By: Dr. Nguyen Anh Tuan

Vietnam has been facing a debt crisis since 2006 although its difficulties began before that when the rapidly changing economy exposed a number of key weaknesses such as inflation, a skyrocketing state budget deficit and the inefficient use of SOEs as economic spearheads.

The current problems stem from the effort by the country’s economic czars to push high growth strongly through investment, which after an extended period drove the investment to GDP ratio to second only to China’s in the world.

The rate of increase in money and credit supply was also among the world’s highest, driving inflation to record levels, as can be seen when comparing Vietnam’s exceedingly high investment-to-saving ratio from 2005 to 2011.

GDP growth vs. investment and saving 2000-2011

Figure/Year 2000-2004 2005 2006 2007 2008 2009 2010 2011
Investment/GDP (%) 33 38 41 43 40 38 39 33
Saving/GDP (%)   28 28 26 23 23 23 24
Difference between investment and saving (%)   10 13 17 17 15 16 9
GDP growth rate (%) 7.1 8.4 8.2 8.5 6.3 5.5 6.8 5.9

Source: Vu Quang Viet, Crisis and the financial-credit system: Practical analysis in regard to the American and Vietnamese economy

The rate of investment rose much faster than savings, rising some years to 16-17 percent of gross domestic product. There were only two ways to achieve that – borrowing from foreign sources or extensive, even excessive issuance of credit lines, resulting in bad debts and very high inflation. As a result, when the government didn’t adjust the exchange rate between the Vietnamese dong and the US dollar, imports were hugely stimulated, resulting in an unprecedented trade balance deficit, some years as high as US$18 billion.

This excessive investment while efficiency was low resulted in an excessive public debt, which could have reached US$129 billion, equal to 106 percent of GDP in 2011, of which state-owned enterprise debt was US$62.1 billion.

Managing and preventing the crisis

The most pressing requirement is an effective governmental regulatory mechanism to control financial activities and fund flows. This includes transparency of information and the effective maintenance of a macro-level supervisory mechanism while guaranteeing the needs for social welfare and mobilizing and combining resources to develop the country in a sustainable manner.

In the long term, state investment needs to be actively reduced while investment from non-budget sources needs to increase relative to total social investment. The focus of state investment must be shifted outside of economic activities so as to concentrate on social and infrastructural investment. The state investment process has to be streamlined and reformed so as to serve as a selection and standardization criteria for public projects.

State-owned corporations and enterprises must cease diversifying investment outside of their main businesses and production. SOEs should be concentrated in pillar industries, mainly those related to and dealing with socio-economic infrastructure, public services and those pertaining to macroeconomic stability.

Systemic stability, prevention of side effects and debt traps and practical efficiency in both SOE and financial-banking sector restructuring should be ensured. At the same time, proper care should be taken to effectively handle such matters as firm acquisitions and mergers, unemployment insurance and social welfare.

On the basis of these guidelines, we can draw a number of in-depth lessons and suggestions for public debt crisis prevention in Vietnam.

First, excessive investment into SOEs must cease and only a minimal, manageable number of SOEs should be maintained. Diversification outside of expertise – especially letting an SOE own a bank, or vice versa – must end. The National Assembly must carefully discuss and approve every decision to found new SOEs. The government needs to stop spending more than the budget previously approved by the National Assembly. In a number of countries this is considered illegal.

Second, the State Bank must stop issuing money for spending and credit distribution, especially for SOEs as a spearhead for development. In these times a 3 percent of GDP deficit is already seen as a warning threshold in some countries.

Demand stimulus through deficit spending is only a temporary solution and should only be used when there are no other options as an economy falls into a crisis owing to plummeting demand. It should never be used as a method for stimulating economic growth because it will lead to high inflation and loss of stability, since budget deficits invariably would be remedied by printing money.

Vietnam’s current economic crisis is due to the stimulation of demand via credit growth, which increased from 35 percent to 125 percent of GDP between 2007 and 2011, but without control of the utilization of credit flow.

Third, the ratio of equity (paid-up or owner’s capital) has to be raised in both private firms and SOEs to ensure stable development. Currently, in Vietnam the debt-to-equity ratio is 1.77, much higher than in the United States or Europe (around 0.7). This high ratio of debt can very quickly lead to financial distress and insolvency should the interest rate rise.

Fourth, there is a need to focus the power for development investment into seven regions instead of on a provincial basis to avoid waste owing to overlapping construction investment, as well as to reduce the influence of the locality on the central organs located in provinces. In addition, management of territory, forests, rivers and seas needs to be stratified between central, regional and local government so as to concentrate power for infrastructural development.

Local governments should not be permitted to issue their own bonds to foreign markets. Furthermore, local government bonds should be tightly regulated so as to avoid uncontrollable layering of debts.

Fifth, the excessive expansion of credit in Vietnam is because the State Bank lacks independence according to the standard of a market economy. Because of this, it did not act on the ultimate goal of maintaining market price stability, but rather according to the government’s directive to print money for inefficient SOEs to become spearheads for the economy, to the economy’s detriment.

The difficulties facing the Vietnamese economy occurred when the government began to execute stimulus packages but did not closely supervise them. Hence most of those funds were not invested on production but on stocks and real estate. When the bubble popped, this caused great difficulties for the financial-banking system with an increasing ratio of bad debts.

Sixth, according to the Credit Organizations Law (2010), many banks were given permission for establishment for the sole purpose of helping local governments and their clienteles to carry out rent seeking activities. Commercial banks in the US and EU use deposits from clients to lend, while investment banks mainly implement portfolio investment using their own money, or serve clients to invest in portfolio for the service fees.

Hence, in order to avoid systemic financial risk and crisis, there is an urgent need to amend this law to emphasize on the difference between the role and function of these two categories of banks, as well as stopping banks from owning non-financial enterprises, or conversely, non-financial enterprises founding banks to serve themselves.

Seventh, the state bank should establish a standard for minimum capital for each category of bank, as well as set up and announce basic statistics of each bank in particular and the financial-monetary system in general to serve both policy-makers and users of financial services. This financial system is complicated, overlapping and was not properly supervised and controlled.

The situation has proven that weaknesses in government budgeting, in the banking system and low growth are inseparable and one cannot be examined or solved without the other. Considering the present state of the Vietnamese banking and financial sector and its many issues, how these three problems interact and how to tackle them is an important area that policymakers and future research should pay attention to.

(Nguyen Anh Tuan is Editor-in-Chief of the Journal of International Studies at the Diplomatic Academy of Vietnam.   This is excerpted from his scholarly study The Ongoing Public Debt Crisis in the EU: Impacts and Lessons for Vietnam.)