## 2.   Principles of Effective Supervision over State-Owned Financial Institutions

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### Key findings and risks related to the Development Assistance Fund (DAF)
- The DAF was created in 1999 when policy lending through the state-owned commercial banks (SOCBs) was formally abolished.
- The DAF is a State Financial Institution, wholly owned by the government, governed by the Law on Domestic Investment Encouragement, and is not subject to the banking law despite taking corporate deposits.
- The DAF falls under, and reports to, the Ministry of Finance (MOF); the Prime Minister approves and amends its charter and issues policies and operational guidance to be carried out by DAF.
- DAF operations are kept off-budget (except for the interest subsidy), as the authorities consider its debt to be contingent liabilities akin to those of SOCBs.
- The current framework for policy lending does not adequately address common governance issues related to state involvement in investment decisions and is insufficient to ensure the quality of investment.
- The potential threat to fiscal sustainability could increase significantly if the DAF and other local development funds were to be given greater autonomy or transformed into development banks without strengthening regulation and supervision first.
- Immediate fiscal transparency steps recommended: account for all government-led lending operations in annual budget documents and incorporate the associated liabilities in official public debt statistics.

### DAF structure, mandate and operations
- Geographic and human resources:
  - Offices in 61 provinces and a headquarters in Hanoi; employs around 2,200 people.
- Organizational roles:
  - Central DAF: project appraisal for large investment projects (Groups A and B) and institutional oversight of local DAF branches.
  - Local DAFs: loan appraisal and servicing for all types of lending; mobilize corporate deposits in the local market; manage trust funds for large investment projects.
  - DAF provides loan appraisal and servicing, and financial management on a fee-for-service basis for 11 regions’ own local development funds.
- Legal/financial role:
  - Local development funds established by the Chairman of the local People’s Council, funded out of local government revenues, cannot currently issue debt, but local development funds are to be allowed to issue their own debt from 2007.
- Main tasks:
  - mobilize funds to finance economic development;
  - provide financing (State Credit) for long-term investment projects on the list of eligible sectors (Annex II) and short-term export promotion support (since 2002);
  - provide loan guarantees and interest subsidies for domestic investment projects;
  - act as the government’s main agent in disbursing and collecting ODA on-lent funds (about 20 percent of ODA reportedly continues to be channeled through SOCBs).

### Decision-making, appraisal and practical shortcomings
- Annual lending program and oversight:
  - Annual DAF lending program is decided by the Prime Minister based on investment needs reported by line ministries; the program is indicative and can be altered throughout the year and includes targets for lending and funding (including amount of new DAF bonds to be issued).
  - The Management Board meets every three months; comprised of five members: a chairman, a vice-chairman, and three members from the MOF (vice-minister), Ministry of Planning and Investment (vice-minister) and State Bank of Vietnam (deputy governor).
- Appraisal process (in principle vs practice):
  - In principle: DAF roles include loan appraisal, loan disbursement and servicing; appraisal involves a technical project feasibility study and a financial viability study; DAF provides a written request within 30 days to competent authorities asking for their views and then makes final lending decision.
  - In practice: most lending decisions for Group A and B projects are based on political and socioeconomic considerations outside DAF’s purview, and DAF often acts as a government agency for disbursement and servicing of policy loans.

### Size, funding sources and loan portfolio (exact figures preserved)
- Relative size: The DAF is one of the largest financial institutions in Vietnam and ranks second only to the agricultural bank, VBARD, relative to the four largest SOCBs.
- Non-ODA funding sources: domestic bond issuance (DAF bonds), borrowing from the social security fund, and borrowing from the Postal Savings Service Company (PSSC). Lesser sources include earmarked treasury bills, deposits mobilized by local DAF branches, and resources in the sinking fund.
- PSSC role: mobilizes retail savings (mostly sight deposits) through local post offices and loans these to the DAF with maturities of 1 to 5 years.
- Bond issuance and activity:
  - In 2004, the value of outstanding DAF bonds nearly doubled to VND 13 trillion (US$825 million, or 1.8 percent of GDP).
  - DAF bonds: fixed-rate 5-, 10- and 15-year bonds sold via auction and through underwriters; maximum interest rate set by the MOF; bonds carry one lump-sum repayment (interest paid either upfront or capitalized and paid in full upon maturity); tradable but no secondary market activity to date.
  - As of May 2005 only 18 percent of the annual bond issuance plan had been issued.
- Loan portfolio (end-2004):
  - Total: 5,924 projects; Outstanding Loans 38,395; Percent 100.0; Average Loan Size 0.412 (US$ millions)
    - Group A: 781 projects; 10,964 outstanding; 28.6 percent; 8.925 (US$ millions)
    - Group B: 469 projects; 14,649 outstanding; 38.2 percent; 1.983 (US$ millions)
    - Group C: 5,377 projects; 12,782 outstanding; 33.3 percent; 0.151 (US$ millions)
  - By ownership:
    - SOE 2,954 projects; 34,068 outstanding; 88.7 percent; 0.732 (US$ millions)
    - Private 2,970 projects; 4,327 outstanding; 11.3 percent; 0.093 (US$ millions)
  - By sector:
    - Construction and industry 2,915 projects; 24,767 outstanding; 64.5 percent; 0.539 (US$ millions)
    - Transportation 287 projects; 5,559 outstanding; 14.5 percent; 1.230 (US$ millions)
    - Agriculture, forestry, fisheries 1,970 projects; 6,379 outstanding; 16.6 percent; 0.206 (US$ millions)
    - Other 752 projects; 1,689 outstanding; 4.4 percent; 0.143 (US$ millions)
- Mobilized capital (in billions of dong):
  - Chartered capital (2004): 4,981
  - Mobilized capital (2004): 39,829
    - DAF bonds (2004): 13,368
    - Post savings (2004): 5,535
    - Social Security Fund (2004): 9,600
    - Sinking fund (2004): 2,135
    - Treasury bills and bonds (2004): 2,989
    - Capital mobilized by DAF's branches (ST) (2004): 4,297
  - ODA (2004): 38,347
  - Total (2004): 83,157
  - Total as a percent of GDP (2004): 11.7

### Asset quality, provisioning and regulatory discretion (exact figures preserved)
- Reported NPLs (end-2004):
  - Reported level of non-performing loans (NPLs) is under 2 percent at end-2004.
  - For ODA on-lending the NPL ratio is reportedly 0.44 percent.
  - For export credit the NPL ratio is 2.67 percent.
  - For State Credit the NPL ratio is 3.2 percent, mostly on loans to the sugar industry extended by DAF’s predecessor institution.
- Caveats on NPL figures:
  - These NPL numbers should be viewed with extreme caution due to a lack of rigorous regulations regarding loan classification and rescheduling, structural issues related to the brief period in which the DAF has been in operation versus the long-term nature and term-structure of its lending portfolio, and potential evergreening enabled by current discretion.
- Managerial discretion:
  - Current regulations give considerable discretion to the General Director of DAF to extend, reschedule and otherwise change the terms of overdue loans.

### Operational regulations under Decree 106 (Box 1) — salient features (preserved text and numbers)
- Legal changes:
  - Decree 106 of April 1, 2004 overhauled the DAF framework; followed by Decision 54 of June 16, 2004 (list of projects entitled to investment loans valid through December 31, 2005).
- Exposure and co-financing limits:
  - total support level shall not exceed 85 percent of the investment capital of any given project, and investment loans shall not exceed 70 percent of investment capital.
- Eligibility criteria for investment loans:
  - projects must be on the list of eligible projects; have profitable business plans; have financial plans or loan capital repayment plans evaluated by the DAF before investment decisions are made; comply with regulations regarding insurance and non-disposal of assets used as collateral.
- Lending terms:
  - maximum loan maturity is 12 years, with an exception for projects subject to long capital recovery periods (specifically re-forestation projects) of 15 years;
  - fixed interest rate set at 70 percent of the average medium- and long-term loan interest rate of SOCBs; the rate will be announced by the Minister of Finance;
  - if market interest rate fluctuates by more than 15 percent, the finance minister will adjust the rate a maximum of twice per year.
- Late payments and penalties:
  - after 10 working days, missed amortization and interest payments will be considered non-performing and a penalty rate of 150 percent of the contracted rate will be charged.
- Extensions and rescheduling:
  - for “objective reasons” debtors can request adjustments; the General Director of the DAF can adjust terms (grace period, repayment terms and/or maturity), with a maximum extension of one-third of the original loan maturity.
- Risk Reserve Fund:
  - DAF may set up annually a risk reserve fund; the Minister of Finance will guide the setting up, with the maximum provision of 0.2 percent of the sum of the average investment loan portfolio outstanding and investment loan guarantees.
- Resolution of unresolved NPLs:
  - Minister of Finance will submit proposed resolution to the Prime Minister, which may include evergreening through interest rate exemption, principle write down, debt “freeze or remission”, or other changes; where the DAF’s risk reserve fund is insufficient, the case is sent to the prime minister for resolution.

### Suggested best-practice measures and immediate policy recommendations
- Immediate and interim recommendations:
  - Remove residual policy lending from commercial banks.
  - Improve prudential regulations and supervision of the DAF and local development funds well before granting them significant autonomy.
  - Increase transparency and accountability of DAF and local development funds.
  - Establish effective regulatory framework for development-lending institutions, recognizing that this will take time; in the meantime, promptly account for all government-led lending operations in annual budget documents and incorporate associated liabilities in official public debt statistics to enhance the government’s ability to assess the fiscal position.
- Specific operational steps:
  - DAF should be audited regularly and audited financial statements published; DAF operations for 2003 were recently audited by the State Audit of Vietnam (SAV); auditors reportedly invited to audit DAF’s 2004 financial statement (audit results not published).
  - Strengthen DAF management capacity in credit risk management and project appraisal techniques.
  - Streamline eligibility list for DAF projects and open non-priority sectors to private investment.

### Principles of effective supervision over state-owned financial institutions (Box 2 summary, preserved assertions)
- Standards and alignment:
  - There is no standard-setting body regarding best practice in development banking; hence no formal “best-practice” standard exists.
  - Fiechter and Kupiec proposed Ten Proposed Principles of effective supervision of state-owned financial institutions (the List).
  - The List draws heavily on, and is consistent with, the Basel Core Principles of Effective Banking Supervision, with an added focus on public disclosure as a means for overcoming limitations to effective supervision imposed by state participation.
  - Where institutions are hybrid (both commercial and policy lending), commercial lending should be subject to Basel Core Principles, while policy-directed lending should be subject to principles like those summarized in the List.
- Core supervisory principles (numbered as in the source):
  - 1. Preconditions: sustainable macroeconomic policies, a well-developed legal system, and a robust accounting profession.
  - 2. Limitation of activities and audit/evaluation: authorizing law should provide a clear mission statement; define permissible activities and use of market resources; specify accounting and auditing procedures; establish process for setting goals and evaluating performance.
  - 3. Supervisory objectives, empowerment and disclosure: assign clear responsibilities and objectives to each supervisory agency; supervisor empowered with legal means to enforce prudential standards; reinforced by public disclosure.
  - 4. Supervisory role: supervisor responsible for monitoring activities, required to evaluate activities versus mission statements, and raise public objections against inadmissible activities.
  - 5. Capital adequacy: supervisor or authorizing legislation should define regulatory capital and set minimum risk-adjusted capital adequacy standards reflecting the nature of the institution’s liabilities.
  - 6. Independent evaluation and audit: supervisor should conduct independent evaluations and ensure appropriate independent internal or external audit and compliance functions.
  - 7. Transparency: institution should publish on a regular basis audited financial statements that fairly reflect its financial condition; state-owned financial institutions subject to accounting standards ensuring assets and liabilities, including off-balance sheet items, are valued appropriately; supervisor should be satisfied accounting standards in authorizing law reflect true financial position or be empowered to recommend modifications.
  - 8. Risk Management: supervisor should ensure institution has comprehensive risk management, including senior management oversight and modern risk-modeling techniques.
  - 9. Monitoring: supervisor should conduct both on-site and off-site supervision.
  - 10. Corrective Action: supervisor should be able to bring about timely corrective action and have legal authority to take remedial actions and to make concerns and recommendations public.

### Supervisory and regulatory issues specific to Vietnam and DAF governance
- Fit with best practice:
  - Fiechter and Kupiec propose supervision over state-owned financial institutions should follow closely the Basel Core Principles, with particular focus on transparency and public disclosure; OECD Guidelines on the Corporate Governance of State-Owned Enterprises are also relevant.
- DAF governance shortcomings:
  - DAF’s internal Supervisory Board (SB / Control Board) is not independent: SB appointed by and answerable to the Management Board; MB can dismiss deputy-chairman and members of SB at proposal of chairman of SB; salaries of SB members paid out of DAF funds and amounts decided by General Director of DAF.
  - Current authorizing legislation does not discuss prudential regulations nor empower SB to set these standards.
- Broader systemic issues:
  - Directed lending has contributed to the build-up of non-performing loans in the Vietnamese banking sector over the last decade.
  - Government continues to exert considerable influence over SOCBs’ lending decisions, including through moral suasion.
  - Alternative sources of policy lending are rising: local development funds finance local infrastructure projects with MOF support despite no regulatory framework; these funds could expand if authorized to issue bonds.
- Institutional milestones:
  - State Audit Law to come into effect from January 1, 2006.
  - SAV expected to complete the State Auditing Standards by end-2007 to bring them more into line with international practice.
  - Government is considering streamlining eligibility list for DAF projects and working towards establishing appropriate regulatory framework for local infrastructure funds.
- Preconditions for conversion:
  - Best practice requires an independent bank supervisory agency empowered to enforce prudential standards and conduct independent evaluations. Establishment of an effective and independent supervisory agency is prerequisite for conversion of DAF into an autonomous development bank.

*Prepared by Carol Baker (APD); content based solely on the supplied chapter excerpt.*

### 2.   Principles of Effective Supervision over State-Owned Financial Institutions.........9

### 2.   Principles of Effective Supervision over State-Owned Financial Institutions.........9

### Key findings and risks related to the Development Assistance Fund (DAF)
- The DAF was created in 1999 when policy lending through the state-owned commercial banks (SOCBs) was formally abolished.
- The DAF is a State Financial Institution, wholly owned by the government, governed by the Law on Domestic Investment Encouragement, and is not subject to the banking law despite taking corporate deposits.
- The DAF falls under, and reports to, the Ministry of Finance (MOF); the Prime Minister approves and amends its charter and issues policies and operational guidance to be carried out by DAF.
- DAF operations are kept off-budget (except for the interest subsidy), as the authorities consider its debt to be contingent liabilities akin to those of SOCBs.
- The current framework for policy lending does not adequately address common governance issues related to state involvement in investment decisions and is insufficient to ensure the quality of investment.
- The potential threat to fiscal sustainability could increase significantly if the DAF and other local development funds were to be given greater autonomy or transformed into development banks without strengthening regulation and supervision first.
- Immediate fiscal transparency steps recommended: account for all government-led lending operations in annual budget documents and incorporate the associated liabilities in official public debt statistics.

### DAF structure, mandate and operations
- Offices in 61 provinces and a headquarters in Hanoi; employs around 2,200 people.
- Central DAF: project appraisal for large investment projects (Groups A and B) and institutional oversight of local DAF branches.
- Local DAFs: loan appraisal and servicing for all types of lending; mobilize corporate deposits in the local market; manage trust funds for large investment projects.
- DAF provides loan appraisal and servicing, and financial management on a fee-for-service basis for 11 regions’ own local development funds.
- Local development funds are established by the Chairman of the local People’s Council, funded out of local government revenues, cannot currently issue debt, but local development funds are to be allowed to issue their own debt from 2007.
- DAF main tasks:
  - mobilize funds to finance economic development;
  - provide financing (State Credit) for long-term investment projects on the list of eligible sectors (Annex II) and short-term export promotion support (since 2002);
  - provide loan guarantees and interest subsidies for domestic investment projects;
  - act as the government’s main agent in disbursing and collecting ODA on-lent funds (about 20 percent of ODA reportedly continues to be channeled through SOCBs).

### Decision-making, appraisal and practical shortcomings
- Annual DAF lending program is decided by the Prime Minister based on investment needs reported by line ministries; the program is indicative and can be altered throughout the year and includes targets for lending and funding (including amount of new DAF bonds to be issued).
- The Management Board meets every three months; comprised of five members: a chairman, a vice-chairman, and three members from the MOF (vice-minister), Ministry of Planning and Investment (vice-minister) and State Bank of Vietnam (deputy governor).
- In principle DAF roles in policy lending: loan appraisal, loan disbursement and servicing. Appraisal involves a technical project feasibility study and a financial viability study; DAF provides a written request within 30 days to competent authorities asking for their views and then makes final lending decision.
- In practice, most lending decisions for Group A and B projects are based on political and socioeconomic considerations outside DAF’s purview, and DAF often acts as a government agency for disbursement and servicing of policy loans.

### Size, funding sources and loan portfolio (exact figures preserved)
- The DAF is one of the largest financial institutions in Vietnam and ranks second only to the agricultural bank, VBARD, relative to the four largest SOCBs.
- Sources of non-ODA funding (in addition to direct state budget capital transfers): domestic bond issuance (DAF bonds), borrowing from the social security fund, and borrowing from the Postal Savings Service Company (PSSC). Lesser sources include earmarked treasury bills, deposits mobilized by local DAF branches, and resources in the sinking fund.
- The PSSC mobilizes retail savings (mostly sight deposits) through local post offices and loans these to the DAF with maturities of 1 to 5 years.
- In 2004, the value of outstanding DAF bonds nearly doubled to VND 13 trillion (US$825 million, or 1.8 percent of GDP).
- DAF bonds: fixed-rate 5-, 10- and 15-year bonds sold via auction and through underwriters; maximum interest rate set by the MOF; bonds carry one lump-sum repayment (interest paid either upfront or capitalized and paid in full upon maturity); tradable but no secondary market activity to date.
- As of May 2005 only 18 percent of the annual bond issuance plan had been issued.
- At end-2004, DAF had a portfolio of 5,924 project loans financed by State Credit, with an average loan size of about VND 6.5 billion (US$412,000).
- SOEs account for about 70 percent of the total number of projects financed by DAF, absorbing nearly 90 percent of State Credit.
- DAF loan portfolio by ownership and sector (end-2004, preserved format):
  - By project group: 5,924 projects; Outstanding Loans 38,395; Percent 100.0; Average Loan Size 0.412 (US$ millions)
    - Group A: 781 projects; 10,964 outstanding; 28.6 percent; 8.925 (US$ millions)
    - Group B: 469 projects; 14,649 outstanding; 38.2 percent; 1.983 (US$ millions)
    - Group C: 5,377 projects; 12,782 outstanding; 33.3 percent; 0.151 (US$ millions)
  - By ownership: SOE 2,954 projects; 34,068 outstanding; 88.7 percent; 0.732 (US$ millions); Private 2,970 projects; 4,327 outstanding; 11.3 percent; 0.093 (US$ millions)
  - By sector: Construction and industry 2,915 projects; 24,767 outstanding; 64.5 percent; 0.539 (US$ millions); Transportation 287 projects; 5,559 outstanding; 14.5 percent; 1.230 (US$ millions); Agriculture, forestry, fisheries 1,970 projects; 6,379 outstanding; 16.6 percent; 0.206 (US$ millions); Other 752 projects; 1,689 outstanding; 4.4 percent; 0.143 (US$ millions)
- Mobilized capital (Table 2, preserved figures, in billions of dong):
  - Chartered capital (2004): 4,981
  - Mobilized capital (2004): 39,829
    - DAF bonds (2004): 13,368
    - Post savings (2004): 5,535
    - Social Security Fund (2004): 9,600
    - Sinking fund (2004): 2,135
    - Treasury bills and bonds (2004): 2,989
    - Capital mobilized by DAF's branches (ST) (2004): 4,297
  - ODA (2004): 38,347
  - Total (2004): 83,157
  - Total as a percent of GDP (2004): 11.7

### Asset quality, provisioning and regulatory discretion (exact figures preserved)
- Reported level of non-performing loans (NPLs) is under 2 percent at end-2004.
  - For ODA on-lending the NPL ratio is reportedly 0.44 percent.
  - For export credit the NPL ratio is 2.67 percent.
  - For State Credit the NPL ratio is 3.2 percent, mostly on loans to the sugar industry extended by DAF’s predecessor institution.
- Caveats: these NPL numbers should be viewed with extreme caution due to a lack of rigorous regulations regarding loan classification and rescheduling, structural issues related to the brief period in which the DAF has been in operation versus the long-term nature and term-structure of its lending portfolio, and potential evergreening enabled by current discretion.
- Current regulations give considerable discretion to the General Director of DAF to extend, reschedule and otherwise change the terms of overdue loans (see Box 1 summary below).

### Operational regulations under Decree 106 (Box 1) — salient features (preserved text and numbers)
- Decree 106 of April 1, 2004 overhauled the DAF framework; followed by Decision 54 of June 16, 2004 (list of projects entitled to investment loans valid through December 31, 2005).
- Maximum project exposure and co-financing: total support level shall not exceed 85 percent of the investment capital of any given project, and investment loans shall not exceed 70 percent of investment capital.
- Eligibility criteria for investment loans: projects must be on the list of eligible projects; have profitable business plans; have financial plans or loan capital repayment plans evaluated by the DAF before investment decisions are made; comply with regulations regarding insurance and non-disposal of assets used as collateral.
- Lending terms: maximum loan maturity is 12 years, with an exception for projects subject to long capital recovery periods (specifically re-forestation projects) of 15 years; fixed interest rate set at 70 percent of the average medium- and long-term loan interest rate of SOCBs; the rate will be announced by the Minister of Finance; if market interest rate fluctuates by more than 15 percent, the finance minister will adjust the rate a maximum of twice per year.
- Late payments and penalty rates: after 10 working days, missed amortization and interest payments will be considered non-performing and a penalty rate of 150 percent of the contracted rate will be charged.
- Extensions, rescheduling and changes in lending terms: for “objective reasons” debtors can request adjustments; the General Director of the DAF can adjust terms (grace period, repayment terms and/or maturity), with a maximum extension of one-third of the original loan maturity.
- Risk Reserve Fund: DAF may set up annually a risk reserve fund; the Minister of Finance will guide the setting up, with the maximum provision of 0.2 percent of the sum of the average investment loan portfolio outstanding and investment loan guarantees.
- Agency responsibilities for unresolved NPLs: Minister of Finance will submit proposed resolution to the Prime Minister, which may include evergreening through interest rate exemption, principle write down, debt “freeze or remission”, or other changes; where the DAF’s risk reserve fund is insufficient, the case is sent to the prime minister for resolution.

### Suggested best-practice measures and immediate policy recommendations
- Remove residual policy lending from commercial banks.
- Improve prudential regulations and supervision of the DAF and local development funds well before granting them significant autonomy.
- Increase transparency and accountability of DAF and local development funds.
- Establish effective regulatory framework for development-lending institutions, recognizing that this will take time; in the meantime, promptly account for all government-led lending operations in annual budget documents and incorporate associated liabilities in official public debt statistics to enhance the government’s ability to assess the fiscal position.

### Principles of effective supervision over state-owned financial institutions (Box 2 summary, preserved assertions)
- There is no standard-setting body regarding best practice in development banking; hence no formal “best-practice” standard exists.
- Fiechter and Kupiec proposed a list of Ten Proposed Principles of effective supervision of state-owned financial institutions (referred to as the List).
- The List draws heavily on, and is consistent with, the Basel Core Principles of Effective Banking Supervision, with an added focus on public disclosure as a means for overcoming limitations to effective supervision imposed by state participation.
- Where institutions are hybrid (both commercial and policy lending), commercial lending should be subject to Basel Core Principles, while policy-directed lending should be subject to principles like those summarized in the List.

*Prepared by Carol Baker (APD); content based solely on the supplied chapter excerpt.*

### 1. Preconditions. Supervision is enhanced under the following conditions: sustainable macroeconomic

### _cr0620 - 1. Preconditions. Supervision is enhanced under the following conditions: sustainable macroeconomic

### Preconditions and Supervisory Principles
- Supervision is enhanced under the following conditions: sustainable macroeconomic policies, a well-developed legal system, and a robust accounting profession.
- Core supervisory principles (numbered as in the source):
  - 1. Preconditions: sustainable macroeconomic policies, a well-developed legal system, and a robust accounting profession.
  - 2. Limitation of activities and audit/evaluation: authorizing law should provide a clear mission statement; define permissible activities and use of market resources; specify accounting and auditing procedures; establish process for setting goals and evaluating performance.
  - 3. Supervisory objectives, empowerment and disclosure: assign clear responsibilities and objectives to each supervisory agency; supervisor empowered with legal means to enforce prudential standards; reinforced by public disclosure.
  - 4. Supervisory role: supervisor responsible for monitoring activities, required to evaluate activities versus mission statements, and raise public objections against inadmissible activities.
  - 5. Capital adequacy: supervisor or authorizing legislation should define regulatory capital and set minimum risk-adjusted capital adequacy standards reflecting the nature of the institution’s liabilities.
  - 6. Independent evaluation and audit: supervisor should conduct independent evaluations and ensure appropriate independent internal or external audit and compliance functions.
  - 7. Transparency: institution should publish on a regular basis audited financial statements that fairly reflect its financial condition; state-owned financial institutions subject to accounting standards ensuring assets and liabilities, including off-balance sheet items, are valued appropriately; supervisor should be satisfied accounting standards in authorizing law reflect true financial position or be empowered to recommend modifications.
  - 8. Risk Management: supervisor should ensure institution has comprehensive risk management, including senior management oversight and modern risk-modeling techniques.
  - 9. Monitoring: supervisor should conduct both on-site and off-site supervision.
  - 10. Corrective Action: supervisor should be able to bring about timely corrective action and have legal authority to take remedial actions and to make concerns and recommendations public.

### Findings on Policy Lending, DAF, and SOCBs
- Best practice linkages:
  - Fiechter and Kupiec propose supervision over state-owned financial institutions should follow closely the Basle Core Principles of Effective Banking Supervision, with particular focus on transparency and public disclosure.
  - OECD Guidelines on the Corporate Governance of State-Owned Enterprises are also relevant.
  - Key needs: clear delineation and limitations on authorized activities, proper audit and evaluation, adequate objectives and empowerment of supervisors.
- Policy lending principles:
  - 17. Policy lending should be well targeted and should not compete for projects which could be carried out on commercial terms; restricted to projects where private participation on a commercial basis would not be forthcoming and which can yield a positive stream of net socio-economic returns.
  - 18. Policy lending should be completely removed from commercial banks; systemic risk from large-scale policy lending through commercial banks is potentially large and supports carrying out policy lending through a specialized financial institution or directly through the budget process.
- Vietnam-specific observations:
  - 19. Removing residual policy lending from SOCBs is important to limit systemic risk and to enable banking sector reform; substitution of SOCB lending for DAF lending undermines investment quality and transparency of fiscal and monetary accounts.
  - Use of both DAF and SOCBs to on-lend ODA funds (through multiple accounts) is particularly problematic.
  - Proposal reportedly under study: transform DAF into a development bank supervised by the SBV and falling under the banking law; for desired outcomes, DAF management and supervision would need significant strengthening.
- DAF performance issues:
  - 20. Directed lending has played a major role in the build-up of non-performing loans in the Vietnamese banking sector over the last decade.
  - Government continues to exert considerable influence over SOCBs’ lending decisions, including through moral suasion.
  - Removing policy lending from SOCBs alone is insufficient; soundness and operational efficiency of the DAF must be improved simultaneously.
  - 21. Quasi-fiscal activities such as directed credit should be placed on-budget and associated liabilities duly recorded in official public debt statistics; DAF should be audited regularly and audited financial statements published. DAF operations for 2003 were recently audited by the State Audit of Vietnam (SAV); auditors reportedly invited to audit DAF’s 2004 financial statement. Audit results have not been published.
  - 22. DAF’s ability to turn down low-or-negative-return projects is hindered by institutional factors and capacity constraints: projects often put forth or backed by the same ministries charged with authorization; DAF personnel have limited knowledge of borrowers’ true financial position; need for training in credit risk management and project appraisal techniques.
  - 23. Authorities have narrowed list of sectors eligible for DAF lending (see Annex II) but sectoral approach provides no guidance on assessing quality of individual projects; scope exists to further streamline eligibility list and open non-priority sectors to private investment.

### Supervisory and Regulatory Issues
- 24. Supervisory and prudential framework for state-owned financial institutions should be aligned with best international practice for commercial banks, recognizing special difficulties and risks faced by development institutions. This must be accompanied by strengthening accounting standards in line with IAS, developing rigorous criteria for evaluating socio-economic returns, and developing a legal system encouraging private investment.
- 25. Best practice requires an independent bank supervisory agency empowered to enforce prudential standards and conduct independent evaluations. Establishment of an effective and independent supervisory agency is prerequisite for conversion of DAF into an autonomous development bank.
- 26. DAF’s internal Supervisory Board (SB / Control Board) is not designed to be an independent supervisory agency:
  - SB authority to carry out programs approved by Management Board (MB); inspect and supervise observance of guidelines and policies; report on financial performance to MB.
  - SB appointed by and answerable to MB; MB can dismiss deputy-chairman and members of SB at proposal of chairman of SB.
  - Salaries of SB members paid out of DAF funds, amounts decided by General Director of DAF.
  - Current authorizing legislation does not discuss prudential regulations nor empower SB to set these standards; unclear what prudential regulations SB should gauge against.
- 27. Alternative sources of policy lending are rising: local development funds finance local infrastructure projects with MOF support despite no regulatory framework; these funds could expand if authorized to issue bonds. Municipalities of Hanoi and Ho Chi Minh City issuing their own bonds to finance large investment programs. Shift toward alternative funding increases opacity and reduces scrutiny relative to on-budget activities.
- 28. State Audit Law (to come into effect from January 1, 2006) is an important step to enhance external monitoring and control over DAF operations:
  - Under this law, SAV to become independent agency under the National Assembly with authority to appoint and, if necessary, dismiss the auditor general.
  - SAV reports approved by the National Assembly are to be publicly disclosed.
  - SAV expected to complete State Auditing Standards by end-2007 to bring them more into line with international practice.
  - Government is considering streamlining eligibility list for DAF projects and working towards establishing appropriate regulatory framework for local infrastructure funds.

### Policy Recommendations (explicit)
- General recommendations (paragraph 29):
  - Policy-based lending should be limited to cases of market failure, and only for projects selected based on rigorous evaluation of their socio-economic returns, with a view to increasing the quality of publicly-funded projects and avoiding the crowding out of private investment.
  - The DAF and local development funds should align operations with best international standards on accounting, supervision and regulation, and should not be granted greater autonomy in their funding and lending operations until these standards have been fully put in place.
- Interim and prompt steps to protect debt sustainability and enhance fiscal transparency (paragraph 30):
  - Residual policy lending should be completely removed from the SOCBs.
  - DAF’s transparency and accountability should be increased through the conduct of external audits and publication of its audited financial statements.
  - Operations carried out through the DAF and local development funds should be explicitly accounted for in annual budget documents, and the resulting contingent liabilities incorporated in official government debt statistics.

### Key statutory and numeric milestones, project eligibility, and thresholds
- Legislative and audit timing:
  - State Audit Law to come into effect from January 1, 2006.
  - SAV expected to complete the State Auditing Standards by end-2007.
- DAF audit status:
  - DAF operations for 2003 were audited by the State Audit of Vietnam (SAV); auditors reportedly invited to audit DAF’s 2004 financial statement; audit results not published.
- Annex I: Investment Categories and Approval Process — project thresholds and approval route (preserved numeric values exactly):
  - Group B / Group C thresholds by project type (selected entries):
    - Point 2 (power, oil and gas, chemical and fertilizer, machine building, cement, metallurgy, mineral exploitation and processing industries; major traffic infrastructure projects; building of residential quarters): Over VND 600 billion (Group A), Between VND 30 and 600 billion (Group B), Less than VND 30 billion (Group C).
    - Point 3 (irrigation, traffic except point 2, water supply and drainage, technical infrastructure, electric technology, production of information, electronic, informatics, chemo-pharmaceutical, medical equipment, and other mechanical engineering structures): Over VND 400 billion (Group A), Between VND 20 and 400 billion (Group B), Less than VND 20 billion (Group C).
    - Point 4 (light industry, chinaware, porcelain, glassware, printing; national parks, nature conservation zones, agricultural and forestry production, aquaculture, agricultural and forestry products processing): Over VND 300 billion (Group A), Over VND 300 billion (Group B), Less than VND 15 billion (Group C).
    - Point 5 (healthcare, culture, education, radio, television broadcasting, other civil construction excluding housing, warehousing, tourism, physical training and sports, scientific research and other projects): Over VND 200 billion (Group A), Between VND 7 and 200 billion (Group B), Less than VND 7 billion (Group C).
  - Approval and Appraisal Process (marks indicate applicability):
    - 1. Approval by the Prime Minister required: X
    - 2. Approval by relevant line ministry or People’s Committee: X X
    - 3. Project appraisal by central DAF: X
    - 4. Project appraisal by HCMC branch instead of central DAF, where relevant: X
    - 5. Project appraisal by local DAF branch: X X
- Annex II: Projects entitled to investment loans through 12/31/05 (Decision 54 (2004) as supplemented by Decisions 80 (2004), 19 (2005) and 31 (2005)) — selected entries preserved as in source:
  - Examples of eligible project types include: planting concentrated paper raw-material forests, pulp and artificial board associated with processing enterprises; projects aimed at producing prototype breeds and new breeds using high technology; potable water projects; production and processing of industrial salt; manufacturing of antibiotics; investment projects on job-training schools; investment projects on complete textile, printing and dying factories; manufacturing of vehicles with 25 or more seats with more than 40 percent domestic content; manufacturing of diesel engines of 300 CV or more; manufacturing of heavy and new mechanical products and large-scale casting projects; manufacturing of nitrogenous and DAP fertilizers; reciprocal capital for projects financed through ODA on-lending.
  - Special authorizations and restrictions preserved as in source (e.g., special authorization to Song Cong Diesel Company for 100–400 CV engines; special authorizations via Decision 31 for certain cement projects and enterprises; Vinashin company special authorization; geographic eligibility notes tied to government lists B and C; rural areas indicated by a double asterisk).

*Source: IMF staff compilation based on the supplied content.*

### 1.      Regional trade integration has gained momentum in recent years in the Asia and

### Regional trade integration has gained momentum in recent years in the Asia and Pacific region

### Vietnam’s trade performance and openness
- During 1993–2004, Vietnam’s trade openness (exports plus imports in relation to GDP) more than doubled, while market share of its exports more than tripled (Tables 1 and 2).
- Vietnam’s CEPT rates had fallen to an average of 5.9 percent, down from an average of 7.1 percent in 1999.
- Simple average tariffs, 2002:
  - Vietnam 16.5
  - Asia and Pacific region 12.0
  - APEC 8.1
  - ASEAN 8.8
  - ASEAN-5 7.5
  - World 12.6
- Under the 2001 bilateral trade agreement (BTA) with the United States:
  - U.S. tariffs on imports from Vietnam fell dramatically on average to around 3–4 percent from around 40 percent.
  - The BTA required Vietnam to reduce its tariffs by 25–50 percent, mostly on agricultural products.
- Vietnam applied to join the WTO in 1995 and is expected to become a WTO member in 2006.

### Regional agreements, timelines, and commitments
- ASEAN / AFTA:
  - AFTA objective: integrate ASEAN economies via the Common Effective Preferential Tariff (CEPT) scheme to reduce tariffs to no more than 5 percent.
  - Tariff reduction completion targets:
    - ASEAN-6 (original five members + Brunei Darussalam): by 2003.
    - Newer members: Vietnam committed to reduce its CEPT to no more than 5 percent by 2006; Lao P.D.R. and Myanmar by 2008; Cambodia by 2010.
    - All import duties to be eliminated by 2010 for the former six countries and by 2015 for the latter four.
  - More than 99 percent of products in the CEPT Inclusion List of the ASEAN-6 have been brought down to the zero percent tariff rate.
- APEC:
  - APEC trade liberalization is based on concerted unilateral liberalization under MFN; Bogor Declaration targets: free trade by 2010 for developed and by 2020 for developing countries.
  - APEC tariffs are below the world average and declining.
- Trade evolution (selected observations from ASEAN statistics, 1993–2003):
  - Intra-ASEAN exports rose overall (total intra-ASEAN trade increased markedly over the decade).
  - Vietnam’s intra- and extra-ASEAN exports and imports rose substantially (e.g., Vietnam exports to APEC rose from 2,211 in 1993 to 14,839 in 2003; percentage change 571/137 as presented in Table 6).

### The gravity model: specification, data, and identification
- Model equation (log-linear gravity specification):
  LnTradeij = α + β1 Ln[GDPi GDPj] + β2 Ln[GDP per capitai GDP per capitaj] + β3 Ln[Distij] + β4 RTA + εij
- Key modeling choices:
  - Economic mass proxied by product of GDPs; development level proxied by product of GDP per capita; distance between economic centers; RTA membership dummy variables.
  - Distance expected negative; all other continuous variables expected positive.
  - All variables in natural logs except RTA dummies.
- Data and estimation:
  - Cross-sectional COMTRADE bilateral trade data for the year 2002.
  - Sample: 182 countries and 32,942 observations.
  - OLS regression technique applied to estimate coefficients.
- Identification of RTA effects:
  - Specification 1 (RTA2): RTA2 = 1 if both countries i and j are members of the same RTA; 0 otherwise. Positive coefficient → RTA generates more intra-member trade.
  - Specification 2 (RTA1 and RTA2): RTA1 = 1 if exactly one of the pair belongs to the tested RTA and the other does not; 0 otherwise. Coefficient on RTA1 captures trade between a member and a nonmember relative to non-RTA pairs. Negative coefficient on RTA1 → evidence of trade diversion.
  - An “Asia effect” is introduced in some regressions to capture Asia-specific features unrelated to RTA membership (e.g., regional growth dynamism).
  - A subgroup dummy (ASEAN-5) is tested to capture differential effects for the original ASEAN members with lower average MFN tariffs.

### Empirical findings and interpretation
- Aggregate result on RTAs:
  - RTAs in the Asia and Pacific region have promoted trade among their members.
  - These RTA effects do not appear to have occurred at the expense of trade with nonmembers.
- Vietnam-specific fit and inference:
  - The model’s estimates fit Vietnam’s cross-country trade flows well, on average.
  - While the impact of RTAs on Vietnam’s trade appears to have been strong, it is unlikely that the increasing trade with RTA members has been accompanied by diversion of trade vis-à-vis nonmembers.
- Implication for trade creation versus trade diversion:
  - Positive RTA2 coefficients indicate trade creation among RTA members.
  - Absence of negative RTA1 effects for the RTAs analyzed suggests limited evidence of trade diversion from nonmembers.

### Organization of the chapter and robustness
- Chapter layout:
  - Section B: review of RTAs in the Asia and Pacific region and Vietnam’s integration progress (regional and multilateral).
  - Section C: presentation of gravity model.
  - Section D: regression results.
  - Section E: assessment of whether Vietnam overtrades or undertrades with neighboring countries using regression results.
  - Section F: conclusions.
  - Annex: further discussion of model specifications.
- Model robustness features:
  - Multiple RTA dummies estimated simultaneously across seven regressions to measure effects of membership in several—and sometimes simultaneous—RTAs.
  - Comparison across specifications that include/exclude Asia effect and ASEAN-5 subgroup.

*Prepared by Patrizia Tumbarello (APD). Source: IMF staff chapter content as provided.*

### 17.      The empirical estimates show that all three standard gravity variables—

### The empirical estimates show that all three standard gravity variables—economic size, per capita income, and bilateral distance—are statistically significant at the 99 percent confidence level and have the expected signs

### Empirical estimates of standard gravity variables
- GDP coefficient (regression 1, Column i) = 1.07.
- GDP per capita coefficient (regression 1, Column i) = 0.16.
- Distance coefficient (regression 1, Column i) = -1.129.
- Interpretation: trade increases with country size and income; trade decreases with distance (transportation costs).
- Elasticity example: when the distance between two countries is increased by 1 percent, trade between them falls by 1.13 percent.

### Impact of Regional Trade Agreements (RTAs) on bilateral trade flows
- General finding: RTAs established under the auspices of ASEAN and APEC have generally had a positive impact on bilateral trade among their members; regional dummies in regressions 1, 5, 6 and 7 are highly significant and positive.
- ASEAN (regression 6): trade between two ASEAN countries is estimated to be four times larger than between two otherwise similar countries.
- Simultaneous ASEAN and APEC test (regression 5): ASEAN bilateral trade estimated to be 1.2 times more than any other similar pairing.
  - Calculations shown: [exp(1.649)-1=4.2] and [exp(0.806)-1=1.2].
- ASEAN-5 (regression 7): trade among the ASEAN-5 countries is five times greater than between two otherwise similar countries.
  - Explanation: ASEAN-5 have liberalized their trade regimes more than the broader ASEAN group, yielding a larger positive impact.
- Asia region (regression 1): two Asian countries trade 2.6 times more than two similar countries of which at most one belongs to the Asia region, even when testing simultaneously for APEC effect.
- APEC (regression 1): two APEC countries tend to trade 3.6 times more than another similar pair of non-APEC countries when controlling for an Asia effect.
- Regression 6 finding: bilateral intra-ASEAN trade is estimated to be 180 percent greater than the bilateral trade of ASEAN members with nonmembers; however, ASEAN effect becomes non-significant when an APEC effect is introduced (regression 5).

### Trade-creation versus trade-diversion (second specification)
- Second specification separates RTA2 and RTA1 effects:
  - RTA2 = both countries are RTA members.
  - RTA1 = one country is an RTA member and the other is not.
- Key result: coefficients on both the RTA2 and RTA1 dummies are positive for APEC, ASEAN, and ASEAN-5 wherever statistically significant (e.g., equations 1, 3, 6, 7), indicating membership is associated with increasing trade both with members and nonmembers (trade-creating effect).
- Regression 5 (second specification):
  - Both ASEAN and APEC members traded more with each other and with nonmembers than predicted by a standard gravity model that abstracts from RTAs (both RTA1 coefficients positive).
  - When allowing for trade-creation and trade-diversion, trade between two APEC countries is estimated to be 4.2 times greater than trade between an APEC member and a non-APEC member (regression 5).
    - Note: this 4.2 estimate is lower than the corresponding first-specification estimate because of different comparison groups.

### Vietnam: actual versus predicted bilateral trade (model fit and patterns)
- Overall model fit:
  - The gravity model appears to account for 84 percent of Vietnam’s world trade flows.
  - The model provides at least as good an account of Vietnam’s trade with emerging Asia and NIEs.
- Key country- and region-level Predicted-to-Actual ratios (based on Table 8; one hundred indicates perfect prediction; numbers >100 indicate undertrading, numbers <100 indicate overtrading):
  - Japan — Actual: 5,031; Predicted: 10,971; Predicted-to-Actual: 218.
  - Singapore — Actual: 3,471; Predicted: 367; Predicted-to-Actual: 11.
  - China — Actual: 3,275; Predicted: 3,386; Predicted-to-Actual: 103.
  - United States — Actual: 3,041; Predicted: 2,794; Predicted-to-Actual: 92.
  - Hong Kong SAR — Actual: 1,061; Predicted: 2,318; Predicted-to-Actual: 218.
  - Malaysia — Actual: 1,010; Predicted: 332; Predicted-to-Actual: 33.
  - ASEAN-5 — Actual: 2,969; Predicted: 1,909; Predicted-to-Actual: 64.
  - ASEAN — Actual: 6,574; Predicted: 2,297; Predicted-to-Actual: 35.
  - APEC — Actual: 21,910; Predicted: 24,229; Predicted-to-Actual: 111.
  - World — Actual: 30,450; Predicted: 25,648; Predicted-to-Actual: 84.
- Interpretation of Vietnam results:
  - The model indicates unexploited trade potential on average with APEC countries and the Asia and Pacific region.
  - Significant overtrading with ASEAN overall—partly driven by overtrade with Singapore (role as transshipment center).
  - Model accounts almost fully for bilateral trade with China.
  - Significant undertrading with Japan (suggesting substantial potential for expanding exports to Japan); Japan granted MFN status to Vietnam in 1999, and the underlying data refer to 2002 (three years after MFN).
  - Undertrading also noted with Korea and, to a smaller extent, Hong Kong SAR.
  - Large overtrading with the Euro zone and the Russian Federation—possibly reflecting historical/political/cultural links not captured by the standard gravity model.
  - Model predicts bilateral trade with the United States accurately, but the gravity specification does not include a dummy for the 2001 BTA; inclusion might reveal further unexploited trade potential with the United States.

### Conclusions and policy implications for Vietnam
- Progress and challenges:
  - Vietnam has made considerable progress integrating regionally and multilaterally; trade with ASEAN and APEC countries increased rapidly over the last decade.
  - The 2001 BTA with the United States contributed to a sharp expansion in exports to the U.S. and likely supported multilateral liberalization.
  - Vietnam has opened its trade system substantially since the early 1990s and increased its export market share.
  - Vietnam’s MFN tariff remains relatively high, possibly reflecting ongoing tariffication of nontariff barriers; scope exists for further multilateral liberalization.
- RTA effects and policy implications:
  - APEC and ASEAN-5 have promoted trade among members and have not generally led to trade diversion; APEC’s open regionalism shows particularly strong trade-creating effects.
  - The trade-creating effects of broader ASEAN membership appear less pronounced, possibly because the average MFN tariff of ASEAN members is still higher than the average MFN tariff of other groups.
  - Policy recommendation: ASEAN members with more restrictive trade regimes should continue to decrease their MFN tariffs to minimize risks of trade diversion.
- Strategic recommendation for Vietnam:
  - While enhancing intra-Asian integration is desirable, regional integration cannot substitute for multilateral liberalization.
  - Vietnam should strengthen outward-oriented policies toward the rest of the world and pursue WTO accession in the near future; continuing multilateral liberalization will help Vietnam reap the benefits of regional integration without significant trade diversion.

### Gravity model specifications (annex summary)
- First specification (Table 7, Column i):
  - LnTradeij = α + β1 LnGDPi + β2 (GDPi/Popi) + β3 LnGDPj + β4 RTA2 + β? Dist + ε
  - RTA2 dummy (β4) = 1 if both countries belong to the same RTA; measures extra trade between two RTA members relative to pairs where at most one is a member.
- Second specification (Table 7, Column ii):
  - LnTradeij = α + β1 LnGDPi + β2 (GDPi/Popi) + β3 LnGDPj + β5 RTA2 + β6 RTA1 + β? Dist + ε
  - RTA1 dummy (β6) = 1 if exactly one country in the pair belongs to the tested RTA.
  - In the second specification, β5 measures extra trade between two RTA members relative to two non-RTA members; β6 measures trade between one RTA member and one nonmember relative to two nonmembers. The difference (RTA2 − RTA1) represents trade between two RTA members relative to one member and one nonmember.
- Data notes:
  - Dependent variable: bilateral trade of 182 countries in 2002 (sum of exports and imports). Data do not include Brunei Darussalam and Taiwan Province of China.
  - Standard errors and R-squared adjusted for duplication of observations (original 32,942 observations; corrected number 16,471).
  - Sources: GDP and population data from WEO; distance data from CEPII database; trade data from COMTRADE.

*Source: Author's estimations and accompanying text from the specified IMF chapter.*

### 1.      The role workers’ remittances play in economic development, their determinants, and

### The role workers’ remittances play in economic development, their determinants, and the channels through which they are transferred

### Overview: size, measurement, and macroeconomic relevance
- No public record exists of the number of Vietnamese migrants abroad or their incomes; available estimates are based on incomplete information and anecdotal evidence.
- Permanent migrants (Viet Kieu) are estimated at about 3 million (close to 4 percent of the country’s population).
- Temporary migrants are currently estimated at about 300-400 thousand.
- Measured remittances exclude transfers through informal channels; under-reporting was substantial in the 1990s but likely declined with liberalization and improved integration with international transfer networks.
- Market estimates of remittance flows and reporting:
  - Majority of migrants remit annually US$500-1000 each through official channels; temporary workers remit US$300–500 each.
  - Implied total annual remittances in the range of US$1.5 to 3.0 billion; the upper bound is in line with official data for recent years.
  - Informal remittances are estimated by some to be another US$1.5–3.0 billion.
- Official balance of payments reporting of remittances began in 1991 and covered only flows through official channels (banking system, licensed transfer companies, postal and customs offices).
- Reported remittances grew from US$35 million in 1991 to almost US$3 billion by 2004.
- Remittances’ coverage of merchandise imports rose from less than 2 percent to almost 10 percent over the same period.
- In 2004 the size of remittances was substantially larger than equity FDI or ODA disbursements (Table 3 notes this comparison).

### Migrant types, earnings, and remittance behavior
- Two broad migrant groups:
  - Permanent migrants (Viet Kieu): about 90 percent of total migrants; tend to be trained professionals or small business owners; earn higher incomes abroad; remit a smaller portion of income but higher absolute amounts; many settled in United States, Germany, Australia, Canada.
  - Temporary migrants: initially hired for 2–3 year contracts; often overstay to accumulate more savings; typically less skilled; most work in East Asian countries (notably Taiwan Province of China, Malaysia, South Korea per Table 2).
- Reported earnings:
  - Temporary workers earn US$100–350 per month on average, excluding food and accommodation (which are often provided).
  - When food and accommodation are not included (typically for more skilled labor), temporary workers’ average monthly salary is reported to be US$500–600.
- Remittance patterns:
  - Permanent migrants remit a smaller fraction of income due to closer ties to host countries and support of non-working family members abroad, but absolute remittances per person are likely higher.
  - Aggregate remittances are higher for permanent migrants because they constitute about 90 percent of total migrants.

### Channels, measurement issues, and classification challenges
- Official channels reported: banking system, licensed transfer companies, postal and customs offices; large transfer companies such as Western Union and Moneygram have been allowed to operate and form alliances with local banks.
- Informal channels (cash carried across borders, transfers around Tet) were previously substantial.
- Important measurement and conceptual issues:
  - Workers’ remittances in principle should include only transfers remitted by workers who are not permanent residents of the host country; bulk of Vietnam’s remittances are migrants’ remittances rather than narrowly defined workers’ remittances.
  - Remittances should be unrequited transfers. Some recorded “remittances” may actually be payments for acquisition of real estate or other assets by Viet Kieu and should be classified in the capital account (FDI or portfolio investment) rather than as private transfers.
  - If unreported remittances were fully recorded, net errors and omissions could become a large negative number, indicating large unreported outflows.

### Government policies and institutional changes affecting remittances (Box 1)
- Factors encouraging flows through official channels:
  - Arbitrary treatment of formal transfers (including possible seizure) discontinued; monitoring relaxed.
  - Migration and remittances encouraged by labor and immigration regulations since mid-1990s, including:
    - Government Decree No. 12/1995/ND-CP on social security registration;
    - Government Decree No. 152/1999/ND-CP and Circular No. 28/1999/TT-BLDTBXH on implementation of the Labor Code for temporary workers abroad;
    - Decree No. 05/2000 on the exit and entry of Vietnamese citizens.
  - A 5 percent tax on remittances was removed in 1997; the personal income tax on them was removed in August 1999 (Government Decision No. 170-1999-QD-TTg).
  - Regulations mandating that transfers be withdrawn only in local currency were removed in August 1999 (Decision No. 170); transfers can now be withdrawn in foreign currencies or maintained in bank accounts in these currencies.
  - Large transfer companies (Western Union, Moneygram) allowed to operate and partner with local banks, expanding distribution networks into urban and rural areas.
  - Government Decree No. 81-2001-ND-CP allowed Viet Kieu to purchase residential housing in Vietnam; Joint Ministerial Circular (02-2005-TTLT-BKH-BTP-BNG-BCA) reasserted this right and further liberalized investment regulations for foreigners and Viet Kieu (e.g., removed the 30 percent cap on ownership of a single company if that company is not governed by the Law on State-Owned Enterprises).

### Benefits of remittances for Vietnam
- Balance of payments support:
  - Remittances are non-debt creating, typically stable, and exhibit low volatility relative to other foreign exchange receipts, making them valuable for balance of payments support.
- Contribution to growth:
  - As unrequited receipts they increase absorptive capacity (consumption plus investment), can finance physical and human capital, and thus can enhance productivity and growth.
  - Potential Dutch Disease risk (real exchange rate appreciation reducing competitiveness) can be mitigated by sound macroeconomic policies; to date Vietnam shows moderate real exchange rate appreciation and continued upward trend in non-oil export market share.
- Financial sector and knowledge spillovers:
  - Remittances provide financing formally and informally, promoting financial sector development and private sector growth in a transition economy.
  - Professional and business background of many Vietnamese migrants could bring benefits similar to FDI by transferring entrepreneurial skills and technological knowledge, potentially offsetting “brain drain” effects.
- Poverty reduction:
  - Remittances often reach lower-income groups and improve housing, nutrition, health care, education, and finance small businesses that create employment.

### Determinants and analytical approaches
- Two main theoretical approaches:
  - Portfolio approach: migrants’ decisions to transfer funds for homeland investment rather than investing in host country.
  - Altruism approach: family and personal links motivating migrants to remit to help family or country.
- Both approaches recognize the role of host-country economic conditions; they are not mutually exclusive and likely combine in practice.
- Empirical assessment for Vietnam:
  - Rigorous econometric analysis is difficult due to short time series (15 years).
  - The chapter relies mainly on findings from cross-section studies and assesses applicability to Vietnam.
  - An OLS regression is estimated for Vietnam as an indicative exercise, but results are to be viewed cautiously.

*Prepared by Khaled Sakr — summary based solely on the provided chapter text.*

### 19.      The major determinants of remittances can be derived from the two main factors

### _cr0620 - 19.      The major determinants of remittances can be derived from the two main factors

### Determinants: Altruism and Portfolio Considerations
- Altruism: migrants help relatives in the homeland; implies remittances higher the worse the economic situation in the homeland. Expected negative correlation with per capita income in Vietnam under pure altruism.
- Portfolio considerations: migrants invest more in the homeland the better the economic environment is there. Some studies use per capita income in the homeland to represent this factor and the altruism motivation combined.
- For Vietnam, the aggregate impact of both factors is expected to be positively correlated with Vietnam’s per capita income because:
  - Portfolio considerations are expected to dominate given the relatively high level of income of the majority of migrants (Viet Kieu).
  - Viet Kieu have a relatively weaker relationship with the home country compared to typical developing-country migrants.
- Alternative proxies and considerations:
  - Interest rate differential between home and host countries could proxy difference in rates of return, but requires financial system liberalization and monetary policy independence.
  - A viable alternative proxy for the attractiveness of the investment environment and economic prospects is FDI; remittances would be expected to be positively correlated with FDI inflows.
- Migrant income effect:
  - Represented by per capita income in host countries; for Vietnam, average income in the main host country, the U.S., is a reasonable proxy.
  - Remittances generally expected to be positively correlated with per capita income in the host country.
  - However, higher per capita income in the host country could indicate better investment opportunities there, which could motivate migrants to remit less.
- Transfer restrictions and fees:
  - Remittances, especially those transferred through official channels, are highly sensitive to restrictions, fees, and transfer security.
  - Removing restrictions while implementing effective AML/CFT safeguards should help attract more remittances through official channels.
  - The relaxation of regulatory framework and of restrictions on investments by non-residents in the second half of the 1990s can be represented by a dummy variable, and the more recent relaxation in the last few years by another dummy.

### Empirical specification and OLS results (1991–2005)
- Estimated OLS regression on annual data over the period 1991–2005 (using estimated data for 2005):
  - REMIT = 2.03 + 2.85*GDPpc – 1.21*USGDPpc + 0.02*FDI + 0.53*D1996 + 0.12*D2000
    - (0.09)       (2.54)          (-0.45)        (0.04)          (1.50)           (0.32)
  - R-squared = 0.979
  - DW = 2.085
- Variable definitions:
  - REMIT = remittances
  - GDPpc = Vietnam’s per capita income
  - USGDPpc = per capita income in the U.S.
  - FDI = foreign direct investment
  - D1996 = dummy variable equal to 1 during 1996-2005 and 0 during 1991-95
  - D2000 = dummy variable equal to 1 during 2000-05 and 0 during 1991-99
- Numbers in parentheses are t-statistics.

### Interpretation and robustness caveats
- Caution advised due to short sample period, which did not allow for stationarity tests or cointegration techniques.
- Evidence supports the portfolio approach for Vietnam:
  - Remittances appear positively correlated with favorable economic conditions in the homeland as represented by per capita GDP.
  - Remittances appear positively correlated with the overall investment climate (as proxied by FDI).
  - Remittances appear correlated with relaxation of the regulatory environment, particularly in the late-1990s.
- The coefficient for per capita GDP in the U.S. is negative (–1.21) but statistically insignificant (t-statistic = –0.45). This is consistent with portfolio dominance: improving economic conditions in the U.S. could make Vietnam relatively less attractive as an investment destination, reducing remittances.

### Conclusions and policy recommendations
- Remittances play an increasingly important role in supporting Vietnam’s balance of payments and have potential contributions to economic development and poverty reduction.
- Remittances in Vietnam are likely to be heavily influenced by:
  - Overall economic conditions,
  - The investment climate,
  - The degree of openness in the regulatory framework.
- Policy actions to continue attracting remittances:
  - Continue reforms aimed at enhancing the investment climate.
  - Further liberalize the trade and exchange system while putting in place effective safeguards to combat illicit flows (AML/CFT).
  - Continue to relax regulations governing the ability of Viet Kieu to buy property and other assets.

### Risks, mitigation, and data needs
- Potential risks from continued increases in remittances:
  - Risk of Dutch Disease if competitiveness is not maintained.
- Mitigation measures:
  - Continue to enhance competitiveness through structural reforms.
  - Avoid significant misalignment in the real exchange rate through maintenance of sound macroeconomic policies and a flexible exchange rate policy.
- Data recommendation:
  - Address identified data issues to facilitate economic analysis and policy assessments.

*IMF staff analysis in document _cr0620, Section 19–27*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr0620.pdf_