Credit Growth: Vietnam’s New Challenges amid Overheating

International Monetary Fund. External Relations Dept.
Published Date:
May 2008
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Vietnam has emerged in recent years as one of the world’s most attractive new investment destinations.

The country’s 2007 accession to the World Trade Organization and a surge of new foreign direct investment and portfolio inflows highlight an impressive course of economic reform, particularly in trade and investment liberalization.

These reforms have led to strong economic performance—an average annual growth rate over the past decade of 7.5 percent, one of the fastest rates in Asia.

The number of people living below the poverty line fell from 58 percent of the population in 1993 to about 16 percent in 2006. Growing access to international markets and greater opening of the domestic economy will likely bring further benefits in the future.

However, increased global integration has posed significant challenges to Vietnam. The government needs to maintain sound macroeconomic policy, increase policy flexibility to deal with new risks, and press ahead with its broader reform agenda.

Increasing vulnerability

Although Vietnam’s recent economic performance has rightly drawn much praise, the economy is overheating, threatening sustained economic growth over the medium term.

Increasing domestic and external imbalances are a major concern. Credit growth rose to about 63 percent in March 2008, contributing to a rise in inflation, which reached 21 percent in April 2008.

Property prices in large cities have risen sharply. While exports have continued to grow strongly, strong demand pressures have fueled rapid import growth, resulting in a sharp widening of the current account deficit to an estimated $5.3 billion in the first quarter of 2008, compared with $7 billion for the whole of 2007, with the deficit increasingly financed by short-term capital flows.

A slowdown in the United States and Europe, which are Vietnam’s largest export markets, will confront Vietnam with two challenges: first, it will lower economic growth in 2008; second, it will further widen the current account deficit and thus increase Vietnam’s vulnerability to external shocks—a vulnerability heightened by the relatively rigid exchange rate regime.

Key challenges

An immediate challenge for Vietnam is to take a number of steps to reduce domestic and external imbalances:

  • Rein in rapid credit growth. The recent increase in interest rates and the decision to raise the reserve requirement in June 2007 and February 2008 are welcome steps in the right direction. However, the State Bank needs to make more effective use of interest rate policy to ensure that market interest rates are positive in real terms, without disrupting financial intermediation in the banking system. Taking steps to address imprudent lending practices in commercial banks will also be a priority.

  • Adopt greater exchange rate flexibility. Vietnam has a de facto currency peg to the dollar, which has complicated monetary policy in the face of large capital inflows. A more flexible exchange rate regime would make monetary policy more effective, thereby assisting macroeconomic management. It also would create an incentive to manage exchange rate risks effectively, deepen financial markets, and enhance Vietnam’s resilience to external shocks.

  • Restrain public sector expenditures. Monetary policy will need to be complimented by restraining off-budget and state-owned enterprises’ (SOEs) expenditures, which resulted in a sharp increase in public sector borrowing in 2007. Because there is a great need to improve Vietnam’s infrastructure, the emphasis should be on improving the efficiency of public sector investment and scaling back unproductive projects. In this context, the expeditious implementation of SOE reforms, including the “equitization” program, can play an important role. Equitization is a form of privatization, involving the sale of shares representing a portion of state capital in an enterprise.

Over the medium term, Vietnam needs to advance structural reform to sustain high growth. One key priority is banking sector reform, which will help develop the banking sector and safeguard its stability. The planned equitization of state-owned commercial banks and the development of a sound regulatory and supervisory framework are important steps in this process. Advancing tax reform, improving the business environment, and enhancing human capital are also high on the reform agenda.

Recognizing these challenges, the government decided to lower the 2008 growth target to 7 percent and give top priority to controlling inflation. It announced that it will tighten monetary and fiscal policy and restrain public sector expenditures to ensure macroeconomic stability. With its strong commitment to sound economic management and reform, Vietnam has good prospects for sustained growth and poverty reduction in the medium term.

Shogo Ishii

IMF Asia and Pacific Department

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