Vietnam - Economic Update

IMF Article IV Consultation, July 2019

Recent Developments

Growth has remained resilient to rising trade tensions and volatility in emerging economies, despite a stock market correction.  Growth of about 7% YoY has continued in Q1 2019.  Expansion has been broad-based, fuelled by growth in incomes and consumption, strong trade, tourism and remittances.  Manufacturing has surged and direct investment inflows are strong.  Export growth has slowed in Q1 2019 with smartphone exports.

Inflation has remained contained.  It reached 2.9% YoY in April 2019, below the 4% target.  Core inflation remained steady at 1.9%.

Trade tensions: the IMF’s models suggest a small impact on Vietnam (-0.3% to -0.8% change in exports).  A potentially larger and more durable impact  could come from shifts in investment, however, as international firms shift facilities to Vietnam in response to rising costs in China and to diversify production locations.  Vietnam has demonstrated an ability to move up the manufacturing value chain.

External position:  A current account surplus of 6.4% of GDP is substantially stronger than warranted by fundamentals.  The exchange rate is undervalued by an estimated 8.4%.  The gap reflects barriers to accessing land and credit and an uneven playing field for domestic firms, which discourage private domestic investment.  More ambitious reforms are needed to strengthen private investment and to improve public investment efficiency.

The Vietnamese authorities have expressed agreement on this last point and have indicated they are revising their FDI strategy to ensure greater linkages with domestic industry.   However, they have responded to the IMF’s call for greater two-way exchange rate flexibility by saying SBV intervention has been bidirectional and that Dong depreciation in 2018 was lower than in other countries.

Risks: downside risks have risen, principally from slower partner country growth and trade uncertainty.  Banking sector risks remain, but the recapitalisation underway is a mitigating factor.  Bottlenecks in the anti-corruption campaign could delay investment.  On the upside, numerous new free trade agreements could usher in productivity gains and growth could surprise on the upside if trade diversion and investment relocation effects continue to work to Vietnam’s advantage.

Fiscal Policy

Public and publicly guaranteed debt has fallen from a peak of 60% of GDP in 2016 to 55.6% of GDP in 2018 and, under the base case scenario, is expected to decline to less than 50% of GDP in 2024.  Compared to the analysis made in 2018, the debt trajectory has been made more benign by strict limits on new public guarantees, greater planned used of equitization revenues, and lower interest payments.

Debt sustainability risk is judged “low”, although uncertainty about equitization revenues and potential contingent liabilities related to banks and SOEs remain.   The IMF notes that unfunded pension liabilities and infrastructure gaps will need to be reckoned with over the longer term. 

Poverty has fallen from over 60% to below 5% in the last 30 years, with social spending on health and education critical in the process.  However, the IMF estimates there is a deficit in health and infrastructure spending of 7% of GDP annually under its Social Development Goals (SDG) assessment.  Under current policies, social system outlays will start to exceed revenues in the 2030s as the population ages.   The health insurance fund has already fallen into deficit as health care spending has risen from 7.9% of the budget in 1995 to 14.2% in 2014.

The IMF is therefore advocating more fundamental reforms to broaden the tax base, including VAT (collections of which have weakened) and reforms of property tax.  In addition, it thinks there is scope to rationalise expenditures and to make investments more efficient.

The Vietnamese authorities have broadly accepted these views and have said they are committed to continued fiscal consolidation.  The public sector headcount is being reduced, the new Public Investment Law has been drafted to put the PIMA recommendations into effect, and a law on PPPs is being prepared to limit risks on PPP procurement and management.   The National Assembly is to consider an increase in the retirement age for men from 60 to 62 and, for women, from 55 to 60. 

The authorities are confident they can raise revenue further using administrative reforms and are studying options for property taxation and registries.  They recognise that coverage of public pensions is narrow and that expansion in coverage and limited expenditure control has resulted in cost escalation in health.

Credit, the Exchange Rate and Monetary Policy

After a period of excessive growth at the start of the decade, which left bank credit to GDP at elevated levels, the authorities have brought credit growth down to less than 13% in 2018.  They have also resolved large quantities of NPLs. 

Looking forward, they are seeking to constrain real estate lending by imposing higher risk weights and by limiting short-term lending for long term projects.  The State Bank has sought to introduce a cap on the share of cash loans to consumers and to prohibit lending to borrowers with weak credit.  Tighter bank credit in turn is helping the development of capital markets and is improving the efficiency of credit allocation to credit worthy companies. 

The State Bank plans to reduce credit growth further to close to nominal GDP growth, whilst replacing the administrative allocation of credit with market-based mechanisms.   It is intended that Vietnam should adopt Basel II standards by January 2020.   All of this has been welcomed by the IMF.

The State Bank manages the Dong within a three percent band and the currency depreciated by a modest 2.1% against the US Dollar in 2018.  At the same time, it appreciated by 3.8% in REER terms as the RMB depreciated.   In the face of strong inflows in Q1 2019, the Dong was kept fairly stable against the US Dollar.

The IMF thinks the State Bank could consider modest nominal appreciation of the Dong against the US Dollar (within the band) in order to condition market expectations and also to help reverse still substantial cash dollarization (Vietnam’s US Dollar cash “hoard” is estimated at 25% of GDP).  If faced with persistent shocks, it could re-centre the band.  The IMF believes this can be managed in a way that would permit reserves to rise to an adequate level in 5 years.

The authorities accept a need to modernise the monetary framework, but are maintaining their gradualist approach, estimating is could take six to eight years.  Interbank rates are too volatile to serve as an operational target today, so the IMF is suggesting it should be first stabilised by having the State Bank pay interest on reserves.  It could then proceed to phase out credit growth targets and use the interbank rate to set monetary policy.

The Banking Sector

Banking profitability has been improving with a shift to retail lending and an increase in fee income from bond issuance, credit cards and cash transfers.  As large firms have issued more bonds, the banks have lent more to SMEs.

Banks have stepped up their efforts to solve legacy NPLs.  They have been helped by the strong economy and by rising real estate prices and, as NPL ratios have been declining, the banks have been buying back NPLs from the Vietnam Asset Management Corporation (VAMC) aggressively.   Resolution 42 of 2017 has helped the process by providing more legal powers for the seizure of collateral and opportunities to sell NPLs at auction.

The strengthening of bank capital is in progress, supported by the promised introduction of Basel II standards in 2020.   Improved profitability and equity injections for foreign investors have played their part. 

The systemic state-owned commercial banks (SOCB), however, continue to face a capital shortfall equivalent to 2% of GDP.  They are urged to issue equity to private investors, divest from private banks and non-bank entities and to shrink rather than grow their balance sheets.  If these measures to not suffice, they will be permitted to retain earnings.

The State Bank has strengthened banking sector stress tests and monitoring, and a National Financial and Monetary Advisory Council has been created to monitor system-wide risks and to provide advice on policy measures and financial markets deepen, become more interlinked and are liberalised.  The Council is chaired by the Deputy Prime Minister.

The IMF is hopeful that NPLs will continue to come down.  At 6.5% they are still high compared with the average of emerging market economies (4.5%).  Nonetheless, it urges risks arising from the shift to retail lending, including lending related to real estate investment.  It adds the decline in credit growth will, of itself, cause the decline in NPL ratios to start to slow.  There is scope to tighten the macroprudential framework in respect of loan-to-value and debt service-to-income requirements.   Financial liberalisation should be carefully sequenced to follow and not precede strengthened bank sector capitalisation, and an improved supervision and financial stability assessment capability.

Modernising Economic Institutions

Vietnam is committed to private sector-led growth and is emphasising the state’s enabling function over public production.

Regulatory quality, the ease of doing business have improved and the SOE framework has been revamped with the creation of an independent State Capital Management Committee which oversees large SOEs and improves accountability and efficiency, whilst leaving management and regulation with the in-line ministries.

International trade agreements, including the CP-TPP (January 2019) are driving institutional reforms, including in criminal court, property rights, labour courts, and insurance laws.  Additional priorities identified by the IMF are:

  • Modernising institutions of macroeconomic management
  • Strengthening risk-based banking supervision, the management of SOCBs, and broadening the application of international bank accounting standards
  • SoE reforms: accounting standards, quality of audit, allowing 100% foreign shareholding in areas not critical to national security
  • Reducing regulatory barriers to private sector ownership, having regulators operate on an arms-length basis
  • Reducing the concentration of land ownership in state hands; making competitive land auctions the norm; developing a land use market with simplified regulations
  • Strengthening the quality of data used for surveillance, and modernising data publication

Despite the progress that has been made, the IMF thinks greater efforts need be made to improve governance and fight corruption.   In particular, it recommends

  • Improving asset declarations and making the inspectorate’s independence
  • Strengthening the capacity of the judiciary to enforce contracts, strengthen legal interpretation, and facilitate resolution, restructuring and bankruptcy
  • Incorporating into the legal framework safeguards against the unfounded criminal prosecution of public officials for good faith performance of their duties
  • Strengthening Anti-Money Laundering systems (eg. due diligence on politically exposed persons)

In response, the authorities have re-stated their commitment to reforming Vietnam’s economic institutions, to completing the 2016-20 equitisation plan (and to drawing additional plans for 2021-30) and to the complying with obligations imposed on them by international trade agreements. 

Priorities include:

  • Streamlining taxation and administrative rules
  • Making land use and zoning more streamlined and transparent
  • Revising the Enterprise Law to reduce licencing requirements and allow 100% foreign ownership in all but strategic sectors
  • Reorienting FDI to advanced sectors that are more environmentally friendly and have stronger linkages to the domestic economy
  • Improving the quality of data and its dissemination
  • Training anti-corruption inspectors and centralizing the asset declaration registry.

 

To read the full IMF report, please use the following link:

https://www.imf.org/en/Publications/CR/Issues/2019/07/16/Vietnam-2019-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-47124

 

 

In July, the IMF published its latest regular report on the Vietnam economy under the Article IV consultation process.

Economic Summary

In it, the IMF noted that, despite trade tensions and financial volatility, the economy remains resilient and that growth reached a 10-year high of 7.1% in 2018.  The growth is broad-based, reflecting healthy growth in the incomes and consumption of the growing an urbanising middle class, a strong harvest and a surging manufacturing sector.  Inflation averaged 3.5%.

Growth is expected to sustain at 6.5% in 2019 and over the medium term, aided by competitive labour costs, a diversified trade structure, and recently signed free trade agreements, which are spurring reforms. Inflation is expected to pick up slightly in 2019 on the back of administered price increases, but to remain below the 4% target. 

Macroeconomic policies have been tightened in recent years.  A reduction in the budget deficit, limits on government guarantees and strong economic growth have caused public debt to fall from 60% at end-2016 to 55.5% at the end of 2018.  Credit growth has been reduced, but liquidity remains ample, supported by external inflows and the growing capital market.  The central bank is guiding banks to adopt Basel II standards in 2020 and is developing plans to recapitalise the systemic state-owned banks.

The external position is substantially stronger than fundamentals require.  The authorities have intervened in both directions to keep the Dong within a narrow band and reserve accumulation has continued.  The IMF’s directors have called for reforms to reduce the remaining barriers to investment, including improving access to land and credit, which would boost private investment and, with it, raise worker productivity and growth.

Reform Summary

Reforms continue on a wide front: the monetary and fiscal systems are being modernised, blocks in large state companies are being offered for sale, there has been progress in the fight against corruption, a Public Investment Management Assessment (PIMA) has been completed and the Anti-Money Laundering (AML/CFT) system is to be reviewed.  

 

The IMF’s Executive Board has commended the authorities for their prudent policies, their commitment to macroeconomic stability and their wide-ranging reforms.  Specifically, they have welcomed Vietnam’s

  • Fiscal consolidation efforts, especially improvements in tax policy and administration, including higher environmental taxes, tighter government guarantees and lower current spending
  • The current monetary and credit policy stance, especially declining credit growth
  • Reforms in the financial sector, including a shift in banking models to lending to households and private firms, which has been accompanied by more prudent credit growth targets and a deepening of bond and equity markets, and the planned adoption of Basel II standards
  • Reforms to modernize economic institutions and improve governance

 

Looking forward, the Board believes Vietnam should continue to focus on building buffers, strengthening governance, and boosting productivity and private sector growth.  Areas of focus highlighted in the press release accompanying the report include:

 

  • Keeping the public debt on a declining path to create room for priority infrastructure and social spending, to prepare for rapid population ageing, and to deal with the effects of climate change and digitalization.  Possible measures include:
    • Broadening the revenue base through unifying VAT rates, a property tax, reducing exemptions and improving administration
    • Rationalising the public sector wage bill and improving public financial and investment management
  • Maintaining efforts towards greater exchange rate flexibility, whilst reducing the remaining barriers to investment (including improving access to land and credit) to boost private investment and raise worker productivity
  • Swiftly recapitalising the systemic state-owned banks and replacing quantitative credit limits with a modern macroprudential framework
  • Strengthening anti-corruption legislation further, reforming the SOEs, implementing the PIMA recommendations, and improving statistical systems and data.