Vietnam Economy - World Bank Update, December 2016

The World Bank has recently published the latest edition of its biennial report on the Vietnam economy “Taking Stock.”

In it, it comments that, although global growth is softer than expected, Vietnam’s economy is showing resilience, supported by robust domestic demand and export-oriented manufacturing. The rate of growth slowed to 5.9% in Q1-Q3 2016, mainly because of a severe drought, cuts in oil production and slowing external demand. However, the fundamental drivers of the economy remain broadly intact.

Administrative price hikes for health and education have caused inflation to pick up, but the headline rate is expected to remain below the official target of 5%.  Meanwhile, slowing growth in imports has helped the current account surplus to widen and FDI inflows remain robust. The exchange rate has been relatively stable and the SBV has been able gradually to rebuild reserves, albeit to a relatively low level of 2.6 months of imports. However, the real exchange rate has appreciated, which could cause some issues for export competitiveness further down the line.

The World Bank’s main concerns on the economy centre on loose monetary conditions and the growth of credit, which “remains elevated”. These may exert pressure on asset prices and inflation, and pose risks for medium term financial stability—particularly as the debt to GDP ratio, at 112%, is already high for a country of Vietnam’s income level.

The fiscal deficit has averaged 5.5% of GDP over the past 5 years; public debt has risen fast and is approaching the statutory limit of 65% of GDP. The World Bank therefore has welcomed the government’s commitment to reducing the deficit to 3.5% of GDP by 2020, although it cautions these targets need to be underpinned with specific policy measures in order to bring the adjustment about as efficiently as possible.

Concluding that the medium term outlook remains favourable, the World Bank also cautions there are signs that growth has become overly reliant on factor accumulation (capital, resources and low-skilled labour) and macroeconomic stimulus, and that productivity’s contribution has declined. It therefore argues further structural reforms are required to support growth in the longer term.  Specifically, it welcomes the priority attached by the government to strengthening the banking system, deepening the capital markets, improving the efficiency of the SOEs, strengthening public investment, and helping the private sector to become more productive and dynamic.

Recent Economic Developments

Although growth has slowed in recent quarters, domestic demand and export-oriented manufacturing remain robust. Because of the drought and a problem with salinity intrusion in the Mekong delta, agricultural output expanded by only 0.7% in Q1-Q3 2016, and a drop in oil production caused resources output to drop by 7.1%. However, these were offset by growth in the value added of the industrial and construction sectors of 7.5%—which contributed about half of overall GDP growth over the same period. Domestic demand has also been underpinned by buoyant investment (+9.9% YoY, with FDI up by 12.4% YoY) and retail sales growth of 9.5%.

Inflation has picked up from 0.6% YoY in December 2015 to 4.1% in October 2016. About two thirds of inflation has been caused by administered price hikes in healthcare and education. The drought has also had some effect on food prices.

Of some concern is the way unsterilized foreign reserve accumulation has resulted in looser monetary conditions.  Reflecting ample liquidity, short-term interbank rates have fallen to below 1%, and credit growth remains elevated.  At 19% YoY in October 2016, the last is running at more than twice the rate of nominal GDP growth and now the debt to GDP ratio (112%) is high by the standard of countries with Vietnam’s income level. The World Bank notes also that the NPL overhang has not been fully resolved and that the credit intensity of growth has been on the rise.

On the fiscal side, persistent deficits of the order of 5.5% of GDP in the past 5 years have caused the stock of public debt to rise by about 12% (relative to GDP), to 62% of GDP. In this context, the World Bank notes that medium term fiscal financing needs are substantial and that access to concessional external financing can be expected to tighten. It also notes that, whilst revenue collection in the first nine months was running at 71% of plan, income from recurring sources has been performing worse than this. In meeting its objective of reducing the deficit to 3.5% of GDP by 2020, the Bank suggests there will need to be a balance of both revenue and expenditure measures and, in particular, improvements in the efficiency of spending.

The external position remains strong. Exports have grown by an estimated 7% YoY in the first 10 months of 2016, despite lower prices for oil and rice, and weaker than expected external demand.     Import growth has slowed markedly to just 2.2% YoY. A 15% decline in imports of machinery by foreign firms suggests their investment cycle may be maturing, although domestic firms’ imports have continued to grow, as a number of investment projects are not yet completed. Growth in imports of raw and intermediate goods has also slowed, which reflects weaker external demand, as well as higher inventories.

The picture on FDI has been very strong. With some of the lowest labour costs in the world, strong openness to trade, and an advantageous geographical location, Vietnam has now accumulated FDI commitments of around $290bn (or 150% of GDP) in a broad range of industries, from more than 100 countries. FDI contributes about 18% of GDP, a quarter of total investment, two thirds of total exports, and also is bringing in new technologies, management capacity and market knowledge. The one area of weakness in this healthy picture remains the low level of linkages to domestic firms. As long as the export model remains primarily based on low labour costs, it will be exposed to the eventual inevitable rise in wages.

Building on Steady Progress, Structural Reforms Remains Critical

Vietnam has made progress in a number of areas, but challenges remain, and the World Bank thinks an acceleration and a deepening of reforms is required.

This is because growth has become overly reliant on factor accumulation (capital, natural resources and low skilled labour) and stimulus, while the contribution of productivity increases has declined. Labour productivity has slowed to about 4% on average over the last 5 years and the rates of return on capital have diminished. At the same time, the impact of growth on the environment has been increasing.

The World Bank notes the Vietnamese government has reinforced its commitment to reforms designed to raise productivity, strengthen quality and improve competitiveness. Priorities for the plan to 2020 include:

• developing a robust private sector, and attracting FDI by (i) improving the business environment, (ii) strengthening support for SMEs, (iii) supporting the longer-term investments and brand building of major enterprises, (iv) adopting fair and strong market competition practices
• restructuring the state sector, including restricting the role of SoEs in sectors where the private sector can operate effectively, consolidating the state budget, and improving public service delivery
• restructuring credit institutions and deepening capital markets
• modernizing master planning to enhance productivity, quality and performance, and to prioritise the development of critical sectors and regions offering comparative advantages
• restructuring important factor markets such as land use rights, human resource development, and science and technology

Medium-Term Economic Outlook and Risks

A summary table of the World Bank’s estimates and forecasts for the economy is reproduced below:

On the external front, the main risks to these projections include the possibility of a further slowdown in the global economy, fragility in financial markets, and protectionist rhetoric (as recently over TPP in the USA.)

On the domestic front, the World Bank thinks a delay in the implementation of structural reforms will weaken medium term growth prospects, as the current structure of growth will eventually run into constraints. In turn, this could raise demand for a further loosening of monetary and fiscal policies, and thus increase inflationary pressures.

Special Topic: Transforming Vietnamese Agriculture—Gaining More From Less

The World Bank rounds off its report with a 24 page survey on Vietnamese agriculture, which it now feels sits at a turning point. This is because:

• low smallholder farmer profitability, under-employment among agricultural workers, mixed product quality, and low value-addition are suggestive of a comparatively low quality of growth
• some growth has come at the expense of the environment (deforestation, biodiversity loss, land degradation, water pollution), as more output has come from more and more inputs
• competition for land from cities, industries, and services is expected to increase, and rising labour costs will increasingly impact upon Vietnam’s ability to compete internationally as a low cost producer of bulk commodities

Looking forward, the Bank suggests the government needs to reduce its role in certain spheres (such as land use planner, production target setter, manager of farms, commodity trader etc.) and allow the private sector greater scope to participate in the provision of direct investment and technical services.

This will free up resources to improve the quality of regulation in areas such as environmental protection and food safety risk management. The government should continue to be involved in supporting rural infrastructure, the land market and in revitalizing agricultural innovation.

Please use the following link if you wish to look at the World Bank’s full report: http://documents.worldbank.org/curated/en/608961480599012554/pdf/ 110676-WP-PUBLIC.pdf