards
may benefit from the pursuit of further structural
establishing macro stability (and a more ‘boring’
reforms.
market to watch) through structural reforms may
We are aware that we live in a world where have to wait a while more.
governments are playing much bigger economic
roles even in the staunchest of capitalist nations.
However, we believe that further liberalization
remains the best way to unlock more of Vietnam’s
great economic potential. And after all, that was
the goal when the country stepped on the path that
it chose in 1986. Equally important, continual

4
Macro
Economics abc
26 May 2010

Trade deficit
 Vietnam’s growth rate may be admirable but it is running current
account and trade deficits – very unlike faster-growing China
 With national savings at a relatively low level, an improvement in
the efficiency of capital allocation will be favourable
 Improving the competitiveness of domestic enterprises could help
to boost exports and offset an affinity for foreign imported goods

The same but different follow the exceptionally high-growth path set out
by China.
Vietnam began its economic reforms (doi moi)
and adopted a “socialist-oriented market Alas, even as China powered ahead, Vietnam
economy” in 1986. Although investment never quite made it past the high single-digit
subsequently started to trickle in, it was not until growth of the preceding years – posting 8.5%
2006 that the country began to garner serious growth in 2007. Not shabby but well below
investor attention, with its integration into the China’s 13% growth that year, for instance.
global economy epitomized by entry into the
5. Playing catch-up
World Trade Organization in November that year.
Real GDP grow th ( % y-o-y)
Attracted by the double-digit GDP growth of 14

China around that period, which had been 12


gradually reforming its own socialist economy 10
since 1978, investors were eager to scout around 8
for the “next big thing” – and it was common 6
wisdom that Vietnam fit the bill.
4
Like China, Vietnam was seen as a fellow 20 00 2001 2002 2003 2004 2005 20 06 2 007 2008 2009
communist country transiting from a state-led Vietnam China

economy into a market-based one – with all the Source: CEIC, HSBC

efficiencies to be unlocked and opportunities to be


gained. The thinking was that Vietnam had now Moreover, Vietnam seems to struggle to register
formally ditched its autarkic cocoon and substantial GDP growth rates without running
integrated itself into the global economic system, large trade and current account deficits – clearly
just as China did when it entered the WTO in not an issue for China despite its significantly
2001. Therefore, Vietnam would be poised to higher pace of growth. Between 2005 and 2009,
China registered a current account surplus worth

5
Macro
Economics abc
26 May 2010

6. Dare to be different? 7. A cut above others

Current A cct Ba lance , % of GDP Private Consumption, % of GDP


15 80
10
60
5

0 40
-5 98 99 00 01 02 03 04 05 06 07 08 09
20
-10

-15 0

Vietnam China VN CH US HK IN ID KR M A PH SG TA TH

Source: CEIC, HSBC Source: CEIC, HSBC

8.5% of GDP on average. In contrast, over the During the global crisis, the large share of private
same period, Vietnam’s current account balance consumption helped keep the Vietnamese
stood at a deficit of 6.0% of GDP. Moreover, it economy relatively shielded, even as the trade
sometimes ballooned further – posting a 12% of sector suffered from the slowdown. In fact, China
GDP deficit in 2008, for example. itself is now actively trying to boost private
consumption (at less than 40% of the economy) in
With that in mind, we ask: what is so different
an attempt to rebalance its growth drivers.2
about Vietnam that it should be running current
account deficits that threaten to balloon further However, this consumption buffer does not come
occasionally, while China has continually run cheap. For one, Vietnam’s consumers appear to
surpluses that have helped it to accumulate the have developed a taste for foreign goods, pushing
largest foreign reserves in the world?1 up imports and contributing to the country’s trade
deficit. (Please see the section ‘For the love of
Not saving enough
imports: Taste for iPhones & foreign scrap’ for
By definition, Vietnam’s current account deficit details).
stems from an excess of investment over savings.
The flipside of having such a high share of
While much has been said about China’s high consumption in the economy is that Vietnam’s
saving rate and low consumption, Vietnam’s saving rate is comparatively low. According to
economy appears to have the opposite situation of IMF estimates, gross private savings stood at 23%
not saving enough and consuming too much. of GDP in 2009, less than half of China’s 51%.
Moreover, Vietnam’s saving rate has been falling
As much as two-thirds of Vietnam’s GDP can be
in recent years, with the latest data 5ppts of GDP
attributed to private consumption, a level that,
lower from the 28% registered in 2006.
within Asia, is only surpassed by the Philippines.

1
Although China ran an USD7.2bn trade deficit in March –
the first monthly deficit in six years – it proved to be 2
temporary as April saw a trade surplus again. For details, For details, please see the 26 February report “China
please see the 10 May note from our China economists, Economic Spotlight: NPC Meeting: What can we expect?”
“China’s Exports (Apr): Upbeat recovery extends into 2Q”. from our China economics team.

6
Macro
Economics abc
26 May 2010

8. Not saving nearly enough Demographics aside, there may be another reason
% of GDP why the Vietnamese are not saving much – they
50 12 are simply not economically incentivized to do so.
45 10
40 8 It is perhaps no coincidence that the saving rate in
35 6
30 4
Vietnam started to suffer a decline right when
25 2 inflation in the country accelerated, starting from
20 0 late 2007 till mid 2008. Rising above 10% y-o-y
2005 2006 2007 2008 20 09 in November 2007, inflation powered on to reach
Cu rrent Ac count Defic it - RHS
Sav ings
28% by mid-2008.
Inv estment
Meanwhile, policy rate rises were too late to
Source: IMF, CEIC, HSBC. Note: Saving and investment data for 2009 are estimates
by the International Monetary Fund. prevent real interest rates from falling deep into
negative territory throughout 2008.4
Why does Vietnam save so much less than China,
9. It doesn't pay to save?
and especially in recent years? A number of
factors might be at play. % % y -o-y
10 80

A formal safety net, in the form of official social 5 60

security programmes, remains in the early stage of 0 40

development in both countries (and much of -5 05 06 07 08 09 10 20


Asia). This means that the informal support -10 0
network of the family continues to be the main -15 -20
safety net in both countries. -20 -40

On that note, the difference in family structure Real Rates - LHS Dem and Deposits

between the two countries may be one reason that Source: CEIC, HSBC. Note: Data on deposits is available only up to December 2009.

helps explain the saving rate differences. China’s


one-child policy has curbed its population growth Effectively, people were incentivized not to save.
rate to 0.5% per annum in recent years. On the
Leaving money in the bank only to watch its
other hand, Vietnam’s population growth rate
purchasing power dwindling rapidly in real terms
remains more than double that, though it has also
was presumably a rather unattractive option
been trending down over the years.3
during the period of high inflation in 2008.
Effectively, the Vietnamese can count on a
As we have pointed out on several occasions,
broader support network when the need arises.
inflationary pressures have picked up again, even
Moreover, because there are more people who are
if they are unlikely to reach the heights of 2008.
expected to contribute, each person should feel
less burdened by the prospect as well. In short: Already, real rates have dipped back into negative
more people to count on, on the one hand, fewer territory, curbing recent growth in deposits as
obligations to chip in on the other. It is probable well. While the central bank tightened rates by
that this has led them to save less and consume
more, relative to the Chinese. 4
Strictly speaking, real interest rates are equal to nominal
interest rates minus expected inflation over the time
3 duration. Given that there is no data on inflation
Officially, Vietnam has a “two-child” policy, but it has been expectations, we have loosely proxied it with the actual
only loosely enforced since 2003. inflation rate of the period.

7
Macro
Economics abc
26 May 2010

100bps in November 2009, we believe that more capital, no matter the source, has become less and
needs to be done. less efficient in Vietnam in recent years. The
decline in capital efficiency can be seen most
The willingness of the central bank to move
clearly in terms of the trend of what is called the
further might be curbed by their lack of
incremental capital-output ratio (ICOR), which
operational independence. There appears to be a
measures the ratio of investment to the increment
gradual build-up of support coming from the
or change in output.
authorities on that front, but we do not expect any
major breakthrough soon. (Please see the next 10. Capital inefficiency: Up, up and away

chapter for further discussion.) Incremental Capital-Output Ratio


8
It looks like Vietnam’s structurally low saving
7
rate may remain in place for a while more. 6
5
Inefficient investment 4
The low (and declining) saving rate comes at an 3

inopportune time as Vietnam’s investment rate is 2

picking up rapidly. In 2007-08, Vietnam’s 19 90 1993 1996 1999 2002 2005 2008

investment exceeded 40% of GDP, and is inching Vie tnam China

closer to that of China. Unlike its northern Source: CEIC, HSBC. Note: It is not yet possible to calculate the 2009 ICOR for China,
because it has not released the expenditure breakdown of its GDP for the year.
neighbour, however, Vietnam’s investment is not
fully funded by its domestic savings, as reflected
As the chart above shows, Vietnam’s ratio has
in its current account deficit.
recently increased to its highest level in at least 20
So far, two external sources have been plugging years. Comparing its ICOR value of 7.9 in 2009
the domestic funding shortfall. FDI inflows have with the 4.5 figure of 2000 suggests that it took
proved to be strong, even during the extremely 75% more capital to produce one unit of output in
challenging global environment of recent times. 2009 than at the start of the decade. Moreover,
The other source remains development aid with Vietnam has been a more inefficient deployer of
bilateral lenders such as Japan, and multilateral capital than China in recent years, even as the
ones such as the ADB and World Bank pledging latter has often been accused of ‘wasting capital’
USD1-2bn commitments each this year.5 in its investment-driven growth. The country, in
short, relies on foreign savings to complement its
While we believe that the external sources should
domestic funding needs, but will have to continue
broadly cover the domestic funding shortfall in
to demonstrate to investors that it can deploy
the coming years, we are watchful of the declining
resources more efficiently.
savings in the country. This is particularly true if
we consider the fact that the deployment of Moreover, this challenge has become more marked
if we zoom in on the last two years. Going by the
ICOR value, it took 20% more capital to produce
5
In the case of multilateral aid, it will be interesting to watch one unit of output in 2009 compared to just a year
their loan terms in the coming years, as Vietnam graduates
above the low-income threshold. Already, the World Bank’s ago. The increase in inefficiency, of course, in part
USD1.2bn loans in the past few months come from its IBRD
arm (which provides loans to middle-income countries, with
may be related to the fact that the government
higher interest rates) as opposed to its IDA arm (which funds stimulus package ratcheted up state investments –
the world’s poorest countries with grants and concessional
loans). which jumped 38% y-o-y compared to the 15%

8
Macro
Economics abc
26 May 2010

overall investment growth rate. Since state 11. Goods imbalance

investment has a strong infrastructure component,


% o f GDP Vietnam
it tends to yield economic returns more gradually 10
5
over a longer period and may have skewed up the
0
ICOR measure – which tracks changes over a -5
rolling 2-year period – in the near term. -10
-15
-20
Still, the central bank recently pointed out that such
1 998 20 00 200 2 2004 2006 20 08
state-led investment had “surpassed the economy’s
Goods Serv ic es
ability to supply capital, creating great pressure on Income Transfers
interest rates and the exchange rate,” and added Curren t Acco unt

that inefficient use of investment capital would Source: CEIC, HSBC

contribute to inflationary pressures, as well.6


The foreign-invested sector has been a net
In short, the economy may benefit from positive contributor to the country’s trade balance,
continuing the liberalization measures that have though we believe that the FDI sector could play a
been pursued in recent years. By encouraging bigger role in closing Vietnam’s overall trade gap.
private enterprises to grow alongside the state- On the other hand, its domestic sector registers a
owned ones, the country may accelerate its large deficit, effectively dragging down the whole
already impressive growth rate yet further with country’s trade balance. For instance, the
better allocation of capital. “domestic” trade deficit fell as low as USD24bn
Trade deficit breakdown (26% of GDP) in 2008. This stands in sharp
contrast to the consistent surpluses registered by
Earlier, we looked at Vietnam’s current account
China’s domestic sector. (Chart 13).
deficit from the perspective of the savings-
investment balance. 12. Vietnam's deficit stems from the domestic

Vie tnam
In this section, we look at the issue via the balance USD bn
10
of payments breakdown. 5
0
Specifically, Vietnam’s trade deficit is the chief -5
-10
culprit. In 2007 and 2008, its goods balance
-15
registered sharp deficits of around 15% of GDP. If -20
not for the substantial transfers in the form of -25

remittances and ODA grants, worth about 8-9% of 1997 1999 2001 2003 2005 20 07 20 09

GDP in 2007-08, Vietnam’s current account dome stic foreign total


deficit would have been higher still. Source: CEIC, HSBC

To delve into the factors that contribute to


Vietnam’s trade deficit problems, let us start by
looking at the breakdown of the trade balance,
making a distinction between the foreign invested
sector and the domestic one.

6
“Vietnam’s currency now in balance – central bank,”
Reuters, 15 April 2010.

9
Macro
Economics abc
26 May 2010

13. While China's surplus proves to be a joint effort 14. Bring ‘em in!

USD bn China 60

Import s of dom estic s ect or,USDbn


300 50
250
40
200
150 30
100 20
50
10
0
-50 0
19 97 199 9 2001 2 003 20 05 200 7 2009 200 4 00 600 800 1000 1 200

dom es tic fo reign total GDP p er cap ita, U SD

Source: CEIC, HSBC Source: CEIC, HSBC

Between 2004 and 2009, for every dollar that More recently, however, perhaps as a reflection of
Vietnam’s domestic sector exported, it imported how globalized Vietnam has become, the import
USD1.74 worth of goods on average – compared of iPhones has apparently surged as well. The
to imports worth USD1.20 in 1997-2003. (For the import of electronics and computers in total
sake of comparison, Chinese domestic players exceeded USD1bn in 1Q10, an increase of 53%
spend less than a dollar, roughly 80cts, on imports y-o-y, prompting a senior government official to
for every dollar they gain from exports). lament that “It’s not necessary for a poor country
to spend US$1 billion importing the iPhone!”7
The skewed export-import dynamics of Vietnam’s
domestic sector may be as much a reflection of its 15. If the iPhone did this, what might the iPad do?

propensity to import as its relatively weak export


Imp orts, %y- o-y 3mma
sector. We discuss both factors in turn. 60
40
For the love of imports
20
Taste for iPhones & foreign scrap 0
Since its reforms, the standard of living of
-2 0
Vietnam’s population has increased dramatically.
-4 0
Over the past decade, GDP per capita nearly
J an-09 A pr-09 J ul-09 Oct-09 Ja n-1 0
tripled from under USD400 in 2000 to nearly Elec tronic s M achine ry
USD1100 in 2009 – a 12% per annum growth rate
Source: CEIC, HSBC
that is probably eclipsed only by China’s 16%
over the same period in this part of the world.
The broader point is that, lately, the import of
As the people witness a better environment and items to fulfil consumers’ desires has tended to
feel more confident about the future, they have outpace that of goods that will add to productive
developed a taste for ‘status goods’. In Vietnam’s capacity, such as machinery and equipment. To
case, this often means imported goods. put it starkly, any import directly adds to the trade
deficit but the import of machinery for factories at
Initially, this translated into increased demand for
least carries the potential of improving the
motorcycles, which still remain largely imported
in either pre-assembled or completed forms.
7
“Vietnam allows more loans at negotiable rates,” Thanh
Nien News, 3 April 2010.

10
Macro
Economics abc
26 May 2010

country’s capacity for exports – something that Why can’t they export more?
can hardly be said of consumer goods.
Not adding much
A taste for foreign goods extends beyond As we noted in the previous section, Vietnamese
consumer goods to influence choices made by products seem to have problems finding
domestic enterprises as well, it seems. customers even at home, such that local
consumers prefer imported goods.
It is seemingly bizarre, for instance, that Vietnam
should be importing scrap paper. Apparently, If that is the case, then what are the chances that
domestic paper product enterprises are hesitant to Vietnamese firms can compete to push their
source it from small domestic merchants who do products globally? Quite low, unfortunately.
not have official business permits from the
Looking at the breakdown of manufactured
government.8
exports, we find evidence suggesting that Vietnam
Less bewildering, but no less troubling, is still largely entrenched in low value-added
Vietnamese firms spent over USD1.4bn importing production.
fertilizer in 2009, despite the fact that domestic
16. The value-add gap widens
fertilizer factories have been running below
Mac hine ry exports, % of manufac tured expo rts
capacity, with 300,000 tons in storage to boot.
50

Uncompetitive pricing may be an issue, 40


highlighting the need to boost the scale of 30
domestic industries. (See the section ‘Small 20
enterprises….remaining so’ for details.) 10

It is illustrative that the production costs of 0

Vietnam’s sugar producers are 15% higher than 199 5 1997 1999 2 001 20 03 2005 2007

their Thai competitors. The domestic producers Vietnam Chin a

are predominantly small-scale refineries which are Source: UNCTAD, HSBC

still stuck with backward technologies. The end


impact of the lack of economies of scale is that Exports of goods in the higher value-added
the much cheaper imported Thai sugar poses machinery and transport category, for instance,
serious competition for domestic producers.9 continue to languish at around 10% of total
manufacture exports for Vietnam with no sign of
Importing ‘cool’ items that are not available
any increase.
domestically is one thing. A situation where
domestic users have a higher incentive to buy In contrast, as a measure of how quickly China
from overseas what is available at home is quite has managed to move up the value chain in
another. It points to a lack of competitiveness of manufacturing, this ratio has been inching closer
domestic products, even at home. to 50% lately, a marked improvement from the
20% level it saw in 1995.

What would it take for Vietnam exporters to mimic


8 the trajectory of their China-based counterparts and
“Wasting dollars on luxuries expands trade deficit,”
Vietnam Business News, 6 April 2010. move up the value chain, so manufacturers start to
9
“High production costs cause Vietnam’s sugar to fall in its bring in more export dollars?
home market,” VietNamNet Bridge, 20 April 2010.

11
Macro
Economics abc
26 May 2010

Big state legacy exact. If Vietnam’s trajectory follows that of


To strengthen the competitiveness of home-grown China’s, then more and more home-grown
enterprises so that they can collectively move up enterprises in Vietnam will be privately run and thus
the export value chain and help to turn around the better equipped to compete in the export markets.
deficit problem, reforms aimed at growing private However, this scenario presumes that Vietnam’s
enterprises further could be helpful. privatization of state-owned enterprises will
Despite years of reforms towards a market-based continue apace going forward. Last year, only 65
economy, the state still maintains a relatively high enterprises were liberalized (or ‘equitized’, in the
level of control in the economy – about 35% of government parlance). This compares poorly
GDP in 2009 was generated by state-owned against the 2008 figure of 349. To some extent, the
entities, for instance. recent slow pace of privatization may be a function
of the relatively poor appetite for Vietnamese
17. The state of the state-owned
securities in the market. The planned 1Q10 IPO of
State- ow ned industrial prod uction, % of total the paper producer Vinapaco has yet to take place,
70 for instance.
60
50 There is, however, a risk that the momentum to
40
liberalize might have taken a more lasting hit.
30
20 Anecdotal evidence suggests that, coming out of
10 the global crisis, some officials have pointed out
0
that the state-owned enterprises had provided
99 00 01 02 03 04 05 06 07 08 09
greater employment security for the people,
Vie tnam China
helping to buffer Vietnam against the worst
Source: CEIC, HSBC
effects of the crisis. The subtext of this view is
that the country, and its people, would have
If we consider the industrial production figure,
suffered a lot more if not for the stabilizing
arguably a better reflection of the export-related
presence of the state-owned enterprises.
segments of the economy, a sizeable 31% of total
production is still attributable to state-owned This is not easy to argue against, especially since we
enterprises. Granted that this is a big fall from the live in a world where governments are playing
65% ratio of 1999, but it has some way to go much bigger economic roles even in the staunchest
compared to China, where state-owned enterprises of capitalist nations. Still, in the long run, the
now account for less than 10% of total production. experience of many developing countries has
It is also interesting to note that Vietnam’s ratio demonstrated the importance of private-sector
today stands where China’s was ten years ago.10 development to job creation and efficiency gains.

The bigger role that the state is playing in Vietnam For its home-grown industries to compete
is probably largely due to the fact that it started its successfully in the cutthroat global markets and
reforms later than China did – by eight years, to be turn around the country’s trade deficit, it is hard to
imagine them doing so without the dynamism that
10 privately run enterprises typically deliver. On top
China has recently re-engaged further liberalization to
encourage the growth of the private sector, particularly in of that, let us not forget that the story of Vietnam
investment. For details, see the 13 May note “China transforming from a state-led economy into a more
further deregulates to lift private investment” by our
China economics team.

12
Macro
Economics abc
26 May 2010

market-based one is the underlying structural theme businesses disproportionately. Economies of scale
that the government and investors bought into to work within the context of lobbying power as
begin with. well, and their small size means that private
enterprises in Vietnam have had to adhere to
Small enterprises…remaining so
regulations drawn up by various state agencies
Apart from privatizing state-owned companies, with limited potential for recourse. As many as
boosting competitiveness should also entail giving 400 new such regulations have apparently been
existing private enterprises the space to grow. issued, sometimes putting heavy requirements on
Private and household enterprises currently private enterprises, even as 180 old ones were
contribute about 40% of the GDP – a sizeable abolished during the last major push to help the
chunk that could play an important role in private sector in 2005.12
boosting Vietnam’s competitiveness, but only if Lately, there have been some hopeful signs that
nurtured fully. the government is recognizing the need to level
Most of the private enterprises are small and have the playing field between small private enterprises
remained so. They are, by and large, engaged in and big state-owned ones. For instance, there is
low-tech production and are yet to be now a proposal to allow private firms to access
internationally integrated. The architect of financing from ODA sources – a funding privilege
Vietnam’s enterprise reforms, Dr Le Dang Doanh, that state-owned enterprises alone have been
stressed this fact by saying that about the only enjoying to date. However, as some observers
integration he knew of was that of household point out, this might have come too late given that
enterprises supplying spring rolls to big the country is scheduled to soon graduate away
international hotels in Hanoi.11 from its low-income status – which means that
preferential loan rates from development agencies
For these enterprises to grow beyond spring rolls may soon become less available overall.13
and the like, and have an improved chance of
competing globally, a number of hurdles need to Can foreigners do more?
be overcome. Access to financing is one of them. As we have noted in the previous section,
According to Dr Le, “it’s a fact” that as many as Vietnam’s trade deficit problem reflects more on
64% of small enterprises are denied access to the export-import gap of home-grown enterprises
bank loans, starving them of crucial funds to than its foreign-invested companies which are
expand and grow their trade. To some extent, already running trade surpluses in aggregate.
small businesses anywhere in the world tend to be
disadvantaged when it comes to funding, due to However, we wonder if there is any potential for
higher perceived risks. In Vietnam’s case, this foreign companies operating in Vietnam to
issue is compounded by the fact that the country’s contribute more towards the narrowing of the
banking sector remains relatively early in the trade deficit. After all, the foreign sector
development stage. commands a significant chunk of the economy –
at nearly 19% of GDP in 2008. Judging from the
Apart from funding difficulties, administrative still-rapid pace of FDI inflows into the country,
requirements may be affecting small private
12
“Bureaucratic hurdles still hobble private sector,”
VietNamNet Bridge, 10 April 2010.
11 13
“Bureaucratic hurdles still hobble private sector,” “Hopeful signs for the private sector,” VietNamNet
VietNamNet Bridge, 10 April 2010. Bridge, 11 March 2010.

13
Macro
Economics abc
26 May 2010

18. Vietnam's taking in FDI in droves 19. FDI getting less export-oriented?

Realiz ed FDI, % of GDP USD bn


15 12
10
8
10
6
4
5
2
0
0
2002 2003 2004 2005 2 006 2007 2008 200 9
90 92 94 96 98 00 02 04 06 08 Trade Balance of Foreign-Inv ested Firms
Vietna m Chin a Reali ze d Foreign Direct Inv es tmen t

Source: CEIC, HSBC Source: CEIC, HSBC

the role that foreign-owned companies play in the indications that recent FDI into Vietnam may be
economy (and its potential to help turn around less export-oriented than before.
trade deficits) will continue to be important.
Compare the FDI inflows that the country is
As a proportion of GDP, Vietnam has been a receiving versus the trade balance of the foreign-
significantly larger recipient of foreign direct invested sectors, for instance. Even though
investment than China (Chart 18). Even at the realized FDI into Vietnam more than doubled
height of the Great Recession, it appears that from USD4.1bn in 2006 to an estimated
Vietnam remained a favourite destination for FDI. USD10bn in 2009, the trade balance of foreign
Despite a challenging global environment, the firms in the country stayed largely stagnant at
country took in realized investments of USD6-7bn, and dipped below USD5bn in 2009
USD11.5bn in 2008 and an estimated USD10bn in when faced with the especially tough global
2009 – a testament to the continued attractiveness environment of that year.
of Vietnam’s long-term growth story.
There seems to be less trade surplus bang for the
On an ongoing basis, the healthy FDI inflows, FDI buck, essentially. So, why is that the case?
together with the still-extensive development aid
For clues, let’s take a look at the sectoral
and overseas remittances have enabled the country
breakdown of foreign investments going into
to escape an outright balance of payments crisis,
Vietnam in recent years.
despite the perennially large current account
deficits that it has been running. However, the Interestingly enough, Vietnam has witnessed an
structural imbalances within the system are clear increasing share of foreign investment into its real
and it is inherently unsound to depend to such a estate sector. In 2009, the real estate sector
large extent on these inflows to plug the trade gap accounted for nearly 40% of foreign investment,
on a sustainable basis. It is much better to narrow for example, surpassing investment into the
the deficit somewhat to begin with. manufacturing sector, which has been slipping on
a relative basis. In contrast, the sectoral
Going local?
breakdown of investment going into China seems
In the context of enlisting the foreign sector to to have stabilized in recent years – at about 50%
narrow Vietnam’s trade deficit, it is slightly into manufacturing and 20% into real estate.
worrying to see that there are some early

14
Macro
Economics abc
26 May 2010

20. Are investors in Vietnam getting more 'grounded'? In the Executive Opinion Survey by the World
% o f total FDI Economic Forum, business leaders rank
80 Vietnam’s local supplier quantity at 74th and its
60 quality at 92nd out of 133 countries – as opposed
40 to China’s 11th and 53rd, respectively.
20 In an era where higher-end manufacturers are
0 adopting the extended production chain model,
03 04 05 06 07 08 09 Vietnam’s relative lack of suitable local suppliers
VN Manufacturin g VN Real Es ta te acts as an impediment towards attracting investors
CH Manufacturin g CH Real Es ta te who may be keen on using it as an export base,
Source: CEIC, HSBC particularly in the higher value-add production
stages – precisely the type that the country needs
One could interpret this as a trend where investors to narrow the gap between its imports and exports.
are keener to capitalize on the growing wealth of
the Vietnamese population by selling them houses Moreover, the lack of domestic suppliers means
and apartments, than to utilize the country as a that manufacturers are forced to import the
manufacturing base. If this trend continues, there necessary parts from other countries, further
may be some ramifications on the size of the trade compounding the trade deficit.
surpluses that the foreign-invested firms have The need to promote domestic suppliers
generated for Vietnam as a whole. After all, there reinforces the call for greater competition between
is arguably nothing less exportable or more local private and state-owned enterprises.
domestic-orientated than real estate. Alongside state firms, private enterprises can play
Foreign investments going into the manufacturing a key role in strengthening the local supplier base.
sector, in contrast, carry the potential of Without that, Vietnam may find it difficult to
increasing Vietnam’s exports and the chance to narrow its trade deficit on its own. It may also
help narrow its trade deficits. prevent foreign enterprises from taking their
Help us help you operations in Vietnam to a higher level, and
bringing the host country along with it.
To fully nurture the potential of foreign
manufacturers as export dollar generators,
improving the quantity and quality of local
suppliers is an important part of the game.

15
Macro
Economics abc
26 May 2010

Inflation
 Vietnam has a tendency to suffer bouts of high inflation
 Although factors such as food prices play a role, the lack of
central bank autonomy may matter more, structurally speaking
 To successfully grow within the middle-income band, it needs to
project macroeconomic stability, including stable inflation

Finding stability helped limit inflation somewhat in April and May,


which registered 9.2% and 9.1% y-o-y,
Apart from trade deficits, another issue which has
respectively. Overall, underlying inflationary
been plaguing Vietnam has been inflation.
pressures remain strong, however, as illustrated
In 2008, headline inflation was nearly 30% in by the still-strong momentum in the prices of
year-on-year terms on the back of big jumps in construction materials, for example.
food prices, which constitute 40% of the country’s
After tightening by 100bps in November 2009,
consumption basket. The core inflation measure,
the State Bank of Vietnam (SBV) has since
which strips out the effect of food and energy,
chosen to keep its policy rate unchanged at 8.0%.
trekked up significantly as well, hitting 13.6% in
We argue that more tightening may still be
October that year – suggesting that there is a
needed, particularly if the tamer-than-expected
material tendency for pass-through.
inflation of recent months proves to be temporary.
In recent months, inflation has trekked up again.
As discussed in the ‘Not saving enough’ section
In March, inflation hit 9.5% y-o-y, the highest in
in the earlier chapter, Vietnam’s real interest rates
12 months. The seasonally abundant harvests
run the risk of falling deeply into negative

21. Quite a ride 22. Wherever you go, I'll follow?

Inf lation (% y-o -y) %


30
50
25
40
20
30
15
20
10
10
5
0
0
-10 99 00 01 02 03 04 05 06 07 08 09 10
05 06 07 08 09 10
Headline Food Core Policy Rate Inflation

Source: CEIC, HSBC Source: CEIC, HSBC

16
Macro
Economics abc
26 May 2010

territory again.14 In 2008, the policy rate hikes Discussions about granting more operational
came too late, such that real rates dipped as low as autonomy to the central bank have been going on
-14% in September that year. Together with for a long while now. In 2006, the prime minister
exchange rate depreciation pressure, this resulted approved a master development plan whereby the
in the significant dis-saving activities we saw SBV, by the year 2020, will be “independent in
earlier – demand deposits in the system dropped setting policies on monetary, interest rate and
more than 20% in y-o-y terms by November 2008. exchange rate management.”16

This might help More recently, a new draft law has been submitted
to the National Assembly for approval. Although
Despite robust growth and price pressures, the
this law would potentially grant more operational
SBV has kept the policy rate on hold since hiking
powers to the SBV, it stops short of dropping the
it by 100bps and removing the 4ppt subsidy on
ministerial agency status – a sign that central bank
interest rates on loans at the end of last year. This,
independence would remain elusive for a while
arguably, may reflect a preference among
longer.17
policymakers for growth over inflation. Allowing
more autonomy for the central bank might help to Having said that, there appears to be some gradual
alleviate this issue. build-up of support within the National Assembly
to promote central bank independence. The Vice
Its current legal framework stipulates that the
Chairman of the parliament’s Economic
SBV is a “ministerial agency of the
Committee recently acknowledged that the new
Government”.15 As of now, the SBV’s monetary
central bank law should be amended to give it
policies need the government’s approval before
“increased autonomy and flexibility in creating
they can be carried out.
and implementing monetary policies.”18
In addition to not having full control over policy,
All in all, however, the process of granting the
the SBV can sometimes have conflicting
SBV more independence looks unlikely to come
objectives. Lately, the government has been
any time soon, especially considering the elevated
directing the central bank to embark on cutting
political considerations in the run-up to the next
interest rates while achieving price stability at the
national congress early next year. This means that
same time – an unenviable, if not virtually
the anchoring of inflation expectations may
impossible, task barring a sharp fall in
remain an uphill battle.
international commodity prices.

The conflicting nature of the government directive


highlights the value to Vietnam of having an
autonomous central bank that can enhance its
credibility by better anchoring inflation
expectations.

14
For the calculation of the real interest rate, we have used 16
“State Bank law opens door to greater power,” Vietnam
the actual inflation rate as proxy for inflation
Investment Review, May 2009.
expectations, given that there is no data on the latter. 17
15 “Central Bank Independence: Another Perspective,” The
“Decree: Prescribing the functions, tasks, powers and
Saigon Times, 26 August 2009.
organizational structure of the State Bank of Vietnam,” 18
No. 96/2008/ND-CP, the Government of the Socialist “Vietnam lawmaker wants more autonomy for central
Republic of Vietnam. bank,” Thanh Nien, 14 April 2010.

17
Macro
Economics abc
26 May 2010

Conclusion
Vietnam’s challenge is to adopt strategies that will
see it progressing within the new middle-income
‘club’ that it has worked so hard to join. To this
end, minimising the occasional bouts of high
inflation and currency depreciation arising from
its trade deficit would help to reduce perceptions
about the country’s macroeconomic volatility.

While we do not expect any major structural


reforms this year because of the heightened
political considerations, the reform process may
resume next year, including enhanced competition
among local enterprises as well as institutional
reforms towards central bank independence.

Until further reform is implemented and enforced


and savings increase to bolster the country’s
capacity to finance its investment needs, Vietnam is
likely to continue to face the same issues
highlighted in this report.

As we have maintained on many occasions,


Vietnam’s economic potential remains
exceptionally promising. Achieving better
macroeconomic stability would provide a much
better platform to harness this potential, in our view.

18
Macro
Economics abc
26 May 2010

Disclosure appendix
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Economics abc
26 May 2010

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Global Economics Research Team


Global Emerging Europe, Middle East and Africa
Stephen King Kubilay Ozturk
Global Head of Economics +44 20 7991 6045 kubilay.ozturk@hsbcib.com
+44 20 7991 6700 stephen.king@hsbcib.com
Alexander Morozov
Madhur Jha +7 495 783 8855 alexander.morozov@hsbc.com
+44 20 7991 6755 madhur.jha@hsbcib.com
Murat Ulgen
Karen Ward +90 212 376 4619 muratulgen@hsbc.com.tr
+44 20 7991 3692 karen.ward@hsbcib.com
Simon Williams
Europe +971 4507 7614 simon.williams@hsbc.com
Janet Henry Latin America
Chief European Economist
+44 20 7991 6711 janet.henry@hsbcib.com Argentina
Javier Finkman
Astrid Schilo Chief Economist, South America ex-Brazil
+44 20 7991 6708 astrid.schilo@hsbcib.com +54 11 4344 8144 javier.finkman@hsbc.com.ar
Germany Ramiro D Blazquez
Lothar Hessler Senior Economist
+49 21 1910 2906 lothar.hessler@hsbctrinkaus.de +54 11 4348 5759 ramiro.blazquez@hsbc.com.ar
France Jorge Morgenstern
Mathilde Lemoine Economist
+33 1 4070 3266 mathilde.lemoine@hsbc.fr +54 11 4130 9229 jorge.morgenstern@hsbc.com.ar
United Kingdom Brazil
Stuart Green Andre Loes
+44 20 7991 6718 stuart1.green@hsbcib.com Chief Economist
+55 11 3371 8184 andre.a.loes@hsbc.com.br
North America
Tatiana G Gomes
Ryan Wang Senior Economist
+1 212 525 3181 ryan.wang@us.hsbc.com +55 11 3371 8183 tatiana.g.gomes@hsbc.com.br
Stewart Hall Mexico
+1 416 868 7523 stewart_hall@hsbc.ca Sergio Martin
Chief Economist
Global Emerging Markets
+52 55 5721 2164 sergio.martinm@hsbc.com.mx
Philip Poole
Central America
+44 20 7992 3683 philip.poole@hsbcib.com
Lorena Dominguez
Asia Pacific Economist
+52 55 5721 2172 lorena.dominguez@hsbc.com.mx
Qu Hongbin
+852 2822 2025 hongbinqu@hsbc.com.hk
Wellian Wiranto
+65 6230 2879 wellianwiranto@hsbc.com.sg
Frederic Neumann
+852 2822 4556 fredericneumann@hsbc.com.hk
Seiji Shiraishi
+81 3 5203 3802 seiji.shiraishi@hsbc.co.jp
Janus Chan
+852 2996 6975 januschan@hsbc.com.hk
Song Yi Kim
+852 2822 4870 songyikim@hsbc.com.hk
Christopher Wong
+852 2996 6917 christopherwong@hsbc.com.hk
Yukiko Tani
+81 3 5203 3827 yukiko.tani@hsbc.co.jp
Sophia Ma
Associate
Sun Junwei
Associate

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