Vietnam: Aiming high despite challenges Asia Pacific Economic Outlook, Q4 2016

Vietnam has set its sights on becoming an upper-middle-income economy by 2035. To achieve this, it needs to ensure rapid growth, bolstered by innovative reforms, some of which have already been undertaken. However, sluggish reforms, a complicated external environment, and the lull in growth pose challenges.

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Special Topic: ASEAN Economic Community

Countries:
Malaysia
The Philippines
Taiwan

After almost a decade of quick growth, emerging market economies (EME) have experienced below-trend growth since the end of the global financial crisis in 2009. Factors such as a slowdown in China, depressed commodity prices, tepid demand in developed economies, elevated levels of household and corporate debt, and the normalization of US monetary policy are likely to keep the lid on EME growth in the near term. However, despite the broad slowdown, there have been pockets of quick growth—in Asia; Vietnam stands out, having recorded the second fastest rate of growth in 2015, behind India. The “Doi Moi” market reforms initiated in Vietnam 30 years ago (1986), allowed the economy to propel itself from low-income status in 1990 to lower-middle-income status in 2015 (figure 1). Growth during this period was dominated by the inflow of foreign investment. Lower labor costs relative to China have also lured manufacturers to shift base to Vietnam in recent years. At present, with foreign investment continuing to flow into the economy, Vietnam has set its sights on becoming an upper-middle-income economy by 2035. To achieve this long-term goal, rapid growth will need to be bolstered by a fresh new spurt of innovative reform in the near to medium term. Indeed, measures to reform the Vietnamese economy have already been undertaken, partly under compulsion, due to participation in the proposed Trans-Pacific Partnership (TPP). However, the sluggish pace of reform, a complicated external environment, and the current lull in the rate of growth pose challenges to Vietnam’s future growth trajectory.

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Growth dips in the first half of 2016 due to drought and slower gains in industry

Growth in real GDP moderated to 5.5 percent in the first half of 2016 from an annual growth rate of 6.7 percent in 2015 (figure 2).1 A persistent El Nino-fueled drought, one of the most severe over the span of a century, has affected agricultural production in the country’s fertile Mekong Delta. Lack of rain and salinification from sea intrusion have had an adverse effect on the agriculture, forestry, and fishery sector in 2016—the sector, dominated by agriculture, declined 0.2 percent in the first half of the year. Agriculture alone shrank by 0.8 percent in the first half of 2016 relative to the same period a year ago.2 Even though the primary sector accounts for just 16 percent of GDP, it employs nearly half of Vietnam’s workforce. Furthermore, the drought has also reignited discussion over China’s hydroelectric dams across the head of the river Mekong, which affect the flow of water to Laos, Cambodia, and Vietnam in the south. Internally too, a rapid increase in the number of wells in the Mekong delta and a labyrinth of agricultural infrastructure built due to policy that supports intensive production of rice (a water-thirsty crop) is proving burdensome.

A persistent El Nino-fueled drought, one of the most severe over the span of a century, has affected agricultural production in the country’s fertile Mekong Delta. Lack of rain and salinification from sea intrusion have had an adverse effect on the agriculture, forestry, and fishery sector in 2016.

The industry and construction sector also slowed in the first half of 2016, growing 7.1 percent from the same period a year ago compared to annual growth of 9.6 percent in 2015.3 Part of the slowdown is due to base effect. However, industry growth was mitigated by a dip in mining and quarrying due to low commodity prices, particularly of crude oil. The moderation in industry growth is despite robust gains in the manufacturing sector (10.1 percent in the first half of 2016). Construction grew a healthy 8.8 percent in the first half of the year, but gains were below the annual growth rate of 10.8 percent in 2015.4

The services sector was a bright spot in the first half of the year—it grew 6.4 percent relative to the same period last year, marginally faster than the annual growth rate of 6.3 percent in 2015.5 Wholesale and retail, finance and banking, boarding and lodging, and real estate recorded healthy growth. This reflects the healthy domestic demand, quick credit growth, influx of tourists, and the liberalization of the real estate sector.

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From an expenditure-on-GDP perspective, consumption grew a healthy 7.0 percent in the first half of the year and gross capital formation increased by 10.0 percent. However, net exports subtracted from overall growth in GDP.6 Vietnam’s trade deficit in services exceeded its trade surplus in goods, reflecting continued dependence on the import of trade-related services, particularly of transportation services.

Quick growth and further reform is what Vietnam requires for future success

According to a joint report by the government of Vietnam and the World Bank Group, Vietnam needs to grow at an annual rate of at least 7.0 percent over the next 20 years in order to fulfill its ambitions of becoming an upper-middle-income country by 2035.7 However, achieving this long-term goal requires the hastening of reforms. The report identifies six key transformations that are required—building modern institutions, enabling private sector-led economic modernization, developing innovation capacity, promotion of social inclusion, managing efficient urbanization, and achieving sustainable and climate-resilient growth.8 Furthermore, the joint report forecasts that Vietnam would achieve only two-thirds of its GDP per capita growth target over the next two decades if reforms are not fully implemented.9

At present, certain reforms are underway. These include the privatization of Vietnam’s large state-owned enterprises (SOEs), consolidation and reform in the banking sector, liberalization of the real estate sector, and reforms in the labor market. However, the pace of reform is a cause for concern. For instance, Vietnam is behind its target for privatizing SOEs—the government targeted 289 SOEs in 2015 but managed to privatize only 182.10 Moreover, mostly small stakes were offloaded without affecting management control.

Similarly, in the banking sector, consolidation targets are unlikely to be achieved on time. The World Bank noted in a report in April 2016 that reducing the number of commercial banks in Vietnam to the targeted 15, from the current 34 by 2017 would be difficult.11 Furthermore, even though the non-performing loan ratio in the banking sector has been reduced to less than 3.0 percent, much of the bad debt has merely been transferred to the Vietnam Asset Management Company (VAMC). The VAMC, however, lacks a well-defined strategy to sell the bad debt it has undertaken. Additionally, private sector credit grew rapidly in 2015 (17.3 percent), and a growth rate of 18.0 to 20.0 percent is targeted in 2016.12 However, quick credit creation coupled with the easing of ownership rules for foreign investors in Vietnam’s real estate sector could raise the specter of the 2011–12 real estate credit bubble. Finally, the push toward labor market reforms, such as allowing the formation of independent trade unions run the risk of being token efforts toward meeting the requirements of the Trans-Pacific Partnership (TPP) if trade union links to the Vietnam Confederation of Labor continue to stay in place.

Uncertainty surrounding the TPP and internal problems will pose a challenge

While Vietnam works toward meeting the requirements of the TPP, the risk that the deal will not be ratified by the US Congress has risen. The final realization of the TPP remains closely linked to the outcome of the US presidential elections. Both presidential candidates have offered resistance to the TPP at this stage. This is significant for Vietnam, especially since it is likely to be the foremost beneficiary of the trade deal. Nonetheless, if the TPP is ratified by the United Sates, it would likely signify Vietnam’s shift away from China’s ambit of influence in terms of trade (figure 3). This would likely hasten backward linkage investments into the country from China and South Korea, Vietnam’s main sources of imports, primarily in the textiles, garments, and footwear sector. The TPP therefore takes on added significance for Vietnam, not least because of its dependence on China for imports and the recent territorial dispute between the two nations in the South China Sea (East Sea in Vietnam).

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In addition to these external uncertainties, Vietnam has internal problems to address. The fiscal deficit stood at 5.9 percent of GDP in 2015, having grown over the years due to expansionary fiscal policy in the wake of the global financial crisis.13 At present, fiscal debt is steadily approaching the ceiling of 65.0 percent of GDP set by the Ministry of Finance; it is currently estimated at 62.0 percent of GDP.14 The government’s bid to maintain fiscal prudence could result in a slowdown of investment in much-needed infrastructure. Additionally, even though Vietnam continues to be a destination for the influx of export-oriented foreign direct investment (FDI), domestic support industries have not benefited from this influx. For example, only 36.0 percent of Vietnam’s domestic firms are involved in export-focused industries.15 Finally, even though Vietnam currently has a relatively young population (median age of 30.7 years), it will also be home to one of the fastest aging populations in the world. By 2040, Vietnam is projected to have three times the number of people currently aged 65 years or older.16

It is only right that Vietnam aims high

Despite the difficulties, there are strong reasons to remain optimistic about Vietnam. Fiscal tightening, for instance, could expedite the privatization of SOEs. An encouraging development in this direction is the lifting of restrictions on foreign investment in public SOEs (except in certain sectors). In July, it was announced that Vinamilk, one of Vietnam’s best-known brands and a public SOE, will be available for 100 percent foreign ownership.17 Vietnamese banks, in need of capital in order to meet Basel II requirements by the end of 2018, are also attracting foreign buyers. In August, Singapore’s sovereign wealth fund, GIC, announced the purchase of a 7.7 percent stake in one of Vietnam’s largest banks.18 Vietnam topped the Financial Times’ emerging market index for greenfield FDI for the second consecutive year in 2015, and FDI inflow has surged 105.0 percent in the first half of 2016 relative to a year ago (figure 4).19 Furthermore, tourist arrivals in Vietnam are up 21.0 percent in the first half of the year, following the country’s visa-waiver policy.20

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In a broader sense, Vietnam remains favorably placed, geographically (near both China and India) and diplomatically (with closer ties to the United States) to take advantage of the wind in its sails. If it steers in the right direction, it could enjoy upper-middle-class income status within the span of a generation. However, if it succumbs to the challenges that lie in its path, Vietnam could be yet another victim of the middle-income trap.