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A. RECENT ECONOMIC DEVELOPMENTS

Economic Performance

Despite many caveats and conflicting analyses, most economists agree that with a Real GDP growth of 6% (World Bank’s estimate), Vietnam has performed well during the year 2002.

A strong performance of industry and construction (up 9.8%) and services (6.1%) has made up for the lower than expected growth of the agricultural sector (3.4% against a target of 4%) that has held down the aggregate growth due to its important weight in the economy as a whole. After a slow start of the year (exports in particular), the second half of the year has helped to bring Real GDP growth to an encouraging outcome, which could have been higher if inflation had not overshot its target of 4%.

Growth components

In terms of ownership, the private sector grew by 25%, the foreign-invested sector by 14.5% and the State-owned sector by 11.8%, lending credit to the idea that the private economy will eventually become the engine of growth in the Vietnamese economy. Among the main contributors to economic growth, industrial production grew by 14.4%, with strong contributions from automobile and motorcycle production (35.9% and 24.4% respectively, despite import restrictions of kits at the end of the year), steel (up 27.7%), cement (up 25.8%) and processed aqua-products (25.2% year on year).

In geographic terms, Ho Chi Minh City continues to grow at a strong rate (14.7%) despite increasing price pressures. Apart from Vung Tau (second in production only to HCMC, but centred in crude oil), Dong Nai (with increased growth of 17%), Binh Duong (up 36.9%) and Hanoi (23.8%) continue to be the main centres both of production and attraction of investment. In terms of Foreign Direct Investment commitments, HCMC attracted 21% of investment, followed by Binh Duong (20%), Dong Nai (19%) and Hanoi (10%), consolidating the South of Vietnam as the economic centre of the country.

Internal demand (retail sales) has increased 13% during the year 2002 (a 5-year high), from a low of 5% in 1998, leading also to renewed confidence in the state of the economy, and leading to stronger investment in order to meet demand.

Source: Intellasia
Figure A.2 – 12 month deficit - % change year-on-year

Investment

Private investment by Vietnamese small and medium enterprises has increased by 40% to about EUR 2.88 billion, representing about one third of total investment, which stood at 31% of GDP. Since a sizeable proportion of this investment has been dedicated to imports of capital goods, the current GDP growth seems able to be maintained at least in the short to medium term. Total investment by the state sector (government and SOEs) reached about 18% of GDP, the rest being contributed by foreign investment.

New commitments of Foreign Direct Investment, however, have been dismal during the year 2002, decreasing by 47%, from a EUR 2.29bn to EUR 1.25bn. While the Vietnamese Government - and some multilaterals - have dismissed this fact as almost irrelevant (after using for many years FDI commitments as a key benchmark -and proof of the attraction of the Vietnamese economy) such stance is questionable. If it is true that their new focus of attention -implemented FDI- has stood close to €2,1bln (a slight decrease over the previous year), it is also important to bear in mind that implementation of FDI tends to follow commitments, albeit with a lag.

Regardless of the benchmark used, Vietnamese FDI has been also influenced by an important trend: the massive attraction of FDI that China is experiencing after its WTO accession. FDI commitments in China have increased from EUR 43bn in 2001 to EUR 50bn in 2002; part of it diverted from going to ASEAN countries, including Vietnam. Masking this effect may not help the Vietnamese authorities realize the urgent need to create a more FDI-friendly environment to compete with their powerful northern neighbour.

Finally, reduced FDI may also have a positive effect: while commitments have fallen by 47%, the number of licensed projects has risen by 30% to over 600. This is a welcome trend, for it may indicate a more focused approach by investors into smaller projects with more chances to be effectively implemented.

So far, the effect of the incipient Stock Exchange in investment mobilization is negligible due to its lack of depth and breath. Proof of its limited attraction, so far, is the total market capitalization (about EUR 112m), the number of companies listed (21) and the number of foreign investors who have registered to trade in it (33).

Agriculture and Fisheries

During the year 2002, Vietnam has finally seen improve the profitability of one of its key commodities: rice; which has helped achieve a 3.4% yearly growth despite drought in the Central Highlands and floods in the South of the country. Like with other agricultural products, Vietnam has been victim of its own success by becoming in a very short time one of the main world exporters of several crops.

Thanks to the upsurge of the international price of rice during the year 2002, Vietnam has reduced its rice exports by 13.1% in volume, yet has achieved a 16.2% growth in value to EUR 775m. While this amount is not significant in terms of exports, the rebound of rice price, and the subsequent increase of available rent to farmers, has provided a necessary breathing to the countryside. Other produces, such as coffee (far more export oriented) have not rebounded significantly from the 30-year lows in the international markets, although drought in the Central Highlands and reduced acreage (exports down 23.6% in volume and 19,1% in value) have at least stopped the free-fall of prices experienced during the last few years.

In other export commodities, Vietnam has replicated its experience with coffee, becoming so successful at generating a high output that has contributed to depress international prices. For example, Vietnam has now become the number one exporter of black pepper, with exports of 77,000 Metric Tonnes (increase of 35.1% in volume but only 18.4% in value) and the third largest exporter of cassava starch.

Performance of fishery products has been very robust. Despite transitory problems with health inspections due to traces of Chloramphenicol and Nitrofuran in shrimp exports to the EU, and the problematic export of catfish to the United States, exports have reached EUR 2.162m, consolidating itself as the third main export, after crude oil and Textile/Garments. Despite numerous problems such as the antidumping and denomination cases against Vietnamese catfish (now re-named Ba Sa) the US has become the largest consumer of Vietnamese fisheries with 30% of the total, followed by Japan and the European Union.

Industry and services

As earlier mentioned, industrial growth has been led by private domestic sector with a 19.2%, followed by Foreign-invested enterprises (up 14.5%) and the state sector with 11.7% for the year.

Crude Oil production continues to be the main export in the country (up 3.2% to EUR 3.446m) and has benefited from the slight increase of oil prices due to international political uncertainty and the prospect of a war in Iraq. Due both to higher international prices and to the recent discovery of another large deposit (which could increase total production by 10%) Vietnam will likely increase crude production during the year 2003.

The power-generation sector has also benefited from increased demand (up 15%) and from the Nam Son Con gas project finally going on-line. This bodes well for the Phu My Industrial Park and surrounding areas of the Ba Ria – Vung Tau area, which should see important industrial growth as the benefits as the gas-turbine power and urea plant spills over to suppliers and other industries.

In an attempt to build an industrial base to compete with other regional players, the GoV still favours heavy industry (steel in particular, but also shipyards and automobiles) in its investment priorities implemented through the newly-created Development Assistance Fund, which provides policy loans to help free commercial banks from increased rates of Non Performing Loans (NPLs). Other than the traditional import-substitution (steel, cement, paper, etc.) industrial policy is now focusing on consolidating the vehicle (automobile and motorcycle) parts supplier sector by imposing tariff and quantitative restrictions to imports (effective from January 1st 2003), much protested by Japanese companies.

Garment and textile manufacturing have become a major part of Vietnamese industry and foreign currency earner (up 37.2% to EUR 2.895m) during the year 2002, mostly thanks to the ability to sell quota-free to the US market. The Textile Agreement between U.S. and Vietnam, signed on 25 April 2003, ended this by including quotas for the main export categories. The tourism sector has seen an increase of 12% during the year 2002, to reach 2.6 million visitors. Hotel occupancy rates have been very high and tourism now represents 2% of total employment. The upsurge in visitors arriving to Vietnam after the October 2002 bombing in Bali is bound to continue, as the threat of international terrorism persists throughout the region. Vietnam benefited from its image of social stability until early 2003 when the outbreak of a Severe Acute Respiratory Syndrome (SARS) in Vietnam and Asia severely hit the sector.

Inflation

At 4.7%, inflation surpassed the targeted 4%, mainly due to the expected increase in food prices (mostly in grains, with rice being the largest contributor) despite last year’s reduced weighting of the foodstuffs component of the CPI to 47%. Housing and construction materials also stood above the average with 5.4%, due in part to the resilient internal consumption. Other factors such as the controlled depreciation of the Dong against the US Dollar (3.99%, from 14,806 to 15,320 VND/USD) and the Euro (6.96% from 13,263 to 14,186 VND/EUR) have also contributed to increase inflation by making imports (up 19.4%) more expensive.

Employment

Official urban unemployment estimates have hovered around 6%, although this does not account for the substantial underemployment both in the cities and (specially) the countryside. As the demographic pyramid keeps bringing to employment age the Vietnamese baby boomers born after the war (population growth stands now at 1.5%), the need for job creation (currently at about 1.2m per year) will become more acute. In order to absorb both these newcomers to the job market, as well as those made redundant through the restructuring of the economy, Vietnam will have to face the challenge of sustaining a growth rate close to 7% for some years to come.

Trade

Total exports have picked up substantially after a dismal start of the year. By August 2002, exports had actually declined by 1.7% against a target of 14% growth. The last quarter of the year, however, has recorded an extraordinary comeback, leaving yearly exports at EUR 17.66bn, and 10% growth (much of it, due to the implementation of the US-Vietnam Bilateral Trade Agreement), still far from the objective, but not as dramatically as expected. Imports, on the other hand, have experienced a robust growth to EUR 20.62bn at an annualized rate of 19.4%. The resulting trade deficit of EUR 2.95bn (up 16.76%) is just slightly superior to last year’s increase 16.56%. Since imports are expected to keep growing at a 15 to 17%, Vietnam will need to improve on last year’s export performance in order to avoid pressure on its forex reserves.

Source: Intellasia



Figure A.3 – 12 month exports - % change year-on-year

Figure A.4 – Trade of goods 1997-2002 Source: Eurostat

State Owned Enterprises

SOEs continue to be an important part of the Vietnamese economy, generating about 38% of the GDP, but their privatization through the process of equitisation2 appears to have reached a hiatus. As of November 2002, only 150 of the 502 SOEs divestures planned for 2002 took place, which is a worrying trend already experienced in previous years. Since 1999 the number of equitised SOEs has consistently fallen year after year.

In itself, this is not an immediate risk for Vietnam, but points towards a flagging commitment to go through the painful process of reforms. However, the importance of SOE restructuring should not be underestimated.

Figure A.5 - Divested SOEs 1999-2002 (Nov) Source: World Bank

While the impact in terms of employment is small (their share is about 5% of total employment) SOEs tend to be very capital-intensive enterprises, and many of them are highly indebted, with little possibility -or incentive- for a debt workout (nigh impossible due to the lack of audited accounts).

While their current outstanding debt is estimated at around EUR 6.41bn by the World Bank (or about 40% of total domestic credit), they can become an important factor in future years, when their poor competitiveness meets the increasing opening of Vietnam’s economy to foreign companies.

Should SOEs fail to reform by then, they will likely incur in higher levels of NPLs and may represent a risk to the banking system. Realistically a very high percentage of NPLs will never be accounted for or recovered, but at this stage it is far more important not to incur in new ones.

However, there are also positive signs from the process of SOE reforms. A recent study3 on the effects of equitisation in SOEs has found that after State divesture companies have increased sales by 20% on average, employment by 4%, wages by 12% and assets by 21%. With about 90% of them reporting doing better or much better than before. One of their few reported misgivings about the process, is enduring first hand (and for the first time) the same difficulties of their private brethren: the difficulties in accessing credit, land use rights, licenses, permits, etc. Although the reported results are encouraging, one must bear in mind that this group early group may include some of the most promising SOEs, other than the ones the State wants to keep.

For the rest, greater responsibility in the banking system has lead to reduced access to new credit for SOEs (now at only 25%) and will result in the closure, by liquidation rather than equitisation, of most SOEs which try to avoid reforms.

Fiscal Policy
In order to sustain the 7% annual growth of the Vietnamese economy, the Government expects to generate investments of EUR 74.8bn over three years. This ambitious objective (mostly financed through the state budget) will place severe strains in the intended budget deficit cap of 5%. To meet this target, Vietnam must improve substantially its tax collection (and drastically reduce tax evasion and VAT fraud) as well as control expenditures and reduce subsidies (SOEs, energy, etc.) otherwise the planned reduction in income generated by lower tariff receipts due to AFTA commitments will put the budget under severe strain and may tempt the bank of Vietnam to increase again the monetary mass, leading to increased inflation down the road. Reduced dependency from its oil revenue (which provided 32% of the budget in 2002) is also necessary to avoid the risk of shocks to the budget due to world crude price fluctuations, in particular since the use of protective financial derivatives is not common.

Monetary Policy

The State Bank of Vietnam has recently reduced monetary restrictions in the banking sector. Banks can now hold up to 30% of total capital in US Dollars (up from 15%) and has lowered the reserve ratio on convertible currency from 8% to 5%, removing the cap on interest rate for VND loans. Another positive step was taken in May, with the reduction of compulsory surrender of foreign exchange from 40% to 30% (which reduced in 2001 from 50% to 40%).

While all these changes add necessary flexibility and liquidity to the banking system, the banking sector itself is still largely in the hands of the state, with a credit market share of 70% concentrated in its 4 large banks, which allows it to still control much of the credit growth, and interest rates in Dong despite having lifted the cap. The rest of the participants specialize on smaller niches: Thus, the 26 foreign banks control 15% of credit (tending mostly to foreign companies), and the 43 joint-stock banks and 4 joint-venture banks (with respective market shares of 12% and 3%) specialize in credit to the domestic private sector.



Figure A.6 – Commercial Interest Rates Source: World Bank


The Bank of Vietnam has also increased the depth of the financial sector with the (limited) opening of insurance and leasing markets to foreign investors, where the State remains the main actor, by far, through its SOEs.

External Debt

According to the WB, Vietnam’s external debt stands around EUR 14.2bn, or 37% of GDP. Its servicing, at a 8% of exports, is manageable and should not represent any risk in the foreseeable future. In an effort to improve its credibility among foreign investors, Vietnam has been making an effort to re-purchase about one third of the EUR 587m of Brady bonds issued in 1998, and has gained modest but positive ratings by the main international rating agencies of BB (Fitch), B1 (Moody’s) and BB (Standard & Poor’s). These ratings could improve as Vietnam builds on its currently, short-lived, rating record.

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