Vietnam: Growth story likely to continue Asia Pacific Economic Outlook, Q2 2017
The Trans-Pacific Partnership may be in jeopardy, but Vietnam, whose GDP growth depends heavily on foreign direct investment and exports, is likely to grow at a healthy pace due to favorable factors beyond demography and cheap labor.
Explore the Q2 2017 Outlook
After a difficult first half in 2016, primarily resulting from a slowdown in the agriculture sector because of widespread drought, Vietnam recovered, and posted annual growth of 6.2 percent. Though marginally below target, economic growth has been healthy. The drivers of this growth—foreign investment and exports—are likely to continue through the near to medium term. Despite the demise of the proposed Trans-Pacific Partnership (TPP), Vietnam looks set to grow at a healthy pace in 2017 due to various favorable factors. Moreover, if economic reforms, political stability, and prudent decision-making continue, Vietnam could sustain growth and move closer to its goal of becoming an upper-middle-income nation.
Healthy FDI inflows, exports likely
Foreign direct investment (FDI) disbursement in Vietnam reached $15.8 billion in 2016, up 9 percent from a year ago.1 The total value of new FDI commitments and additional funding for existing projects climbed 7 percent from a year ago to $24.4 billion. By country of origin, South Korea was the largest direct investor in Vietnam in 2016, investing a total of $7 billion. Japan and Singapore were second and third respectively. South Korean direct investment was bolstered by a $1.5 billion investment by LG Display Company to produce and process plastic OLED display for mobile phones. Additionally, LG Innotek invested $550 million to produce camera actuators.2 Electronics manufacturing has grown rapidly in Vietnam as technology firms shift low-end production and assembly out of China into South-East Asia due to the availability of abundant, relatively cheap, skilled labor. The shift is not limited to large foreign-owned multinational corporations; Chinese firms are also ramping up investment in Vietnam, as indicated by China’s outbound direct investment into Vietnam (figure 1).
Apart from electronics, apparel, textiles, and footwear are sectors in which Vietnam continues to attract investment. The country is already home to factories catering to international clothing and footwear brands. Vietnam’s primary destination for the export of apparel, textiles, and footwear is the United States. In fact, exports of apparel, textiles, and footwear to the United States represent 40 percent of total exports to the United States and roughly 9 percent of Vietnam’s total annual exports.3 The prospect of the TPP coming to fruition had been the immediate incentive for FDI into Vietnam’s apparel and textile sector. The death of the TPP in its proposed form, after the withdrawal of the United States, may moderate the pace of FDI inflows into the apparel and textiles sector. Nevertheless, Vietnam will continue to remain attractive to prospective investors in apparel and textiles due to favorable free trade agreements (FTAs) and growing domestic demand.
The FDI sector is closely linked to Vietnam’s export success: It accounts for 70 percent of Vietnam’s exports, while the domestic sector accounts for only 30 percent.4 Overall exports grew 8.9 percent in 2016, converting a trade deficit in the previous year to a surplus of $2.4 billion.5 Steady inflows of FDI and subsequent growth in exports are likely to continue to buoy Vietnam’s economy in the near to medium term. For instance, January 2017 saw FDI disbursement rise 6.3 percent from a year ago.6
Loss of the TPP may not deter progress
The proposed TPP had added considerably to Vietnam’s attractiveness as a destination for foreign investors, primarily because the country was likely to be the biggest beneficiary of the agreement. However, the loss of the TPP in its proposed form (without the participation of the United States) is unlikely to stall Vietnam’s overall progress. The country is likely to remain an attractive destination for foreign investors due to several factors that work in its favor. Indeed, 70 percent of Vietnam’s total population is of working age, and wages in Vietnam are a third of those in China.7
However, Vietnam’s comparative advantage stretches beyond demographics and labor costs. The other factors that keep Vietnam attractive are its geographical proximity to China and, therefore, to manufacturing supply chains; its long coastline, which stretches a lucrative nautical corridor; political stability; improved ease of doing business; and its membership in the Association of South-East Asian Nations (ASEAN) and FTAs. In the 2017 Doing Business report, the World Bank ranks Vietnam 82 out of 190 countries, an improvement of 9 ranks from the previous year.8
Furthermore, Vietnam’s membership in ASEAN and its FTAs adds to its appeal as a lucrative economy. Among Vietnam’s FTAs and economic partnerships are the ASEAN free trade area, agreements with China, Japan, South Korea, India, Australia, and New Zealand via ASEAN, independent bilateral agreements with South Korea and Japan, and an FTA with the Eurasian Economic Union led by Russia. An FTA with the European Union has also been successfully negotiated. Additionally, the Regional Comprehensive Economic Partnership (RCEP), championed by ASEAN and China, could support Asia-Pacific economic integration and free trade, which in turn will likely benefit Vietnam. Moreover, a resurrection of the TPP without the participation of the United States, remains a possibility. Finally, any protectionist policy from the United States targeted at China might hasten the shift of manufacturing investment across the border to Vietnam.
Vietnam’s omnidirectional foreign policy and a gradual weakening of the dong are likely to support exporters over the near to medium term. On the internal front, monetary policy is likely to remain unchanged in the near term though tighter policy is likely later in the year in response to rising interest rates in the United States and domestic inflation. Prices are likely to rise in 2017 due to cost-push factors such as higher crude oil prices and rising wages as well as demand-pull factors due to expanding economic activity. Fiscal policy consolidation is likely to be gradual due to Vietnam’s spending on infrastructure and due to revenue loss from the lowering of import tariffs. However, expanding economic activity and the continued privatization of state owned enterprises (SOE) are likely to have a counterbalancing effect. Commitment to fiscal consolidation is likely to continue through the medium term as the debt to GDP ratio approaches the predefined ceiling of 65 percent.
Vietnam should stay the course of economic reform
Despite the demise of the TPP, Vietnam’s drive to reform the economy, invigorated by the effort to comply with standards set by the trade deal, should continue. Efforts to privatize large and inefficient SOEs that account for a substantial share of non-performing assets as well as reforms in the banking sector should continue as important focus areas. Developing domestic infrastructure beyond ports, such as approach roads and railway networks is also likely to be beneficial to the economy. Additionally, efforts to integrate small and medium-sized domestic industries into export supply chains as well as efforts to upskill the existing workforce are likely to be advantageous in the long term. Finally, political stability and prudence during the current period of growth will likely set the stage for sustained economic success in the future.