IMF Executive Board Concludes 2007 Article IV Consultation with VietnamPublic Information Notice (PIN) No. 07/136
November 21, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On October 26, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Vietnam.1
Vietnam has recorded continued strong economic performance since the conclusion of the last Article IV consultation. GDP growth rose to 8.2 percent in 2006, with non-oil exports remaining an important engine of growth. Private investment has also expanded briskly, led in large part by accelerated foreign direct investment (FDI) disbursements in the wake of Vietnam's historic World Trade Organization (WTO) accession. Industrial activity, retail sales, and trade data point to a continued strong expansion so far in 2007.
However, rising inflation points to tightening capacity constraints. Inflation picked up to 8.4 percent (y/y) as of July 2007, up from 6.6 percent in late 2006. While this pick-up was due partly to food supply shocks, rising world commodity prices, and overdue adjustments in administered prices, Vietnam's core inflation has remained on an upward trend, and its inflation seems higher and more entrenched than in other countries in the region.
The balance of payments has remained sound. Import growth picked up to 30 percent (y/y) during the first seven months of 2007, but high oil prices, booming non-oil exports, and buoyant remittances helped to restrain the current account deficit. With rapidly growing FDI and portfolio inflows, gross official reserves rose from US$11½ billion at end-2006 to around US$19 billion (3½ months of imports) as of end-May 2007.
The surge in reserves has contributed to an easing of monetary conditions. Despite increased sterilization, the growth of overall credit to the economy picked up from 25 percent in 2006 to 35 percent (y/y) as of end-May 2007. Reserve requirements on bank deposits were virtually doubled from June 2007 (to a range of 4 to 10 percent), and banks' securities-related lending made subject to a cap equivalent to 3 percent of total loans. Interbank rates and real time deposit rates, however, have remained low.
The overall fiscal deficit was lower than budgeted in 2006, but the budget plan for 2007 suggests that the fiscal stance appears set to be eased. A better-than-expected revenue outturn, together with slow implementation of off-budget investment plans, helped to compress the overall deficit to 3.8 percent of GDP. However, if the government fully implements its plans for 2007, the fiscal deficit could widen to well over 7 percent of GDP in 2007, with the non-oil deficit rising by at least 1-1½ percentage points of GDP.
Vietnam's exchange rate continues to be pegged de facto to the U.S. dollar, with the dong/U.S. dollar rate depreciating by about 1 percent a year. In January 2007, in the face of large capital inflows, the trading band of the dong versus the U.S. dollar was widened from +/-0.25 percent to +/-0.5 percent around the daily reference rate set by the State Bank of Vietnam (SBV), and the dong was temporarily allowed to appreciate modestly. However, this appreciation has been more than reversed since March. The nominal effective exchange rate (NEER) of the dong has depreciated by about 8 percent since end-2005, but the real effective exchange rate (REER) has been broadly stable, and remains close to its long-run average.
The improved investment climate generated by WTO accession contributed to an unprecedented boom in the stock market. The Ho Chi Minh City Stock Market Price Index rose by 144.5 percent in 2006, and by another 51 percent in early 2007, before receding by about 20 percent during March-July. A rapid expansion of the number of listed companies spurred rising foreign and domestic investment in shares, with the latter partly financed by local banks. The stock market's capitalization soared from US$0.5 billion at end-2005 to around US$18 billion (25 percent of GDP) as of end-July 2007.
The near-term outlook remains broadly favorable, and Vietnam has good prospects for sustained growth and poverty reduction over the medium term, provided that the government can take timely action to rein in demand pressures. GDP is projected to expand by about 8-8¼ percent in 2007-08, underpinned by continued strong growth in exports, investment, and private consumption. The increase in domestic demand would likely lead to a widening of the current account deficit to 3-3½ percent of GDP, but that deficit would continue to be comfortably financed with official development assistance, FDI, and other private capital inflows.
However, this favorable outlook is subject to risks. Large foreign exchange inflows could prevent an effective tightening of monetary policy, and continued rapid credit growth, together with a weak regulatory environment, could threaten domestic financial stability. On the fiscal front, large increases in public wages and pensions, and heavy on-lending to state-owned enterprises (SOEs), could compound inflationary pressures, and lead to a rapid accumulation of public debt. Insufficient improvement in banking sector and SOE governance, and continued state-sector dominance of key industries, could pose additional risks, as sub-optimal lending and investment by these sectors would weaken the efficiency of investment and possibly place additional future burdens on the budget.
Executive Board Assessment
Executive Directors commended Vietnam for its impressive record of economic growth and poverty reduction over the last few years, and welcomed its historic accession to the World Trade Organization (WTO). The near-term outlook remains favorable, with exports expected to continue to grow and domestic demand and investment remaining strong. At the same time, inflation has crept up, and credit growth and equity prices have risen sharply and substantially. The current account deficit continues to be more than financed by official development assistance and private inflows, especially foreign investment, but significant inflows of portfolio capital in the context of the present level of financial sector development and the pegged exchange rate regime could expose Vietnam's external position to risks.
Against this background, Directors welcomed recent measures toward greater monetary restraint, which will help to lower inflation and safeguard external stability. They supported the authorities' plans to slow significantly the growth of monetary and credit aggregates. To ensure that the official monetary and credit targets for end-2007 are achieved, Directors encouraged the authorities to continue to sterilize foreign currency inflows, as needed. Directors supported the authorities' request for technical assistance in the eventual transition to an inflation-targeting framework.
Directors agreed with the staff's assessment that the exchange rate of the dong is aligned with medium-term fundamentals. They welcomed the authorities' plan to introduce greater exchange rate flexibility as the institutional and operational infrastructure for it is set in place. Greater flexibility could facilitate disinflation and de-dollarization over the medium term, while reducing the need for intervention and sterilization. It would also create an incentive to manage exchange rate risks effectively, and protect external stability in the event of an abrupt reversal of capital inflows.
Directors called on the authorities to maintain a prudent and restrained fiscal policy. Given the need to curb inflationary pressures in the short run, the non-oil fiscal deficit needs to be placed on a declining path as soon as possible. Directors therefore welcomed the government's decision to postpone further large increases in public sector wages. Most Directors recommended that any revenue windfalls be saved. Directors encouraged the authorities to complete as soon as possible the pass-through of higher oil prices to domestic administered prices, while ensuring that an adequate social safety net is in place to protect low-income groups. Directors also encouraged the authorities to ensure that state-owned enterprise (SOE) projects are not funded through the issuance of new sovereign bonds.
Directors stressed that over the medium term, a concerted effort to boost revenues and curb expenditure growth will be required to protect debt sustainability. Planned tax reforms will need to be carefully designed, and tax administration should continue to be strengthened. Civil service administrative reforms, including the implementation of a more differentiated, merit-based wage structure and overall rationalization of employment, also need to be pursued. Directors noted that efficiencies in building critical infrastructure could be secured by improving the screening of public projects, and encouraging private investment in those that are commercially viable.
Directors observed that the opening up of Vietnam's financial system has heightened the importance of banking system reform. They supported the government's plans to equitize the main state-owned commercial banks (SOCBs). In this regard, Directors welcomed the recent approval of the equalization plan for Vietcombank. They considered that allowing scope for foreign strategic investors to participate in SOCB equitizations would help strengthen SOCB governance. Directors encouraged the authorities to expedite plans to grant the State Bank of Vietnam (SBV) adequate autonomy and authority to carry out monetary policy aimed at price stability and effective bank supervision. They supported the authorities' request for technical assistance to build financial sector institutional capacity.
Directors shared the authorities' concerns about the risks posed by possible overheating in the stock market, and they supported the measures to tighten prudential controls on banks' securities-related lending. Improved securities market regulation, including steps to discourage insider trading and money laundering, will be essential to protect the stability and integrity of the capital market.
Directors called for faster SOE reform in order to enhance competitiveness and efficiency. They welcomed plans to expand the equitization of SOEs, and urged the authorities to be open to participation in the equitizations by foreign strategic investors. They stressed that related-party lending within new SOE groups involved in a mix of industrial and financial operations should be prohibited. Directors supported steps to implement ahead of schedule WTO-mandated tariff reductions, which will also enhance efficiency.
Directors welcomed the recent publication of the first external debt bulletin by the Ministry of Finance. They encouraged the authorities to improve transparency further, including by strengthening reporting on external debt of SOEs, portfolio capital flows, and government and SOE bond issues.