Vietnam Seeks to Restart Economy

As investors are far too painfully aware, Vietnam, which captured the affections of global investors when its growth reached 7.2 percent between 1990 and 2010, has begun to sink into despair.

Having lived on hubris for two decades, the Communist government is now trying to dig its way out by saying it would reform its bloated and inefficient state owned enterprise sector and invite in foreign investors. But it has tried that before and the results were minimal. Although political infighting has crippled both the president and prime minister, they can hardly be cast as reformers in any case.

While other emerging Asian markets have recovered faster than the west in the wake of the global financial crisis, Vietnam's recovery has been relatively slow and painful, with 2012 growth the lowest in 13 years at 5.0 percent, well below the once-basket case Philippines at 6.6 percent and the 6.2 percent achieved by Indonesia.

The problems for the economy are spelled out in a new, detailed report by Samsung Economic Research Institute which is available only by subscription. Beyond the SERI report, however, public discontent and protest have grown with almost-daily demonstrations of varying magnitude at Communist Party and government offices in Hanoi and Ho Chi Minh City, often about farmland seizures with minimal compensation.

"The slowdown in the Vietnamese economy is not temporary, and is due to structural causes," according to the SERI report. "Without sweeping reforms, it is unlikely that growth will resume its previous trajectory. This estimate is based mainly on predictions that the contribution from the labor force and capital formation, which drove the economic expansion in the 2000s, will decrease significantly."

In September 2012, Moody's downgraded Vietnam's rating. Its stock market remains at only 40 percent of its pre-crisis value while shares in Indonesia, Thailand and the Philippines have risen to more than 160 percent of their peak.

What went wrong?

The country appears to face all of the familiar drawbacks of a command economy, in which government leaders stubbornly refuse to relinquish the reins of a swollen and inefficient state-run economy, even in the face of clear evidence from a 1986 restructuring that reform is the answer. Giving up economic power too plainly means giving up political power and the rent-seeking of well-connected cadres.

The Communist Party was forced into a humiliating public apology last October for its mismanagement of the economy. The government now says it will sell stakes in state companies although plans to do that have been stalled for a decade. It also plans to end investment in non-core businesses and sell stakes of 600 corporations in which it is the sole shareholder, and is said to be "also pondering increasing the role of foreign-funded companies in its economy."

The government also says it will reorganize the state sector to focus on defense, "natural monopolies," core public goods and strategic high-tech industries that have significant ripple effects. That appears to mean the government will keep a substantial role in the economy and raises questions over its commitment.

"Despite all these efforts, potential still exists for the pace of reforms to slow due to political conflicts and a financial market recession," according to the SERI report. "Since various entities, including the central government, local government, and government agencies are engaged in operating state-run corporations, they can be inactive in stake selling and restructuring.

"It is also possible that momentum for reform will lose steam depending on political changes. Power is shared between communist party leaders, the president and the prime minister. The three are currently at odds with each other, and the prime minister is being criticized by the parliament and the communist party for his economic policy."

Mistakes continue to be made. When the government screwed down credit in 2011, the state-owned enterprises faced particular trouble, with Vinashin, the state-owned shipping company defaulting in late 2010 due to mismanagement. At its peak, Vinashin owned more than 400 affiliates and 160 at the time of its default. Several company officers have been arrested and charged with corruption. Other SOEs, with their low productivity and fragile financing, have suffered disproportionately. Banking sector debt rose sharply, from 2.1 percent in late 2011 to 8.8 percent in September 2012.

A whole array of problems looms according to reports cited by SERI. The United Nations estimates that the average annual increase in Vietnam's economically active population will drop from the 2.6 percent posted from 2005-2010, to 2.1 percent from 2010-2015, and down to 0.8 percent in 2015-2020.

The International Monetary Fund says the country's investment to-GDP ratio is set to fall from 38.7 percent (2005-2009) to 34.4 percent (2010-2014). Based on these forecasts, McKinsey expects that even if productivity growth over the past decade continues through the next decade, the economy will grow at an average rate of 4.5-5.0 percent annually, well below the government's target of 7 percent.

As an indication of how difficult it will be to restructure, it has been 27 years since economic architect Nguyen Xuan Oanh, a Harvard University-trained economist, persuaded the government to launch Doi Moi, the restructuring campaign in 1986 targeting agriculture, prices, the economy, market liberalization and the exchange rate. After Oanh's reforms, the pace of reorganization stopped, with government leaders reluctant to give up the government's role.

Since 2005, the government has established "state economic groups" and integrated state-owned companies across the board (state economic groups are parent companies that own controlling stakes in affiliates). At the same time, the government proceeded with privatization, cutting the number of state-run companies to 3,300 in 2009, and reducing their share in industrial production from 34 percent in 2000 to 17 percent in 2010.

Despite that, SERI found that in 2009-2010, state-owned firms accounted for 99 percent, 97 percent and 94 percent of the fertilizer, coal, electricity and gas markets respectively.

In beer, sugar and textiles, SOEs took up 41 percent, 37 percent and 21 percent of the market.

In the late 2000s, the government expanded investment via state-run corporations in an effort to revive the economy. Previously, the state sector's share in investment had decreased from 59.8 percent in 2001 to 33.9 percent in 2008.

By 2011 however, the state share had returned to 38.9 percent thanks to government spending increases after the global financial crisis, the SERI report found. "Furthermore, with the stock market recession, ‘equitization' of state corporations was postponed."

With abundant funding from state-owned banks, SOEs expanded into non-core business areas. State firms went into banking, securities, insurance and real estate, industries which enjoyed rapid expansion during the financial bubble. Rent seeking activities increased.

The financial market stabilized after the government's recent announcement of the stimulus package and restructuring plan for the financial sector. The central bank cut rates seven times from March 2012 to March 2013, dropping the rate by seven percentage points in total. In March 2013, the government approved a US$1.4 billion stimulus package. As investors showed a favorable response to the government's reform plan, the stock market rallied in the first quarter of the year (as of March 22, the market rose 17.1 percent from the beginning of the year.) The banking sector has also stabilized as the ratio of bad debt decreased from 8.8 percent in September 2012 to 6.0 percent in February 2013. Thanks to the government's plans, the World Bank has decided to provide the nation with Economic Management and Competitiveness Credits worth $250 million in March 2013.