IMF Executive Board Concludes 2006 Article IV Consultation with VietnamPublic Information Notice (PIN) No. 06/129
November 7, 2006
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On October 25, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Vietnam.1
Overall macroeconomic performance has remained strong since the conclusion of the last Article IV consultation. Real GDP growth rose to 8.4 percent in 2005, spurred by strong domestic and external demand, and it remained robust in the first half of 2006 as continued strong domestic consumption and rising export growth offset a slowdown in public investment. However, the expansion of aggregate demand, together with increases in world commodity prices, has hampered efforts to bring down inflation. The year-on-year (yoy) rate of inflation has edged down from 8¾ percent in December 2005 to 7½ percent in August, but inflation has become more broadly based and has remained well above the rates prevailing in Vietnam's major trading partners. The continued brisk pace of exports and resulting strengthening of the current account, together with strong official development assistance (ODA) and foreign direct investment (FDI) has kept the balance of payments in comfortable surplus. Gross official reserves rose from US$6.3 billion at end-2004 to US$8.6 billion as of end-2005, and to nearly $11 billion as of end-June (Table 1).
Fiscal policy was eased considerably in 2005. Despite the oil revenue windfall, the narrowly-defined official budget balance shifted from a surplus of 1 percent of GDP in 2004 to a deficit of about 1 percent of GDP in 2005. Expenditure growth outpaced revenues, spurred by increasing public sector wages and oil subsidies. A surge in off-budget investment and net lending further boosted total outlays, and the overall deficit (as measured in accordance with the IMF's definition, which includes on-lending through the Development Assistance Fund and other off-budget operations) rose from less than 3 percent of GDP in 2004 to almost 6 percent of GDP in 2005. The non-oil deficit widened more markedly to 14½ percent of GDP, while the stock of public debt rose to 43½ percent of GDP as of end-2005.
The rate of growth of credit to the economy fell from more than 30 percent in 2005 to 21 percent (yoy) as of June 2006. New lending fell sharply as state-owned commercial banks (SOCBs) endeavored to meet the new prudential standards of the State Bank of Vietnam (SBV). However, with bank liquidity boosted as a result of the already-mentioned sharp increase in official reserves, reserve money growth increased to 31 percent (yoy) as of June. The SBV's policy rates were raised by about ½ percentage point in December 2005, and they have remained unchanged since then (with the discount rate at 4½ percent, the refinancing rate at 6½ percent and the base rate at 8¼ percent). However, open market operation rates have fallen to 2-3 percent in recent months, as sales of SBV bills have fallen far short of absorbing banks' excess reserves. While bank lending rates have remained basically flat, dong deposit rates have been under upward pressure, reflecting intensified competition for funds among joint stock banks, which have ample capital adequacy.
Good progress has been made over the last year in adopting legislation and market opening measures required for WTO compliance. The National Assembly approved the much-awaited Common Investment Law and Unified Enterprise Law in November 2005. The implementing regulations that are now being finalized should help level the playing field between domestic and foreign investors and private businesses and state-owned enterprises (SOEs). Vietnam has now completed all bilateral negotiations and hopes to accede to the WTO shortly. With the accession, Vietnam is expected to lower its trade barriers to a wide range of products and services.
Progress in SOCB and SOE reform has remained uneven. The development of plans for the resolution of nonperforming loans (NPLs) and for SOCB recapitalization has been delayed by difficulties in implementing new prudential standards. Discrepancies between SOCBs' initial NPL estimates and those of international auditors have led to further uncertainty regarding the size of potential contingent liabilities. However, the approval in May of a comprehensive Banking Sector Reform Roadmap has reiterated the government's commitment to banking sector reform. In the SOE sector, progress towards restructuring larger enterprises has remained slow, with equitized firms representing only 12 percent of SOE assets as of end-2005.
The outlook for the rest of 2006 is positive. With public investment expected to rebound in the second half of the year, and with the external environment remaining broadly favorable, GDP growth is projected to be close to the official target of 8 percent in 2006. However, inflation would remain higher than in trading partner countries. The rise in international oil prices, together with the continuing boom in non-oil exports, is projected to keep the external current account in a small surplus, which together with buoyant ODA, FDI and incipient private capital inflows would lead to a continuing rise in reserves.
Medium-term prospects for sustained high-quality growth and poverty reduction are also favorable but subject to risks. WTO accession should create new opportunities for growth of non-oil exports and FDI, and high oil prices should continue to underpin the public finances. However, greater exposure to global competition following WTO accession could pose challenges for SOEs operating in sectors that still benefit from protective tariffs or government subsidies. Additional risks to the outlook would stem from expansionary macroeconomic policies and delays in needed reforms. On the external front, key risks include a significant slowdown in the U.S. economy; a disorderly adjustment of global imbalances, which could reduce investors' appetite for risk; and a fall in international oil prices.
Executive Board Assessment
Executive Directors praised Vietnam's impressive record of sustained high growth and rapid poverty reduction, and noted that continuing efforts to improve the economy's market orientation had made Vietnam an attractive destination for foreign investment. Looking ahead, Directors underscored that faster reforms of previously-protected industries would be essential to enable the economy to reap the full benefits from Vietnam's forthcoming WTO accession.
Directors noted that the short-term outlook is broadly positive, but medium-term prospects are subject to some uncertainties. Inflation remains higher and more entrenched than in most other Asian countries and, under the new Five-Year Socio-Economic Development Plan, growth will continue to rely heavily on public investment, whose quality remains uncertain. While recognizing the economy's large infrastructure needs, Directors cautioned that a rising public debt burden could eventually crowd out poverty-reducing outlays in the event of a slowdown in world growth or lower oil prices.
Directors stressed the need for a more prudent fiscal stance, particularly in light of the economy's strong cyclical position. They welcomed the substantial reduction in oil subsidies in 2006, but considered that the recent decline of international oil prices had weakened the fiscal outlook, reinforcing the need to rein in growth in public spending. Furthermore, Directors urged the authorities to contain future increases in public wages and intensify efforts to improve the screening of new investment projects. In this context, they called for the adoption of enabling regulations to help enforce the recently-approved laws to curb corruption and prevent the waste of public funds. Directors stressed that more transparent accounting, reporting, and monitoring of the government's extra-budgetary operations and all publicly-funded projects is needed to shore up donor and investor confidence.
Directors welcomed the recent deceleration of credit growth, and stressed that continuation of this trend would help contain inflation and reverse the growth of banks' NPLs, although excess bank liquidity could reverse the recent progress in this area. Directors urged the authorities to step up liquidity-absorbing open market operations, avoid directed lending through state-owned commercial banks, and introduce adequate prudential measures to limit banks' off-balance-sheet risks.
Directors commended the authorities' acceptance of the obligations under the Fund's Article VIII and supported their plan to make the dong fully convertible by 2010. While the dong does not currently appear to be misaligned, most Directors were of the view that the current strength of the external position would facilitate a move towards greater exchange rate flexibility, which would serve to cushion the economy from external shocks and foster better management of exchange rate risks. In this respect, they welcomed the recent move toward liberalizing banks' own exchange rates for currency transactions.
Directors welcomed the authorities' Banking Sector Reform Roadmap and the plans to convert the State Bank of Vietnam into a modern central bank. They also supported the plans to apply International Accounting Standards for all state-owned banks, and urged the authorities to proceed with a realistic valuation of NPLs as a basis for NPL resolution and bank recapitalization plans. Directors emphasized that, to place state-owned bank operations on a sound commercial basis, their managers would need to be given increased operational autonomy. While supporting the government's plans to accelerate the issuance of equity in state-owned banks, Directors stressed that adequate strategic foreign investor participation would be important to help improve governance.
Directors welcomed the authorities' plans to restructure and issue equity in most state-owned enterprises by 2010. They urged the authorities to grant managers full autonomy to make their own pricing and investment decisions. In this connection, Directors welcomed the recently-announced plans to liberalize the prices of cement, steel and fertilizer and reduce state subsidies in the energy sector, and urged the authorities to adopt time-bound plans to remove all other remaining distortionary price regulations.
Directors stressed that a continuing opening up of the trade and investment regimes would be key to private sector-led growth. They urged the authorities to implement the Common Investment Law and Unified Enterprise Law to level the playing field, while preventing any increase in government intervention.
Directors urged the authorities to improve the timeliness and quality of data on off-budget fiscal activities, money and banking statistics, and balance of payments and reserve data to support informed policy decisions and effective interaction with markets.