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p. 27 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia Cambodia Indonesia Lao People’s Democratic Republic Malaysia Myanmar Philippines Thailand Viet Nam South Asia The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : Southeast Asia

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Viet Nam

GDP growth accelerated to 6.1 percent in 2000 from 4.7 percent in 1999, due to a recovery in domestic private demand and robust export performance. The signing of a bilateral trade agreement with the US boosted export prospects, although structural constraints and quality problems remain. The investment rate needs to be raised to reach the Government’s target of at least 7 percent annual growth over the next 10 years.

Recent Trends and Prospects

Economic growth improved to 6.1 percent in 2000, following two slow years when growth ranged between 4.4 percent and 4.7 percent. On the supply side, the recovery was led by a strong performance in industry. On the demand side, domestic consumption recovered from a slump in 1998–1999, but the contribution of net exports to GDP growth turned negative.

The sectoral pattern of GDP performance in 2000 saw growth in agriculture of 3.6 percent despite floods in the central and southern regions, and drought in the north. Rice production increased by about 3.8 percent over the 1999 level, but producers saw their earnings dip due to low export prices, increased transport costs (because of higher oil prices), and the limited supply and high cost of credit. Industry turned in a strong recovery with a 9.7 percent expansion in 2000 after two years of slower growth. Within this sector, industrial output surged by an estimated 15.5 percent, led by processed marine products (up by 32.2 percent), electrical machinery (up by 23.3 percent), and cement (up by 19.1 percent). Construction strengthened by 5.0 percent from 2.4 percent growth in 1999. Services sector growth improved to 4.4 percent from 2.1 percent in 1999. Wholesale and retail sales, accounting for over 40 percent of value added in the services sector, rose by 9.2 percent, compared with 2.1 percent expansion in 1999.

On the demand side, real consumption growth increased to 5.6 percent from 1.6 percent in 1999. This pickup reflected the rise in public sector wages and the Government’s fiscal stimulus package. The investment recovery has, however, lagged behind. Gross domestic investment as a share of GDP was 23.0 percent in 2000, a modest improvement from 20.1 percent in 1999 but still below 1997’s peak level of 28.3 percent. This is because the proportion of foreign direct investment (FDI) in GDP, which had reached 8.9 percent in 1997, has since fallen sharply and is estimated at 3.2 percent in 2000.

The fiscal deficit is estimated to have been 3.0 percent in 2000 compared with 2.8 percent in 1999. The widening of the deficit, financed from domestic nonbank and external sources, reflects the easing of the fiscal stance to spur economic recovery. Revenue receipts as a share of GDP fell marginally to 18.7 percent from 18.8 percent in 1999, continuing the declining trend exhibited since 1994. They should, in fact, have been stronger given robust growth of exports, recovery of imports, and overall economic recovery. That revenue collection did not reflect these developments is in part because oil import tax rates were cut to zero to contain domestic prices of refined oil products, and to protect state enterprises from incurring losses. Also, value-added tax on essential goods and services and on capital goods was scaled back to ensure that these categories could gradually adjust to the newly introduced system for this tax. Of concern, however, is the fact that poor revenue performance poses a risk for fiscal sustainability over the medium term. On the expenditure side, overall spending as a share of GDP is estimated to have increased by 0.8 percent to 22.0 percent in 2000. This was due to a 25 percent wage increase in public sector salaries and higher capital spending, mainly on rural infrastructure.

Consumer prices fell in 2000. As of end-December 2000, the year-on-year percentage fall in the consumer price index (CPI) was 0.6 percent. The drop in world prices of agricultural commodities, particularly rice, led to a decline in the food price index that was only partially offset by higher prices of nonfood items in the CPI basket. Indeed, trends in food prices largely determine the behavior of the CPI as food items make up 61 percent of the basket.

The monetary policy of the State Bank of Viet Nam (SBV) was accommodative. Credit growth, subdued in 1999 at 10.5 percent, surged in 2000 to about 25 percent while broad money supply (M2) grew by 40.6 percent. The latter’s rapid rise was due in part to continued growth in foreign currency remittances from abroad and in part to a year-end acceleration of disbursements under state-funded projects that were deposited in banks. Interest rate policies are gradually being liberalized. In August 2000, SBV replaced the monthly ceiling rate on dong borrowings with a prime monthly rate of 0.75 percent. The ceiling interest rates for foreign currency lending were replaced with a rate based on Singapore’s interbank market.

On 1 December 2000, SBV raised the reserve requirement ratio for commercial banks’ foreign currency holdings from 8 to 12 percent. The move was intended as an incentive to turn dollar deposits into dong, in a bid to curb the growing dollarization of the economy. To check the rising cost of their currency holdings as the reserve requirement ratio increased, local banks have been cutting the interest they pay on their dollar deposits. Furthermore, the general reduction in dollar deposit interest rates has lessened the incentive for local banks to deposit dollars in foreign banks to take advantage of the interest rate gaps that had previously existed between the local and foreign markets. The opening of the country’s first stock exchange is as yet only symbolic as just four local firms have officially registered with it.

The current account surplus fell by half to 2.0 percent of GDP, reflecting the recovery of imports (including refined oil products) after a three-year slump. Export performance remained strong in 2000, with growth of 24.3 percent, led by the price-driven surge in crude oil exports, which in value went up by 71.2 percent but in volume by only 4.1 percent. On the capital account, net FDI showed a modest pickup in 2000 from its level in 1999. The signing of the $1.1 billion Nam Con Son sea basin oil and gas exploration project in December 2000 provided a much-needed boost to Viet Nam’s FDI prospects. Foreign currency reserves at the end of December 2000 stood at $3.9 billion, representing 13.9 weeks of import cover. The exchange rate was relatively stable until the last quarter of the year when the dong depreciated. The nominal depreciation of the dong against the dollar during 2000 was in the order of 3.3 percent. The external debt position improved after agreement was reached with the Russian Federation in September 2000 in which Viet Nam secured a significant writedown of its outstanding nonconvertible debt.

The global environment is expected to provide some support for consolidation of Viet Nam’s economic recovery. The economy is expected to grow by 6.4 percent in 2001 and by around 7 percent in 2002. Growth will be led by manufacturing, which is expected to expand by around 9 percent. The fiscal deficit is expected to widen over the next two or three years to meet the costs of reform, especially in banking and state-owned enterprises (SOEs). Inflation is projected at around 3–5 percent in 2001 and 2002, on the assumption that low world agricultural commodity prices that dragged down domestic prices will recover.

The prospects of higher exports to the US over the medium term have brightened with the signing of a bilateral trade agreement in 2000, but structural constraints and quality problems in the export sector need to be addressed to realize the potential benefits of this agreement. The trade balance will depend to a significant extent on the relative impact that softer oil prices (vis-à-vis 2000) will have on crude oil export revenue and the cost of refined oil imports. Export growth over the next two years is likely to be around 12–13 percent while import growth is likely to increase faster than exports at 16–17 percent, implying that the current account surplus will become a deficit in 2001.

Issues in Economic Management

Notwithstanding the economic recovery now under way, the investment response has been weak (Figure 2.12). Gross domestic investment increased from about 15 percent of GDP in 1991 to 28.3 percent in 1997. Following the Asian financial crisis, it fell sharply to about 20 percent of GDP in 1999. It rose modestly in 2000 to 23.0 percent, of which the government, SOE, domestic nonstate, and foreign investment shares were 8 percent, 7 percent, 3.5 percent, and 4.2 percent, respectively. The relatively weak investment response is of concern because, to achieve the Government’s GDP growth target of about 7 percent or more in the coming years, the investment rate will have to pick up to around 30 percent. The scope for significantly higher levels of investment from government, SOE, and FDI sources is, however, limited, meaning that private domestic investment will have to provide much of the required increase.

Raising private domestic investment is predicated on creating a level playing field for private sector development, which is necessary to improve the expected profitability of investment. In turn, higher profits can become a source of savings for further capital accumulation. Factors that have constrained private investment in Viet Nam include (i) an industrial structure characterized by a very small private corporate sector and the predominance of household enterprises, (ii) low growth of enterprises’ retained earnings to finance investment and their inadequate access to term financing, and (iii) inadequate stock of complementary public infrastructure capital.

Broadly speaking, the private corporate sector is constrained by the policy environment. In regard to access to term financing, private investors are constrained by the limited quantity rather than the cost of capital. The available evidence suggests weak effects of changes in interest rate policy and of tax incentives on investment. The volume of credit to the private sector has been curtailed by the practice of preferential credit given by state-owned commercial banks to SOEs. As a result, the private sector has been crowded out. The rising share of nonperforming loans, which have made banks reluctant to lend, is also a factor. The Government’s stated objective is to separate policy-based lending from commercial lending, and the establishment of the National Development Assistance Fund is a step in this direction. A potential problem in realizing this objective, however, is that financing for this Fund is inadequate to cover the policy-based lending that is likely to be made to loss-incurring SOEs.

The bias against the private sector extends to the availability of foreign exchange. While the improvement in the external account has allowed the Government to relax import restrictions and reduce foreign exchange surrender requirements, private enterprises still continue to experience difficulties in securing foreign exchange.

Another deterrent to private investors is inadequate infrastructure. Viet Nam’s infrastructure needs face a large investment gap: while government forecasts indicate that investment of 12 percent of GDP is required over the next three years, the public infrastructure investment program can meet only half this amount. Funding for the remainder will have to come from retained earnings of utilities and private sources, but given that the Government is not expected to raise tariffs, retained earnings are unlikely to be sufficient for this.

Although the scope for significantly higher levels of public investment in infrastructure is limited over the medium term, room exists for raising the efficiency of such investment. This can be accomplished by better targeting (particularly in remote areas where the private sector will not invest), better maintenance of existing public investment, and making public enterprises more efficient. The Government also needs to develop a strategy for build-operate-transfer projects to provide additional funds to the public infrastructure investment program. Foreign investment in infrastructure projects would probably increase significantly if the Government allowed international competitive bidding and took steps to enhance transparency and speed in its decision making in this area.

Policy and Development Issues

Viet Nam’s development partners have recognized the significant progress it has made in trade liberalization, while continuing to urge that the remaining agenda for trade reform should be tackled quickly. The measures taken in the last two years include the freeing up of trading rights, removal of export taxes, removal of quantitative restrictions on seven commodity groups, reduction of the maximum tariff rate, and increased transparency and codification of the trade regime. The Government’s commitment to trade reform is also signaled by its participation in the ASEAN Free Trade Area, which it joined in 1995, and the bilateral trade agreement with the US, the implementation of which will involve further dismantling of trade barriers.

However, the following issues remain: (i) quantitative restrictions still cover a third of imports and need to be phased out; (ii) the maximum tariff rate has been reduced but, at 50 percent, remains high; (iii) the number of tariff rates (12) needs to be reduced; (iv) the cascading tariff structure requires rationalization; and (v) trading activities that are still concentrated in the hands of a few state trading bodies need to be further liberalized. Over the next few years, however, more significant reductions in tariff levels are to be effected: tariffs on 95 percent of the tariff lines are to be reduced to under 20 percent by 2003, and tariffs on imports from ASEAN countries are to fall to under 5 percent by 2006.

The case for accelerating the pace of trade reform has been made on the grounds that high tariffs and pervasive quantitative restrictions have resulted in a structure that has protected industry. Where the economy does not have a competitive advantage, such as in capital-intensive import-substitution industries, protection should be reduced. At the same time, production in areas such as agriculture and light manufacturing, where the economy has a comparative advantage, should be encouraged. Also, consumers and industries dependent on protected goods for inputs have been penalized. The perception that high levels of protection make the cost of doing business in Viet Nam high has also kept many foreign investors away, although they have returned to other regional competitors that have restructured their economies. Consequently, in the changing regional environment, the Viet Nam economy risks being left behind.

The Government must also focus attention on some of the broader ramifications of trade liberalization and the measures needed to mitigate some of the potential adverse effects in designing an appropriate sequence of trade liberalization measures. This means that it will have to minimize the potential negative revenue effects of trade liberalization, and introduce properly structured and administered tariffs that dovetail with a broadening of the domestic tax base.

Viet Nam faces a wide technology gap as it moves toward closer integration with the global economy. It has a weak science and technology base and needs to build up skills and technological capabilities required for competition in the international economy. The problem is compounded on the demand side by the virtual lack of dynamic domestic firms that can draw on the country’s scientific and technological resources. So far there is also little evidence that FDI—including that in the industrial zones and export processing zones set up to fast-track industrial development—has served as a vehicle for technology transfer. This is partly because local industry is not yet capable of handling subcontracting and partly because some of the earlier investment was in import-substitution industries. The extent of protection and enforcement of intellectual property rights is also a factor—in industries where these rights are considered critical, weak enforcement may have acted as a deterrent to FDI.

If the economy is to fully realize the benefits of trade and investment liberalization, the Government will need to plan for the acquisition of know-how in those sectors where it is to be imported. It will also have to identify, as well as adequately fund, research and development activities that can be undertaken domestically. Although FDI can serve as a channel for technology transfer, it requires an appropriate and supportive policy environment. At the same time, the Government will need to focus on complementary policies, including human capital accumulation, that enhance the economy’s absorptive capacity of technical know-how.

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