## 1. Poverty Reduction, Inclusive Growth, and Remaining Challenges ## Source details **Canonical URL:** [1. Poverty Reduction, Inclusive Growth, and Remaining Challenges](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14311.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14311.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14311.pdf.json) --- ### Context: recent performance and vulnerabilities - Growth is improving gradually, underpinned by robust exports and foreign direct investment (FDI), while domestic activity remains subdued. - Inflation has declined to mid-single digits. - The external current account remains in large surplus and international reserves have increased. - Significant gains in poverty reduction made in recent decades have been preserved. - Growth is below its previous trend and the economy is exposed to spillovers from downside external shocks. - Domestic vulnerabilities include banking sector weakness and inefficient state-owned enterprises (SOEs), both restraining activity. - Public and publicly guaranteed debt has risen to a level that requires attention. - Government targets (through 2020): average growth of 6½–7 percent with single-digit inflation. - Recommended macro/structural priorities: - Prioritize macroeconomic stability, tackle banking sector vulnerabilities, and reform SOEs and public investment. - Accelerate and deepen reforms, create fiscal space to address potential contingent liabilities from reforms while safeguarding critical social and investment spending. - Move gradually toward using inflation as a nominal anchor with greater exchange rate flexibility. ### Progress on past Fund advice and implementation gaps - Banking system reforms initiated, including individual bank restructuring plans, and a scheme to transfer nonperforming loans (NPLs) to an asset management company. - Full implementation of prudential regulations to bring asset classification and provisioning closer to international standards has been delayed. - Slow progress in NPL resolution and bank recapitalization. - SOE restructuring has progressed with plans for equitization, enhanced transparency, and legal framework improvements, but implementation has been slow. - Fiscal consolidation has not materialized. ### Key statistics and indicators - Real GDP expanded by about 5½ percent in 2013. - Headline and core inflation have fallen, to 5 and 3½ percent, respectively, in mid-2014. - The 2013 fiscal deficit is estimated at 5½ percent of GDP (GFS 2001), compared to 4¼ percent implied by the budget. - Tax revenues fell short by about 1½ percentage points of GDP. - The State Bank of Vietnam (SBV) reduced policy rates by 50 basis points in early 2014. - Private sector credit growth was 2¼ percent (s.a., ytd) in March 2014. - System-wide loan-to-deposit ratio has fallen to below 90 percent from a peak of around 105 percent in 2011. - The official NPL ratio rose to 4.2 percent. - System-wide ROA and ROE in 2013 were 0.5 and 5.6 percent, respectively. - Prices of real estate have fallen by about 50 percent from their peak. - Gross international reserves rose in early 2014 to above US$36 billion, 2½ months of prospective imports of goods and services. - Current account surplus was 5½ percent of GDP in 2013. - Staff’s baseline projection for 2014: real GDP growth at 5½ percent, inflation around 5¼ percent, the current account in surplus, and reserves around 2½ months of prospective goods and services imports. - Medium-term projection: growth around 6 percent. - Under the current fiscal stance, public sector debt would accumulate to around 60 percent of GDP (slightly below the authorities’ legal limit of 65 percent). ### Policy implications highlighted - Accelerate banking sector reforms, including stricter loan classification and provisioning, NPL resolution, and bank recapitalization. - Advance SOE restructuring, equitization, transparency improvements, and legal reforms. - Create fiscal space to manage contingent liabilities from reforms while protecting social and investment spending. - Transition gradually to an inflation-anchored monetary framework with greater exchange rate flexibility. ### Box 1 — Poverty reduction, distributional challenges, and recommended policies - Poverty measurement: - “Basic needs” poverty line (updated in 2010): national poverty rate declined from 58 percent in 1993 to around 17 percent in 2012. - Second approach (rice equivalents revised in 2005): poverty fell from around 28 percent in the early 1990s to around 9½ percent by 2012—the official rate. - Inequality and distribution: - Gini coefficient was 0.39 in 2012. - Remaining poor depend heavily on subsistence agriculture and live in remote upland rural regions. - Poverty has taken an increasingly ethnic dimension; income gap between ethnic minorities and the Kinh majority has grown. - Many incomes remain close to the poverty level and are susceptible to falling back into poverty from macroeconomic shocks. - Quality of, and access to, public services and social assistance vary between rich and poor households. - Policy recommendations: - Ensure macroeconomic stability and reduce vulnerabilities, and pursue structural reforms to support robust, sustainable growth. - Support productivity growth in rural areas through improved connectivity, strengthening skills, improving the investment climate, expanding access to basic services, better targeting agricultural and social support, and fostering occupational and geographic mobility of labor. - Improve access of the poor to higher-quality education and health services, particularly in rural areas and by minority ethnic groups. - Better target social spending and social assistance to account for regional differences in the cost of living and basic services. - Improve the system for monitoring and publishing data on poverty. ### Box 2 — Productivity, technical efficiency, and potential GDP - TFP trends and frontier analysis: - Total factor productivity (TFP) contribution to growth has declined in the last decade; capital’s contribution increased but by less than TFP’s decline, leading to slower growth. - Stochastic production frontier analysis (Cobb-Douglas form with a composed error term) estimated using Penn World Tables data from 1970 to 2013. - Estimated inefficiency gap increased in the early 1990s, early 2000s, and again from 2009 forward. - Potential output and output gap: - Potential growth is currently around 6 percent (below the 7 percent average of the last decade). - A negative output gap opened after the global financial crisis and widened to around 1½ percent of potential GDP in 2013. - The output gap tracks well with recent inflation trends. - Implication: - Under a gradual reform scenario with inputs, TFP, and inefficiency around current levels, potential growth would remain close to around 6 percent in coming years. --- ### Risk assessment and potential shocks (scenario: slow banking reform) - Domestic risks are tilted to the downside if banking reform is slow, raising vulnerability to adverse shocks and negative macro-financial feedback. - Delays in fiscal consolidation would reduce fiscal space for banking and SOE reforms, could pressure interest rates, crowd out growth-enhancing spending, erode public confidence, and ultimately undermine debt sustainability. - Risk matrix highlights (Risk — Likelihood — Impact — Policy Response): - Banking distress becomes acute — LH — Adverse macro-financial feedback loop — Activate crisis management plan; ensure emergency liquidity while maintaining monetary control; orderly bank resolution and recapitalization; strengthen safety nets. - Fiscal consolidation delayed — MM — Persistently higher interest rates; business confidence undermined — Broaden revenue base; reduce exemptions; strengthen administration; introduce a property tax; curtail non-essential spending. - Surges in global financial market volatility — HL — Capital outflows pressure exchange rate and reserves — Greater exchange rate flexibility; stand ready to raise interest rates; accelerate fiscal consolidation and structural reforms. - Protracted slower growth in advanced and emerging economies, growth slowdown in China — H/MM — Weaker export growth and remittances — Adopt monetary policy with more exchange rate flexibility; accelerate financial sector and SOE reforms. - Geopolitical disruptions in East Asia — H — Capital flight, weaker FDI inflows, lower tourism, export and import growth — Stand ready to raise interest rates; allow exchange rate flexibility; accelerate structural reforms. - Earlier-than-expected implementation of TPP or FTAs — L — Stronger exports and investment; productivity improvement — Accelerate SOE and market reforms; adopt monetary policy framework with more exchange rate flexibility. ### External vulnerabilities and regional linkages - Short-term external risks include surges in global financial market volatility and higher global interest rates. - Medium-term external risks stem from high openness and reliance on FDI; China is a key trade, FDI, and tourism partner. - Upside opportunities: early agreement on TPP and FTAs with EU and Korea could secure export market access and spur reforms. ### Authorities’ assessment and responses to external risks - Authorities broadly concurred with the near-term macroeconomic outlook. - Mitigating actions: reassured investors after geopolitical events; emphasized structural reforms, trade diversification, and on-shoring through TPP and other FTAs. - Authorities noted current account surplus, capital flows management, and relatively small holdings of domestic assets by nonresidents limited impact of global financial volatility. - On domestic risks, authorities reported work underway on bank and SOE restructuring; viewed systemic distress risk as small. - They considered public debt manageable but recognized risks of further increases and plan gradual fiscal tightening. ### Fiscal position, recent stance, and vulnerabilities - 2014 deficit projected to rise to around 6½ percent of GDP (GFS 2001). - Revenue shortfalls linked to corporate income tax cut from 25 to 22 percent, tariff reductions, exemptions, and subdued growth. - Revenue and expenditure dynamics: - Tax and tariff reductions and exemptions have eroded revenues as a share of GDP. - Improved administration measures include reducing tax evasion and arrears, disclosing incidents of tax fraud, and streamlining VAT refunds while introducing thresholds. - Profitable SOEs required to pay dividends in 2013–14. - VAT rate halved for certain housing projects; corporate income tax rate reduction to 20 percent planned in 2016. - Composition of expenditure: - Spending on education is higher than in comparator low-income and emerging-market countries. - Expenditure on public employee compensation is significantly higher as a share of GDP. - Capital spending has historically been in line with other low-income countries, but a decline is budgeted in the current year. ### Public debt: levels, risks, and debt threshold analysis - Public debt projections and facts: - Public debt projected to increase to around 55 percent of GDP in 2014. - Public and publicly-guaranteed debt almost doubled since 2000; at around 55 percent of GDP in 2014, higher than regional averages. - Domestic debt has accounted for most of the increase. - Domestic bond market: - Maturities < seven years comprised 94 percent of total annual domestic bond issuance in 2008–13. - Agencies other than the Ministry of Finance may issue bonds with maturities exceeding one year. - Debt threshold estimation: - Three econometric models applied; a buffer for contingent liabilities subtracted. - Results suggest a safe debt level ranging from 40 to 45 percent of GDP for Vietnam. ### Staff recommendations on fiscal consolidation and reforms - Objective: return the debt ratio over the medium term closer to 45 percent of GDP. - Revenue-side measures: - Broaden the tax base: eliminate exemptions, reduce incentives, introduce a property tax, include pensions under personal income tax. - Forgo planned corporate income tax reduction would contribute around ⅓ percentage points of GDP in revenue. - Institutionalize SOE dividend payments to the budget. - Strengthen tax administration to restore past revenue productivity. - Expenditure-side measures: - Protect social spending and well-targeted capital expenditure. - Rationalize the public wage bill through efficiency-enhancing civil-service reforms. ### Authorities’ position on fiscal reform and consolidation - Authorities broadly agreed with the baseline fiscal assessment and aim to broaden the tax base and strengthen administration. - Noted political/difficulty constraints: property tax and personal income tax on pensions would be difficult to enact. - Consideration being given to raising excises. - Authorities emphasized protecting social spending with priority to poverty reduction, agriculture and rural areas. - Revised Public Investment Law adopted to enhance prioritization; greater use of public-private partnerships under consideration. - Authorities expect debt-GDP ratio to peak around 2016 and decline afterward; government ceiling of 65 percent of GDP would not be breached. - Authorities reiterated that public funds would not be used for banking sector restructuring. ### Fiscal consolidation scenario (IMF staff projections; percent of GDP) - Total revenue and grants: 2014 20.3; 2015 20.9; 2016 21.6; 2017 22.4; 2018 23.0; 2019 23.7; 2020 24.3; 2021 24.9; 2022 25.4 - Capital expenditure: 2014 6.5; 2015 6.5; 2016 6.6; 2017 6.6; 2018 6.7; 2019 6.8; 2020 6.9; 2021 6.9; 2022 7.0 - Non-interest current expenditure: 2014 18.9; 2015 18.6; 2016 18.4; 2017 18.1; 2018 17.9; 2019 17.6; 2020 17.4; 2021 17.1; 2022 16.9 - Interest expense: 2014 1.5; 2015 1.5; 2016 1.6; 2017 1.6; 2018 1.6; 2019 1.6; 2020 1.4; 2021 1.4; 2022 1.2 - Net lending (+)/borrowing (-): 2014 -6.6; 2015 -5.7; 2016 -4.9; 2017 -4.0; 2018 -3.1; 2019 -2.3; 2020 -1.4; 2021 -0.6; 2022 0.3 - Public and public-guaranteed debt: 2014 54.8; 2015 56.8; 2016 58.2; 2017 58.4; 2018 57.6; 2019 56.0; 2020 53.6; 2021 50.8; 2022 47.3 - Real growth impact (percentage point): 2016 0.0; 2017 0.1; 2018 -0.2; 2019 0.0; 2020 -0.1; 2021 -0.2; 2022 -0.2; 2023 -0.3; 2024 -0.2 ### Public debt dynamics, DSA findings, and stress tests - At end-2013: - Total external debt (including private sector debt) amounted to 38.5 percent of GDP. - Public and PPG external debt amounted to 26.5 percent of GDP. - Domestic PPG debt amounted to 25 percent in 2013. - Total PPG debt amounted to 51.6 percent of GDP. - External DSA: - PV of PPG external debt to GDP projected to decline in the long-term and remain well below thresholds. - Debt-service to revenue ratio projected to rise in the medium-term before declining. - PV of PPG external debt most sensitive to a one-time depreciation; nevertheless remains below thresholds under stress. - Public DSA: - Baseline: public sector debt projected to reach around 60 percent of GDP by 2017. - Fixed primary balance scenario (primary deficit of 4 percent of GDP): PV of debt to GDP becomes unsustainable. - One-time nominal depreciation of 30 percent: PV of debt to GDP increases to about 10 percentage points below the 74 percent benchmark in 2016–18 before declining. - Banking sector distress scenario (additional 15 percent of GDP liabilities absorbed by government; GDP growth falling to 3 percent in both years): PV of debt to GDP hits 74 percent around 2019 and remains above; PV of debt to revenue would rise to over 350 percent; debt service to revenue would rise to over 70 percent in the long-term. - Staff conclusion: current debt indicators remain below distress thresholds and Vietnam is at low risk of external debt distress, but the public debt profile has worsened and consolidation is advised. ### Macroeconomic projections and outlook (selected) - Real GDP growth projected to decline gradually to 5½ percent after 2020 as demographic dividend dissipates. - Selected time-series entries reported for growth and inflation across tables (examples): - Real GDP growth series (selected): 6.2; 5.2; 5.4; 6.4; 0.9; 5.5; 5.6; 5.7; 5.8; 5.9; 6.0; 5.7; 5.5; 5.5; 5.6 - Inflation (GDP deflator, percent) series (selected): 21.3; 10.9; 4.8; 12.3; 6.2; 6.4; 6.2; 4.2; 5.1; 4.3; 4.4; 5.1; 4.5; 4.4; 4.6 - Reserve coverage expected: around 2½ months of imports in 2014, rise to about 3½ months by 2016, and stabilize thereafter. - Current account: near-term surplus; medium-term deteriorates to a deficit “norm” of 4½ percent in the long term, mostly financed by continued FDI flows. ### Monetary policy stance and framework transition - Maintaining a supportive monetary stance is appropriate as long as inflation pressures remain absent. - Evidence: excess supply gap exists; growth below potential; core inflation declined; wage pressures benign. - Contingency for capital outflows: greater exchange rate flexibility should be first line of defense; consider raising domestic interest rates if significant outflows occur. - Recommended initial steps toward inflation targeting: - Gradually widen the band for exchange rate fluctuation. - Promote a deep and liquid foreign exchange market. - Establish an interest rate instrument while reducing reliance on quantitative targets. - Improve liquidity forecasting and management. - Reorient monetary policy communications increasingly toward price stability. - Exchange rate assessments: - Real effective exchange rate appreciated by about 2 percent compared to a year ago. - Alternative CGER outcomes: macro-balance suggests a 5–8 percent real effective appreciation needed; equilibrium approach suggests a 16 percent real effective depreciation needed; results have a large margin of error. - Reserve adequacy: - In early-2014, reserves were about 2½ months of prospective imports, below the 8 months average of regional emerging market countries and below minimum desirable for a fixed exchange rate per Fund metrics. - Staff: external position would benefit from fiscal consolidation, more flexible exchange rate, and higher reserves. ### Monetary transmission and bank lending - Methodology: panel Arellano-Bond GMM on bank balance sheet data (2000–2013) with interaction between policy rate and bank heterogeneity. - Findings: - Monetary policy changes have inverse direct impact on private credit growth common across banks. - Bank lending channel emerges after 2011; credit supply reacted less to policy rate changes in 2012–13 vs 2000–11. - Banks’ health is overriding determinant of credit supply: weakening banks lower credit growth; strengthening capital and liquidity would boost credit growth. - Elasticities align with estimates for Germany, France, and Italy (1999–2011). ### Banking sector reform: measures and remaining challenges - Recent measures: - Improved liquidity due to accommodative monetary conditions and FDI/remittance inflows. - Most banks asked to submit restructuring plans to SBV. - New risk management regulation based on Basle II being drafted; pilot in ten banks; phased compliance to 2015/2018. - VAMC purchasing NPLs and planning liquidation, restructuring, outright sales; capital to be increased. - Revised bankruptcy law adopted; related legislation under review. - Increased limit on banks’ single foreign owner under unchanged overall foreign ownership cap of 30 percent. - New Monetary and Financial Stability Department at SBV and an action plan for banking sector issued. - Persistent problems: - Asset quality under pressure from weak activity and real estate declines; profitability low. - Full implementation of tighter loan classification postponed to 2015; loan rescheduling and new lending to delinquent customers allowed until then. - Banks have five years to provision against NPLs sold to VAMC in exchange for nonmarketable, non-interest-paying, non-guaranteed bonds. - Legal hurdles for transfer of loan titles and collateral impede NPL resolution. - Macroprudential framework needs refinement; administrative levers (sector lending directives, interest rate limits) remain. ### Comprehensive banking reform agenda (core pillars and sequencing) - Assess recapitalization needs with priority for systemically important banks using diagnostics and strict prudential norms. - Revise classification criteria to guide resolution options and identify systemically important institutions. - Recapitalize, restructure, and resolve: immediate recapitalization of SOCBs after diagnostics; time-bound plans for undercapitalized but viable institutions; orderly resolution of non-viable institutions with legal frameworks for purchase and assumption. - Strengthen VAMC: more equity capital, legal framework for transfer of loans and collateral, legal/operational independence, transparent governance, incentives for rapid disposal, and a sunset clause. - Develop additional NPL resolution options: court-led track for large/complex groups; bank-led track with pre-packaged plans; special administrative restructuring track for selected SOEs financed by SOCBs. - Tighten supervision and phase out regulatory forbearance; eliminate measures allowing lending to defaulted borrowers. - Revamp crisis management architecture: senior policy group (SPG), technical secretariat, templates for notifications/instructions, communications strategy. - Strengthen financial safety nets: extraordinary liquidity provision and extended deposit insurance may be necessary, with ex-ante conditions and fiscal transparency. - Authorities broadly agree with recommendations but prefer more gradual pace to match capacity and support recovery; constraints include legal system, connected lending, and decision not to use public funds for recapitalization. ### SOE reform: progress, challenges, and measures - Progress: - Restructuring plans developed; legal amendments, divestment from noncore areas, and equitization underway. - New regulations to enhance SOEs’ financial reporting and transparency; several SOEs had IPOs. - Challenges: - Implementation uneven, especially among subsidiaries. - Fragmented oversight by government agencies. - Risk that partial equitization diverts attention from operational efficiency reforms. - Need for enhanced public disclosure of SOEs’ financial condition based on international accounting practices. - Measures to enhance restructuring: - Establish high-level steering committee to oversee reform and coordinate ministries. - Expand divestment scope beyond noncore areas; involve external management expertise where appropriate. - Enhance capacity at ministries and estimate restructuring costs to quantify fiscal implications. ### Staff appraisal and recommendations (summary) - Macroeconomic stabilization progress: inflation reduced to mid-single digits; growth recovering; current account surplus and rising reserves; banking system liquidity improved. - Main constraints: weak banks and inefficient SOEs; rising public debt reducing fiscal space. - Recommendations: - Fiscal consolidation to create space for critical expenditures and contingent liabilities; target medium-term public debt around 45 percent of GDP. - Raise revenue via broadening the base, improving administration, foregoing further corporate income tax cuts, and institutionalizing SOE dividends to budget. - Rationalize public expenditure and undertake civil service reforms to raise efficiency. - Gradually shift monetary policy framework from exchange rate anchor to inflation anchor; preparatory steps for inflation targeting recommended. - Expedite comprehensive banking sector restructuring: recognize NPL losses, restructure viable banks, orderly exit of insolvent institutions, diagnostic assessments, recapitalization (including foreign participation) under strict conditions, eliminate forbearance, and legal reforms for NPL resolution. - Accelerate and deepen SOE reform and governance improvements beyond partial equitization. - Consultation cycle: next Article IV recommended on standard 12-month cycle. ### Authorities’ response and views - Authorities broadly agree with staff’s assessment and recommendations. - Highlighted achievements: containing inflation, preserving macro stability, accelerating SOE and banking reforms, record international reserves of more than USD36 billion as of end-May 2014 (about 12 weeks of prospective imports), and improved banking governance and supervision. - Monetary and exchange rate policy actions: SBV depreciated VND by 100 bps on June 19, 2014; VND appreciated recently allowing SBV purchases of USD to raise reserves. - Liquidity and credit: banking system liquidity ample; credit low due to weak domestic demand. - Fiscal policy: commit to fiscal consolidation; government allowed reductions/deferrals/exemptions to provide breathing space for businesses; plan to reduce public service staff and delay public salary roadmap. - Financial sector reform: VAMC chartered capital to be tripled by end-2014; Circular 02 effective June 1, 2014; Circular 09 allows loan rescheduling without reclassification from 20 March 2014 to 31 March 2015 under conditions. - SOE reforms: hope to make significant progress by end-2015; relevant laws (Resolution No. 15/NQ-CP, Land Law 2013, Bankruptcy Law 2014) to facilitate bankruptcy proceedings and NPL resolution. - Concluding stance: authorities committed to reforms, recognize challenges and need for multilateral support. *Source: IMF staff report chapter "1. Poverty Reduction, Inclusive Growth, and Remaining Challenges" and excerpts from IMF staff analysis and authorities’ statement (IMF Article IV Consultation, 2014).* ### 1. Poverty Reduction, Inclusive Growth, and Remaining Challenges _______________________________4 ### 1. Poverty Reduction, Inclusive Growth, and Remaining Challenges ### Context: recent performance and vulnerabilities - Growth is improving gradually, underpinned by robust exports and foreign direct investment (FDI), while domestic activity remains subdued. - Inflation has declined to mid-single digits. - The external current account remains in large surplus and international reserves have increased. - Significant gains in poverty reduction made in recent decades have been preserved. - Growth is below its previous trend and the economy is exposed to spillovers from downside external shocks. - Domestic vulnerabilities include banking sector weakness and inefficient state-owned enterprises (SOEs), both restraining activity. - Public and publicly guaranteed debt has risen to a level that requires attention. - The government’s socio-economic development plan (through 2020) targets average growth of 6½–7 percent with single-digit inflation. - Recommended macro/structural priorities (as emphasized by the authorities and staff): - Prioritize macroeconomic stability, tackle banking sector vulnerabilities, and reform SOEs and public investment. - Accelerate and deepen reforms, create fiscal space to address potential contingent liabilities from reforms while safeguarding critical social and investment spending. - Move gradually toward using inflation as a nominal anchor with greater exchange rate flexibility to provide a monetary policy framework more conducive to maintaining stability and buffering external shocks. ### Progress on past Fund advice and implementation gaps - Banking system reforms initiated, including individual bank restructuring plans, and a scheme to transfer nonperforming loans (NPLs) to an asset management company. - Full implementation of prudential regulations to bring asset classification and provisioning closer to international standards has been delayed. - Slow progress in NPL resolution and bank recapitalization. - SOE restructuring has progressed with plans for equitization, enhanced transparency, and legal framework improvements, but implementation has been slow. - Fiscal consolidation has not materialized. ### Key statistics and indicators (from the source text) - Real GDP expanded by about 5½ percent in 2013. - Headline and core inflation have fallen, to 5 and 3½ percent, respectively, in mid-2014. - The 2013 fiscal deficit is estimated at 5½ percent of GDP (GFS 2001), compared to 4¼ percent implied by the budget. - Tax revenues fell short by about 1½ percentage points of GDP. - The State Bank of Vietnam (SBV) reduced policy rates by 50 basis points in early 2014. - Private sector credit growth was 2¼ percent (s.a., ytd) in March 2014. - System-wide loan-to-deposit ratio has fallen to below 90 percent from a peak of around 105 percent in 2011. - The official NPL ratio rose to 4.2 percent. - System-wide ROA and ROE in 2013 were 0.5 and 5.6 percent, respectively. - Prices of real estate have fallen by about 50 percent from their peak. - Gross international reserves rose in early 2014 to above US$36 billion, 2½ months of prospective imports of goods and services. - Current account surplus was 5½ percent of GDP in 2013. - Staff’s baseline projection for 2014: real GDP growth at 5½ percent, inflation around 5¼ percent, the current account in surplus, and reserves around 2½ months of prospective goods and services imports. - Medium-term projection: growth around 6 percent. - Under the current fiscal stance, public sector debt would accumulate to around 60 percent of GDP (slightly below the authorities’ legal limit of 65 percent). ### Policy implications highlighted - Accelerate banking sector reforms, including stricter loan classification and provisioning, NPL resolution, and bank recapitalization. - Advance SOE restructuring, equitization, transparency improvements, and legal reforms. - Create fiscal space to manage contingent liabilities from reforms while protecting social and investment spending. - Transition gradually to an inflation-anchored monetary framework with greater exchange rate flexibility. --- ### Box 1 — Poverty reduction, distributional challenges, and recommended policies - Poverty measurement: - “Basic needs” poverty line (updated in 2010): national poverty rate declined from 58 percent in 1993 to around 17 percent in 2012. - Second approach (rice equivalents revised in 2005): poverty fell from around 28 percent in the early 1990s to around 9½ percent by 2012—the official rate. - Inequality and distribution: - Gini coefficient was 0.39 in 2012. - Remaining poor depend heavily on subsistence agriculture and live in remote upland rural regions. - Poverty has taken an increasingly ethnic dimension; income gap between ethnic minorities and the Kinh majority has grown. - Many incomes remain close to the poverty level and are susceptible to falling back into poverty from macroeconomic shocks. - Quality of, and access to, public services and social assistance vary between rich and poor households. - Policy recommendations to reinforce poverty reduction and support inclusive growth: - Ensure macroeconomic stability and reduce vulnerabilities, and pursue structural reforms to support robust, sustainable growth. - Support productivity growth in rural areas through improved connectivity, strengthening skills, improving the investment climate, expanding access to basic services, better targeting agricultural and social support, and fostering occupational and geographic mobility of labor. - Improve access of the poor to higher-quality education and health services, particularly in rural areas and by minority ethnic groups, to address inequality of opportunities. - Better target social spending and social assistance to account for regional differences in the cost of living and basic services as the economy is restructured. - Improve the system for monitoring and publishing data on poverty to deliver reliable and accurate information to policymakers and the public. ### Box 2 — Productivity, technical efficiency, and potential GDP - TFP trends and frontier analysis: - Total factor productivity (TFP) contribution to growth has declined in the last decade; capital’s contribution increased but by less than TFP’s decline, leading to slower growth. - Stochastic production frontier analysis (Cobb-Douglas form with a composed error term) was estimated using Penn World Tables data from 1970 to 2013. - The estimated inefficiency gap increased in the early 1990s, early 2000s, and again from 2009 forward, consistent with a decline in TFP contribution from 2009 forward. - Potential output and output gap: - Potential growth is currently around 6 percent (below the 7 percent average of the last decade). - A negative output gap opened after the global financial crisis and widened to around 1½ percent of potential GDP in 2013. - The output gap tracks well with recent inflation trends. - Implication: - Under a gradual reform scenario with inputs, TFP, and inefficiency around current levels, potential growth would remain close to around 6 percent in coming years. --- *Source: IMF staff report chapter "1. Poverty Reduction, Inclusive Growth, and Remaining Challenges" (excerpts).* ### 10. Under this scenario, domestic risks are tilted to the downside. Slow progress in banking ### _cr14311 - 10. Under this scenario, domestic risks are tilted to the downside. Slow progress in banking ### Risk assessment and potential shocks - Under this scenario, domestic risks are tilted to the downside: slow progress in banking reform raises the economy’s vulnerability to adverse shocks and heightened distress, which could result in negative macro-financial feedback, significantly undermining growth and adding to public-sector liabilities. - Delays in fiscal consolidation would reduce fiscal space for banking and SOE reforms, could pressure interest rates, crowd out growth-enhancing spending, erode public confidence, and ultimately undermine debt sustainability. - Risk matrix entries (Risk — Risk Side — Likelihood — Impact — Transmission Channels — Policy Response): - Banking distress becomes acute —  — LH — Adverse macro-financial feedback loop — Activate crisis management plan, ensure emergency liquidity while maintaining monetary control, orderly bank resolution and recapitalization, strengthen safety nets. - Fiscal consolidation delayed —  — MM — Persistently higher interest rates; business confidence undermined — Broaden revenue base, reduce exemptions, strengthen administration, introduce a property tax, curtail non-essential spending. - Surges in global financial market volatility —  — HL — Capital outflows pressure exchange rate and reserves — Greater exchange rate flexibility and stand ready to raise interest rates. Accelerate fiscal consolidation, and structural reforms to support confidence and FDI. - Protracted period of slower growth in advanced and emerging economies, growth slowdown in China (medium-term) —  — H/MM — Weaker export growth and remittances — Adopt monetary policy framework with more exchange rate flexibility. Accelerate financial sector and SOE reforms to improve productivity, FDI, and domestic activity. - Disruptions triggered by geopolitical incidents in East Asia —  — H — Capital flight, weaker FDI inflows, lower tourism, export and import growth — Stand ready to raise interest rates, allow exchange rate flexibility. Accelerate structural reforms to support confidence and investment. - Earlier-than-expected implementation of TPP or FTAs —  — L — Stronger exports and investment; productivity improvement — Accelerate SOE and market reforms, and adopt monetary policy framework with more exchange rate flexibility. ### External vulnerabilities and regional linkages - Short-term external risks: - Surges in global financial market volatility, higher global interest rates, or protracted regional geopolitical tensions could undermine confidence, and reduce international reserves absent greater exchange rate flexibility. - Medium-term external risks: - High degree of openness and reliance on FDI make the economy vulnerable to slower growth in major trading partners. - China is an important trade partner, main source of imports into the electronics and garments supply chain, and source of FDI and tourism. - Upside opportunities: - Early agreement on Trans Pacific Partnership (TPP) negotiations and Free Trade Agreements (FTAs) with the European Union and Korea could secure access to main export markets and spur market-based reforms. ### Authorities’ assessment and responses to external risks - Authorities broadly concurred with the near-term macroeconomic outlook. - To mitigate external risks they have: - Reassured investors following recent geopolitical events. - Reinforced the importance of structural reforms, trade diversification, and on-shoring of supply chains through TPP and other FTAs. - Authorities noted: - The current account surplus, capital flows management, and the relatively small holdings of domestic assets by nonresidents limited the impact of global financial volatility on domestic markets. - On domestic risks, work was underway on bank and SOE restructuring, with progress in line with their plans; they viewed the risk of systemic distress as small. - They considered the level of public debt as manageable, but recognized the risks of a further increase, and were looking to tighten fiscal policy gradually going forward. ### Fiscal position, recent stance, and vulnerabilities - Fiscal stance and outlook: - For 2014, the deficit is projected to rise to around 6½ percent of GDP (GFS 2001), with lower revenue (reflecting a cut in the corporate income tax rate from 25 to 22 percent, continued tariff reductions, exemptions, and subdued growth) more than offsetting expenditure restraint, including capital outlays and a freeze on the size of the civil service and wages. - Revenue and expenditure dynamics: - Tax and tariff reductions and exemptions have contributed to a downward trend in revenues as a share of GDP, resulting in an expansionary revenue stance in cyclically adjusted terms. - Improved administration measures include reducing tax evasion and arrears, disclosing incidents of tax fraud, and streamlining VAT refund procedures while introducing thresholds. - Profitable SOEs have been required to pay dividends in 2013–14. - Vietnam compares favorably in the region in terms of tax revenue productivity but the base has eroded, reflecting in part exemptions and incentives. - The VAT rate was halved for certain housing projects and a further corporate income tax rate reduction, to 20 percent in 2016, is planned. - Composition of expenditure: - Spending on education is higher than in comparator low-income and emerging-market countries. - Expenditure on public employee compensation is significantly higher as a share of GDP. - Capital spending has historically been in line with other low-income countries, but a decline is budgeted this year. Maintaining high-quality investment spending would improve the stock of public capital in a regional comparison. ### Public debt: levels, risks, and debt threshold analysis - Public debt status: - Public debt is projected to increase to around 55 percent of GDP in 2014. - Public and publicly-guaranteed debt almost doubled since 2000, and at around 55 percent of GDP in 2014, is higher than average in the region and among low-income economies. - Domestic debt has accounted for most of the increase. - Domestic bond market and maturity: - Maturities of less than seven years comprised 94 percent of total annual domestic bond issuance in the 2008–13 period. - Agencies other than the Ministry of Finance are allowed to issue bonds with maturities exceeding one year. - Debt threshold estimation (Box 3): - Three econometric models (Probit Approach, Signal Approach, Debt Intolerance Framework) applied to determine thresholds beyond which debt distress could materialize. - A buffer for potential contingent liabilities is subtracted from estimated debt distress thresholds; the buffer value equals the average debt increase that has materialized in international experiences of systemic banking distress. - The results suggest a safe debt level ranging from 40 to 45 percent of GDP for Vietnam. ### Staff recommendations on fiscal consolidation and reforms - Overall recommendation: - Staff recommended a fiscal consolidation that protects social spending and investment and makes space for potential restructuring costs. - Objective: return the debt ratio over the medium term closer to 45 percent of GDP to support robust inclusive growth and poverty reduction, and mitigate risks. - The adjustment would provide space for potential bank and SOE restructuring costs, higher capital spending, and maintaining critical social expenditures. - Revenue-side measures: - Reverse the decline in the revenue to GDP ratio by broadening the tax base: eliminate exemptions, reduce incentives, introduce a property tax, and include pensions under personal income tax. - Forgoing the planned reduction in the corporate income tax rate would contribute around ⅓ percentage points of GDP in revenue. - Making permanent the requirement for SOEs to pay dividends to the budget would also contribute importantly. - Strengthening administration could return revenue productivity to past higher levels and result in significant revenue gains. - Expenditure-side measures: - Ensure the sustainability of social spending and targeted measures to address inequality and growth inclusiveness. - Safeguard well-targeted capital expenditure to support growth potential. - Rationalize the public wage bill sustainably by replacing across-the-board wage and hiring freezes with deeper, efficiency-enhancing civil-service reforms. ### Authorities’ position on fiscal reform and consolidation - Authorities broadly agreed with staff’s baseline fiscal assessment. - They aim to broaden the tax base and strengthen administration, but noted: - A property tax and personal income tax on pensions would be difficult to enact. - Consideration is being given to raising excises. - Income tax rate reductions are needed to support growth and competitiveness, and should result in higher revenues. - Social spending and investment priorities: - Social spending will be protected with priority given to poverty reduction, agriculture and rural areas. - The law on public investment has been revised to enhance efficiency and prioritization. - Greater use of public-private partnerships is under consideration. - Public wage bill: - Authorities concurred with the objective of containing the public sector wage bill, highlighting the importance of addressing redundant employees, and plan to undertake a public expenditure review with World Bank assistance. - Authorities’ public debt outlook: - They expect the debt-GDP ratio to peak around 2016 and decline afterward with a gradual consolidation. - Emphasized that the government’s ceiling of 65 percent of GDP would not be breached. - Noted downside risks if adverse external shocks materialized, or if SOE performance deteriorates, but reiterated that public funds would not be used for banking sector restructuring. ### Fiscal consolidation scenario (IMF staff projections and fiscal path) - Fiscal Consolidation Scenario (values reported as percent of GDP, source: IMF staff): - Total revenue and grants: 2014 20.3; 2015 20.9; 2016 21.6; 2017 22.4; 2018 23.0; 2019 23.7; 2020 24.3; 2021 24.9; 2022 25.4 - Capital expenditure: 2014 6.5; 2015 6.5; 2016 6.6; 2017 6.6; 2018 6.7; 2019 6.8; 2020 6.9; 2021 6.9; 2022 7.0 - Non-interest current expenditure: 2014 18.9; 2015 18.6; 2016 18.4; 2017 18.1; 2018 17.9; 2019 17.6; 2020 17.4; 2021 17.1; 2022 16.9 - Interest expense: 2014 1.5; 2015 1.5; 2016 1.6; 2017 1.6; 2018 1.6; 2019 1.6; 2020 1.4; 2021 1.4; 2022 1.2 - Net lending (+)/borrowing (-): 2014 -6.6; 2015 -5.7; 2016 -4.9; 2017 -4.0; 2018 -3.1; 2019 -2.3; 2020 -1.4; 2021 -0.6; 2022 0.3 - Public and public-guaranteed debt: 2014 54.8; 2015 56.8; 2016 58.2; 2017 58.4; 2018 57.6; 2019 56.0; 2020 53.6; 2021 50.8; 2022 47.3 - Real growth impact (in percentage point): 2016 0.0; 2017 0.1; 2018 -0.2; 2019 0.0; 2020 -0.1; 2021 -0.2; 2022 -0.2; 2023 -0.3; 2024 -0.2 (note: table shows dashes and specific year alignments in source) *Source: IMF staff analysis and projections in _cr14311.* ### 22. Maintaining a supportive monetary stance is appropriate as long as inflation pressures ### 22. Maintaining a supportive monetary stance is appropriate as long as inflation pressures ### Monetary policy stance and near-term assessment - Maintaining a supportive monetary stance is appropriate as long as inflation pressures remain absent. - Evidence cited: - An excess supply gap exists and growth is below potential. - Core inflation has declined and wage pressures are benign. - Transmission of easier monetary conditions to credit growth has been dampened in recent years. - Financial stability assessment: - At this juncture, easy monetary conditions do not pose a risk to financial stability. - Real estate prices remain subdued and equity market price/earnings ratios are around 15 percent. - Supportive liquidity conditions are facilitating banking system adjustment. - Contingency for capital outflows: - Greater exchange rate flexibility should be the first line of defense. - Consideration might also be given to raising domestic interest rates if significant capital outflows occur. ### Transition toward inflation as nominal anchor and framework reforms - Current framework features multiple targets and instruments, including broad money, bank credit, and various interest rates. - A daily US$/VND exchange rate target is announced, with a band of ±1 percent. - Short- and medium-term challenges: - Maintaining a supportive stance and the exchange rate peg will be challenging in the near term if global interest rates rise. - In the medium term, the economy will increasingly face asymmetric shocks and would benefit from an independent monetary policy. - Recommended initial steps toward inflation targeting: - Gradually widen the band for exchange rate fluctuation. - Reform to promote a deep and liquid foreign exchange market. - Establish an interest rate instrument while reducing reliance on quantitative targets. - Improve liquidity forecasting and management. - Reorient monetary policy communications increasingly toward price stability. ### Exchange rate flexibility and reserve adequacy - The real effective exchange rate has appreciated by about 2 percent compared to a year ago. - CGER-type analysis and broader balance of payments trends suggest no convincing evidence of misalignment overall. - Alternative CGER outcomes reported: - Macro-balance/external sustainability approaches suggest the real exchange rate is moderately undervalued, requiring a 5–8 percent real effective appreciation to close the gap. - Equilibrium real exchange rate approach (after 2012–13 appreciation) points to substantial overvaluation, with a real effective depreciation of about 16 percent needed to restore equilibrium. - Results are within a large margin of error. - Reserve adequacy and vulnerabilities: - Although reserves increased recently, measured against several metrics Vietnam’s international reserves are lower than before the global financial crisis and below regional comparators. - In early-2014, reserves made up about 2½ months of prospective imports of goods and services, well below the 8 months average of regional emerging market countries and below the minimum level desirable for countries with a fixed exchange rate, according to the Fund’s reserve adequacy metric. - Staff’s overall assessment: the external position would benefit from further strengthening; fiscal consolidation, a more flexible exchange rate and higher reserves would reduce vulnerabilities. ### Monetary transmission and bank lending (Box 4) - Methodology: - Panel model on balance sheet data for state-owned and other commercial banks over 2000–2013, using an Arellano-Bond GMM specification with fixed effects. - Interaction term between policy interest rate and observed financial heterogeneity across banks to isolate the bank lending channel. - Controls: past loan growth, GDP growth, ROE, LLP, size, liquidity, capital, and a time dummy for 2012Q1–2013Q4. - Key findings: - Changes in monetary policy have an inverse direct impact on private credit growth that is common across banks. - The bank lending channel emerges after 2011; credit supply by the banking system as a whole reacts less to policy rate changes in 2012–13 compared to 2000–11. - Banks’ health is an overwhelming factor determining credit supply: weakening banks lower credit growth ceteris paribus, while strengthening capital and liquidity would have a vigorous positive impact on credit growth. - Additional notes: - Elasticities are in line with estimates for Germany, France, and Italy during 1999–2011. ### Banking sector reform: recent measures and remaining challenges - Recent policy measures contributing to improvement: - Liquidity has improved owing to accommodative monetary conditions and FDI and remittance inflows. - Most banks asked to submit restructuring plans to the SBV. - A new risk management regulation based on Basle II is being drafted with a pilot in ten banks; piloted banks expected to implement Basel II basic indicator approach and standardized approach by 2015 and 2018, respectively, with remaining joint stock banks to comply with the basic indicator approach by 2018. - The VAMC has begun purchasing NPLs and plans liquidation, restructuring, and outright sales; its capital will be increased. - A revised bankruptcy law has been adopted; related legislation under review. - The limit on banks’ single foreign owner was increased slightly under an unchanged overall foreign ownership cap of 30 percent. - A new Monetary and Financial Stability Department was created in the SBV and an action plan for the banking sector issued. - Persistent problems and constraints: - Asset quality remains under pressure from weak domestic activity and declines in real estate prices; profitability is low. - Full implementation of tighter loan classification postponed to 2015, allowing loan rescheduling and new lending to delinquent customers without reclassification. - Banks have five years to provision against NPLs sold to the VAMC in exchange for bonds that are nonmarketable, pay no interest, and are not government guaranteed. - Significant legal hurdles for transfer of loan titles and collateral impede NPL resolution. - Macroprudential framework requires refinement; administrative levers including sector-specific lending directives and interest rate limits remain. ### Comprehensive reform agenda and staff recommendations (Box 6 and paras 30–31) - Core pillars and recommended sequencing: - Assess banks’ recapitalization needs with priority for systemically important banks via diagnostic assessments based on audits by internationally reputed firms, strict prudential norms, and accounting for connected lending and multiple gearing. - Revise classification criteria to guide resolution options (healthy; undercapitalized but viable; insolvent and nonviable) and identify systemically important institutions. - Recapitalize, restructure, and resolve: recapitalization of SOCBs immediately after diagnostics, elimination of forbearance, time-bound plans for undercapitalized but viable institutions, orderly resolution of non-viable institutions with legal frameworks for purchase and assumption transactions. - Strengthen the VAMC: more capital in the form of equity rather than bonds, enabling legal framework for transfer of loans and collateral, legal and operational independence, transparent governance, incentives for rapid disposal of assets, and a clearly defined sunset clause. - Develop additional NPL resolution options: (i) court-led track for large/complex economic groups; (ii) bank-led track with “pre-packaged” plans; (iii) special administrative restructuring track for selected SOEs financed exclusively by SOCBs; coordinate NPL resolution with SOE restructuring. - Tighten supervision and phase out regulatory forbearance; eliminate measures allowing lending to defaulted borrowers. - Revamp crisis management architecture and procedures: senior policy group (SPG) including SBV Governor and Minister of Finance, technical secretariat for daily reports, templates for notifications and instructions to banks, and a communications strategy. - Strengthen financial safety nets during reform: extraordinary liquidity provision and extended deposit insurance may be necessary, with conditions and funding identified ex-ante and in a fiscally transparent manner. - Authorities’ position: - Broad agreement with recommendations but preference for a more gradual pace to match banks’ capacity to absorb losses and to support economic recovery. - Authorities noted tightened forbearance, stricter NPL reporting to the SBV, and that financial weaknesses were not systemic. - Constraints highlighted: existing legal system, connected lending, decision not to use public funds for recapitalization. - Authorities acknowledged need for a comprehensive reform package including budgetary and legal reforms and emphasized progress to date. ### SOE reform - Progress reported: - Restructuring plans developed; focus on legal amendments, divestment from noncore areas, and equitization. - New regulations to enhance SOEs’ financial reporting and transparency, improve internal controls by defining government agency responsibilities, and improve corporate governance. - Enterprises can now sell assets below book value with government approval; several SOEs have had IPOs. - Implementation challenges: - Implementation progress is uneven, particularly among some SOEs’ subsidiaries. - Oversight by government agencies is fragmented. - Risk that focus on partial equitization diverts attention from operational reforms to enhance efficiency. - Need to enhance public disclosure of SOEs’ financial condition with timely publication based on international accounting practices. - Measures to enhance restructuring: - Establish a high-level steering committee to oversee reform, coordinate ministries, and monitor implementation. - Expand scope of divestment beyond noncore areas to improve efficiency and level the playing field for the private sector, ideally with external management expertise. - Enhance capacity at ministries and estimate restructuring costs to quantify fiscal implications. *Source: IMF staff report excerpt (Vietnam).* ### 35. The authorities emphasized their efforts to develop the legal framework, and to ### _cr14311 - 35. The authorities emphasized their efforts to develop the legal framework, and to ### SOE legal framework and equitization - Authorities are developing the legal framework and improving management and supervision of SOEs. - Current ownership structure of SOEs is described as fragmented. - Equitization efforts constrained by weak economic conditions and lack of budgetary resources to fund SOE restructuring. - Authorities hoped to make significant progress by end-2015. - A law is being drafted to make dividend payments from profitable SOEs permanent. ### Staff appraisal: macroeconomic stabilization and progress - Vietnam has made significant progress with macroeconomic stabilization and important steps in banking and SOE reform. - Growth is recovering and inflation has been reduced to mid-single digits. - The current account remains in surplus and gross international reserves have risen in recent years. - Banking system liquidity has improved; steps toward bank restructuring—albeit gradual—are underway. - The VAMC continues to purchase NPLs and is planning resolution. - SOE reform has moved forward with restructuring plans, amendments to the legal framework and equitization. ### Risks and constraints to growth - Economic growth remains below potential; key constraints are weak banks and inefficient SOEs. - Public debt is rising and approaching a level that reduces fiscal space for critical expenditures and potential costs of banking and SOE reforms. - The gradual pace of banking reform increases vulnerability to adverse shocks and negative macro-financial feedback that could undermine growth and add significantly to public sector debt. - The economy is vulnerable to external shocks including surges in global financial volatility, slower trading partner growth and regional geopolitical tensions. ### Fiscal policy guidance and debt target - Fiscal consolidation is recommended to create space for critical expenditures and possible contingent liabilities, reducing risk and supporting growth. - Implement a medium-term plan to return public debt to around 45 percent of GDP in a growth-friendly manner to provide space for potential bank and SOE restructuring costs. - Raise revenue to allow consolidation while safeguarding social spending and well-targeted capital expenditure to support growth and inclusiveness. - Revenue strategy elements recommended: - Broaden the tax base. - Improve tax administration. - Forego further corporate income tax rate reductions. - Institutionalize SOE dividend payments to the budget. - Rationalize public expenditure, including broader civil service reforms to raise efficiency and address the large public wage bill. - Reforms to increase public investment efficiency are encouraged. ### Monetary policy stance and framework transition - Current monetary policy stance is appropriate. - Monetary policy framework should gradually shift from the exchange rate to inflation as the nominal anchor. - With output below estimated potential, supportive monetary conditions are appropriate as long as inflation pressures remain muted. - Recent increase in international reserves is welcome; greater exchange rate flexibility would help buffer shocks and facilitate higher reserve adequacy. - Preparatory steps to move toward inflation targeting include: - Promote a deep and liquid foreign exchange market. - Initiate reforms to establish an interest rate instrument. - Improve liquidity forecasting and management. - Gear policy communications toward price stability. ### Banking sector restructuring: recommended approach - A comprehensive and more expeditious approach to banking sector restructuring is critical to reduce macro-financial risks and support sustainable growth. - Risks of the current gradual approach: - De facto forbearance and reliance on liquidity could deprive growth of new credit to profitable enterprises. - High risk of contagion due to cross-ownership among banks and between banks and enterprises. - Recommended measures: - More expeditious recognition of losses on NPLs. - Restructuring of viable banks and orderly exit of insolvent institutions. - Prioritized diagnostic assessments of banks under stricter prudential norms to focus restructuring and estimate recapitalization costs. - Recapitalization, including greater foreign participation and using public funds under strict conditions for systemically important institutions. - Elimination of forbearance and continued strengthening of supervision. - Legal reforms to facilitate NPL resolution—beyond the revision to the bankruptcy law. - Strengthen the VAMC with equity capital and the ability to buy and sell NPLs at market value. - Consider additional NPL resolution options such as bank- and court-led and administrative tracks. - Pursue a stronger crisis management framework. ### SOE reform acceleration and governance - Accelerating SOE reform will reduce risks and support growth by improving resource allocation. - Further efforts needed to accelerate implementation and improve coordination across agencies and ministries; current reform agenda is fragmented. - Efforts must go beyond partial equitization to focus on strengthening corporate governance and ensuring a level playing field. ### Consultation cycle recommendation - It is recommended that the next Article IV Consultation take place on the standard 12-month cycle. ### Key numeric indicators highlighted in the text excerpt (selected) - Authorities hoped to make significant SOE progress by end-2015. - Inflation reduced to mid-single digits. - Recommended medium-term public debt target: around 45 percent of GDP. - Example of fiscal outcomes and risks cited: public debt projected to rise to around 60 percent of GDP in 2017 before falling to around 48 percent of GDP at the end of the projection period (from the Debt Sustainability Analysis summary). - The DSA classification: Vietnam is at low risk of external debt distress (LIC DSA). *Prepared by the staffs of the International Monetary Fund and the International Development Association in consultation with the Asian Development Bank; July 15, 2014.* ### 1. Vietnam’s debt has been rising rapidly in recent years. This has mainly been due to ### _cr14311 - 1. Vietnam’s debt has been rising rapidly in recent years. This has mainly been due to ### Overview - Vietnam’s debt has been rising rapidly in recent years, mainly due to increases in the PPG domestic debt, while external debt has been relatively stable. - At end-2013: - Total external debt (including private sector debt) amounted to 38.5 percent of GDP. - Public and PPG external debt amounted to 26.5 percent of GDP. - Domestic PPG debt amounted to 25 percent in 2013. - Total PPG debt (domestic and external) amounted to 51.6 percent of GDP. - Recent increase in domestic debt is mainly related to domestic fiscal financing requirements in 2012–13, which were significantly higher than projected during the last DSA. ### Composition of Debt (Scope of DSA) - Coverage: - Public and publicly guaranteed external debt and the domestic debt of the general public sector, including the central government, local governments and state-owned enterprises (SOEs). - External composition (as percent of GDP): - 11 percent owed to multilateral creditors. - 9½ percent to bilateral creditors. - 1 percent to commercial creditors. - An additional 5 percent is publicly guaranteed debt of SOEs, largely commercial. - Private external debt is estimated at 5.6 percent of GDP. - Level of concessionality: grant element estimated at about 12 percent. - Domestic composition: - About 13 percentage points of GDP consists of marketable and nonmarketable securities (bonds). - About 6 percentage points consists of loans and advances from private sector financial institutions. - An additional 6 percentage points consists of domestic publicly guaranteed debt of the SOEs. - Domestic debt is in local currency. - Effective nominal interest rate has remained at around 5 percent between 2010 and 2013. - Government domestic bonds: average term at 3.8 years in 2013; coupon ranging from 7.5 to 9 percent. - Holders: mostly banks, with about 7 percent of the outstanding stock held by nonresidents. ### Underlying Assumptions (Differences from previous DSA) - Slightly higher near-term growth: - Previous DSA: real GDP growth rising to 5½ percent through 2020, and stable thereafter. - This DSA: real GDP growth rising gradually to 6 percent through 2020, and then declining in the long term to 5½ percent. - Lower inflation: in line with lower inflation outcome for 2013 and projections for a continued negative output gap in the medium-term, closing only gradually. - Higher net borrowing by the government: - Previous DSA assumed fiscal consolidation starting in 2013. - This DSA assumes net borrowing continues at a high level in line with a loose fiscal policy through 2017 that brings the debt ratio to 60 percent of GDP, before beginning a gradual consolidation thereafter. - Financing strategy: - Authorities rely increasingly on domestic debt to develop the domestic debt market. - As concessionality of external debt is reduced in line with Vietnam’s graduation from low-income status in 2017, the advantage of accessing external debt will diminish. ### External DSA Findings - Baseline: - The ratio of the PV of PPG external debt to GDP is projected to decline in the long-term, and to remain well below the relevant thresholds. - The ratio of the PV of PPG external debt to exports and to revenue also declines gradually and remains well below thresholds. - Debt-service to revenue ratio is projected to rise in the medium-term before declining gradually, largely because the grace period for recent borrowing is ending and revenue growth is projected to slow down. - If remittances are included in the denominator of the debt indicator calculations these results continue to hold. - Sensitivities and historical scenario: - PV of PPG external debt is most sensitive to a one-time depreciation of the exchange rate, but even under these scenarios the debt would remain well below thresholds. - Historical scenario stress test (not shown) projects negative long-term debt ratios due to historical non-interest current account surplus, high level of FDI inflows and high grant element of external debt in the last 10 years. ### Public DSA Findings - Baseline: - Public debt remains below thresholds for distress in the baseline, but without gradual consolidation the risk of debt distress could rise rapidly. - Public sector debt is projected to increase in nominal terms, reaching around 60 percent of GDP by 2017. - The ratio of the PV of debt to GDP rises before beginning a gradual decline; at all times it is below the benchmark of 74 percent of GDP. - Alternative scenarios highlight vulnerabilities: - Fixed primary balance scenario: - Keeping the primary balance at its 2013 level (a deficit of 4 percent of GDP) would result in the PV of debt to GDP becoming unsustainable and rising throughout the projection period. - One-time nominal depreciation scenario: - A one-time nominal depreciation of the exchange rate by 30 percent in the first year of the projection period (the most extreme shock) increases the PV of debt to GDP to about 10 percentage points below the benchmark in 2016–18 before declining thereafter. - Banking sector distress (customized scenario): - Assumes additional 15 percent of GDP in liabilities absorbed by the government over the first two years; GDP growth falling to 3 percent in both years before returning to baseline. - Additional debt assumed domestic on similar terms to current domestic debt (five years maturity and 7 percent coupon). - Under this scenario: - PV of debt to GDP would hit the benchmark of 74 percent around 2019 and remain above the benchmark for most of the projection period. - PV of debt to revenue ratio would rise to over 350 percent. - Debt service to revenue ratio would rise to over 70 percent in the long-term. - Ratios would be higher if financing conditions were less favorable. ### Conclusions and Policy Implications - Current assessment: - Debt indicators remain below thresholds for distress, placing Vietnam at low risk of debt distress currently. - External debt risk remains very low due to current account surpluses and FDI flows. - Rising risks: - Total public debt profile has worsened relative to last year; without consolidation risks could rise rapidly. - Fixed primary balance stress test indicates maintaining primary deficits at current level would make PV of debt to GDP unsustainable. - A one-time nominal depreciation of 30 percent would bring PV of debt to GDP ratio to within 10 percent of the threshold in 2016–18. - A bank distress scenario adding 15 percent of GDP to public debt would bring public debt above the threshold for most of the projection period. - Authorities’ stance: - Authorities broadly agree with the DSA: external debt distress risk remains very low, but public debt profile has worsened. - They view recent public debt increases as necessary to finance ongoing public investment projects, but recognize levels warrant increased attention. - They noted the debt ratio remains well below the 65 percent of GDP limit imposed by the National Assembly. - If debt continues to rise as in the baseline, authorities stated they would begin consolidation. - Authorities recognize risks surrounding banking and SOE reform strategies but continued to emphasize budgetary resources would not be used to recapitalize banks or restructure SOE debt. ### Key Scenarios and Stress Tests (summary) - Baseline: PV of PPG external debt declines; public debt reaches around 60 percent of GDP by 2017 then is assumed to gradually consolidate. - Fixed primary balance (primary deficit of 4 percent of GDP): PV of debt to GDP becomes unsustainable. - One-time nominal depreciation of 30 percent: PV of debt to GDP rises to about 10 percentage points below the 74 percent benchmark in 2016–18. - Banking sector distress: additional 15 percent of GDP liabilities absorbed; GDP growth falls to 3 percent for two years; PV of debt hits 74 percent around 2019 and remains above; PV to revenue > 350 percent; debt service to revenue > 70 percent. ### Box 1 (Key Macroeconomic Assumptions for the Baseline Scenario, 2014–34) - Real GDP growth is projected at 5.6 percent in 2014, and rising gradually to 6 percent in 2018– *Source: IMF staff DSA text as provided in the content unit.* ### 2020. After 2020 growth is projected to decline gradually to 5½ percent as the demographic ### _cr14311 - 2020. After 2020 growth is projected to decline gradually to 5½ percent as the demographic ### Macroeconomic projections and outlook - Real GDP growth - Projected to decline gradually to 5½ percent after 2020 as the demographic dividend dissipates and the economy matures. - Key annual projections and averages reported: 6.2; 5.2; 5.4; 6.4; 0.9; 5.5; 5.6; 5.7; 5.8; 5.9; 6.0; 5.7; 5.5; 5.5; 5.6 (as shown in the Key macroeconomic assumptions table). - Inflation - Projected to decline gradually from its level of 6 percent in 2013 to 4½ percent in the medium- and long-term. - Inflation (GDP deflator, in percent) time series highlights: 21.3; 10.9; 4.8; 12.3; 6.2; 6.4; 6.2; 4.2; 5.1; 4.3; 4.4; 5.1; 4.5; 4.4; 4.6. - Interest rates on foreign borrowing - Effective average interest rate on foreign borrowing expected to be about 2 percent in 2014, rising to about 3½ percent in the long run. - Effective interest rate (percent) series: 2.6; 2.4; 2.0; 2.6; 0.4; 2.1; 2.4; 2.6; 2.8; 2.9; 3.0; 2.6; 3.1; 2.3; 3.0. - Average nominal interest rate on forex debt (in percent): 2.6; 2.5; 1.9; 2.3; 0.2; 2.1; 2.2; 2.4; 2.6; 2.8; 3.1; 2.5; 3.1; 1.6; 2.9. - Reserve coverage - Expected to remain at around 2½ months of imports in 2014, rise to about 3½ months of imports by 2016, and stabilize thereafter. ### External sector: current account, capital flows, and reserves - Current account - Expected to remain in surplus in the near-term due to strong export growth related to foreign direct investment and demand from major trading partners, while imports remain subdued. - In the medium-term the current account is expected to deteriorate as the economy recovers and reach the deficit “norm” of 4½ percent in the long term, mostly financed by continued FDI flows. - Capital and financial account - Surplus moved into a small deficit in 2013 and is projected to continue to be negative in 2014 as international interest rates rise. - In the medium-term the capital and financial account is expected to stabilize at a surplus of around 3½ percent of GDP related to FDI inflows and gradual expansion and opening of the domestic capital market. - External debt and related indicators (selected figures from the baseline tables) - External debt (nominal) series: 38.8; 38.0; 38.5; 38.1; 38.3; 38.9; 39.1; 39.0; 38.3; 31.7; 17.9. - PV of external debt (selected years): 35.2; 34.7; 34.6; 35.1; 35.0; 34.6; 33.7; 27.2; 15.2 (as reported). - PV of PPG external debt (selected years): 23.2; 23.0; 23.0; 23.2; 23.1; 23.1; 22.5; 17.3; 7.5. - PV of PPG external debt in percent of exports (selected years): 27.8; 26.8; 26.7; 26.4; 26.3; 26.2; 26.0; 21.3; 9.6. - Debt service-to-exports ratio (in percent) series: 3.6; 3.7; 2.8; 3.1; 2.9; 2.9; 3.0; 3.5; 3.7; 3.8; 2.6. - PPG debt service-to-exports ratio (in percent) series: 2.3; 2.3; 1.5; 1.9; 1.7; 1.9; 2.0; 2.2; 2.4; 2.6; 1.6. ### Public debt dynamics and fiscal projections - Public sector debt (general government gross debt) - Reported levels: 46.7; 48.5; 51.6; 54.7; 56.9; 59.1; 60.0; 60.7; 60.7; 58.2; 48.4 (selected series). - Foreign-currency denominated share of public sector debt: 28.3; 27.0; 26.5; 26.4; 26.7; 27.1; 27.3; 27.5; 27.1; 21.8; 10.1. - Net borrowing and debt path - Net borrowing by government projected to be high in 2014, and continue at a high though declining level through 2017, to bring the debt ratio to around 60 percent of GDP. - Debt ratio expected to decline in the long run to around 48 percent of GDP by 2034. - Primary balance and deficits - Primary deficit expected to be around 5 percent of GDP in 2014 and decline gradually to around 2 percent of GDP in 2019. - Primary deficit and related flows (selected entries): Primary deficit values and primary (noninterest) expenditure series reported across tables (see Primary deficit; Primary (noninterest) expenditure values). - Automatic debt dynamics and contributors - Automatic debt dynamics series: -7.8; -5.5; -2.8; -3.2; -3.6; -2.9; -3.6; -3.2; -3.3; -2.9; -2.1. - Contribution from interest rate/growth differential: -9.7; -5.2; -3.1; -4.0; -4.3; -3.5; -4.0; -3.6; -3.8; -3.3; -2.1. - Contribution from real GDP growth: -2.8; -2.3; -2.5; -2.7; -2.9; -3.1; -3.2; -3.3; -3.4; -3.1; -2.6. ### Stress tests, vulnerabilities, and financing needs - Debt sustainability stress testing - Figures and charts present indicators of Public and Publicly Guaranteed (PPG) external debt under alternative scenarios, 2014-2034, with the most extreme stress tests identified (e.g., one-time depreciation shock, terms shock, exports shock). - Gross financing need and debt service - Gross financing need (Billions of U.S. dollars) series: 2.5; -5.1; -5.0; -0.8; 0.3; 2.1; 5.8; 12.2; 16.7; 34.2; 68.8. - Gross financing need (percent of GDP) reported in Table 2: 4.4; 10.3; 10.3; 12.2; 11.7; 11.8; 11.3; 10.9; 10.8; 11.1; 6.2. - Identified net debt-creating flows and current account dynamics - Identified net debt-creating flows series: -11.1; -15.7; -13.3; -10.1; -9.2; -8.4; -6.9; -4.9; -3.6; -0.1; 1.3. - Non-interest current account deficit series: -1.0; -6.8; -6.2; 1.5; 5.6; -4.9; -4.2; -3.5; -2.2; -0.3; 0.8; 3.6; 3.5; 3.7 (as reported across tables). ### External support, concessionality, and aid flows - Aid flows and concessional financing - Aid flows (in Billions of US dollars) series: 7.7; 7.0; 5.3; 4.1; 4.2; 4.5; 5.1; 5.1; 5.0; 4.2; 3.4. - Of which: Grants (annual): 0.6; 0.5; 0.2; 0.2; 0.2; 0.2; 0.2; 0.2; 0.2; 0.2; 0.2. - Of which: Concessional loans series: 7.1; 6.6; 5.0; 3.8; 4.0; 4.2; 4.9; 4.8; 4.8; 4.0; 3.2. - Grant element of new public sector borrowing (in percent) reported in projections: 31.5; 30.3; 28.8; 28.5; 27.0; 26.4; 28.8; 22.2; 16.6; 20.4 (selected entries). - Grant-equivalent financing (in percent of GDP) projection entries: 1.1; 1.1; 1.1; 1.1; 1.0; 0.9; 0.5; 0.2; 0.4 (as shown). - Grant-equivalent financing (in percent of external financing) series: 34.1; 32.6; 30.9; 30.3; 28.6; 28.2; 24.0; 18.2; 22.1. ### Data quality, statistical issues, and institutional relations - Data adequacy for surveillance - Data provision has some shortcomings, but is broadly adequate for surveillance; most affected areas are: financial sector, national accounts, government finance, and external sector statistics. - National accounts and prices - GSO rebased national accounts to 2010 from 1994; methodologies broadly consistent with SNA93 but data collection and coordination need strengthening. - CPI methodology largely in line with international standards but with notional inclusion of owner-occupied and rental housing; recommendation to adopt geometric mean of price relatives at lower aggregation levels. - Government finance and monetary statistics - Government operations data exclude quasi fiscal activities of the central bank and some extra-budgetary funds; compilation is on a cash basis for final annual data. - IMF/STA recommendations to improve coverage of fiscal data and align definitions with GFSM 2001; Vietnam tentatively confirmed participation in the three-year GFS TA project for Asia and Pacific Island countries. - Monetary statistics: STA encouraged SBV to develop reporting for comprehensive breakdown of banks’ credit by sectors and to reclassify certain on-lending funds in banks’ reporting. - External sector statistics and financial sector data - Balance of payments statistics rely on limited source data; improvements needed in tourism revenue, workers’ remittances, treatment of goods for processing (BPM6), DI concepts and data sources, and errors and omissions. - Financial sector statistics availability is very limited and quality requires substantial improvement, including key financial soundness indicators. - Institutional relations and cooperation - Extensive technical assistance from IMF in tax policy, public financial management, statistics, financial soundness indicators, banking supervision, monetary operations, and liquidity management. - Ongoing collaboration with World Bank and Asian Development Bank on debt sustainability, public financial management, banking supervision, and development projects. *Sources: Vietnamese authorities; and IMF staff estimates and projections.* ### 1. Our authorities highly appreciate the candid and constructive discussions on macroeconomic ### 1. Our authorities highly appreciate the candid and constructive discussions on macroeconomic developments and policy issues in Vietnam during the 2014 Article IV Consultation of the IMF mission led by Mr. John Nelmes. ### Economic Developments - Authorities broadly agree with staff’s assessment and main policy recommendations. - Achievements highlighted: - Containing inflation, preserving macro stability, and accelerating SOEs and banking sector reforms while ensuring sustainable economic growth and social security. - Record high international reserves of more than USD36 billion as at the end of May 2014, equivalent to around 12 weeks of prospective imports of goods and services, and expected to be built up further. - Authorities will consider Article IV Consultation advice in the development plan. ### Monetary, exchange rate and credit policies - Exchange rate policy: - Flexibly managed in line with other monetary instruments to stabilize the market. - SBV proactively depreciated the VND by 100 bps on June 19, 2014 to promote economic activities. - Market quickly restored stability and the VND has been appreciated recently, facilitating SBV purchases of USD to increase international reserves. - Liquidity and credit: - Liquidity in the banking system is ample, facilitating banking sector reforms. - Banks are willing to provide credit while focusing on improving credit quality and safety. - Credit growth is low due to weak domestic demand and economic difficulties. - Credit policy conducted flexibly, including lending in foreign currency and channeling credit to prioritized sectors. ### Fiscal Policy - Fiscal consolidation: - Authorities view fiscal consolidation as crucial for long-run fiscal sustainability and commit to fiscal consolidation. - To provide breathing space for businesses, the Government allowed reductions, deferrals, and exemptions in certain types of taxes and revenue to foster economic development and increase budget revenue in the long run. - Budget expenditure will continue to be tightened. - Government plans to reduce the size of public service staff in the next few years and delays the planned roadmap of public salary increase. - Authorities share Staff recommendation that fiscal consolidation should protect social spending and investment and make space for potential NPL resolutions and banks recapitalization. - Public investment reform: - Revised Public Investment Law adopted by the National Assembly in 2014 to enhance efficiency of public investment activities and greater use of public-private partnership. ### Financial Sector Reform - Comprehensive measures: - Government and SBV proposed comprehensive and synchronous measures to solve root causes of system weaknesses. - CI restructuring has gained significant progress and the financial condition of the banking system has improved. - Authorities share IMF recommendation for a comprehensive reform package to promote banking reform and NPL resolution, especially to allocate state budget for those activities and accelerate legal reform. - Governance, supervision, and legal framework: - Significant progress in banking governance and supervision and legal framework. - Risk-based supervision improved following SBV’s Action plan for implementation of 2011-2015 Banking Restructuring Plan. - All banks are required to submit operational and financial restructuring plans for SBV approval. - NPL resolution and VAMC: - NPL resolution achieved positive outcomes given budgetary and legal constraints. - VAMC initially appears effective in curbing and resolving NPLs; a large portion of NPLs has been removed from the system. - VAMC’s chartered capital will be tripled by end-2014 to accommodate enlarged operations. - Loan classification and provisioning: - Legal framework improved; Circular 02 was effective from June 1, 2014. - Authorities note that full implementation of Circular 02 would have great impacts on the banking system, especially restricting credit expansion and accessibility. - To support economic activities, authorities issued Circular 09 that amends and supplements some articles of Circular 02 by allowing loan rescheduling without reclassification from 20 March 2014 to 31 March 2015 subject to very rigorous conditions: - (i) loan rescheduling can only be undertaken once during the term of the loan; - (ii) customers have to provide a feasible repayment plan in line with the purpose of the borrowing in the credit contract, production and business conditions, satisfying prudential ratios and limitation requirements; - (iii) CIs have to issue internal regulations to strictly control and supervise the loans and periodically report to the SBV; and - (iv) CIs have to maintain loan classification based on consolidated results from the Credit Information Center. ### SOE Reforms - Progress and plans: - Authorities have made great efforts in supporting SOE restructuring and believe significant reform progress can be achieved by end-2015. - Restructuring plans developed; focus on amendments to legal framework to enhance SOEs’ financial reporting and transparency, improve internal controls and corporate governance, and support SOEs in equitization and divesting from non-core businesses. - Relevant measures include Resolution No. 15/NQ-CP, Land Law 2013 and Bankruptcy Law 2014 to facilitate removal of constraints on bankruptcy proceedings, help VAMC timely handle debts and mortgaged assets, and contribute to speeding up NPL resolution. ### Concluding Remarks - Authorities will continue implementing the reform agenda to take advantage of growth prospects within the growing Asian region, while recognizing considerable challenges ahead and that sustainable results will take time to materialize. - Authorities share full commitment and determination to undertake necessary restructuring measures and policies to improve the investment climate and sustain economic growth, while providing buffers against external and domestic shocks. - These efforts need to be supplemented by support from multilateral institutions and other countries. *Statement of Vietnam authorities in response to the 2014 Article IV Consultation.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2014/_cr14311.pdf_