10.05 - hsbc - vietnam economy - boring not bad
TRANSCRIPT
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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
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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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