10.05 - HSBC - Vietnam Economy - Boring Not Bad

8/6/2019 10.05 - HSBC - Vietnam Economy - Boring Not Bad

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abcGlobal Research

The governments economic strategy

has propelled Vietnam to middle-income

status a major accomplishmentHowever, macro instability in the form

of bouts of inflation and trade deficits

continues to concern investorsTo 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

countrys nascent private enterprises, which have yet to

command the resources to move up the value chain. As a

result, export potential is crimped at a time when the

population is developing a taste for more imported goods.

Meanwhile, the government has yet to grant sufficient

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.

As we have highlighted before, Vietnams economic

potential remains exceptional. Achieving better macro

stability through market reforms would provide a steadier

platform to harness this potential. But investors should

remain cautious on the near-term progress of reforms.

Macro

Economics

Vietnam:Seeking Stability(Or why boring isnt always bad)

26 May 2010

Wellian Wiranto

Economist

The Hongkong and Shanghai Banking Corporation Limited

Singapore Branch

+65 6230 2879 [email protected]

View HSBC Global Research at: http://www.research.hsbc.comIssuer of report: The Hongkong and Shanghai Banking

Corporation Limited Singapore Branch

MICA (P) 177/08/2009

Disclaimer & DisclosuresThis report must be read with thedisclosures and the analyst certificationsin the Disclosure appendix, and with theDisclaimer, which forms part of it
http://www.research.hsbc.com/http://www.research.hsbc.com/http://www.research.hsbc.com/


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A strong start

After embarking on reforms to move towards a

market-based economy and away from its socialist,

state-controlled model, Vietnam has succeeded in

lifting the living standards of its people.

1. Its been a great ride up

GDP per capita, USD

0

200

400

600

800

1000

1200

199 3 199 5 199 7 199 9 200 1 20 03 20 05 20 07 20 09

Source: CEIC, HSBC

It managed to quintuple its GDP per capita in 15

years, from USD190 in 1993 to more than

USD1100 by 2008 a commendable feat.

Significantly, this achievement also elevated the

country to the middle-income ranks, nominally

defined as USD1000 of per capita GDP.

However, Vietnams admirable growth rate has

not come without any problems. The fast-growing

economy has exhibited a tendency to experience

significant macroeconomic instability, in the formof bouts of inflation and large trade gaps

especially in more recent years.

2. ...with a few bumps along the way

USD bn, 3mm a

-10

-5

0

5

10

15

20

25

30

35

04 05 06 07 08 09 10

% y-o-y

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Infl ation T rade Defi cit - R HS

Source: CEIC, HSBC

In the period between late 2007 and early 2008,

for instance, the trade deficit ballooned to the tune

of USD1-3bn per month. Around the same time,

Vietnam registered outsized price pressures, with

the year-on-year inflation rate running above 15%for 12 consecutive months.

Diagnosing the issues

Vietnams 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 enterprisesFurther liberalization and a more independent central bank can

help foster stability and set up Vietnam for the next growth stage


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Although some semblance of order returned by

the start of 2009, inflation began trending up in

the last few months of the year, rising close to

double-digit territory. The trade deficit embarked

on an unfriendly trajectory again, hitting USD2bn

by November 2009, and has lingered substantially

above the USD1bn per month level since. In

response, the government has already depreciated

its currency twice in the past 6 months, as foreign

exchange reserves are thought to have fallen.

3. Trade deficit exerts pressure on the currency

USD/VND, % y -o-y

-10

-8

-6

-4

-2

0

2

04 05 06 07 08 09 10

Source: CEIC, HSBC

While both the trade deficit and inflation in recent

months are better than in 2008, they nonetheless

paint a volatile macroeconomic picture not least

because they have come barely two years after the

previous episode, still fresh in the minds of many

investors.

Tell me whyFinding the root cause of such volatility is a

crucial first step towards creating macroeconomic

stability in Vietnam. This is especially important

considering the fact that the country has joined the

middle-income ranks which means that Vietnam

will increasingly have to compete with better-

positioned peers.

As of now, Vietnam is low on the list in terms of

macroeconomic stability, at 112

th

out of 133countries, according to the 2009-2010 Global

Competitiveness Report by the World Economic

Forum.

So, why is Vietnam prone to episodes of

macroeconomic instability?

Our analysis suggests that the countrys

incomplete transition from the state-controlled

economy that it was, towards a more market-

based system may be one of the reasons behind

its macro volatility.

For instance, the still-large state sector may be

contributing to the countrys trade deficit. At one-

third of GDP, state-owned enterprises still

command a dominant role in the economy and its

allocation of resources. As such, the countrys

nascent private enterprises have yet to be given

the resources to grow and move up the value

chain and become more competitive exporters.

To increase the countrys export receipts (and

help to turn around the trade deficit problem), one

option the government could pursue is to boost

the relative importance of private enterprises

within the domestic economy.

On another front, as the experience of some

countries which have moved towards central bank

independence suggests, Vietnam may benefit from

giving the central bank, the State Bank of Vietnam

(SBV), more operational independence as this

could go some way to better anchor inflationexpectations and help minimize the frequency with

which bouts of high inflation occur.

As a measure of the intertwined nature of these

factors, getting a better handle on inflation may

also encourage higher savings, which could in

turn help to finance domestic enterprises in their

drive to gain competitiveness on the global stage

a positive for the trade position.

Such interconnectedness is best illustrated in thefollowing stylized flowchart. The various causal

linkages will be detailed throughout the report.


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The takeaway message will hopefully be clear:

lying at the root of the macroeconomic problems

that Vietnam has been experiencing is the fact that

the country is still very much in a hybrid stage

with the state-owned sector remaining dominant

and the central bank still to gain enough

operational independence to begin enhancing its

inflation-fighting credibility.

To establish stability on the macro front and to

better position the country to compete against other

middle-income countries, the Vietnam economy

may benefit from the pursuit of further structural

reforms.

We are aware that we live in a world where

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 Vietnams

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

reform has also been the main force of attraction

for foreign investors over the past years.

Though we remain hopeful that important reforms

will be carried out in due course, we believe that it

may be premature to expect major steps to be taken

in the near term. The 11th Communist Party

Congress to decide the countrys next leadership

cohort is due next year, making it less likely that

there will be a significant push for reforms at this

juncture.

This means that the crucial next steps towards

establishing macro stability (and a more boring

market to watch) through structural reforms may

have to wait a while more.

4. Many of the economys problems stem from the same source

State Se ctor:remains dominant

Incomplete

Tran sition to

Market Econom y

Private Sec torscrowded out

Inefficient

Investment

UncompetitiveExporters

InsufficientSavings

Hard to move upthe Value Chain

Central Bank Autonomy:a work-in-progress

Hands are tied inpursuing proactive

mon etary policy

Hard to anchorinflation

expectations

High

Consumption

Po licy rates lag

behind i nflation

Tendency fornegative real

rates

Dep reciat ion P ressure

FinancingIssues

Affinity forForeign Goods:

e.g. iPhone!High Imports

Trade Deficit Inflation B outs

+

Imports

>Exports

Source: HSBC


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The same but different

Vietnam began its economic reforms (doi moi)

and adopted a socialist-oriented market

economy in 1986. Although investmentsubsequently started to trickle in, it was not until

2006 that the country began to garner serious

investor attention, with its integration into the

global economy epitomized by entry into the

World Trade Organization in November that year.

Attracted by the double-digit GDP growth of

China around that period, which had been

gradually reforming its own socialist economy

since 1978, investors were eager to scout around

for the next big thing and it was common

wisdom that Vietnam fit the bill.

Like China, Vietnam was seen as a fellow

communist country transiting from a state-led

economy into a market-based one with all the

efficiencies to be unlocked and opportunities to be

gained. The thinking was that Vietnam had now

formally ditched its autarkic cocoon and

integrated itself into the global economic system,

just as China did when it entered the WTO in2001. Therefore, Vietnam would be poised to

follow the exceptionally high-growth path set out

by China.

Alas, even as China powered ahead, Vietnam

never quite made it past the high single-digitgrowth of the preceding years posting 8.5%

growth in 2007. Not shabby but well below

Chinas 13% growth that year, for instance.

5. Playing catch-up

4

6

8

10

12

14

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Vietnam China

Real GDP grow th (% y-o-y )

Source: CEIC, HSBC

Moreover, Vietnam seems to struggle to register

substantial GDP growth rates without running

large trade and current account deficits clearly

not an issue for China despite its significantlyhigher pace of growth. Between 2005 and 2009,

China registered a current account surplus worth

Trade deficit

Vietnams 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


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8.5% of GDP on average. In contrast, over the

same period, Vietnams current account balance

stood at a deficitof 6.0% of GDP. Moreover, it

sometimes ballooned further posting a 12% of

GDP deficit in 2008, for example.

With that in mind, we ask: what is so different

about Vietnam that it should be running current

account deficits that threaten to balloon furtheroccasionally, while China has continually run

surpluses that have helped it to accumulate the

largest foreign reserves in the world?1

Not saving enough

By definition, Vietnams current account deficit

stems from an excess of investment over savings.

While much has been said about Chinas high

saving rate and low consumption, Vietnams

economy appears to have the opposite situation of

not saving enough and consuming too much.

As much as two-thirds of Vietnams GDP can be

attributed to private consumption, a level that,

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

temporary as April saw a trade surplus again. For details,

please see the 10 May note from our China economists,

Chinas Exports (Apr): Upbeat recovery extends into 2Q.

7. A cut above others

Private Consumption, % of GDP

0

20

40

60

80

VN CH US HK IN ID KR MA PH SG TA TH

Source: CEIC, HSBC

During the global crisis, the large share of private

consumption helped keep the Vietnamese

economy relatively shielded, even as the trade

sector suffered from the slowdown. In fact, China

itself is now actively trying to boost private

consumption (at less than 40% of the economy) in

an attempt to rebalance its growth drivers.2

However, this consumption buffer does not comecheap. For one, Vietnams consumers appear to

have developed a taste for foreign goods, pushing

up imports and contributing to the countrys trade

deficit. (Please see the section For the love of

imports: Taste for iPhones & foreign scrap for

details).

The flipside of having such a high share of

consumption in the economy is that Vietnams

saving rate is comparatively low. According to

IMF estimates, gross private savings stood at 23%

of GDP in 2009, less than half of Chinas 51%.

Moreover, Vietnams saving rate has been falling

in recent years, with the latest data 5ppts of GDP

lower from the 28% registered in 2006.

2For details, please see the 26 February report ChinaEconomic Spotlight: NPC Meeting: What can we expect?

from our China economics team.

6. Dare to be different?

Current Acct Balance, % of GDP

-15

-10

-5

0

5

10

15

98 99 00 01 02 03 04 05 06 07 08 09

Vietnam China

Source: CEIC, HSBC


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8. Not saving nearly enough

20

25

30

35

40

45

50

2005 2006 2007 2008 20 09

% of GDP

0

2

4

6

8

10

12

Cu rrent Ac count Deficit - RHSSavingsInv estment

Source: IMF, CEIC, HSBC. Note: Saving and investment data for 2009 are estimates

by the International Monetary Fund.

Why does Vietnam save so much less than China,

and especially in recent years? A number of

factors might be at play.

A formal safety net, in the form of official social

security programmes, remains in the early stage of

development in both countries (and much of

Asia). This means that the informal supportnetwork of the family continues to be the main

safety net in both countries.

On that note, the difference in family structure

between the two countries may be one reason that

helps explain the saving rate differences. Chinas

one-child policy has curbed its population growth

rate to 0.5% per annum in recent years. On the

other hand, Vietnams population growth rate

remains more than double that, though it has also

been trending down over the years.3

Effectively, the Vietnamese can count on a

broader support network when the need arises.

Moreover, because there are more people who are

expected to contribute, each person should feel

less burdened by the prospect as well. In short:

more people to count on, on the one hand, fewer

obligations to chip in on the other. It is probable

that this has led them to save less and consume

more, relative to the Chinese.

3Officially, Vietnam has a two-child policy, but it has beenonly loosely enforced since 2003.

Demographics aside, there may be another reason

why the Vietnamese are not saving much they

are simply not economically incentivized to do so.

It is perhaps no coincidence that the saving rate in

Vietnam started to suffer a decline right when

inflation in the country accelerated, starting from

late 2007 till mid 2008. Rising above 10% y-o-y

in November 2007, inflation powered on to reach

28% by mid-2008.

Meanwhile, policy rate rises were too late to

prevent real interest rates from falling deep into

negative territory throughout 2008.4

9. It doesn't pay to save?

-20

-15-10

-5

0

5

10

05 06 0 7 08 09 10

%

-40

-200

20

40

60

80% y -o-y

Real Rates - LH S Dem an d De posits

Source: CEIC, HSBC. Note: Data on deposits is available only up to December 2009.

Effectively, people were incentivized not to save.

Leaving money in the bank only to watch its

purchasing power dwindling rapidly in real terms

was presumably a rather unattractive optionduring the period of high inflation in 2008.

As we have pointed out on several occasions,

inflationary pressures have picked up again, even

if they are unlikely to reach the heights of 2008.

Already, real rates have dipped back into negative

territory, curbing recent growth in deposits as

well. While the central bank tightened rates by

4Strictly speaking, real interest rates are equal to nominalinterest rates minus expected inflation over the time

duration. Given that there is no data on inflation

expectations, we have loosely proxied it with the actual

inflation rate of the period.


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100bps in November 2009, we believe that more

needs to be done.

The willingness of the central bank to move

further might be curbed by their lack of

operational independence. There appears to be a

gradual build-up of support coming from the

authorities on that front, but we do not expect any

major breakthrough soon. (Please see the next

chapter for further discussion.)

It looks like Vietnams structurally low saving

rate may remain in place for a while more.

Inefficient investment

The low (and declining) saving rate comes at an

inopportune time as Vietnams investment rate is

picking up rapidly. In 2007-08, Vietnams

investment exceeded 40% of GDP, and is inching

closer to that of China. Unlike its northern

neighbour, however, Vietnams investment is not

fully funded by its domestic savings, as reflected

in its current account deficit.

So far, two external sources have been plugging

the domestic funding shortfall. FDI inflows have

proved to be strong, even during the extremely

challenging global environment of recent times.

The other source remains development aid with

bilateral lenders such as Japan, and multilateral

ones such as the ADB and World Bank pledging

USD1-2bn commitments each this year.5

While we believe that the external sources should

broadly cover the domestic funding shortfall in

the coming years, we are watchful of the declining

savings in the country. This is particularly true if

we consider the fact that the deployment of

5In the case of multilateral aid, it will be interesting to watchtheir loan terms in the coming years, as Vietnam graduates

above the low-income threshold. Already, the World Banks

USD1.2bn loans in the past few months come from its IBRDarm (which provides loans to middle-income countries, with

higher interest rates) as opposed to its IDA arm (which funds

the worlds poorest countries with grants and concessional

loans).

capital, no matter the source, has become less and

less efficient in Vietnam in recent years. The

decline in capital efficiency can be seen most

clearly in terms of the trend of what is called the

incremental capital-output ratio (ICOR), which

measures the ratio of investment to the increment

or change in output.

10. Capital inefficiency: Up, up and away

Incremental Capital-Output Ratio

2

3

4

5

6

78

19 90 1993 1996 1999 2002 2005 2008

Vie tnam China

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.

As the chart above shows, Vietnams ratio has

recently increased to its highest level in at least 20

years. Comparing its ICOR value of 7.9 in 2009

with the 4.5 figure of 2000 suggests that it took

75% more capital to produce one unit of output in

2009 than at the start of the decade. Moreover,

Vietnam has been a more inefficient deployer of

capital than China in recent years, even as the

latter has often been accused of wasting capital

in its investment-driven growth. The country, inshort, relies on foreign savings to complement its

domestic funding needs, but will have to continue

to demonstrate to investors that it can deploy

resources more efficiently.

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

one unit of output in 2009 compared to just a year

ago. The increase in inefficiency, of course, in part

may be related to the fact that the government

stimulus package ratcheted up state investments

which jumped 38% y-o-y compared to the 15%


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overall investment growth rate. Since state

investment has a strong infrastructure component,

it tends to yield economic returns more gradually

over a longer period and may have skewed up the

ICOR measure which tracks changes over a

rolling 2-year period in the near term.

Still, the central bank recently pointed out that such

state-led investment had surpassed the economys

ability to supply capital, creating great pressure on

interest rates and the exchange rate, and addedthat inefficient use of investment capital would

contribute to inflationary pressures, as well.6

In short, the economy may benefit from

continuing the liberalization measures that have

been pursued in recent years. By encouraging

private enterprises to grow alongside the state-

owned ones, the country may accelerate its

already impressive growth rate yet further with

better allocation of capital.

Trade deficit breakdown

Earlier, we looked at Vietnams current account

deficit from the perspective of the savings-

investment balance.

In this section, we look at the issue via the balance

of payments breakdown.

Specifically, Vietnams trade deficit is the chief

culprit. In 2007 and 2008, its goods balance

registered sharp deficits of around 15% of GDP. If

not for the substantial transfers in the form of

remittances and ODA grants, worth about 8-9% of

GDP in 2007-08, Vietnams current account

deficit would have been higher still.

To delve into the factors that contribute to

Vietnams 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.

6Vietnams currency now in balance central bank,Reuters, 15 April 2010.

11. Goods imbalance

Vietnam

-20

-15

-10

-5

0

5

10

1998 2000 2002 2004 2006 20 08

% of GDP

Goods Serv ic es

Income Transfers

Current Account

Source: CEIC, HSBC

The foreign-invested sector has been a net

positive contributor to the countrys trade balance,

though we believe that the FDI sector could play a

bigger role in closing Vietnams overall trade gap.

On the other hand, its domestic sector registers a

large deficit, effectively dragging down the whole

countrys trade balance. For instance, the

domestic trade deficit fell as low as USD24bn

(26% of GDP) in 2008. This stands in sharp

contrast to the consistent surpluses registered by

Chinas domestic sector. (Chart 13).

12. Vietnam's deficit stems from the domestic

Vietnam

-25

-20-15

-10-5

0

5

10

1997 1999 2001 2003 2005 20 07 2009

USD bn

dome stic foreign total

Source: CEIC, HSBC


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13. While China's surplus proves to be a joint effort

China

-50

0

50

100

150

200

250

300

1997 1999 2001 2003 20 05 200 7 2009

USD bn

dom es tic fo reign total

Source: CEIC, HSBC

Between 2004 and 2009, for every dollar that

Vietnams domestic sector exported, it imported

USD1.74 worth of goods on average compared

to imports worth USD1.20 in 1997-2003. (For the

sake of comparison, Chinese domestic players

spend less than a dollar, roughly 80cts, on imports

for every dollar they gain from exports).

The skewed export-import dynamics of Vietnamsdomestic sector may be as much a reflection of its

propensity to import as its relatively weak export

sector. We discuss both factors in turn.

For the love of imports

Taste for iPhones & foreign scrap

Since its reforms, the standard of living of

Vietnams population has increased dramatically.

Over the past decade, GDP per capita nearly

tripled from under USD400 in 2000 to nearlyUSD1100 in 2009 a 12% per annum growth rate

that is probably eclipsed only by Chinas 16%

over the same period in this part of the world.

As the people witness a better environment and

feel more confident about the future, they have

developed a taste for status goods. In Vietnams

case, this often means imported goods.

Initially, this translated into increased demand for

motorcycles, which still remain largely importedin either pre-assembled or completed forms.

14. Bring em in!

0

10

20

30

40

50

60

200 400 600 800 1000 1 200

GDP per capita, USD

Importsofdom

esticsector,USDb

Source: CEIC, HSBC

More recently, however, perhaps as a reflection of

how globalized Vietnam has become, the import

of iPhones has apparently surged as well. The

import of electronics and computers in total

exceeded USD1bn in 1Q10, an increase of 53%

y-o-y, prompting a senior government official to

lament that Its not necessary for a poor country

to spend US$1 billion importing the iPhone!7

15. If the iPhone did this, what might the iPad do?

-40

-20

0

2 0

4 0

6 0

J an-09 Apr-09 J ul-09 Oct-09 Ja n-10

Elec tronics Machine ry

Imports , %y- o-y 3mma

Source: CEIC, HSBC

The broader point is that, lately, the import of

items to fulfil consumers desires has tended to

outpace that of goods that will add to productive

capacity, such as machinery and equipment. To

put it starkly, any import directly adds to the trade

deficit but the import of machinery for factories at

least carries the potential of improving the

7Vietnam allows more loans at negotiable rates, ThanhNien News, 3 April 2010.


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countrys capacity for exports something that

can hardly be said of consumer goods.

A taste for foreign goods extends beyond

consumer goods to influence choices made by

domestic enterprises as well, it seems.

It is seemingly bizarre, for instance, that Vietnam

should be importing scrap paper. Apparently,

domestic paper product enterprises are hesitant to

source it from small domestic merchants who do

not have official business permits from the

government.8

Less bewildering, but no less troubling,

Vietnamese firms spent over USD1.4bn importing

fertilizer in 2009, despite the fact that domestic

fertilizer factories have been running below

capacity, with 300,000 tons in storage to boot.

Uncompetitive pricing may be an issue,

highlighting the need to boost the scale of

domestic industries. (See the section Small

enterprises.remaining so for details.)

It is illustrative that the production costs of

Vietnams sugar producers are 15% higher than

their Thai competitors. The domestic producers

are predominantly small-scale refineries which are

still stuck with backward technologies. The end

impact of the lack of economies of scale is that

the much cheaper imported Thai sugar poses

serious competition for domestic producers.9

Importing cool items that are not available

domestically is one thing. A situation where

domestic users have a higher incentive to buy

from overseas what is available at home is quite

another. It points to a lack of competitiveness of

domestic products, even at home.

8Wasting dollars on luxuries expands trade deficit,Vietnam Business News, 6 April 2010.

9High production costs cause Vietnams sugar to fall in itshome market, VietNamNet Bridge, 20 April 2010.

Why cant they export more?Not adding much

As we noted in the previous section, Vietnamese

products seem to have problems finding

customers even at home, such that local

consumers prefer imported goods.

If that is the case, then what are the chances that

Vietnamese firms can compete to push their

products globally? Quite low, unfortunately.

Looking at the breakdown of manufactured

exports, we find evidence suggesting that Vietnam

is still largely entrenched in low value-added

production.

16. The value-add gap widens

0

10

20

30

40

50

1995 1997 1999 2001 20 03 2005 2007

Vietnam China

Machinery exports, % of manufac tured exports

Source: UNCTAD, HSBC

Exports of goods in the higher value-added

machinery and transport category, for instance,

continue to languish at around 10% of totalmanufacture exports for Vietnam with no sign of

any increase.

In contrast, as a measure of how quickly China

has managed to move up the value chain in

manufacturing, this ratio has been inching closer

to 50% lately, a marked improvement from the

20% level it saw in 1995.

What would it take for Vietnam exporters to mimic

the trajectory of their China-based counterparts andmove up the value chain, so manufacturers start to

bring in more export dollars?


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Big state legacyTo strengthen the competitiveness of home-grown

enterprises so that they can collectively move up

the export value chain and help to turn around the

deficit problem, reforms aimed at growing private

enterprises further could be helpful.

Despite years of reforms towards a market-based

economy, the state still maintains a relatively high

level of control in the economy about 35% of

GDP in 2009 was generated by state-ownedentities, for instance.

17. The state of the state-owned

State-ow ned industrial production, % of total

0

10

20

30

40

50

60

70

99 0 0 01 02 03 04 05 06 07 08 09

Vie tnam China

Source: CEIC, HSBC

If we consider the industrial production figure,

arguably a better reflection of the export-related

segments of the economy, a sizeable 31% of total

production is still attributable to state-owned

enterprises. Granted that this is a big fall from the

65% ratio of 1999, but it has some way to gocompared to China, where state-owned enterprises

now account for less than 10% of total production.

It is also interesting to note that Vietnams ratio

today stands where Chinas was ten years ago.10

The bigger role that the state is playing in Vietnam

is probably largely due to the fact that it started its

reforms later than China did by eight years, to be

10

China has recently re-engaged further liberalization toencourage the growth of the private sector, particularly in

investment. For details, see the 13 May note China

further deregulates to lift private investment by our

China economics team.

exact. If Vietnams trajectory follows that of

Chinas, then more and more home-grown

enterprises in Vietnam will be privately run and thus

better equipped to compete in the export markets.

However, this scenario presumes that Vietnams

privatization of state-owned enterprises will

continue apace going forward. Last year, only 65

enterprises were liberalized (or equitized, in the

government parlance). This compares poorly

against the 2008 figure of 349. To some extent, therecent slow pace of privatization may be a function

of the relatively poor appetite for Vietnamese

securities in the market. The planned 1Q10 IPO of

the paper producer Vinapaco has yet to take place,

for instance.

There is, however, a risk that the momentum to

liberalize might have taken a more lasting hit.

Anecdotal evidence suggests that, coming out of

the global crisis, some officials have pointed out

that the state-owned enterprises had provided

greater employment security for the people,

helping to buffer Vietnam against the worst

effects of the crisis. The subtext of this view is

that the country, and its people, would have

suffered a lot more if not for the stabilizing

presence of the state-owned enterprises.

This is not easy to argue against, especially since we

live in a world where governments are playing

much bigger economic roles even in the staunchestof capitalist nations. Still, in the long run, the

experience of many developing countries has

demonstrated the importance of private-sector

development to job creation and efficiency gains.

For its home-grown industries to compete

successfully in the cutthroat global markets and

turn around the countrys trade deficit, it is hard to

imagine them doing so without the dynamism that

privately run enterprises typically deliver. On top

of that, let us not forget that the story of Vietnam

transforming from a state-led economy into a more


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market-based one is the underlying structural theme

that the government and investors bought into to

begin with.

Small enterprisesremaining so

Apart from privatizing state-owned companies,

boosting competitiveness should also entail giving

existing private enterprises the space to grow.

Private and household enterprises currently

contribute about 40% of the GDP a sizeable

chunk that could play an important role in

boosting Vietnams competitiveness, but only if

nurtured fully.

Most of the private enterprises are small and have

remained so. They are, by and large, engaged in

low-tech production and are yet to be

internationally integrated. The architect of

Vietnams enterprise reforms, Dr Le Dang Doanh,

stressed this fact by saying that about the only

integration he knew of was that of householdenterprises supplying spring rolls to big

international hotels in Hanoi.11

For these enterprises to grow beyond spring rolls

and the like, and have an improved chance of

competing globally, a number of hurdles need to

be overcome. Access to financing is one of them.

According to Dr Le, its a fact that as many as

64% of small enterprises are denied access to

bank loans, starving them of crucial funds to

expand and grow their trade. To some extent,

small businesses anywhere in the world tend to be

disadvantaged when it comes to funding, due to

higher perceived risks. In Vietnams case, this

issue is compounded by the fact that the countrys

banking sector remains relatively early in the

development stage.

Apart from funding difficulties, administrative

requirements may be affecting small private

11 Bureaucratic hurdles still hobble private sector,

VietNamNet Bridge, 10 April 2010.

businesses disproportionately. Economies of scale

work within the context of lobbying power as

well, and their small size means that private

enterprises in Vietnam have had to adhere to

regulations drawn up by various state agencies

with limited potential for recourse. As many as

400 new such regulations have apparently been

issued, sometimes putting heavy requirements on

private enterprises, even as 180 old ones were

abolished during the last major push to help the

private sector in 2005.12

Lately, there have been some hopeful signs that

the government is recognizing the need to level

the playing field between small private enterprises

and big state-owned ones. For instance, there is

now a proposal to allow private firms to access

financing from ODA sources a funding privilege

that state-owned enterprises alone have been

enjoying to date. However, as some observers

point out, this might have come too late given thatthe country is scheduled to soon graduate away

from its low-income status which means that

preferential loan rates from development agencies

may soon become less available overall.13

Can foreigners do more?

As we have noted in the previous section,

Vietnams trade deficit problem reflects more on

the export-import gap of home-grown enterprises

than its foreign-invested companies which arealready running trade surpluses in aggregate.

However, we wonder if there is any potential for

foreign companies operating in Vietnam to

contribute more towards the narrowing of the

trade deficit. After all, the foreign sector

commands a significant chunk of the economy

at nearly 19% of GDP in 2008. Judging from the

still-rapid pace of FDI inflows into the country,

12 Bureaucratic hurdles still hobble private sector,VietNamNet Bridge, 10 April 2010.

13 Hopeful signs for the private sector, VietNamNetBridge, 11 March 2010.


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the role that foreign-owned companies play in the

economy (and its potential to help turn around

trade deficits) will continue to be important.

As a proportion of GDP, Vietnam has been a

significantly larger recipient of foreign direct

investment than China (Chart 18). Even at the

height of the Great Recession, it appears that

Vietnam remained a favourite destination for FDI.

Despite a challenging global environment, the

country took in realized investments of

USD11.5bn in 2008 and an estimated USD10bn in

2009 a testament to the continued attractiveness

of Vietnams long-term growth story.

On an ongoing basis, the healthy FDI inflows,

together with the still-extensive development aid

and overseas remittances have enabled the country

to escape an outright balance of payments crisis,despite the perennially large current account

deficits that it has been running. However, the

structural imbalances within the system are clear

and it is inherently unsound to depend to such a

large extent on these inflows to plug the trade gap

on a sustainable basis. It is much better to narrow

the deficit somewhat to begin with.

Going local?

In the context of enlisting the foreign sector to

narrow Vietnams trade deficit, it is slightly

worrying to see that there are some early

indications that recent FDI into Vietnam may be

less export-oriented than before.

Compare the FDI inflows that the country is

receiving versus the trade balance of the foreign-

invested sectors, for instance. Even though

realized FDI into Vietnam more than doubled

from USD4.1bn in 2006 to an estimated

USD10bn in 2009, the trade balance of foreign

firms in the country stayed largely stagnant at

USD6-7bn, and dipped below USD5bn in 2009

when faced with the especially tough global

environment of that year.

There seems to be less trade surplus bang for the

FDI buck, essentially. So, why is that the case?

For clues, lets take a look at the sectoral

breakdown of foreign investments going into

Vietnam in recent years.

Interestingly enough, Vietnam has witnessed an

increasing share of foreign investment into its real

estate sector. In 2009, the real estate sector

accounted for nearly 40% of foreign investment,

for example, surpassing investment into the

manufacturing sector, which has been slipping on

a relative basis. In contrast, the sectoral

breakdown of investment going into China seems

to have stabilized in recent years at about 50%into manufacturing and 20% into real estate.

18. Vietnam's taking in FDI in droves

Realized FDI, % of GDP

0

5

10

15

90 92 94 96 98 00 02 04 06 08

Vietnam Chin a

Source: CEIC, HSBC

19. FDI getting less export-oriented?

USD bn

0

2

4

6

8

10

12

2002 2003 2004 2005 2 006 2007 2008 200 9

Trade Balance of Foreign-Invested F irms

Re alize d Fo reign Direct Inv es tment

Source: CEIC, HSBC


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20. Are investors in Vietnam getting more 'grounded'?

% o f total FDI

0

20

40

60

80

03 04 05 06 07 08 0 9

VN Manufacturin g VN Real Es ta te

CH Manufacturin g CH Real Es ta te

Source: CEIC, HSBC

One could interpret this as a trend where investors

are keener to capitalize on the growing wealth of

the Vietnamese population by selling them houses

and apartments, than to utilize the country as a

manufacturing base. If this trend continues, there

may be some ramifications on the size of the trade

surpluses that the foreign-invested firms have

generated for Vietnam as a whole. After all, there

is arguably nothing less exportable or more

domestic-orientated than real estate.

Foreign investments going into the manufacturing

sector, in contrast, carry the potential of

increasing Vietnams exports and the chance to

help narrow its trade deficits.

Help us help you

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.

In the Executive Opinion Survey by the World

Economic Forum, business leaders rank

Vietnams local supplier quantity at 74th and its

quality at 92nd out of 133 countries as opposed

to Chinas 11th and 53rd, respectively.

In an era where higher-end manufacturers are

adopting the extended production chain model,

Vietnams relative lack of suitable local suppliers

acts as an impediment towards attracting investors

who may be keen on using it as an export base,particularly in the higher value-add production

stages precisely the type that the country needs

to narrow the gap between its imports and exports.

Moreover, the lack of domestic suppliers means

that manufacturers are forced to import the

necessary parts from other countries, further

compounding the trade deficit.

The need to promote domestic suppliers

reinforces the call for greater competition betweenlocal private and state-owned enterprises.

Alongside state firms, private enterprises can play

a key role in strengthening the local supplier base.

Without that, Vietnam may find it difficult to

narrow its trade deficit on its own. It may also

prevent foreign enterprises from taking their

operations in Vietnam to a higher level, and

bringing the host country along with it.


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Finding stability

Apart from trade deficits, another issue which has

been plaguing Vietnam has been inflation.

In 2008, headline inflation was nearly 30% in

year-on-year terms on the back of big jumps infood prices, which constitute 40% of the countrys

consumption basket. The core inflation measure,

which strips out the effect of food and energy,

trekked up significantly as well, hitting 13.6% in

October that year suggesting that there is a

material tendency for pass-through.

In recent months, inflation has trekked up again.

In March, inflation hit 9.5% y-o-y, the highest in

12 months. The seasonally abundant harvests

helped limit inflation somewhat in April and May,

which registered 9.2% and 9.1% y-o-y,

respectively. Overall, underlying inflationary

pressures remain strong, however, as illustrated

by the still-strong momentum in the prices of

construction materials, for example.

After tightening by 100bps in November 2009,

the State Bank of Vietnam (SBV) has since

chosen to keep its policy rate unchanged at 8.0%.

We argue that more tightening may still be

needed, particularly if the tamer-than-expected

inflation of recent months proves to be temporary.

As discussed in the Not saving enough section

in the earlier chapter, Vietnams real interest rates

run the risk of falling deeply into negative

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

21. Quite a ride

Inf lation (% y-o -y)

-10

0

10

20

30

40

50

99 00 01 02 03 04 05 06 07 08 09 10

Headline Food Core

Source: CEIC, HSBC

22. Wherever you go, I'll follow?

0

5

10

15

20

25

30

0 5 06 07 08 09 10

%

Policy Rate Inflation

Source: CEIC, HSBC


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territory again.14 In 2008, the policy rate hikes

came too late, such that real rates dipped as low as

-14% in September that year. Together with

exchange rate depreciation pressure, this resulted

in the significant dis-saving activities we saw

earlier demand deposits in the system dropped

more than 20% in y-o-y terms by November 2008.

This might help

Despite robust growth and price pressures, the

SBV has kept the policy rate on hold since hiking

it by 100bps and removing the 4ppt subsidy on

interest rates on loans at the end of last year. This,

arguably, may reflect a preference among

policymakers for growth over inflation. Allowing

more autonomy for the central bank might help to

alleviate this issue.

Its current legal framework stipulates that the

SBV is a ministerial agency of the

Government.

15

As of now, the SBVs monetarypolicies need the governments approval before

they can be carried out.

In addition to not having full control over policy,

the SBV can sometimes have conflicting

objectives. Lately, the government has been

directing the central bank to embark on cutting

interest rates while achieving price stability at the

same time an unenviable, if not virtually

impossible, task barring a sharp fall in

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

the actual inflation rate as proxy for inflation

expectations, given that there is no data on the latter. 15Decree: Prescribing the functions, tasks, powers and

organizational structure of the State Bank of Vietnam,

No. 96/2008/ND-CP, the Government of the Socialist

Republic of Vietnam.

Discussions about granting more operational

autonomy to the central bank have been going on

for a long while now. In 2006, the prime minister

approved a master development plan whereby the

SBV, by the year 2020, will be independent in

setting policies on monetary, interest rate and

exchange rate management.16

More recently, a new draft law has been submitted

to the National Assembly for approval. Although

this law would potentially grant more operationalpowers to the SBV, it stops short of dropping the

ministerial agency status a sign that central bank

independence would remain elusive for a while

longer.17

Having said that, there appears to be some gradual

build-up of support within the National Assembly

to promote central bank independence. The Vice

Chairman of the parliaments Economic

Committee recently acknowledged that the new

central bank law should be amended to give it

increased autonomy and flexibility in creating

and implementing monetary policies.18

All in all, however, the process of granting the

SBV more independence looks unlikely to come

any time soon, especially considering the elevated

political considerations in the run-up to the next

national congress early next year. This means that

the anchoring of inflation expectations may

remain an uphill battle.

16 State Bank law opens door to greater power, VietnamInvestment Review, May 2009.

17 Central Bank Independence: Another Perspective, TheSaigon Times, 26 August 2009.

18 Vietnam lawmaker wants more autonomy for central

bank, Thanh Nien, 14 April 2010.


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ConclusionVietnams 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 countrys 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 countrys

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,

Vietnams economic potential remains

exceptionally promising. Achieving better

macroeconomic stability would provide a much

better platform to harness this potential, in our view.


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Documents

10.05 - HSBC - Vietnam Economy - Boring Not Bad