Some of the stabilisation measures, initially introduced through Resolution 11, were continued to be implemented during 2012-demonstrating the government’s strong commitment toward macroeconomic stability.

Year-on-year headline inflation has fallen from of 18.1 percent in December 2011 to 6.8 percent in December 2012. The unofficial exchange rate has traded within the ±1 percent band around the official exchange rate for most of the year. The increased supply of US dollars in the market has enabled the State Bank of Vietnam (SBV) to replenish foreign exchange reserves, which are now close to more than two months of imports. Vietnam’s sovereign bond traded at a premium of less than 300 basis points in early November 2012 compared to a peak of 600 basis points at the end of 2011.

Since the start of the boom and bust cycle in 2007, this is the first time that Vietnam has maintained macroeconomic stability for a period of 18 months or longer—one of its few achievements in recent years. The improved situation has been made possible by good domestic policies and a favorable external environment.

The depreciation of the currency, lowering of credit growth targets, keeping real interest rates positive and trimming of some of the wasteful public investments are clear demonstration of the government’s commitment to come to grips with its macroeconomic vulnerabilities.

Equally important is the continuous assurance provided by the government and the Party that macroeconomic stability remains one of its most important economic goals. These actions and pronouncements have helped to calm jittery investors and revived confidence in the dong as seen by robust growth in deposits and the increasing share of dong deposits in the banking system.

The developments in the domestic economy have been complemented by improved confidence in the global financial markets and lower price of risks as seen by record low sovereign spreads and greater flow of portfolio investment into Vietnam.

Given the stop-go policy culture of the not so distant past, the authorities’ determination to maintain appropriate macroeconomic policies for two consecutive years is a welcome change and will certainly help Vietnam to gradually rebuild its track record as a country with sound macroeconomic management.

Significant downside risks

Vietnam’s gains on the macroeconomic front are, however, still fragile and face several downside risks. First, core inflation—which is calculated after excluding some of the more volatile components of the CPI basket such as food and fuel prices—is still very high at 11.6 percent.

Second, while the level of foreign exchange reserves has risen in recent years, it is considerably low by international standards and especially so for a country like Vietnam whose trade to GDP ratio and M2 to reserves ratio are one of the highest in the East Asia and Pacific region. Third, the country remains susceptible to premature loosening of policies that could lead to resurgence of inflation. Fourth, the quality of assets in its credit institutions are worsening and its current level of public debt could rise sharply if some of the contingent liabilities in the banking sector and SOEs are realised. Finally, the delayed and inadequate implementation of structural reforms including the triple restructuring - of banks, SOEs and public investment - are starting to affect investors’ confidence and could spill over to affect macroeconomic conditions.

A two speed economy: strong exports, but a subdued domestic sector

In 2012 the Vietnamese economy is expected to record its slowest growth performance since 1999. The fragile global economic recovery coupled with the domestic stabilisation policy and slower than expected progress on structural reforms have led to a significant slowdown in economic activities in 2012. The impact was severe in the first quarter of 2012, when GDP increased by only 4 percent compared to the same period in 2011. The performance has steadily improved since then, partly reflecting the government’s efforts to support economic activity and partly the result of seasonality in Vietnam’s GDP data.

In May 2012, the government adopted Resolution 13 that included a range of measures from tax breaks to additional capital spending to boost the slowing economy. It was complemented by aggressive reduction in policy rates by SBV amounting to 500 basis points during the first half of 2012. The economy responded to these initiatives, with growth reaching 4.8 and 5.1 percent in the second and third quarter, raising the overall growth to 4.7 percent for the first three quarters of the year. With last quarter performance expected to be good, Vietnam is likely to post 5 percent growth rate in 2012.

The slowdown has been felt most acutely in the construction and manufacturing sectors. Weak domestic consumption has played an important role to slowing retail sales, which increased by an estimated 6.2 percent in real terms in 2012 from a year earlier.

The slowdown in the manufacturing sector is a matter of great concern. Vietnam’s development success story has been written on the back of a rapidly growing and competitive manufacturing sector that employs around than 7 million people or one seventh of the country’s labor force.

Whilst the sector has been buffeted in recent years by cyclical factors such as weak global demand and high real interest rates, more alarmingly, its performance has been hamstrung by structural weakness in the economy such as high logistics costs, poor and unreliable infrastructure and lack of skilled labor.

The trend growth rate of the manufacturing sector is not only negative, it is also slowing down faster than the rest of the economy. Accelerating structural reforms could reverse the downward trend one sees in the manufacturing sector.

A major source of recent growth deceleration is also due to slow growth in public and private investment. With slowing credit growth and efforts to restructure public investment, total investment has fallen sharply - from 41.9 percent of GDP in 2010 to 36.4 percent in 2011 and to a projected to be around 33.5 percent in 2012 - the lowest level since 2000.

The decline has been uniformly spread across the state budget, state-owned enterprises and the private sector. Within the private sector, whilst domestic private enterprises have scaled back their investment plans, investments from foreign firms have not slowed down significantly in absolute terms.

Vietnam’s impressive export performance stands not only in sharp contrast to the lackluster growth performance but also with respect to the export performance of its regional competitors. At 34 percent, Vietnam recorded the highest rate of export growth in developing East Asia in 2011, with Indonesia second and China coming third. This pattern has continued through the first two quarters of 2012. The bulk of these exports are originating in the foreign invested sector (including crude oil) which contributed 63 percent of total exports and grew at 31 percent in 2012.

In 2012, Vietnam is expected to post its largest ever trade and current account surpluses. Not long ago large trade and current account deficits were considered a key source of macroeconomic vulnerability for Vietnam. Not anymore. The trade deficit (based on BOP definition) was only 0.4 percent of GDP in 2011 and is expected to yield a record surplus of 6.8 percent of GDP in 2012. Similarly, the current account balance has turned from a huge deficit of 11.9 percent of GDP in 2008 to a minor surplus of 0.2 percent of GDP in 2011 and is projected to report a record surplus of about 5 percent in 2012.

Strong performance in exports, slower growth in imports and continued robust flow of remittances have helped Vietnam to turnaround its external sector. This in turn has contributed to improve its balance of payments situation, augmented its stock of foreign exchange reserves and helped to reduce the pressure on the exchange rate. However, this performance may not last forever as imports are expected to pick up once the economy regains strength.

Restructuring is Crucial to Reviving Growth

Vietnam’s slower growth in recent years (average 6.1 percent in 2008-2011compared to 8.3 percent in 2003-2007) is due to falling productivity resulting from a slow pace of structural reforms. Inefficiencies in SOEs, financial institutions and public investments are a drag on Vietnam’s long-term growth potential. The government has prioritised reforms in these areas, but progress needs to accelerate.

The worsening global economy, and limited policy space to maneuver domestically, could jeopardise the macroeconomic stabilisation gains achieved in 2012. This would require a delicate balancing of growth and stability objectives even during this economic slowdown. Without credible restructuring of SOEs and banks, the upside growth potential will remain highly limited.

Source: VIR