The economy remains fragile in Vietnam

Vietnam will remain dependant on foreign capital inflows, but these have not yet recovered from a plunge during the global credit crisis.

Madrid - 07-mar-2011

Vietnam is moving from a centralised Communist economy to a system of market-socialism. Economic reform [doi moi] has resulted in high economic growth rates [7-8% year-on-year between 2000 and 2007]. Vietnam’s export-driven economy [exports account for 75% of GDP], specialised on footwear and garments production, was hit quite badly by the global downturn. However, a recession was avoided, and the economy actually grew by 5.4% in 2009, due mainly to massive government stimulus packages worth US$ 8 billion, largely in infrastructure investment and by subsidising banks´ loans to businesses.

According to government sources, GDP grew 6.4% year-on-year in the second quarter of 2010, thanks to increased domestic demand an a rebound in exports. Industrial production increased 14% year-on-year between January and August. In the same period, exports of textiles and garments rose 17%, while imports increased 25.5%. Overall, a 6.4% GDP growth is expected in 2010, based on increased private investment, consumption and non-oil exports. Due to the massive stimulus package, the budget deficit increased to 8.9% of GDP in 2009, but is forecast to decrease this year as the stimulus measures expired at the end of 2009 and GDP growth has picked up again. Inflation has been persistently high [above 8% since January 2009], and started to rise again in September 2010.

Economic policy

Vietnam’s high inflation is the result of the government’s expansionary fiscal and monetary policy: it aims to increase credit by 25% this year, to boost economic growth ahead of an important Communist Party congress in January 2011. The Dong has been devaluated three times since November 2009 to support exports and to narrow the trade deficit [Vietnam largely exports low-value goods and therefore competes on price] but this measure has, in turn, increased the cost of imports.

Both the increase in loans and the Dong devaluation endanger price stability. Rising inflation, in turn, increases the downward pressure on the Vietnamese currency. The Central Bank had kept the base interest rate at 8% since December 2009 to stimulate growth, but finally shifted its policy to combat inflation in early November 2010, and raised the base interest rate to 9%. At the same time, the government has said that it will refrain from a further adjustment of the exchange rate before February 2011.

Structural economic weaknesses

A structural weakness in Vietnam’s economy is the relative strong focus on labour-intensive and low value-added goods. With its focus on textiles, footwear and agricultural products, the country now faces stiff competition from other low-cost producer such as Bangladesh. Following the example of the ‘Asian Tigers’, Vietnam plans to enhance its production capabilities and profile by attracting more electronics producers and creating a shipbuilding industry. However, Vietnam’s investment climate is still hindered by many shortcomings. Rampant corruption, poor transport infrastructure, an ineffective legal system and an outdated, Communist-inspired education system are serious obstacles. Therefore, the main challenges for the economy are: reform of the financial sector and state-owned enterprises; improvement to the accessibility of land for private enterprises; infrastructure improvements; education of the workforce, and; combating corruption.

Outlook

Although the government has indicated that it would refrain from further currency depreciations, the Dong will remain under downward pressure. A further devaluation in the short-term future cannot ruled out.

GDP growth is expected to increase to nearly 7% in 2011. As Vietnam imports many goods and services, this will also fuel inflation, which is expected to remain high in the coming months and reach 9.1% in 2011. The budget deficit is forecast to drop further in 2011, but will remain persistently high at 6.7% of GDP. While the government has pursued a loose monetary policy throughout 2010 and has urged banks to loosen their lending conditions to boost economic growth, the focus has shifted to curbing inflation, especially as growth this year will exceed the government target.

The government has to avoid any contradictory market policies and reassure the market of its priority of achieving macroeconomic stability if it is to gain confidence. Therefore, it needs to continue to convey an unambiguous commitment to combating inflation and an assurance that it can avoid a further widening of the trade deficit.

The current account deficit will remain high in 2011 [9% of GDP], and, despite a modest build-up in foreign currency reserves in 2010 and 2011, the international liquidity position will remain poor. Since the current account will persistently show large deficits, Vietnam will remain dependant on foreign capital inflows, but these have not yet recovered from a plunge during the global credit crisis.

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