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IMF Executive Board Concludes 2004 Article IV Consultation with Vietnam
On November 22, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Vietnam.1
The three-year PRGF arrangement expired in April 2004. During the arrangement, Vietnam maintained strong economic growth and low inflation and achieved further poverty reduction, supported by favorable macroeconomic conditions and increasing integration with the world economy facilitated by trade liberalization.
Since the last Article IV consultation, Vietnam's economy has performed well. Real GDP grew by 7¼ percent in 2003, led by strong investment and export growth. Growth slowed in the first quarter of 2004 mainly due to the impact of the avian flu outbreak and droughts on agricultural production, but began to rebound in the following months; agricultural production has recovered and industrial production has picked up. Inflation rose from 3 percent at end-2003 to 10 percent in September 2004 (both year-on-year), reflecting the jump in food prices, which comprise about half of the CPI basket. Since July, however, annualized monthly inflation has fallen rapidly.
Vietnam's overall balance of payments has strengthened notwithstanding the widened current account deficit. Although exports grew rapidly, surging imports driven by strong investment increased the current account deficit to 4¾ percent of GDP in 2003. With the deficit more than fully financed through a combination of higher long-term capital inflows and a substantial run-down of domestic banks' foreign assets, Vietnam's international reserves significantly increased, reaching US$5.6 billion at end-2003 (about nine weeks of imports). This increase, however, slowed considerably in the first seven months of 2004, despite continued strong export growth and a slowdown in import growth.
Credit growth has accelerated, and monetary aggregates continue to grow rapidly. Credit growth accelerated to 28 percent at end-2003 and further to 36 percent in July 2004. The sharp increase in credit growth in 2004 was led by the state-owned sector. Broad money growth rose to 25 percent in 2003 and stayed at about the same level in the first seven months of 2004, reflecting the ongoing monetization. Short-term dong deposit and lending rates rose only slightly in recent months.
In response to rising inflation and higher credit growth, the authorities have taken a series of measures. They substantially increased reserve requirements and adjusted several administered prices, including a lowering of tariffs on petroleum and steel products. More recently, the Prime Minister issued a directive calling for a cut in government expenditure and lending by state-owned banks, a strengthening of enterprises' efforts to reduce production and distribution costs, and a tightening of price control enforcement.
For 2004 as a whole, economic growth and the external current account are likely to be broadly unchanged from 2003, with inflation falling toward the end of the year and the budget deficit narrowing. Real GDP growth in 2004 is likely to be at 7-7½ percent, aided by a recovery in agriculture and a pick up in industrial production in the second half of the year. Inflation is expected to fall to 9½ percent (year on year) by the end of the year. The current account deficit is projected to be at 4½ percent of GDP, financed by a combination of official development aid and foreign direct investment inflows. Reduced short-term capital inflows, however, would allow for only a modest accumulation of international reserves. Initiatives to tighten projects' eligibility requirements for domestically-financed on-lending and reduced expenditure are expected to lead to a significant fiscal tightening compared to 2003.
Vietnam's economic growth is projected to remain strong in 2005 and beyond, with real GDP growing at about 7 percent per year. Achievement of this outlook, however, depends on progress in private sector development and structural reforms, especially in the areas of state-owned banks and enterprises to contain the build-up of public sector debt, and WTO accession—which is key to sustained strong export growth. While there has been continued progress in the areas of private sector development and trade reform, progress in reforming the state-owned sector continues to be slow.
Executive Board Assessment
Executive Directors commended the authorities for their strong record of success in achieving high growth and poverty reduction over the past years, their prudent macroeconomic management, and Vietnam's increasing integration into the global economy. Directors encouraged the authorities to build on these achievements in order to sustain the momentum of strong growth and poverty reduction into the medium term. This will hinge on structural reforms in key areas, including restructuring of state-owned banks and enterprises, improving the private sector investment climate, securing WTO accession, and enhancing governance and the transparency of policy making.
Directors noted that the near-term economic outlook appears favorable, provided that the authorities can contain second-round inflationary effects from the recent supply-side price shocks. They welcomed the authorities' aim to contain these effects, as indicated by recent monetary policy actions supplemented by a number of administrative and fiscal measures. Directors encouraged the State Bank of Vietnam (SBV) to tighten monetary conditions further using more conventional means, especially by raising interest rates, if these measures prove insufficient. They advised that the central bank eliminate conflicting policy objectives and move toward increased reliance on indirect policy instruments.
Directors cautioned that the currently rapid rate of credit growth should be reduced significantly in light of uncertain loan quality and the banks' weak balance sheets. While noting that the significant increase in the reserve requirement ratios has reduced liquidity in the banking system, Directors urged the SBV to take further measures if the pace of credit growth does not fall significantly. They cautioned that maintaining rapid credit growth to meet the government's short-term growth target could lead to mounting quasi-fiscal liabilities, which could threaten fiscal sustainability and long-term growth.
Directors encouraged the authorities to move cautiously toward greater exchange rate flexibility, which would facilitate adjustments to external shocks and rapid structural changes. Accordingly, Directors urged the authorities to limit foreign exchange intervention to addressing disorderly conditions. This will help strengthen Vietnam's modest reserve position. They noted that increased exchange rate flexibility would also encourage market participants to manage exchange rate risks, thereby avoiding excessive foreign exchange exposure in the economy. Directors also encouraged the authorities to eliminate remaining exchange restrictions and to accept Article VIII obligations.
Directors commended the authorities for their prudent fiscal management in 2004. They emphasized the importance of setting budget targets for 2005 and beyond consistent with medium-term public debt sustainability, taking into account the existing stock of quasi-fiscal liabilities and the costs associated with the financial sector reforms. In this regard, Directors highlighted possible budget pressures from the fiscal costs of state-owned bank and enterprise restructuring, stagnating oil revenues, and revenue pressures from further trade liberalization. Directors encouraged the authorities to begin identifying possible tax measures in addition to ongoing tax administration efforts to achieve their goal of holding revenue steady as a share of output over the medium term. They called for discontinuation of price subsidies as soon as possible.
Directors emphasized that Vietnam's state-owned commercial banks are an important source of vulnerability in the economy, given their dominance and uncertain asset quality. They urged faster progress in reforming these banks. Directors welcomed the authorities' decision to equitize one of the four large banks, noting that this initiative could provide impetus to state bank reform provided that the equitization ultimately shifts the bank's operations to a more commercial basis. In this regard, Directors recommended that consideration be given to selling a large share of the bank to a foreign strategic partner, which, country experiences suggest, can be an effective way to improve the performance of state-owned banks. In addition to equitization, they underscored that a more active ownership role by the Ministry of Finance and measures to strengthen the SBV's supervision are important elements of state bank reform. Directors considered that further developing money and capital markets and the stock exchange should be an integral part of financial sector reform. They also called for independent audits at the central bank and swift progress in establishing effective means of combating money laundering and terrorism financing.
Directors emphasized the importance of further developing the private sector and improving the efficiency of state-owned enterprises for Vietnam's successful transition to a more market-oriented economy. In this regard, Directors welcomed initiatives to reduce the number of strategic sectors in which state-owned enterprises remain under full state ownership and to expand the equitization program to include large state-owned enterprises. They emphasized the importance of focusing the design of the equitization plans on strengthening commercial incentives for managers, increasing accountability, and improving performance. Directors noted that the elimination of regulations discriminating against the private sector and measures supporting small and medium enterprises have helped the private sector expand rapidly, and urged further improvements through full implementation of the Land Law to facilitate private investment, and unification of the investment and enterprise laws to promote a level playing field.
Directors supported Vietnam's objective of achieving early WTO membership, emphasizing its importance for Vietnam in maintaining market access, sustaining foreign direct investment inflows, and furthering integration into the international economy. They noted, however, that early entry requires significant actions, including putting in place necessary legislation.
Directors emphasized the need for Vietnam to improve transparency as well as reliability and timeliness of data. They welcomed the passage of the new Statistics Law, which would improve data collection by strengthening inter-agency coordination, but noted that Vietnam's macroeconomic statistics had significant weaknesses, and supported the provision of Fund technical assistance to improve the statistical base.
Directors welcomed the opportunity to review the Fund's past engagement with Vietnam, focusing on the three-year PRGF arrangement that expired in April 2004. They observed that Vietnam achieved further poverty reduction through maintaining strong economic growth and low inflation throughout the PRGF period. Nevertheless, valuable lessons of the ex post assessment are that sufficient time should be allowed for the institutional changes that underpin structural reforms, and that coordination between the Fund and the World Bank and other bilateral donors needs to be improved. While commending the impressive progress in trade liberalization, Directors noted that the pace of reforming state-owned commercial banks and enterprises has been slow and highlighted the need for fundamental institutional changes to address weaknesses in these areas. Fund technical assistance will be important in this regard.
IMF EXTERNAL RELATIONS DEPARTMENT