FROM MACROECONOMIC INSTABILITY TO RESTRUCTURING

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1 FROM MACROECONOMIC INSTABILITY TO RESTRUCTURING 1

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4 FROM MACROECONOMIC INSTABILITY TO RESTRUCTURING Copy right 2012 belongs to the Economic Committee of the National Assembly and UNDP in Vietnam. Any copy and circulation without permission of the National Assembly s Economic Committee and UNDP is copyright infringement. 4

5 Editor: TO TRUNG THANH NGUYEN TRI DUNG REPORT ON MACROECONOMY 2012: FROM MACROECONOMIC INSTABILITY TO RESTRUCTURING 5

6 This research is undertaken within the framework of Support for enhancing capacity in advising, examining, and overseeing macroeconomic policies project chaired by the National Assembly s Economic Committee and funded by the United Nations Development Program in Vietnam (UNDP). Chairman of the Project Steering Committee: Nguyen Van Giau Chairman of the National Assembly s Economic Committee Project Director: Nguyen Van Phuc Deputy chairman of th e National Assembly s Economic Committee Project Vice Director: Nguyen Minh Son Head of National Assembly Office Economic Department Project Manager: Nguyen Tri Dung 6

7 CONTENT INTRODUCTION OVERVIEW Chapter FROM MACROECONOMIC INSTABILITY TO RESTRUCTURING Importers FDI Remittances ODA Tourism Chapter FISCAL DEFICIT RISK Chapter FINANCIAL MARKET INSTABILITY Chapter TRADE DEFICIT CHALLENGES Chapter WORKFORCE AND EMPLOYMENT FLUCTUATION EMPLOYMENT SITUATION IN Chapter FOUNDATIONS OF GROWTH Chapter THE THINKING INNOVATION AND THE INSTITUTIONAL REFORM

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9 LIST OF TABLES Table Vietnam s key economic cooperation Table Plan and implement data Table GDP growth by sectors, Table The structure of GDP in the total demand Table Final consumption in GDP, Table Asset accumulation and GDP (at real prices) Table The structure of social investment capital, (%) Table Vietnam balance of Payments ( ) (million USD) Table Finacial depth of several countries in Table The weight of components in GDP growth, Table ICOR in terms of economic sectors Table Money and credit supply, (% increase compared to the end of previous year) Table Vietnam budget deficit over years (% of GDP) Table Vietnam public debt over years (% of GDP) Table The proportions of different taxes in the total revenue from taxes and fees Table Budget deficit excluding unsustainable revenues (% of GDP) Table The government spending scales in some Asian countries (% of GDP). 112 Table The state budget spending over years Table Total social investment over years Table The investment of the state economic sector

10 Table The public investment by economic lines (%) Table Growth rate of the broad money supply (M2), total domestic credit and total mobilization of the economy, Table The structure of the market to mobilize capital I and II compared to total assets (%) Table Some financial indicators of listed banks, Table Overdue and bad debts in the whole system, Table 4. 1: Trade variables of Vietnam and some countries (average of ) Table 4. 2: GDP and Manufacturing Value Addition of Vietnam and other countries Table 4. 3: Market position market Table 4. 4: Comparison of savings, investments and trade among countries in the region (%) ( ) Table 7. 1: Global Competitiveness Ranking Table 7. 2; The business environment index Table 7. 3: The Corruption Perception Index (CPI) Table 7. 4: The electronic environment index

11 LIST OF FIGURES Figure 1. 1.Budget deficit of some countries in the EU Figure Net debt of some countries in the EU Figure Public financial deficit and public debt in the US Figure Fed s interest rates and ten-year bond interest rates Figure Japan s macroeconomic prospects Figure Japan s public financial deficit and public debt Figure World oil prices Figure Food price index Figure Gold and metal price index Figure Stock market index in various economies Figure The Vietnam s employment growth in the period Figure Exchange rate USD/VND, (Monthly) Figure Exchange rate USD/VND in the free market and the Interbank in Figure Current account and capital account of Vietnam in the period (billion USD) Figure International Trade of Vietnam, Figure The growth rate of money supply, credit and inflation of Vietnam Figure Monthly inflation Figure Monetary Survey of Vietnam, Figure Net foreign assets in bank system, Figure The loan to deposit in the period Figure The loan to deposit ratios of banking systems in 2009 and Figure Movement of kinds of interest rates in inter-banking system

12 Figure Foreign debts of commercial banks (monthly) in 2010 and Figure Bad debt proportion in Vietnam s banking system Figure Economic growth rate and the weight of capital investment in GDP (%) Figure Comparison of the ratio of investment to GDP between Vietnam and other countries Figure The structure of social investment in terms of economic sectors (%) Figure The rate of Credit/GDP at the end of 2010 (%) Figure Budget balance - the situation of Vietnam and some countries Figure Growth and inflation in countries around the world ( ) Figure Trade deficit, investment-saving gap and budget deficit (%GDP) Figure Budget deficit of some Asian countries, period (% of GDP) Figure Vietnam s sources of revenues (% of GDP) Figure Taxes and charges in some Asian countries (% of GDP) Figure Difference between Savings and Investment (% of GDP) Figure The government bonds issued over years (thousand billion dong) Figure Savings, investment and trade deficit Figure The relationship between M2 and CPI of Vietnam Figure Fluctuations in sales deposits withdrawn before maturity (billion dongs) Figure VND annual interbank interest rate, Figure Relationship between money supply (M2) and GDP growth

13 Figure USD/VND interbank exchange rate, Figure The export-import value and merchandise trade balance ( ) Figure The proportion of international trade variables over GDP ( ) Figure The growth of Import-Export of goods and services (in current prices and 2005 prices) Figure Cumulative reactions of the trade balance to shocks Figure Nominal exchange rate, real exchange rate and trade deficit ( ) Figure Gross impact to import of 1 % exchange rate adjustment Figure 4.7: Percentage of imported goods values Figure 4. 8: Gross impact of exchange rate shock to trade balance Figure Structure of export sector group in Vietnam Figure Structure of export processing industry Figure Technology content of export industrial products in Vietnam and other countries Figure 4. 12: Competitive position of several key export sectors ( ) Figure 4. 13: Trade deficit the difference between investments savings and budget deficit (%GDP) Figure 5. 1: Vietnamese employment structures, 2006 and Figure 5. 2: Unemployment rate, Figure 5. 3: Underemployment rate, Figure 6. 1: The progress of development thinking

14 Figure 6. 2: The ultimate goal and intermediate goals of economic growth Figure 6. 3: The contribution of factors to economic growth, (%) Figure Figure 7. 1: The contribution of factors to economic growth, (%) Figure 7. 2: Comparing the quality of policies and institutions in some countries Figure 7. 3: The Government Effectiveness and the Regulatory Quality

15 INTRODUCTION Within plan for support activities for Economic Commission of National Assembly in preparing Verification Report on additional evaluation of the performance of socioeconomic plan and state budget and commenting on Master Plan on Economic Restructuring in association with conversion of the growth model, Capacity Support in Advisory, Verification and Monitoring of macroeconomic policy, funded by UNDP, Economic Commission of National Assembly, along with Macroeconomic policy Advisory Group (MAG), has developed Annual Macroeconomic Report Annual Macroeconomic Report is an annual publication which is produced in a friendly manner for members of National Assembly and policymakers. It aims at summarizing and evaluating macroeconomic situation in Vietnam and in the world, providing in-depth analysis of noticeable issues and macroeconomic policies in a year. Besides, in the report, problems in medium and long term are discussed, resulting in realistic recommendations on policies. Hopefully, the report will provide the members of National Assembly and policymakers with a comprehensive picture of annual economic situation as well as, through in-depth analysis of macroeconomic issues in medium and long term, enhance the awareness of the issues and promote positive change in thinking of policymakers. From macroeconomic instability to restructuring is chosen as topic of Annual Macroeconomic Report Based the analysis of economic instability in association with economic structure and growth model in 2011, an urgent demand for or an unparalleled opportunity to restructure the economy and reform growth model are discussed. The report also concerns growth foundations and important preconditions for restructuring process. Opinions, analyses and assessments presented in this report are given from the view of the authors and do not necessarily reflect the view of the Economic Committee or the Project Management Unit We would like introduce the report to readers. PROJECT MANAGEMENT UNIT 15

16 OVERVIEW Taking the responsibility for advising, verifying and monitoring macroeconomic policy in 2011, Economic Commission led the verification of Socioeconomic Plan , and reported the following content to National Assembly at the third session of the National Assembly XIII: Economic growth rate is 5.89% in 2011, falling short of expectation; however, the rate is comparatively high when compared with other countries in the region. Agriculture growth stays unchanged at high rate, ensuring national food security. Consumer Price Index is on a sharp increase in the first months of the year before a gradual decrease (monthly) from May, 2011 as a result of attempts to stabilize macroeconomic policies and curb inflation after resolution No. 11. Thanks to advantages of international price, exports rise by 34.2%, contributing to the steady upward trend in trade deficit to export ratio (10.1% of exports). Capital account experiences an improvement when FDI source is disbursed and new registered FDI is constant while the world economy is faced with difficulties. Improvement of trade balance results in stability of foreign exchange market from the second half of the year and increases the foreign-exchange reserve. However, these results have not been constant and sustainable, especially in the context of volatile and unpredictable world economy and tougher and tougher domestic economy. It is said that in 2011, in particular after becoming an official member of World Trade Organisation (WTO) in early 2007, Vietnam continues to confront long-lasting macroeconomic instability such as high inflation of 18.15%, erratic foreign exchange rate, huge budget deficit of 4.9% GDP with public debt and external debt being reaching danger threshold. To specify, public debt accounts for 52.9% of GDP; government debt is equivalent to 41.9% of GDP, and external debt makes up for 41.1% of GDP. Financial market is vulnerable to drastic changes in interest, eroding market confidence in macroeconomic management. Therefore, Economic Commission is one of the first agencies that have a radical voice of change priority objective of operating economy from growth focus to macroeconomic stability. Basing on that, overall objective described in Resolution on Socio-economic development in 2011 is Strengthening macroeconomic stability and inflation control in accordance with reforming the growth model and transforming economic structure; aiming at a higher growth rate than that of 2010, improving the quality, efficiency and competitiveness of the economy, ensuring social security and welfare, raise 16

17 living standard, maintaining political security, ensuring national defence, social and order, improve the efficiency of foreign affairs and international integration 1. Macroeconomic instability in 2011 and predicted difficulties in 2012 are partly because of external causes when Vietnam has progressively integrated into global competitive environment with inconstant variations, and at the same time, natural and environmental conditions as well as climate change are increasingly abnormal and disadvantaged. Nevertheless, the fundamental cause is due to the fact that the old growth model has been applied in a long period, leading to structural weaknesses and internal extreme conflicts within the economy. The export-led model primarily depends on widening factors such as capital and labour that are reaching limits, improperly applies market economy, lacks active competitiveness mechanism to mobilize resources of economic sectors; motivations of intensive growth have not been improved to become development motivation; economic structure is slowly reformed to meet the demand of fast and sustainable economic development and international integrated economy. Recently, thanks to short-term solutions the economy has overcome temporarily overcome difficulties, but structural instability which have not been fully dealt with always pose the risk of recurrence and outbreak, especially when exacerbated by worse external shocks that are not under control of temporary policy interventions. In such a situation, Economic Commission organizes Science Conference Vietnam Economy: medium and long term problems in February, 2011 and proposes a theory of economic development particularly for Vietnam, in which macroeconomic stability is the first priority and throughout. In order to achieve macroeconomic stability and sustainable growth, besides focusing on handling the pressing issues, Vietnam necessarily has appropriate strategy and solutions to the fundamental problems in the medium and long term such as reforming the growth model to restructuring the economy. Specifically, according to Report on Verification of Socio-economic Plan for 5 years between , the goal of economy is defined as quickly and sustainably developing the economy, in association with innovating growth model and restructuring the economy towards improving quality and efficiency of competitiveness while ensuring social welfare and security, laying foundation of an industrialized country towards modernization for Vietnam in Before that, in Recommendation of Science Conference Overcoming crisis challenge: Vietnam Economy in 2009 and prospect in 2010 delivered to members of National Assembly on May 2010, Economic Commission determined to prioritize macroeconomic stability, creating favorable environment to meet the growth target. 17

18 This goal requires time, appropriate schedule and steps to achieve. Firstly, there is necessarily to innovation in system thinking that has existed for a long time and proved unsuitable, becoming the underlying cause of intrinsic weaknesses in the economy. It should be aware that market mechanisms need to be fully functional and flexible to strongly and effectively promote all resources, and central planning thinking in favour of administrative orders of macroeconomic policy planners must come to an end. The role of State should be redefined, in which the principle "State only operate what the private sector does not want to do or cannot do when they are provided with favourable conditions and support from the State" must be must be consistent. The dominant role of the public sector should not be interpreted and described as taking a dominant position in economic sectors and key fields and having monopolies on a number of fields; State owned enterprises (SOEs) should not be used as a tool of state-oriented and macroeconomic regulation. In addition, another necessary condition for effective resource allocation is appropriate institutions, especially property rights and fair competition; thank to that economic structure is changed towards efficient and sustainable and competitive situation. Constitution 1990 should be amended from the direction for sectors, ownership, economic freedom and organizational structure of the state apparatus to exercise public power. Laws on the organization of state power bodies should be amended, basing on outlines of amended Constitution, and elected bodies should take a more considerable role. Law on Land 2003 should be adjusted to redesign regulations, creating a transparent and properly protected ownership system. There should be an additional law on state ownership of SOEs and state-owned capital in enterprises or a law on enforcement of state ownership of SOEs and the state owed capital in enterprises to effectively perform the role of SOEs. The process of restructuring economy associated with renewing the growth model should be simultaneously carried out in all industries and fields throughout the country and within each locality and each grass root unit with a long term vision and a detailed road map. We pay centre of attention to restructuring the economy in three key areas including investment with focus on public investment, SOEs with focus on state groups and corporations, financial market with focus on commercial banking system and the financial institutions. For public investment restructuring, it is necessary to restructure the capital resource of public investment so that social capital is mobilized, and capital from state budget is gradually 18

19 reduced. In addition, there is a need for management mechanism of efficient public investment. Accordingly, there are several specific measures such as: (i) reducing the state budget revenues to GDP ratio to a more reasonable level in order to increase capital accumulation and investment, (ii) publicising lists of items, projects, procedures and mechanism of government for investment promotion to direct both local and foreign investors towards selections of capital resources mobilization, (iii) rapidly improving public private partnership mechanisms for investment (PPP), (iv) prioritizing agriculture, rural areas, aquaculture infrastructure, national security, education, science and technology, health care, socio-culture, environmental protection and social welfare targets when allocating state capital; achieving a breakthrough in building system infrastructure, focusing on continued projects to accelerate construction, (v) target program should be shortened and arranged in an order where important, urgent and effective projects are put at the priority top, and (vi) implementing methods for building medium-term budget (3-5 years) to determine the scale of the required financial resources for implementing existing policies in the medium term and balancing needs of various sectors with the total available resources, regarding master national priorities and each ministry s ones. To fully address existing shortcomings in public investment, it is required innovative mechanisms for decentralized management of economy, particularly decentralization of investment management and supervision. Accordingly, fundamental solutions include: (i) forming regional management institutions that are competent in the decision on socioeconomic development planning, (ii) assigning distinct management rights and responsibilities to each level, enhancing local authorities capacity of selecting and making decisions and the role of supervising local authorities public investment that central level, departments and sectors perform, (iii) focusing on innovating supervision mechanisms for investment towards principles which require a close co-operation between sector management with local management, clearly define state management of ministries/ sectors and state management of provincial authorities, and (iv) the project funded by central budget should be approved and supervised at both central level and local level to avoid the situation that localities carelessly plan projects to propose central budget. The approval should satisfy some necessary criteria, including practical contribution to local development and not breaking other master plans. For SOEs restructuring, it is crucial that we should clearly identify consistent and long term grounds, criteria and directions of establishment, maintenance and operation of the SOE; 19

20 SOEs are prohibited from investing in manufacturing and trading sectors that are not permitted by the government, implement of modern corporate governance, transparency and explanation accountability. Besides, it is necessary to clarify the role and function of state ownership representatives and state management in SOEs in accordance with market principles with several specific measures such as : (i) renewing thinking, accordingly, state management in SOEs is the government function of government while and state owner s management in SOEs is the business function performing rights and obligations of a business owner, (ii) necessarily completely separating and form an agency specialized in state ownership representative, called by Management and Supervision of State Ownership Rights Agency and organized as a commission (or department). The agency performs the function as an owner of large-scale groups, corporations and SOEs. Provinces and cities with a large number of SOEs may establish Provincial Management and Supervision of State Ownership Rights Agency. This is a specialized agency representing the state ownership, having specialized professional organization and staff and professional and being independent from state administrative agency, (iii) strengthening the accountability of authorized representative of the state ownership in SOEs which is shown in the contract of rights and liabilities between the authorized representatives and the representatives of state ownership and transparency of involved actors (organizations and individuals) to perform the function of state owner. The authorized representatives in SOEs do not perform the function of the state administration. In addition, it is essential to continue promoting and enhancing the quality of SOEs equitization, divesting state capital in joint stock companies, especially those were transformed SOEs, completing transfer independent enterprises under Ministries and localities and shares that are hold by Ministries and localities to State Capital Investment Corporation, increasing competitiveness and reducing monopolies of SOEs, especially corporations, companies in economic sectors, and researching to prepare for the equitization of several corporations and corporations from Market-based restructuring methods are applied; ownership structure is diversified, and SOEs, parent companies of groups and corporations are equitized. For restructured banking sector, we should strengthen the organization and activities of State Bank of Vietnam (SBV), early form basic the premise of a modern central bank. This is a priority task of restructuring the financial system in general and commercial banks in particular. SBV takes a crucial role in and contributing to the formation and development of financial 20

21 market; therefore, whether financial market, particularly commercial banks, is effectively operates or not largely depends on SBV s capacity of management and administration. Thus, SBV is necessarily given a highly independent legal position. On the one hand, SBV is not put under government s pressure which leads to a passive role in operating a passive monetary policy; on the other hand, SBV takes responsibility for disclosing results of monetary policy to the public. Besides improving the efficiency of commercial banking system, we should speed up the development of non-bank capital channel for economic activities, reducing the dependence of almost entire economy on commercial banking system at present. Such a situation not only poses difficulties and risks to businesses because high rates is beyond the endurance of businesses, accompanied with an increase in bad debt rate, but also erodes effectiveness of monetary policy since the demand for capital is not met while control inflation and macroeconomic stability are targeted. Along with official opinion shown in the Verification Report on Socio-economic Development Plan, Economic Commission has also produced publications reviewed by independent economic experts for further discussion about economic issues and policies more objectively. Recommendations drawn from the semi-annual Economic Forums and Macroeconomic Reports are two of such publications. They create effective meaningful room for policy review. While the recommendations come straight to detailed specific policy recommendations, Economic Report systematizes macroeconomic issues and policies in a coherent, understandable and simple manner, coming up with the most comprehensive policy recommendations. * * * Report on Macro Economy 2012 will review and assess changes in macro economy of Vietnam and analyze macroeconomic highlights of 2011 in depth, basing on that to dig deeper into instability year after year coming from the extensive growth model while the quality and efficiency of growth are increasingly impaired. Consequently, the report not only emphasizes the requirement for restructuring the economy and innovating growth model innovation as an 21

22 opportunity in the current context, but also mentions foundations of growth and the most important preconditions of restructuring process. To attain this goal, Report on Macro Economy 2012 is divided into chapters serving different purposes. Chapter 1 with the title referring to the subject of report covers full contents and ideas of Report, including the contents of subsequent chapters, and being presented in a consistent manner. Subsequent chapters (from Chapter 2 to Chapter 5) analyze the enormous economic problems such as budget deficit, unstable currency financial market, persistent trade deficit and labor - employment fluctuations in relation to the growth structure and model, clarifying points of Chapter 1 and making specific practical policy recommendations to address the mentioned issues. The last two chapters of Report refer to the most long-term and fundamental issues of restructuring and reforming the growth model to elucidate contents as well as indispensable preconditions of restructuring economy. Chapter 6 reviews growth origins and foundations, thereby assessing characteristics of current the growth model in Vietnam as well as objectives and contents of restructuring and innovating the growth model. Chapter 7 discusses the most important preconditions for a successful restructuring process, innovative economic thinking and institutional reforms. Chapter 1. From macroeconomic instability to restructuring The world economy has not seen a recovery trend while sudden changes took place in almost all countries and continents, and the risk of the European debt crisis is prevalent throughout 2011 and Macroeconomic Evolutions become complex and difficult to predict at different stages and at different times. In the first half of 2011, while developing countries are facing the risk of inflation and overheating growth, developed counterparts are confronting the fears of a dropping commodity prices. However, at the end of the year, while the developing countries, especially those in Asia, are dealing with a completely reverse risk of dropping commodity prices and trade, and reducing volatile international capital flows, the developed world is struggling with the unpredictable trend of poor fiscal policies and vulnerable financial markets. In Vietnam, the real highlight of 2011 is Resolution No. 11/NQ-CP targeting at curbing inflation and stabilizing macro economy, and orientating the monetary and fiscal policy and fiscal considered conscious and tightened during the year accordingly. Consequently, despite a reducing growth compared with previous years, but a number of macroeconomic instability was 22

23 relieved such as inflation is under control in last months, exchange rate is relatively stable, and the trade balance is improved. However, these problems are not shown to be sustainably addressed, but in fact, continues for years as in case of high inflation, persistent trade deficit and small foreign exchange reserves, unpredictable volatile exchange rate accompanied by dollarization, high budget deficits accompanied by rising public debt, vulnerable financial currency markets to major risks of the system, etc. Adverse volatile changes macroeconomic variables are considered as a consequence of the Vietnamese growth extensive growth with the efficiency of resources decreasing, accompanied with temporary policy response to situations whose effectiveness is limited by the growth model. This model leads to a tradeoff between growth and inflation, and accordingly growth efforts go with the contractionary policy and more and more serious inflation and macroeconomic instability. Increasing and uncontrollable trade deficit is also regarded as a consequence of these changes, and as a result, there is always a devaluation pressure put on the Vietnam dong, leading to a vicious cycle in which high exchange rate inflation have a negative effect on balance of payments and decrease foreign exchange reserves, losing market s confidence and exacerbating dollarization. Besides, that the growth model is applied in the context of less efficiently developed financial market and lack of supervision gradually poses risks such as liquidity risk and bad debts to as banking. For this reason, monetary policy brings about modest and short-term impacts. Therefore, reform of the growth model and restructuring the economy is the only solution and a wonderful opportunity in the current context. Reforming the Vietnamese growth model are necessarily understood as a transition from the primarily extensive growth model to the primarily intensive growth model based on enhanced technical efficiency, allocation efficiency and scientific technical progress, targeting sustainable growth. For quick transition from extensive growth to intensive growth, restructuring the economy is considered as a priority choice at the first stage, and accordingly economic resources are allocated the most effectively, supporting in the reform of economic model. However, preconditions for the successful restructuring are a changing mindset and an institutional reform. Economic thinking needs to be changed. Public sector focused on dealing with shortcomings of marker based economy, eliminating the privileges granted to SOEs and creating a fair business environment for various sectors. Institutions must be reformed to build a monitored and transparent government, a reliable 23

24 predictable law system and protected property rights, aiming at the ultimate objective of creating a fair and transparent environment for investment and innovation. Chapter 2. The risk of fiscal deficit Analyses show that Vietnam is facing risks of fiscal problems including budget deficit and soaring public debt, less transparent fiscal balance, unsustainable public revenue, persistent high spending prolonged, large-scale, scattered and inefficient public investment and a number of potential risks from SOEs. These risks have been resulted in persistent inflation and high interest rate, crowding out effect, substantial trade deficits and devaluation pressure put domestic currency, low growth, and even a financial crisis if policy adjustments are not promptly made. Fiscal problems and their consequences show that it is time for Vietnam to have a radical and comprehensive reform in fiscal policy in order to gradually return to budget balance and maintain long-term economic stability. Thus, possible policy measures are integrated into Chapter. The measures directions include adjusting both the size and structure of fiscal revenue/ spending, besides paying a meticulous attention to SOEs. Chapter 3. Financial market instability Tight monetary policy provides Vietnam with a favorable condition to successfully curb inflation and keep the exchange rate stable in However, the unwanted consequence is liquidity tensions in the banking system, climbing interest rate, and a sharp rise in the ratio of non-performing loans and overdue loans to total gross loans, severely impaired property markets, including stock market and real estate markets. The underlying cause of this phenomenon is that Vietnam has applied capital highly intensive growth model, heavily relying on public investment and SOEs for a long time. Investment demand is huge, but investment is less efficient while savings follow a downward trend. Therefore, the economy must depend on contractionary monetary policy, leading to inflation. The policy that allows banks to convert rural banks into urban ones contributes to uncontrollable investment in inefficient projects. To use capital efficiently, it is necessary to regard addressing non-performing and overdue loans of credit institutions system as the central of monetary policy in SBV should establish an independent fund for restructuring banking system. Regarding the exchange rate policy, SBV should allow interbank exchange rate to fluctuate within a larger band. In addition, SBV should accept more members of inter-bank foreign exchange market, including all of 24

25 investment companies and foreign exchange brokers, and even individuals to eliminate completely the dual exchange rate regime. For gold market, besides centralized management of gold bars, SBV necessarily establishes gold certificate and national gold trading as a tool to manage this market in a professional manner and pay respect to market rules instead of administrative measures. Chapter 4. Challenge of trade deficit Trade deficit of Vietnam is claimed to derive from practical and structural factors. The direct cause is that Vietnam is left far behind in term of competitiveness and technology; over the past decade, there has been hardly any change in national competitiveness when the economy still relies on relative competitiveness in traditional industries using raw materials or a small amount of technology, creating low value-added. Meanwhile, the current competitiveness of export sector is vulnerable to external shocks. The root cause of that is a huge difference between investment and domestic savings, growth models relying on investment while investment brings about declining low efficiency. To solve the trade deficit, it is necessary to ensure two conditions in which a necessary condition is to enhance the national competitiveness of technology, and a sufficient condition is to reform the growth model. Enhancing industrial competitiveness is to ensure stable exports that require the transition of production structure from simple products to value added intensive products in each sector, and besides, shifting production from industries using raw materials and containing a small amount of technology to those requiring a larger amount of technology. That process is influenced and dominated by national technology development policies including the basic and supporting ones. The sufficient condition goes with a fundamental solution, renewing the growth model and restructuring the economy. In addition, it is crucial to strongly restructure the finance and banking system to not only increase the net savings rate, but also effectively control the growth rate of outstanding credit. Chapter 5. Fluctuations of labor and employment In 2011, the labor market shows positive fluctuations in the context of high inflation and macroeconomic instability. Compared with 2010, both unemployment rate and underemployment rate are on a decrease; nominal wages of several labor groups surveyed continue rising although real wages are adversely affected by high inflation. The highlight of the 25

26 macro-economic picture is related to economic growth - in terms of both growth rate and structure. Regarding growth rate, the growth rate was only 5.89 %, but this is remarkable figure in comparison with a large number of countries in Asia and around the world. Regarding growth structure, agriculture, forestry and fishery reach the highest growth rates of three years. Similarly, exports, especially in labor -intensive industries, achieve an impressive growth, having a positive effect on growth, labor and employment in In 2012, however, the situation has changed dramatically and quickly, which may lead to a reversal of the labor market. Economic growth tends to decline, while growth structure experiences unfavorable changes such as in the first quarter, agricultural growth follows a slight decline; industrial growth significantly decreases with the construction industry witnessing negative growth due to the impact of reducing investment and frozen real estate market. There is a slowdown in some labor-intensive export industries. Consequently, the number of registered unemployed follows a rise during first months of These adverse fluctuations demonstrate that the situation is rapidly changing, leading to the possibility of adjusting policies to support employment. In the medium and long term, there should be an effective surveillance system labor market providing timely regular information on employment and income - important indicators to macroeconomic policy planning. Chapter 6. Foundations of growth Economic growth is maintained in the long term only when essential foundations are established. These foundations not only rely on an increase in inputs, but are also formed and strengthened by an appropriate incentive system that enhance the efficiency in general, including technical efficiency, allocation efficiency and technological advances. Since Doi Moi, Vietnam has gradually liberated the workforce market-based reformed policy (including both institutional reform and developing private sector), macroeconomic stability and global economic integration. Thanks to this, economy has reached a relatively high and continuous growth rate despite some declining periods. However, the economic growth of Vietnam is still largely based on increased inputs, especially capital and labor. This trend becomes clearer than that in the 2000s when growth model focuses on high growth based on investment (especially public investment) and credit. In contrast, labor productivity and total factor productivity take a faint role in economic growth. All of technical efficiency, allocation efficiency and technological advances have not 26

27 achieved significant breakthroughs. Meanwhile, economic growth is faced with a number of risks and not really sustainable; challenges of sustainable society and environment exist. Consequences of macroeconomic instability associated with previous growth model require drastic economic restructuring and growth model reform. On this path, it is urgently required to gain the intensive growth focusing on improving the efficiency of economy in general, and technical efficiency, allocation efficiency, and the development of sciencetechnology in particular is required urgent. There is room for this content while possibility of increased inputs was much more limited. Chapter 7. Innovative thinking and institutional reform To improve the efficiency of public investment and promote the role of private sector in industrialization, it is essential to change thinking about the role of SOEs, the role and function of government in market economies and deeper integration into the world economy. Meanwhile, economic institution plays an important part in economic activities in Vietnam because the institution establishes and regulates the operation of market mechanisms, global integration, and the development of the private sector besides the state sector that has occupied a monopoly for many years. A large number of shortcomings of the economy are derived from economic institutions, planning, plans, public investment, etc. The 3rd Conference of the Party Central Committee recognized thinking of term and interest groups as a disease of the economic institution, having a direct effect on areas such as banking - finance, investment and SOEs. A strong institutional reform: monitoring power at all stages, all levels and all areas; monitoring independently and transparently in compliance with international standards on public governance and corporate governance is seen as a key to gradually overcome the existing disease of institution and requires a great political determination. 27

28 Chapter 1 FROM MACROECONOMIC INSTABILITY TO RESTRUCTURING PREFACE Two decades after the economic reform, Vietnam has achieved numerous remarkable results such as making it to the group of low-average income countries since 2010, significantly improving the standard of living, providing better social welfare, successfully eradicating mass poverty, quickly achieving many targets of the Millennium Development Goals. However, the recent negative changes in the global economy have gradually exposed the basic disadvantages of the Vietnamese-mannered model of economic growth, in which growth is mostly due to expanding the scale of input resources; nevertheless, the lack of efficient use of the resources has got the economy faced up with macroeconomic instability for a long time. Thus, reforming a new growth model and restructuring the economy has been an urgent and top-prioritized policy since During the period from when the national economy had to encounter a number of difficulties, the idea of restructuring the economy was once proposed; however, Vietnam was not determined enough and missed the chance to make it real. As a result, the spiral of difficulties and instability became more serious during the next period In the difficult global economic situation, when the geographical balance and influences of the policy became weaker due to the growth model itself, the intensive macroeconomic instability that lasted until 2011 should have been considered as an opportunity that could not be missed again to reform the growth model and restructure the economy. Chapter 1 will show the contents and ideas of the entire report, which is an overall picture of the economy, especially the macroeconomic instability in 2011, analyzing the major causes of the prolonged instability that came from the economy s structure and the growth model. It will also clarify the nature of the process of restructuring the economy and reforming the growth model and suggest an important premise: Vietnam needs to change its thinking on economics and institutional reforms. Some major problems outlined in Chapter 1 will be explained more specifically in the next chapters. Chapter 1 consists of three parts. Part 1 concentrates on describing the economy and the policies in Part 2 analyzes the features of Vietnam s 28

29 growth model and links them to recent macroeconomic instability. Part 3 mentions conditions that are necessary for the process of restructuring to be successful. VIETNAM S ECONOMY IN 2011: CONTINUED MACROECONOMIC INSTABILITY World economy in 2011 After the global recession in the years , the world economy seemed to recover quickly with an impressive growth rate of 5% in In fact, in the first half of 2011, the economic situations remained relatively favorable, and international institutions actually made positive predictions about global growth. However, the economic situations turned worse in the second half of 2011, resulting in lowering growth forecast 2. The global economic growth rate in 2011 finally reached 3.8% only. In addition, there were considerable changes in different groups of economies, among which a big difference became easier to recognize. The economic growth division was maintained; economic growth rates in developed countries and in developing ones, in that order, were 1.6% and 6.2%. Besides, during the first six months of 2011, while the developing countries were facing the risk of inflation and overheating, the developed countries worried about the decrease in commodity prices. Nevertheless, at the end of the year, Asian developing economies, the world s leading growth, were faced with completely opposite issues: reductions in commodity prices and trade and volatility in international capital flows; at the same time, the developed economies (mostly European countries, the US and Japan) were struggling against the unpredictable and fast-changing circumstances of the poor fiscal policies and the vulnerable financial market. Generally, owing to adverse conditions everywhere, never have all continents been put under pressure of inflation, falling prices and growth with fear of sinking into a new recession. 2 Economic growth forecasts in April 2011 for the globe, the developed countries and the developing countries by IMF were 4.4%, 2.37% and 6.54%, respectively. At the end of the year, due to the fluctuation in production and consumption caused by natural disasters such as floods, droughts, as well as the public debt crisis in Europe, in September 2011, the economic growth forecast for the globe was 3.96% and the figures for developed countries and developing ones were 1.6% and 6.4%, respectively. (According to World Economic Outlook issues published in September 2010, September 2011 and World Economic Outlook Update issues published in January 2011 and in January 2012.) 29

30 Europe s public debt became more serious The 2011 European public debt was so severe that it posed a major threat to the global economic recovery and growth. That the South European countries were close to the edge of insolvency and the growth rate was too low would probably lead to a Eurozone break-up 3. At the end of 2009, concerns were raised about Greece s ability to manage public debt after it was revealed that the actual value of the county s budget deficit was much larger than estimations. In 2010, countries such as Portugal, Ireland and Spain, whose ratios of budget deficit to GDP and net debt to GDP were higher than those of other countries in the Eurozone, had to deal with the same issue (Figure 1.1, 1.2) 4. The EU and IMF s bailout for Greece and the creation of the European Financial Stability Facility (EFSF) did not manage to alleviate the fear of solvency in late , which worsened the spreading of public debt crisis in the same year. The second bailout fund (the European Financial Stabilization Mechanism - EFSM) was set up, and Portugal and Greece were saved once again during the first half of the year. Nevertheless, the crisis reached Italy in November 6. This was a real problem since Portugal, Ireland and Greece were small economies, which contributed only 2% of the Eurozone s GDP; meanwhile, Italy was a large economy of the region, constituting 17% of the Eurozone s GDP 7. 3 Report Euro break-up - the consequences by the Union Bank of Switzerland (UBS) even suggested a disaster scenario, in which the Euro break-up would cause economic, political and social consequences for the Europe and the global economy. According to UBS, the political consequences would be the breakdown of the European Union (EU). Meanwhile, the social results would be even worse than the economic ones: social disorder would explode and spread all over the continent. UBS warned that there would be outbreaks of social dislocation, civil unrest, demonstrations, which were happening in Greece at that time, or even civil wars. 4 While Greece was suffering from high budget deficit for consecutive years, Spain and Ireland had been net-lending economies before the global economic recession in 2008 with a low ratio of debt to GDP. However, falling revenues along with rising costs during the crisis demanded a higher interest rate for government bonds ( Italy s ten-year government bonds rate went from 3.8% by the end of 2010 to 5.9% as of October Although budget surplus including interest payments was seen in late 2011, Italian ten-year bonds were temporarily transacted at a rate of 7% - a threshold at which the decrease on Italian debt would by no means come. Meanwhile, other countries whose bond rates had reached that threshold already received grants. The scale of Italy s economy showed that such activities were nearly impossible to carry out. 30

31 Figure 1. 1.Budget deficit of some countries in the EU Source: IMF, WEO September Figure Net debt of some countries in the EU Source: IMF, WEO September Fortunately, in early 2012, an agreement of debt swap was reached between Greece and its creditors, thanks to which, Greece got the next bailout package from the EU and the IMF, 31

32 resulting in positive changes in the Europe s public debt crisis. Consequently, the national credit rating of Greece was upgraded by international institutions such as S&P and Fitch. In addition, that revenues from exports were increasing in Ireland and Italy succeeded at issuing government bonds while Portugal was likely to achieve budget deficit targets in 2012 would leave the door open to prospects for the region s economy. However, according to EIU, the chance of widening crisis still remained due to Greece s high level of debt in a situation where solutions of limiting spending could not save the economy from prolonged recession, and budget revenues continued to decline while debt increased. Besides, Spain could not meet budget deficit targets in 2011 and seemed unable to do so in Under the circumstances, belt-tightening policies being implemented would be carried out more thoroughly in most countries in the Eurozone. Besides, financial volatility as well as stricter loan conditions also urged European banks to cut debt. This would lead to a scarcity of credit and growth limitation, and fail to cut the high unemployment rate. On the other hand, according to IMF (2011), the fact that the Eurozone economy had not reached the potential output was not the only reason for its low growth rate. That was also because of the low level of potential output. IMF s forecast issued in January 2012 said that the rate of Eurozone s economic growth would stand at only -0.5%; the figures for Spain, Italy, France and Germany were -2.8%, -2.2%, 0.2% and 0.3% respectively, which were much lower than the growth rate forecast in September Hence, the reforms necessary to regional growth would focus mainly on economic structure problems such as liberalizing labor markets, reforming state apparatuses, cutting public spending. Notwithstanding, this progress would have to cope with political affairs. And even when promptly enacted, these reforms would still take time before economic growth could recover. Slow recovery of the US economy The year 2011 witnessed a slow-paced recovery of the world s biggest economy, which suffered from negative effects of volatility in financial markets as well as a fall in the domestic demand due to a slight increase in the proportion of savings, which was a reaction to measures to stabilize the fiscal systems. The US budget deficit dropped sharply, going from 12% in 2008 to 9.5% in 2011 and was predicted to continue to decline by 1.5% in Meanwhile, the ratio of public debt to GDP had risen considerably since 2007 (Figure 1.3). The US public debt was so 32

33 high that it led to a debate between the Federal Government and the Congress 8. Nevertheless, until the end of 2011 and the beginning of 2012, prospects for the US economy became brighter with the growth rate of 1.8%, which was 0.3% higher than forecasts in September In addition, a decrease was seen in the unemployment rate, which fell from 9% in late 2011 to approximately 8.5% by March One of the reasons for those positive changes was that the domestic demand increased again while savings declined slightly thanks to the fact that Europe s fiscal problems had been solved, which put less financial pressure on the US economy. However, concerns about the sustainability of the economic recovery and the stability of developing countries fiscal systems required a contractionary policy from the US government. Despite being an obstacle to economic growth in 2012, the policy was still expected to be operated in an aggressive way. In addition, the deep political division made the economic policies of the US more unpredictable and risky 11. In contrast to contractionary policies, expansionary ones, in which interest rates had stayed close to 0% since 2009 (Figure 1.4), seemed to continue to be pursued 12. Generally, both the US and developed economies did choose expansionary policies when there had not been a sign of increasing inflation rates 13. Federal Reserve s reports pointed out that its low interest rate would be hold until mid Fed s second quantitative easing (QE) ended in mid-2011 while another round of QE easing was appeal to be carried out. By doing so, the Fed could purchase assets in order to decrease long-term interest rates In mid-2011 started a political debate on the debt level of the Federal Government, resulting in a downgrading of the US credit rating, which, however, did not cause a rise in interest rates. Despite of a low aggregate demand and a high unemployment rate, political debates in 2011 still concentrated on the sustainability of the public finance. 9 Source: WEO January See Prices or jobs? Could the Federal Reserve lower unemployment by revamping its goals? at 33

34 Figure Public financial deficit and public debt in the US Figure Fed s interest rates and ten-year bond interest rates Source: IMF, WEO. Source: The Federal Reserve. Asia: Natural disasters and hidden risks Asia s economy seemed to have never set foot in the global recession spiral. The year 2011 witnessed impressive growth rate of the Asia s economy. Although the region s output had 34

35 been badly affected by natural disasters in Japan and Thailand, the continent s growth rate still reached 7.9% in The 2011 tsunami in Japan caused not only huge loss of life and infrastructure 15 but also great effects on Japan s economy as well as the world s economy. Its automotive industry with big automobile manufacturers was forced to discontinue while 425 Japanese companies went bankrupt. The disaster also led to disruption in the global production chain and a slowdown in world s economic growth during the second quarter of It took Japan back to recession after one year of average growth (Figure 1.5). Budget deficit occupied more than 10% of the GDP, and public debt rose sharply to 130% of the GDP. However, the government bond rates were still kept at a low level (Figure 1.6), and Japan s fiscal volatility was not as worrisome as that of the EU since 90% of the government bonds were in the domestic sector s hand 16. Figure Japan s macroeconomic prospects Source: IMF, WEO. 15 On 11 March 2011, the most powerful earthquake ever to hit Japan occurred and initiated a series of large tsunamis, which caused more than 27,000 deaths and enormous damage for the Fukushima Daiichi Nuclear Power Plant. See more at

36 Figure Japan s public financial deficit and public debt Source: IMF, WEO. Japan was not the only country that suffered from devastating effects of natural disasters. In 2011, the worst flood in five decades hit Thailand causing nearly 400 deaths and 600,000 people unemployed. The total value of covered damage was approximately up to 19 billion USD. The central bank of Thailand estimated that the nation s economic growth rate would likely to fall by 1.5 % and stop at 2.6% in The flood also interrupted the global supply chain of hard-disk drives, automobiles, etc. as multinational companies manufacturing such products had set many plants here 18. There was a growing concern among foreign companies about the stability and safety when investing in Thailand, making them consider shifting their investment to neighboring nations 19. Besides, about more than 12.5% of agricultural land for rice paddies were severely damaged after the flood, resulting in a reduction in rice output used for exporting Biggest foreign investors in Thailand were paying their attention to Vietnam and Indonesia, which both attracted more foreign direct investment than Thailand in See more at 36

37 In spite of being the world s fastest-growing major economy in 2011, there still existed hidden risks from the economy. In fact, some researchers have proved that the reasons for China s tightening monetary policies and contractionary ones were the risk of the bursting of real estate bubbles as well as the risk of hard-landing of the economy. Therefore, in the next few years, China s economy would be hardly likely to grow as fast as it has recently. Prices in various markets Commodity markets In 2011, the world s commodity prices followed two trends: they increased sharply during the first six months then gradually became stable for the rest of the year thanks to the recovery of commodity supply and the decrease in demand. The prices of oil rose again after having dropped to 40 USD per barrel since late 2008 and early In 2011, oil prices increased by 8% within the first ten months (Figure 1.7) and reached its peak at 120 USD/barrel in April, which was mostly because of political volatility in Middle East and North Africa. When volatility was less likely to spread to large oil exporters such as Saudi Arabia, the prices of oil started to decline rapidly. An increase in the oil supply from the Organization of the Petroleum Exporting Countries (OPEC) and the fact that developed countries allow the use of strategic oil reserves were the main reasons for the decrease in oil prices. In 2012, global economic growth prospects could possibly have impacts on the prices of oil. The World Bank (WB) predicted that the oil price would follow a slight downward trend and stay at 94 USD per barrel next year. The forecast is based on the European recession that might lead to cutting demand for energy. 37

38 Figure World oil prices Figure Food price index 20 Source: WB The world price of food had risen rapidly since June 2010 and reached its peak in February 2011 (Figure 1.8). The pressure of the supply and the demand had certain effects on this increase. That global production was disrupted owing to natural disasters and food output was declining while the average income of developing countries was being improved raised the demand for different kinds of food such as cooking oil and meat. Increased energy prices were also one of the main reasons for the rise in food prices as energy was an important input to agriculture 21. However, thanks to the improved supply, prices had been stable since March 2011 and the WB predicted that the food price index would drop by 13% in 2012 because food output continued to grow. 20 The World Bank did not give any data about the prices of Vietnamese rice 5% before They did not make prediction about the price of this type of rice either. 21 Econometric estimates show that if energy prices rose by 10%, the rice prices would increase by 2-3% averagely. In fact, this was proven to be true: the price of oil rose around 223% during the period from the years to the years ; the food prices increased 50% approximately. See more at 38

39 Figure Gold and metal price index Source: WB. The gold prices have increased continually the past years and 2011 was not an exception when it climbed by 23% within the first ten months. The demand for gold followed an upward trend since investors took precautions against the economic growth that was lower than expected and the pressure of stock markets and prices. The increase in gold prices reflected the fading faith in the position of the US dollar. However, the WB made prediction that gold prices would fall by $1500 per ounce in Meanwhile, the prices of metal and ores had fluctuated during the first half of 2011 before dropping sharply to fewer than 20% in the second half. Concerns about global economic prospects were a major cause of falling prices as risks from the recession in Europe and from the tightening monetary policies in China had reduced the demand for copper and aluminum. The WB predicted that prices of most metal would not fluctuate much in the next year. Stock markets The US stocks following a positive upward trend since the second half of 2010 increased sharply during the first quarter of In May 2011, growing bad prediction about the US economy together with the European crisis led to a sharp fall in the S&P index in July After rising considerably in October, the US stocks dropped by 6% in November and stayed at 39

40 25%, under its peak before the economic recession. However, positive signs from the economy made the S&P 500 index go up dramatically until the end of March The last time it reached its peak was in June Figure Stock market index in various economies Source: WB. Note: The indexes calculated in January 2010 equals to 100%. In Europe, the stock market suffered huge loss when the Euro STOXX BROAD index fell by 20% in November The main reason for this was worries about public debt. European banks seemed unable to create enough credit for other fields. Decreased stocks also reflected the rising risk of poverty in Europe when governments pursued contractionary fiscal policies to deal with public debt despite high unemployment rates. However, with positive changes in the public debt crisis in early 2012, Europe s stocks went up again as seen in Figure In Japan, after a lackluster performance in 2010 when decreeing by 2.5%, the Nikkei 225 followed another downward trend dropping by 22% in The earthquake in March

41 resulted in a decrease of 7% within one day, and concerns about global growth in August 2011 led to a sell-off in the market. Japan s recession left investor less optimistic. If it those two shocks had not occurred, some supposed that the Nikkei index would still have fallen sharply. Despite growing relatively high, generally, global stock market prospects in 2012 were not really sustainable due to concerns about the comeback of Eurozone s public debt in the first quarter of In addition, the recovery of the US economy also had effects on investors. Although American companies continued to make profit, low growth prospects were believed to hinder their expansion. Meanwhile, in Europe, volatility in finance and banking would pull stock market prospects down, even when Eurozone was able to avoid economic recession. In Japan, in spite of the recovery after the disastrous earthquake, an increase in stock market for long term still remain difficult with the country s aging population. Impacts of the world economy on Vietnam s economy Global economy made great impacts on Vietnam through the following channels: trade, investment, remittances, official development assistance (ODA) and tourism. That was because Vietnam s economy was more open, compared to the ratio of trade to GDP up to 160% ( ) 22 and that Vietnam s biggest importers such as the US, the EU, Japan, China and Australia (Table 1.1) were likely to get into volatile situations. Besides, the fluctuation of commodity prices in global market would also affect the domestic economy through the channels mentioned above. Vietnam is a net crude oil and food exporter; therefore, a change in these commodities will bring a corresponding change in income, government revenues, investment and economic growth 23. Moreover, with high proportion of imported material for production, changes in prices of key commodities in global market will likely to resonate with other factors leaving Vietnam s inflation more unpredictable. Vietnam also received critical capital from the outside. Its foreign direct investment (FDI) came mainly from the US, Taiwan, Japan and Singapore 24. Especially, in 2010 and 2011, the indirect capital flows played a more important role proved by its increasing scale. Remittances were another essential capital source of Vietnam, which equaled to 7% of The ratio trade/gdp is the ratio of exports and imports to GDP General Statistic Office s data. 41

42 GDP. Despite being equivalent to half of remittances, the ODA was also one of the most important sources of foreign capital. Japan and the EU were the two biggest aid donors in Vietnam ( ) 25. Recently, tourism has also made a positive contribution to the economy. Most tourists that visited Vietnam came from Asian countries such as China, South Korea and Japan 26. Table Vietnam s key economic cooperation Importers FDI Remittances ODA Tourism 1 The US 20% Malaysia 14% The US 58% Japan 29% China 18% 2 The EU 18% The US 12% The EU 18% The EU 23% South 10% Korea 3 Japan 13% Taiwan 10% Australia 10% The US 6% Japan 9% 4 China 9% Japan 9% Canada 9% Australia 4% The US 9% 5 Australia 7% Singapore 9% Cambodia 2% South 1% Taiwan 7% Korea Source: Vietnam General Statistic Office, Vietnam National Administration of Tourism, OECD and WB. Note: Each figure is the proportion of each corresponding element to the whole value, except for tourism, in which the figures represent the percentage of the total number of tourists. Thus, when the global economic prospects for 2012 were not so positive, Vietnam s economy would be affected somehow. Firstly, the recession in America and the Europe might have effects on the exportation. These two regions occupied up to 40% of markets that imported goods from Vietnam. The recession in either market would lead to a reduction in the demand for importation. In fact, during the global recession in the years , several factories had to shut down and some others had to make redundancies (VASS, 2009). Fortunately, Vietnam was somewhat protected from negative effects of the recession as its exported commodities were generally the cheaper clothing and textiles, and the demand for food is less likely to follow a cyclical trend and less dependent on financial situations 27 (necessity goods). If the recession in 25 OECD, DAC IMF, consult term IV 2009, page

43 Europe had become worse in 2012, it would have brought the oil prices down, and then reduced the total value of Vietnam s exported oil as well as budget revenues. Economic issues in Asia could also affect goods prices because most of increases in demand for energy and metal came from China and India. Furthermore, economic recession was often followed by protectionism policies that were meant to allow fair competition between imports and goods and service produced domestically to ensure production and employment in the country. Hence, Vietnam should also prepare to face the risk of currency war 28 or increasing trade barriers from partnerships when global economy was under bad circumstances. Secondly, foreign investment and private investment flows would have declined sharply if the crisis in Europe had led to a global financial crisis. Over the next year, European banks and its partnerships seemed to refuse further credit in order to cope with possible losses 29. When European banks tended to have less cooperation with Vietnam, tightening credit markets could lead to a decrease in capital flows in Vietnam. Thirdly, recession in the US would make bad impacts on remittances to Vietnam. During the global recession, Vietnam s remittances fell by 9% from 2008 to 2009, reflecting the poor working conditions in the US and Europe. Employment growth rates were predicted to rise slowly; as a result, the remittances did not seem to increase sharply in The recession in America and Europe could decrease remittances going to Vietnam, an important source of foreign exchange and income. Fourthly, the global economic conditions would affect Vietnam s tourism. Fluctuating income of developed countries would decrease the demand for overseas visiting. During the years of recession from 2008 to 2009, foreign tourists visiting Vietnam fell by 20%. Over the past years, Chinese and Korean tourists had accounted for 30% of the total number of tourists in Vietnam. Thus, growing income in these countries would give support to Vietnam s tourism in Finally, the ODA from Europe might decline because the governments were doing their best to decrease their large budget deficit. While the UK pursued belt-tightening policies, other countries had hardly done anything. For Vietnam, Japan committed an aid record despite its large deficit and the earthquake in March See Carmen M. Reinhart and Kenneth S. Rogoff (2008)

44 Overview of Vietnam s economy in is the first year of the economic and social development plans with much macroeconomic instability that needed to be dealt with. The structural weaknesses of the plans affected directly the effectiveness of the economy: prolonged inflation, unstable and lower growth, along with other macroeconomic instabilities such as trade deficit, public debt and foreign debt30. Since lately 2007, there were clear indications of economic weaknesses. In 2008, in the context of global economic difficulties and a vulnerable economic structure, the growth target set by the Government has been adjusted downward from 8.5-9% to 7.2%, but unachievable eventually. GDP growth was only 6.23% in 2008, marking a decline in the growth rate. In 2009 and 2010, the rate of economic growth kept low at 5.32% and 6.78%, respectively in Vietnam. Economic growth, thus, were not able to meet the target level (see Table 1.2). Besides, in the past four years, Vietnam is the country with the highest inflation rates in Asia. Foreign currency reserves are also frequently in tension with foreign exchange rate is adjusted by the administrative decisions and often under devaluation pressure. Financial markets, especially stock market, fluctuate with a large band. Meanwhile, sovereign credit ratings partly show poor performance of Vietnam in comparison with other countries in the region. In new period, the plan of economy and social development in 5 years was approved on 8th, November, 2011 by the National Assembly No.13. In this plan, two main issues of the economy were mentioned and defined as targets which need to be resolved: (i) Macroeconomic stability is top priority, and (ii) orienting the improvement of the economy effectiveness. The target for the next 5 years is to maintain the growth rate of 6.5-7% per year which is lower than the previous 5-year plan. Consumer price index is targeted at a lower level of 5-7% in The public debt is lower than the previous years for implementing the plan to maintain that total public debt does not exceeding 65% of GDP, government debt and the national debt does not exceed 50% of GDP. At the same time, the 5 years plan also pays more attention to the efficiency factor of the economy with three criteria: (i) the percentage of high-tech products was 30% of the tot al industry value; (ii) social labor productivity 30 The period was unstable when inflation climbed; growth was unstable and lower than the last years. This period witnessed a strong influence of global financial crisis on Vietnam. That proves both considerable economic integration and vulnerable characteristics of Vietnam to external shocks. 44

45 increased by 29-32% from 2010 to 2015; and (iii) decreasing from 2.5-3% per year in energy consumption to GDP. Table Plan and implement data plan Implement Criteria Increase in GDP from the plan started year 2.1 times 2.02 times GDP growth (%,yearly average) GDP per capita (USD) 1,050 1,100 1,173 The structure of GDP (%) - Agriculture-forestry-fishery Industry and Construction Services Annual growth of export turnover (%) The rate of mobilization to the budget (%/GDP) Gross social investment capital (%/GDP) Source: GSO, Ministry of Finance, Ministry of Planning and Investment Indeed, these above policy directions have been implemented in the first months of under Resolution No. 11/NQ-CP dated 24/2/2011 of the Government (Box 1). This resolution is also an orientation of macroeconomic policies throughout the year, confirming the goal of macroeconomic stability rather than economic growth and affects many aspects of the economy in the last year. Box 1: The important highlights of the Resolution No. 11/ NQ-CP In the first two months of 2011, the fluctuations of global economy (a sharp increasing trend in the prices of gas, food and basic commodities ) and domestic economy (a dramatic alteration in petrol price and electricity price,soaring inflation, practically chaotic exchange rate in free market, thin foreign exchange reserves, constantly high 45

46 trade deficit, high degree of dollarization and goldization, extirpation in confidence in dong currency and macroeconomic management and so on) showed that Vietnam was facing serious challenges and macroeconomic instability was threatening the sustainable development of the economy. As a result, macroeconomic stability was essential goal as well as the only option at that time. The Resolution No. 11/ NQ-CP of main solutions to curb inflation stabilize macro economy and ensure social security on 24/2/2011 demonstrates clearly political determination in the fight against macroeconomic instability which was in danger threshold. That, up to now, is the most aggressive and strong action of the Government. It is the first time the Government has completely eliminated its growth target in 2011; all measures and policies are aiming at macroeconomic stability. Solution groups in the Resolution No.11 Solution groups 1. Implement cautiously and tight monetary policy Specific solutions - Operating and controlling to ensure credit growth below 20% in 2011, the total payment (M2) growth about 15 16%; prioritizing credit for development of production and business, agriculture, rural export, industry and supporting medium and small enterprises. - Operating flexibly exchange rate and foreign exchange market; requesting groups and the state corporations to sell foreign currency to banks if they have and to be purchased upon reasonable demand. - controlling strictly gold trading activities: centralize gold import sources, then eliminating the bullion trade in the free market; preventing effectively smuggling gold across the border. - Monitoring compliance with the provisions of foreign currency exchange and gold trading 2. Implement tight fiscal - Increasing by 7-8% in budget revenues compared to the 46

47 policy, reducing public investment and state budget overspending budget estimates in 2011; saving regular budget spending more 10%; reducing state budget overspending below 5% of GDP in Not to advance state budget and government bonds to projects except urgency projects about disastrous consequence prevention and remediation; Not to prolong the implementation of investment funds from the state budget, government bond as plan in Vietnam Development Bank reduced at least 10% of investment credit plan from state capital credit. - Not to start new constructions and projects using capital from the state budget and government bond except urgency projects about disastrous consequence prevention and remediation, national key projects and investment projects from ODA. - The economic groups and state corporations checked, reduced, and rearranged their investment projects, focused on main production and business sector. 3. Promoting production, encouraging exports, curbing deficit, saving energy - To promulgate and implement regulations of regulating the balance between supply and demand for each essential commodities; to ensure reasonable combination between domestic production and import operation. - Striving to ensure that the trade deficit does not exceed 16% of the total value of export; to guarantee the amount of foreign currencies to import essential commodities that domestic production cannot meet. - To prioritize guarantee of supplying power for production. - To encourage development of agriculture and rural area, increase production, create job, income for workers, ensure 47

48 food security. 4. Altering the prices of electrical and petrol associated with poor households support 5. Strengthening guarantee of social security 6. To promote Because of quite drastic implementation of Resolution No.11, Vietnam's economic growth in 2011 was only 5.89%, below the target set. Nevertheless, macroeconomic instability has also been eased, inflation has been contained at the end of the year, and after many years of deficit, and the current account was a surplus. However, macroeconomic instability still existed and no signs of being resolved in a sustainable manner. Meanwhile, suddenly applying tightens policy when bank and financial system was weak and had some disadvantaged caused tension of financial area. More details about Vietnam s economic changes in 2011 along with the impacts of policies in the past year, especially tight monetary policy, would be shown in the next section through four key areas including output and employment, external economic, monetary and budget balance. Changes of output and employment The structure of sectors in GDP According to the data from the General Statistics Office, comparing with Gross Domestic Product (GDP) in 2010, this figure increased by 5.89% but was smaller than the target lowered (6%) in June, In particular, despite still contributing the lowest proportion in growth, the percentage of agriculture forestry fishery sector increased significantly from 7% in 2010 to 11.15% in In 2011, the value of this sector at constant price was estimated to reach trillion dong, rising by 4% from In agriculture, rice production experienced a successful year with the highest yield growth in the last 10 years (the General Statistics Office, 2011). In general, in the whole of 2011, agriculture - forestry - fishery has been a significant expansion and 31 Vietnam s economic growth indicator was set 7.5% in December However, before the requirement of macroeconomic stability, growth target was down the second and reduced to 6% in June

49 is a factor contributing to economic stability especially with the impressive contribution of the agricultural sub-sectors. Table GDP growth by sectors, Sector Growth rate (%) GDP Agriculture - forestry - fishery Industry - Construction Service The contribution to GDP growth rate GDP Agriculture - forestry - fishery 0,72 0,64 0,68 0,32 0,47 0,66 Industry - Construction 4,17 4,34 2,95 2,29 3,2 2,32 Service 3,34 3,5 2,9 2,71 3,11 2,91 The percentage of sector s contribution to GDP growth rate GDP Agriculture - forestry - fishery 8,77 7,52 14,3 1 6,05 6,99 11,2 Industry Construction 50,68 51,22 37,2 9 43,0 7 47,1 9 39,4 Service 40,55 41,6 48,4 50,8 8 45,8 2 49,4 Source: the General Statistics Office and the calculation of researchers. 49

50 In contrast to the agricultural sector, adverse changes in the economy were reflected primarily in the industrial and construction sector 32. To specify, two fields which were most severely affected and had negative growth rate in the last year were the mining industry and construction. After a decrease of 2.2% from 2010, the general growth rate of industry sector was 5.53% in Particularly, while production and supply of electricity, gas and water sector experienced the lowest decline, the mining has continued to show very low growth with its scale shrunk since There was a more optimistic sign in the processing industry, opposite to the change in the shock of ; this sector s growth rate went down slightly from 8.38% in 2010 to in Nevertheless, the processing industry s tolerance will be tested in 2012 because the impact of the crisis on this sector is longer than the others. Meanwhile, macroeconomic instability and tight monetary and fiscal policy seems to have less effect on service sector. The statistics showed this sector s stability with 7% growth and the increase in the contribution to GDP growth 33. The expenditure components of GDP Table The structure of GDP in the total demand Criteria GDP at current price Asset accumulation Final consumption Net export Inaccuracy Source: CEIC, the General Statistics Office 32 The construction sector can be used to herald the economy's troubles. Two recent crises can be diagnosed through changes in this field with a large-scale decline in 2008 and In the service sector, the real estate brokerage witnessed a largest decrease with growth speed just be 1.83%. This field has dropped continuously since 2007 together with the fall in the real estate sector and construction. Two sub-sectors whose growth speed was higher than that in the previous year were healthcare and education. 50

51 Final consumption of both private sector and the Government witnessed an upward trend in the last time 34. In 2011, after a rise by 24.02%, final consumption was 1,794,500 trillion dong. In specify, the figure for the Government was 164,300 trillion dong while the data of private sector increased by 23.72% to 1,630,200 trillion dong in That growth speed of private consumption was bigger than that in 2010 showed demands of consumer rising. Despite the Government s urge to tighten fiscal, growth speed of the Government s expenditure climbed from 23.7% to 27.07% in Concerning contribution percentage in GDP growth, the figure for consumption was about 17.55% in Generally, this has been the second highest contribution (lower than that in 2008) since Table Final consumption in GDP, Value (trillion dong) Final consumption Private The Government Growth speed (%) Final consumption Private The Government The proportion of GDP growth (%) Final consumption Private The Government Source: CEIC, the General Statistics Office and the calculation of researchers 34 In 2008, consumption growth speed surged to nearly 35%, in which, the figure for private was 34.82% and for the Government was 31.28%. In 2009, because of impacts from economy crisis, final consumption growth speed of both the Government and private sector decreases to about 10%. Then, with the economic recovery, consumption rose in

52 Asset accumulation showed expenditure for investing in fixed, current and precious assets. As a result of global financial and economic crisis together with reaction of policies, growth speed of asset accumulation strongly fluctuated and significantly dropped. Before economic crisis, growth speed of asset accumulation was 37.55%. In two years , this speed decreased to 19.55% and 7.22%, respectively, leading to a decrease in proportion asset accumulation in GDP from 43.13% in 2007 to 39.71% in 2008 and 38.13% in Therefore, contribution in GDP growth declined much more than that before the recession, from 13.82% to 8.43% and 2.87%. In 2010, thanks to the government's effective stimulus packages, the asset accumulation climbed by 21.8% compared with 2009, which caused proportion asset accumulation to rise to 38.88% and reach 8.31% of GDP. However, because the implementation of tight monetary and fiscal policies orienting the Resolution No 11/NQ-CP on Feb 24, 2011 leaded to high interest as well as world economy had some adverse impacts, generally investments in domestic economy reduced. The proportion asset accumulation was just 32.62% in Table Asset accumulation and GDP (at real prices) Criteria Asset accumulation (billion dong) Proportion of GDP (%) In which Fixed asset 38,27 34, Current and precious asset 4,86 5, Growth speed of Asset accumulation 37,55 19,55 7, Contribution in GDP growth 13,82 8,43 2, Source: the General Statistics Office 52

53 There was an upward trend in the social investment capital 35. In 2007, investment capital was 532,093 trillion dong, in 2010, after a rise by 17.1% at the real price comparing with 2009; the figure was 830,278 trillion dong. The implementation social investment capital at the real price, before reaching trillion dong and accounting for 34.6% of GDP, experienced an increase by 5.7% from Considering the structure of the investment capital in detail, the proportion of the state economic area witnessed a downward trend from 40.6% in 2009 to 28.1 % in In the next year, this figure climbed by 5.7%, equal to 101.8% of plan. Meanwhile, the data of the non-state area, which was trillion dong in 2011 after rising by 3.3% from 2010, occupied 35.2 % of the gross investment capital. Besides, the foreign direct investment area, after growing by 5.8% comparing with that in the previous year, contributed trillion dong and made up 25.9% of the gross investment capital. Thus, the economic problems only hindered the investment capital growth of the non-state sector, the measures to tighten monetary and fiscal mostly caused the private sector to shrink while the figure for both the State sector and the foreign investment sector witnessed a significant growth speed. Table The structure of social investment capital, (%) Source The state sector The non-state sector Foreign direct investment area , Total Gross social investment capital Source: the General Statistics Office In external demand sector, import is always bigger than the other. This means domestic demands are always bigger than production ability of the economy. A good sign was a decrease 35 According to the General Statistics Office, while the asset accumulation means investment in fixed assets and change in current asset inventory in the economy, general investment in this section means expenses of increasing the amount of fixed, current and precious assets and so on. Thus, there are a gap between investment in statistic and fixed asset accumulation which is considered as material investment in the economy. A part of this gap is explained by investments in human and short-term financial investment. 53

54 in trade deficit in the last years. Especially, the deficit was lower than 10% in However, this was still a high import surplus comparing to countries in the region and in the world 36. Details of this item will be mentioned in the external sector of the economy. Labor and Employment In the period , the total employment in the economy increased from 44 million to 50.6 million (average rise by 2.83% per year) (Figure 1.8). Meanwhile, the growth of the volume of labor equaled to the figure for employment (2.8% per year), which showed fairly corresponding expansion of supply and demand in the labor market. Even so, because the new job growth was still lower than the labor growth, unemployment rate climbed slightly from 2.1% to 2.3% in the period, with the amount of unemployment rising from 1 to 1.2 million. However, the unemployment rate in urban areas experienced a positive change in a decline from 4.8% in 2006 to 3.6 % in In addition, comparing with 2010, there were some positive changes in unemployment rate in The figure for urban workers was 3.6%, for rural workers was 1.71% (in 2010, the respective number were 4.29% and 2.30%). The percentage of workers in working age was 3.34% in 2011, in which, the data of the urban area was 1.82%, of the rural area was 3.96% (in 2010, the corresponding ratio is 3.57%, 1.82%, 4.26%). Concerning the structure of labor force (aged 15 and over) are working in the economic sectors, until 2011, the domestic private sector, especially agriculture and unofficial area, had a main role in creating job for the economy (occupying 86% of the number of employment), whereas, the State area had a less important role (only 10.4%). Despite just making up a small proportion of total employment, the figure for the foreign investment capital area has tended to increase (from 3% to 3.5% in the same period). Thus, the development of the domestic private sector played an important role for job creation and unemployment or underemployment restriction. Simultaneously, according to the General Statistics Office, the percentage of agriculture-forestry-fishery sector dropped from 48.7% in 2010 to 48.4 % in 2011; the figure for industry and construction sector went down from 21.7% to 21.29%; the data of service sector 36 In the period , some countries like Indonesia, Malaysia, Thailand and China had the net export to average GDP ratio, respectively, be 6.1%, 22%,, 9.3% and 6.9% (More in chapter 4) 54

55 rose from 29.6% to 30.3%. This situation showed that the service is an important sector in job creation in the economy. Figure The Vietnam s employment growth in the period Source: the General Statistics Office, 2011, the data of the first 9 months in 2011 Another important criterion of labor market is income. In spite of no data of wage from the General Statistic Office, with statistics collected from the surveys by the Institute of Social Sciences of Vietnam in the industrial zones and a number of other important areas in some provinces such as Hanoi, Ho Chi Minh City, Dong Nai, Binh Duong during the period , it is showed that this indicator recovered well after falling to the lowest level under the impact of the economic crisis in the first quarter of Both nominal wages and real wages (excluding inflation) in areas surveyed in August, 2011 were higher than that in the previous three years (June, 2008). To summary, all three key indicators in the labor market - employment, unemployment, and wages were relatively positive in 2011 despite the decline of economic growth. These results of the labor market can be seen as the highlight of macroeconomics in the past year. Changes in external sector Changes in exchange rate In general, the operating exchange rate in Vietnam in the past time can be summarized as following: sharp devaluation in context of the economy crisis, the high pressure from market and a big gap between the official exchange rate and that in the free market; and in case of a stable economy and the gap between the official exchange rate and that in the free market becoming 55

56 very small, the exchange rate was anchored closely (Vu Quoc Huy and partners, 2011). During the period from 2001 to 2008, exchange rate policies of Vietnam were quite rigid. They only have been altered since the financial crisis, signing for a start of a period when exchange rate is altered more often. Figure Exchange rate USD/VND, (Monthly) Source: The State Bank of Vietnam To understand the exchange rate volatility in the last year, it is need to consider the reason for some exchange rate instabilities in recent years. Vietnam s exchange rate has fluctuated sharply since 2007 when a surge in foreign inflow put dong currency under pressure to increase. Nevertheless, this revaluation period of Vietnam was quite short. Vietnam s high inflation in the first months of 2008 as well as a macroeconomic instability and the world economic crisis from the mid-year caused Vietnam indirect inflow to be reversed 37. Meanwhile, trade deficit surged continuous and prolonged (except the first three months of 2009), because demand for gold and foreign currency reserves increased sharply when the economy had much stability, foreign currency demand for gold and good import also had a same pattern. These factors impacting simultaneously put Vietnam under the high devaluation pressure. Therefore, The State Bank of Vietnam (The SBV) had to continuously extend continuously exchange rate 37 According to the Center for Informatics - ONA (2009), the net foreign indirect investment outflow from Vietnam was 578 million USD in

57 from 0.75% in 2007 to 5% in 3/2009 after four adjustments, before continuing to devalue by 5.4% in 11/2009, and shrinking the trading band to 3% 38. Even so, the devaluation pressure was still very high in the following time because another reason was that fear for devaluation of dong currency made psychology pressure on people to hoard gold and foreign currency. This was showed in a surge from 1 billion USD in 2008 to 9 billion USD in 2009 in the scale of the Error and Flaw item in the Balance of Payment 39. In 2/2010, The SBV continues devaluing dong currency, leading the exchange rate to increase to 18,544 VND/USD. Together with devaluation were the administrative measures such as closing gold trading, ending gold trading on the foreign accounts of credit institutions as well as the adjustment of interest rates on context of high level inflation signs. After these policies, the forex market temporarily stabilized until mid-2010 with the positive sign of direct investment, indirect investment and remittances. In In favorable conditions, in spite of relatively stable exchange rate, the SBV proactively adjusted the exchange rate. Nevertheless, the exchange rate pressure returned due to an increase in inflation, trade deficit, repayment pressure of enterprises and the speculation in exchange rate of people in the end of With a small number of foreign currency, in 2/2011,one more time, the SBV had to devaluate sharply by 9.3%, pushing exchange rate to VND/USD, and committed that exchange rate would increase less than 1% until the end of that year. Together with this devaluation, in 2011, interest rate policy maintained the gap between foreign and domestic currency interest rates as well as management of foreign exchange was made more stringent, resulting in mobilizing a huge foreign currency from residents to bank system and reducing significantly pressure on the forex market. Besides, the cautious fiscal and monetary policies 38 However, in 2009, there were many relatively favorable conditions in Vietnam when the number of inflow remittance rose to over 6 billion USD and the foreign indirect investment outflow from Vietnam only was 71 million USD. Simultaneously, the amount of transferred profits of foreign investors also reduced to $ 3 billion compared with $ 4.4 billion in 2008 (Vu Quoc Huy et al, 2011). 39 The statistics from CEIC. The Error and Flaw item showed inaccuracies in statistics and domestic trading outside bank system of the economy. Using this figure to measure the level of dollarization or foreign currency hoarding is not completely correct because there are some small errors due to mistakes in statistic process. However, an error and fault level of more than 9 billion compared to a relatively low value of the previous years (just about $ 1 billion ) is not simply because of negligence s, it is necessary to question about the amount of foreign currency hold by residents and enterprises. 57

58 which aimed to reduce the overall demand leaded to a decrease in trade deficit and gradually exchange rate stability in a long time in Nevertheless, in the end of 2011, there was a similar pattern in exchange rate pressure changes in 2010 when demand for repayment by foreign currency and hoarding assets increased 40 due to high inflation. Furthermore, gold market was not really organized and controlled well with the problems about group benefit, gold import quota and hoarding assets psychology leading to higher price of domestic gold price comparing that in the world 41. This stimulated gold smuggling for the purpose of speculation, resulting in a surge in foreign currency demand. Figure Exchange rate USD/VND in the free market and the Interbank in 2011 Source: The SBV and the collected data of research team However, with the positive sign from the elements of the balance of payments, exchange rate target in 2011 was achieved. Particularly, import surplus decreased in 2011 thanks to a better controlling than the previous years as well as a fall in domestic demand. The current year witnessed the lowest import surplus in the past five years as well as the lowest import surplus to export turnover ratio since Meanwhile, there were some positive changes in remittances and indirect investment capital, and direct investment just slightly decreased, so foreign currency 40 More details will be presented in the part The monetary field of the economy. 41 In December 2011, there was a moment when the domestic gold price exceeds 2.5 million dong per 37.5 gram, according to tin-dung-nam-2011-duoi-11.html. 58

59 supply still guaranteed of a small devaluation in dong currency. Thus, only considering the exchange rate in 2011 showed a period which was more stable than the period Nevertheless, that comparing the context showed that this stability could be maintained or not would depend on the changes in factors negatively impacting on the exchange rates in as analyzed. In fact, analyzing each factor shows that there is no certain basic to assert that favorable movements in 2011 will be repeated in 2012, but it is able to changes to negative trend in the short time. Changes in the balance of payments In the long time, the current account balance of Vietnam has been always in a state of deficit, but the deficit levels has become particularly severe in the recent 4 years since 2007 when Vietnam joined the WTO. It is quite fortunate that Vietnam has maintained a surplus in the capital account (thanks to foreign investment flows and remittances) to offset the current account deficit, which helped Vietnam avoid a crisis in the balance of payments. Figure Current account and capital account of Vietnam in the period (billion USD) Source: CEIC 59

60 The current account Figure International Trade of Vietnam, Source: the General Statistics Office The value of export of Vietnam experienced an impressive growth period from 2000 to 2008 before dropping with the changes in the world economy in However, this figure rose again in 2010 and then continued to increase at a higher speed in 2011 (33.3% compared with 26.47% in 2010), with exports reaching billion USD. But the main reason for an increase in export in 2011 was world prices of the main export commodities of Vietnam rising. Since joining the WTO in 2007, the import value of Vietnam has increased sharply, resulting in prolonged and more severe trade deficit. The trade deficit has been large because Vietnam s the structure of good import mainly has been the raw materials while the domestic support industries have been less developed. In addition, that tariff policy does not ensure real protection for a number of items together with less competition in terms of quality of Vietnam s goods is one of the factors leading to an increase in the number of final consumer goods, contributing to cause trade deficit to rise sharply in the past years. Nevertheless, in 2011, there were numerous policy measures implemented to limit import after the Resolution No.11/NQ-CP on 24th, February 2011 of the Government 42. Even so, the import growth was higher than the 42 Tax imports of some consumer goods were finally adjusted up but still within the committed limits of WTO. Along with that, in the last year, tax policy on some items that were previously thought to be not protected was adjusted. In addition, non-tariff measures accepted by WTO such as quality standards and technical barriers have been applied more frequently in the years since the first time introduced to Vietnam in These measures are required by applicable standards or procedures for the import and export of various commodities such as salt 60

61 previous year with the estimated value is 24.7% in 2011 comparing with 21.26% in 2010 and 28.6% in The import value was about billion USD in In 2011, although the trade deficit was extremely 9.5 billion USD, with remittance be about 9 billion USD, the current account deficit of Vietnam decreased sharply. In comparison with 11 billion USD FDI implementation FDI capital and 3.2 billion disbursed ODA capitals in 2011, the amount of foreign currency from remittances was very large. Meanwhile, the stability of the latter is higher than the former 43. Capital account While in the pre-crisis period, Vietnam strongly attracted foreign capital, the amount of foreign direct capital (FDI) 44, despite a recover, is not as abundant as before. In 2011 registered capital of Vietnam goes down to 26%, only being 74% of that in However, the amount of implemented capital stays unchanged at $ 11 billion as in 2010 and experiences positive changes in spending these funds. While foreign direct investment in 2010 and previous period caused concerns owing to a relatively high proportion of this source in the real estate sector rather than the manufacturing one, in 2011, this proportion significantly reduces 45. In contrast to a decline in registered FDI, although the macro context of Vietnam was more complex and stock market index continues going down in 2011, there in a rise in foreign indirect investment (FII) in Vietnam. According to the SBV, for first seven months of 2011, FII of Vietnam is estimated at USD 700 million, witnessing a slight increase compared to the same period of 2010, and in the first 9 months of 2011, the figure is estimated at USD 1 billion, being negligibly higher than However, this source is the most sensitive to external economic instability because of high liquidity of the market and the easy movement of capital flows. If the transition and withdrawal of FII occur as a flight" in a wide range and with a large amount, the breakdown and crisis of investment - financial monetary, high inflation, even the economic (Circular 68/2011/TT-BNNPTNT), cables (Circular 4976/TCHQ-GSQL ), tea (Circular 4962/TCHQ-GSQL), computer and laptops (Circular 20/2011/TT-BTTTT ), motorcycles (Circular 43/2011/TT-BGTVT), and automobiles (Circular 20/2011/TT-BTC). 43 Buch and Kuckulenz (2004). 44 In 2008 total amount of registered FDI was more than USD 65 billion. 45 According to estimations of Military Bank (2011), the proportion of FDI poured into real estate market is 36.8% and 5.8% in 2010 and 2011, respectively. 46 In the first months of 2010, excluding USD 1 billion from international government bond, FII in Vietnam is USD 940 million. 61

62 crisis will happens to the host country. Especially, when Vietnam s banking system has a considerable level of risk and double mismatches in terms of both currency and term structure, this risk should be carefully monitored. In addition to FDI, FII and aids, foreign debt makes a significant contribution to balance of payments in the last year in Vietnam, including official development aids (ODA) and commercial loans. In recent years, Vietnam's foreign debt has increased significantly, putting more and more considerable pressure on raising foreign capital of Vietnam. According to the Ministry of Finance (2011), total government debt and government guaranteed debt is more than USD 32 billion by the end of 2010 was, going up noticeably compared with total government debt by the end of 2009, USD 27.9 billion. The outstanding balance increases Vietnam s foreign debt to over 42% of GDP in Table Vietnam balance of Payments ( ) (million USD) A. Current Account Trade balance -2,287-2,439-2,776-10,438-12,783-7,607-5,147 Exports (FOB) 26,485 32,447 39,826 48,561 62,685 57,096 72,192 Imports (FOB) 28,772 34,886 42,602 58,999 75,468 64,703 77, Service balance ,421-2,461 Exports 3,867 4,176 5,100 6,030 7,006 5,766 7,460 Imports 4,739 4,472 5,108 6,924 7,956 8,187 9, Net transfers 3,093 3,380 4,049 6,430 7,311 6,448 7,885 Private net transfers 2,919 3,150 3,800 6,180 6,804 6,018 7,569 Net official transfers Net Investment Income ,205-1,429-2,190-4,401-3,028-4, By the end of 2009, the proportions of ODA and commercial loans in Vietnam are 75% and 20% approximately, respectively, and the remains are favorable loans. Short-term liabilities of Vietnam are rising. While Vietnam s liabilities are USD 1.32 billion in 2011, the figure of 2012 is USD 1.5 billion for both principal and interest payment. 62

63 Receiving ,166 1, Paying 1,079 1,569 2,097 3,356 5,758 3,781 5, Other goods, services and income -1,763-1,501-1,437-3,084-5,351-5,449-7,025 Receiving 4,055 4,540 5,768 7,196 8,363 6,519 7,916 Paying 5,818 6,041 7,205 10,280 13,714 11,968 14,941 B. Capital Account 2,753 3,087 3,088 17,730 12,341 6,755 6, Foreign Direct Investment 1,610 1,889 2,315 6,516 9,279 6,900 7,100 Receiving 1,610 1,954 2,400 6,700 9,579 7,600 8,000 Paying Medium and Long term Liabilities 1, ,025 2, ,473 2, Short-term Liability , , Portfolio Investment ,313 6, , Savings ,535 2, ,803-7,063 C. Net Errors and Omissions , ,045-9,022 D. Overall Balance 883 2, ,875-1,765 10,199 Source: IFM Movements of inflation, monetary policy and banking system In recent years, financial depth of Vietnam has remarkably developed (see Table 1.9). Money supply/gdp ratio and deposits/gdp ratio have risen sharply recently 48. Meanwhile, the percentage of money in circulation to total deposits declines from 28% in 2006 to approximately 48 Calculations based on IMF s data (2010) show that M2/GDP ratio increases from 94% in 2006 to 133% in 2010; deposits/gdp ratio rises from 78% to 109.8%, respectively. 63

64 17.5 % in This shows the greater impact of currency on production, and hence a more responsive policies of SBV. Money supply and credit to the private sector to GDP are relatively high in comparison with other countries in the region. The rate of credit to GDP of the economy soars to %, just left behind by Hong Kong (167 %) and China (145 %) in However, the capital in the economy mainly depends on the banking system. This is shown by the large difference between the bank credit/gdp ratios over 123 % while the stock market capitalization to GDP ratio is approximately 35% in Thus, banking system plays a crucial role in Vietnam economy, compared to other economies in the region. Table Finacial depth of several countries in 2010 M2 (%GDP) (1) Credit for private sector (%GDP) (2) Cash to Deposit ratio (%) (3) China Hong Kong Korea Taiwan Indonesia Malaysia Philippines Singapore Thailand Vietnam Source: (1), (3): ADB (2011), Key Indicator 2011 Database. (2): WB (2011), World Development Indicator Database. This section will review relevant contents such as growth of payment instruments, domestic credit growth and changes in net foreign assets of the system in relation to a number of key macroeconomic variables such as inflation, growth, interest rates and exchange rates. Credit growth, total payment instruments and inflation According to research by the IMF (2006), since 2002, there is closer relation between money supply growth and inflation in Vietnam. While in the period before 2000, the growth of the savings and money demand did not directly contribute to inflation, since 2002, their positive 49 Result is calculated based on data from Economy Watch 64

65 correlation with a 12 month delay have been seen in Vietnam. Considering the period since 2006, credit growth and money supply have shown a remarkable positive correlation with inflation about a 5 to 12 month delay 50 (see Figure 1.16). During this period, the growth of money supply associated with soaring credit in the economy. Due to the nature of economic growth mainly based on investment, the credit growth has been one of the promoted factors in order to achieve growth objectives in recent years. Figure The growth rate of money supply, credit and inflation of Vietnam Source: CEIC. Expansionary monetary policy and credit growth for a long time, along with the inefficient investment and credit flows into the property markets has resulted in inflation, especially by the end of 2010, accelerating sharply in the first months of During this period, credit growth rate can be seen as a leading indicator of inflation. Besides, at the same time, the adjustment of some goods and drastically changed exchange rate are simultaneously implemented. That electricity and water prices continue to be increased while gasoline price is flexibly adjusted to international movements, accompanied by increased exchange rate contributes to higher import prices of inputs, putting a cost-push pressures on inflation in the first 50 According to IMF s research in 2006, the delay of credit growth and inflation is 12 months; however, when other factors such as expected inflation, structure of financial areas are inconsistent, the delay changes. 65

66 months of Especially in April, 2011, the CPI went up by 3.5% from the previous month level, being the highest inflation rate in the same period since Figure Monthly inflation Source: GSO In the context of high inflation, monetary policy has been determined in accordance with Resolution 11 aiming at restricting credit growth of the banking system at fewer than 12% and the growth rate of the total payment instruments at fewer than 16%. Interest rate will also be increased, respectively; the base rate was adjusted to 9% since 2010/11, the refinancing rate and overnight lending rate were adjusted to 11% in February, 2011, 12% in March, 13% in April and 14% in May, while the rediscount rate is adjusted from 7% to 12% in March and to 13% in May. At the same time, the required reserve ratio for foreign currency deposits rose by 1% in June, In addition, to ensure an appropriate interest to businesses, SBV set a ceiling interest rate of deposit at 14%. However, concerning impacts of policy on commercial banks, we can see the ceiling interest rate has result in low (even negative) real interest rates. This reduces incentives to keep money in the banking system, reducing the number of deposits, or in other words, to form another channel that further tightens monetary. Since September, 2011, the monetary tightening measures have proven effective; annual credit growth are dramatically lower than the previous years, only about 11-13%, being lower than the restricted level of 15%, and the consumer price index (monthly) fell rapidly after a consecutive rise in several months (see Figure 1.17). However, inflation remained high at 18.13%, in 2011 while inflation of other countries in the region was single digit. That shows that 66

67 although over years, inflation is due to objective reasons objective that many countries face such as rising international commodity prices, subjective ones is internal policy, especially contractionary monetary policy in the past years. Changes in net foreign asset reserve, exchange rate and inflation Concerning the relationship between Balance of payments and Monetary area 51, it is easy to see that every change in Balance of payments which leads to the change in the amount of net foreign assets contributes to change the amount of money supply in the economy 52. Regarding Vietnam, before September, 2009, although trade deficit rose significantly, the volume of net foreign assets surged due to a large inflow capital. In the floating exchange rate regime, an above increase in the amount of net foreign assets affects exchange rate, resulting in higher price of domestic currency and slightly rise in money supply adjustment. Nevertheless, the exchange rate regime inclining the fixed in Vietnam that The State bank maintained exchange rate while the amount of assets climbed leaded to faster increase in money supply. Especially in the period from the end of 2006 to the early of 2009, money supply in the economy was always financed by inflow foreign capital when Vietnam's economic prospect was appreciated. 51 The equation in account balance of monetary area is: M2 = NFA + NDA, in which: M2 is extra money supply, NFA is the amount of net foreign assets, and NDA is the amount of net domestic assets including domestic credit and the other accounts. 52 Particularly, the changes in the amount of foreign currency in current transactions and investment in the economy cause the change in the amount of money supply in the economy. 67

68 Figure Monetary Survey of Vietnam, Source: CEIC The amount of foreign investment capital to Vietnam has plunged since world economic crisis. Comes with it, Vietnam s trade deficit was more serious in and just dropped slightly in 2010 and In theory, a decrease in net foreign assets leads to a fall in money supply and, simultaneously, puts pressure on exchange rate. However, the fact is that Vietnam currency was under a huge devalued pressure in this period. As a result, that VND devalued sharply (9.3%) by the State Bank in February, 2011 due to inability to anchor the exchange rate leaded to a decline in net foreign assets, causing not only to be difficult to reduced money supply and inflation but also contribute rising inflation. The history has showed that Vietnam s inflation strongly affected by psychological factor as well as the proportion of raw materials in imported goods has been large. Consequently, exchange rate increases by any reason as foreign currency demand rising or net domestic assets supply declining, easily leading to a reduction in confidence in dong currency, a rise in the demand for speculation in the property such as gold or foreign currency. Simultaneously, this situation is responsible for the higher good prices while the input price has risen, pushing inflation exchange rate spiral continued. However, after the decision to devalue VND and a series of monetary policies such as tightening credit and closely managing foreign exchange in 2011 as mentioned, the exchange rate has been maintained relatively stable; the inflation has slowed in the last months. Besides, the foreign exchange reserves of the State Bank has risen since the mid of 2011 because of a decrease in trade deficit. Even so, there still was a downward trend in the total net foreign assets of all bank system. The main reason for this situation is that net foreign assets of the commercial 68

69 banks still has been negative continuous since the mid of In the future, that the State bank wants to strengthen the ability to keep the price of dong currency, improve the effects of policy instruments and stabilize citizen s psychology by mobilizing more foreign exchange reserves from the domestic area may have some difficulties because the amount of this property experienced a sharp decline in the past time and has been no longer plentiful as the period before 2010 or the early of 2011 (Figure 1.19) Figure Net foreign assets in bank system, Source: CEIC The Commercial Bank system In 2011 and the early of 2012, the Vietnam s commercial bank system is facing some big problems which threaten to the stability of whole system including: (i) less liquidity, (ii) double mismatches in the structure of time and currency, and (iii) high bad debt rate. Less liquidity One of the indicators of liquidity risk is the amount of mobilized capital dropping while loan to deposit ratio rising. Considering the data on monthly basis, it is clear that the loan to deposit ratio has risen dramatic since 2006 (Figure 1.20). These number show that there was a sharp increase in the credit risk of the Vietnam s commercial bank system for 3 recent years, especially in the early months of In the first four months, credit rose by 5.1% while deposit almost remain unchanged, causing the loan to deposit ratio to reach a quite high level (131%), which showed many latent risks in the Vietnam s commercial bank system. Although Circular 69

70 No.13 coming into effect from October, 2010 stipulates that the loan to deposit ratio of banks is 80% and the figure for another credit institutions is 85%, credit institutions have failed and there is no sanction to strictly handle them. Figure The loan to deposit in the period Source: CEIC Meanwhile, in comparison with other countries in the region, the loan to deposit ratio is the highest 53 (according to Figure 1.21). In 2009, this ratio of Vietnam was the second highest to that of Korea. In 2010, it climbed significantly to 131%, well above the average of 80% among other countries in the region. Such a high loan to deposit ratio implies a large amount of risk in Vietnam s commercial banking system which is more vulnerable to external economic hits than those of other countries. Figure The loan to deposit ratios of banking systems in 2009 and 2010 Source: BMI (2011) 53 Normally, loan to deposit ratio, which is used for assessing a bank s liquidity, is limited to 110% and many countries like Korea and Indonesia have been trying to lower it down to 100%. On the contrary, Vietnam removed this regulation in September 2011 through Circular 19 issued by the State Bank of Vietnam. 70

71 Liquidity concern is not only reflected by the ratio of loan to deposit but also by interbanking interest rates. Low liquidity in banking system forces commercial banks to borrow in order to finance their loans, which is accompanied by monetary tightening and high inflation rates, increases deposit rates and lending rates substantially. Moreover, loosen lending rate caps, together with imposed deposit rate caps, pushes the ratio of loans to deposits to a riskier level. Reality showed that in 2011, many banks managed to stipulate their interest rates to exceed interest rate caps, resulting in interest rate races and the breaking of deposit rate deal. Figure Movement of kinds of interest rates in inter-banking system Source: CEIC In addition, low liquidity was reflected by rising short term interest rates, which were almost equal to long term interest rates. Normally, long term interest rates (12 months and beyond) are higher than short term interest rates (1 month to 6 months). However, this was not the case for interest rate situation in Vietnam in the first 6 months of 2011 when 12 month interest rates were around and sometimes were even lower than the 3 month interest rates. Double mismatch The closeness of long term and short term interest s rates does not only reflect low liquidity concerns but also implies a maturity mismatch in Vietnam s banking system. In the 71

72 situation of high inflation rates like in Vietnam, depositors are more likely to make short-term deposits in order to reduce interest rate risk. The reduction in long-term deposit accumulation equals an increase in short-term deposits used to finance long-term loans. Accompanied by an already high rate of short-term and demand deposit used to finance long-term loans (75% in 2008 according to Le Van Anh (2008)). According to risk premium theory, only projects with high levels of risks can bring about high return rates, which discourage the investments in lower risk projects with moderate rates of return. Therefore, solvency risks caused by high interest rates also go up. In addition to the maturity mismatch, Vietnam s banking system also has to face a currency mismatch. Due to a large gap between nominal domestic and foreign interest rates, foreign credit grew at a much faster rate than domestic credit. At the end of 2011, foreign credit grew at 18.7% while domestic credit grew at only 10.2% in comparison with At the same time, domestic currency depreciation, account balance deficit and decreasing foreign investment remain ongoing concerns. Besides, net foreign assets in commercial banks have been negative recently, not because of a decrease in foreign assets. It is due to a substantial increase in foreign debts that banks hold. Negative net foreign assets also confirm the currency mismatch as foreign funded loans are used to finance domestic loans. Figure Foreign debts of commercial banks (monthly) in 2010 and 2011 Source: CEIC 54 visited in 24/11/

73 Bad debts One of the biggest threats to the stability of the banking system is bad debts. During recent years, the ratio of bad debts rose significantly. According to Vietnam s accounting standards, bad debts ration in June 2013 was 3%. However, according to Fitch Ratings, in compliance with international accounting standards with regards to bad debt classification, this ratio was 13%. Moreover, monetary and fiscal tightening policies, which led many enterprises to reduced manufacturing and even bankruptcy, also exerted negative impacts on the system. Figure Bad debt proportion in Vietnam s banking system Note: IFRS (International Financial Reporting Standards; VAS: Vietnamese Accounting Standards) Source: Fitch Ratings (2011) Another critical area that could impact the bank s asset balance in terms of bad debts and liquidity is the real estate market. During previous years, there were a massive foreign capital inflow which was poured into the asset market and a large amount of capital was invested in the real estate market due to easy and cheap cash flows from loosen policies and investors concern about macroeconomic instability. The consequence was an asset bubble, which captured a large amount of capital in the real estate market and prevented it from flowing into the manufacturing sector. Contractionary monetary policy and orders from directive 01/CT-NHNN/2011 to reduce the weight of credit extended to non-manufacturing sector (including real estate) to 16% towards the end of 2011 and to disregard this sector as favored credit extended subject led to the frozen real estate market. Companies in this sector experienced a tough time and even bankruptcy when the value of mortgages plummeted, turning loans from banks into bad debts. 73

74 Budget Situation 2011 has seen a better management of state budget. Domestic revenue reached billion VND, 13% higher than expected and 19.9% higher than the same period last year. Among increasing categories of revenue was personal income revenue, which rose by 28.6% compared to the original budget plan. Next the revenue from FDI companies witnessed an increase of 11.3%. Revenue from private enterprises and state-owned enterprises went up by 10.6% and 0.8% respectively. Revenue from crude oil reached an average export price of 102USD per tank, an increase of 25% compared to forecast price. In addition, oil output also rose beyond plan at a relatively low level 55. Therefore, oil revenues are estimated to surge by 44.6% compared to 2010 and by almost 43.8% compared to planned level. Revenues from foreign economic activities went beyond plan with trade revenues growing by 3.8% compared to plan. Revenues from foreign aids grew significantly by 10% more than forecast. According to the Ministry of Finance, there were 3 main reasons for the increase in state budget compared to plan. The 1 st reason was the improvement of the economy in the end of 2010, which boosted the state budget in Secondly, the rising price of commodities especially agricultural products, seafood and wood products and the changing of the exchange rates between VND and USD contributed to this rise. At the same time, the rising price level of crude oil contributed to a 25% increase in oil revenues in the state budget. Thirdly, an intensive execution of budget management, including a stricter control of supervising and collecting tax debts and on time revenue collection, etc. In 2011, state expenditure was under tight control with the aim of reducing unexpected expenditures. Budget was properly allocated on important projects, leading to a rise of 1,053 completed projects in 2011 based on billion VND transferred. On top of that, local governments and offices were required to cut their regular expenditures by 10%. Nevertheless, the actual amount of state expenditures still surged by 18.6% compared to 2010 and 9.7% compared to the plan. Spending on investment and development rose by 9% compared to 2010 and 15.1% higher than expected, which did not meet the target of reducing that kind of spending in Debt and aids financing also increased by 25.9% compared to 2010 and 17.4% higher than expected. Part of this spending was used to compensate for 55 The annual output was 14,13 million tons, which increased by 0,11 ton compared to plan 74

75 exchange rate risk as VND was devalued by 9.3% to USD in February Regular spending increased by 4.8% than expected and 17.5% compared to This was mostly allocated to overcome natural disasters, epidemics and to assure social security as well as improve on salary 56. In summary, despite intensive regulations and the issue of resolution 11/NQ=CP in February 24 th 2011 to execute contractionary monetary and fiscal policies, the spending of state budget did not fulfill its role in tightening fiscal policies. Vietnamese kind of Growth The roots of macroeconomic instability From the macroeconomic situation described in Part 1, it can be concluded that in 2011, macroeconomic instability remained an ongoing concern for Vietnam. This was reflected by fluctuating and decreasing economic growth (from 8,2% in the period of to 6,0% in the period of to only 5,89% in 2011); rising inflation (14% increase on average over the past 5 years with the highest increase of 18,3% in 2011); worsening trade deficit (accounting for more than 10% of GDP in continuous years); worsening budget deficit and public debts reaching a critical level (5-6% of GDP with regard to budget deficit, public debts and foreign debts increased by 54,6% and 41,5% of GDP respectively); fluctuating exchange rate accompanied by dollarization; vulnerable banking and financial system with increasing interest rates which affected companies performance, etc. Based on the analytical framework of the grounds for economic growth, Part 2 will reevaluate characteristics of Vietnam s growth model together with macro policies to support the model. Then, it will prove that all the macroeconomic problems in 2011 are due to the instability Vietnam s economy has to trade off from following Vietnamese growth model. Analytical framework of grounds for economic growth Economic growth is an increase in a country s real level of output to meet social demands. It is a narrower concept than economic development. Economic development includes not only economic growth but also social, political and natural development. Different as they are, they are closely connected with each other. In this modern time, development goes together 56 Besides, as analyzed in the part of GDP growth, government spending increased by 27% in compared with 23.7% in 2010 after the call to reduce expenditure by Resolution 11 somehow reflected the large government expenditures. 75

76 with economic growth, sustainable development and especially human development. Sustainable development requires that current needs be met without doing harm to the needs of future generations. Human development opens up choices for people in terms of economic, political and social aspects so that each human being can take full advantage of social welfare to develop to the fullest. In that sense, economic growth is a prerequisite for economic development. However, if economic growth is achieved at all cost without paying attention to income relocation, macroeconomic stability and other long-term foundations for development, it will not result in economic development and at a certain point of time, it will become counterproductive. On the contrary, sustaining development will enhance sustainable economic growth. Every nation s utmost target is to Strengthening long-term social welfare sustainably and fairly. To achieve that final purpose, a certain economy has to wisely choose to balance medium and inseparable targets which are fast economic growth and sustainable economic growth. To achieve fast economic growth, an economy can grow i) horizontally by increasing the amount of inputs or ii) vertically by increasing the efficiency of using inputs. In other words, economic growth may be simple due to a rise in inputs such as labor force and natural resources. However, in the situation of fixed inputs, the economy can still grow by means of better resource allocation, which can be measured by Total Factor Productivity (TFP) and Incremental Capital Output Ratio (ICOR). To accomplish sustainable economic growth, economic, social and environmental sustainability have to be assured. Economic sustainability has to be built up by macro risks proof policies and institutions which can handle macro shocks. Social sustainability can be achieved by assuring that every member of the economy benefits from the growth through better job opportunities and reducing risks to low skilled people. Environmental sustainability has to guarantee that current resource needs do not do harm to future needs. Characteristics of Vietnam s growth model Based on the analytical framework of grounds for growth, Vietnam s growth model is judged on two criteria of fast and sustainable growth, together with their components. Economic growth is mostly based on broad term and lacking depth 76

77 Based on macroeconomic situation and data, it can be stated that Vietnam economy has relied mostly on broad term that is increasing the amount of inputs, especially by exploiting investment capital. Meanwhile, the growth lacks depth as the efficiency of using resource has been limited. Figure Economic growth rate and the weight of capital investment in GDP (%) Source: General Statistics Office of Vietnam From figure 1.25, it can be seen that Vietnam has maintained its economic growth by relying on its investment capital, which has been ever-increasing especially since The capital to GDP ratio increased from 33.23% in the period of to 42.85% in the period of and 41% when two periods combined. In 2011, in an effort to curb inflation and stabilize the macro economy, the capital to GDP ratio decreased significantly to 34.6%. In the period of , the proportion of capital to GDP was 28.2% and the growth was 8.21% on average. However, in the period of , investment accounted for 42.7% of GDP but only created the growth of 6.9%. These numbers were 34.6% and 5.89% in

78 Figure Comparison of the ratio of investment to GDP between Vietnam and other countries Source: world Bank (based on asset accumulated in each economy) According to figure 1.26, in comparison with other countries in the region and low middle income level countries, Vietnam ranks highest in terms of the ratio of investment to GDP (second to China). Moreover, this rate tends to stabilize during recent years on the global scale while it has an upward trend in Vietnam. In the structure of social investment, investment from state sector, although experienced a downward trend, accounted for the largest part, an average of 39.1% in the period of (Figure 1.27). Figure The structure of social investment in terms of economic sectors (%) 78

79 Source: General Statistics Office of Vietnam With a large proportion of investment in GDP, it contributed a great deal to GDP growth. In the period of 1990 to 2000, it accounted for 34% of GDP and the number increased to 53% in the next 10 years, making it the highest rate among Asian nations (Table 1.9). In conclusion, Vietnam s growth during economic reform was mostly based on investment capital, most of which came from the state sector. Table The weight of components in GDP growth, Source: WDI; ACI, from Vietnam Competitiveness Report in 2010 However, since 2000, the quality of growth in Vietnam decreased to a low level. It was easily proved by the analysis of TFP 57 and ICOR 58. The weight of TFP in Vietnam s economic growth soared through time. Table 1.8 shows that this weight went from 44% in the period of to 26% in the period of , which was much lower than that of China, India and other Southeast Asian nations. Simultaneously, Vietnamese labor force s productivity was at a low level as the major of this workforce lacked skills, discipline and modern management capacity. According to the International Labor Organization (ILO), despite an increasing growth rate in the period of Total-factor productivity (TFP) is a variable which accounts for effects in total output not caused by traditionally measured inputs of labor and capital. 58 Incremental capital to output ratio (ICOR) is a metric that assesses the marginal amount of investment capital necessary for an entity to generate the next unit of production 79

80 2010, Vietnamese labor force s productivity was equal to 68,8% of that of other lower middle income countries (57,8% compared to China, 34,2% compared to Thailand and 22% compared to Malaysia). Meanwhile, considered as the main drive for economic growth, investment efficiency experienced a downward trend, which was reflected by a continuous increase of ICOR. According to Bui Trinh (2011), the ICOR of the whole economy was at a high level. To be more specific, it rose from 4.89 in the period of to 7.43 in the period of Public investment accounted for the most part, but its efficiency was lower than that of private and foreign sectors, of which ICOR rose from 6.94 to The poor efficiency of public investment drove down the general efficiency of the whole economy. Most of research showed that this poor efficiency resulted from unsystematic investment, scattered capital invested in too many projects which led to prolonged execution, waste of money and made way for corruption. It also resulted from weak supervision and inferior infrastructure and lack of consistency between delegation and supervision of capital usage. Vietnam s growth model made way for public investment to dominate private investment, which reduced the contribution of public investment in the previous decade (according to To Trung Thanh (2011)). Table ICOR in terms of economic sectors Calculation from investment capital Calculation from asset accumulation Total State Private FDI Total State Private FDI ICOR ( ) ,04 4,37 1,81 3,11 ICOR ( ) 7,43 9,68 4,01 15,71 4,40 5,13 2,54 9,70 Source: Bui Trinh (2011) Unsustainable economic growth In regard to economic unsustainability Sustainable economic growth has to be built on macroeconomic stability. However, risk prevention policies and response policies prove to be inefficient. In order to hedge against macro 59 This number was much higher than that of newly industrialized countries like in the period of For example, Taiwan s ICOR was 2.7 and that of Korea was 3. Thailand s ICOR in the period of was4.1 and that of China in was 4. 80

81 risk, normal policies have to aim at keeping inflation rates under control, maintaining a low level of budget deficit and public debts and keeping current account deficit at a low level. However, the macro analysis in part 1 shows that the government s policies failed to hedge against risks. One of the main reasons was that for a long time, macroeconomic stability priority was placed behind growth priority. Even when inflation curb was prioritized at the cost of economic growth, the government was not able to determine which the acceptable reduction level of growth rate was. Consequently, due to the lack of depth in economic growth, economic growth exerted a lot of pressure on macroeconomic stability. In other words, the manner of economic growth itself made macroeconomic environment prone to risks, resulting in sustainable growth in the long term. In addition, the efficiency of response policies to macroeconomic instability was proved to be poor. These late, bumpy and inconsistent policies, on top of heavy dependence on State bank of Vietnam, weakened the responsive capacity 60. In regard to social unsustainability In terms of social aspect, sustainable economic growth has to be far-reaching growth. In Vietnam, agricultural and non-official sectors provide jobs to 75% of the labor force, most of which are low skilled. However, studies show that related policies in these sectors are inadequate and prevent the transfer of the workforce among sectors and from rural to urban areas. Moreover, biased policies, especially credit policies have been barriers for small and medium sized companies which employ a large number of low skilled labors. In addition, policy barriers have prevented non-official companies from turning into official enterprises to ensure labor rights, etc. In conclusion, economic growth in Vietnam hasn t opened up job opportunities, hasn t reduced risks to low skilled labor, which lowers social sustainability. In regard to environmental unsustainability 60 For example, at the beginning of WTO integration, Vietnam had to face with instability like global rising price level while the economy was open and did not have suitable import restrictions in accordance with WRO s rules; risks associated with increasing foreign capital inflow, etc. However, policies proved to be ineffective when facing with these risks. Rising money supply without sterilization is the consequence of that ineffectiveness. 81

82 Many studies have shown that the economic reform hasn t place an adequate emphasis on environmental sustainability 61. In line with the expansion of industrial zones, the amount of greenhouse gas and sewage has increased rapidly especially in Southern economic zones. One of the main reasons for that is the lack of checking and supervising in terms of environment effects. Besides, the over exploitation of natural resources is another characteristics of environmentally unsustainable development. In conclusion, Vietnam s growth model has pursued the main medium goal of fast economic growth without adequate attention to the medium goal of sustainable growth. Meanwhile, to achieve fast growth, Vietnam economy mainly develops on broad term, which lacks depth (that is, growth is mostly based on an increase in input while the efficiency of resource usage decreases). The consequences of the growth model prolonged and worsened macro instability Although Vietnam s growth model in broad term has positive influence on remarkable economic achievement during the beginning of Doi Moi (Economic reform), that is the period of loosen institution and unleash of manufacturing resources. However, the prolonged application for this model has accumulated macro instability so that it made Vietnam economy vulnerable to external economic hits. Consequently, the medium goal of sustainable growth seems to be out of reach. In this part, the consequences of Vietnam s growth model are the tragic trade-off between growth and inflation; worsening trade deficit and accumulated risks in banking system. These consequences lead to macro instability that the economy has to face recently. Tragic trade-off between growth and inflation Short-term movement of growth and inflation can be explained by the movement of aggregate supply (AS) curve and aggregate demand (AD) curve. According to an investmentbased growth model, accompanied by loosen monetary and fiscal policies, aggregate demand increases and moves to the right, which increases the whole economy s price level. However, inflation mostly depends on the slope of AS curve. 61 The amount of greenhouse gas in Vietnam increased from million tons of CO 2 to 121 tons in 138 and was estimated to reach 138 million tons in

83 If the aggregate supply is steep, just a slight increase in aggregate demand can lead to high inflation, meaning that there is huge trade-off between growth and inflation. This is exactly the case of Vietnam - with an economy of which the quality and efficiency of resources use are still poor, wasted and inefficient, in order to increase 1 unit of production, businesses in particular and the economy in general must consume more resources, increase production costs, and make the price that companies are willing to sell rise (this also means the economy's aggregate supply curve will be very steep). Table Money and credit supply, (% increase compared to the end of previous year) Total payment Credit for the economy Source: IMF, SBV. With the very steep aggregate demand curve, in order to increase the output (growth) as targeted, the policies have to be loosened to a greater extent, and of course, inflation will jump up really high. To increase investment capital under the pressure of economic growth target, Vietnam has implemented monetary loosening for a long time; consequently, the money and credit supply grow remarkably (Table 1.12). Except for the last six months of 2008, the State Bank of Vietnam always maintained refinancing interest rate at a low level, ranging from 5 to 7.5% in the periods, making the bank s interest rate level relatively low, from 7 to 8.5% during this period. This also made the economy s credit boom. In 2010, with the squirming and uncertainty in the target and policy of the economy, there were the increases in money and credit supply. Accordingly, the economy s ratio of credit to GDP is at higher level than that of other country in the same region (see Figure 1.28). Expansionary monetary policy and credit growth in the long run (the rapid rise of the "cheap" and "easy" cash flow) really work, but inefficient investment and the credit flow in the property market such as real estate (not directly create real output) has made inflation rise quickly, especially in late 2010, and continued increasing strongly in the early months of

84 Figure The rate of Credit/GDP at the end of 2010 (%) Source: IFS, the Central Banks and BMI (2011). Also for investment-driven growth purpose, Vietnam has pursued the policy that has deficit-oriented to promote economic growth. Deficits occurred continuously for over the last decade and increased its levels over time. In period , the budget deficit was approximately 5% of GDP. From 2007 onwards, the budget deficit was even more variable. In 2009 and 2010, budget deficit in compared to GDP reached high level at 6.9% and 5.6% 62 respectively. Also due to the long-lasting budget deficit, Vietnam had to borrow more. Vietnam's total public debt rose from about 40% GDP in late 2007 to more than 57% GDP at the end of 2010; it only decreased slightly in 2011 due to high inflation. At the same time, Vietnam's foreign debt jumped from 32% to nearly 42% GDP. 62 However, these numbers may not reflect the true nature of fiscal deficits in Vietnam today. International organizations have deficit numbers which are far different from numbers reported by MoF. Specifically, in 2009 alone, the deficit figure excludes amortization as reported by MoF is 3.7% GDP, while the corresponding figures of the Asian Development Bank (ADB) and the International Monetary Fund (IMF) are much higher: 6.6% and 9.0% GDP respectively. 84

85 Figure Budget balance - the situation of Vietnam and some countries Source: Eduardo and others (2011). Note: Figures of Vietnam in 2011 by the Ministry of Finance. When the economy is close to full capacity and if it previously had continuous fiscal deficits, continuing the fiscal expansion will quickly lead to high inflation, high interest rates, current account deficits, and financial uncertainty. Take the Vietnam s lesson of stimulate aggregate demand in 2009 and its consequences in as a typical example of this case. Besides, if the government expenditures are not funded by taxes or other revenues, but by increasing the economy s money supply for many years, it is certain that the economy will finally have to experience high and prolonged inflation 63. In Vietnam, the fiscal deficit is financed mostly by borrowing through issuing government bonds and even uses the budget in advance (a form of printing money to consume). However, government bonds and government guaranteed bonds are sold primarily to large commercial banks. These amounts of bonds are later pledged by commercial banks at the State 63 This transmission channel can be simply explained by the decisive role of money supply in the long run to the economy s inflation. The increase in money supply may not increase inflation if the economy is growing and the pre-transaction demand also increases, or when other asset markets become less attractive. This increase in money supply can be totally absorbed by the increase of money demand and thus does not cause an increase in price of goods and services in the economy. However, when the private sector is satisfied with the amount of money that they are holding, the increase in money supply will finally increase their spending and, if there is not enough supply for goods and services, high prices will occur until the market has a new equilibrium. When the Government sponsors the deficits by increasing the money supply, they are regarded to collect inflation tax of those who are holding money (see more in Chapter 3). 85

86 bank to take cash through open market operations or through rediscount window. Finally, this will increase the money supply and cause high inflation. According to the statistics of Hanoi Stock Exchange (HNX), the total amount of government bonds and government guaranteed bonds has the value of about 336 trillion VND, which equals to more than 13% nominal GDP and nearly 12% M2 money supply of Thus, along with higher demand for credit by private sector, public spending financed by issuing bond also indirectly led to a sharp increase in money supply in recent years. High money supply growth and hyperinflation make the residents seek shelters on value-stable property such as gold, hard currencies and real estate; which causes instability in the property market and reduces the effectiveness of domestic monetary policy. Figure Growth and inflation in countries around the world ( ) Source: WDI, taken from Economic Report 2012 of VASS. Note: growth rate and inflation index of each country is average value of this index in according period of time. Vietnam is expressed by the big red point. The line represents for average trade-off line between growth and inflation of the world. Therefore, with the current model, economic growth must pay a really expensive price: inflation. For many years, the Government has pursued growth targets, the economy has to face with high inflation and volatility, leading to other instabilities in exchange rate, dollarization, or goldization, which becomes difficult to solve. Figure 1.30 shows that at the beginning of period , the price of the trade-off between growth and inflation in Vietnam was much higher as compared to the world s "average trade-off price". 86

87 In some certain short term periods, to cope with inflation while geographical balance policy is not much left (huge budget deficit, high interest rate, few foreign exchange reserves, etc.), the Government often makes use of administrative methods such as domestic price control, trade restrictions, exchange rate control, etc. However, if these administrative methods are prolonged, the aggregate supply curve will be affected, which results in the distortion of domestic market factors of production and the limitation of production and export capacity (due to the lack of imported materials); the resources will be unreasonably and ineffective allocated. Accordingly, the aggregate supply is even steeper, and the price of the growth and inflation trade-off is higher, the expansion policies aimed to boost economic growth will even accelerate inflation, causing macroeconomic instability in the later stages to become increasingly serious. The trade deficit is getting worse The study results 64 show that the exchange rate policy and monetary-nature related policy can hardly improve deficit situation in Vietnam, because the role of explaining the magnitude and volatility of impact on the trade balance is negligible. Meanwhile, trade deficit is explained mainly from the real and structural elements, relating to the model of economic growth that Vietnam is pursuing. Theoretically, the trade balance reflects the disparity between domestic saving and investment (net savings) of a country. National net savings equal to net savings of the Government (budget balance) and the private sector s saving - investment disparity 65.Thus, if a country has a trade deficit, it is the reflection of negative net savings (means that investment rates is higher than savings rate). 64 See more in chapter 4 65 According to macroeconomic theory, (TG) + (SI) = NX, in that, T - G is the budget balance, reflecting the net savings rate of public sector, S - I is the net savings rate of private sector, NX is the trade balance. 87

88 Figure Trade deficit, investment-saving gap and budget deficit (%GDP) Source: IMF, WDI and TCTK As clearly seen from Figure 1.31, the economy s investment-saving gap has remarkably increased since 2007, accompanied by a sharp rise in trade deficit. Investment-saving gap in Vietnam hit a staggering 11.5% of GDP during , whereas other countries in comparison all witnessed net savings (even at as high a level as Malaysia with 22%). The major cause was that the domestic investment rate was noticeably high (stemming from the investmentbased economic growth model) but proved inefficient. Domestic net savings cover savings from both public sector and private sector (households and enterprises, including foreign enterprises). Budget deficit (negative government s net savings) remained significant during a long period of time to serve the economic growth model, principally leading to a low domestic saving rate. Nevertheless, another equally crucial reason lay in the considerably widening investment-saving gap in private sector, worsened by macroeconomic policies and inherent issues of finance and banking sector. There have been no publicized figures about net private savings; however, evaluations can be made through observing the behavior of households and enterprises for the past few years. With regard to households, net savings still remained minimal owing to the young, weak and risky domestic financial market, especially under the context of growing inflation and macroeconomic vulnerability. Most strikingly, Vietnam received an enormous flow of foreign capital in 2007, but the Central Bank s inexperience in neutralizing the abruptly rising cash flows had led to widespread inflation and bubbles in Vietnamese asset markets (stock market and real 88

89 estate market). This brought about an exaggerating boost in consumption, especially from consumers in urban areas. Meanwhile, the business sector witnessed much higher investment rates compared to saving rates, clearly shown from the expanding scale of credit for the past few years. The cause of this imbalance not only arose from economic growth policies (expansionary monetary and fiscal policies during a long period of time) and enterprises incautious, unsystematic and inefficient investment behavior; but also from the dull financial system in which macro and micro-supervision proved ineffective and numerous small banks pursued the objective of rapid growth by significantly expanding credit activities without reasonable control. Growing and uncontrollable trade deficit was one of the fundamental reasons for macroeconomic instability. Trade deficit always put VND under the pressure of devaluation and posed negative impacts on inflation-exchange rate cycle. Worsened balance of payment and diminishing foreign reserves led to a decline in the exchange rate policies efficiency and the investors faith in Central Bank s governing competence, followed by dollarization and growing pressures on foreign exchange market. High trade deficits also caused capital accounts to maintain significant surpluses, indicating that national debts were accumulated through time. Free exchange rates fluctuated while the Central Bank maintained the target rate, putting monetary policies at passive position and affecting other objectives. Risk accumulation in banking system The major issues of Vietnamese banking system analyzed in Section 1 (bad debts, weak payment and dual errors) partly arose from the horizontal economic growth model. Expansionary monetary policies expanded the money supply, boosted credit and enabled unreasonable capital structure. When cheap and easy currencies existed in the market, enterprises tended to largely invest in the fields of real estate, industrial zone development and others whatsoever. On the other hand, as many banks were the backyards of real estate enterprises in essence, real estate credit and infrastructure development activities covered a considerable proportion in those banks. Therefore, capital was unreasonably distributed between short-term and long-term loans, as well as between real estate investment loans and production loans. The fact that Vietnam s economic growth had to largely depend on banking system also resulted in improper capital structure. Since the capital market had not developed in line with the hot demand for economic growth, 89

90 the capital burden converged into the credit market, forcing credit organizations to utilize most of the short-term capital from households to facilitate medium-term and long-term projects. Additionally, facing the growing need of capital mobilization in response to the whole economy s demand for economic growth, the Central Bank had allowed 13 commercial banks to transform from rural into urban models during Before transformation, these banks charter capital only ranged from several dozens to several hundreds of billion VND. However, as the charter capital was stipulated at a minimum of 3,000 billion VND in 2011, the commercial banks were forced to increase their equities by 10 to 20 times within 5 years only. The pressures of rapid development caused such banks to expand their assets at any price to match the corresponding increase in equities. As their management competence cannot keep pace with the speed of asset expansion, the credit quality proved to be low. Another issue accompanying this process was cross-possession. To rapidly increase their equities, commercial banks were forced to depend on contributed capital, according to which they became the backyards of public and private corporations. At the same time, the lightning speed of banks equity expansion also led their backing corporations to borrow from other banks to match the requirement. The effect of cross-possession was that those corporations borrowed capital was misused and the credit quality was significantly low, sowing the seeds for bad debts when the economy ran into difficulties. In the stage of expansionary monetary policies, the banking system appeared to operate smoothly owing the ease in capital mobilization in inter-bank market and the existence of cheap capital flows, which ultimately led to inefficient resource allocation within the economy and dampened the effectiveness of the economic growth model. Nevertheless, in time of escalating inflation and macroeconomic vulnerability, when the Central Bank had to sharply decrease the money supply and largely increase the discount rate (as in the end of 2008 and 2011), numerous risks and shortcomings in the banking system were revealed. The system s liquidity particularly ran into difficulties. Commercial banks, offering too many medium-term and long-term loans and mainly sponsoring real estate and industrial zone development projects, had faced serious imbalance in capital structure because mobilizing money from TT1 (from residents), TT2 (from inter-bank market) and from the Central Bank became really difficult due to contractionary policies. In addition, low credit quality and frozen real estate market (due to contractionary credit policies) had led to a boost in bad debts and overdue debts within the system of credit organizations. Cross-possession 90

91 also resulted in the spill-over effect among bad and overdue debts within the whole system, which was hard to determine and resolve. Due to low liquidity and booming bad debts, banks must significantly raise the interest rates on TT1 or launch interest rate wars when the mobilization ceiling was controlled by the Central Bank, therefore, borrowing interest rates continued to be maintained at staggering levels, even when inflation showed signs of decrease since the end of At such growing interest rates, the effects of monetary policies diminished noticeably, though the money supply and credit were just slightly tightened. If contractionary polices were still proceeded to control inflation, interest rates would continue to rise quickly and be painfully traded off with sharp declines in economic growth and employment. By contrast, if we loosened the policies, inflation might threaten to come back and overall banking system s inefficiency would continue to be nurtured with cheap and easy capital flows and systematic risks would be accumulated day by day. RESTRUCTURING THE ECONOMY COMPREHENSION AND PREMISE FOR IMPLEMENTATION With the analysis in Section 2, it can be inferred that macroeconomic instability mainly stemmed from the inefficient horizontal economic growth model and the unresponsive policies whose effects were limited by the model itself, and this vicious circle became more and more serious recently. Therefore, the only solution at present is to reform the growth model along with restructuring the economy, aiming at rapid but sustainable development. Under this context, macroeconomic stabilization and inflation control policies in 2011 (since the implementation of Resolution 11 in February 2011), whether implicit or explicit, clearly revealed the government s acceptance to trade off with diminishing economic growth in short-term and open up the mindset for economic restructure in long-term. The determination in economic restructure was strengthened since the Third Meeting of the 11 th Central Committee of the Communist Party of Vietnam, which defined investment restructure (focusing on public investment), financial market restructure (focusing on reorganizing commercial banking system and financial institutions) and public enterprise restructure (focusing on state-owned corporations and parent companies) as three major contents to be emphasized in the forthcoming time. 91

92 However, the comprehension of such basic concepts as growth model reform and economic restructure has not been clarified and unified, hence efforts in the past few years, which were still minimal and unsystematic, have neither hit the essence of the problems nor grouped up in a united form. At the same time, the government has designed the project of restructuring the national economy and breakthrough sectors, but the key initial premises have not been clarified, causing hazards to restructure approaches and hindering the final objective of restructure attached with growth model reform. Section 3 would focus on clarifying two contents the comprehension and premises of restructuring national economy. The comprehension of growth model reform and economic restructure in Vietnam Reforming Vietnam growth model plays an urgent and critical role under present context, especially when the whole economy has been boosting the process of international economic integration both vertically and horizontally. With the afore-mentioned growth foundations, Vietnam s growth model reform should be understood as the process of transforming from the principally horizontal growth model into the principally vertical growth model, on the basis of enhancing growth efficiency and aiming at sustainable development (economically, socially and environmentally) to achieve the final objective of improving long-term social welfare sustainably and equitably. In the process of obtaining the first intermediary objective, namely rapid development, the first priority is to quickly transform from horizontal growth (through expanding the scale of inputs) into vertical growth, which could resolve macroeconomic vulnerability and contribute to the intermediary objective of sustainable development through economic sustainability. In theory, vertical growth means enhancing the efficiency of utilizing resources through: (i) technical efficiency, (ii) allocation efficiency, and (iii) technical progress. Technical efficiency is reflected in the highest possible output obtained with similar inputs in terms of quantity and quality 66. Allocation efficiency is defined as achieving the highest production value with a given system of input and output prices, according to which scarce resources of 66 Reality has shown that technical efficiency is a major problem for public investment projects. For instance, at the same quality, the price of a road in particular and infrastructure in general in Vietnam is often higher than in other countries in comparison. 92

93 enterprises/the economy are allocated based on different needs of consumers/the economy 67. Technical progress can improve the overall production capacity of the economy, shifting the country s production possibility frontier outward. The process of transforming growth model involves many different stages, different intermediary objectives and different methods (tools). Nevertheless, in the initial stage nowadays, economic restructure is a critical process to quickly transform from horizontal into vertical growth. Economic restructure should be understood as the process of renovating the method of reallocating the economy s resources in a certain period of time to achieve allocation and technical efficiency. This is also a stepping stone for the success of long-term growth model transformation. With the objective of obtaining technical and allocation efficiency, it is necessary to clarify the fundamental elements needed to enhance them and defining intermediary objectives and basic methods of restructuring. Research and experience have shown that the absence of competition in output markets (monopoly, special treatment for state-owned enterprises, etc.) and the lack of motivations and suitable performance-based treatments inside enterprises (public enterprises, institutions managing public investment projects, etc.) were the major factors causing technical efficiency to be lower than its potential level. Therefore, to improve technical efficiency, it is important to conduct more robust and thorough reforms in the sector of state-owned enterprises, eliminate monopoly and public special treatments, and renovate management approaches of public investment projects. In theory, besides, to achieve allocation efficiency, the economy s resources must be optimally allocated allowing for social benefits and social costs. In other words, they must be allocated based on the needs of the economy, according to which total welfare is maximized. Research and experience have shown that at national level, eradicating price distortions (distortions misleading the signals of resource allocation) would help enhance allocation 67 In microeconomics, allocation efficiency is also known as Pareto efficiency, or social efficiency when the economy s resources are optimally allocated (allowing for social benefits and social costs), according to which the economy s total welfare is maximized. 93

94 efficiency in terms of capital, labor or natural resources 68. With regard to inputs, special treatments for state-owned enterprises or private enterprises under interest groups in approaching credits, land or other important production resources 69 without obeying rules of market economy would decrease allocation efficiency through distorting the allocation process. Besides, the inherent issues of public investment also reduce allocation efficiency at national level: (i) unreasonable allocation between hard and soft infrastructure, or within the scope of each sub-industry 70 (due to hierarchy problems and partial benefits), (ii) the encroachment of public investment over private investment. The major issues in the financial-monetary system (bad liquidity, bad debts, cross-possession, the role of public possession, weak competence, etc.) also significantly contribute to the process of allocating resources (mainly capital) into inefficient production sectors, further dampening allocation efficiency. With afore-mentioned analysis, it can be inferred that to achieve technical and allocation efficiency, intermediary objectives are needed so that resources will be allocated in the most reasonable way, in which the objective of efficient structuring must be obtained in several breakthrough sectors (due to their enormous impacts on technical and allocation efficiency), including public investment sector, public enterprise sector and financial-monetary sector. Therefore, the spirit of Resolution 3 of Central Committee (in terms of economic restructure attached with growth model reform) focused on three aspects: (i) investment restructure, focusing on public investment, (ii) public enterprise restructure, focusing on state-owned corporations and parent companies, and (iii) credit system restructure, focusing on commercial banks. This proves to be plausible and can be a bonus to the mindset of reforms and progresses. The premise for restructure renovating mindset and reforming institutions 68 For instance, electricity price subsidies would distort resource allocation, leading to overproduction and overinvestment in electricity-intensive industries like cement and steel lamination, without promoting enterprises to invest in electricity industry or other alternative energies themselves at the same time. 69 Until 2010, public sector covered up to 38.1% of total social investment, but contributed only 33.7% to overall GDP and created jobs for merely 10.4% of workforce. Meanwhile, private sector constituted 36.1% of total social investment and 86.1% of workforce in 2010, but contributed only 47.5% to overall GDP. Although such figures do not fully express the advantage of public and large-scaled private enterprises (in approaching credits, information, policies, etc.), the allocation inefficiency proved clear. 70 In particular, several researches have shown that Vietnam has too many ports. Meanwhile, infrastructure in some cities or rural areas has not received proper investment. In the field of soft infrastructure, hospitals and schools in many regions still suffer from overload. 94

95 The inefficient horizontal growth model is assumed to be worsened by obsolete economic mindset and outlooks and ineffective institutions, including legal frameworks, policies and the authority s mode of operation and action. Therefore, but for robust renovations in mindset, structure and institutional operation, the target transformations (successful growth model reform and economic restructure) would be unobtainable. Renovating the obsolete mindset state-owned economy plays the principal role The obsolete mindset state-owned economy plays the principal role would hinder the process of economic restructure, according to which the economy s resources are not allocated into the most effective sectors. This mindset has explicitly created a business environment lacked of fair competition and transparency among economic elements, causing difficulties to the private sector in approaching input resources and conducting business equitably. Meanwhile, equality in approaching and utilizing national resources as well as freedom in conducting business, in theory, are the fundamental basis for proper resource allocation, efficient economic structure and enhancement of technical and allocation efficiency. This mindset is often interpreted as utilizing state-owned enterprises (especially public corporations and parent companies) as macroeconomic stabilization tools or orientation and macro-regulation tools. However, this proves to be groundless because public enterprises, in essence, are a member of the economy like every private or foreign enterprise, not an element of instruments or macroeconomic policies. Assigning the role of macroeconomic regulation or stabilization to public enterprises has granted an economic member (which are supposed to enjoy equal opportunities like others) the absolute advantage over other members, thus resources are allocated biasedly as a result. Several consequences can be listed as follows: (i) inequality in business environment in approaching the economy s resources, (ii) public enterprises monopoly and inefficiency, (iii) the state in which regulated prices (electricity, gasoline, etc.) are distorted, wrongly indicating market signals and leading to price shocks, etc., and (iv) the encroachment of public sector over domestic private sector, while the latter should be quickly strengthened to compete against foreign enterprises penetrating into Vietnam through integration agreements, etc. Even, public enterprises investment activities into such risky fields as securities and real estate in search of profits have gone against the role of macroeconomic stabilization tool. This mindset has also been utilized by interest groups to seek benefits for individuals involved. This can be considered a fertile land to create and develop relationships around public 95

96 corporations and parent companies. This had led to the advent and development of several private enterprises in Vietnam, quickly flourishing not due to technological progress, labor capacity enhancement or environmental protection, but mainly through exploiting such natural resources as land, wood, sea, minerals, etc. The owners of such enterprises implicitly grant themselves numerous privileges, and in many cases, show disrespect towards the legal system as well as laborers legitimate rights and benefits. This distorted development led to unsustainable growth in private sector, which proves inappropriate for green growth and harmonic development among social benefits. Therefore, to successfully restructure the economy and effectively allocate resources for rapid and sustainable development, there is no path but changing the mindset about state-owned economy as follows: (i) public sector only focuses on resolving major distortions of market economy to efficiently regulate the multi-sector commodity economy operating based on market mechanism; the State only participates in economic fields that private sector cannot or is not willing to participate in; (ii) public services should be increased in quantity and enhanced in quality; (iii) the withdrawal of the State from the role of investor and enterprise owner should be accelerated, the budget subsidy system should be eliminated, and public enterprises advantage in business rights and opportunities should be eradicated; and (iv) the State s role of orienting and supporting development should be enhanced and its managerial competence should be strengthened to create an equitable and friendly business environment for every economic element. In addition to renovating mindset about the role of public sector, it is necessary to transform the mindset about private sector. Private sector should not only be considered one of the motivations for economic growth but also be emphasized as the fundamental motivation to create breakthroughs in the economy, matching the overall trend of modern market economy under the context of accelerating international economic integration horizontally and vertically. Renovating mindset about the role of private sector will play a key part in transforming strategic mindset in the step of designing and implementing macroeconomic policies, which aims at creating an environment with equitable opportunities of accessing development resources among various forms of enterprises. Therefore, this greatly contributes to restructuring the economy and transforming growth model. Reforming institutions 96

97 Research has shown that economic institution plays an important role in economic growth. From the perspective of international theories and experience, the work of two professors named Daron Acemoglu and James Robinson, Why Nations fail, The Origins of Power, Prosperity, and Poverty 71, published in March 2012, had raised the question why there were countries becoming rich despite poor natural resources, while others with rich natural resources did not. The two authors clearly specified economic institution as the major reason. The world can be divided into two groups of nations, one governed by inclusive institutions, and the other ruled by extractive institutions. The authors pointed out that: Societies [inclusive] really have a more plausible division of political authority, which are absent in other societies. If extractive institutions gain the authority, which means that political authority is concentrated into a small group, there will be no prosperity or private rights that can save this country from the consequence of downfall because ownership rights can be manipulated. If political authority involves the widespread participation of the community, political and economic institutions can generate prosperity and welfare for the majority of the community. The authors argument is that prosperity mainly stems from investment and creativity, but these are the behaviors of faith: investors and creators must have reliable reasons to reckon that if they succeed, their achievements will not be seized by authoritative individuals. This also indicates that a good institution supporting economic growth and prosperity must be based on a reliable legal system which recognizes and protects rights of free ownership; free contracting and free competition; a mechanism which helps resolving disputes; and a transparent authority whose intervention into the economy is predictable. Nevertheless, in Vietnam, the design and operation of a cumbersome, inefficient and ineffective institution which do not follow the rule authority must be supervised (shown through deficiency in transparency and responsibilities) proves to be the root of corruption, authority abuse and institution deterioration. Hence, the investment environment has become nontransparent, unfriendly with investment and creative activities and lacked of a reliable mechanism to allocate economic resources effectively. 71 D.Acemoglu and J.Robinson, Why Nations fail, The Origins of Power, Prosperity, and Poverty, Crown Publishers, New York,

98 The institution is also closely attached with interest groups 72. Owing to institutional, legal and traditional causes, interest groups in Vietnam have not had any official channel influencing the compilation and implementation of Congress s laws and Government s policies. The motivation process has not been publicized and legalized, thus Vietnamese interest groups are various and complex 73. Vietnamese interest groups are characterized by relations to authoritative individuals, especially officials in human resources, finance, budgeting, investment, land, mining, sea and forestry, etc Taking advantage of the lack of publicity, interest groups often create networks through personal relationships, in which money is the major bond. The looser the laws are and the less authority supervised is, the more recklessly interest groups will perform. As a result, the economy s resources are not effectively allocated and thus distorted to serve different interest groups. The institution is attached with hierarchy division, while hierarchy division and the central-local relationship in Vietnam are experiencing noticeable shortcomings. Vietnam has become the country with the highest level of decentralization in administrative system compared with other countries in the region. However, hierarchy division proves unsystematic: investment hierarchy or land hierarchy have been evenly divided, which is similar and too broad for every city and province all over the country without allowing for absorption capability as well as evaluation and supervision competence in each local region. Hierarchy division also guarantees no responsibilities of accounting for necessary cases and is lacked of supervision, collaboration with policies and unity in the overall national development. As a consequence, the national economy is equipped with a wide range of sea ports, airports, industrial zones, etc. but does not allow for the characteristics of natural and socioeconomic conditions as well as capabilities in capital, human resources and technology, leading to discrete, unsystematic and inefficient natural resources exploitation. The decisions to construct sea ports, airports, universities, etc. were made by the Prime Minister or Ministry officials based on local suggestions, thus the discrete and unsystematic economic system is resulted from the designing and implementation processes at 72 Interest group is a community of many individuals and organizations sharing a mutual concern and stimulating their objectives by influencing government policies, through lobbying to create or amend legal terms and their execution to benefit their own group. 73 Secretary General Nguyen Phu Trong was the first person to publicly point out the names of interest groups in the statement ending the Third Meeting of Central Committee of the Communist Party of Vietnam on October 10 th,

99 both local and central levels. Therefore, reforming institutions, especially respecting ownership rights, fair competition and transparency, is the prerequisite to allocating resources effectively and contributing to the success of economic restructure. Institutional reforms include transforming several outlooks, laws, policies and operational modes of the economic system, which should focus on some major contents as follows: Designing a supervision mechanism at every level, in which every organism must be strictly controlled by one or several independent institutions. This proves to be suitable with international conventions, aiming at restraining the abuse of authority to serve personal or group interests. In particular, it is necessary to strictly conduct supervision authority in the whole process of building and implementing state budgets into public investment, public purchasing, land decisions, natural resources exploitation and control over public ownership rights within public enterprises. According to that, it necessary to complement and amend Constitution 1992 and other laws related to Congress, People s Council, People s Court, People s Procures and Government. Establishing independent anti-corruption organisms, operating by law under the supervision of Congress. The officials of anti-corruption organisms will be assigned by Congress and protected by law within the scope of Vietnamese legal system, avoiding overlapping in such an important aspect as anti-corruption. Guaranteeing publicity, transparency and suitability with international standards and customs in every activity of State organisms and officials related to economic action and people s lives (such as publicizing timetables, contact numbers, business field-trip costs, decisions on key positions in State system, etc.); publicizing the process of official selection and the standards for each position; publicizing the results of creditability votes for officials. It is necessary to specify the responsibilities of accounting for necessary cases for State organisms in utilizing national budgets publicize widely on the press and define the mechanism of regular conversations with citizens through means of media. Enhancing central managerial competence in strategic and macroeconomic issues at regional and central levels to establish a unified economy; adjusting the present mechanism of hierarchy division in light of balancing between rights and obligations; conducting appropriate hierarchy division based on capabilities and conditions of each local region, enhancing local ideas, enabling local development in various aspects which match geographical, historical and 99

100 socioeconomic conditions of each region on one hand, while resolving discreteness and creating industrial agricultural structure in each city and province which did not collaborate at regional level, experienced too broad a hierarchy division in terms of investment and land and lacked determination about responsibilities of accounting for necessary cases, etc. It is possible to allow the execution of local autonomy in every city and province (through collecting certain types of taxes, fees or deciding on some expenditure on infrastructure, education or healthcare), aiming at stimulating local creativity and autonomy and creating distinctions and diversity among different local regions. CONCLUSION Vietnam economy in 2011 has shown non-stop stressful macroeconomic vulnerability, which has been temporarily eased but still unsustainable. Such risks and instability would continue in 2012 but for strategic remedies. The fundamental cause of these macroeconomic shortcomings (lasting for a long period of time) lies in the Vietnamese-styled growth model, which is principally based on increasing inputs, especially utilizing investment capital intensively, whereas the efficiency proved low and diminishing, accompanied by responsive policies whose effects were dampened by the growth model itself. Therefore, reforming growth model and restructuring national economy is our only path, or in other words, an indispensable opportunity under present context. Growth model reform in Vietnam is considered the process of transforming principally horizontal to principally vertical growth model, on the basis of improving technical efficiency, allocation efficiency and technological progress, along with aiming at sustainable development economically, socially and environmentally. Economic restructure is considered the initial and urgent stage to achieve allocation and technical efficiency through the process of reallocating the economy s resources, especially in three key sectors (public investment, public enterprises and finance-banking). The premises for successful restructure lie right in renovating mindset and reforming institutions. In particular, economic mindset should orient the national economy at resolving market distortions, eliminating public enterprises advantage in business rights and opportunities, and creating an equitable business environment for every economic element. Institutional reforms need to aim at a reliable and predictable policy and legal framework, which protects ownership rights and guarantees a transparent, regularly supervised authority with the 100

101 final objective of creating an equitable and transparent environment for investment and creative activities. 101

102 Chapter 2 FISCAL DEFICIT RISK PREFACE Fiscal policy is one of the factors determining a country s stability in short term and sustainable growth in long term. In particular, it is more and more important for a country with a large-scale state sector like Vietnam. The state sector can have influences on economic activities, directly through budget spending and mobilization programs, or indirectly through impacts on the private sector s allocation/use of resources. Empirical researches conducted in many countries all over the world show that the weaknesses in fiscal management are the main causes of a series of serious economic issues such as prolonged high inflation, large current account deficit, and low or even negative growth rate. Therefore, fiscal policy is always considered as key factor of every reform for economic restructuring. Vietnam s economy has suffered the toughest time since the reform in the early 1990s. The recent negative fluctuations in the global economy have revealed fundamental flaws in the economy pursuing the target of growth in short term and disregarding the stability in long term. The economic growth rate continuously fell down, to approximate 6% in the period from over 8.2% in the period Meanwhile, the inflation rate remained unchanged at a high level, up to over 14% per year on average in the past five year. Severe trade deficit constantly increased to over 10% of GDP in many years. Especially, large budget deficit and increasing public debt, as a result of long lasting economic stimulus policies through public spending, have continued to be potential risks worsening macroeconomic indicators and threatening the economic stability in the future. The budget deficit in the last few years was up to 5-6% of GDP, while the public debt and external public debt soared to 57% and 42% of GDP respectively at the end of More seriously, the poor management in combination with recent economic difficulties have forced inefficient state-owned enterprises to fall into losses and to be on the edge of bankruptcy, in which the Vietnam Shipbuilding Industry Corporation Vinashin is taken as a typical example. The high public spending and prolonged budget deficit have led to many threats to the Vietnam s economic stability in the future such as unsustainable and high inflation rate, high interest rate stunning the private sector, prolonged current account deficit resulting in exchange 102

103 rate volatility, slow growth speed due to low resource-use efficiency, etc. Moreover, with limited resources due to prolonged budget deficit, the Government has often tried to curb these uncertainties through administrative measures such as price control, interest rate and credit ceiling, exchange rate control and international trade restrictions. However, these non-market rule measures are clearly temporary and sooner or later they will lead to a supply shortage due to a distortion of causes of economic stimulation, inefficient resource allocation, and limited production capacity. Instead of administrative measures, what the Vietnam s economy needs is a real restructure program, in which fiscal reform is among the keys goals in order to thoroughly address current economic instability and target the economy to a sustainable growth in the future. This paper is aimed to analyze the practice of the fiscal deficit and its negative effects on the country at present and probably in the upcoming time. At the same time, there are also some discussions about policy practices included in the paper for the Government to choose with an aim of achieving macroeconomic objectives of growth, unemployment, inflation and balance of payments. CURRENT SITUATION OF FISCAL DEFICIT AND PUBLIC DEBT Budget deficit and public debt to soar Annual budget deficit is defined as the difference between total revenue and expenditure of the Government in the same year. Meanwhile, the public debt is computed on the basis of accumulated value of budget deficit over years. Statistics about Vietnam budget deficit and public debt are varied in sources. Even the annual state budget final account by the Ministry of Finance provides two figures about the level of budget deficit: (i) budget deficit including principal payment; and (ii) budget deficit excluding principal payment. The overall fiscal picture indicates that Vietnam has been pursuing policies oriented deficit to boost the economic growth. The budget deficit constantly occurred over the last decade with an increasing extent. Specifically, Vietnam budget deficit, without principal payment, in the period was only 1.3% of GDP on average; however, this figure doubled to 2.7% of GDP in the period Noticeably, ongoing budget deficit in the recent years has led to a sharp increase of the public debt. Vietnam total public debt increased from about 40% of GDP at the end of 2007 to above 57% of GDP at the end of 2010, and then followed by a slight decrease in 2011 due to high inflation rate. At the same time, Vietnam external debt rose from 32% to nearly 42% of GDP. 103

104 Nevertheless, these figures may not reflect the true nature of Vietnam current fiscal deficit. The figures provided by international organizations are far different from those reported by the Ministry of Finance (MoF). Specifically, in 2009 only, the budget deficit excluding principal payment as reported by the MoF was 3.7% of GDP, while the corresponding figure by the Asian Development Bank (ADB) and the International Monetary Fund (IMF) were much higher, at 6.6% and 9.0% of GDP respectively. Averagely in the two years , Vietnam budget deficit marked the highest level compared to other countries in the region, at around 6% of GDP per year. This figure was approximately six times higher than the corresponding figure of Indonesia, three times against China s, and mostly two times against Thailand s. Vietnam has separate accounting methods which do not follow the international practice. Many budget expenditures from the Government bonds for education, irrigation, health, etc projects are offbalance sheet accounts which are not sufficiently taken into account in the budget deficit and public debt as followed by the international practice. Besides, the expenditures on major prolonged projects are gradually allocated in the multi-year budget but not wholly included in the year of bonds issued as a loan. The lack of consistency in fiscal accounting has led to the incorrect reflection in the statistics about Vietnam public debt situation, causing an information disturbance for market participants. At the same time, it causes difficulties for international comparison, risk analysis and management of Vietnam public debt. Table Vietnam budget deficit over years (% of GDP) MoF1-4,9-4,9-4,9-5,0-5,7-4,6-6,9-5,6-4,9-4,8 MoF2-1,8-1,1-0,9-0,9-1,8-1,8-3,7-2,8-2,1-3,1 IMF -3,8-3,3-4,8-1,2-3,3-0,2-2,5-1,2-9,0-5,7 ADB -3,5-2,3-2,2 0,2-1,1 1,3-1,0 0,7-6,6 Note: MoF 1 : Budget deficit including principal payment, MoF 2 : Budget deficit excluding principal payment. Source: The author s collection from MoF, World Economic Outlook (IMF, 2011) And Key Economic Indicators (ADB, 2011). Table Vietnam public debt over years (% of GDP) Threshold 104

105 Total public debt External public debt External debt Note: The threshold of the public debt and external debt are recommended by the MoF. Source: The MoF. Figure Budget deficit of some Asian countries, period (% of GDP) Source: Key Economic Indicators (ADB, 2011). The omission in the Vietnam budget deficit and public debt accounting is clearly shown in the figures reflecting difference between the real number of the Government bonds issued as a loan and that recorded in the State budget final accounts. According to the statistics by the Hanoi Stock Exchange (HNX), in two years 2010 and 2011 alone, total value of the annually issued government bonds and government guaranteed bonds was about 110 thousands of billion 110 thousands of billion VND, far higher than the figure denoted in the State budget final accounts. In addition, there are also a large number of the state-owned enterprises debts which are not reflected in the Vietnam annual budget deficit and public debt as followed by the international practice and recommendations of many international organizations. High tax rate 105

106 According to the MoF s State budget final accounts, in the period , Vietnam total state budget revenue was rather stable at about 29.0% of GDP on average. If there were only contribution from taxes and fees, this figure would be 26.3% of GDP. Excluding revenue from crude oil, the figure would be around 21.6% of GDP. Noticeably, the revenue from crude oil tended to decline while total state budget revenue fell down to under 3.1% of GDP in 2011 from about 6.9% of GDP in This implies that the proportions of other revenues are on an increase. The tax rate and fees in Vietnam, regardless the contribution from the crude oil, are relatively high in comparison with other countries in the region. In particular, China s tax and fee to GDP ratio in the last 5 years was 17.3% of GDP, Thailand and Malaysia s was approximate 15.5%, the Philippines was 13.0%, Indonesia s was 12.1% and that of India was just 7.8% 74. Figure Vietnam s sources of revenues (% of GDP) Source: The State budget final accounts and estimates, Source: ADB Key Economic Indicator for Asia and the Pacific (2011). 106

107 Figure Taxes and charges in some Asian countries (% of GDP) Source: ADB Key Economic Indicator for Asia and the Pacific (2011). Vietnam s revenues from taxes and crude oil have not seen any sign of a decline except for 2009 when the Government implemented a series of tax cuts and tax breaks so as to stimulate aggregate demand. The preliminary estimates for 2010 and 2011 in the final accounts of the State budget showed that the tax and fee to GDP ratio remained at high level and even increased to about 22.6 and 22.4% of GDP respectively. As a result, besides suffering from annual doubledigit inflation tax rate, each Vietnamese citizen has been sustaining a tax and fee to GDP ratio of about 1.4 to 3 times higher than other countries in the region because of protection policies and overlapping taxes. Regarding income tax, although Vietnam s tax brackets are quite similar to those of other countries, the range of taxable income taxed at the related tax brackets is much lower. For instance, concerning income tax, the range of taxable income taxed at 10% is approximate 3,451-5,175 USD per year. Meanwhile, the corresponding figure in Thailand and China are 4,931-16,434 USD per year and 3,801-9,500 USD per year respectively. 75 Similarly, the corporate income tax rate of 25% is applied in every enterprise in Vietnam while other countries apply different tax rates ranging from 2 to 30%. In addition to corporate tax, Vietnam imposes many high tax rates applicable to consumption such as excise duty and import duty. Especially, besides taxes and fees, Vietnam s enterprises have to pay other high informal costs. According to the 75 The calculations from 107

108 survey on the Provincial Competitiveness Index (PCI) in 2011, despite a reduce in the occurrence frequency of this situation, there were still more than 52% of enterprises questioned said that they had to pay money as a bribe to the local administrative staff, 7% of the enterprises had to pay up to over 10% of their total income for informal costs. The report also shows that though petty corruption is likely to reduce, substantial one tends to increase through behaviors such as kickback in case of signing contracts, public procurement, or lucrative land deal. In this regard, there were 56% of the enterprises involved in the procurement of state projects revealed that the paying of commissions was a common. This partially raises the inequality among interest groups and a majority of people, and at the same time and undermines confidence in the bureaucracy. The high ratio of total tax revenue to GDP limits the capacity of accumulation, reduce development investment, and improve competitiveness of the private sector. This also encourages tax frauds as the recent transfer pricing of the Foreign Direct Investment Enterprises (FDI). The statistics in recent years indicates that though the FDI enterprises account for about 20% of GDP in the whole economy, they just contribute less than 10% of the state total budget revenue. Many businesses in this sector continued to declare losses, but they still expanded production. That Vietnam s tax rate is higher than that of the other countries in the region is a cause which encourages the FDI enterprises to transfer their profits oversea for lower corporate income tax rates. Despite a high ratio of tax revenue to GDP, Vietnam s system of public infrastructure and social services are far less than other countries all over the world. The narrow and degraded transportation system, overwhelming hospitals, low quality of education, etc. are huge threatens to the development of the economy in long term. High public spending put total revenue under the pressure of being at a constant high level over the past few years. The approach to lower budget deficit through a tax increase and basis of taxation is less likely to be applied. The rise in revenue can only be done by measures of enhancing compliance rate, preventing losses and smuggling. Unsustainable revenues The MoF s annual final account of state budget shows that Vietnam s total taxes and fees mainly come from three sources, which are value added tax, corporate income tax, import and export duties and excise duty applicable to imports. However, the proportion of corporate 108

109 income tax tended to decrease gradually from 36% in the period to 28% in the period At this time, this proportion of the value added tax and import and export duties rose sharply. That the proportion of revenues from import and export duties and excise duty applicable to imports was on increase, from 10,0% in 2006 to 18,4% in 2009 and 14,5% in 2010 shows a rapid rise in the international trade; on the other side, reflects the high trade protection of Vietnam. This heavy dependence on taxes can make Vietnam s budget deficit be worse in the upcoming years when the country has to fulfill WTO commitment of cutting tax. Table The proportions of different taxes in the total revenue from taxes and fees Corporate income tax 0,33 0,36 0,28 Value added tax 0,22 0,23 0,29 Import and export 0,13 0,13 0,15 duty Others 0,33 0,29 0,28 Source: State budget final accounts and estimates In particular, revenue from sales of state-owned houses and user right assignment tend to decrease in absolute scale as well as proportions in total revenues and grants, from 9.3% in 2007 to about 6.6% in 2011 when these state-owned assets gradually disappear. For a deeper look at the fiscal picture, Vietnam should develop on more measure of budget deficit excluding revenues from sales of state-owned assets. That these revenues are taken into account when calculating budget balance will lower the seriousness of the budget deficit as reported. In term of its nature, this is similar to an individual selling his assets for consumption. His debts can reduce but his assets can also reduce, which means that he is getting poorer. In the same way, revenues from oil and other resources are similar to those from sales of national assets in nature and unsustainable because natural resources are limited. Particularly, revenue from oil constantly declined in proportion to total state budget in the past years. This revenue accounted for 28.8% of budget revenue in 2006 and decreased to just 11.6% in Besides, revenue from grants should be excluded in when calculating annual budget deficit due to its short-term and unsustainable nature. 109

110 For a more exact picture of current situation of Vietnam s annual budget deficit, we separated temporary, unsustainable revenues and revenues from sales of state-owned assets from total revenues and recalculate measures of budget deficit without principal payment. The results of the calculation shown in the Figure 2.4 implies that the degree of Vietnam s budget deficit, excluding principal payment, after deducting these revenues was up to 11.6% of GDP per year on average in the period and 8.7% per year in the period Obviously, the budget deficit was extremely serious even when Vietnam s taxes and fees were far higher than these of other countries in the region. Table Budget deficit excluding unsustainable revenues (% of GDP) Budget deficit excluding principal payment -0,9-1,8-1,8-3,7-2,8-2,1-3,1 Budget deficit excluding grants -1,7-2,3-2,4-4,2-3,1-2,3-3,3 Budget deficit excluding grants, revenue from sales of state-owned houses and user right assignment -3,5-5,0-4,7-6,5-5,3-4,1-4,5 Budget deficit excluding grants, revenue from sales of state-owned houses and user right assignment, and oil -12,1-11,9-10,7-10,2-8,9-7,2-7,5 Source: The author s calculation from the state budget final accounts over years. Prolonged high budget spending In many years, public spending was considered as an important driving force to motivate Vietnam s economic growth. Nonetheless, the role of the public spending in the economic growth is still a controversial topic. Many studies have pointed out that if Government spending is too low, the economic growth will be at low level because the realization of economic contracts, protection of property rights, infrastructure development, etc. will encounter many difficulties without the Government s role. In other words, some Government spending is necessary to ensure the economic growth. However, the economic growth will be hindered once Government spending exceeds a certain threshold as it causes an inefficient allocation of resources, corruption, losses and elbowing out the private sector. Counting on the empirical analysis, economists all agree that the optimal scale of the public spending for developing 110

111 economies is in the range of of GDP 76. Internationally comparative figures by ADB shows that Hong Kong, Taiwan, Indonesia, Singapore and India are among the countries with the minimum scales of the government spending, just accounting for nearly 15-18% of GDP. Meanwhile, the scale of budget spending of Vietnam, including capital expenditure and recurrent expenditure, is far above the optimal level, accounting for over 30% of GDP in recent years. A paradoxical thing is that after more than 20 years of reform transforming the economy from a centrally planned to a market economy, the scale of Vietnam government spending increased sharply from about 22% in 1990 to more than 30 % of GDP in Of course, economic success does not just depend solely on fiscal policy, but also depends on the monetary policy, trade, labor, etc. Furthermore, there is a fact that it is quality or efficiency of the government spending which is the important factor determining the growth rate and level of development of each country, not the scale. Sweden, Denmark, France, and the UK with the government spending scales of more than 50% of GDP are the countries with the highest income in the world and developed society. In contrast, Bangladesh and Cambodia are still among the poorest countries all over the world though this scale make up for below 50% of GDP. However, the dramatically increasing government spending at high level despite a very low efficiency was one of the main factors, directly or indirectly, results in macroeconomic instability in the past time in Vietnam. It is extremely difficult for enhancing the efficiency of the government spending in such current condition when it is too large in scale and scattered. Moreover, this situation is contributing to a shift of society s resources from the private sector to the public sector which is much less efficient. Finally, it also raises pressure of a revenue increase in the future and undermines the incentives of production in the private sector. 76 See more The Anh Pham (2008), Survey of the relationship between government spending and economic growth, Journal of Economic Studies, No. 10/

112 Table The government spending scales in some Asian countries (% of GDP) Bangladesh 12,4 14,4 14,5 15,0 15,3 15,9 Cambodia 8,4 14,8 14,8 13,2 20,5 20,7 China 18,5 16,3 18,3 22,4 22,5 Hong Kong 14,3 16,4 17,7 16,9 17,8 17,4 India 17,3 14,1 15,5 13,7 15,6 15,4 Indonesia 19,6 14,7 15,8 18,4 16,7 16,5 Korea 15,2 15,3 18,1 21,4 23,9 21,4 Laos 23,4 26,7 20,8 18,4 21,0 24,8 Malaysia 27,7 22,1 22,9 23,9 30,3 26,5 Pakistan 25,9 23,0 18,9 16,8 19,8 20,0 The 20,4 18,2 18,1 16,9 17,7 16,8 Singapore 20,2 15,6 18,5 17,9 Taiwan 14,5 14,3 22,6 15,1 15,9 Thailand 13,6 15,4 17,3 18,5 20,8 20,4 Vietnam 21,9 23,8 22,6 27,3 31,8 30,7 Source: ADB (2011), Key Economic Indicators for Asia and the Pacific. Notably, recurrent expenditure makes up a huge percentage in total budget spending while development expenditure s proportion is much smaller. While there was a slight decrease in the proportion of the development expenditure in the total budget spending, from 36.8% in 2003 to 28.3% in 2010 and about 24.6% in 1022 thanks to the efforts of cutting public spending for economic stability, the recurrent expenditure tended to rise, from the level of in 2003 to 71.7% in 2010 and 75.4% in This partially indicates the cumbersome and costly expenditure of the bureaucracy. Table The state budget spending over years Value (thousand billion dong) Growth rate (%) % of GDP Proportion (%) Development Recurrent expenditure expenditure

113 Source: The State budget final accounts and estimates over years by MoF. High, scattered and inefficient public investment Public investment is regularly defined as expenditures of the state sector for materials in order to create public goods and social services, such as roads, harbors, bridges, schools, hospitals, etc. the public investment capital can be withdrawn from the state budget, state credit, government bonds, or development aid from foreign countries. In Vietnam, public investment also includes projects for purely business purposes carried out by state-owned enterprises (SOEs). In the duration of , total social investment of Vietnam was ranked among the highest in the world, at about upper 40% of GDP on average with the growth rate of over 18% per year; whereby, the proportion of public investment was approximate 40% of total social investment though it was on a decrease in the past few years. In the context of domestic savings and national savings accounting for only about 28.5 and 32.5% of GDP, and just rising at a rate of approximately 16% per year, the large scale and rapid increase of the total social investment, including public investment, has created large disparities between savings and investment in the economy 77. This difference has led to the rapid increase of external debt and the domestic money supply growth so as to compensate for the gap between savings and investment in the past years. 77 National savings equals domestic savings minus net income paid to foreigners in form of interests, profits, dividends, etc. and plus net transfers received from abroad for example remittances. 113

114 Table Total social investment over years Value Proportion (%) (thousand billion dong) Growth rate (%) % of GDP State economic sector Non-state economic sector Foreign investment sector ,5 12,8 35,4 59,8 22,6 17, ,1 17,4 37,3 57,3 25,3 17, ,2 19,5 39,0 52,9 31,1 16, ,9 21,6 40,7 48,1 37,7 14, ,1 17,9 40,9 47,1 38,0 14, ,7 17,9 41,6 45,7 38,1 16, ,1 31,5 46,5 37,2 38,5 24, ,7 15,9 41,7 33,9 35,2 30, ,8 14,9 42,2 40,6 33,9 25, ,3 17,1 42,6 38,1 36,1 25, ,9 5,7 34,6 38,9 35,2 25,9 Source: General Statistics Office

115 Figure Difference between Savings and Investment (% of GDP) Source: ADB (2011) Key Economic Indicator for Asia and the Pacific. Regarding sources of finance, there was about 51.7% of the total public investment funded by the state budget each year on average in the past 10 years while loans and SOEs capital accounted for 23.1% and 25.2% respectively. Noticeably, the proportion of the state budget in the public investment fell dramatically when that of loans rocketed to over double times of this figure, from 13-15% in the previous years to 36.6% in The public spending is not only large in scale but also scattered. One can see that the state sector s investment was scattered in all fields, from nonprofit fields such as security, defense, education, health, etc. to purely profit business as processing industry, mining, arts, entertainment, etc. especially, the proportion of the investment in real estate, finance, banking, construction, housing services soared from 1.9% of the public investment in 2006 to about 4.8% in The public investment was considered as a key incentive of economic growth, but its efficiency was low and tended to fall down. According to the Report on Vietnam s Competitiveness by the Asia Competitiveness Institute, Vietnam s ICOR, the measure of the extra capital needed to create another unit of productivity in the period and

116 2008 was 4.8 and 5.4. This is far higher than its corresponding figures in the Newly Industrialized Countries (NICs) in the transition period For instance, during this period, Taiwan s ICOR was 2.7 and Korea s was 3. In addition, between 1981 and 1995, Thailand s ICOR was 4.1 and the China s was 4 during The investment efficiency of the state economic sector was much lower than that of the non-state economic sector and the foreign investment sector. Also in this report, the ICOR of the state economic sector was estimated to be about 1.5 times of the average figure all the economy. The poor efficiency in the public investment, especially the SOEs investment, led to a decrease to low level of the social investment s efficiency. Table The investment of the state economic sector Value Proportion (Thousand billion dong)) Growth rate (%) % of GDP State budget Loans SOEs ,4 16,2 20,2 43,6 31,1 25, ,0 14,0 21,2 44,7 28,2 27, ,7 12,5 21,4 43,8 30,4 25, ,6 10,3 20,6 45,0 30,8 24, ,8 10,5 19,5 49,5 25,5 25, ,6 15,6 19,3 54,4 22,3 23, ,1 14,5 19,0 54,1 14,5 31, ,0 7,0 17,3 54,2 15,4 30, ,0 5,6 14,1 61,8 13,5 24, ,5 37,6 17,1 64,3 14,1 21, ,3 10,0 16,2 44,8 36,6 18, ,5 8,0 13,5 52,1 33,4 14,5 Source: General Statistics Office

117 Table The public investment by economic lines (%) Transportation, warehousing 20,7 18,3 22,5 18,1 18,1 Electricity, water 14,6 13,2 12,6 16,8 16,7 Processing industry and mining 16,8 19,9 13,7 15,3 15,2 Science and technology, education, health 10,1 10,5 10,6 8,4 8,3 Information, arts, entertainment 7,7 8,2 8,1 8,1 8,0 Politics, security and defense 6,7 7,4 8,6 7,4 7,9 Agriculture, forestry and fisheries 7,1 6,7 7,2 5,9 5,9 Real estate, finance, banking, insurance, construction, housing services 1,9 2,8 3,1 4,8 4,8 Other 14,5 13,0 13,7 15,2 15,1 Risk from the state-owned enterprises Source: General Statistics Office Being guided to be hold prominent possibilities in the economy, the SOEs receive a lot of incentives from the Government in many aspects, from access to credit, lands, market, patent protection, etc. to other political supports. In fact, these enterprises have had a certain contribution in the process of industrialization and job creation in Vietnam, especially in the early years of reform. However, the recent rapid expansion in scale and widespread participation of the SOEs in all sectors, combined with the lack of a mechanism for close monitoring and transparency has made the management of the SOEs be loosen, the economic efficiency of the businesses seriously declined, causing great risk to the economy. Besides low investment efficiency, reflected by high ICOR, SOEs were likely to show their weakness in the job creation in the economy. Specifically, despite an approximately 40% of the total national investment, public sector created only about 10% jobs for society. Meanwhile, the non-state economic sector with 35% of the total investment created the employment of 87% of the entire economy 78. In particular, among the SOEs, the state-owned groups have received great support from the Government with an expectation to make them become the spearhead of the economy. However, instead of focusing on core business activities, many groups quickly developed into tangled networks of hundreds of general companies, subsidiaries, joint ventures and associates. The groups make scattered investment in the line of businesses which are not their strengths, 78 Source: General Statistics Office

118 ranging from investments in finance, banking, securities, real estate, mining, construction, commercial, and resort, etc. in which the Vietnam Shipbuilding Industry Corporation (Vinashin) is a typical example. The adventurous projects forced Vinashin's debts to grow; then it rapidly fell into losses and bankruptcy. The lax supervision from superiors and poor management of the corporation's leaders led to a series of activities using inefficient and wrong capital, such as using new debt to pay old debt, short-term loans to pay long-term loans, and even working capital to make investment. In December, 2010, Vinashin officially lost the ability to pay principal of $ 60 million, a portion of the $ 600 million debt issued in 2007 to the international creditors. The Elliott Advisers LP, one of the creditors, filed a lawsuit in the Court of Appeals, London against the Government of Vietnam for the claim of unpaid debts. Although Elliott Advisers LP recently withdrew the lawsuit as a domestic corporation purchased the debt of the Vinashin. Details of the deal have not been disclosed, but surely the price of the terms that the government must negotiate is not small. Vinashin has been restructured, but the consequences it have on the economy will be enduring for years to come. Behind consequences and lesson learnt from Vinashin are concerns about the efficiency and financial health of the other state-owned groups. The Government inspectorates have made a formal announcement about the breaches which are up to ten of thousand billion dong in the Vietnam Oil and Gas Group (Petro Vietnam - PVN). PVN was most in favor of retaining earning after tax in the long run to form a development fund so as to implement key projects in oil and gas, business expansion, capital contributions with oil and gas contractors, etc. However, it is noteworthy that this fund was used to finance PVN subsidiaries and joint ventures for the project with improper purposes. According to the inspection, the amounts of PVN investments in noncore businesses such as securities, insurance, banking, real estate have so far amounted to billion dong. The losses of ten of thousand billion dong due to scattered investment and investment in non-core businesses was also seen in a number of other corporations such as the Vietnam Electric Group (EVN), Song Da Corporation (SHB), etc. The lack of a close and transparent managing and monitoring mechanism in the use of the state budget has worsened and posed more risks to the fiscal situation of Vietnam. Debts and losses of the state-owned corporations have raised more warnings about the efficiency and the lax monitoring in state-owned economic 118

119 units. Whether or not be guaranteed by the Government, the SOEs debts will become a burden in form of taxes and fees for citizens of the country if they are not efficiently used. IMPACTS OF THE BUDGET DEFICIT ON MACROECONOMIC VARIABLES In order to clarify the impacts of the budget deficit on important macroeconomic variables of the economy including GDP growth, inflation, interest rate, trade balance, and exchange rate, we carried out qualitative analysis of the possible transmission channels of the budget deficit and measures to finance deficit on these variables. Inflation The government expenditures which are not funded by taxes or other revenues can contribute to the redundancy of aggregate demand and then lead to inflation. This is much likely to happen when the government spending is funded by an increase of money supply in the economy. If there is only a tiny proportion of the fiscal deficit funded by the increase in the money supply, inflation is not likely to occur. In contrast, if this source of finance is huge, and constantly used over years, the economy will definitely have to suffer high and long-lasting inflation. This transmission channel can be simply explained through the determining role in long term of the money supply to inflation of the economy. Increase in the money supply may not push inflation rate up if the economy is growing and the money demand in transaction is increasing too, or other property markets are becoming less attractive. Then the increase in the money supply can be absorbed by the increase of the money demand and thus do not cause an increase in prices of goods and services in the economy. However, when the private sector is satisfied with the amount of money that they are holding, the money supply increase will ultimately raise their spending and, in case goods and services supply do not catch up with this increase, the prices will, therefore, rocket until a new equilibrium is restored. When the government funds deficit by increasing the money supply, they are regarded as collecting "inflation tax" for those holding cash. In short term, many Governments can utilize the approach of using the money supply for the budget deficit funding because of a delay in the adjustments of the prices. Nevertheless, when inflation occurs, the possibility of collecting the inflation tax is low. The reason is that the private sector will quickly reduce the money they are holding and turn to other assets which have stable real value in high inflation environment like gold and strong foreign currencies. 119

120 Consequently, the phenomenon of goldization and dollarization will become common in the economy. The developments of these impacts are very similar to the facts of Vietnam situation in the past few years. The fiscal deficit is mostly funded by loans through government bonds issuing and even the budget advance (a manner of printing more money for spending). However, the government bonds and the government guaranteed bonds are mainly sold to big commercial banks. This volume of bonds will be pledged by the commercial banks in the SBV for cash through open market operations or discount window. Finally, this will lead to an increase in the money supply and inflation in the economy. According to the statistics by the Hanoi Stock Exchange (HNX), total outstanding government bonds and government guaranteed bonds worth about 336 thousand billion dong, equal to over 13% of nominal GDP and nearly 12% of money supply M2 in In short, along with the high credit demand of the private sector, the public spending funded by issuing bonds has indirectly led to a dramatic rise in the money supply in the recent years. High money supply growth, hyperinflation has made the public to find their shelters in the assets with stable value as gold, strong foreign currencies, and real estate, causing instability in the property market and reducing the effect of domestic monetary policy. Interest rates When not being subjected to administrative constraints, the interest rate will be determined by supply and demand in the capital market where the savings of households meet investments of businesses. The sum of government savings and private savings, also called national savings, reflects the supply, and investment represents the demand side of the capital market. The fiscal deficit will reduce the government savings, and the national savings, thereby reducing the supply and increasing the interest rate on the market. The increase in interest rates will eventually reduce the investment of the private sector. This is the crowding out effect on the private investment of the public spending. In other words, excessive public spending will lead to budget deficit. The government will be forced to borrow through bonds and reduce the amount of loans in the market that is supposed to be accessed by the private sector at low prices. In the recent years, Vietnam s debt structure has tended to shift from external debt to domestic debt. The current external debt accounts for around 58% of total debt and is on a decline, while the domestic debt is 42% and on its way to increase. Nonetheless, this is not necessarily a good trend reflecting a reducing dependence on foreign countries. This essentially 120

121 reflects the decreasing external preferential loans of Vietnam. High commercial interest rates of external debt plus the exchange rate risks force us to shift to domestic borrowing. The large domestic debt however, strongly suppresses investment of the private sector and reduces economic growth once the loan is not efficiently used by the public sector. Figure The government bonds issued over years (thousand billion dong) Source: HNX. Averagely in two years 2010 and 2011, the Vietnamese Government borrowed over 120 thousands billion dong per year through domestic bonds issuing. This figure approximately doubles compared with 56 thousands billion dong per year in the period The interest rate on the money market during was also more than two times of that in This is a typical example of the public investment crowding out the private investment. More seriously, the possibility of the domestic capital mobilization via issuing the Government bonds sometimes does not incur naturally following the market rule of supply and demand. In the period , with the interest rate ceiling of the government bonds ranging between 10-12% per year, while market interest rate was up to over 20% per year, there should have been no commercial banks willing to buy the government bonds. However, this was the 79 The figure includes both government bonds and government guaranteed bonds (Source: HNX). 121

122 most successful years of issuing the government bonds. The nature lying under this fact is that commercial banks can sell/pledge the government bonds to the SBV at a low discount rate, and then make loans to banks with low liquidity at high interest rate for great benefit. This action resulted in periods when capital flowed from the government bonds market to interbank market and vice versa, but not came to the private sector. Trade balance and exchange rate Citizens in a country can spend over the value of goods and services they produce by importing from other countries. Therefore, if the Government increases spending without any policy to control spending of the private sector, import and trade deficit will consequently increase. The relationship between fiscal deficit and trade balance can be simply demonstrated through the relationship of national income accounting as following: Y = C + I + G + NX (1) Where: Y denotes Gross Domestic Product (GDP); C refers to private consumption; I is private investment; G reflects public spending; NX is trade balance. National savings is defined by sum of the private savings (Y T C) and government savings (T G). Where: T is taxes. Thus, national savings can be rewritten as following: S = Y C G (2) Finally, by replacing (2) into (1), one can see the relationship between savings, investment and trade balance as following: S = I + NX (3) This accounting equation shows that the national savings will equal total private investment and trade balance. The budget deficit will lower the national savings on the left side, and therefore, reduce private investment and/or reduce net export on the right side. The decline in private investment caused by the budget deficit can be easily understood through effect of crowding out. Furthermore, the decline of net exports can be explained by the impacts of increasing government spending on imports. The increase in public spending and budget deficit will immediately make the total domestic spending larger than domestic output. With an aim to meet this additional expenditure, in addition to domestic production increasing, imports will increase and cause the trade deficit. The impacts of the budget deficit on the trade deficit will also particularly severe in the countries where domestic production is heavily dependent on imported raw materials like Vietnam. 122

123 Figure Savings, investment and trade deficit Source: ADB (2011) Key Economic Indicator for Asia and the Pacific. The impact of the budget deficit on the trade deficit does not stop there. The import of goods and services will lead to a shift of the asset flow back to overseas. When import exceeding export, initially we have to pay foreign currency to the foreigners. Then these foreign currencies can be used by the foreigners to buy stocks, corporate bonds, government bonds or real estate. Therefore, when the budget deficit occurs, Vietnam became a net importer of goods and services, as well as a net exporter of assets. The amount of domestic assets hold by the foreigners will become greater and greater. The budget deficit reduces the supply of loans to the private sector and thus increases interest rates. In terms of the other factors remaining unchanged, an increase in interest rates could attract flows of international capital flows into the country. Also, supply of foreign currency can increase and domestic currency will appreciate. However, in our country, this impact is not enough to offset the pressure of the currency devaluation caused by the large trade deficit. Moreover, the inflow of foreign capital is limited more by the environment of high inflation and the difficult-to-predict domestic exchange rate policy. Growth 123

124 Fiscal policy can affect the growth of an economy s output through two transmission channels. First, it can change the savings and investment, and therefore, the production capacity in the long term of a country. Second, it can alter the effectiveness of the resources use, and thus change both the current output and its future growth. During the economic downturn, fiscal expansion and accepting budget deficit at a certain degree can help to bring the domestic production back to its increasing orbit by stimulating aggregate demand. This policy is especially effective in the prior economy pursuing fiscal balance. However, if the economy is close to full capacity with continuous fiscal deficit before, the effect of the policy is very limited. The fiscal expansion even then will quickly lead to high inflation, high interest rates, current account deficit and financial instability. Lesson of stimulating the aggregate demand in Vietnam in 2009 and its aftermath in are examples of this case. In response to the increase of the inflation rate and current account deficit as a result of prolonged fiscal deficit, the Vietnamese Government as well as some other countries often applies administrative measures to control domestic prices, trade restrictions, and exchange rate control. However, these measures increase shortages of the aggregate supply owing to the fact that they distort the market by the domestic factors of production, resources will be allocated in an unreasonable manner, and the capacity of production and export will be limited due to the lack of imported raw materials. The prolonged fiscal expansion continues to worsen the current account balance and accelerated inflation. The decline in confidence in the domestic currency and the domestic economy can lead to an outflow of foreign capital except when the government has to pay much by monetary tightening, raising interest rates in order to restore confidence in domestic currency. The vicious circle among fiscal deficit - trade deficit - fiscal deficit may continue when the price and trade control policy reduce taxes, especially revenues from imports. This makes the curbing of the budget deficit more difficult and the pressure of increasing or taxes/fees will be among the last measures that the government can apply. The burden of high taxes/fees will reduce the incentives of production, reduce savings and investment of the private sector, and ultimately the economy will have low or even negative growth rate. Hard landing Hard landing is a term reflecting the situation in which an economy rapidly shifts from high growth to slow-growth and then recession. This situation usually occurs when the 124

125 government tries to reduce budget deficit and control public debt. It may be too early to put Vietnam in hard landing circumstance with the debt on GDP ratio being at an average level, but necessary for orienting fiscal policy towards long-term objectives. Hard landing may happen when national debt increases so quickly that foreign capital outflows is triggered. Firstly, as analyzed above, budget deficit tends to cause trade deficit, which is made up for by selling domestic properties to foreign investors. However, foreign investors are willing to acquire the limited number of assets. If twin deficit continues to occur, the demand for domestic assets will be saturated and their price will witness a sharp decline. Secondly, that fiscal deficit prolongs and public debt rises to a certain level will contribute to investors fear for the risk of government s insolvency. As a consequence, both foreign and domestic investor liquidates domestic assets. Finally, the country witnesses decreases in property price and investment, a rise in interest rates, investment, and domestic currency depreciation and skyrocketing inflation. Not only does the higher interest rate worsen the situation where placing heavier debt burden on government but it also reduces tax revenues due to lower consumption demand. In response to such a bankrupt risk, governments often quickly raise income tax and property tax to achieve a surplus basic budget balance 80. Consequently, consumption is lower and lower, causing recession. Another consequence of hard landing is a climb in inflation through importing channel when domestic currency loses value owing to outflow of foreign capital. In addition, Central Bank is put under high pressure to pay off debt, resulting in galloping inflation. Finally, hard landing may result in a financial crisis. Property prices are on a fall and the burden of interest payment put a large number of enterprises at risk of bankruptcy. Then, enterprises bankruptcy, in turn, brings financial difficulties to the banking system because of increasing bad debts. The worst scenario of this situation is a credit crunch and bankruptcy of financial institutions when the economy falls into recession like what the world experienced during the 1930s. CONCLUSIONS AND POLICY RECOMMENDATIONS 80 Basic budget balance equals Gross Revenue minus Gross Expenditure, excluding principle and interest payment of government 125

126 The above analyzed fiscal and public debt challenges show that it is time for Vietnam to carry out a thorough and comprehensive fiscal reform in order to bring its budget to the balanced status for assuring the debt sustainability and prolonged economic stability. As usual, there are two approaches for policy makers to carry out fiscal reforms: gradual adjustment or sharp correction once. Advocates of "sharp correction once" approach believe that fiscal reform process should be implemented immediately and comprehensively as quickly as possible. In contrast, proponents of the "gradual adjustment" approach say that the adjustment process should be carried out gradually during a long period of time in order to avoid too significant negative shocks to the economy. The objective of the fiscal reform related to adjustments of public spending and tax system orienting to a balanced and stable budget. In order to achieve this objective, the accounting of budget and public debt must be performed transparently following international standards. The off-balance sheet expenditure accounts must be absolutely avoided. The budget deficit measures, except for unsustainable revenues and revenues from sale of property, need further calculations for accurate assessment of current fiscal situation. In addition, the budget burdens arising in the future, such as pension payments or health insurance, should also be included in the forecasts of the budget deficit to get a more accurate picture of public debt outlook in the coming years. Secondly, so as to reduce public spending, we need to have a comprehensive assessment of the effectiveness of public spending in different sectors, not just purely look at the numbers of increase or decrease. We should not make mistake by cutting all expenditures by a certain fixed proportion. Cuts must be based on the evaluation and screening of inefficient spending programs/projects with low priority, or fields where the private sector can operate better. In addition to reallocating capital expenditures toward more efficient direction, current expenditure which is estimated to be over 3.6 times higher than capital expenditure in 2012 should also be reviewed and cut drastically. Thirdly, in order to efficiently behave to the SOEs, we need to classify enterprises with purely public purposes, for instance, enterprises in security-defense sector combined with those operating in business to earn profits. A comprehensive assessment of the effectiveness of the SOEs in terms of profit, technology, job creation, budget contributions, etc. need carrying out based on the principle of transparency in information about business operation. The number and proportion of the SOEs should be targeted descending via thorough equitization process of 126

127 enterprises operating in the business line, regardless of whether they are operating well or not, and at the same time creating favorable conditions for private enterprises to participate in all markets. Finally, tax system should be reformed to ensure criteria for sustainable, efficient, fair and transparent revenue. The tax burden needs properly reducing adjustment. However, this level of reasonability depends very much on the process of public spending cut. The too high tax burden will make the tax system less effective because it encourages tax evasion and distort the resource allocation. Tax and fee system should be reviewed to avoid overlapping. The taxes should be adjusted to ensure social security for low-income people, to encourage savings and limit consumption, especially imported luxury consumer goods. 127

128 CHAPTER 3 FINANCIAL MARKET INSTABILITY PREFACE In 2011, monetary policy could be considered as the mainstream tool dominating economic activities of the country. In front of increasing inflation developments in the early years, the SBV proactively implemented tight monetary policy, including measures to reduce money supply, sharply raise policy interest rates, and many other administrative measures to curb credit growth, particularly in the non-manufacturing sectors. The greatest success of the monetary policy in 2011 was to stop a rise in inflation since August. The VND/USD exchange rate was stable again. However, in 2011, a series of problems arising in the financial and monetary sector requires dissection of details. Specifically: Tight monetary policy makes money supply growth, deposits and credit significantly reduce. Liquidity in the banking system was intense. At many times, the interest rate on the interbank market was up to 30 %. At the end of the year, banks have to have collateral to borrow on the interbank market. Lending interest rates increased and much higher than mobilizing interest rates, this brought about huge profit to banks. NPL ratio and the overdue loans to total outstanding loans of the banking system soared. The issue of cross-ownership between banks and banks become s backyard of corporations, including state-owned and private ones, at an alarming rate. Tight monetary policy caused the property market, stock market and real estate market, severely impaired. The exchange rate is relatively stable but physical gold market remained strong influences on domestic exchange rate. In the context of the world economy in 2011 being relatively favorable for Vietnam's economy, the cause of these above problems was mainly from the structural instability 128

129 accumulated from many years ago. The main reasons to mention are loosen monetary policy for stimulating economic growth in many years, the imbalance between total outstanding loans and total deposits which is hard to be resolved, and the policy changing urban commercial banks to rural commercial banks. In 2011, the SBV implemented lots of measures to solve these problems. However, besides the fundamental solutions such as raising the interest rate policy, using of open market instruments and refinancing more flexibly, etc. the SBV used multiple administrative measures as mobilizing interest rate ceiling, credit growth ceiling, the credit limit for the non-production areas, etc. The short-term solutions in the period did not solve the root of the problem, just to move from a difficulty to another. In this chapter, we will try to coherently present the above issues as well as the reasons behind them. We believe that the underlying causes of instability in the financial markets over the past years mainly derived from inappropriate structure and growth model when the market economy of Vietnam has relatively developed and deeply integrated in the global economy. Therefore, the monetary policy like this cannot solve the instability in a sustainable way. The existing structural problems in the economy and the banking system lead to a sharp increase of the interest rate whenever the monetary policy is tightened, affecting the growth incentive and risk of stagflation, or whenever the monetary policy is loosen, the credit growth becomes hard to control, and then the effect of the monetary policy will be undermined. Therefore, in order to stabilize the macroeconomic and financial markets, we believe that monetary policy in 2012 had to deal with the immediate problems such as bad debt problems and ensure tradeoff between inflation target and support for growth, formulate more flexible policy of exchange rates, and build a modern gold market. On the other hand, we continue to emphasize that the objective need is to change the growth model and restructure the banking and financial system along with restructuring the property market (due to the relationship and the cross-risk among these markets). The structure of this chapter is organized as follows. In the next section we will present the outstanding issues in the financial and property markets in Section 3 will discuss the achievements and limitations of the monetary policy in Vietnam in And finally, in Section 4, we will firstly explain the underlying causes behind the financial and monetary instability in 129

130 2011, and then present challenges to the monetary policy in 2012 as well as suggest a number of solutions to overcome these challenges. OUSTANDING ISSUES IN THE FINANCIAL AND PROPERTY MARKET IN 2011 Tight monetary policy helps to lower CPI In 2011, the SBV conducted tight monetary policy. The growth rate of the broad money supply (M2) in 2011 was about 10.8%, compared with an increase of 33.3% in 2010 and 29% in However, the tight monetary policy was relatively aggressive in the first half of IMF data shows that in the first six months of 2011, the growth rate of M2 was only 3.05%. Due to tight money supply, credit growth also significantly reduced to 4.78% in the first half of 2011 and was estimated at 12% in 2011, compared with an increase of 30.9% in 2010 and 45.3% in However, the credit growth rate was higher than deposit growth rate, only about 10% in Because of this fact, the loan to deposit ratio (LDR) of the whole system remains at a very high rate, This rate was much higher than those of many countries in the region, such as Thailand (95.8%), Malaysia (79.3%), Indonesia (75.5%), and the Philippines (62.6%) (BMI Report, Quarter IV/2011, p. 32). Difference between credit and deposits which was not improved was the main reason that made the interest rate continue to remain at high level throughout 2011 and pulled over into 2012, despite inflation. Table Growth rate of the broad money supply (M2), total domestic credit and total mobilization of the economy, (preliminary) Money supply growth rate (%) 20,31 28,67 33,3 10,88 Total mobilization growth rate (%) 22, ,3 9,89 Total domestic credit growth rate (%) 27,6 45,3 31,86 12 Loan to deposit rate (LDR) 1,01 1,13 1,1 1,11 1,12 Source: IMF (2011); the preliminary data at the end of 2011 published by the SBV. 81 Data from the IMF and the preliminary data published by the SBV mainly differ in terms of credit growth. Preliminary data published by the SBV generally does not include net credit to the government and not estimate the investments made by the credit institutions which are essentially credits, such as corporate bonds, investment trusts, and other accounts receivable, etc. The authors of this study estimated that, if including these items, the SBV data published basically close to the IMF data. 130

131 The tightening money supply of the SBV in 2011 had a significant impact on the growth rate of the CPI in the last months of According to observations, the Vietnam s CPI growth rate over the same period last year had a relatively close relation with the broad money growth, with a lag of about six to nine months 82. This is the main reason why annual CPI decreased 23.02% from its peak in August, 2011 to 18.13% at the end of the year when M2 money supply growth started to decline from February, Figure The relationship between M2 and CPI of Vietnam Source: TCTK, IMF, and estimates based on the data published by the SBV. The liquidity of the credit institutions continued to be intense In 2011, the Vietnam s system of credit institutions was constantly at the situation of intense liquidity, with the following signs: - Loan to deposit ratio (LDR) still remained high in According to the IMF, the Vietnam LDR ratio fell from 117 % in January, 2011 to 109 % in October, However, this level was equivalent to the level of 2009 and If the amount of credit that the credit 82 In addition to monetary factors, Vietnam's CPI in 2011 was affected by a number of cost-push factors and exchange rate adjustment. Specifically: Gasoline prices soared. Even in the first quarter of the year, gas prices increased by nearly 30%, from 16,400 VND/litter up to 21,300 VND/litter, despite a correction in August, but the reduction is only VND 500. Electricity prices increased to 15.28%. From 1/3, electricity prices rose from 1,058 VND/kWh to 1,220 VND/kWh. Due to fuel and electricity prices are in input costs of most manufacturing goods should cost to produce increased output costs also increase with. As a result, commodity prices increased. Exchange rate USD/VND were adjusted to increase from 18,932 up to 20,693 VND by the SBV, equivalent to 9.3%, along with the narrow margin of the rate applicable to commercial banks from + / -3 % to + / -1%. This is the highest break ever. Rate increases caused inflation imported from outside. 131

132 institutions (CIs) tried to sneak the credit ceiling (20%) and ceiling rate of non-production credit (16%) through other forms of investment in corporate bonds, investment trusts and other accounts receivable were taken into account, the rate could be much higher. Moreover, the imbalance between credit and deposit mainly occurred in a number of weak commercial banks. This is the main reason why this group of banks raised interest rates to compete at any cost. - The money inflow and outflow of the credit institutions sharply fluctuated. Imbalance in lending/deposit forced some credit institutions belonging to the weak group to take measures to attract capital as a way of competing fiercely with interest rates to attract deposits. This was the main reason for withdrawal before maturity deposits increased in the sector, especially in the second half of As of 12/31/2011, these sales almost doubled compared to the same period in Figure Fluctuations in sales deposits withdrawn before maturity (billion dongs) Source: National Financial Supervisory Commission. The credit institutions focus mostly on making loans in short-term rather than long-term. Loan sales increased more than twice, but only average outstanding loans increased by 13%. The narrow term loans to help banks more flexibility in controlling credit growth quotas at the end of the year to not exceed 20%. Sales of deposits withdrawn before maturity increased significantly with short-term maturity that makes the banks be always in a state of stress due to continuous liquidity balance between loans and term deposit. Many credit institutions depend on the 132

133 interbank market (TT2) 83 that market interest rates rose sharply in many times. According to the National Financial Supervisory Commission, TT2 to Total assets increased from 16% in 2010 to 21.3% in There are a few banks this ratio accounts for 50% of total assets, increased mobilization TT2 56% compared to the same period in Deposit ratio increased TT2 to total assets among commercial banks and joint venture banks group and foreign banks. Table The structure of the market to mobilize capital I and II compared to total assets (%) Source: National Financial Supervisory Commission Sales transactions in the interbank market focus on the short term, especially overnight and weekly transactions, up to 80% of the total transaction value. Because many banks rely too heavily on the interbank market, so when the whole credit system is undercapitalized due to the SBV s tight money supply in the first quarter of 2011, the banks were forced to borrow on the interbank market with very high interest rates, primarily in the second quarter of 2011 of 20%. 83 The credit institutions conduct credit activities on the two markets. Market 1 (TT1) is the market for credit transactions between individuals and organizing non-credit business. Market 2 (TT2), also known as the interbank market, the market is trading between banks together. TT2 is to help the credit market liquidity conditioning. In normal conditions, the interest rate on the TT2 usually hovering around the central bank interest rate policy. In terms of trends, the central bank tightened monetary and credit system liquidity will be more stress, which increases the interest rate on previous TT2, TT1 led to increased interest rates, and vice versa, when the central bank monetary easing, liquidity credit system becomes abundant, which lowered interest rates on TT2 quickly, leading to reduction in interest rates on TT1. 133

134 Figure VND annual interbank interest rate, 2011 Source: Development Department, the Military Bank. A notable phenomenon in the market 2 is that from September until the end of 2011, the liquidity of this market has stalled. The market transactions mostly arose among banks with high liquidity. The weak commercial banks were virtually impossible to borrow money from banks as they could not repay old loans. According to the National Financial Supervisory Commission, on 12/31/2011 overdue loan in the market 2 increased 94.2 % billion compared to that in To borrow money on the interbank market, the credit institutions must have collateral. This is the first time in the history of Vietnam's credit system, commercial banks require other commercial banks to have new mortgage to borrow in the interbank market. The main reason for this phenomenon is due to the fact that weak banks cannot raise capital on the market 1 when the SBV acts severely punished ceiling raise interest rates. Another equally important reason is the highly rising bad debt at the end of the year, making the bank cannot be obtained money to improve their liquidity. Deposit rates and lending rates soar, the commercial banks have big profits, but may not real Although the SBV set the ceiling interest rate of 14 % since the end of 2010, but for most of 2011, except for three months, from September to late November when the SBV raised banks severely punished ceiling, interest rates of credit institutions were over ceiling. Competition in interest rates and capital fight among banks were pretty stiff. Banks must raise interest rates for 134

135 fear of actual deposits would flow out to other banks. Yield curve in the figures listed in the bank turned into line when, in fact, interest rate in the short term was higher than the long-term. As interest rates rose and bad debt ratio tended to increase, commercial banks pushed interest rates higher. At the end of the year, despite a reduce of a few percentage points, lending activity remains the production of nearly 20%, while consumer loan interest rates most individuals remain at 22-24%. The difference between deposit rates and lending rates were yanked up 4-5% from normal levels of about 3%. In addition to raising account with competitive rates around 16% -19% in 2011, the banks benefited greatly from applying policy interest rate ceiling of 14 % of the central bank. Most small savings under 100 million would not get "bonus" from the banks. The small deposit did not account for the total mobilization of the entire system. Thanks to the large gap between lending and deposit rates, especially thanks to the policy of the SBV interest rate cap pressure, most major banks had big profits in 2011 than in 2010 despite rate credit growth lower than every year. ROE on average of eight listed banks increased from 18.83% in 2010 to 19.68% in 2011 (see Table 3.3). However, it should be noted that the intrinsic rate of commercial banks may not be so great. If banks full provision is entirely possible profits of commercial banks will decrease significantly. Most banks NPL ratio increased, but the rate of provision of bad debt risks tended to decrease. Of provision for credit losses at end of 2011 with 62.81% of total loans and 17.15% decreased compared to Habubank s case was the most typical. The bank reports bad debt of only 4.69% and interest at the end of 2011 was different from the figures in the document Habubank merger proposal was announced in SHB, accordingly bad debts was up to 16% and if provision was adequate, the loss Habubank had to suffer would be up to 4,066 billion. 135

136 Table 3.3. Some financial indicators of listed banks, Bank NIM ROA ROE NIM ROA ROE ACB 2,69% 1,25% 21,74% 3,44% 1,32% 25,53% CTG 4,19% 1,12% 22,21% 5,03% 1,40% 25,29% EIB 3,32% 1,85% 13,51% 3,72% 1,94% 20,46% HBB 2,41% 1,42% 14, 4% 2,46% 0,88% 8,46% NVB 2,75% 0,81% 9,84% 4,07% 0,85% 6,86% SHB 3,45% 1,26% 14,98% 3,58% 1,21% 14,73% STB 3,55% 1,49% 15,55% 4,48% 1,39% 14,40% VCB 2,96% 1,50% 22,66% 3,98% 1,34% 18,03% Average 3,37% 1,36% 18,83% 4,18% 1,40% 19,68% Note: NIM : net interest marginal, ROA : Return on assets; ROE : Return on equity. Indicators in 2010 are based on the consolidated financial statement. Source: Ba Tinh Ho, Saigon Economic Times, 2/9/2012. The rate of bad debts and overdue debts of the banking system at an alarming rate Despite high profits in 2011, the results of Vietnam's commercial banks are not really sustainable. The rate of bad debts, overdue debts on total outstanding loans of most banks has increased sharply compared with the previous year. Meanwhile, the percentage of bad debt provision is less than the previous year. According to the SBV, bad debts (categories 3, 4, 5) general banking system in 2011 has increased up to 3.72% from 2.29% in According to data from eight banks have announced separate financial statements fourth quarter of 2011, only VCB NPL reduction, the remaining bad debt ratios are high. Particularly Habubank, NPL ratio increased from 2.39% in 84 Decision No. 493/2005/QD-NHNN by SBV dated April 22, 2005 issuing the Regulations on Classification of Debts and Loss Provisioning in Banking Operation of Credit Institutions as follows: Category 1 (pass): debts that are not due and the borrower is able to pay the principal and interest of debts in full and in a timely manner; Category 2 (special-mention): debts that are overdue less than 90 days and rescheduled debts that are not due; Category 3 (sub-standard): debts that are overdue from 90 to 180 days and rescheduled debts that are overdue less than 90 days; Category 4 (doubtful): debts that are overdue from 181 to 360 days and rescheduled debts that are overdue from 90 to 180 days; and Category 5 (loss): debts that are overdue more than 360 days, rescheduled debts that are overdue more than 180 days and debts that are subject to rescheduling arrangements as directed by the Government. However, loans may be subject to a worse rating if there are reasons to doubt the borrower s ability to continue to service such loans. 136

137 2010 to 4.69% in Overdue (category 2) of most banks rose sharply in late Overdue debts in the credit report at the time of 12/31/2011 accounted for 11.09% of total loans and 3.32% increase over Among the listed banks, the HBB had delinquency rate rose fastest, respectively, from 9.86% in 2010 to 13.34% in Next is Vietcombank whose figure increased from 5.27% in 2010 to 8% in Certainly part overdue at the end of 2011 will turn into bad debt in Table Overdue and bad debts in the whole system, Items Overdue/total outstanding debts 7,77 11,0 Where: State-owned commercial banks 10,43 13,3 Joint stock commercial banks 3,73 6,43 Venture, foreign banks 4,66 5,76 Financial and leasing banks 21,06 40,8 Overdue/total outstanding debts 2,29 3,72 Where: State-owned commercial banks 2,95 2,16 Joint stock commercial banks 2,30 1,87 Venture, foreign banks 1,86 1,20 Financial and leasing banks 34,50 11,3 Source: National Financial Supervisory Commission One point worth noting is overdue and bad debts of group companies and financial leasing in severity, the state-owned banks at an alarming rate. The overdue rate of financial companies and financial leasing in 2010 was turned into bad debt in This makes the overdue rate for this group fell from 40.85% to 21.06%, but the rate of bad loans increased from 11.38% to 34.5%. What is more dangerous is the overdue of state-owned banks is very high at 10.43%, down a little from 13.36% in Due to this group's overdue for 61% of total overdue debt market (while this group accounts for 50.64% market share of credit), so if like 2012, and overdue loans were converted into the substance liquidity of the market will be seriously threatened. Although overdue and bad debt tended to rise, the rate of provision for bad debt risk tended to decrease. Of provision for credit losses at end of 2011 with % of total loans and % 137

138 decreased compared to Reserve ratio on bad debts and overdue in the region and the stateowned banks and financial companies leasing decreased. If implemented loan classification and provisioning sufficient allowance was in accordance with the business results of many banks will decline sharply. Many credit organizations would fall into losses, even heavy losses. Thus, the loss of liquidity risk in 2012 was still very serious. Another serious phenomenon in 2011 was overdue increasing in the interbank market. Overdue debt on the interbank market at 12/31/2011 increased 94.24% increase compared to 2010 and accounted for % of total outstanding loans. However, excluding a special case of a foreign bank with overdue accounts overdue 82% of the whole industry, its overdue group of credit institutions in the country increased by only 17.07% compared to 2010, in which the group's overdue state-owned banks increased 23.97% compared to 2010 and accounted for 94%. Ownership structure of the banking system increasingly overlapping The issue of cross-ownership between credit institutions in Vietnam is becoming more serious, is one of the reasons for the fact that disbursement based on relationships rather than efficiency. Cross-ownership in Vietnam's banking system can be divided into the following groups: Ownership of state-owned banks and foreign banks in the joint venture banks: Currently there are six joint venture banks in the system of credit institutions in Vietnam. Normally a bank owned by a joint venture banks are foreign banks and domestic banks. Such banks Vietnamese Thailand joint venture banks between 3 partners : Bank of Agriculture and Rural Development of Vietnam ( Bank for Rural Development), Commercial Bank Siam Thai and Group Charoen Pokphand ( CP ) of Thailand, who corresponding capital ratio was 34 %, 33 % and 33 %, Vietnam Russia Bank, a joint venture between the Bank for Investment and Development of Vietnam ( BIDV ) and VTB Bank (formerly the Bank for Foreign Trade of the Russian Vneshtorgbank ) with a capital contribution equal. Strategic foreign shareholders in banks, both state and joint stock front needs to attract capital and management skills from the financial institutions experienced foreign central bank policy has encouraged domestic banks to seek foreign strategic shareholders do. To date, there are 10 commercial banks is a strategic partner of foreign financial groups. Shareholders in the banks that fund management companies: Since 2005 the past, the fund 138

139 managers began to appear more capital in Vietnam. These funds typically invest in commercial banks with good development potential. For example, Vinacapital capital investment in Sacombank, Eximbank VOF investment, investment bank Dragon etc. Property of the State-owned commercial banks at commercial banks: the ownership relationship formed mainly of banking weakness of the commercial banks in its early stages as well as during the crises. Currently, there are nearly eight commercial banks with shareholding relationship with the four state-owned banks. Typically, Vietcombank, owns 11% of the Military Bank, Eximbank 8.2%, 4.7 % at the Oriental Bank, Bank 5.3 % in Saigon. Mutual ownership of commercial banks: The phenomenon of mutual ownership between commercial banks is also common in Vietnam today. From the information released by the bank, is at least six commercial banks have shareholders as a joint stock commercial bank. For example, Eximbank owns 10.6 % stake in Sacombank, 8.5 % stake in Bank of Vietnam Asia. Commercial banks owned by conglomerates, corporations and private: the boom of commercial banks and financial investment funds, many corporations and state-owned corporations have contributed capital formation of credit institutions. Currently there are approximately 40 state enterprises and privately owned more than 5% stake in the banks. Moreover, most of the state-owned corporations are financial companies. The relationship between commercial banks to private corporations is becoming increasingly complex. Many banks can be owned by a many family companies or family members and leadership capital in other enterprises 85. In the above relationship, the three groups of cross-ownership is the first positive because the relationship is primarily aimed at strengthening trade promotion activities between Vietnam and international governance capacity and promoting the use of a capital efficient manner. This is the most worthwhile relationship of the three following groups. When the SCBs are major shareholders of joint-stock commercial banks, state banks could affect the bank the following headings in providing capital for state-owned enterprises. With two cases banks are major shareholders are the business, they are likely to become commercial banks backyard, 85 A typical example for this situation is the case of Mr. Thanh Tam Dang with Navibank Bank and the West Bank. Although Mr. Thanh Tam Dang owns only 2.97% in Navibank and no stake in the West Bank, he indirectly owns both banks. Telecommunications JSC Saigon, where he held 23.69% and through the development corporation Kinh Bac (KBC), which he held 34.94% of stock. JSC Saigon Telecommunication directly owns 9.41% of the West Bank. And KBC 483 billion investment in energy JSC Saigon - Binh Dinh, which accounts for 9.85% of equity in the West Bank and the Bank Navibank 11.93%. 139

140 specializing in raising capital from residents to finance their projects. Although according to the banks not to loan their shareholders, but the banks could circumvent this regulation by the subsidiaries of the lending business. Similarly, the cross-ownership between banks and to facilitate the banking business owner can easily get a loan from another bank. Thus, three cases have owned this risk will lead to commercial banks to loan appraisal carried reckless. If this happens, it can be considered as one of the important causes leading to bad debt in the credit system of Vietnam is rising. Tight monetary policy led to economic growth and asset markets declined sharply Tight monetary policy in 2011 had significantly impacts on growth target of Vietnam. Although the target was adjusted earlier this year from 7.5% to 6% by mid-year but ended the year 2011, the GDP growth was only 5.89%. In general, the lower the overall growth in 2010, but the growth of the sector is fairly components. Growth over the quarter and slower than in previous years: quarter rose 5.57%, 5.67% the second quarter, third quarter and fourth quarter up 6.07% increased by 6.1%. Compared with 2009 context, we can see the trend to grow again in the third quarter just as that huge amount of stimulus money given from the beginning of Because tight monetary policy is still the mainstream in 2012, if there is no breakthrough in productivity or the inflow of foreign capital, the declining trend of economic growth will likely continue through 2012 sooner rather difficult. Figure Relationship between money supply (M2) and GDP growth Source: TCTK, IMF, and announcement by the SBV. The author s calculations The strongest impact of tight monetary policy on the economy is that it has reduced the growth rate of total retail sales of consumer goods and services - a key component of aggregate 140

141 demand. If deducting price factors, the growth rate of total retail sales of consumer goods and services since the beginning of the year compared with the same period last year fell sharply from 9.5% in the year to 4.5% in last year. Due to reduced domestic demand, inventory levels of the enterprise increase. The number of businesses has closed or bankrupt therefore also increased. Specifically, according to the Ministry of Planning and Investment, in the first nine months of 2011 there were about 49,000 businesses going bankrupt. But in nearly three months of 2012, the number of enterprises encountering difficulties and having to be dissolved or suspended operations increased 6% and the number of businesses complete dissolution procedures increased 57 % compared to the same period last year. When tightening the money supply, coupled with the decline of the real economy, asset markets such as real estate and securities has also been a sharp decline. CBRE Vietnam's data (2012) show that the price of apartments, land, and leased premises in 2011 in Hanoi and Ho Chi Minh City decreased from 3-20% compared to Vacancy in the office market has risen to 28 %. For the stock market, VN - Index and HNX - Index has decreased by 27.7 % and 48.2 % in Because the real estate market and the stock market are two markets depend heavily on future expectations as well as the liquidity of capital flows to the tight money supply, investors will see the decline of economy in the short term as well as the cash flow into the market. Only when confidence in the growth of the economy to go back and credit operations returned to normal, the two markets can return to growth cycle. USD/VND rate has stabilized but is still affected by strong gold prices That the real interbank exchange rate end of 2011 was only slightly higher than last year is considered as a success in monetary policy by the Government last year. The main reason for exchange rate stability is due to the huge difference between interest rates in VND and USD. With dong deposit interest rates of about % in fact most of the year while the U.S. rate was only 2-3 %, it is clear that the attractiveness of holding foreign currencies has been significantly reduced. 141

142 Figure USD/VND interbank exchange rate, 2011 Source: Development Department, the Military Bank. Another reason is that the exchange rate remained stable because of the trade deficit has been controlled better than the previous year. In 2011, the total export turnover reached U.S. $ 96.3 billion, up to 33.3 % compared with 2010, which was the record exports, the highest ever. This figure exceeded the target by 20.4 % compared to the U.S. $ 80 billion in Meanwhile, the total value of imports in 2011 reached billion U.S dollars, increased by 24.7 % compared to the previous year. Like exports, imports exceeded the target by 11.1 % compared with the year 2011 which was 94 billion USD. Thus, the deficit for 2011 is estimated at 9.5 billion, down nearly 25 % from the previous year and by 9.9 % of the total export turnover. The deficit this year is the lowest in the last five years and the annual trade deficit rate in comparison with that of exports reached its lowest point since Notably, in the past year, there were two months of trade surplus in June and July as exports of gold and other precious metals. Although the rate stabilization objective has been achieved in 2011, but there are still interbank rate ceiling for most of the time in In addition, the gold market is not really well organized. Domestic gold price is often higher than the world price. This disparity has stimulated smuggled gold, making the exchange rate more freely beyond the interbank rate, negative impact on the operating rate of the SBV. MONETARY OF THE STATE BANK OF VIETNAM IN 2011: ACHIEVEMENTS AND LIMITATIONS Facing with macroeconomics instability in 2011 as described above, the SBV has implemented a series of policies in the spirit of Resolution 11, dated 24/2/2011 of the 142

143 Government. Here are the achievements and limitations of monetary policy in our evaluation. The achievement of monetary policy in 2011 The tight monetary policy was implemented steadily and consistently In 2011, the most prominent achievements of the monetary policy are that the SBV and the government have consistently pursued tight monetary policy. In pursuit of this policy, SBV Governor Nguyen Van Binh has recently candidly acknowledged high inflation in recent times mainly derived from monetary causes instead of pouring in the most "objective" others. Thanks to dare " look at the facts, so SBV has consistently targeted monetary tightening to curb inflation until the end of fourth quarter of 2011 and plans to extend to the whole of 2012, despite the difficulties the regional capital of banks and businesses. Exchange rate policy is somewhat more flexible Although Vietnam is still under the regime of crawling peg, being different from the operator of years ago, the center rate was adjusted more frequently according to the market trend by the SBV. But these adjustments are not really sticking to the volatility of the market, but the pressure to make any significant adjustments as the previous year shall be released. Moreover, the central bank has also more active in buying and selling foreign currencies from foreign exchange reserves to ensure national rate fluctuations are not too strong. The adjusted operating policies such exchange has contributed to the year-end exchange rates return to levels comparable with the central bank the currency devaluation in early February, A number of administrative measures to help cash flow in the right direction Normally when there is a sudden monetary tightening, if the SBV does not handled with skills, it is very easy to lead to the loss of liquidity in the system of credit institutions, making the transfer stalled flows, as well as good business bad inaccessible funding. In this case, production will decline very sharply, economic growth may be negative. To avoid this situation, in 2011, the central bank has been working closely with the banks to direct capital inflows into the manufacturing sector, agriculture, and exports. The regular meeting, the SBV regularly with groups of 12 major banks also helps both sides understand each other better. Thanks to these measures, the capital flows have reached the business of agriculture and forestry exports, helping growth in the agricultural sector reached a high level compared to recent years. Exports also grew significantly; improve the balance of payments of the economy. 143

144 Some shortcomings of monetary policy in 2011 The administrative measures are maintained too long and rigid In 2011, the SBV has adopted a series of administrative measures alongside traditional tools is the interest rate policy to control money supply. The typical administrative measures are: - Imposing a ceiling interest rate of 14% for deposit by VND for a term of one month or more. - Imposing a ceiling interest rate of 6 % for deposit by VND the term under a month. - Imposing a ceiling interest rate of 2% for deposits by foreign currencies. - Imposing ceiling 20% credit growth in 2011 for all credit institutions. - Imposing ratio of non-production loans under 16 % for all credit institutions. The fact that the administrative measures mentioned above only works in the short term. After a period of time, they continue to face difficulties in liquidity banks have found ways to overcome barriers and try to cover up the act hurdle in the accounting profession. For example, to apply the policy interest rate ceilings, banks have used many forms of bonuses, the different forms of trust, acceptance or even active interest penalties due to depositors slow to circumvent the ceiling. The policy credit growth ceiling, the credit application form investment trusts or corporate bonds or using accounting operations included in the "Other account receivables" to ceiling. As for the policy limit credit rate ratio in non-manufacturing16 % CIs for the procedure also buy corporate bonds, investment trusts, escrow deposits, other assets, etc. to the spleen. Imposing rigid lending rate non-production credit for making the real estate sector and stock is reduced dramatically. Measures "hard landing" for the two markets makes this property from being converted into decline "freeze". Bad debt of the credit system increases sharply. The loss of market liquidity also makes real estate inventory in the real estate business and supply construction materials rose sharply, making the production of the economy falling into stagnation. Thus, the administrative measures are unlikely to monitor in a long time, and trying to impose it always causes negative consequences unforeseen. The maintenance of these measures not only help the central bank achieve its goals but also cause moral hazard for the entire financial market. While this is an area to which the criteria of honesty and transparency are 144

145 placed on top of the invisible measures were "encouraged" banks to falsify books and hide data. This is not only costly for both banks and customers, but also caused certain difficulties for the SBV in monitoring systemic risk data provided by the central bank is not true. Ineffective gold policy In 2011, the SBV had no effective measures to unfreeze the flow of capital in the form of physical gold; the central bank estimated that up to tons, to serve economic ends. To reduce people hoarding gold, the SBV issued Circular no. 11/2011/TT-NHNN termination provisions mobilized by commercial banks as well as loans of physical gold. Invisibly the policy made the capital in the form of gold which people lose contact with the credit system of the economy. However, before this move, the bank has taken many forms in order to circumvent the rules of the central bank, instead of raising commercial banks "safe-keeping" gold pay dividends. Gold mobilized by commercial banks to use as collateral, deposit, deposits, etc. which is essentially credit activities. Measures to prevent the influence of the gold price on the USD/VND exchange rate is also proved ineffective. Allowing banks involved in selling gold in November to pull the domestic price of gold prices close to international success. Although the first time, the domestic price of gold than gold only difference between international 500,000 but this state is only maintained for some time. After approximately 1 month, the domestic gold price returned higher gold prices internationally 2-3 million /ounce. The major difference between the gold price and foreign leading to import of gold smuggled across the border. When this happens, it will lead to the phenomenon of collecting foreign currency exchange rates on the market that freedom increase. People will then hoarding of foreign currency exchange rates affecting the interbank. Exchange rate policy has not been linked to the exchange rate freely interbank rate. Although the exchange rate in 2011 is considered to be relatively stable, the SBV was unable to work for free rate movements in interbank rates. When there is an impact of gold price or the impact of the economic stability, the free price is often significantly higher than the interbank rate. Although the SBV has adopted administrative measures to prevent the sales and purchase of foreign currency illegally on the free market, basically these measures are maintained only for a short time. The needs of the people in the foreign currency trading on the 145

146 free market is very large, cannot get rid of the free market. CHALLENGES FOR 2012 AND THE NEXT: SUGGESESTIONS AND SOLUTIONS Although the SBV has some interventions in 2011 and has achieved certain success in curbing inflation and stabilizing the exchange rate, but the core problems of the financial markets, the currency remains. The rate of bad debts, overdue debts to total loans continued to rise, real estate markets are still frozen, the economy is in danger of falling into decline, while inflation remains high, two issues rate, the difference between the free market rate and the interbank rate, remains constant ; gold resources in the population has not been cleared, etc. These phenomena occur on the currency markets, finance, and banking in 2011 as described in the mutual relationship. For example, the phenomenon of reduced money supply is a key cause of stress lead to liquidity, pushing up interest rates, economic growth declined. Exchange rate stability is also partly due to VND interest rates are pushed up, making demands of people of foreign currency reduced. However, we believe that the above-mentioned phenomena are rooted in a deeper cause, namely, from three main causes: (i) expand the money supply policies in the past, (ii) the unreasonable capital structure, and (iii) from moving too fast banks operating in rural areas to urban areas. Understanding the underlying causes will be the basis for our proposed policies solved the problem in the financial markets, monetary exist in 2012 and the following years. The underlying reasons behind the currency instability in 2011 Money supply expanded for policy stimulus credit The main cause of unrest in 2011 came from the "braking" money supply to control inflation in the context of growth of money supply and credit growth rates are maintained at a very high level of the previous year. According to the IMF, the growth rate of money supply, credit and raising the annual average for was 32.5%, 35%, and 34.6%. Except for the last six months of 2008, central bank maintains its refinancing rate was low, ranging from 5 to 7.5 %, in the period , causing the interest rate of the bank deposit is maintained at low levels, respectively, from 7 to 8.5 % during this period. This is the reason for the credit boos economy. Vietnam economy to sustain high growth rate of money supply in the last year has roots in the growth model relies heavily on investment. Specifically, to obtain the average GDP growth 146

147 rate of 7.5% annually in the period and 6.9% in the periods, Vietnam has required an average investment of respectively 39.1% and 42.7%. Investment demand while saving large tends to reduce the economy must rely on monetary policy loosening. Because of its ability to absorb less capital investment, mainly from lower investment efficiency and the weak performance of the SOE sector, should have created the phenomenon of excess cash in the economy, inflation pressure. When money is put into circulation too much, the general price will increase after about 6-9 months. That's what happened to the economy of Vietnam between 2007 and 2008 and from 2010 until To cope with inflation, the central bank is effectively decreased the money supply and increase operating rates. SBV has taken this policy in 2008 and But when this takes place, the liquidity of the banking system goes. The business, previously due to too much investment should appear many works in progress, cannot stop, and so it cannot cut deposit credit immediately. Credit demand remains so high despite high interest rates. Meanwhile, by tightening the money supply should be raised from the population cannot be in a corresponding increase. As a result, the rate of loan/deposit of the system of credit institutions continued at a high level.therefore, interest rates remain high even as inflation fell as signs of the end of 2011 to date. Capital structure is not reasonable Capital structure is not rational part derived from the loose monetary policy of the previous year. When the cheap money available on the market, the business will continue to expect future "beautiful" as it is now. Thus, firms tend to invest heavily to develop projects in the field of real estate, industrial parks, etc... On the other hand, because many banks are essentially "backyard" of the business real estate, infrastructure development, so the loan real estate, infrastructure development accounted for a huge share in the bank.capital structure is therefore not reasonable allocation between short -term loans and long term loans; between investment loans in the real estate and investment loans produced. Having to rely too heavily on bank credit to infrastructure development as well as the cause for the capital structure is not reasonable. Due to underdeveloped capital markets demand growth up front " hot " economy, the burden of which accrue credit markets has caused banks to use short- term deposits to finance residential support for the medium and long term projects. 147

148 During the period of monetary expansion, raising capital on the interbank market quite easily, so this group of banks can always raise capital in the market 2 to finance real estate projects and the infrastructure. However, when monetary policy is tightened suddenly, the liquidity of the system will face difficulties. The central bank lending and too much long -term, primarily finance real estate projects and industrial parks being unbalance serious capital. One of these banks can not withdraw funds from the loan real estate loans on the other hand; the interbank market will face difficulties, making the liquidity of the bank stress seriously. Thus, the capital structure is not rational, but the main reason is due to expansion of money supply and therefore the mechanism previously cross-ownership in the banks, is the main reason why the banks weak forced to increase interest rates very high to attract capital from the market first. They are also the cause for bad debts, overdue increase in the system of credit institutions when the real estate market became frozen. Rapid conversion of rural banks into the urban banks Prior to demand increased funding to meet the demands of the general growth of the economy, in the period , the central bank has approved 13 banks allow conversion from rural to model urban. These bank before conversion, capital only a few dozen to a few hundred billion. However, the capital requirements at least 3000 billion in 2011, the banks were forced to raise equity to times in just 5 years 86. The consequence of having developed extremely fast pace of the group of banks is that they have to grow assets at all costs to correspond with the amount of additional equity. Due to the level of the bank management is not keeping pace with rising property should result in the credit quality of the banks less. Another reason that the credit quality of the bank 's bad because they are often the " backyard " of corporations, both public and private, due to increased equity such large banks is forced to rely on the contribution of this group. Another problem arises when the pace of equity increase is too fast, the banks is the Group behind these banks have also borrow from other banks to meet the requirements. Consequently, the Group's loans are used for the wrong purposes. This is one of the key reasons for making bad loans, overdue led wire in the entire system of credit institutions in Vietnam. Therefore, the group crossed the weaker banks to 86 For example, Ocean Bank was converted from NHTMC Rural Hai Hung shares from January 1/ /2007, the bank has increased its chartered capital to 1,000 billion, 5.6 times higher than in The bank continued to increase its charter capital to VND 2,000 billion in 2009, billion in 2010, and 5,000 billion in

149 restructure not easy. Policy recommendations for 2012 and subsequent To settle bad debts, overdue debts to stabilize the banking system liquidity Settlement of bad debt, overdue The biggest challenge in 2012 is to solve the problem of bad debts, overdue credit in the system to stabilize the liquidity in the system. To perform the cleanup bad debts and overdue system of credit institutions, Vietnam obviously need to have an equity line of ' clean ' relatively large external injection, estimated to trillion (corresponding to the ratio of bad debts, overdue debts of about % of total loans). Inflows may come from abroad or from the state budget. Domestic capital formation from the can may establish or permit the establishment of businesses acquired overdue debts at banks under the State Bank. The overdue but less likely to be difficult to recall a similar nature have bad debt will be selected commercial banks to sell the debt purchasing business. Currently we are trading company of outstanding debts and assets of the business (DATC) under the Ministry of Finance. Government may establish additional trading company debt or additional new funding for DATC to perform a task the acquisition system's bad debt credit institutions. However, so as not to increase the money supply and increases the budget deficit, the additional funds will not bond funds that borrow from the central bank issued a special bond with a period of three to five years to raise cash free from the banks. In order for these bonds do not affect the budget deficit, the repayment of this bond should be cut from the budget expenditures of the state, especially the recurrent expenditures. According to the General Statistics Office and the Ministry of Finance, current expenditures increased from about 16-17% of GDP in the period , to approximately 20-21% of GDP in recent years. If it is possible to decrease the rate of around old as implemented in the period from , the excess budget will be around 3% of GDP, or about 70 trillion. This is a relatively large amount of money to contribute to the fund buying and selling bad loans, overdue credit system. However, even if the expenditures can be reduced to the sum of money on this figure only accounted for about 25-30% of bad debts and overdue that the current credit system to solve. 149

150 While the resources of local enterprises is limited to adding new money, not the other way is to create favorable conditions for foreign businesses to set up debt trading businesses. If not raise funds from abroad at handling bad debts, overdue debts, then this process will continue occurring, making the interest rate can hardly be lower. The economy will stagnate lasted, the more that the number of bad debts soared. Of course, do not necessarily have to raise tens of billions of dollars overseas to buy back all loans overdue and the rest of the banking system. Just a portion of which is included in the economy will also generate significant stimuli, allowing capital inflows in the economy is widening. Many businesses will revive again, make profits and can pay back overdue debts; making delinquency rate is now significantly reduced. Improved rate loan / deposit of less than 100% Liquidity Credit System institutions continue to be unsustainable if the loan to deposit rate on the market 1 continued higher today. This situation cannot be improved within a short time. When credit growth declines, the economy s growth rate also reduces, making residents money only grows slowly, which leads to lower capital mobilization growth rate. Thus, to improve this ratio, the key is to change economic structures to increase production capacity so as to manufacture more goods with less capital required. This process makes the economy s savings rate increasingly higher than investment rate. Slow mobilization growth is also caused by the imbalanced periods due to applying interest rate ceiling. When the ceiling deposit rate is maintained, the commercial banks will often exceed the ceiling. Moreover, because the ceiling deposit with high interest rates typically remains from one to three months, the banks cannot raise capital for medium and long term loans. Only when the interest rate ceiling is removed, the commercial banks will announce competitive interest rates with different terms, and then depositors will decide on deposit term and long-term options in a certain bank. Ensure market liquidity 2 The fact that the appearance of bad debt in market 2 requires credit institutions to have mortgages is a bad precedent for the credit system in Vietnam. Because market 2 is liquidity 150

151 market, the relationship between the credit institutions must be based on trust to ensure that the banks which meet liquidity constraints can be responded immediately. To solve this situation, the State bank should have regulations to remove weak banks from operating in the interbank market to ensure that loans are only based on pledge of trust (no collateral). The lending activity among credit institutions which requires mortgages should be repo activities, but not to be active in the interbank market. SBV may also support banks which have loss of liquidity with the proceeds from the bonds issued to banks with excess liquidity. Besides, to help weak commercial banks be less dependent on market 2, the key solution is to remove the interest rate ceiling. When the interest rate ceiling is still there, small banks will have difficulty mobilizing capital; therefore, will continue to dependent on the interbank market. Balance among growth, inflation and anti-bubble property market The narrow down of production in 2012 is unavoidable when interest rates cannot decrease at least until mid Compared to 2009, the growth only recovered strongly in the third quarter when stimulus package was implemented from early For 2012, in order to avoid repeating the stimulus mistake of 2009, the Government should not stimulate even just by spending budget on public houses. Therefore, even when the State bank has a policy to promote credit from the second quarter onwards, but with high interest rates, the level of disbursement is not big; and in the context when input prices as well as costs still stay high, the business s profit will continue to be at a low level throughout Monetary policy in the second half of 2012 will be the choice between boosting growth and controlling inflation. The choice to support growth is only a matter of time because of businesses pressures. If the Government does not promptly restructure the economy to boost growth based on the productivity, the scenario in 2010 and 2011 will repeat. Economic growth continues to be at an average of around 5%, but it will face a10-12% inflation in 2012 and Furthermore, policies are needed to keep real estate prices and stock at current levels in order to prevent bad debts from soaring. However, cash flow should not be allowed to be strongly attracted to these two channels because the manufacturing sector is still the region which needs more financial support at this time. The stock market only needs to improve the regulations controlling foreign investment rate, shorten transaction time from T+3 to T+2, and strengthen market supervision. This is sufficient to ensure market not to decline and not to 151

152 sharply increase. For the real estate market, if there is foreign capital which helps settle bad debts and overdue debts of the credit system, and if there are clear rules about land ownership for foreigners, the market will surely recover. Consequently, the solution to ensure inflation falling below 10% while maintain growth rate at a moderate level is promoting reforming economy structure, reduce the corporate tax rate, alter legislation toward market orientation to increase productivity instead of expanding the money supply. In addition, solution to address the bad debt, overdue debt on both market 1 and 2 to unfreeze capital flows is needed. Direct exchange rate policy to be more flexible Although the exchange rate policy in 2011 was considered to be successful, we should note that the exchange rate is maintained relatively stable in 2011 primarily due to the active devaluating national currency by more than 9% of SBV in the early years and import demand decreasing due to slow increase of economic growth. Exchange rate risk in Vietnam is very high when the nominal exchange rate is much lower than the real rate 87. In 2011 Vietnam's inflation rate is over 18%; thus, Vietnam is ranked as one the countries having the highest inflation rate, the gap continues to expand. Therefore, when VND interest rate falls, holding the USD is tend to increase. Moreover, as the economy begins to recover, the demand for imports will increase. They are the cause of VND s downward movement. To avoid dramatic currency devaluations as last year, the key is letting USD/VND rate to move more flexibly according to real supply-demand of the market. SBV can set the average exchange rate to increase no more than 3% compared to 2011, but should allow fluctuation during the year to be higher or lower, in order to reflect the season of service rate. In 2012, the 87 Compared to 2000, Vietnam's CPI in 2010 has increased to approximately 123%, while the U.S. CPI rose 26.7% during the same period. Nominal exchange rate between VND and USD only increased approximately 30.4%. Simply calculated, the real exchange rate USD/VND in 2010 is higher than the nominal exchange rate of about 65.9% compared to the 2000's level. Additionally, in order to stop the two rates situation of free market and interbank market now, State Bank of Vietnam should quickly consider expanding interbank market for brokerage and foreign investment firms, gradually allowing individuals to trade in this market. This expanded forex trading platform will surely make current illegal foreign currency trading activities become the legal ones, and thus the government would easily control the foreign currency trading activities which are actually illegal (namely smuggling, money laundering, etc.). 152

153 amplitude of fluctuation can be up to +/-5% in comparison with the average rate of previous years; and in subsequent years fluctuation range can be higher than average rate of last year. Constructing modern gold market The construction of a modern gold market is necessary for Vietnam to raise tons of gold hold by the public in order to support economic development and to prevent activities on the gold market affecting the exchange rate. We believe that the crucial problem of Vietnamese gold market is how to separate physical gold trading from gold speculation. Currently, most Vietnamese people buy gold to speculate on. However, due to the fact that gold trading are not allowed as well as gold certificates are not existed, gold speculation of residences must be done through the exchange of physical gold with intermediate parties. This exchange process of physical gold not only increases the transaction costs among speculators, but also makes the activity of gold speculation associate with foreign currency flows when inflow and outflow of physical gold occur in Vietnamese borders. In order to eliminate the influence of speculative activity from the flow of physical gold, SBV should quickly issue gold certificates as well as establish national gold market. Gold certificates should be guaranteed 100% by physical gold in national gold repository. Each gold certificate has a code corresponding to a code of one ounce of real gold in the repository. Whenever SBV puts one ounce of gold into the repository, one gold certificate will be issued. And conversely, each time SBV takes one ounce of physical gold from the repository, a corresponding certificate will be retrieved. There should be a law to ensure that SBV issue the exact number of gold certificates according to the amount of real gold in repository. With issuing gold certificates mentioned above, the export of gold will be stick on the demand of physical gold for example crafting gold to be jewelry or being material for producing industry. The gold speculation of citizens basically is eliminated from the exchange of physical gold. The national gold exchange helps to reduce the number of gold speculation through gold certificates. Beside the demand of import physical gold to provide for crafting jewelry, most of nations don t import physical gold for the purpose of speculation. Vietnam should import physical gold for speculation only if the amount of exchange in the specific point is larger than the real amount of gold saving in Vietnam. It is rare to have the amount of gold hold by citizens being

154 tans. On other words, the speculation activities in domestic basically do not affect the exchange rate. Restructure the banking system Restructure the banking system will include some activities as below: dissolution some weak banks, merge weak banks with stronger banks and strengthen activities of others in the banking system in order to make sure after restructure, the banking system will be safer and work more effectively. Rather than dealing with a weak banks in normal times, restructuring the banking system requires a uniform plan and long term, including order of restructure process as well as building scripts for backup the worst case scenario, so that in the process of restructuring, payment activities and operations of the credit system is not affected. The process of restructuring the banking system must firstly make people believe in the success of this process. State Bank did very well in 2011 for example: delivered the message to ensure no depositor losses when a bank that is dissolved or merged into other banks in the restructuring process. Project named "Restructuring the system of credit institutions in ," approved by the Prime Minister (Decision 254/QD-TTg) also gave the message that the remaining banks will actually be healthier in the future. It means that remaining banks will apply the international accounting standards and auditing practices (especially relating to the recognition of bad debts and asset classification); with measures for risk management and good internal control based on the Basel II standards in the coming years. However, there are two issues that the government needs to concern. First, the central bank should introduce clear legislation on debt trading activities, especially for foreign investors. This is a very important requirement to accelerate the resolution of bad debts, overdue debts in the future. Second, the government should establish a fund to restructure the banking system. Although the project "Restructuring the system of credit institutions in of the State bank mentions the role of Debts and assets trading corporation (DATC) in debt sale but the nature of the debt trading period in the normal period will be different from the restructuring period. During the restructuring period, the purchasing decisions should be quick, decisive for the transaction of great value. These decisions need to be decided by the head of Government. The experience of other countries in the world shows that the process of restructuring the 154

155 banking system will inevitably expensive. The cost of the process, including funding for the deposit insurance fund, making up of weak banks go before being merged with other healthy banks, financial support for banks to weak but continuous operation achieving international standards, etc. Therefore, the formation of a separate fund to restructuring by the Finance Ministry and the State Bank management may be more appropriate. In order to ensure that this fund can be operating, the Government should indicate the source of money for the fund will be formed from, funds will only be used in what circumstances, for what purpose, and when the fund closes? As discussed above, this fund should only use savings from government spending or issue bonds to borrow from the economy rather than issuing bonds to the State bank buying. Funds can also be formed from loans from the IMF or other international funds that Vietnam participated. Only with such resources, Vietnam economy can avoid the risk of inflation. The establishment of a fund with its own rules and objectives as mentioned is very important. It ensures that all costs are accounted for. Basically, the costs should be viewed as investments of government to banks that continue to operate. Whatever the fund can be spent for any public purposes, it also needs to be converted into shares contributed by the remaining banks. If the active restructuring of the banking system are successful, the remaining banks will operate more effectively and safely in the future. In that case, the investment of government for restructuring activities of the banking system will be recovered. Another issue is that the restructuring process of the banking system must solve the crossownership issues in the banking system. Although the government and State bank issued regulations to limit ownership rate between banks as well as require state corporations divest from financial institutions, credit institutions, the State bank has apparently not touched any relationship between the banks and the private sector. An individual or a corporation can have a huge impact in the credit activity of banks through subsidiaries, branches of companies. The rate controlling ownership in the financial and credit institutions by individuals as well as corporation needs to take into account the indirect ownership. CONCLUSION In this report we have pointed out the striking phenomenon of monetary policy as well as their impact on financial market and the money market of Vietnam in The tight monetary 155

156 policy caused the growth rate of money supply; mobilization and credit are significantly reduced. As a result, the banking system suffered stressful banking liquidity rate, rising interest rates, the rate of bad debts and overdue increase in total loans, asset markets, including the stock market and housing market real, serious declined. There is a positive phenomenon which is the relative stability of the exchange rate, although it is still under the impact of fluctuations in the physical gold market. There was a positive signal which was exchange rate stability despite its substantial vulnerability to commodity gold market. Although these phenomena were closely related to each other, we managed to realize the underlying cause for them. It was the growth model which relied too much on investment capital, especially public investment and state-owned enterprise investment. To attain a GDP growth of 7.5% on average in the period of and 6.9% in the period of , Vietnam required an average amount of capital which was equal to 39.15% and 42.7% of GDP. Due to high demand but inefficient use of capital and a downward trend of savings, the economy had to rely on contractionary monetary policy, which resulted in inflation. Easy money pumped into the economy was also responsible for imbalance capital structure. Enterprises were likely to invest in too many projects in real estate, industrial zones, etc. Another reason for the instability was the policy which allowed rural banks to transform into urban banks, which forced these banks to increase their chartered capital by dozen times in 4 or 5 years. It was the influx of capital and weak banking management turned these banks into corporations back yards. When contractionary monetary policy came into effect, bad debts and overdue debts would be unavoidable. Based on these analyses, we concluded that in 2011, the State Bank of Vietnam (SBV) executed tightening monetary policies well despite of pressure from enterprises in order to curb inflation. SBV also managed to direct the capital flow into manufacturing sectors like agricultural, export sectors. Thanks to that, the economy s growth rate was maintained at decent level. In addition, the Government made some improvements in regulating exchange rate policies, which contributed to more stable exchange rate situation in However, we also found out some problems with monetary policies in It was the stiff and prolonged administrative methods regarding interest rate caps and credit growth limits. We proposed that these methods were of little effect and even induced moral hazards in the banking 156

157 system. Moreover, we realized that policies regarded to gold market were passive and ineffective. SBV did not come up with any effective methods to connect the black market s exchange rates to the official exchange rates. This could induce exchange rate instability in the future. In 2012, we suggest that SBV should continue to prioritize the curbing of inflation to keep CPI at a one-digit level. The fight against inflation requires lots of determination as the lesson in 2009 showed that once money supply was loosened, inflation was extremely likely to expose at a great cost. In order to reduce the loss of the economy in 2012, SBV should be highly focused on dealing with bad debts and overdue loans in financial institutions. It is the matter of life or death to open up capital flow in order to reduce interest rate base. We think that SBC should establish a banking system restructuring fund which is financed by savings from government regular spending or borrowings from international financial institutions of which Vietnam is a member like IMF. Moreover, it needs to allow foreign companies to actively participate in this bad debt trading activity. In the medium term, the restructuring of state-owned enterprises and public investment is critical for enterprises to access cheap capital sources. This is a prerequisite for the loan to deposit to stay below 100%, which results in a stable reduction in interest rate base. With regard to exchange rate policies, we propose that SBV allows inter-banking exchange rate to fluctuate in a broader band to truly reflect the market s situation. It is to ensure that exchange rate shock like the ones in the beginning of 2011 and in previous years will not happen again. In addition, we suggest that SBV opens the door for other members to join the inter-banking system such as foreign exchange investment firms and even individuals to permanently clear out the two-tier exchange rate systems of black market and official market. The last policy we want to mention here is establishing a modern gold market in Vietnam. On top of managing gold by SBV, SBV needs to build up gold certificates and gold trading floor to better manage this market instead of merely administrative methods. 157

158 Chapter 4 TRADE DEFICIT CHALLENGES PREFACE A trade deficit is not a totally bad situation for economies. Developing countries may have to adapt with trade deficit during the conversion process when they have high demand for raw materials, equipment or foreign technologies while domestic capability and level of production are still low with limited capital. However, when the scale of trade deficit grows highly and sustains over a long period of time without any signs of improvement (like the situation in Vietnam), it means that there is a cumulative process and the earlier foreign technology did not work effectively for improving production and export capacity of the economy. In addition, trade deficit is also a major cause of macroeconomic instability. Because of trade deficit, VND is always made under pressure of devaluation, which negatively impacts on exchange rate and inflation. Due to the fact that balance of payments is affected and foreign exchange reserves declines, the effect of exchange rate policy as well as market s confidence in the operating ability of The State Bank of Vietnam (SBV) also decrease, which comes together with dollarization leading to increasing pressure on foreign exchange market. At the same time, high trade deficit requires that capital and finance accounts must maintain large surpluses, which means the national debt converges over time. Exchange rate fluctuates freely while SBV maintains the exchange rate according to targets, which results in passive monetary policy and affects other objectives of the policy. There comes a question of what is the fundamental root of trade deficit? This paper will looking for the answer under the perspective of national competitive ability and growth model, with the hypothesis that these are necessary and sufficient conditions to solve the long-lasting trade deficit situation. This paper is divided into five main parts. Part 1 is a noticeable slice about the economy s trade deficit during the past 10 years. In part 2, the author uses SVAR model to quantify the magnitude of impact and the role of "real" shock and "nominal" shock to the trade balance, with the assumption that trade deficit is mainly from "real" and "structural" shock, not from "nominal" shock. Part 3 will deeply analyze the role of exchange rate policy (a "nominal" shock) to trade deficit to clarify the findings from Part 2, by estimating the trade balance s 158

159 elasticity, and exports and imports by exchange rate. Part 4 will focus on trade deficit s "structural" causes, which are analyzed by two basic factors: national industry competitive ability (directly impacts on the ability to maintain exports sustainable in the new trend of international trade) and growth model (the underlying cause of long-lasting trade deficit). Finally, section 5 will summarize main findings and give recommendations on policy. TRADE DEFICIT PROBLEMS TO BE CONCERNED Rapidly increasing economic openness comes with high and persistent trade deficit Along with the process of global economic integration, in over the past decade, the export turnover of Vietnam had an impressive growth. In period , the average growth rate of total merchandise trade was about 19% per year; in 2011, export value increased by 28.7%. Accordingly, exports/gdp increased from 46% in 2001 to 78% in 2011, imports/gdp rose from 49% to 86% during the same period, making the total value of trade / GDP increased from less than 100% to 164%, which was very high compared to China and some ASEAN countries, demonstrating the large openness of the economy (Figure 4.1). Figure The export-import value and merchandise trade balance ( ) Source: GSO, IFS (IMF). 159

160 Figure The proportion of international trade variables over GDP ( ) Source: GSO, IFS (IMF). However, because the growth speed of imports is much rapidly than that of exports, the trade balance deficit is increasing. The trade deficit was first considered to be seriously in 2003 with GDP of 12.9%, and even more stiff in 2008 (right after Vietnam joined the WTO) with 14.1 billion dollars deficit (nearly 20% GDP); this ratio continued maintaining in subsequent years. If in period , trade deficit was averagely at 9.1% GDP, the next 5-year period ( ), the number increased to 14.7% GDP 88. Meanwhile, China and other ASEAN countries such as Indonesia, Thailand or Malaysia have really high trade surplus (Malaysia had 22% GDP). 88 The situation will be even more intense if gold is removed from the merchandise trade balance. In 2009 and 2010, Vietnam exported 2.24 billion and 1.72 billion USD of gold (recorded as non-cash currency by General Statistics Office). When excluding gold, the merchandise trade deficit in these two years was 15.1 billion and 14.3 billion dollars (accounting for 15.5% and 13.5% GDP). 160

161 Table 4. 1: Trade variables of Vietnam and some countries (average of ) Vietnam Indonesia Malaysia Thailand China Exports/GDP Imports/GDP MTB/GDP Import and export/gdp Source: WDI (WB) and IFS (IMF); Malaysia: average figures in period. In 2011, trade deficit had signs of strong decline: only 9.5 billion dollars (compared with 12.6 billion in 2010), accounting for 7.7% GDP (compared with 11.9% in 2010); deficit ratio/export was only 9.8%, far below the target level of the Congress (16%). However, as the following analysis, those good results are mainly due to favorable prices, especially export prices. Therefore, trade deficit reduction trend is not likely to be sustainable because the risk of world price shocks in upcoming time, if there is no significant structural improvement. The price factor plays a major role in commercial value growth Since 2000, except for a few years, export value s growth rate is all above 20%, accordingly, the exports/gdp proportion of Vietnam stood at a very high level compared to other countries in the same region (66% GDP in period ) (see Table 4.1). In 2011, despite the world economic downturn, export growth remained very high (33.4%), compared with an increase of 26.4% in 2010, exports/gdp reached 78%. Figure The growth of Import-Export of goods and services (in current prices and 2005 prices) 161

162 Source: GSO, IFS (IMF). However, Figure 4.3 shows that the growth rate of exports (calculated for both goods and services) in 2005 s prices was much lower than the growth rate in current prices. In period , exports grew by 19.3% but the real value was only 12.7%. In period , the growth rate s disparity was even higher (22.2% and 9.9%). Thus, highly increased export turnover in dollars had a positive contribution to the balance of payments but the actual contribution to GDP was much less. This also means that price factor contributed significantly to export growth in recent years, and indeed export capacity of the economy is not as high as expected. The above statements are clearly shown in 2011, when the real export growth rate was less than a half compared with the nominal growth rate because the world market s export prices soared. Table A.4.1 (Appendix) lists some key export commodities showing that prices of those goods were very high compared to the previous years, while the quantity growth rate was very low, and even declined. Import turnover of goods also increased at very high level in the last decade. In the period from 2001 to 2010, the average growth rate was above 19%, and in 2011 was 24.7% (nearly 106 billion dollars). Accordingly, the ratio of imports/gdp increased from 41% in 1999 to 86% in 2011, which is really dominant compared to that of China and other countries in the same region (see Table 4.1). Similarly to exports, the rapid increase of import value was also because of the price factor. Figure 4.3 shows that the goods and services import value s growth rate (in U.S dollars) in period was 19.6%, while the real growth rate was 13.04%. The gap was even wider in period (24.1% and 11.72%) and especially in 2011 (39% and 13%). Thus, the price factor has positively contributed to the rapid growth of imports and exports for recent years. This also means, downward trend of trade deficit in 2011 may not recur in 2012 and the following years if global price reverses the trend (likely to occur in the context of worse global economic downturn). However, it should be noted that average import growth (both in current and constant prices) is higher than exports, showing that the efforts to narrow down trade deficit is facing and will face many challenges. TRADE DEFICIT: DUE TO REAL SHOCK OR NOMINAL SHOCK? 162

163 To assess the basic causes of trade deficit, the authors analyzes the impacts of shocks to the trade balance 89. The analyzed shocks include: (i) external shocks such as oil price shock, interest rate shock or productivity shock, etc.; (ii) domestic supply shocks, such as labor, technology supply shock, changing laws and management systems, tax reform, removing or establishing barriers of trade and finance, etc.; (iii) domestic demand shocks such as changes in fiscal policy, trend of government consumption shock, etc.; and (iv) domestic nominal shocks such as changing money supply, devaluation or revaluation of the domestic currency, etc. In that, the first three shocks (foreign supply, domestic supply and domestic demand) are "real" shocks which relate to and have impact on the economy s structure; while the final shock is "nominal" which is related to the nature (origin) of currency. Figure Cumulative reactions of the trade balance to shocks follows: Source: Results from the experimental models. The estimation results being shown in Figure 4.4 allow the assessment of the shocks as 89 The author used SVAR model (Structural Vector Autogressive) to quantify the magnitude of impact and the role of the shocks relating to trade balance. It is based on long-term constraints that are applied to a small country, further developed and extended from the theoretical and experimental basis of Prasad (1999), Hofmaister and Roldos (2001), Blanchard and Quah (1989). This model was built from four quarterly macroeconomic variables (from quarter I/1996 to quarter IV/2011), including real world output (can be measured by the U.S s GDP), real domestic output (domestic GDP), trade balance (measured by the ratio of exports/imports), and the real exchange rate. The model will analyze the impact of shocks to the volatility of trade balance based on impulse response functions and variance decomposition. 163

164 The impact of external shocks: Outside positive real shocks make the real world production increase with positive impacts on trade balance due to relative increasing demand for Vietnamese exports. Figure 4.4 shows the impact magnitude of world shock is the strongest shock of all, reflecting the wide openness of the economy. The effects of this shock to the trade balance last for approximately 12 quarters (three years) before becoming stable. The impact of domestic supply shocks: A positive shock to the domestic supply (for example: to increase productivity) causes the real output of the economy to increase and the trade balance to deteriorate. The main reason is increased demand for imports to meet the domestic production s demand. In the first five quarters, this impact is huge before the trade balance slightly improves in some later stages. The reason is that increased output will lead to increased real exchange rate (Vietnamese goods will gradually be more competitive), and at these stages, the impact of increased real exchange rate overwhelms that of demand for imports. However, the final combined effect in long term is declined proportion of exports/imports, indicating the large-scale imports to boost domestic output. The impact of domestic demand shocks: A positive shock to domestic demand (for example: to increase the scale of Government spending) causes the trade balance to deteriorate in the first five quarters, slightly improve in the next four quarters, and causes trade deficit to increase. The reason is that the positive shock not only makes real output of the economy increase (accordingly, real exchange rate and exports increase) but also boosts aggregate demand and domestic absorption of imported goods. Vietnam s estimation results show that the impact of domestic absorption overwhelms the influence of increased real output, reflecting the situation of higher domestic spending demand resulting in import of foreign goods, rather than improving the domestic production capacity and competitiveness of exports. The impact of domestic nominal shocks: A positive nominal shock (for example: to loosen monetary policy or to actively devalue domestic currency) may initially causes the trade balance to increase in the first two quarters, however, the trade balance gradually deteriorates and finally, it does not significantly affect the trade balance. This also means that exchange rate policy in Vietnam (continuously reduce the nominal value of VND) may not have a positive impact on trade balance. 164

165 Table A (Appendix) is used to assess the relative importance over time of each shock to the volatility of trade balance. Accordingly, in all periods, the trade balance s variability is mainly from real shocks which have structural nature (accounting for around 70 %), while nominal shocks only contribute to 30 % of the trade balance s variance. Thus, the results of experimental studies show that the exchange rate policy and moneyrelated policy can hardly improve the trade deficit situation in Vietnam, because the role of explaining the fluctuations as well as the magnitude that impact on the trade balance is unnoticeable. Meanwhile, trade deficit is mainly explained by the real factors that relate to the economy s structure. Accordingly, the trade balance is strongly influenced by external shocks, reflecting the vulnerability of the economy; the import demand is very high to meet increased domestic production demand; while domestic spending demand mainly leads to large-scale imports rather than improving the domestic production capacity and increasing export value. In the following sections, the author will clarify these above statement by analyzing the role of exchange rate policy to trade deficit reduction efforts, and also have further study the role of "real" factors with "Structural" nature to Vietnam s trade balance. WHAT DOES EXCHANGE RATE POLICY CONTRIBUTE TO TRADE DEFICIT REDUCTION EFFORTS? With high and persistent trade deficit over the years, exchange rate policy is still considered as a tool. Many people still believe that Vietnam has pursued policy of currency devaluation to encourage exports and to reduce the trade deficit. So actually, whether the continuous devaluation (lower the nominal value of Vietnam dong) for over 10 years has contributed to trade deficit reduction efforts? In theory, exchange rate adjustment has impact on real exchange rate - the price competitiveness capability of domestic goods - is still seen as a reason affecting the international trade balance. The real exchange rate is computed from the nominal exchange rate adjusting by domestic and foreign price index which follows formula RER = NER (P*/P), in which RER is the real exchange rate, NER is the nominal exchange rate, P* and P are foreign price index (US) and domestic price index respectively. Accordingly, if RER increases, the domestic currency is regarded to be undervalued, creating international commercial competitive advantage for 90 A variance decomposition table was used to separate the variation of the trade balance regarding the components of the shock. 165

166 domestic goods. Conversely, if RER decreases, the domestic currency is considered to be overvalued, and then the competitive advantage of domestic goods will deteriorate. Thus, undervaluation of the domestic currency is considered as an essential key to maintain trade surplus in some countries at particular period. 91 The method of exchange rate adjustment in Vietnam remaining the interbank rate for a long time and suddenly making a medium adjustment has made the money always overvalued actually. Figure 4.5 (calculating the real exchange rate in comparison with that in early 2000) shows that, before 2004, the exchange rate was relatively stable, along with low domestic inflation, real exchange rate increased and followed closely to the nominal exchange rate. However, since 2007, as inflation has risen, the adjustment of the exchange rate has been inflexible which widened the gap between real exchange rate and nominal rate gradually, and the Vietnam dong has been overvalued. Figure Nominal exchange rate, real exchange rate and trade deficit ( ) Source: SBV, GSO and calculation of author Other opinion views that the adjustment of nominal exchange rate is inadequate, which decreases real exchange rate, reduce competitive advantage of Vietnamese goods in international markets, and negatively impacts on trade balance. However, after a period of strong decline in 91 The case of Thailand after the Asian economic crisis is taken as an example. Before 1997, Thailand always had faced with the trade deficit for many years, but after devaluating Baht currency, the country had trade surplus at 1% of GDP in 1997 and within next years (1998), trade surplus has increased by 14.5% of GDP. 166

167 2007, the real exchange rate has changed slightly since early 2008 while the trade deficit has strongly fluctuated. This led to doubts that in Vietnam, even when changing the nominal exchange rate is strongly adjusted (for example, the adjustment on 11 February 2011), increasing the real exchange rate, whether the trade balance is improved. In fact, the export value is measured in cash, not in goods, (recorded in the balance of payments and has impact on Foreign Exchange market) also depends on the elasticity of the exchange rate. Therefore, relationship between Vietnam dong devaluation and trade deficit need to be further studied basing on the exchange rate elasticity. 92 Gross impact to import of 1 % exchange rate adjustment The first result of the empirical model is to estimate the percentage gross changes of monthly export and import figures by 1 % change of exchange rate (elasticity) after the rate increases (Figure 4.6). Theoretically, when the domestic currency is devaluated, price of imported goods would be less competitive which leads to volume effect - the number of imported goods would fall. However, price devaluation also leads to import value effect - the price of imported goods per unit would rise. Figure 4.6 shows that when price increases by 1 %, imports in the first month are slightly decreased (-0.04 %), and the reduction will stop within 8 months, duration of volume effect would be longer than that of import value effect. However, from 9th month, imports begin to increase as the impact of the exchange rate, and the value of imports increases by approximate 0.06 % after a year. This suggests that import value effect gradually neutralizes and overwhelms volume effect eventually. 92 For this above question, in order to quantify the impact of exchange rate adjustment to trade balance, author uses VECM model (Vector Autoregressive Error Correction Model) and VAR (Vector Autoregressive) with variables such as the real exchange rate, exports, imports, exports-imports ratio, the value of domestic industrial production (representing domestic output variable), the value of U.S. industrial production (representing the world output variable),etc., collected monthly from January 2000 to December

168 Figure Gross impact to import of 1 % exchange rate adjustment Source: Result from the empirical model Import turnover which remains unchanged after adjusting exchange rates is explained by the imported structural characteristic in Vietnam. The majority of imported goods include machinery and raw materials, accounting for about 90% of the annual value of imports in period (see Figure 4.7), to serve the domestic production process. In the early stage of economic development, the structure could be considered to be reasonable; however, this structure has not changed and persisted for a long time which reveals the main weak point that, auxiliary industries has not been developed in Vietnam. Therefore, the economy is still highly dependent on imports and is vulnerable to external shocks, which challenges the reduction of importing. 168

169 Figure 4.7: Percentage of imported goods values Source: General Statistics Office Gross impact to export of 1 % exchange rate adjustment The export value, according to the empirical model, would not rise after the rate increases. Theoretically, the increase of exchange rate may makes prices of Vietnamese commodities more competitive and thus increases export. However, this is only true in the first three months, negative impacts of exchange rate adjustment appears in the fourth month and following months. When adjusting the exchange rate by 1 %, export value is estimated to decrease by 0.15 % after a year. Exports do not increase as expected because the majority of Vietnamese main exported commodities consume a high proportion of imported inputs (for example, the food industry uses imported fertilizers and pesticides; textile industry employs imported cotton yarn; electronics industry uses imported machinery and components, etc.). When import value effect overwhelms, input costs of export manufacturing sector will increase, output prices also rises and neutralizes effects of more competitive price of domestic goods in early stage. Gross impact to trade balance of 1 % exchange rate adjustment Figure 4.8 shows that the gross impact of positive rate shock to trade balance is only good within eight months, while for the whole year, the trade balance is not improved, and trade deficit even increases. The trade balance almost goes back to the original point after 14 months 169

170 of rate adjustment. With the reaction of export and import values by exchange rate adjustment discussed above, this movement of the trade balance is completely understandable. Figure 4. 8: Gross impact of exchange rate shock to trade balance Source: Result from the empirical model Results of the quantitative research indicated that adjusted rate policies virtually do not improve trade deficit of the economy, even when the nominal exchange rate is strongly adjusted and the real rate increases. This also means that nominal shocks (monetary and exchange rate policies target the nominal exchange rate and the real exchange rate) would not only have little role in efforts to reduce trade deficit, but also have impact on inflation, leading to a vicious circle of exchange rate - inflation - exchange rate. As a result, there would be real and structural shocks, rather than "nominal" ones to solve trade deficit problem. ROOT OF THE TRADE DEFICIT STRUCTURE ELEMENTS So what is the underlying cause of trade deficit, and accordingly, what are necessary and sufficient conditions to solve prolonged trade deficit problem? Contents of study in Part 2 have suggested the answer: root of trade deficit comes from real and structural" elements which are associated with method of constructing national competitiveness in Vietnam and characteristics of growth model. The first factor, which relates to necessary condition of solving the trade 170

171 deficit, is industrial competitiveness of the economy in general and Vietnamese export sector in particular, which is still poor and does not keep up with the world trend, making export capacity is limited and vulnerable. The second one, which relates to sufficient condition of trade deficit settlement, is that the growing model depends primarily on inefficient investments, widening difference between investments and savings, and being expressed through current account deficit (mainly in trade balance). Vietnam lags behind too far on national competitiveness race In general trend of the world today, competitive advantages building up from possession of raw natural resources and cheap labor force; and from labor intensive and low technology industries is facing danger of unsustainable. Instead, technology levels, labor skills, infrastructure and managerial capability are important elements making up national competitiveness. In terms of industrial national competitiveness, countries in the world would not avoid the principle of gradually shifting to higher technology industries, rather than just exploit industries with comparative advantages that are unstable in the long run and vulnerable. This fact also reveals technology development process in history, when countries should gradually shift to higher technology level and reach the world technological standard.93 Data of UN Comtrade shows that industrial production in over the past 10 years had new developments. Export value and marginal value added (MVA) of technology intensive industries have fast growth rate that is much higher than other industries. 94 In this context, in order to enhance exports sustainably, unavoidable trend is production transforming from low commercial growth rate industries into high commercial growth rate sectors (from sectors with low technology levels into sectors with higher levels of technology). Accordingly, industrial competitiveness of nations should be analyzed through marginal value added and technology levels in production and export values. 93 According to To Trung Thanh (2010), there are two strategies building up national industrial competitive advantage. The first method is improving technology in all sectors, from which establishing new technology capability and seeking new markets together with market failures. This is how countries follow sequential stages of industrial development. The second way is rapidly changing industrial structure, boosting the level of high technology in production and exports. Now when the world markets are constantly changing, with fluctuations from crisis economy, the second strategy has been preferred. 94 According to To Trung Thanh (2010), there are two strategies building up national industrial competitive advantage. The first method is improving technology in all sectors, from which establishing new technology capability and seeking new markets together with market failures. This is how countries follow sequential stages of industrial development. The second way is rapidly changing industrial structure, boosting the level of high technology in production and exports. Now when the world markets are constantly changing, with fluctuations from crisis economy, the second strategy has been preferred. 171

172 Box 4.1: Definition of technology content in industries Industries based on raw resources: For example: food processing, tobacco, simple wood products, refined petroleum products, chemicals, etc. The production of these products can use cheap technology, be labor-intensive (food processing) or capital-intensive and use many skills (oil filter, etc.). Competition in these industries (conventionally) is based mainly on natural resources. Industries with low level of technology content: For example: textiles, footwear, toys, simple plastic and metal products, joinery, glass, etc. The production of these products tends to use stable technology with low cost of research and development (R&D) and low skill requirements, and has few economic advantages on scale. Labor cost accounts for a large proportion of total cost. Products are often less distinctive, barriers to entry are low. Competitive advantage in these industries especially in developing countries is price, not quality or brand. Industries with medium level of technology content: For example: cars, mechanical products, industrial chemicals, equipment, electronics, etc. The production of these products uses complex but slowly changing technology with medium R&D cost, modern design and production skills and large scale. Barriers to entry are quite huge due to high capital requirements. There is usually a combination of value chain between producers, suppliers, etc. Industries with high level of technology content: For example: complex electronics, telecommunication products, instruments with high precision, chemicals and pharmaceuticals, etc. These industries use technology that is modern and changes rapidly, need complex skills and have huge barriers to entry. The R&D investment cost is high and infrastructure of technology is modern. Source: Lall (2001) and UNIDO (2002). Table 4. 2: GDP and Manufacturing Value Addition of Vietnam and other countries GDP GDP MVA/ MVA/ GDP GDP MVA/ MVA/ (billion /person labor GDP (billion /person labor GDP USD) (USD) (USD) (%) USD) (USD) (USD) (%) 172

173 Vietnam China Indonesia Malaysia Thailand Source: the author has calculated from UN Comtrade, UNIDO, WDI (WB). Manufacturing Value Addition (MVA) and technology content of production Table 4.4 shows that one Vietnamese labor created two low MVA in average comparing to other countries in the region, and this value was quite the same after 10 years. Specifically, in 2000, MVA/Vietnamese labor was only about 1/3.5 of China, 1/3 of Indonesia, 1/5 of Thailand, and even was 1/20 of Malaysia. After 10 years, these rates remained very low relatively as 1/5, 1/3, 1/5.5 and 1/10. The proportion of Vietnam MVA/GDP was also one of the lowest numbers in the region, only accounted for 20% of GDP, while in China and in Thailand, the numbers were about 34%. Not only does the technology content in production industries create low manufacturing value addition, but it is also very low comparing to other countries, and has been almost unchanged for many years. Proportion of industries with medium and high level of technology content only accounted for 25% of industrial value in the period, compared with over 60% in Thailand, Malaysia and China - dynamic countries that combined value chain of medium and high technology content to adjust production structure to general trend of the world (see To Trung Thanh (2010)). Technology content in Vietnam industrial exports According to standards of foreign trade announced by General Statistics Office (Figure 4.9), proportion of export processing industries has only accounted for approximately 50% of total export value in recent years and almost had no upward trend, while the agricultural, forestry and fishery sectors remained stable at 20%. In the structure of export processing industries, proportion of industries of computers, electronic components (which are the industries with medium level of technology content) accounted for only 10% over several years. The main part 173

174 belonged to industries with low technology content or based on raw materials (footwear, textiles, joinery, etc.) (Figure 4.10). Figure Structure of export sector group in Vietnam Figure Structure of export processing industry Source: General Statistics Office Source: General Statistics Office According to the classification of UNIDO, Figure 4.11 shows that technology content of export sectors of Vietnam almost unchanged after 10 years. The proportion of sectors with high technology only accounted for 12-13%; sectors with medium technology took 10%, while sectors with low technology spent more than 60%. Meanwhile, all other countries in the region have high proportion of medium-high technology sectors in export structure. Until 2009, the proportion of high-tech industries in China accounted for 35.6%, in Malaysia was 45.7% and in Thailand was 27%. Moreover, the share of sector using low technology was only below 30% in 174

175 China 95 and even lower in others. This problem obviously shows the lagging far behind in Vietnam comparing to other countries in identifying technological competitiveness. Figure Technology content of export industrial products in Vietnam and other countries Source: the author has calculated from UN Comtrade. Competitive position of several key export sectors To further clarify the competitiveness of Vietnam exports, the competitive position of some important export sectors will be revaluated. Table 4.5 classifies and identifies whether or not the sector is competitive, grows stably or be vulnerable and need to be restructured. The sector (which is competitive) will win in the global race if Vietnamese market share in global trade of that sector increases in the upward trend of trade proportion in total international trade. 95 According to To Trung Thanh (2010), exports of China have developed through strategies of diversification, intensive high technology, maintenance of medium technology (electronics and machinery production for example) without abandoning lowtech sectors (such as textiles, footwear, toys, etc.) 175

176 Table 4. 3: Market position market Promotion of products in total international trade Vietnamese market share in the world Increase (competitive) Increase (growth) Optimal winner Decrease (stagnation) Be vulnerable take advantages in adverse circumstances Decrease (uncompetitive) Weak loser Restructure declining sector Source: To Trung Thanh (2010). Five export sectors that are the most important of Vietnam selected for analysis are the electronics, machinery components and transportation (turnover of 11.2 billion USD in 2011) under medium technology group; textiles - garments (14 billion USD) and footwear (6.5 billion USD) under low technology group; and joinery (3.9 billion USD) under group using raw resources. Figure 4.12 shows that all five groups located at the vulnerable part in competitive position matrix. It means that the most important export sectors of Vietnam have increasing market share in the world, while proportion of these sectors in total global trade is in downward trend (due to international trade is gradually transforming to sectors using higher technology). 176

177 Figure 4. 12: Competitive position of several key export sectors ( ) Source: the author has calculated from UN Comtrade. Therefore, not only is the key export sectors of Vietnam in far position behind other nations in competitive race of sectors with medium and high technology content, (mainly under group with low technology content or using raw materials) but they are also vulnerable and face with risk of the negative impact from externalities and adverse conditions in the world market, which contributes to deficit in long run. Especially, this situation has existed for many years without any improvement, which reflects the failure of Vietnam in establishing national competitiveness and technology content in domestic production and exports are not upgraded. The cause shown by To Trung Thanh (2010) is that Vietnam is lack of clear strategic and consistency in establishing competitiveness in a long time, which is showed in the lack of focus on basic policies (that create stable and competitive production environment) and supporting policies (human resources development, FDI and technology import policies, investment and development, etc.). Vietnamese style growth model - the major cause of trade deficit If the failure in process of establishing technological competitiveness of national production and trade makes difficulties in sustainable increase of export and contributes to trade 177

178 deficit, the more underlying cause of trade deficit is economic growth pattern that Vietnam is pursuing. Theoretically, trade balance reflects the difference between savings and domestic investment of a country. National Net Savings balance with Government Net Savings (budget balance) and the difference between investments savings of private sector. Therefore, deficit in trade balance of a country (trade deficit) reflects that net savings are negative (i.e. investment rate is higher than saving rate). Figure 4. 13: Trade deficit the difference between investments savings and budget deficit (%GDP) Source: IFS (IMF), WDI (WB) and General Statistics Office. Figure 4.13 shows that difference between investments savings of the economy has increased sharply since 2007, together with increase of trade deficit. Difference between investment-savings/gdp reached a high level of 11.5% in the periods, while other comparing countries have net savings, even at a very high level as Malaysia (22%) (See Table 4.6). 178

179 Table 4. 4: Comparison of savings, investments and trade among countries in the region (%) ( ) Vietnam Indonesia Malaysia Thailand China Savings/GDP Investments/GDP Difference between investment-savings/gdp Trade balance/gdp Source: WDI (WB) and IFS (IMF); Malaysia: average figures in period. So what is the reason why net savings of Vietnam are very high negative number? In fact, saving rate of Vietnam is not low. Since 2006, the average saving rate of Vietnam is over 30% of GDP, which is equal to figures of Indonesia and Thailand. According VASS (2011), savings rate of Vietnam is even higher than general average of low income countries (about 21%), of lowmiddle income countries (about23%) and of world average (about 25%). Thus, the main culprit is that domestic investment rate is too high. Chapter 1 of report shows that Vietnam maintains growth by being based on capital investment but investment effectiveness is inefficient. Therefore, the total investment of society has continued to increase and maintain a high level in order to achieve growth objective. The ratio of capital/gdp increased from 35.4% in 2001 to 41.9% in 2010, the average for the whole period was approximately 41%, in which the proportion in recent 5-year period ( ) was 42.9% that doubled in Malaysia and was more than half time comparing with in Indonesia and Thailand (see Table 4.6). Domestic net savings include net savings of Government sector and net savings of Private sector (households and businesses also including SOEs). High level of budget deficit (net savings of Government are negative) that is persistent for a long time to serve growth model has contributed significantly to low domestic saving rate (see Figure 4.13). However, the increase of difference between investments savings (negative net savings) of private sector also plays an important role and is "supported" by macroeconomic policies and internal problems of the 179

180 Banking - Finance sector (this is consequence of growth model and economic structure - as analyzed in Chapter 1). The published data of net savings in private sector is not available, but we can observe the behavior of households and business sector in recent years for evaluation. For the household sector, one reason of low net savings in this sector is that financial market is still young, weak, and contains many risks in the situation of increasing inflation and macroeconomic instability in recent years. Especially since 2007, Vietnam has received a large foreign capital while SBV has no experience in balancing the sudden increase of cash flow, which led to inflation and bubble in asset market such as securities market and real estate market. This problem stimulated excessive consumption in a part of consumers, especially in urban areas. Meanwhile, the business sector has huge investments comparing with savings, which can be seen through high scale of debt credit in recent years. Chapter 1 and Chapter 3 of this report shows that the ratio of Vietnamese credit/mobilization is very high comparing with almost countries in the region. The cause of this imbalance is not only derived from policies stimulating economic growth through expansionary monetary and fiscal policies for a long time and investment behaviors of businesses that is incautious, "grabbing", spreading but ineffective; but it is also strengthen significantly by poor banking system and the lack of effective macro and micro monitoring, in which many small banks do business with the goal of rapid credit growth with easy or even no control. 96 CONCLUSION AND POLICY RECOMMENDATION Main Conclusions Along with the further integration process in international economic, Vietnam is one of the countries that have large openness (the total value of export and import/gdp is above 150%), taking a crucial part in economic growth. In the initial development of economy, acceptance of trade deficit is unavoidable. However, if large-scale trade deficit lasts in long time without improvement, it shows the internal problem of economy structure. The fact indicates that lastlong trade deficit is one of the main reasons lead to macro-economic instability, deepen exchange cycle rate inflation exchange rate and make health economics to be vulnerable to external 96 The banking system tried to provide large-scale credit for economy while savings and mobilization are low for a long time, which puts commercial banking system at huge risks of liquidity contributing to stressful situation of interest rate in 2010 and 2011 (Trung Thanh, 2011b). 180

181 factor. Although trade deficit decrease significantly in 2011, but trade gap remains high, and sustainable reduction is still challenged by risk of price shock in the world. Cutting down trade deficit and attaining the trade balance must be considered as priority in near future. In order to solve trade deficit problem, it is necessary to find out the fundamental cause of change in trade balance. According to a research, the extent and degree of effect from nominal shock (for example: exchange rate policy) to trade balance is negligible. It is not as expected, after a year of increasing 1% in nominal rate, imported value is estimated to increase by 0.06%, and exported value is estimated to decline by 0.15%; thus, the trade balance cannot be improved, even in increasing trend of trade deficit. Trade balance is almost back to the original position after 14 month of regulating exchange rate. It tells that importing price impact gradually overwhelmed "capacity impact", and there is the lack of supporting industries, especially for the export sector. Meanwhile, the level of impact from real, structure shock to trade balance is large and lasts in several years. Foreign shocks have huge effect to trade balance, reflect the high degree of economic opening and the vulnerability of international trade. Positive domestic supply and demand shock has negative impact on trade balance, show the large import absorption of economy but cannot metabolized markedly to boost domestic production capacity and export value. As can be seen from empirical result, 70% of variance fluctuation of Vietnam trade balance is caused by these real shocks; it means that root causes of trade deficit come from factors related to economic structure, and is divided into two clear manifestations: Vietnam industrial competitive ability is lagging too far behind other countries in the same region; and expanded investment-saving disparity dues to growth based on investment. While China or other countries have admirable effort to raise national industrial competitive ability through increasing value-added industries, enhancing the structuring conversion of production and export sectors with middle and high technologies, Vietnam over 10 years hardly improves national competitive ability (according to popular criteria, they are industrial value added and technology). Vietnam still depends on traditional competitive ability on area using raw resource or low technologies, gaining low economic value-added, meaning that Vietnam has lagged so far in competitiveness, technology, attributed to the trade deficit. Meanwhile, Vietnam large foreign exchange earning industries like textile, footwear, wooden furniture, electronics, etc. are in vulnerable status of competitiveness and deal with many risks 181

182 from outside shocks. Besides the direct reasons of weakness, lagging and vulnerability of competitive ability in production and export, another fundamental reason of chronic trade deficit is large investmentsaving disparity (net national saving is negative), originated from growth based on investment, especially inefficient public sector investment. In theory, the balance of trade reflects net national savings, including net savings of public sector (budget balance) and net savings of private sector (savings rate minus investment rate of households and businesses, including SOEs). Go further to behavior of each economic sector, it can be seen that the government keep budget in deficit status to maintain growth targets based on investment, contribute to negative net savings. Besides that, the weakness and internal problems of banking and financial system help the saving rate of household to decline, while credit debt ratio of private sector increase (show by the high credit/deposit rate, above 100%), leading to high negative rate of net saving of private sector. Therefore, if changing growth structure, restructuring economy, including banking and financial system do not occur, trade deficit is hard to solve and sustain. Policy recommendations Base on the root causes of trade deficit in the research, it can be seen that in order to reduce deficit of trading two things must be assured: (i) necessary condition is improving capacity of national technological competition, and (ii) sufficient conditions are transforming growth model and restructuring the economy. Improving industrial competitive capability to ensure stable export increase requires restructuring production composition from simple product to high value added products in each sector; at the same time, shifting from production using raw resources and low technology to high-tech industries is need to deployed. This process is influenced and governed by national developing technology policy, divided into main policies group and supporting policies group. Group of main policies aims to help businesses improving and enhancing high technology, includes: Macro-economic policies facilitate businesses in long-term investment in developing hightech production. Thus, it is important to build stable macro-economy (inflation, exchange rates, interest rates, etc...). The policies which establish competitive environment in business enable enterprises to 182

183 quickly take and apply new technologies effectively: Competitive environment in general are created by international trade policies and national industrial policies. o For international trade policy, it is necessary for supporting businesses to purchase input factors at international price level for the purpose of accessing to new technologies. o For the national industrial policy, it is crucial to create friendly competition environment, which is easy and airy to enterprises - this is the best condition for businesses to use and apply technologies efficiently. Group of supporting policies intends to improve the supplying capacity of businesses in the technology development process, including: Development of human resources: It is need to develop skilled and qualified workforce through effective educational and training system, the program of good training development and management, etc, because this is the essential input element in applying innovation and developing technology. Increase the chance of enhancing foreign technologies of businesses: through important channel, enterprise should be facilitated to access technologies. Transferring technology is a major source of national technology improvement, and is carried out through two main channels FDI and technology imports. Therefore, it is crucial to boldly tight regulation of providing FDI in order to focus on the sector using medium and high technology, issuing licenses for the projects of overexploitation of natural resources, polluting environment and using outdated technology should be resolutely refused. High technologies import policy need to ensure consistency and systematic, after building specific strategies addressed to select and focus on some high-tech industries to quickly shorten the technological development gap with other countries. Ensuring and improving financing for technology development: It is needed to increase spending on research and development; simultaneously, create effective mechanism in using these financial resources. Other task is enhancing accessibility to financial resources supporting to technology for businesses, particularly focusing on businesses having high pervasiveness in technology in order to finance right place, instead of current inefficiency and low applicability. However, sufficient condition and fundamental solution for trade deficit is transforming 183

184 growth model and restructuring economy, so disparity between national savings and investment is also reduced, and ensure the balance of macro economy. General framework in this process includes shifting to sustainable growth mode, improving efficiency and increase in depth, gradually cut down proportion of social investment, while improving efficiency and anti-wasting of investment (especially public investment). Besides that, policy of raising domestic savings rate of the economy should be carried out. On the one hand, fiscal policy should be implemented prudently to maintain low budget deficit; on the other hand, intensive restructure banking and financial system to not only increase the net savings rate of household sector, but also effectively control the growth rate of credit outstanding balance for investment of the private sector. 184

185 APPENDIX Export value growth, volume and price of some goods (%) Cashew Capacity growth rate Price growth rate Coffee Capacity growth rate Price growth rate Rice Capacity growth rate Price growth rate Crude oil Capacity growth rate Price growth rate Rubber Capacity growth rate Price growth rate Source: General Statistic Office. Decomposing the variance of the trade balance in the shock (%) Period External Domestic Domestic Domestic nominal (quarter) shock supply shock demand shock shock

186 Source: Results from the empirical model. 186

187 Chapter 5 WORKFORCE AND EMPLOYMENT FLUCTUATION EMPLOYMENT SITUATION IN 2011 Employment is one of the most important indexes of macro economy. This is more essential in Vietnam because of the high pace of workforce increase, jobs creating and ensuring is one of the substantial macro- obstacles. To capture a big picture of labor and employment circumstance in 2011, it should be put in a period to make comparison easier. According to the statistic of General Statistic Officer, total employment within the economy increased from 44 million to 50.6 million between 2006 and The annual growth rate was approximately 2.5% (Picture Chapter 1). With the workforce growth rate rose at a similar pace, around 2.8% annum, new employment in Vietnam in this period were almost provided for new comer in labor market. In terms of labor structure (15 year olds and above) in economic sectors, Picture number 5.1 shows that there is a considerable movement in the period. Proportion of agriculture, forestry and fishery employment went down from 55.4% to 48%, industrial and civil engineer went up from 19.3% to 22.4% meanwhile service sector increased from 25.3% to 29.6%. The figures show that industry, civil engineer and service are the main sectors contributed for the employment growth, which can be considered as a positive trend. In another perspective of structure analytics, until 2010, the domestic private sector, particularly agriculture and unofficial sector, played an important role in creating jobs for economy (accounted for 86% total employments); meanwhile the state owned sector declined the proportion from 11.2% to 10.4%. Foreign- invested sector made up a mere proportion; however there was a slightly upward trend (from 3 to 3.5%). 187

188 Figure 5. 1: Vietnamese employment structures, 2006 and 2011 Source: General Statistic Office, So, the development of the domestic private economic sector plays an integral role in making jobs, avoid unemployment or jobless. Relevant to this important index, General Statistic Officer s figure indicates that during the period from 2006 to 2011, the unemployment rate marginally rose from 2.1% to 2.3%, i.e. number of unemployment increased from 1 million to 1.2 million. Exclusively in 2009 and 2010, the unemployment rate surged due to the effect of world financial crisis. Even though the unemployment situation in urban area seemed to be more serious than in rural area as well as average number of the country, unemployment rate in the cities slightly declined from 4.8% to 3.6% in 5-year period (from 2006 to 2011). Underemployment figure, another important statistic also went down significantly, which revealed the recovery of economic situation of not only this sector but also the whole economy post- crisis. 188

189 Figure 5. 2: Unemployment rate, The whole country Urban area Rural area Source: General Statistic Office, Figure 5. 3: Underemployment rate, The whole country Urban area Rural area Source: General Statistic Office, Another important index is wages. Although no wage index reported by GSO, the statistic, which was collected from annual surveys by Social Science Academy of Vietnam in industrial zones and some other essential regions in Hanoi, Ho Chi Minh City, Dong Nai, Binh Duong from 2009 to 2011, witnessed a fair recovery after sank to a low in first quarter of 2009 under the effect of global financial crisis. Both nominal and real wages (excluded the inflation factor) in surveyed points at August 2011 were higher than those at June The statistic collected from GSO along with statistic information from Social Science Academy of Vietnam from the quick evaluation of macroscopic fluctuations to the economy, labors and households indicated both 3 main indexes of labor market, unemployment and underemployment rate, wages were quite positive in All these results could be considered as the spotlight of macro economy in

190 ANALYSIS OF FACTORS AFFECTED JOBS AND INCOMES IN 2011 AND PROMISINGS IN 2012 These above results of labor market are highly relevant to the economic growth in both speed and structure in In terms of growth rate, even though the figure only reached 5.89% (only rank above 2009 index during 3 year period from ), this should be remarked compared with the figures from many countries in ASEAN as well as the other countries. This threshold was not too low in comparisons with figures in 2008 and 2010(6.31% and 6.78% respectively). However, the most notably thing is the achievement of growth rate while there was a considerable decline in total social investment, from high level at 41.9% in 2010 to a mere 34.6% in However the structure of growth appeared to be more essential than jobs and employment. The notably figure in agriculture- forestry and fishery sector at around 4% was the highest level during 3 recent years, which contributed to 0.66 mark of economic growth percentage. This was another spotlight of the economy in 2011, and it really played an important role in shockreduction for the economy throughout positively increase the growth rate along with inflation controlling ( by decreasing the price rise of food and agriculture products) and enhance the income of rural residents. The quick survey conducted in 2011 of Social Science Academy of Vietnam as mentioned above also confirmed the effective influences of agriculture to incomes and wages in investigated regions (See Appendix 3). Impressive exporting growth rate in 2011 was another significant factor supporting both growth rate and employments and jobs. The structure of exporting growth rate positively affected the labor market as well: the exporting sectors with intensive workers or relevant to low- skilled labors underwent a high increase. Compared to 2010 figures, the value of exported garment products, shoes, fishes products increased by 25.1%, 27.3% and 21.7% respectively. While electronic and computer exported value went up by 16.9%, that of equipment and equipment elements was 34.5%, wood and wooden products exported value went up by 13.7%, rice at 12.2%, rubber 35% and coffee with 48.1%, etc. Tourist for foreigners, who creates employment and well- influences to jobs and income by direct and spreading impacts, also kept a good growth pace at 19.1%. Two other relevant sectors that create jobs are retails and construction, other non-tradable sector accounted for minor proportion of jobs creation. While retailing still achieved the upward 190

191 trend by a slight margin (24.2% nominal equivalent to 3.7% real rate), construction rate fell insignificantly, at 99.3% compared to 2010 static. Applying that analysis method for information of Quarter 1 in 2012, there was a forecast of the possibility of reverse trend in labor market in The first warning was the decline of growth rate of the whole economy at 4% while it was 5.57% of first quarter in The figure of surging inventory in first quarter of 2011 (inventory rate of manufacture and production increased by 34.9% compared to the previous fellow period) pointed out the difficulty of high potential growth rate in remainder time, due to the products absorbing ability of the economy witnessed a downward trend. The circumstance might continue complicated and many ideas claimed that the growth rate would be hard to be in line with expectation of National Assembly. However, due to the instability of elasticity between employment and economic growth 97 the slower growth on unemployment is even more complex. In other words, the forecasts for employment (or unemployment) based on estimates of employment elasticity of growth is usually not highly reliable. There are several reasons for that. Firstly, because employment is an important economic indicator, as the economy situation goes worse, government policies often prioritize supporting labor-intensive sectors, leading to a certain shift in the structure of resource allocation, which is more beneficial for the region. Secondly, companies often try to keep workers despite declining output in order to avoid the costs associated with new hiring when the economy recovers. Thirdly, due to the coverage of the low unemployment insurance system in particular and the social security system in Vietnam in general, the majority of workers in Vietnam "is not allowed to be unemployed " : they are about to make something else, usually under unofficial sector with lower wages and worse working conditions 98. So the economic downturn generally leads to a decrease in salaries and employee income, rather than making significant changes in employment status. Unfortunately, the present data on income and wages are not collected regularly to monitor accurately the changes in the labor market. 97 A number of studies to estimate level of 0.36 for and increased to 0.46 in (Source: Ministry of Labor, War Invalids and Social Affairs and Labor Organizations ILO Vietnam s employment Trends Trends in employment in 2011 in Vietnam). 98 Labor market in Vietnam is still characterized by the rate of employment in the informal sector, accounting for nearly 75 % of total employment in the country. Area public and official business only accounted for 11% and 16 % respectively (labor force survey in 2007).This characteristic reflects the lack of jobs and poor quality of work due to lack of access social security system and a more worrying problem of Vietnam than full unemployment. 191

192 Analysis of the structure of the first quarter of 2012 with rising growth concerns will likely show a reversal in the labor market, both in terms of employment and income, especially for less skilled workers and low-income ones. Agricultural growth fell slightly, but still passable at 3.7 % compared to the same period of the year before. However, Industrial growth has declined significantly with only 4.1 %, while the construction sector experienced negative growth, only 96.4 % compared with the first quarter of 2010 due to the impact of the reduction in public investment and the freezing of the real estate market. Some industries are labor-intensive exports or related to livelihood of low skilled and income labored witnessed slow growth: textile exports increased by 15.4 % compared to the same period in 2011; footwear increased 14 %, while that was 11.7 % of seafood. The textile and footwear industry was under pressure of declining export orders under the impact of the spreading of European debt crisis and the prolonged trouble in the U.S. economy. Agricultural exports also began to face difficulty, particularly rice and coffee exports fell both in volume and value compared to the same period the year before, with decline of 10.1 % in coffee volume and 11.8 % in value, 42.5 % fall in rice volume and 42.5 % in value. The decline in the growth of the economy in general and of some labor -intensive industries in particular, leads to an increase in unemployment, the number of registered unemployed increased significantly. For example, the report of the Department of Labor, Invalids and Social Affairs in Ho Chi Minh City showed that, in the first 3 months of this year in Ho Chi Minh City there was roughly 29,000 employees lost registration Industry, of which nearly 17,000 people have filed for unemployment benefits, increased from 9,000 in In Hanoi, in the first quarter of 2012, there were 4,667 registered unemployed people, higher than the same period last year. In April, Registered unemployment labor continues to show up 99. Moreover, the structural problems began to be evident in the labor market, most notably an imbalance between areas (key economic areas and rural areas, remote areas) and the structure of skills, knowledge. Therefore, in 2012 there should still be a local labor shortage in some areas and some of the skills despite jobs at the aggregate level might become more pronounced in Workers may face tough dual due to loss of Income and inflation continued at a high level, 99 Source: 192

193 particularly in relation to prices of essential commodities for their lives as the food, electricity, fuel and other services costs. On the business side, they will likely continue to face with the situation of their employee change to another jobs with higher income, which has been pretty common in 2011 and recent years. LABOR MARKET AND MACROECONOMIC POLICY PLANNING The potential reversal on the labor market as outlined above posed the need to solve a different problem than the long-term nature: it is the integration of routine monitoring in the labor market planning and implementation of macroeconomic policies in order to ensure the sustainable growth of society. In Vietnam, policy discussions often focuses on macro- economic growth, inflation, trade deficit, etc. and not intended analysis for group indicators of the labor market, even though they are the key macro indicators of the economy, and being used as the key parameter in the formulation and implementation of macroeconomic policies such as cash currency, fiscal, trade, exchange rates, etc. in many countries around the world. This can be explained by reasons relating to the availability of data as well as the awareness of the need to incorporate indicators of the labor market policy in macro monetary or fiscal policy. In terms of figures, in comparison with other macroeconomic indicators such as growth rate, inflation and the macroeconomic balance, information on the labor market is significantly incomplete, both in frequency as well as data quality. By analysis the impact of economic policies on labor and employment, experts are forced to take a detour to consider the evolution of the labor -intensive industries. This way is useful but flawed by a number of reasons. Firstly, the informal sectors in Vietnam have quite large scale compared to the formal sectors, and these sectors are also using less skilled and low income labors, whereas statistical data related to production and business situation of this region are in shortage. Secondly, the informal sector is the absorption hub of labor from the formal sector, thanks to the tight labor collaboration between the two sectors, especially for low skilled group. Because of that, even if statistics show that the formal sector is in difficulty as discussed above, the overall unemployment rate is unlikely to increase. At that time, informal sector will have to absorb the resignation labors because in Vietnam labors have to find jobs to cover the basic costs of living due to the low coverage of unemployment insurance system (only accounted for 20 % of total employees). Therefore the troubles of enterprises now are conveyed to the decline of income as well as 193

194 decline in the quality of employment (employee severance being forced to do jobs with lower wages and lower working conditions). So it is necessary to continue improving information on the labor market by collecting more frequent (monthly if possible) and better data quality (especially wages). Thanks to the rapid progress of information technology, especially the emergence of cheap tablets allowed to collect and process the information with lower costs, so this may bring feasible development. A good information system with regular updates on the labor market plays an important role in helping regular monitoring of macroeconomic outcomes and the process of restructuring and growth model transformation taken place in the context of global economy and volatility in the country. In relation to the labor market and policy processes, current issues in employment and income are seen primarily from the perspective of such microscope as job training, minimum wage, etc. meanwhile, the macroeconomic policies such as monetary, exchange rate, fiscal, trade, development, etc. play a very important role for job creation. On the other hand, the social security system associated with employees (especially unemployment insurance, etc.) act as a mechanism to stabilize the macro-economy automatic: revenue growth in the economy help cool down the overheating economy and recover the economy economic decline then help increase the temperature when the economy is cool. Therefore, the integration of the results of the labor market in the process of policy making and strengthen macro social security system associated with employees by expanding coverage and increasing the need to effect is seen as an important part of a framework of macro -economic management in the medium and long term. CONCLUSION AND POLICY RECOMMENDATIONS Conclusion The latest figures show that the macro -economic situation in Vietnam changed rapidly in recent months, moving from overheating with high inflation and a significant trade deficit (both resulting pressures for exchange rate) to the deceleration of inflation (inflation in April nearly 0 %) and trade balance was almost equal ( both helps to stable exchange rates), but the signs of stagnating production is becoming increasingly clear( represented by a lower growth rate 4 of % in the first quarter and increased inventory amount) under the action of the mainstream costpush factors. This requires the appropriate policy adjustments in 2012 to help steer macroeconomic 194

195 bypass a narrow corridor between the "volcano of inflation" and "iceberg of economic decline", to achieve an optimum tradeoff between short- term growth and inflation. While there should be simultaneous improvement of the restructuring process to handle the long -term problems of the economy, with a focus on public investment, banking system and state-owned enterprises, to help move the economy from the growth model based on the breadth-added depth to growth based on productivity and efficiency which can ensure environmental and social sustainability. Policy recommendation In short- term, relevant to the policy instruments, as real and expected inflation expectations fell significantly; monetary policy can be implemented more flexible to support the labor- intensive industries in order to maintain jobs and stable social security: State Bank may continue buy foreign currency to increase the liquidity of the system, as well as support export industries and the domestic competitiveness to imported sectors and leverage the foreign currency stock to a safe level. In addition, the continuing of lending foreign currency to exporting companies to approach the cheap capital while protecting the security of the system due to the availability of foreign currency flow. If the decline of the inflation rate continues to be maintained in the coming months, the State Bank may continue to decrease interest rates, but with a shorter jump of 0.5 percentage points instead 1 percentage point at present to not make sudden changes in the behavior of depositors, and the view should be vigilant and continue to prioritize macroeconomic stability. The more important thing is to ask commercial banks to quickly lower the interest rates as there are still a lot of credit availability, because of two main reasons: (I) the large commercial banks currently have higher rates than the power of the companies which are bracing for inevitable losses, and (ii) the incomes of employees at large commercial banks is an unreasonably high compared than the average income of society 100, causing offensive amid the difficult situation of the economy. So in the short term it is pivotal to apply the interest rate ceilings for loans, with an independent mechanism to closely monitor the implementation. 100 Report of the Ministry of Labor, War Invalids and Social Affairs published between May 1/2012 shows, with management officials and officials banking, financial and insurance are the highest paid, on average nearly 16 million VND / person, 1.5 times higher than the industry of mining, processing and construction doubled. 195

196 To encourage banks to lend to small and medium enterprises or prioritized sectors, the State Bank may provide these sectors with higher ratio of credit loan surplus compared to the total credit balance of the bank. The first priority now is to settle down nine weak banks within the fastest time under a public manner, to remove the imbalance between strong and weak banks, which is causing unrest in the entire system. To expedite this, the State Bank may stand directly to control the abandoned banks, even force the owner of the bank to leave with empty-handed. If these Achilles heel aren t tackled, the banking system in particular and the economy in general are still at risk. Once this problem is resolved, the ceiling interest rate can be removed. Regarding fiscal policy, in terms of budget revenue, tax reduction or exemption for laborintensive business should be considered, the extension of tax for other businesses also a good suggestion to increase capital amount. Regarding the budget, there should be resolute cut of nonpriority projects, which has to be monitored closely. Spending on social welfare and security should be increased, especially for medical and health care for the poor and low-income people. Moreover, spending on agriculture and rural areas has to be going up. There should be priority for migrant workers to buy phones at reasonable prices through various forms such as prepaid phone card purchase, etc. to help them not to cut essential spending. For the freezing of the real estate market- an acute problem strongly related to construction and labor intensive materials production, the range of policy is very limited. The biggest problem is a discrepancy in the structures of real estate products, resulting in the inconsistent of supply and demand unless the real estate price plummeted (especially in Hanoi). The only way to support is that the commercial banks allow an extension to real estate loans to enable the real estate business with more time to lower the price of inventory". The business of real estate enterprises must also comply with "market discipline" in market economy as counterparts of other sectors, and the real estate enterprises also shouldn t expect any rescue initiative of the State, which may likely prolong the restructure process of this sector. In the medium to long term period, the business investment environment must be reformed considerably, especially the completion of important laws such as competition Law, Bankruptcy Law to positive influence the practicality of the economy. In recent past and near future, the vicinal countries actively reform the economy to cope with the growing challenges in the world economy. This may increase the FDI attractiveness of the countries. Therefore, Vietnam needs to 196

197 reform and innovate more powerful, especially the legal framework in order to become more attractive to foreign investors, thereby helping the country with more resources to increase production capacity and improved technology. At the same time the need to regularly monitor the results of the labor market such as unemployment, under-employment, salary, etc. become an organic component of the planning process and implementation of macro-economic policies. Information technology should be taken advantage to collect high quality and frequently information and data of the labor market so as to create a fast and reliable feedback mechanism for Government to catch up with situation and come up with policy and solutions timely and reasonably. 197

198 APPENDIX Average personal income of some direct worker groups in industrial zones ( ). Hochiminh city Binhduong- Hanoi Haiduong (VND) Dongnai 2010 Income Approximately Approximately 2- Approximately Approximately million if work 2.5 million VND( million( million( overtime( basic salary million million 1.2 million basic is 1.5 million VND + basic salary basic salary + salary million bonus + million bonus million million bonus+ 1.1 million over time) million over time) bonus million over million over time) time) Renting million/ million/ Almost travel cost capita/ month capita/ month million/ capita/ daily to save (inclusive month rental cost. electricity and water cost) Living Food: Food: Living cost: Single workers cost million/ capita/ month. million/ capita/ million/ living dependent Living cost: month. capita/ month on their families million/ capita/ month Living cost: 1 use 0.5 million million/ capita/ per month and month contribute the rest for family consumption. Married workers find additional 198

199 jobs working. after Saving amount 2011 Around 1.2 million. Around 1.2 million. 0.8 million- just over 1 million Income million ( million ( million ( million 2.5 million basic million million ( million salary+ 0.4 million basic salary+ 0.5 basic salary+ 0.5 basic salary+ 0.8 bonus+ 1.2 million million bonus) million bonus) million bonus) over time) Renting million/ million/ 0.45 million/ 0.35 million/ cost capita/ month room/2 people/ room/ 2 people/ room/ 2 people/ (inclusive month month month electricity and water cost) Living Spending: 1.2- Spending: 1.5- Spending: 0.5 cost- Spending: million/ capita/ 2 million/ capita/ million/ capita/ Saving million/ capita/ month month. month. month amount Saving: Saving: 1 million. million. Source: Quick evaluation of macro-scope fluctuations to enterprise, labors and households (RIM) , quick survey at rental residents of migrant workers in 9 industrial zones (8/2011) (due to the support of electricity and water bill, the accommodation cost didn t increase much). 199

200 Real income of workers in industrial zones (post excluding inflation factor) Income (thousand VND/capita/month) Industrial zone workers pre crisis bottom of crisis* 8/2009 8/2010 8/2011 Nominal income Hà Nội - Bắc Thăng Long TP. Hồ Chí Minh Đồng Nai Bình Dương Consumer price Increase % (Source: TCTK) 6/ /2008 8/2009 8/2010 8/2011 The whole country 1,22 3,47 8,18 23,02 Hà Nội 3,96 2,85 8,62 22,68 TP. Hồ Chí Minh 1,37 4,54 8,20 19,00 Đồng Nai 1,18 3,01 7,58 18,76 Bình Dương -0,21 4,48 6,73 16,50 Hà Nội 4,36 3,14 9,48 24,95 Assumption 1: Worker s Consumer Increase TP. Hồ Chí Minh 1,51 4,99 9,02 20,90 is 10% h i g h e r t h a n CPI** Đồng Nai 1,30 3,31 8,34 20,64 Bình Dương -0,23 4,93 7,40 18,15 Real income (apply the index of 6/2008 o f G e n e r a l S t at i s t ic O f f ic e ) Hà Nội - Bắc Thăng Long TP. Hồ Chí Minh Đồng Nai Bình Dương

201 Real income (apply the index of 6/2008 with Increase Assumption 1) Hà Nội - Bắc Thăng Long TP. Hồ Chí Minh Đồng Nai Bình Dương Hà Nội 4,55 3,28 9,91 26,08 Assumption 2: Worker s Consumer Increase TP. Hồ Chí Minh 1,58 5,22 9,43 21,85 is 15% h i g h e r t h a n CPI** Đồng Nai 1,36 3,46 8,72 21,57 Bình Dương -0,24 5,15 7,74 18,98 Real income (apply the index of 6/2008 with Increase Assumption 2) Hà Nội - Bắc Thăng Long TP. Hồ Chí Minh Đồng Nai Bình Dương Hà Nội 5,15 3,71 11,21 29,48 Assumption 3: Worker s Consumer Increase TP. Hồ Chí Minh 1,78 5,90 10,66 24,70 is 30% h i g h e r t h a n CPI** Real income (apply the index of 6/2008 with Increase Assumption 2) Đồng Nai 1,53 3,91 9,85 24,39 Bình Dương -0,27 5,82 8,75 21,45 Hà Nội - Bắc Thăng Long TP. Hồ Chí Minh Đồng Nai Bình Dương

202 Note: * The lowest income recorded in late 2008 and early 2009 with rotation day off, with 2-3 days off per week and 70-75% salary. Many cases asked for voluntary resign to enjoy onetime unemployment support. ** Commodity basket of migrant workers (rental cost, electric, water bill, food and other living cost...) increased. So the assumption is that the worker s increasing level was higher than society s increasing level. Source: RIM , Interviews with workers about average income of direct workers with 1-2 years working period. Wages of male workers in unofficial sectors in the city. Highest monthly wage Lowest daily wage Lowes monthly wage Highest daily wage Source: Income and wages in researched area in the Evaluation of macro-scope fluctuations impacts to enterprises, labors and households (RIM) conducted by The Social Science Academy of Vietnam. 202

203 Wages of female workers in unofficial sectors in the city. Highest monthly wage Lowest daily wage Lowes monthly wage Highest daily wage Source: Income and wages in researched area in the Evaluation of macro-scope fluctuations impacts to enterprises, labors and households (RIM) conducted by The Social Science Academy of Vietnam. Wages of male workers in unofficial sectors in the country side. Highest monthly wage Lowest monthly wage Daily wage Source: Income and wages in researched area in the Evaluation of macro-scope fluctuations impacts to enterprises, labors and households (RIM) conducted by The Social Science Academy of Vietnam. 203

204 Wages of female workers in unofficial sectors in the country side. Highest monthly wage Lowest monthly wage Daily wage Source: Income and wages in researched area in the Evaluation of macro-scope fluctuations impacts to enterprises, labors and households (RIM) conducted by The Social Science Academy of Vietnam. 204

205 Chapter 6 FOUNDATIONS OF GROWTH PREFACE From the beginning of Doi Moi in 1986, Vietnam has implemented numerous marketoriented reforms, taking father steps in integration to global and regional economy to create more opportunities and improve the ability to take advantages of these opportunities in economic development. This is an important premise for Vietnam to gain important achievements in economic growth and poverty reduction, bringing Vietnam from a low-income country to a lower middle-income country. The biggest challenge for Vietnam in present is how to maintain a rapid and sustainable growth. The process of father international economic integration, especially since the accession to World Trade Organization (WTO) in 2007, has shown that Vietnam s economy becomes more vulnerable to shocks from the global market. In particular, this process also clearly reveals inherent weaknesses of Vietnam's economy - a growth model based too much on the "expansion" of public investment and credit ( easy money"), the expansion of inputs ( such as capital, labor), while efficiency in using resources are slowly improved. In that context, recent economic policies which focus on stabilizing macroeconomics and curbing inflation, either implicitly or explicitly expressing an acceptance of reduced economic growth in the short term, do not undermine the will towards a rapid and sustainable growth. Vietnam is facing both opportunities and pressures in restructuring the economy and transforming the growth model towards higher efficiency and sustainability. Therefore, considering the origin, and more widely, the foundations of economic growth, becomes very necessary to get more appropriate thinking and policies in the future. Growth and the foundations of growth Economic growth is the starting point of development, at both theoretical and practical aspects. Here, economic growth is understood as the creation of more wealth to meet social needs. Economic growth is often measured by such indicators as Gross Domestic Product (GDP) and/or the Gross National Product (GNP). GDP is the total of final goods and services generated in a period (egg one year) by the factors of production in a national territory. GNP also reflects the amount of final goods and services generated within a certain period, but by factors produced 205

206 by citizens of that country ownership. With this indicator, economic growth simply refers to the increase in productivity that creates added value through economic activities. To evaluate the economic growth, GDP / GNP which are calculated at a basic price of the same basic year (real GDP / GNP) usually receive more concerns due to elimination of price fluctuations. Economic growth not only means creating more wealth but also needs to become a process of shifting structure in all aspects of production and consumption. The shift of economic structure and technological level arise due to many reasons. Firstly, increase in earnings leads to a change in consumption trends, putting pressure on reforming production process and technology. In turn new production process and technology could stimulate new consumption patterns, etc... Speed of shifting economic structure depends on institutional capacity (market and state), market openness, etc... It can be said that, economic growth is not everything, but without growth, we go nowhere 101. The economists have acknowledged that economic growth depends on key factors as labor, capital, natural resources (land), knowledge, technology and skills of workers. However, for a long time, capital was considered as the most essential factor to ensure growth. Accordingly, it is very difficult for poor countries to escape the vicious cycle of poverty : low income = > low savings = > low investment = > low growth = > low income. This pessimistic view of the growth was not sufficient due to two factors: (I) investment efficiency is different with different levels of savings and investment, depending on the level of knowledge, governance and skills of laborers, and (ii) in the opening, integration and globalization context, each country may receive additional assistant capital (in most cases be seen as a "kick" to the economy) as well as capacity and skills from outside. In general, besides recognizing the major role of the accumulation and capital, economic theories also launch the same results. The theory of Solow (1956) on the relationship between economic growth and these factors (capital, labor,technology) and investment - saving has been still seen as " most useful" because it not only relies a quite realistic premise, but also has important policy implications, such as: (i) while the role of savings and investment for economic growth is highly valued, investment only raises income per capita in the transition period because the marginal productivity of capital 101 UNESCAP (2001). 206

207 decreases, (ii) poor countries usually have faster economic growth rate and will eventually "catch up " the developed countries. The reason is that poor countries have low capital -labor ratio, so the productivity of each marginal capital will be higher, thus leading to faster growth in the transition period. However, the process of "catching up" is conditional. Many developing economies did not keep up with richer countries, and even fell into poverty and low growth, and (iii) the sole factor maintaining sustainable growth is technological advances. However, Solow did not pointed out the way technological advances take place and whether they are affected by policies. History has shown that the world economy actually grows fast with the industrial and technological revolutions over the past two decades. In the 19 th and 20 th centuries, the world population increased fivefold but the total number of production increased 40 times so the production per capita increased eightfold 102. However, there is a big gap in the rate of growth and development level among many countries in many periods. During the latter half of the 20 th century, some countries kept pace with developed countries but lots of countries didn t get rid of poverty and many countries lost the development impetus, even slid into the recession or social disorder. The term economic growth possesses a much narrower connotation than the term development. Unlike economic growth, the term development reflects all the changes in term of economics, society, politics, natural environment, etc. Many significant changes have been shown even in development thinking, including the aspects of human development, increasing the position and ability of people, freedom and sustainable development in many areas (such as environment, society and culture). However, the start point of this thinking process is the economic growth. It is the process in which economic growth and development have very close relations. In the new age, the economic thinking ties closely with the economic growth, sustainable development and especially human development. Sustainable development requires the meet of present demand but the ability of satisfying the demand of future generations isn t damaged. Ensuring the sustainable development, therefore, accompanies with the resources of assets, human capital, natural capital and social capital or social institutions. Meanwhile, human 102 Refer to Van den Berg (2001) 207

208 development is the extension of economic politic social options and the bettering of human capacity to make use of options to improve social welfare and living quality, making human be the center of the development, both the subject and purpose of the development (Figure 6.1). Figure 6. 1: The progress of development thinking Source: Meier (2001) To reflect the development level, some indicators are often used: - GDP (GNP) per capita; - Human Development Index (HDI), which is based on income per capita, average life expectancy and educational indices (literacy rate, enrollment rates at all levels ); - The index of freedom level for two aspects: political freedom (the impact of the political system) and economic freedom (the freedom to implement manufacturing business activities); - The index of entertainment value (this index is still controversial because the concept entertainment is understood in many different ways and it is sensitive to the concept of morals, cultural tradition, etc.). Obviously, economic growth is a very important precondition for development. Nevertheless, economic growth is just the necessary condition, not the sufficient one for development. High and continuous economic growth will create more opportunities for people to participate in economic activities. However, if we only focus on fast economic growth at all 208

209 costs without attention to the policies of income redistribution, macroeconomic stability, political social stability, and other foundations for long-term development, economic growth won t come with development. In this case, up to a certain time, stagnant development process will cause a negative return to can choose the intermediate objectives such as fast economic growth and sustainable economic growth. Fast economic growth. In contrast, maintaining the development will facilitate the more balanced and sustainable economic growth. All countries look towards a common purpose development. However, due to the different conception and nature of economic growth and development, they achieved different results in development-oriented policies. The controversies over the necessary elements (and dosages) of development policy will hardly end. However, economic policy should aim to ultimately maximize long-term welfare (including both physical and non-physical aspects) of society sustainably and fair. 103 According to macroeconomic researches, this ultimate goal can be specified to Improve the welfare of people on the basis of fast and sustainable growth. The final and intermediate goals of growth are described in Figure 6.2. With the ultimate aim at maximizing long -term social welfare sustainably and fair, an economy economic growth is attributed to the expansion of inputs for economic activities and /or to improving the efficient use of inputs. Meanwhile, sustainable economic growth only exists on the condition that the economy ensures the economic sustainability, in which macroeconomic stability is the central point, social sustainability and environmental sustainability. Whatever the priority is, these foundations of economic growth are dependent on a variety of factors. The important point is that the State can interfere with different impacts in the factors that maintain the foundation of economic growth. However, the proper manner and level of the State intervention is not an easy issue (and very controversial in many aspects). 103 Stieglitz J., and coworkers (2006). 209

210 Figure 6. 2: The ultimate goal and intermediate goals of economic growth Source: Based on the overall research framework of the Macroeconomics Project, Economic Committee of the National Assembly (2011). Foundations of Vietnamese economic growth Analytical framework of growth as well as the foundation of growth in Figure 6.2 has been the basis for assessing the foundation of Vietnam s economic growth since the Doi Moi. Specifically, the above framework is useful to identify the origin and the foundations behind the growth results; thus, show some key issues concerning renewing the growth model and restructuring Vietnam's economy. As shown above, the economic policies should be directed to the ultimate goal 210

211 improving people s welfare based on rapid and sustainable growth. And the two intermediate goals, rapid growth and sustainable growth, complement each other and are inseparable. Rapid growth Economic growth is often measured by the growth rate - GDP, which is calculated and published periodically by the General Statistics Office. This is not a perfect measure of economic growth, but it is popular and quite comprehensive compared with other indicators. Rapid growth can be achieved through: (I) input increase and/or (ii) increasing the efficient use of resources through improving technical efficiency (technical efficiency) and/or (iii) improve the allocation efficiency and/or (IV) the development of science and technology (technological progress). Growth in width On the condition that the efficiency of using resources does not change, growth can be accelerated by increasing the inputs of the economy such as labor, capital and natural resources. In this way, the economy is considered as growing in width. Since the Doi Moi, Vietnam s economic growth has significantly relied on the expansion of inputs, namely capital and labor. Except the period , most of the rest periods have witnessed the significant contribution of capital growth to economic growth. For instance, this contribution amounted to 70.3 % in the period then decreased to 63.0 % in the period before rising again to 68.0 % in the period, even up to almost 84.1 % in 2009 (Figure 6.3). Similarly, the number of labors participating in economic activities also increased sharply, but their contribution to economic growth decreased gradually. Specifically, the labor growth contributed 41.7 % economic growth in the periods, but this figure dropped to 21.0 % in the period and 18.0 % during the period, before recovering slightly to 28.5 % in Thus, economic growth continues to rely mainly on increasing the amount of investment capital and resource exploitation. 211

212 Figure 6. 3: The contribution of factors to economic growth, (%) Source: Scientific Theme at the State level Model of Vietnam s economic growth, , Economic Committee of the Congress and the National Economics University, Growth in depth On the condition that the inputs for economic activities (labor, capital, natural resources) are constant, the economy has still achieved the growth by increasing the efficiency of using resources, i.e. growth in depth. Due to the diversity of economic activities, the measurement of the efficiency of using resources is not easy. The efficiency of the synthetic use of elements is measured by indicators such as the total-factor productivity growth (or TFP), labor productivity and ICOR 104. In order to work out suitable policy intervention, the factors affecting the efficiency of using resources must be dissected. In general, the efficiency of using resources can be increased by: (I) increasing technical efficiency, (ii) increasing allocation efficiency, and (iii) promoting scientific and technological advances in production. These are three components of economic growth based on efficiency. They have connotations, impact factors and need various policy intervention tools. Many research conclusions have been resulted from the above indicators, and it is quite consistent in general. On the one hand, the growth of total-factor productivity has a relatively limited contribution to the economic growth in Vietnam, even is intended to decline. On the other hand, the ICOR index of Vietnam is significantly higher than that of other countries with similar development level. Finally, labor productivity in many sectors is still low and is 104 Note: The growth rate of IFP and ICOR is not published regularly by the GSO so researchers have to calculate themselves to analyze. Meanwhile, labor productivity is issued annually by the GSO. 212

213 improved slowly. Thus, according to many studies as well as in the policy documents, Vietnam needs to change the growth model, with a focus on increasing the efficiency of resource use. Figure 6.3 shows that the rapid and continuous growth that Vietnam has achieved since 1991 has mainly attributed to the input increase. Meanwhile, the growth of total-factor productivity has been limited, and made a small contribution to the economic growth. The largest contribution is in the period , amounting to an average of 49.5 %. 105 In the following years, the role of increasing total-factor productivity faded very much, with an average contribution of 15.9 % and 14.0% in the period and respectively. In the periods, total-factor productivity even decreased, thereby, constrained the economic growth (Figure 6.3). Thus, the efficiency of using input resources isn t significantly improved, and partly reduced by the trend that the increase of investment raises fixed assets. Particularly in the sector of agriculture - forestry - fishery, economic growth has made a positive step forwards. In 1980s, the growth of this area is mainly due to the institutional reforms, thereby contributing to encouraging production activities. By 1990s, this growth was brought about by the expansion of input factors such as capital, land, fertilizer; etc 106 Meanwhile, the 2000s continuously witnessed breakthroughs in agriculture - forestry - fishery, when economic growth of this region made greater contribution to the increase in productivity of comprehensive factors. The rate of this contribution on average reached 88.8% / year during the period of , and 72.1% / year during Thus, the foundation for the growth of Agriculture - forestry - fishery has been somehow strengthened more sustainably. 105 Refer to Dinh Hien Minh and coworkers (2009). 106 Refer Vo Tri Thanh and Nguyen Anh Dương (2011). 213

214 Figure While dealing with macroeconomic instability and awareness of the limitation of the growth model based on increasing inputs, we are gradually restricting the massive investment trend. Geographical balance to increase capital, therefore, would be significantly reduced. At this time, we are in the golden age of population and there would be no potentials for increasing work force in the near future. Here, growth can only rely on the reform (at both macro and micro level) in order to improve the efficiency of resource use. Geographical balance to improve the efficiency of resource use is still quite a lot, for all three components of the effective use of resources - including the efficiency in techniques, allocation, and the development of science technology. Technical efficiency Technical efficiency is reflected in the highest yield to be achieved with the same inputs in terms of quantity and quality. At enterprise level, this efficiency is measured by the volume of products compared with the pioneer in the industry if two enterprises have the same inputs in terms of quantity and quality. At the sector level, the coefficient of technical efficiency is the average rate of technical efficiency for all firms in the industry. The statistics was not included in the official statistics, but can be updated among important industries through the overall data of enterprise and household surveys collected with high frequency. In fact, technical efficiency is a big issue for the public investments. For example, with the same quality, the price of road building in particular or infrastructure construction on the whole 214

215 is much higher than that of compared companies. According to a study by the Recent Research Program Fulbright Economics Teaching, when compared with the U.S. and China, the cost of highway in Vietnam was always higher. The highways Ho Chi Minh City - Truing Long is the first standardized highway cost $ 9.9 million / km for the four-lane road. Highways Ho Chi Minh City - Long Than - Daub Gay is under construction and expected to cost up to $ 18.3 million / km. Highways Ben Luc - Long Thanh construction costs are expected to reach 28.2 million / km. Meanwhile, statistics also showed that in China is only about $ 6 million / km, in the U.S, it would be approximately $8 million / km. Some studies show that the lack of competition for outputs (monopoly) and the shortage of suitable motivations and incentives based on the results of indoors activities the enterprise (in case for many state-owned enterprises, or the case of the management of public investment projects) are the factors which made the technical efficiency lower than potential. Therefore, powerful and radical reform in the sector of state owned companies and the elimination of the monopoly to force the enterprises to use resources in an efficient manner play an essential role in the economic restructure. Allocation efficiency Allocation efficiency is defined as the achievement of highest production value for a given price system. At the national level, the elimination of price distortions (This distortion distorts the signal of the resources allocation) will help improve the allocation efficiency of forces such as capital, labor and other resources. For example, electricity price subsidies will distort the allocation of resources, leading to excessive production and investment in the electricityincentive sectors such as cement and steel, instead of encouraging businesses to invest in the Electricity sector itself or in the alternative energies. For inputs, the preference for state-owned enterprises or private companies belong to the group of advantages in credit access, (even 0% interest loan to pay for Vinashin s employees), the land or other important production resource will also reduce allocation efficiency by distorting this thing. In fact, the allocation efficiency was not high due to the unbalanced and allocation which does not follow the market- economics rules for state-owned and private companies. Until 2010, the state owned sector still took 38, 1% of overall capital, social investment, but only counted for 33.7% of GDP, creating jobs for about 10.4% of work force. Meanwhile, the private sector also 215

216 took 36.1 % of overall social investment and 86.1 % of work force, however, only contributed 47.5% to GDP. Although these statistics have not reflected the advantages of state owned and large private firms, like the ability of credit access, policies information, the lack of allocation efficacy was still clear. Therefore, economic reform, modernizing growth model first started from the political determination of the drastic change in allocation of resources to that the sector, business (probably the private or public ) can use these resources the most wisely. Thus, in the short and medium term, allocation mechanism changes are the largest problem preventing Vietnam from fast and sustainable growth. Some other issues related to efficient allocation at the national level are emerging as hot issues related to public investment such as: (i) within the public investment there is unreasonable allocation between "Hard" infrastructure and "soft" infrastructure or within each sub-sector 107 ; (ii) the crowding out of public investment compared with the investment of the private sector. Related to the first issue, the inefficient allocation of public investment was pointed out by some studies indicate that due to decentralization and local interests, group benefits affect the national interests. For the second issue related to public investment and private investment, if the public investment can reach the highest level of optimization, it will encourage private investment in the long term if it focuses on developing infrastructure (Hard floors: roads, wharves, and soft infrastructure: education, health, etc...) in order to help reduce costs although it can overwhelm private investment in capital markets in the short term. If the private investment is effectively carried out, the stimulus effect (crowding in) will be greater than the overwhelming effect (crowding out), but if not, the overwhelming effects will dominate. One policy issues emerging recently - a collaborative public - private partnership (PPP) in infrastructure development is a topic having important contributions to improving effective allocation of the economy as well as to minimizing the effects of crowding out in public investment compared to what we would do in the past. Technological advances The intensive investment in research and development (R & D) and upgrading education in universities as well as higher education to enhance absorptive capacity in technology are 107 In particular, Vietnam has so many ports and the infrastructure somewhere is too poor and need more investment 216

217 channels helping promote technological progress. This is the biggest weakness of Vietnam's economy generally speaking and Vietnamese enterprises in particular, which is needed to be developed so that Vietnam can maintain the long-run growth. One of the emerging problems now is industrial complex together with auxiliary industries. However, the importance of supporting industries is often misunderstood in current policy debates when promoting this sector is seen as a mean for Vietnam to reduce the deficit by increasing the export increment. That simple viewpoint is pretty much the same as the application of the provisions about local content ratio. The necessity of support industry should be seen in terms of improving the efficiency gained from promoting technical spillovers from the pioneering companies (such as Canon or Intel) to the satellite business in the production chains. The development of industrial clusters themselves will help achieve economy of scale through the interaction between the satellite businesses and pioneering businesses in the production chains. Supporting industries help decrease the trade deficit not because it helps raise domestic rates but helps increase efficiency - expressed in the increment retained nationally. Using primary and secondary statistics and quantitative analysis of the impact of FDI on economic growth, Nguyen Thi Tue Anh and her partners (2006) showed that spillovers of FDI in the period to 2005 seem to appear via two channels: associated production channel (including downstream and opposite direction impacts) and competition channel. Researches show that private enterprises have sought to take advantage of the benefits of these two channels. However, it seems that the state-owned enterprises failed to do that. Also note that, on one hand, maybe before that, many state-owned enterprises received negative spillover effects but still could overcome not by self-adjusting its behavior but by relying on several advantages that private enterprises could not have. On another hand, state-owned enterprises may also have advantages and spillover effects through production linkages, but the negative impacts of competition were greater than positive impacts that the channel brought to. The quantitative studies then showed that the contribution of technology transfer (including R & D activities) of enterprises with foreign direct investment is very limited. Potential technology transfer between foreign firms and domestic competitors is smaller than the impact of competitiveness of foreign enterprises to domestic enterprises 108. Even the case studies (as in 108 See Le Quoc Hoi s research (2008) 217

218 QueVo industrial zone 109 ) also show the financial incentives are not sufficient to encourage technology transfer. The studies generally observed that lack of qualified labor and low technological capacity of domestic enterprises, and lack of forward and backward linkages between foreign -invested enterprises and domestic enterprises are main factors that hinder technology transfer from FDI. Coping with macro-risks that threaten the economic growth, policies normally aim at: (I) curb inflation; (ii) keep budget deficit/ public debt at a low level; (iii) keep deficit in current account at a low level. On inflation control, Vietnam only finds limited success inflation remains high most of the years. Inflation rate in early 1990s was extremely high 66-67%. It cooled down to 5.3% in 1993 before jumping to 14.5% and 12.9% in 1994 and 1995 respectively. Between 1997 and 2001, under the effects of the Asian financial and monetary crisis, the inflation rate was low there was even deflation in After being kept at above 3% in 2002 and 2003, the period that witnessed expansion in credit and investment, inflation regained its moments. Post-WTO era is characterized with persistent inflation and instability. What should be noted is that in addition to our inadequate response to the foreign capital influx and soaring global commodity prices, we suffered from the inflation pressure resulted from loose economic policies of the past. Government budget has been in deficit in many years due to the demand of development investment. The deficit level has increased dramatically from 22 billion dong in 2000 to 40.7 billion in 2005, and billion dong in Compared to GDP, budget deficit has not been over 5% of GDP, which is applicable for golden rule, i.e. acceptable. However from 2007 onwards, the deficit level rose and felt more wildly. Even in 2009 and 2010, the ratio of deficit to GDP was 6.9% and 5.6% respectively. Because of that situation, Vietnam has to owe more. Exclusively foreign debt reached 29 billion USD in 2010, which was a great increase compared to 9.4 million USD thresholds in The state debt to GDP ratio also rocketed and hit a peak of 52.6% in See Nguyen Thi Tue Anh s research (2009) 218

219 Figure 6.4: Trade deficit to GDP and to Export, Source: Trade deficit data from TCTK, GDP data (in USD) from EIU For the current account, Vietnam trade deficit tends to rise continuously until 2008 (Figure 6.4). This is the main reason why the current account has been in deficit continually which was even raised rapidly in some years. Trade deficit was at only $ 1.2 billion in 2001, but increased dramatically and reached nearly $5.1billionin2006. After Vietnam joined WTO, the trade deficit increased even faster, reaching respectively $14.2 billion and $18 billion in 2007 and In the following years, along with the impact of the global economic downturn and the policies to curb the trade deficit, it fell to 12.9 billion dollars in 2009 and $12.4 billion in Average deficit rate was nearly 30.0 % / year during , climbed to88.7 % / year from 2006 to 2008, then decreased by17.1 % / year in the period of The increase in trade deficit - especially in the post- WTO period was mainly caused serious imbalances between domestic savings and investment. 110 Thus, despite the more serious view of macroeconomic stability in recent years, this goal has not been properly assessed. In many cases, the objective of macroeconomic stability is pushed aside for the target of sustaining high and sustained economic growth rate. Even when prioritizing inflation control and macro-economic stability at the expense of growth, the government has not determined the acceptable level of reduction in growth rate, because they have to take unemployment and bankruptcy into consideration, etc... In the meantime, the growth relies on investment, especially public investment, therefore high growth rate will put pressure 110 See Truong Dinh Tuyen and partners report (2011) 219