Vietnam Pushing the tempo

The year began well for Vietnam, with strong economic activity setting the stage for acceleration in GDP growth. The economy is benefitting from a recovery in domestic spending and FDI inflows.

Vietnam_spotThe year began on a positive note for Vietnam. Economic activity was strong in Q1, setting the stage for acceleration in annual GDP growth. The economy is benefitting from a recovery in domestic demand and foreign direct investment (FDI) inflows that continue to support investments and exports. Besides, low global oil prices have pushed consumer price pressures lower. With inflation below the central bank’s target, monetary policy is likely to remain accommodative. The economy will also benefit from reforms aimed at improving the health and efficiency of banks and state-owned enterprises (SOEs). Policymakers are also trying to deepen economic engagement with key trading partners, a move that is likely to reap dividends in the medium to long term.

A quick start to 2015

Vietnam’s economy has been quick off the blocks in 2015, growing 6.0 percent year-over-year in Q1 2015. This is the fastest pace of growth for the first quarter in the last five years. Usually GDP growth in Vietnam accelerates through the year. Consequently, strong growth in Q1 2015 augurs well for the coming quarters. In Q1, industry and construction had the largest impact on GDP growth, contributing 2.8 percentage points. Services and agriculture contributed 2.4 and 0.3 percentage points, respectively.1

Data on a number of indicators for the first five months of 2015 reiterate the strength of economic activity in Q1 and its likely continuation in the next quarter. For example, industrial production grew 9.2 percent year-over-year during January to May while retail sales went up 9.1 percent. Strong growth in retail sales and a surge in imports (15.8 percent) during this period point to strong domestic demand.2 Imports often include large shipments of machinery, an indicator of FDI inflows and overall investment activity. Interestingly, FDI sector imports also include materials that are assembled or processed and subsequently exported. The FDI sector accounts for a large share of Vietnam’s international trade. In 2014, for example, the contribution of the FDI sector to total exports was about 68 percent, while imports by the sector accounted for 57 percent of total imports.3

The surge in FDI over the past few years also points to Vietnam’s increasing market share in low-wage manufacturing as businesses in the segment relocate from China due to rising wages and gains in the yuan. As foreign businesses invest more, Vietnam’s exports continue to flourish. In the first five months of 2015, exports grew by 7.3 percent, continuing from a stellar 13 percent rise in 2014 and contributing heavily to the manufacturing sector. Latest data indicate that this trend is likely to continue. For example, in May, Vietnam’s purchasing managers’ index (PMI) for manufacturing touched a record high of 54.8.4

Vietnam_Figure 1. GDP growth (percent, year-over-year) slowed down in Q1 2015

Monetary policy to remain accommodative in 2015

In May, the State Bank of Vietnam (SBV) devalued the dong by 1 percent against the US dollar. This is the second such devaluation this year; in January the SBV had devalued the currency by 1 percent. The devaluation is primarily aimed at reining in the country’s rising import bill and aiding exporters. Additionally, Vietnam’s trade balance is back in deficit by approximately US$ 3 billion as of May 2015 after three consecutive years of surpluses;5 a further devaluation cannot be ruled out this year if the deficit widens. This is despite the SBV governor’s announcement in December 2014 that the central bank will not weaken the dong by more than 2 percent in 2015.6

The dong’s devaluation is synonymous with a domestic liquidity boost as the central bank buys dollars to enact the change. The accommodative policy stance is expected, given that inflation (less than 1 percent in May) is currently well below SBV’s target of 5 percent. SBV has held policy rates constant since March 2014, when it last cut rates. However, with real interest rates rising due to low inflation, it is possible that the SBV will follow the dong’s devaluation with a rate cut this year, thereby attempting to boost lending to and above the targeted 13 to 15 percent expansion for 2015. However, the country’s troubled banking sector could play spoilsport by preventing an efficient transmission of monetary and exchange rate policies to the real economy.

Vietnam_Figure 2. Dong devaluation amidst low inflation and credit uptick

Reforms in banking and SOEs a step in the right direction

Policymakers have been taking steps to improve banks’ asset quality, Vietnam’s Achilles heel for long. Since Vietnam created the Vietnam Asset Management Company (VAMC), a state-owned enterprise to buy and rehabilitate bad debt, in 2013, the ratio of non-performing loans to total outstanding loans has dropped. In February 2015 it stood at 3.6 percent, down from above 8 percent at the end of 2012.7 The SBV aims to bring it down to below 3 percent in 2015. Toward this goal the VAMC has been issuing special bonds to commercial banks in exchange for bad debt. However, while buying bad debt might be relatively easy, selling the bad debt is expected to be a challenge for VAMC.

The government is also accelerating consolidation in the banking sector, aiming to shrink the number of banks from 40 to 15 by 2017.8 Rating agencies have reacted positively to these efforts, which, they believe, will improve efficiency through better economies of scale.9

The government is also trying to reform SOEs to reduce bad debt and improve efficiency. SOEs contribute less than a third to Vietnam’s GDP, but account for nearly half of public investment and 60 percent of bank lending.10 Worryingly, they account for more than half of Vietnam’s bad debt.11 The government aims to “equitise” or partially privatize more than 300 SOEs before the end of 2015.12 However, the stake on offer to the private sector is miniscule, thereby raising doubts about radical changes in the way large SOEs are run. Nevertheless, the push to clean up SOEs is a step in the right direction as the country tries to liberalize the economy and seeks deeper engagement with the developed world.

Seeking to accelerate on the trade route to prosperity

Vietnam’s reforms to boost domestic efficiency are also geared toward trade liberalization. In focus is the Trans-Pacific Partnership (TPP), a proposed free trade agreement (FTA) between the United States, Japan, and ten other countries along the Pacific Rim, including Vietnam. As understood, TPP membership is intended to boost exports, including those to the United States, Vietnam’s largest export destination. Trade between the two nations was US$ 36.3 billion in 2014.13

The government is also accelerating consolidation in the banking sector, aiming to shrink the number of banks from 40 to 15 by 2017.

Vietnam has also reached the final stages of FTA discussions with the European Union (as of May). This comes on the back of successful FTA discussions with South Korea and with the Eurasian Economic Union led by Russia in December 2014. Additionally, Vietnam also stands to gain from closer economic integration within the Association of Southeast Asian Nations (ASEAN), especially with the advent of the ASEAN Economic Community by the end of 2015.

On the global stage, the trick for Vietnam is to manage relations with China, even as it expands its economic and strategic relationship with the United States. Currently, China is Vietnam’s largest trading partner, with bilateral trade touching US$ 58.8 billion in 2014 and expected to reach US$ 60 billion in 2015.14 Relations between the two countries have been less than cordial of late due to a dispute over the Paracel Islands in the South China Sea in 2014. The dispute resulted in tensions in Vietnam, where protestors vented their ire on businesses from China.

In addition to addressing prickly relations with China, the country also has to deal with internal economic reforms. A key challenge to the continuation of economic reforms is the upcoming leadership change in 2016. For the time being, though, there appears to be no uncertainty. Policymakers seem focused on near- term economic management. They have targeted GDP growth of 6.2 percent this year. And judging by current trends, they are likely to get there.