Vietnam Consultative Group Meeting, Statement by the Representative of the International Monetary Fund
December 27, 2006
Hanoi, December 14-15, 2006
1. Vietnam's overall record of economic performance has continued to be impressive over the last year. GDP growth was sustained at around 8 percent in 2006, brisk export growth and buoyant capital inflows led to a continuing strengthening of the balance of payments, and poverty continued to decline rapidly. With the government's continuing efforts to improve the economy's market orientation, Vietnam has attracted a record amount of foreign direct investment in 2006, and it is now poised to join the WTO as its 150th member.
2. WTO membership will undoubtedly provide Vietnam with enhanced opportunities for continued rapid economic development and sustained poverty reduction in the coming years. The prospect of membership already appears to have encouraged a surge of foreign portfolio investment, contributing to an ongoing boom in Vietnam's emerging stock market. The market's warm reception of recent issues of dong-denominated corporate bonds further attests to the possibilities for financing a growing share of Vietnam's large investment requirements through the capital market.
3. However, as the authorities clearly recognize, a number of challenges remain, and the outlook is not without risks. As we were reminded at yesterday's Vietnam Business Forum (VBF), investors in the capital market need to be wary about the risks posed by irrational exuberance. Sizeable foreign participation, in particular, while desirable in principle as a way to improve the structure of financing and corporate governance of Vietnamese firms, could also increase the economy's vulnerability to changes in market sentiment down the road. To enable the economy to reap the full benefits from increasing global integration, macroeconomic management will need to be increasingly vigilant, reforms of previously-protected industries will need to be stepped up, and financial system regulation and supervision upgraded.
Short-Term Outlook and Risks
4. The short-term outlook for growth and the external finances is positive, but medium-term prospects are subject to some uncertainties. While the average rate of inflation has edged down to about 7½ percent in 2006, it remains higher and more entrenched than in most other Asian countries. Despite a large oil revenue windfall, the stock of public debt has remained on a path of rapid expansion, reaching a level of about 45 percent of GDP in 2006. This trend is likely to continue in the coming years, as the Socio-Economic Development Plan (SEDP) for 2006-2010 envisages sustained heavy reliance on public investment to remove infrastructure bottlenecks. While we recognize the need to support growth, care also needs to be taken to improve the quality of investment, and aim for a more balanced composition between public and private financing. This would help keep the public debt burden within a manageable range, and would also serve to protect poverty-reducing outlays, especially if world growth or oil prices were to decline.
5. The need to protect medium-term debt sustainability, together with the economy's strong cyclical position, calls for a more prudent fiscal stance. While the substantial recent reduction in oil subsidies is welcome, the leveling off of international oil prices has reinforced the need to rein in the growth in public spending and place the non-oil deficit on a declining path. To these ends, future increases in public wages need to be contained, and the screening of new investment projects improved. Effective enforcement of the new laws to curb corruption and prevent the waste of public funds would need to be an integral part of the effort to improve the quality of investment. In this regard, we welcome the recent adoption of a new framework to improve the management and utilization of ODA and look forward to the report from the Government Inspectorate on the status of the government's anti-corruption initiatives.
6. The rate of growth of credit to the economy has decelerated considerably in 2006, and continuation of this trend would help contain inflation and slow the growth of banks' nonperforming loans (NPLs). However, the recent progress in this area could be quickly reversed in the presence of ample excess bank liquidity, especially if state-owned commercial banks (SOCBs) continue to be instructed to finance large, government-approved state-owned enterprise (SOE) projects. We urge the authorities to intensify efforts to mop up excess liquidity, avoid directed lending through SOCBs, and introduce adequate prudential measures to limit banks' off-balance-sheet risks.
7. Vietnam's progressive liberalization of its exchange system has been an important element of its strategy of integration into the global trading system. Following the removal of remaining restrictions on current international transactions in late-2005, and the acceptance of obligations under the Fund's Article VIII, the authorities have adopted a plan to make the dong fully convertible by 2010. We fully support this plan and stand ready to provide the authorities with technical assistance to ensure timely and effective implementation. While the dong does not currently appear to be misaligned, the current strength of the external position provides a propitious environment for a move towards greater exchange rate flexibility. Such a move would serve to cushion the economy from external shocks, foster better management of exchange rate risks, and ensure that the authorities are equipped to manage potentially volatile capital movements.
8. The forthcoming liberalization of entry of foreign banks under the terms of WTO agreements can be expected to increase competitive pressures on domestic banks, and the urgency of banking sector reform. In this context, we welcome the plans to speed up the application of International Accounting Standards to state-owned banks, and urge the authorities to proceed with a realistic valuation of NPLs as a basis for NPL resolution and bank recapitalization plans. To place state-owned bank operations on a sound commercial basis, their managers would need to be given increased operational autonomy. While we support the government's plans to accelerate the equitization of state-owned banks, adequate strategic foreign investor participation would be important to help improve governance.
9. The new market environment also calls for a strengthening of risk management capacities and prudential regulation of all banks. The planned increase in banks' minimum capital requirements, and the SBV's ongoing efforts to upgrade its supervisory functions, are welcome steps in this direction. In addition, the SBV, the State Securities Commission (SSC), and the Ministry of Finance will need to adopt a unified framework to track vulnerabilities associated with portfolio capital movements, regulate stock market-related credit, and discourage insider trading.
10. The imminent WTO accession has also heightened the urgency of reform in the SOE sector. The authorities' plans to restructure and equitize most SOEs by 2010 are welcome. However, it will also be important that all SOEs be given a clear mandate, and adequate incentives, to operate on commercial principles, and their managers granted full autonomy to make their own pricing and investment decisions. In this connection, we welcome the recent decision to adjust electricity prices, and urge the authorities to move forward with their plans to also adjust coal prices, liberalize the prices of cement, steel and fertilizer, and reduce state subsidies in the energy sector. As regards the newly-formed groups of wholly state-owned enterprises in strategic sectors, we encourage the authorities to define clearly their mandates and relations with government, while establishing adequate regulatory safeguards, where needed, to ensure that their market power cannot be used to undermine competition, and limit the scope for related lending or other nonmarket-based affiliated party transactions.
11. A continuing opening up of the trade and investment regimes would be key to private sector-led investment and growth. As was noted by several participants at the VBF, the lack of clarity in the legal system remains an important area of concern to foreign investors. Vietnam's impressive progress toward aligning its legal and regulatory framework with WTO requirements now needs to be complemented by faster steps to adopt the accompanying implementing decrees and circulars, and ensure their transparent and equitable enforcement. We encourage the authorities to work closely with the private sector to ensure that the new WTO-compliant legislation will be implemented in a way to level the playing field, and simplify rules and regulations, while preventing any increase in red tape or government intervention.
12. Improvements in the quality, timeliness, and dissemination of data on money and banking, the balance of payments, public debt, and official reserves would also be essential to support informed policy decisions and effective interaction with markets. In this regard, we welcome the recent government decision to publish foreign debt data on a regular basis and look forward to its early implementation. In addition, more transparent accounting, reporting, and monitoring of the government's extra-budgetary operations and all publicly-funded projects would be helpful in shoring up donor and investor confidence.
13. Vietnam's forthcoming WTO accession is an important milestone. Faster integration into the global economy should facilitate achievement of the SEDP's objective of lifting Vietnam from the ranks of low-income countries by 2010. However, the unfinished reform agenda is long, and the timetable for completion will need to be compressed as exposure to global competition progressively increases. We have no doubt that, with strong commitment to reform within its leadership, and with continued support from its development partners, Vietnam will successfully meet these challenges, and we wish the authorities every success in these endeavors.