Vietnam: In the fast lane Asia Pacific Economic Outlook, Q2 2016
Vietnam’s growth is powered by foreign direct investment, and free trade agreements as well as the prospects offered by the Trans-Pacific Partnership are likely to keep foreign investors interested in the country.
Vietnam is experiencing the quickest rate of growth in real GDP since the onset of the global financial crisis. Domestic demand has recovered in a favorable environment of low inflation, accommodative monetary policy, and consumer confidence, and is likely to stay robust. Furthermore, overall growth has been driven by strength in export-oriented manufacturing, which continues to be powered by foreign direct investment (FDI). Recently signed free trade agreements (FTAs) as well as the prospects offered by the Trans-Pacific Partnership (TPP) are likely to keep Vietnam an attractive destination for FDI in the medium term. This is likely to further augment the manufacturing sector. These factors are expected to keep Vietnam growing at a quick pace in the near to medium term despite challenges such as lack of industrial depth and distress in the banking sector.
Vietnam’s economic performance in 2015 was robust
Vietnam’s real GDP grew 6.7 percent in 2015, surpassing the target growth rate of 6.2 percent. The industry and construction sector was the primary driving force behind real GDP growth in 2015—it grew 9.6 percent, contributing 3.2 percentage points to overall growth. Industry was bolstered by manufacturing, which grew 10.6 percent from a year ago, while construction grew 10.8 percent, the highest rate of growth in the last five years.1 Both manufacturing and construction in Vietnam have been buoyed by the continued inflow of FDI.
Services also registered a healthy growth rate of 6.3 percent, contributing 2.4 percentage points to overall growth. Within the services sector, wholesale, retail, and repair of motor vehicles grew 9.0 percent while finance, banking, and insurance grew 7.4 percent.2 Services, along with industry and construction, constitute a majority of Vietnam’s economy—approximately 40 percent and 33 percent of GDP respectively in 2015.3 Agriculture, which forms 17 percent of GDP, grew 2.4 percent in 2015 and contributed 0.4 percentage points to overall growth.4
From an expenditure point of view, final consumption, both public and private, registered robust growth in 2015 (9.1 percent compared to 2014). Gross capital formation was up 9.0 percent from the previous year but net exports continued to be a drag on overall growth for a second consecutive year.6
Total demand—final consumption plus gross capital formation—has picked up pace amid low inflation (below 1 percent in 2015) and an accommodative monetary policy. This trend is likely to continue through the near term.
Vietnam’s manufacturing sector has been a shining star
Vietnam is steadily emerging as a hub for manufacturing. Over the last decade, large global manufacturing companies have set up production centers in Vietnam, and since then, have built upon their initial investment. Indeed, the Vietnamese economy has continued to attract a steady inflow of foreign direct investment (FDI)—$14.5 billion was disbursed in 2015, a 17.4 percent increase over the previous year.7 Much of the investment in Vietnam has been in the processing and manufacturing sector (accounting for 67 percent of the total capital for investment in 2015).8 This comes at a time when manufacturing in competitor economies in South East Asia are under duress due to a slowdown in China and weakness in global demand. However, the manufacturing sector in Vietnam has been an exception—registering an average monthly year-over-year growth rate of almost 10 percent over the last four years.9
The performance of major sub-sectors—electronics and apparel—has been notable. The average year-over-year growth in the index for apparel manufacturing over the last 12 months is 8.7 percent.10 For computers, electronics, and optical products manufacturing, it stands at 23.9 percent.11
One significant factor that makes Vietnam a bright prospect for foreign investment is its lower wages. In 2013, the average monthly wage in Vietnam was $197, approximately half that in Thailand ($391) and less than a third of the wages in China ($613).12 This factor, along with the fact that China is moving away from large-volume manufacturing, makes Vietnam an attractive destination for low-cost, high-volume manufacturers. Moreover, Vietnam’s relatively stable political environment and demographic structure (70 percent of the population is of working age and 58 percent of the population is below the age of 35 years) adds to its appeal.
Potential gains from trade agreements are likely to keep FDI flowing in
Another reason for foreign investors flocking to Vietnam are the recent FTAs that the country has inked. These include the successfully concluded FTAs with the European Union, South Korea, and the Eurasian Economic Union led by Russia, and closer integration with the Association of South East Asian Nations (ASEAN) through the ASEAN Economic Community. In addition to these agreements is the TPP, which is probably the biggest draw. The TPP is a proposed FTA between the United States, Japan, and 10 other Pacific Rim nations—Australia, Brunei Darussalam, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. Together, these countries represent 40 percent of the global GDP. The TPP was signed in February, but much negotiation lies ahead before the deal is ratified by each of the member nations. Given Vietnam’s comparative advantage (due to lower labor costs), its export-oriented manufacturing sector stands to gain if and when the TPP comes to fruition. At present, the United States is Vietnam’s largest export destination—having accounted for 21 percent of Vietnam’s total exports in 201513—followed by the European Union, which accounted for 19 percent of Vietnam’s exports in 2015; ASEAN countries accounted for 11 percent and China for just 10 percent.14 Given that the TPP will bring down tariffs for trade between Vietnam and the United Sates to near zero, Vietnam’s exports to the United States are likely to surge.
Though China accounts for just 10 percent of Vietnam’s exports, 30 percent of Vietnam’s total imports in 2015 came from China.15 In fact, nearly half of Vietnam’s total imports in 2015 were sourced from China and Korea (but the two countries accounted for just a sixth of total exports in 2015).16 This is because Vietnam’s export-oriented manufacturers are still dependent on China and Korea for machinery and intermediate goods necessary for finished products, particularly in electronics and textiles and garments. Under the TPP, parts used to produce electronic exports will likely be sourced under ASEAN-China or ASEAN-Korea FTAs, and finished products will likely be exported under reduced tariffs to the United States and other TPP members. However, the liberal “rules of origin” applied to electronics does not hold true for Vietnam’s booming textiles and garments sector. The TPP’s “yarn forward” rule implies that everything, from the yarn to the finished garment, must be sourced from a TPP member country.
Vietnam’s textiles, garments, and footwear exports to the United States accounted for approximately 45 percent of total exports to the United States in 2015, constituting 10 percent of Vietnam’s overall exports last year.17 However, much of the fiber and textiles used to produce garments that are exported to the United States are imported from China and Korea. In fact, imports of fiber and textiles from China and Korea amounted to 67 percent of Vietnam’s textiles, garments, and footwear exports to the United States in 2015.18 Under the TPP’s “yarn forward” rule, textile and apparel manufacturers would have to import yarn fiber and textiles from either the United States or Japan (more expensive than China and Korea) if they are to gain from favorable tariffs. An alternative solution would be yarn and fabric weavers relocating to Vietnam, which implies greater FDI in the future.
But there are challenges to Vietnam’s growth story
Although Vietnam’s economy boasts impressive numbers, there are challenges to sustainable growth. While investors in Vietnam’s manufacturing sector have boosted exports, there has also been a surge in imports. On the one hand, the quick uptick in imports indicates strength in domestic demand but on the other, it also indicates a lack of industrial depth, as local Vietnamese firms do not produce any of the components necessary for the production of exported products. In 2015, Vietnam registered a trade deficit of $3.5 billion after three consecutive years of surplus.19
Another potential challenge is Vietnam’s strong dependence on FDI; it accounted for 71 percent of total export turnover and 59 percent of total import turnover in 2015.20 While it is expected that FDI will continue to flow into Vietnam in the near to medium term, it would be wise to tend to the domestic sector as well. In particular, Vietnam’s small and medium enterprises should be integrated into the growth story, especially since there is capacity for building industrial depth. A focus on upgrading the education system would also address the challenges that firms face in sourcing highly skilled labor, while vocational training will likely boost productivity. And as always, improved infrastructure will likely drive efficiency. But Vietnam should consider spending wisely, keeping in mind its public debt is to the tune of 62.5 percent of GDP, up rather quickly from 51 percent in 2012 and just shy of the debt ceiling set at 65 percent of GDP.21Further challenges exist in the banking sector, which has been plagued by bad loans. Though measures have been taken to mop up bad debt, they still fall short of addressing the root of the problem: Vietnam’s large and inefficient state-owned enterprises (SOEs). The process of partially privatizing SOEs in order to drive efficiency needs to be expanded and expedited, particularly since they account for 60 to 70 percent of outstanding credit.22
As things stand, Vietnam is striking while the iron is hot. Domestic demand is likely to remain strong under the favorable conditions of low inflation and accommodative monetary policy. FDI inflow is likely to increase over the near to medium term and, as a result, the manufacturing sector will likely continue to shine. GDP growth in 2016 could edge closer to 7 percent. Additionally, if Vietnam manages to fuel its engines of growth while ensuring that challenges to growth do not develop into roadblocks, then it could well be embarking on a journey to improved prosperity in the long term.