Vietnam -- Mid-year Consultative Group Meeting, Statement by the Representative of the IMF, Can Tho
June 3, 2005
Statement by the Representative of the IMF
Can Tho, Vietnam
June 2-3, 2005
1. I appreciate the opportunity to be here in Can Tho to participate in the mid-year Consultative Group Meeting for Vietnam. With the draft Socio-Economic Development Plan (SEDP) for 2006-2010 now under discussion within government, this is a very propitious time to review the implementation of Vietnam's Comprehensive Poverty Reduction and Growth Strategy (CPRGS), and assess the outlook and challenges for the period ahead.
Developments and Policy Performance in 2004
2. As is well-documented in the government's CPRGS Progress Report, overall economic performance was favorable in 2004, despite the adverse effects of droughts and the outbreak of avian flu. Real GDP growth picked up to 7.7 percent, and great strides continued to be made toward the achievement of the CPRGS's socio-economic objectives, with the incidence of poverty declining to 26.2 percent, down from 32 percent in 2001. Export growth was buoyant, underpinned by strong demand in major export markets, improving terms of trade, and Vietnamese businesses' increasing penetration of new markets. With receipts from tourism and emigrants' remittances also recording large increases, the external current account deficit remained manageable. Official reserves continued to increase, albeit at a slower pace than in 2003, reaching a level of US$6.3 billion (about 8½ weeks of imports). Inflation, however, rose from 3 percent in 2003 to 9.7 percent in 2004, as the above-mentioned domestic supply shocks led to sharp increases in food prices.
3. Fiscal policy was managed prudently during 2004. While revenues were significantly higher than budgeted, owing mainly to windfall receipts from oil exports, the authorities contained the growth in expenditure. The state budget deficit (excluding amortization payments and carry-overs of funds from previous years) narrowed from 2 percent of GDP in 2003 to about 1½ percent of GDP in 2004. As the government also took steps to tighten the screening and eligibility criteria for projects to be financed under the Development Assistance Fund (DAF), the overall government deficit, including on-lending, declined from about 5 percent of GDP in 2003 to less than 3½ percent of GDP in 2004.
4. However, the surge in credit growth, which was already a cause for concern at the time of the 2004 Article IV consultation, continued to gather pace through the end of 2004. Credit expansion was spurred in large part by the launching of a number of new large investment projects by state-owned enterprises (SOEs), which are being financed mainly by state-owned commercial banks (SOCBs). Beginning in July 2004, rising inflation, together with concerns about loan quality, led the authorities to take some measures to tighten monetary conditions. However, the levels of deposit and loan interest rates and the flow of new bank lending did not respond significantly to these measures. In addition, the expected cost of foreign-currency borrowing was reduced in August when the SBV announced that the dong would depreciate by no more than 1 percent vis-à-vis the U.S. dollar in 2004. As a result, commercial banks' foreign-currency lending rose by 58 percent over the full year, and total bank credit by 42 percent.
5. Progress on structural reform was uneven in 2004. While continuing progress was made in the area of trade liberalization, and steps were taken to rationalize the legal framework for foreign investment to pave the way towards Vietnam's accession to the WTO, the restructuring and reform of the SOCB and SOE sectors remained slow. The growing stock of contingent government liabilities in these sectors thus continues to be an important source of vulnerability and a risk to medium-term debt sustainability.
Outlook for 2005 and Challenges Ahead
6. Although the external environment is projected to worsen somewhat in 2005, the outlook for Vietnam remains broadly positive. Despite a weakening of external demand, and intensified competition from WTO members whose textile quotas were recently eliminated, GDP growth would remain at around 7½ percent in 2005 on current trends. The external current account deficit should continue to be financed primarily with ODA and FDI inflows, thus keeping the overall balance of payments in surplus and the external debt burden manageable. However, the relatively low import cover of reserves would leave the economy exposed to external shocks. Inflation also remains a cause for concern. While the year-on-year rate of inflation leveled off at 8½ percent as of April, this has partly reflected delays in the pass-through of recent increases in the world prices of oil and other imported inputs. Thus, vigilance continues to be needed to contain potential inflationary pressures.
7. The main risks to this relatively positive outlook stem from possible efforts to speed up the pace of economic growth in the remainder of 2005 with expansionary policies, which could well be counterproductive. Given that GDP growth has so far fallen somewhat short of the 2001-2005 SEDP targets, it would have to rise to 8½ percent in 2005 to meet the SEDP's average annual target. But expansionary macroeconomic policies at the current juncture could fuel higher inflation, further increase external vulnerability, and probably necessitate adjustment measures that would hamper investment and growth down the road. Moreover, as is recognized in the CPRGS Progress Report, continuing high inflation would have its worst impact on the real incomes of the poorest households.
8. To lessen these risks, a balanced mix of prudent fiscal, monetary, and exchange rate policies will need to be adopted. On the fiscal front, on-lending should continue to be tightly managed, with a view to restraining the overall budget deficit to no more than 3 percent of GDP in 2005. A more concerted effort will also be needed to tighten monetary and credit conditions. While official statements indicate that credit growth is targeted to decelerate to 25-30 percent in 2005, and steps have been taken in recent months to increase SBV's policy rates, there is no clear evidence of the desired slowdown. Indeed, SOCBs seem set to finance a growing list of large new SOE projects during the second half of 2005. Moreover, the effective cost of foreign-currency borrowing is still low, as the dong has remained virtually stable vis-à-vis the U.S. dollar, and the SBV announced again in January that it would depreciate by no more than 1 percent in 2005. To enhance the effectiveness of monetary policy, facilitate adjustment to shocks, and protect the SBV's reserves, a more flexible exchange rate policy should be adopted, with intervention limited to smoothing excessive fluctuations.
9. Looking forward to the pursuit of the CPRGS's medium-term objectives, faster banking sector reforms will be essential to protect debt sustainability, improve credit allocation, and promote higher-quality investment and growth. The recently-approved new loan classification and prudential regulations for commercial banks are a welcome step in this direction, and should be implemented without delay. However, to enable the SBV to enforce these regulations in a credible manner, early action will also need to be taken to strengthen the SBV's independence and clearly establish its supervisory authority over all the banking institutions that operate in Vietnam. In the area of SOCB reform, the authorities' equitization plans need to be pursued in a steadfast and timely manner. At the same time, government interference in the lending decisions of SOCBs will need to be curtailed, and corporate governance significantly strengthened. We look forward to a fuller discussion of the government's financial sector reform roadmap during the remainder of these meetings, and hope that the most critical policy measures will be incorporated in the 2006-2010 SEDP.
10. Reform of the SOE sector should be another top priority. The restructuring of key SOEs will be necessary to alleviate their capacity and financial constraints, enhance their operating efficiency, and enable them to take advantage of opportunities for partnerships with the private sector for infrastructure development. As in the case of the SOCBs, existing plans to equitize and restructure SOEs will need to be accompanied by curbs on government interference in their management and incentives for them to operate on a commercial basis.
11. The establishment of a fair and transparent policy and regulatory framework will be key to improving the investment climate and fostering development of a vibrant and competitive private sector. Early liberalization of administered prices will be essential to improve the transmission of market signals and remove bottlenecks in the supply of key industrial inputs, which could otherwise hamper growth. A rationalization of prices, together with SOCB and SOE reforms, would also limit the scope for rent-seeking activities, and would thus complement the administrative measures to prevent corruption that are detailed in the CPRGS Progress Report. The authorities are also encouraged to pass as soon as possible the ambitious agenda of new laws that will need to be in place to increase the transparency of Vietnam's legal framework and bring it closer into line with those of WTO members. While recent steps to increase financial disclosure by SOEs are welcome, stronger efforts to upgrade the quality, timeliness, and dissemination of key economic and financial statistics will also be necessary to improve the government's own analysis of recent developments as well as the quality of its policy dialogue with development partners.
12. Vietnam has made solid progress toward meeting the objectives of the CPRGS, and, with the right policies, it has good prospects for further gains in the period ahead. The policy priorities are to take timely measures to protect macroeconomic stability and step up needed structural reforms. The development of the SEDP for 2006-2010 provides a unique opportunity for the government to make a decisive shift towards a more market-oriented policy framework, consistent with its aspirations to reap the full benefits of international economic integration. The authorities are urged to resist pressures to boost short-term growth through the use of overly expansionary macroeconomic policies. In addition, to help place the economy on a path of higher-quality, sustainable growth and poverty reduction over the medium term, the reforms to strengthen the banking system, restructure SOEs, liberalize domestic prices, and secure WTO accession should be pursued with determination.
13. It has now been a little more than one year since the expiration of the PRGF arrangement in April 2004, and the Fund's post-program engagement with Vietnam has remained close and constructive throughout this period. Over the last year, we have continued to exchange policy views, and offer our policy advice, in the context of bi-annual surveillance missions, participated in CG meetings, and provided periodic assessment letters for the program operations of other IFIs. We have also continued to make available to Vietnamese officials the Fund's full range of training and technical assistance, including in the areas of tax administration, monetary operations, bank supervision, the exchange system, and economic and financial statistics. We have valued this relationship, and remain committed to maintaining it in the period ahead.
14. In concluding, I would like to reiterate that, while Vietnam's achievements to date are impressive, the tasks ahead remain large. We are confident that, with continued support from the donor community, the authorities will be able to build on their past achievements and adopt the necessary policies to speed up the transition to a market-based system. We wish them every success in these endeavors.