Vietnam
Recent Economic Developments

This paper reviews economic developments in Vietnam during 1992–96. Economic growth was recorded at 8–9 percent during 1992–94, rising to a 9½ percent annual rate in 1995 and the first half of 1996. Investment has been rising steadily over the past few years, owing in part to foreign investment, which increased to 9 percent of GDP in 1995 and continued to rise strongly in 1996. Vietnam’s foreign trade has also expanded and diversified rapidly, with both imports and exports growing at double-digit annual rates.

Abstract

This paper reviews economic developments in Vietnam during 1992–96. Economic growth was recorded at 8–9 percent during 1992–94, rising to a 9½ percent annual rate in 1995 and the first half of 1996. Investment has been rising steadily over the past few years, owing in part to foreign investment, which increased to 9 percent of GDP in 1995 and continued to rise strongly in 1996. Vietnam’s foreign trade has also expanded and diversified rapidly, with both imports and exports growing at double-digit annual rates.

I. Introduction

1. Since Vietnam adopted the policy of doi moi in 1986, a transformation from a centrally planned to a market-based economy has been underway. Much has bean accomplished. The freeing of almost all prices, the institution of private ownership, and reform of the legal system have led to the emergence of a rapidly growing private sector. In addition, the development of a taxation system, the halting of subsidies to state enterprises, and disciplined monetary policy have contributed to a sharp reduction in macroeconomic imbalances. At the same turn, Vietnam has become increasingly integrated into the world economy as a result of the liberalization of the foreign trade and exchange system, the institution of a favorable regime for foreign investment, and, in 1995, membership in the Association of Southeast Asian Nations (ASEAN). This report focuses on developments in the Vietnamese economy during 1995 and through the first half of 1996.

A. Economic Trends

2. Economic growth was recorded at 8-9 percent during 1992-94, rising to a 9 ½ percent annual rate in 1995 and the first half of 1996. Investment has been rising steadily over the past few years, owing in part to foreign investment, which increased to 9 percent of GDP in 1995 and continued to rise strongly in 1996. Vietnam’s foreign trade has also expanded and diversified rapidly, with both imports and exports growing at double-digit annual rates. The external current account deficit has risen significantly as a share in GDP, largely reflecting investment inflows. Despite this deficit, net international reserves rose by $300 million during 1995 and by $200 million in the first nine months of 1996. At end-September 1996, gross official reserves stood at $1.8 billion, the equivalent of 9 weeks of imports.

3. Macroeconomic imbalances have been reduced through the maintenance of tight financial policies. A temporary loosening of credit policies in the second half of 1994, accompanied by rapidly rising rice prices (the result of large export shipments and a poor harvest in the North), caused the price level to rise by 14 ½ percent in 1994 and by a further 11 ½ percent during the first half of 1995. Credit policy was tightened substantially in early 1995 and, with fiscal policy also kept tight, inflation slowed considerably. Prices rose by only 1 ½ percent during the second half of 1995 and by an additional 3 percent during the first 10 months of 1996.

4. One important indicator which has not shown great improvement is the domestic savings rate. While foreign investment has kept investment reasonably strong, the portion financed by domestic saving has been relatively modest, especially in contrast to other Asian economies. The weakness in Vietnam can be taken as a sign that, despite impressive achievements in economic reform, important elements of a well-functioning market economy are still missing.

B. Structural Reforms

5. Progress has been made on a wide range of structural reforms during 1995-96. Even where there have been delays from the announced timetable, some progress has continued to be made. In the state enterprise sector, progress can be seen in improved oversight of state enterprises and the passage of a State Enterprise Law. New accounting standards are being developed. Implementing regulations for the Bankruptcy Law, applying to both private and state enterprises, were also promulgated in 1995.

6. Financial sector reform has also advanced. Interbank foreign exchange and money markets have been created, banks have been exempted from turnover taxes to improve the efficiency of financial intermediation, and an audit of the first of four state-owned commercial banks has been completed. The payments system is being strengthened, the development of a securities market is underway with the introduction of regular treasury bill auctions, and the necessary legal and regulatory framework is being established. In the area of monetary management, reserve requirements have been unified across institutions and across deposit types, treasury bills have been disqualified as reserve assets, the structure of interest rates has improved, and a uniform refinancing rate established.

7. The policy of trade liberalization has generated impressive results, fostering efficiency by imposing greater discipline on state and private enterprises through international competition. The registration procedure for foreign trade has been simplified, shipment-by-shipment import licenses have been abolished, and the number of commodities requiring import permits has been reduced from 15 to 5. Also, a tariff reform, which reduced the maximum tariff to 60 percent and replaced higher tariff rates with excise taxes, took effect on January 1, 1996.1

8. Fiscal management is being improved though promulgation of an Organic Budget Law, a Public Investment Program, and a Public Expenditure Review. The Treasury has also been given responsibility for all capital expenditures. Tax reforms, including a reduction in the number of turnover tax rates from 18 to 11, were approved by the National Assembly in October 1995, and work on a value-added tax and income tax reform was begun by the National Assembly in October 1996. The coverage of the social insurance program was extended in January 1995 to cover all establishments with more than 10 employees.

9. Considerable progress has also been made in other areas. The new Civil Code enacted in October 1995 is a far-reaching reform which contributes to the legal foundation for a market economy. The approval period for foreign investment has been shortened, and the roles of the central and local governments in the process have been more clearly delineated.

10. Several areas of structural reform have not progressed very far. In particular:

  • The environment for private business remains troubled by excessive government oversight. This is manifested by requirements to obtain official approval for too many of the decisions associated with starting and operating a business.

  • The legal climate remains unsettled, and ambiguous government regulations proliferate.

  • The financial system remains underdeveloped, and relies on high interest rates to attract deposits, though a great deal of wealth is still held in nonfinancial assets.

  • The role of the state in the economy remains large, and is likely to remain so.

The conclusions of the June 1996 Communist Party Congress (Appendix I) confirm the intention to make progress in these arras, albeit at a gradual pace.

C. Poverty

11. Despite high growth rates in recent years, Vietnam is still one of the poorest countries in Asia, with a per capita income of about $300. A first systematic assessment of poverty was made in 1993 in the context of a nationwide household living standards survey. Data were collected from 23,000 people living in 4,800 households representing urban and rural areas in each of Vietnam’s seven geographic regions. The results from the household survey indicate that more than 50 percent of the population in Vietnam can be classified as poor.2 Moreover, about half of the poor—25 percent of the population—are food-poor, in the sense that they cannot meet the their daily basic requirement of 2,100 calories per day even if they devote all of their income to the basic food basket.3

12. Although there is no official data on the degree of poverty in earlier years, indications are that poverty has been reduced during the 1990s as a result of strong economic growth. Preliminary results from a new expenditure survey suggest that the share of poor households has decreased by about 2 percent per year during the last few years. Projections by the World Bank indicate that a steady growth rate of 6 percent could reduce the share of the population that is poor to 35 percent by the year 2000 and 8 percent growth could reduce it to 29 percent. These projections assume the same relative growth rates across the regions as in 1993.4 If such regional growth disparities persist and the associated reduction in poverty is slower in the relatively poorer regions, income inequality would widen (see chart).

uA01fig01

Income levels and growth rates in 53 provinces

Citation: IMF Staff Country Reports 1996, 145; 10.5089/9781451840131.002.A001

13. About 90 percent of the poor live in the rural areas (which make up 80 percent of the population), with a particularly strong concentration of the poor in the northern and central provinces. The household expenditure survey further shows that poor households in general are found among farmers with little or no education; have limited access to formal health services; and often face a number of physical infrastructure constraints, including lack of power and water, bad roads, and high transport costs. Hence, further progress in poverty reduction will depend crucially both on the overall rate of economic growth, and on the extent to which the poorer regions take part in the growth process.

II. Economic Developments

14. Driven by rapid productivity growth, the real GDP growth rate averaged nearly 8 percent per year during 1991-94, and, spurred by rising productivity reached 9.5 percent in 1995 (Box 1). At the same time, the 12-month inflation rate fell from almost 70 percent in 1991 to 13 percent in 1995, and continued to decline in 1996. The 12-month inflation rate through October 1996 was 3 percent.

Vietnam: Productivity Growth

The high overall output growth in the economy during the 1990s has been largely due to rapid productivity growth resulting from the switch to mote efficient practices as a result of the increased reliance on market signals under doi moi. Productivity growth in Vietnam can be measured in several ways.

  • Total output per employee is reported to have increased on average by 5 percent per year during 1991-94, and by a further 6 ½ percent in 1995. Labor productivity in industry grew especially fast, increasing by 18 percent and 13 percent in 1994 and 1995, respectively (Appendix Table 15). Even in agriculture, output per employee has been rising, if by less.

  • Gains in the productivity of investment can also be inferred from Vietnam’s incremental capital-output ratio (ICOR), which averaged only 3.2 over the 1991-95 period, compared, for example, with ratios of around 5 for other high-growth ASEAN countries over the same period. The low ICOR in Vietnam reflects efficiency improvements for earlier investment as well as the impact of new efficient technology being brought in from abroad.

  • Measures of total factor productivity also suggest that up to 4 percent per year of GDP growth reflect productivity gains. Under reasonable assumptions about the Vietnam’s capital stock, no more than 4 ½-5 percent of the 8.2 percent growth recorded over the past 5 years can be attributed to growth in labor and capital inputs. While these estimates are subject to substantial margins of error, they strongly confirm the evidence from other methods of the contribution of increased efficiency to Vietnam’s economic takeoff.

A. Macroeconomic Developments

Output

15. The high real output growth in the 1990s was led by industry, which grew at an annual average rate of 13 percent during 1991-95. However, other sectors of the economy also grew rapidly. Since 1992, the growth rate in the services sector has increased each year, and the sector grew on average by 9 percent par year during 1991-95. Over the same period, the agricultural sector grew at an annual rate of 4 percent (Appendix Table 1). By 1995 the services sector was the largest sector in terms of share in GDP—accounting for over 40 percent—while the agriculture and industrial sectors accounted for about 30 percent each (Appendix Table 2).

uA01fig02

GDP by Sectoral Origin

Citation: IMF Staff Country Reports 1996, 145; 10.5089/9781451840131.002.A001

16. Despite the high growth rates in the economy, it is likely that the level of GDP is underestimated. This is a common problem in many developing countries with a fast growing small-scale private sector. In Vietnam, the number of small private enterprises in the industrial sector (with an average of 5-10 employees per enterprise) has increased by about 200,000 (or 60 percent) since 1988. However, labor productivity in these small private enterprises is estimated to be only one-tenth of that in the larger state enterprises. Although the state enterprises may benefit from scale advantages, the size of the difference may partly be explained by an underrecording of private sector output. Another indication that GDP may be underrecorded is that the export and import shares of GDP amount to nearly 50 percent. Considering the income level and stage of development of the Vietnamese economy, this seems exceptionally high. There are also indications that investment is underestimated in Vietnam, especially with respect to rural constructions, although there has been some improvement in this area during the last few years.

Agriculture

17. Although the industrial and services sectors have become increasingly important during the last decade, the Vietnamese economy is still dominated by agriculture. About 80 percent of the population live in rural areas, and more than 70 percent of total employment is in the agricultural sector (Appendix Tables 13 and 17). These proportions have remained fairly constant during the last five years.

18. Reforms in the agricultural sector over the past decade have included decollectivization, price liberalization, and improved security of land tenure. While all land continues to be owned by the state, long-term land use rights to most farmland have been distributed and can be freely transferred among private farmers. The role of the state is now fairly small and only 3 percent of total agricultural output is accounted for by state farms. The reforms have led to a more diversified agricultural base, with industrial crops becoming more important. However, food crops still account for 60 percent of total agricultural production, and rice paddy is by far the dominant food crop accounting for 90 percent of total foodgrain production. Since there are three harvest periods per year in the south, but only two in the north, paddy production is quite unbalanced, and virtually all of the exported rice comes from the south. In addition, about 500 thousand tons of rice is shipped from the south to the north each year (2-3 percent of the total production in the south), to meet local demand.

19. Gross agricultural production increased by about 20 percent between 1991 and 1994, and by a further 6 ½ percent in 1995. About half of the increase in 1991-95 was accounted for by increased production of foodgrain, while higher production of industrial crops and animal husbandly accounted for a quarter each of the total increase (Appendix Table 4). Between 1991 and 1995, foodgrain production grew by 25 percent, owing both to extended planting and higher yields (Box 2). The higher yields were due to better equipment, increased availability of fertilizer, and the introduction of new varieties of paddy. Overall there was a steady increase in both the area sown and the yield of rice paddy and maize, whereas planting and production of other food crops—mainly cassava and sweet potato—decreased (Appendix Table 5). As a result, output per employee grew on average by 2 percent per year during 1991-95 in the agricultural sector.

Vietnam: A Leader in Rice Exports?

One of the earliest and most dramatic achievements of Vietnam’s doi moi policies was the rapid rebound in agricultural production in response to market reforms. Gains in paddy production of over 12 percent per year during 1988-89 transformed Vietnam from being a rice importer (400,000 tons in 1987) to a leading rice exporter (1.4 million tons in 1989). Since then, rice output has continued to grow strongly, with 1995 output up an additional 30 percent over 1989 (see chart).

uA01fig03

Vietnam: Paddy Production, 1985-95

Citation: IMF Staff Country Reports 1996, 145; 10.5089/9781451840131.002.A001

This strong growth has permitted per capita consumption of rice to rise by about 10 percent since 1989 while still allowing further growth in exports. Rice exports were 2.0 million tons in 1995 (fourth in the world, after the U.S., Thailand, and India), a figure already matched in the first 8 months of 1996. Despite Vietnam’s strong presence in international markets, however, it has tended to be a supplier of last resort for many buyers because of problems with unreliable quality and with delivery. As a result, Vietnamese rice is generally sold at $20-25 per ton less than the world market price. A major problem has been that the state-owned food companies that have exclusive control over rice exports do not have the funds to buy and store the crop, so formers themselves store the paddy, often under poor conditions. By waiting for an export contract before going to the formers, the companies often foil to procure the agreed quantity.

20. Following favorable weather conditions, the spring paddy harvest in 1996 reached another record high, rising by about 13 percent from the previous year. The abundance of rice led both to falling rice prices domestically and to increased exports. As a result, in the fourth quarter the government announced that the export quota for the year would be increased from 2.5 to 3.2 million tons.

21. The efforts to diversify the agricultural base is reflected in an increase in planting and production of industrial crops. Total planted area increased by 17 percent between 1991 and 1995 which, combined with a substantial increase in yield per hectare, led to an increase in gross production by over 50 percent. Production of sugarcane, the most important industrial crop, increased by 30 percent from 1991 to 1995, and production of various other industrial crops, including peanuts, coffee, and rubber, grew at even higher rates, especially since 1993 (Appendix Table 6). Vietnam is now the world’s third largest exporter of cashew nuts (after Brazil and India). Production and exports of coffee have nearly doubled during the last three years (albeit starting from a small base), making Vietnam the world’s sixth-largest coffee exporter. And, with 2 percent of the world market in 1995, Vietnam recently joined the Association of Natural Rubber-Producing countries, from which it hopes to receive technical assistance to further boost production.

Industry and energy

22. The doi moi reforms—including price liberalization, trade and foreign exchange liberalization, and state-enterprise reforms—led to an initial downturn in industrial production. However, from 1991 onward there has been strong growth as well as a shift in activity from small (often locally managed) state enterprises and cooperatives toward private enterprises and larger state enterprises.

23. Industrial output increased on average by 12 ½ percent per year during 1991-94 (on a value-added basis) and by 14 percent in 1995. During the first half of 1996, industrial output rose by about 13 percent (compared with the first 6 months of 1995). The sector’s share in GDP increased from 24 percent in 1991 to 30 percent in 1995. Over the same period, the number of industrial state enterprises declined by more than 20 percent, of which the reduction almost entirely fell on the smaller locally-controlled state enterprises, whereas the number of private enterprises increased by 15 percent (Appendix Table 10). However, the remaining centrally managed state enterprises increased in size and the total number of state employees in the industrial sector increased slightly between 1991 and 1995. As a consequence, the share of industrial output accounted for by state enterprises has remained relatively unchanged—at about two-thirds of the total—during the 1990s. The state enterprise reforms ensured that state-owned enterprises were given greater autonomy with respect to decisions over prices and output. At the same time, the enterprises became subject to hard budget constraints—following a virtual halt of state subsidies—and faced increased competition from both foreign firms and new private domestic firms. These reforms led to high labor productivity growth among the surviving state enterprises: output per worker in industry grew by 11 percent per year over the 1991-95 period. Industrial output in the state enterprises grew at an annual average rate of 15 percent over the same period, while output growth in private enterprises grew by 10 percent per year.5

24. About one-half of industrial production is accounted for by heavy industries—mainly fuel, electricity, and machinery. Fuel production (oil and gas) is the most important heavy industry, accounting for about 16 percent of total industrial production (Appendix Tables 8 and 9). Production of oil and gas started to grow rapidly in the late 1980s through a joint venture with the Soviet Union. During the 1990s there has been a large increase in foreign direct investment from Western oil companies and—following the discovery of a number of new oil fields—production has continued to increase. Crude oil production nearly doubled, from 4.0 million tons in 1991 to 7.7 million tons in 1995. As there are no oil refineries in Vietnam,6 all crude oil is exported, mainly to Japan, while refined products are imported, mainly from Singapore. The total value of oil exports amounted to $1 billion in 1995, accounting for ⅕ of total exports. While refined product imports have also risen sharply, the oil trade balance has improved from $0.1 billion in 1991 to $0.4 billion in 1995 (Appendix Table 11).

25. Along with rapid economic growth, demand for electricity has been growing very rapidly, straining the government’s ability to increase supply, and there have been intermittent power shortages, especially in the south. New power plants are under development, both thermal and hydroelectric, and the government has announced its intention to develop a nuclear power plant in the coming years. The financing needs for additional power plant construction are large, and the government has tuned to bilateral donors, the World Bank, and private investors operating under a build-operate-transfer framework, to fund new capacity.

26. Vietnam’s rapid growth has also resulted in a construction boom. The construction sector grew at an average annual rate of 14 percent during 1991-95 and production of both steel, cement, and other building materials increased by more than 15 percent per year during the same period. The government has made the development of additional productive capacity in cement and steel a priority, and a number of projects in these areas have recently been undertaken as joint ventures, most notably the $300 million Morning Star Cement Factory, undertaken with financing from the IFC and a consortium of foreign (mainly Thai) banks; a large steel mill is also being undertaken together with two Japanese firms.

27. Of the light industries, food and foodstuff processing is the most important, followed by textile production. These industries account for ⅓ and 1/10 of total gross industrial production, respectively. During 1991-95, gross production of food and foodstuffs increased on average by 10 percent per year, while the annual average growth rate was 11 percent for textile and garment production.

Services

28. The services sector has responded well to the opening up of the economy to foreign trade as well as to financial sector reforms. The sector grew by 11 percent in 1995 with particularly strong growth in the two largest subsectors; “trade and retail,” and “housing, tourism and repairs.” Together, these two subsectors account for 25 percent of GDP. Large inflows of foreign direct investment into the tourism sector, including a number of joint-venture hotel projects, partly explain the strong growth in this sector. At the end of 1995, disbursed foreign investment into the tourism sector is estimated at $600 million—about one-sixth of total disbursed foreign investment. Financial services, still a relatively small subsector, has recently been posting growth rates above 20 percent per year.

29. About one-half of services sector output is provided for by state-managed entities and one-half by private firms. Annual growth rates have been on average around 9 percent during the 1990s for both the state managed and the privately managed entities. Government administrative services—including health and education services and defense expenditures—represents the most important state-managed services sector, accounting for about half of the state-managed services output.

Consumption, saving and investment

30. Investment has increased from about 15 percent of GDP in 1991 to 27 percent in 1995 largely as a result of rising foreign direct investment.7 Government capital expenditures have increased only slightly (from 5 ½ to 6 percent), while domestic private investment has grown at a lower rate than GDP, its share in GDP falling from 13 percent in 1994 to 12 percent in 1995 (Appendix Table 3). The bulk of foreign investment flows-which accounted for about ⅓ of the total investment in 1995—have been to sectors that produce for export. During 1992-95, $4 billion was disbursed in foreign investment, of which more than ¾ went into these sectors.8 In particular, disbursed foreign investment in 1995 into oil and manufacturing was $1.2 billion and $1.3 billion, respectively. As a share of GDP, foreign direct investment increased to 7 percent in 1994 and to 9 percent in 1995.

31. National saving has also increased during the 1990s, reaching 17 percent of GDP in 1995. The increase was due to a rise in government saving, which has increased by 4 percent of GDP since 1993 (see Section III). Private saving has declined as a share of GDP, while real per capita consumption has grown on average by 8 percent per year during 1993-95 and private consumption has increased as a share of GDP from 60 percent in 1993 to 66 ½ percent in 1995.9

Employment and wages

Employment

32. Official figures indicate that 34 ½ million people were employed in 1995—about 47 percent of the population.10 Although employment has grown at a higher rate than population in recent years, the working-age population has also grown at a higher rate than total population, implying that the unemployment rate has remained fairly stable during the 1990s (Appendix Table 17). Although there is no official time series on unemployment, recent estimates based on a household survey point toward an unemployment rate of about 6 percent in 1994. This would be consistent with a labor force comprising 85-90 percent of the population in the 15-64 age cohort. The household survey showed that youth unemployment was considerably higher: unemployment among 15-19 year-olds was estimated at 18 percent, while among 20-24 year-olds it was put at 11 percent. Unemployment is reported to be higher in cities than in rural areas, though problems of measurement arise in the comparison, particularly with respect to rural underemployment.

33. Following reforms in the late 1980s, employment in the state sector was dramatically reduced. Since 1992, however, employment in this sector has remained in the range of 3 million, including employment in state enterprises, where two-thirds of state employees work (Appendix Table 14). About 31 million people (90 percent of total employment) work in the private sector, from which virtually all of the increase in employment since 1991 has come (Appendix Table 12). About two-thirds of the 3.6 million jobs created since 1991 were in agriculture (Appendix Table 13). Strong employment growth also occurred in retail trade. In 1995, however, with record output growth, employment expansion took place across all sectors.

Wages

34. Data on wages in Vietnam are sketchy, and largely derived from data on the total state wage bill (government workers plus state enterprise employees). Thus, it is difficult to assess whether real wages have followed the increase in labor productivity. Moreover, anecdotal evidence suggests that state enterprises have had difficulty recruiting and retaining the best staff; as private employers—particularly foreign-invested firms—pay substantially higher salaries. While the minimum wage for state employees is around $11 per month, the base rate for foreign-invested firms was increased from $25 to $35 per month effective July 1996, with foreign firms in Ho Chi Minh City and Hanoi subject to a rise from $35 to $45 per month:

35. Average employee income in state enterprises is reported to have increased by 27 percent in nominal terms (about 14 percent in real terms) in 1995, with a particularly strong increase for employees in the industry and transportation sectors (Appendix Table 16).11 However, the income concept includes—in addition to salaries—bonus payments, payments in kind, and social security contributions, and increases in the latter categories account for the bulk of the overall income increase.

36. Government employees have received no general wage increase since 1993, though there have been modest increases for teachers and healthcare workers. Salaries of deputy department heads in government agencies are reportedly around $50 per month. Throughout the civil service, retaining good staff is becoming increasingly difficult, and many government workers resort to second jobs, outside consulting, or petty corruption12 to make ends meet.

Prices

37. Prudent financial policies in recent years have led to falling inflation. The 12-month inflation rate fell from nearly 70 percent in 1991 to 13 percent in 1995. This trend continued in 1996, and prices increased by only 2 ½ percent during the first ten months, yielding a 12-month inflation rate of 3 percent (Appendix Table 18). Various estimates indicate that the underlying—or core—inflation rate has fallen from about 12 percent in mid-1995 to about 6 percent in September 1996 (see Box 3). This downward trend has bean accompanied by a certain degree of movement around the trend. One deviation from the trend occurred in late 1994 and early 1995, when soaring rice prices and monetary expansion temporarily pushed up inflation. In particular, prices of staples (essentially rice) increased by 20 percent during the fourth quarter of 1994, following a disastrous autumn paddy crop. Monetary policy was tightened in early 1995, and, with a moderation in rice prices, inflation resumed its downward path.

Estimation of Core Inflation

Three different approaches have been used to measure the long run, or persistent, component of the price index for Vietnam. Core (or underlying) inflation has been estimated for Vietnam (i) mechanically; (ii) statistically; and (iii) econometrically. The first method simply excludes the the volatile food component of the RPI basket from the price index. The second method involves filtering the actual inflation rate series into a cyclical component and a trend component using the Hodrick-Prescott filter. The filter uses an algorithm which gives decreasing weight to more distant observations, and allows for adjustments in the degree by which the trend tracks the actual series. The third approach uses a vector auto regressive (VAR) model over monthly inflation, broad money growth, and exchange rate changes. Fitted values from this VAR system, are then extracted to form the underlying values.

The results from these exercises, shown below, all point toward the same conclusion: core inflation was 5-10 percentage points below actual inflation in mid-1995, but 1-3 percentage points above the actual rate in September 1996.

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Source: Staff estimates.

38. In 1996, a deviation from trend in the opposite direction was observed: following a bumper winter-spring rice crop, prices of staples declined in absolute terms by 14 percent from May to August, and the overall 12-month inflation rate dropped from 8 ½ percent in April to 3 percent in August. Higher imports also contributed to the low inflation in the first half of 1996, as shipment-by-shipment import licensing was abolished early in the year and some strategic goods were stockpiled. These measures helped to smooth seasonal inflation pressures around Tet, the lunar New Year festival, which is usually a period of heavy consumer spending and sharp price increases.

39. In contrast to the large fluctuations in food prices, price increases for services have followed a steady downward path. The 12-month inflation rate for services alone has declined from 13 percent in December 1994, to 10 percent in December 1995, and 7 percent in

uA01fig04

Annual inflation: RPI and Staples

Citation: IMF Staff Country Reports 1996, 145; 10.5089/9781451840131.002.A001

uA01fig05

Annual inflation: Consumer goods and Services

Citation: IMF Staff Country Reports 1996, 145; 10.5089/9781451840131.002.A001

September 1996. Price increases for services have in recent years been higher than price increases for consumer goods. Since January 1994, the difference in price increases for services and consumer goods has on average been 5 percentage points per year. This may be explained by relatively higher productivity growth in the tradeable-producing sector, i.e., manufacturing. As income has grown, demand for berth services (non-tradeables) and consumer goods (tradeables) have increased, and given unbalanced productivity growth, relative prices have adjusted.

B. Foreign Trade and Payments Developments

40. The evolution of Vietnam’s balance of payments over the past few years reflect the country’s adoption of an export-oriented growth strategy. Exports have boomed. Imports have also grown at a strong pace, driven in large measure by imports associated with foreign direct investment, mainly from neighboring Asian countries. The resulting current account deficit has therefore been largely self-financing, though there has also been a rising flow of foreign aid, and some limited commercial borrowing by domestic enterprises.

41. As a result of external debts taken on before the start of the economic reform program, Vietnam is considered to be a heavily-indebted poor country. Progress is steadily being made, however, in reducing the burden of former debts. Since clearing arrears to the Fund in 1993, Vietnam has concluded debt reduction and rescheduling agreements with many of its creditors and negotiations are ongoing with the others.

Exports

42. The strong export performance of earlier years continued in 1995 and in the first half of 1996. The value of total exports in U.S. dollar terms, which had grown by 36 percent in 1994, increased by 32 percent in 1995 and by 38 percent in the first half of 1996 compared with the corresponding period of 1995. As a result of trade liberalization efforts and significant foreign direct investment—which brought new technology, management and marketing skills—exports have become increasingly diversified. The share of two major export commodities (crude oil and rice) in total exports declined from 43 percent in 1992 to less than 30 percent in 1995. The expansion of coffee exports is particularly notable. With higher production accompanied by a sharp rise in international prices, coffee exports increased from $86 million in 1992 to $565 million in 1995, becoming the second most important export commodity after crude oil (Appendix Table 21). Other cash crops (including cashew nuts and rubber), forestry and marine products (especially shrimp), handicrafts, and light industrial goods (mainly textiles and footwear) also have grown rapidly in recent years.

43. The geographical destination of Vietnam’s exports has become more oriented toward industrial countries in recent years, as Vietnam takes advantage of preferences under the Generalized System of Preferences (GSP) and a rising EU textile import quota. This trend accelerated in 1995, when the share of exports to industrial countries rose to an estimated 61 percent, compared with 43 percent in 1994 (Appendix Table 22). While Japan remained the largest market (accounting for about 29 percent of Vietnam’s total exports, with crude oil comprising half), exports to European countries expanded significantly; in particular, the relative share of exports to Germany more than tripled to 9 percent in 1995. French data indicate that textiles and footwear make up half of that country’s imports from Vietnam in 1994, and this trend is likely to have continued in 1995, when EU imports of footwear alone totaled 61 million pairs worth $250 million. Much of Vietnam’s exports, however, continues to go to other Asian countries: Singapore, Taiwan Province of China, and Hong Kong are major trading partners.

Imports

44. After extraordinary import growth in 1994—49 percent—1995 import growth in U.S. dollars remained very high at 33 percent, but rebounded to 48 percent in the first half of 1996 (compared with the same period of 1995). In 1995, a sharp decline in the growth of imports not related to foreign direct investment (from 53 percent in 1994 to 23 percent in 1995) was only partly offset by a strong increase in imports related to foreign direct investment. Major factors contributing to the sharp increase in imports in the first half of 1996 included the elimination of import shipment licences, a stockpiling of key commodities to suppress consumer price increases during the lunar New Year holidays, and large imports financed by foreign direct investment.

45. Although there is no comprehensive data on the commodity composition of imports, available information suggests that a significant portion of the increase in imports during the first half of 1996 was accounted for by capital goods, raw materials, and intermediate goods. Machinery and spare parts represented about 30 percent of total imports in 1995, compared with only 11 percent in 1992 (Appendix Table 23). Imports of consumer goods remained relatively small, representing only 10 percent of total imports in 1995 and 12 percent in the first half of 1996.13

46. More than three quarters of Vietnam’s imports originate from other Asian countries. Singapore was the largest source of Vietnam’s imports, representing 17 percent of total imports, followed by Korea (13 percent), China (10 percent) and Taiwan Province of China (10 percent). The share of Taiwan Province of China has risen markedly in recent years, reflecting a rapid expansion in its investment in Vietnam. Among industrial countries, Japan and France were major suppliers, with their shares estimated at 9 percent and 3 percent, respectively.

Services and transfers

47. In 1995, the surplus on the balance of nonfactor services increased sharply. While nonfactor services payments (mainly freight and insurance) rose in line with the high growth of external trade, nonfactor services receipts also grew markedly, partly reflecting a significant increase in tourism.14 The deficit on the balance of investment income fell slightly in 1995, as higher scheduled interest payments were more than offset by lower oil profit transfers and higher interest earnings associated with a large accumulation of international reserves. Scheduled interest payments amounted to about $400 million.

48. Net transfers recorded a surplus of over $600 million in 1995. Remittances from Vietnamese working abroad reached an estimated $500 million, while official transfers amounted to $150 million, of which one-third came from Japan. The United Nations and other bilateral donors such as Sweden and Denmark were other major donors.

Capital account

49. Rapidly growing foreign direct investment, which reached $1 billion (or about 7 percent of GDP) in 1994, is the most important component of the surplus on the capital account. Foreign investment flows increased further to $1.8 billion (about 9 percent of GDP) in 1995, financing the bulk of the current account deficit. Medium- and long-term loan disbursements increased from $270 million in 1994 to $440 million in 1995, mainly reflecting an increase in commercial borrowing to $250 million, largely to finance capital goods imports by state enterprises. Disbursements of concessional loans increased only modestly to $190 million, reflecting start-up problems for certain major infrastructure projects. Multilateral institutions accounted for about 55 percent of total disbursements of concessional loans. Among official bilateral lenders, Japan remained the single largest (accounting for 18 percent of total concessional loan disbursements), followed by France and Taiwan Province of China. Scheduled amortization payments (including nonconvertible currency debt) in 1995 were estimated at about $730 million, or about 10 percent of exports of goods and nonfactor services.

50. Short-term borrowing more than doubled in 1995 (to over $300 million) as foreign banks became increasingly comfortable financing Vietnam’s trade, which also resulted in declining interest margins on trade credits. With continuing strong growth of short-term credit in the first half of 1996, the authorities have placed margin deposit requirements on the use of letters of credit with deferred payments for consumer goods imports.

51. The pace of disbursements from foreign investment has picked up significantly in the past two years. Disbursements for foreign investment totaled $5.6 billion in 1988-95, of which it is estimated about 30 percent represents equity and the rest loans provided or guaranteed by parent companies abroad.15 A large portion of these disbursements were concentrated in export-oriented industries. The oil and gas sector, where large projects have recently come on stream, received 31 percent of total disbursements in 1988-95, followed by industry (including labor-intensive manufacturing) with 29 percent, and hotels and tourism with 18 percent (Appendix Table 24).

52. Neighboring Asian countries have been major sources of foreign direct investment in Vietnam. Taiwan Province of China has been the leading investor, followed by Japan, Hong Kong, and Singapore (Appendix Table 26). Japan’s share, which was initially small, has risen sharply. The relative importance of Australia and France, which led foreign investment at the early stage of economic reform in Vietnam, has declined in recent years. The United States resumed direct investment in Vietnam in 1994 following the lifting of the U.S. embargo, but its relative share has remained small.

53. Notwithstanding the recent pick up in disbursements, less than one-third of outstanding commitments to foreign investment projects has been disbursed through end-1995. The outstanding stock of such commitments (including the share from local partners) reached $18.4 billion at end of 1995, with new commitments amounting to $6.2 billion in 1995. In recent years, the sectoral distribution shifted from the development of oil and gas fields to the industrial sector. In 1995, the industrial sector accounted for 22 percent of total new commitments, hotels and tourism industries 15 percent, construction 13 percent, and transport and communication 12 percent (Appendix Table 25). About 33 percent of total outstanding commitments at end-1995 was accounted for by the industrial sector, followed by hotel and tourism with 19 percent. The relative share of outstanding commitments to the oil and gas sector was only 7 percent.

54. Total new commitment of foreign direct investment approved by the government in the first 10 months of 1996 totaled $4.8 billion, a pace noticeably slower than in 1995. While it is possible that this reflects diminished enthusiasm for Vietnam on the part of foreign investors, more careful analysis suggests that the apparent slowdown may owe more to a shift in official policy. A number of officials have expressed an interest in reducing foreign participation in hotel and office development, and, if foreign investment licenses outside of real estate is compared, the 1996 data shows commitments running at a pace more than 25 percent higher than 1995.

External debt

55. Total outstanding medium- and long-term debt in convertible currencies is estimated at $7.2 billion at end of 1995, of which 18 percent was in arrears (Appendix Table 27). The debt includes the loan component of foreign direct investment, which is estimated at $2.7 billion. The terms of these loans are generally favorable, carrying maturities of more than 7 years and interest margins of less than 100 basis points over LIBOR in many cases. Total medium- and long-term public debt (including publicly-guaranteed debt) in convertible currencies amounted to $4.5 billion, of which 56 percent is owed to official bilateral creditors and 16 percent to international organizations (mainly the Fund, the World Bank, and the Asian Development Bank). Debt owed to Paris Club and other official bilateral creditors amounted to $1.8 billion and $0.7 billion, respectively. With the exception of the United States, all bilateral agreements under Vietnam’s 1993 Paris Club rescheduling, which provided for a 50 percent reduction in the value of rescheduled arrears, have been signed. Public debt owed to private creditors at end-1995 (excluding loans for foreign investment) is estimated at $1.2 billion, with commercial bank debt estimated at over $0.8 billion. In May 1996, agreement was reached in principle on a restructuring package for commercial bank debt, all of which had been in arrears for many years (Box 4). Short-term debt at end of 1995 is estimated at $0.8 billion, comprising mainly trade credits to state-owned enterprises.

Rescheduling Agreement with Commercial Bank Creditors

On May 17, 1996, Vietnam reacted agreement in principle with commercial bank creditors on a debt and debt service reduction (DDSR) operation, representing a further significant step in the country’s reentry into the international financial community. The agreement covers debt of about $900 million. The menu of options in the agreement comprises cash buyback, a par bond, a discount bond, and a past due interest (PDI) bond. The par bond carries a maturity of 30 yours with a 15-year grace period. Principal will be paid in 31 installments, with the first 30 installment amounting to 1.67 percent each and the last installment 50 percent (Appendix Table 29). The par bond has full collateral of the last 50 percent principal payment. The interest rate is 3 percent for the first two years and gradually rises to 4 percent for year 10 and 5.5 percent from year 21 on. The discount bond is a 30-year bullet with a 50 percent discount and carries an interest rate of LIBOR plus 13/16 percent, with collateral held against 6 months’ interest payments. The PDI bond carries an 18-year maturity with a 7-year grace period, with principal being paid in 23 equal semi-annual installments. The interest rate is fixed at 3 percent for the first year and will rise to 4 percent in year four and to LIBOR plus 13/16 percent from year eight. The PDI bond requires a cash down payment of US$15 million.

56. Transferable ruble debt at end-1995 is estimated at TR 10.6 billion, which includes arrears of TR 5.6 billion. Debt owed to the Russian Federation accounts for most of this. Vietnam has recently reached agreement on restructuring of debt with several small creditors, including Hungary (October 1995), Poland (February 1996), and the Czech Republic (April 1996)l6 and has been making some payments to the Russian Federation. However, the bulk of the transferable ruble debt remains to be regularized, and Vietnam is continuing discussions with the Russian Federation, Bulgaria, and Romania.

57. With the Paris Club debt relief, scheduled debt service payments on convertible currency debt remained modest, accounting for only 4 percent of exports of goods and nonfactor services in 1994. The ratio rose to about 7 percent in 1995, owing to $95 million in repayments of advances on oil export receipts extended by Japanese companies in the early 1990s. Arrears accumulated on convertible currency debt in 1995 are estimated at about $70 million in 1995. The bulk of debt service payments in transferable ruble falling due in 1995 (TR 1.1 billion) fell into arrears.

III. Monetary and exchange rate policies and outcomes

A. Developments in Money and Credit

58. During the second half of 1994, domestic bank credit expanded quite rapidly. Added to steep increases in the price of rice, this led to accelerating inflation in late 1994 and into 1995. By early 1995, the authorities had begun to address the problem, clamping down tightly on credit. Broad money grew by less than 8 percent during the first half of 1995, while retail prices increased by 12 percent. Inflation slowed quickly in response to the new policies, and money and credit growth were eased somewhat in the second half of 1995. By year-end, broad money had increased by 22 ½ percent and nongovernment credit by 27 percent.

59. In 1996, money and credit growth was restrained early in the year in order to keep the seasonal inflation spike associated with consumer spending at Tet from feeding inflationary expectations. Nongovernment credit grew by around 1 percent in the first quarter, keeping money growth at less than 4 percent despite substantial foreign inflows. In the second quarter, policies were still very tight, with money growth of 2 ½ percent and credit growth of 4 ½ percent.

B. Interest Rates

60. As inflation declined over the course of 1995, the Vietnamese authorities became concerned that real lending rates were becoming too high. The maximum interest rate on short-term bank loans—which in practice was almost uniformly employed by the banks—had remained at 28 percent since late 1993, while the underlying rate of inflation fell to single-digit levels. Demand for loans at these rates had remained robust, however, even when, in the fourth quarter of 1995, credit was allowed to grow at a fester pace than earlier in the year. The repeal of the turnover tax with respect to banks from the beginning of 1996 provided an opportunity to reduce interest rates and pass the benefit of the tax reduction on to the final borrowers. A broader reform of the interest rate system, however, was also carried out.

61. At the beginning of 1996, the SBV reduced the maximum lending rate for short-term loans to 22 percent. During the first ten months of 1996, the maximum lending rate on short-term credits (which constitute the large majority of dong lending) was reduced three more times, to 16 percent. Over the same period, the maximum rate for medium-term loans was reduced more slowly, from 22 percent to 17 ½ percent, establishing for the first time in many years a positive yield curve on loans. Rates on dollar-denominated loans were kept at 9 ½ percent throughout.

62. At the same time that lending rates were being reduced, the authorities switched from mandating specific deposit interest rates to controlling those rates by applying a limit to banks’ interest rate spreads. The maximum spread between deposit and lending rates was set at 0.35 percent per month, or 4.2 percent per year. This limit was to be based on average ex post rates, however, rather than the posted rates on current transactions, and was to be enforced only at the end of each calendar year. In addition, this formulation allowed for the interest foregone through reserve holdings at the SBV to be taken into account in calculating the spread. This formulation ensured that what was being monitored was banks’ net interest income, and provided banks with a degree of flexibility in carrying out the directive in the short run. As the interest rate reductions had been widely anticipated, there had been a shift by depositors in late 1995 into 12-month time deposits, the longest maturity available and the highest yielding. As lending rates were reduced, this placed a squeeze on the income position of banks, and, along with lending rates, interest rates on new deposits fell steeply. By the October 1, 1996, interest rate cut, time deposit rates at many institutions had dropped to only around 6 percent.

C. Exchange Rate Policy and International Reserves

63. During the 1990s, Vietnam has followed a market-based exchange rate policy. Since 1992, the rate has closely followed the U.S. dollar, fluctuating within about 5 percent of the rate of about D 11,025 per dollar prevailing in September 1996. The parallel market rate has not deviated substantially from this rate, and has sometimes traded at a premium to the official rate, reflecting the added convenience and anonymity provided by the parallel market. The real effective exchange rate appreciated by 9 percent in 1995 and by 2 percent in the first eight months of 1996.

64. This stability has occurred with only a modest degree of intervention in the foreign exchange market. Overall, the State Bank has acquired substantial foreign exchange reserves through direct transactions, for example through the Government and from the Fund. Accumulation of official reserves has been equivalent to 2 percent of GDP in 1994 and 1995, and reserves has grown at a similar pace during the first three quarters of 1996. At end-September 1996, gross official reserves of the State Bank of Vietnam, including gold, stood at $1.8 billion equivalent to 9 weeks of total imports.

IV. Fiscal Policies and Outcomes

65. One of the most impressive aspects of Vietnam’s reform effort has been the achievement of fiscal discipline. From an overall deficit of over 10 percent of GDP in 1989, the deficit has been brought down to near balance. Central to this achievement has been the financial improvement of the state enterprise sector, which moved from being a net drain on the budget to being a net contributor. In addition, there were large cuts in military spending following Vietnam’s withdrawal from Cambodia, while on the revenue side, rapid economic growth and the opening of the economy have brought large increases in tax and tariff revenues.

66. Over the past two years, the authorities have stepped up efforts to improve the quality of fiscal management. Simplification of the tax system, upgrading of tax administration, and broadening of coverage to improve collections from the emerging private sector have been the main priorities. In the October 1996 session of the National Assembly, several major pieces of tax reform legislation were introduced that are expected to result in adoption of a value-added tax and a unified corporate profits tax. Work has also proceeded on improving expenditure management. An Organic Budget Law was passed in 1995, establishing rules for the budget process. In 1996, the first Public Expenditure Review and Public Investment Program were completed, helping the authorities to improve the allocation and efficiency of spending.

A. Fiscal Developments Since 1994

Developments in 1994

67. Fiscal revenues (excluding grants) and current expenditures continued to increase as a share of GDP in 1994. Domestic revenues exceeded the budgeted level (D 38 trillion) to reach D 40 trillion—23.6 percent of GDP, an impressive increase from the 15-16 percent of GDP collected during 1989-91 and the 21.6 percent of GDP collected in 1993. Relative to 1993, tax collection increased by D 8 trillion or 34 percent. About one half of this increase came from higher profit and turnover taxes paid by state enterprises. Almost as large was the increase in customs duty collection. The force of tariff—tariff revenues as a proportion of imports—increased from 16 percent in 1993 to 18 percent in 1994. Nontax revenues rose by nearly D 3 billion, partly reflecting higher-than-expected depreciation allowance payments by state enterprises and unbudgeted asset sales.

68. Both current and capital expenditures were kept below budgeted levels. Compared with 1993, however, current expenditure increased significantly, due in part to a delayed impact of the wage adjustment of 1992-93. The largest spending increases were in pension payments and administrative services (mainly wages). On the other hand, spending on economic services, education, and “other expenditures” (which include military spending) showed little increase. Capital expenditures at 5 ½ percent of GDP fell below the budgeted level by about 2 percentage points of GDP, representing a shortfall in aid disbursements. The first donors’ meeting for Vietnam, in late 1993, established a substantial pipeline of project commitments, but disbursements were initially slow. As a result, overall expenditures declined from 28 ½ percent of GDP in 1993 to 27 percent. Reflecting the high level of current spending, current savings showed only a modest increase to 2 ¾ percent of GDP from 1 ½ percent in 1993, but the lower capital outlays contributed to the reduction of the overall balance to 2 ½ percent of GDP from 5 ½ percent in 1993. The deficit was largely financed by domestic nonbank borrowing.

Developments in 1995

69. In 1995, the fiscal stance became tighter: the surplus on current operations increased to around 5 percent of GDP and the overall deficit (excluding grants) was reduced to little more than 1 percent of GDP. Total fiscal revenues as a share of GDP declined slightly to 23.3 percent, as an increase in import tariff receipts was more than offset by a decline in nontax revenues. On the expenditure side, however, current expenditures were compressed, most notably with respect to outlays for general administration (civil service wages were not raised) and “other expenditures.” Relative to 1994, capital expenditures as a share of GDP increased slightly, to about 6 percent of GDP. This was, however, still very much below budgeted levels as aid disbursements continued to be slow.

70. Two important changes were incorporated in the 1995 budget. To protect the budget from revenue shortfalls or other adverse developments, a “contingency fund” was established amounting to D 3 billion (1.4 percent of GDP). Thus, the sum of line item allocations was less-than-expected aggregate expenditure. In the event, this contingency served its objective and played a role in maintaining a low overall deficit. Though useful, this practice has the drawback that it increases the discretionary allocation of funds by the Treasury, weakening the link between the budget and actual spending. The other major change was the establishment of a pension system (the Vietnam Social Insurance Fund, VSIF) outside the budget for those who retire after January 1, 1995 (see the discussion of the social safety net below).

Revenue performance

71. Although declining in relation to GDP, revenues in 1995 increased by 29 percent. The increase in revenues was again most visible in import tariff collection—tariff revenues increased by 64 percent, which made up one-half of the overall increase in revenues. In other areas, there was substantial improvement in revenue mobilization from nonstate enterprises and joint ventures (especially profit and turnover taxes). Added together, these sectors contributed about a third of the additional revenues in 1995.17 This was a major shift from the revenue pattern of 1994 when state enterprises contributed more significantly to revenue gains. The state sector’s contribution declined in 1995: a modest increase in tax revenues from the state sector was more than offset by a decline in nontax revenues from the state enterprises, resulting from a decision to reduce capital user fees and depreciation charges.18

Expenditures

72. Current expenditures declined by 2 ½ percent of GDP from 1994 (to 19 percent of GDP) as a result of real wage compression and a decline of 1 percentage point of GDP in the category “other expenditures.” Despite the overall reduction in current expenditures, efforts were made to maintain priority expenditures under economic and social programs. As a share of GDP, overall economic and social expenditures remained at about the same level as in 1994. Education spending in 1995 increased slightly to 2.1 percent to GDP, but expenditure on healthcare declined from 1.3 percent of GDP in 1994 to 1 percent in 1995. The Government’s view is that healthcare standards should be maintained by supplementing budgetary outlays with user fees and health insurance.

73. Although less than budgeted, capital expenditures increased from 5 ½ percent to 6 percent of GDP, most of which was devoted to infrastructure development. The shortfall in capital spending was again largely due to much weaker-than-expected disbursements of project aid. Only about one-half of the amount expected in the budget was actually disbursed. Since the first donors’ meeting in 1993, aid pledges have averaged about $2 billion per year. However, the establishment of a regular project pipeline has taken much longer than originally envisaged, as it has required not only more time than expected to adequately identify and evaluate individual projects, but also required adaptation on the part of donors and the Vietnamese authorities to coordinate their procedures for aid disbursement. In 1995, project implementation continued to suffer from administrative start-up delays, including delays in bidding processes and in reaching agreements on compensation for resettlement of residents.

The 1996 budget

74. The 1996 budget aims to continue the sound fiscal management practices established over the last few years. The overall deficit, when defined according to international practice, is projected to be below 2 percent of GDP, which is expected to be financed without recourse to bank borrowing. Public investment is projected to increase to almost 7 percent of GDP, and this will be financed primarily from a surplus on current operations and official development aid. Domestic financing of the budget is limited to D 600 billion, or 0.2 percent of GDP.

75. Revenue is targeted at 22.8 percent of GDP in the budget—down by ½ percentage point from 1995—largely reflecting a reduction in the planned contribution of state enterprises of almost 1 percent of GDP. Expenditures are expected to be 25 percent of GDP, about the same level as in 1995. The division between current and capital spending will depend on deployment of the contingency fund; however, current spending is expected to be about 18 percent of GDP, a full one percentage point below the 1995 outturn.19 This reduction is distributed among various spending items. The largest decline is in the area of pensions, reflecting the establishment of the new social insurance fund in 1995. Budget allocations to general administration, economic services, and social services (excluding the category of pension and social relief) are all expected to decline in terms of GDP from the 1995 outturn. No major wage increase was budgeted for 1996.

76. During the first half of 1996, fiscal developments were consistent with the expected budget outcome. Approximately 40 percent of budgeted revenues were collected (revenue tends to pick up in the second half of the year, as certain payments are only due then) and resources amounting to 39 percent of budgeted spending were disbursed. Despite a rapid expansion of imports, collection of tariff revenues was lower than expected, as imports attracting higher tariff rates (i.e., consumer goods) were lower than had been projected for the budget. Once again, the disbursement of foreign aid was slower than assumed in the budget, leading to slower implementation of the capital budget.

B. Tax Reform

77. During 1995, several changes in the tax system were implemented: license taxes on motorcycles and cars were replaced by a transport fee of about 3 cents per liter of gasoline; import tariff rates were raised for petroleum, steel, cars and motorcycles; and land transfer taxes were systematically collected. At the beginning of 1996, the maximum import tariff rate was also lowered to 60 percent from 200 percent, and domestic excises were placed on luxury items.20 In addition, as part of preparations to move to a value-added tax, the turnover tax was streamlined by reducing the number of rates from 18 to 11. As a package, these changes were intended to be revenue-neutral.

78. Draft legislation introducing a value-added tax was discussed by the National Assembly in October 1996. The draft under consideration envisages a VAT coming into effect from the beginning of 1998 with three positive rates. Also under consideration are revisions to the profits tax that would move in the direction of unifying the corporate profits tax rate, and revisions to personal income tax that would broaden the tax brackets.

C. Social Services and the Safety Net

79. Although access to social services in Vietnam compares favorably with other equally poor countries, there are indications that a combination of reduced public expenditures and increased reliance on user fees have benefitted the higher income groups at the expense of the poor. The Government has, however, initiated some reallocation of public expenditure toward lower income groups aimed at increasing the rate of poverty reduction. While a relatively comprehensive set of social benefits exists, it is not designed to protect the poorest households.

Education

80. For its income level, Vietnam has achieved a high level of school enrollment and a high literacy rate. In the early 1990s, both the quantity and quality of schooling deteriorated, but these trends appear to have been reversed. Primary school enrollment in 1995 is estimated at about 90 percent of the relevant cohorts, whereas secondary school enrollment is estimated at about 45 percent.21

81. Indications are that the costs associated with attending school discourages enrollment among the poor. Only about half of all primary school spending is financed by the public sector (amounting to about 2 percent of GDP). The rest is financed privately in the form of official school fees, parental-teacher contributions, book and uniform costs, and transport payments. For secondary schools, these private expenditures cover about 70 percent of total costs. Although total private costs vary across income groups, with the poor students typically paying less than the better off, official fees, the costs for schoolbooks, and parental-teacher contributions are about the same for all students. In addition, three-quarters of public expenditures on education are spent by the local governments, with the poorer provinces in general spending significantly less per capita. This implies that the quality of the education is typically lower in the poorer regions.

Health services

82. Vietnam has developed a system of health facilities—including hospitals and health centers—which is far better than in similar developing countries. However, there has been a marked reduction in the utilization of health services since the early 1990s, possibly due to a deterioration in the quality of health services following the compression of public expenditures, and as a consequence of increased user costs of health services.

83. Although all income groups have access to some kind of medical care, a striking feature of the utilization pattern is a strong overall reliance on self-medication. About two-thirds of the sick resort to self-treatment, and this proportion is significantly higher among the poor. Moreover, formal treatment is provided more commonly at private facilities than public ones. This is true across income groups, but with the important distinction that the poor to a much larger extent seek treatment from paramedics rather than private doctors. Similarly, when seeking treatment by a public provider, the poor tend to rely on village health centers, whereas the richer groups rely more heavily on higher-quality hospital care.

84. Total government health expenditures are about 1 percent of GDP, which private expenditures on healthcare are estimated to be about five times higher. Most of the private expenditures are for drugs either associated with formal treatment—whether in public or private facilities—or for self-medication. Given the large amount of private resources that are devoted to healthcare, the public sector could concentrate its resources on priority areas, such as the village health centers. However, most of the state budget allocation goes to the public hospitals, which implies that the government effectively subsidies the better off. Aggregating across all healthcare programs, the per capita subsidy for the richest quintile is more than twice as high as for the poorest quintile.

The social safety net

85. Vietnam has an extensive social security program. Total outlays on social protection in 1995 amounted to D 7.5 trillion (3.4 percent of GDP), which is more than the outlays on education and health services combined. These expenditures cover three different programs: (i) social security for public sector employees, including pensions and disability payments; (ii) allowances for war veterans; and (iii) social relief measures such as aid for victims of natural disasters. The first category—which captures more than three-quarters of the total expenditures—has the highest transfer-per-beneficiary ratio. However, most of the beneficiaries in this category are concentrated in the higher income groups. Hence, this transfer program does not specifically target the poorest. In this regard, pension expenditures are similar to expenditures on education and health services: a disproportionately large share of expenditures subsidizes higher income groups.

86. The social security system was established in 1961 to provide benefits to employees in the state sector. Until 1985, these benefits were financed from a 4.7 percent payroll tax paid by the employer. Of this amount, 3 percent went to the National Trade Union to provide for sickness, accident, and pregnancy benefits, while 1.7 percent went to the Ministry of Labor, Invalids, and Social Affairs (MOLISA) to provide for pensions, survivor, and disability benefits. In 1985, the employer payroll tax was increased to 15 percent, and from January 1, 1994, a 5 percent employee payroll tax has been imposed as well.

87. On January 1, 1995, the VSIF was created, incorporating parts of the National Trade Union and MOLISA. Coverage has been extended to all enterprises employing 10 or more persons. The VSIF, which has provincial and district organizations under it, is formally governed by a Board chaired by the Minister of Labor and including the head of the National Trade Union and a Deputy Finance Minister. All persons retired as of January 1, 1995, will continue to have their pensions paid by the budget; later retirees will receive benefits from VSIF. The estimated 1995 cost to the budget for the 1.8 million current beneficiaries is D 4.5 trillion.

88. The retirement age is 55 for women and 60 for men. Benefits are indexed to the minimum state sector wage of around $11 per month, and based on earnings in the final five years of work, with initial benefits ranging from 45 percent of salary for a worker with 20 years of contributions to a maximum of 75 percent of salary. VSIF does not provide disability or unemployment benefits.

89. At present, the Social Insurance Fund has a substantial surplus, as there are approximately 4 million contributors and 100,000 beneficiaries. In principle, the VSIF is free to manage the assets of the Fund as it chooses. In practice, at present, the surplus is deposited with the Finance Ministry; D 1 trillion from the Fund were used to finance the 1995 budget, which is expected to be repaid only after the Fund begins to run deficits.

90. VSIF is facing a number of challenges. Most pressing is that of collecting the mandatory contributions, as the tax is seen as excessively high and there are no effective sanctions. In addition, not all enterprises withhold the employee contribution, complicating the task of collection. It is expected that without improved collection of contributions, the VSIF could move into deficit within just a few years. In addition, VSIF lacks the necessary technical, investment, and actuarial skills to effectively carry out its mandate.

Hunger eradication and poverty reduction

91. The government has addressed the poverty problem through its program for Hunger Eradication and Poverty Reduction (HEPR). The aim for the coming five-year period is to eliminate poverty in the 600,000 starving households (these households are defined as the poorest of the poor, and account for about 4 percent of all households), and reduce overall “food poverty” to about 10 percent before year 2000. The HEPR programme spans a wide range of policies and includes measures such as enhanced infrastructure investment in the poorest 1,300 communes; subsidized loans to target groups; free vocational training; waived school fees and provision of books and manuals for the poorest pupils; and free health insurance for family members in the poorest households. Total expenditures for the HEPR programme are expected to average about 0.5 percent of GDP per year over the next five years.

D. Public Sector and Expenditure Management

92. The Government is committed to improving expenditure management so that public resources are allocated and spent according to established priorities. During the first half of 1996, a Public Investment Program and a Public Expenditure Review were completed with the support of UNDP and the World Bank, and an Organic Budget Law was enacted.

93. The Public Investment Program summarizes the pipeline of investment projects for the next five years and places it within a macroeconomic framework. However, the explicit link between the Public Investment Program and annual budgets or credit programs is still weak (a point made by the Public Expenditure Review). Plans have been made to repeat the exercise annually, on a rolling basis.

94. Major recommendations of the Public Expenditure Review include increasing spending on operations and maintenance and on basic social services. On civil service management, improvement is recommended through matching work force skill levels with desired skill mixes through training and improved financial incentives. Recommendations on sector resource allocation include (i) on education, shift resources to primary levels, while improving the quality of teachers—currently there are too many underpaid teachers; (ii) on healthcare, emphasize preventative and village level healthcare, and collect more user fees; (iii) select a set of core projects for transportation that result in smaller number of better maintained projects, as maintenance spending must increase significantly; (iv) focus spending on agriculture on basic extension services and research, and maintain irrigation facilities by making better use of user fees; and (v) increase private participation in oil and gas to help meet the enormous investment needs, and scale down new investments in power (because the existing target is ambitious) and coal (because it faces tough competition from gas).

95. The Government enacted an Organic Budget Law in April 1996. It stipulates the processes of preparation, execution, and accounting of the state budget and facilitates improvement of the expenditure management and control system at the national and local levels. It defines steps to prepare and execute the budget and assigns responsibilities for each step to different public sector entities, largely according to existing practice. Revenues, as well as spending authority in certain areas, are assigned to various levels of government. Among the taxes shared between local and central governments are turnover tax, profit tax, natural resource tax, capital gains tax and income tax on higher-income residents, as well as tax on profit remittances. Details of revenue sharing ratios between the central and local governments for individual taxes are to be defined in the implementing regulations to be issued late in 1996. In addition, the Government will continue its efforts to streamline the executive structure through administrative reform complementing the efforts to improve budgetary processes.

V. Structural Reform

96. The authorities have made steady progress in structural reform over the past several years, and reaped impressive benefits as a result. Many of the most sweeping reforms were undertaken early in the reform process when the economic situation in Vietnam was quite dire. Over the past two years, the process of structural reform has been pursued at a more gradual pace. This reflects both the natural caution of the authorities, who have tended to favor a more step-by-step approach to reform now that the economic situation has improved, and the technical difficulty of many of the reforms that remained on the structural reform agenda.

A. State Enterprises

97. The first round of state enterprise reform included the elimination of operating subsidies from the budget and interest rate reforms that reduced implicit subsidies through the banking system. These policies led to a rationalization of the sector, and several thousand loss-making firms were liquidated or merged. Output in the state sector is now growing very rapidly. Official data show industrial value added rising by over 14 percent per year since 1992, though part-year data for 1996, which separates joint ventures between state enterprises and foreign firms from wholly-state firms, suggests that the joint ventures may be improving these figures substantially. Nevertheless, data for the first nine months of 1996 show that output of state enterprises not involved in joint ventures grew by around 10 percent over the same period in 1995. This performance stands in sharp contrast with state enterprises in central and eastern Europe, and consequently there has not been a significant problem with interenterprise arrears in Vietnam (Box 5).

Interenterprise Arrears

  • Interenterprise arrears in Vietnam is predominantly a problem of outstanding debts of defunct or moribund enterprises from the pre-reform period. Accumulation of new arrears is not a significant issue.

  • The identification of such arrears was completed in 1992, when the total outstanding was identified as D 11 trillion, about 10 percent of 1992 GDP.

  • The settlement process has been very slow: at end-1994, the outstanding total was D 8.2 trillion (of which 1.7 trillion represented bad debt to banks). This was equivalent to around 5 percent of 1994 GDP. Two thirds of the remaining remount is considered uncollectible. The state enterprise action plan calls for (unspecified) measures to accelerate the settlement of arrears. In the past, the government has extended credit to allow settlement of arrears chains, but this has been very limited.

98. The current round of state enterprise reform is proceeding along the path set out at the midterm Communist Party Congress in 1994, the principal elements of which were spelled out in an action plan for further reform adopted by the Government in the first half of 1996. The Government has continued to focus its efforts on improving the efficiency of state enterprises. Control over state enterprises has recently been transferred from line ministries to the Ministry of Finance: the General Department for the Management of State Assets in State Enterprises was established in April 1995 to improve accounting, auditing, and monitoring of state enterprises. The recent State Enterprise Law should further enhance the efficiency of state enterprises, limit the state’s financial responsibility for commercial enterprises, and improve the supervision of state enterprises while giving enterprises greater managerial autonomy. The Government’s long-term plan for state enterprises is to retain a group of strategic firms (largely utilities and defense-related concerns), while divesting other enterprises.

The State Enterprise Law

99. In April 1995 the National Assembly approved a State Enterprise Law, spelling out the rights and obligations of state enterprises and clearly moving most enterprises away from direct state management. Implementation of the law has been held up pending the issuance of implementing regulations, the last of which was issued in October 1996. Together with these regulations, the law does the following: (1) distinguishes commercial enterprises from public service enterprises, permitting the former to begin the equitization process; (ii) establishes clear rules for the creation of new state enterprises; (iii) specifies which enterprises are to be governed by a Board of Management, the division of responsibility between enterprise management and the Board, the selection of Board members, and the Board’s accountability to the State; (iv) establishes guidelines for the allocation of post-tax profit among retained earnings, employee bonus funds, and dividends to the State; (v) allows enterprises to lease, sell, or mortgage its assets; and (vi) establishes a supervision system for state enterprises.

Grouping of state enterprises

100. One of the problems with which the Vietnamese authorities have wrestled in their efforts to make state enterprises more efficient has been how to oversee managers’ performance once bureaucratic oversight is lifted. Of the 6,300 state enterprises, nearly half employ fewer than 100 workers. One solution promulgated in a mid-1994 Government Decision is the creation of General Corporations, which group a number of enterprises under a single management. The Textile and Garment Corporation, for example, has 55 constituent enterprises and a total of almost 100,000 employees. The Government has created 18 General Corporations (see Box 6), as well as 50 of the somewhat smaller Special Corporations. Together these incorporate nearly half of the total number of state enterprises.

General Corporations

The Government has approved the creation of 18 General Corporations, and has no plans at present to create additional ones. The existing General Corporations are as follows:

Electricity Corporation of Vietnam

Coal Corporation of Viet Nam

Vietnam Petroleum Corporation

Cement Corporation of Vietnam

Vietnam National Shipping Lines

Vietnam Airline Corporation

Vietnam Post and Telecommunication Corporation

Vietnam Rubber Corporation

Vietnam Steel Corporation

Vietnam Coffee Corporation

Vietnam Tobacco Corporation

Vietnam Paper Corporation

Vietnam Textile and Garment Corporation

Northern Food Corporation

Southern Food Corporation

Vietnam Chemical Corporation

Vietnam National Gem and Gold Corporation

Vietnam Railways Union

101. The experience to date of General Corporations has been mixed. The goals of these corporations were to reap economies of scale, not only in production, but in distribution, finance, and other areas as well; and to conserve government administrative resources for the remaining larger enterprises. While the aim was to limit both “monopoly powers” and “disorderly competition,” concerns have been raised that General Corporations would in practice lessen the degree of competition in the economy and could lead to cross-subsidization of profitable enterprises by loss-making ones. Government concerns in this area have led the Government to place a Competition Law on the National Assembly’s work program for 1997-98.

102. The constituent enterprises themselves have expressed concerns over the rapid creation of these umbrella corporations, and the general lack of experience of their managements, particularly as many Chairpersons and Board members are political appointees. Concerns have also been raised that some corporations have centralized functions such as procurement, but that the added layer of administration has led to delays and the added expense of holding higher inventories. Cases have also emerged in which enterprises have been required to conduct business with other constituent enterprises, despite the existence of preferred alternative suppliers. Given the relative newness of these structures, however, some of these problems may be transitional in nature.

Equitization of state enterprises

103. Equitization refers to the process of converting a state enterprise into a joint stock company. This implies at least partial privatization because, under Vietnam’s Company Law, a joint stock company must have at least seven shareholders. The need to change the ownership of nonstrategic firms was recognized as far back as the Seventh Party Congress in 1991. In mid-1992, the Government issued a decision to proceed with a pilot project. However, by mid-1996, only six enterprises had been equitized. The extensive delays that were encountered have been attributed to a number of factors, of which perhaps the most important were: (i) apprehension by both workers and management about job security and the future viability of the company once it lost the benefits conferred by law on state enterprises; (ii) the interagency body created to oversee the process was cumbersome and provided opportunities for those opposed to the process to impede progress; and (iii) lack of guidelines for the equitization process, especially in the valuation and sale of shares, particularly since the needed expertise is often lacking. The State Enterprise Law, however, strengthens the legal basis for equitization. The Government has announced plans to equitize up to 200 enterprises by 1997, and, to achieve this goal, altered the rules in May 1996 so that the governmental body that “owns” an enterprise can put it up for equitization, rather than requiring that the that enterprise volunteer itself.

B. Financial Sector

104. Reform of the financial sector is essential to improve the efficiency of financial intermediation, to improve the authorities’ ability to exert monetary control with a minimum of distortions, and to provide an environment conducive to higher saving rates. Although reforms toward these goals has been somewhat piecemeal, progress has been made across a broad front.

Institutional structure

105. As of August 1996, Vietnam’s financial system consisted of the State Bank of Vietnam, 82 commercial banks, over 600 credit cooperatives and people’s credit funds, 2 finance companies, and a few insurance companies. The State Bank of Vietnam took its place as the central bank in a two-tiered banking system with the promulgation of two ordinances on banking in 1990. Of the banks, there are 52 joint stock banks, 22 branches of foreign banks, four joint venture banks and four state commercial banks. The four state-owned banks (the Bank for Foreign Trade, or Vietcombank; the Bank for Investment and Development; the Industrial and Commercial Bank; and the Bank for Agriculture and Rural Development) controlled 70 percent of deposits as of mid-1996. There are also many representative offices of foreign banks without branch status.

Monetary policy tools

Bank-by-bank credit ceilings

106. Since 1994, the authorities have used bank-by-bank credit ceilings to help to achieve their targets for money and credit. The limits were at first imposed only on the four large state commercial banks. Partly as a result, however, the other banks in the system expanded credit more rapidly, so that by mid-1996 the state banks accounted for only around two-thirds of banking system credit compared with almost 90 percent two years earlier. In order to ensure effectiveness of the ceilings, it became necessary to extend them to additional institutions. This was done in stages beginning in the fourth quarter of 1995. By the third quarter of 1996, 22 additional banks—almost all of the urban joint-stock banks—were covered by the ceilings. The limits placed on the nonstate banks are, in general, less restrictive than the limits placed on the state commercial banks. Foreign and joint venture banks, which provide 10-15 percent of total credit, remain entirely exempt from ceilings.

107. Ceilings for individual banks are determined on a quarterly basis by the State Bank of Vietnam. The criteria used to determine each bank’s limit has not been made public. Provisions to permit the trading of credit ceilings have been introduced and implementing regulations were issued in early 1996.22 To date, however, no trading has taken place.

Reserve requirements

108. In March 1994, the SBV replaced a uniform reserve requirement of 10 percent on bank deposits with a differentiated requirement. The required reserve ratio was raised to 13 percent for demand deposits and lowered to 7 percent for time deposits, with deposits of over 1 year excluded from the deposit base. At the same time, banks were permitted to hold up to 30 percent of the required amount as vault cash and up to 15 percent in the form of treasury bills.

109. Further reform of the reserve requirement was introduced in October 1995, when the required reserve ratio (excluding domestic currency deposits over 1 year) was again unified at 10 percent. Under the revised system, treasury bills were excluded from the calculation of reserves, though up to 30 percent of the requirement could still be met with vault cash. Moreover, reserve and settlement accounts were merged, and reserve averaging, both of the reserve base and of reserve holdings, was introduced, though the balance in the new reserve account was still not permitted to fall below 95 percent of the required balance. In practice, this has meant that banks must hold large clearing balances beyond their required reserves.

State Bank refinancing

110. The State Bank uses a collateralized refinance facility to onlend to state commercial banks. The refinance rate was in the past stated as a share of the rate on the loan being discounted, but this practice was discontinued in steps taken during 1994-95. Refinancing now takes place uniformly at the maximum interest rate. The SBV also operates a very short-term facility for meeting liquidity needs of the state commercial banks arising through the clearing system. It provides uncollateralized credit at successively higher rates of interest, culminating in a penal rate of 150 percent of the maximum lending rate for loans outstanding more than 10 days.

111. With the increase in the interest rate on SBV refinancing, the outstanding stock of refinanced credit declined by 13 percent in 1995, and by a further 4 percent in the first half of 1996. Most of the outstanding refinanced credit has been extended to the Bank for Investment and Development to provide long-term project finance in accordance with the Economic Plan.

Liquidity management

112. A new liquidity management section in the State Bank has been established in 1996 and has begun liquidity forecasting. Good progress has also been made in developing the mechanics of open market operations. At this stage, however, the State Bank of Vietnam still lacks the tools to closely control liquidity in the banking system. Specifically, further efforts are required to develop money markets

Money market instruments

113. The State Treasury of Vietnam has for many years issued bills and bonds through its network of 350 offices across Vietnam. Beginning in June 1995, however, some Treasury securities were placed in the money market. Interest rates on the early issues were high, at around 17 percent, but still below the 21 percent then paid on retail bills. After several auctions, the money market placements were put on hold. A second set of auctions was held in early 1996, yielding rates in the range of 12-13 percent. Following a second hiatus, bill auctions were resumed again in June 1996, and were held about every two weeks thereafter. During June-October 1996, around $10 million per month in treasury bill were being auctioned to the banks.

114. Interest rates in September 1996 auctions were in the range of 8-9 percent, compared with rates of around 12 percent on retail bills. Although the auctioned bills could be resold to the public, most of the bills were bought and held by the participating banks (and insurance companies, which also participated heavily in the auctions). These bills were particularly attractive to banks with excess liquidity, as bill holdings were not counted under the individual bank credit ceilings.

115. The State Bank also began to issue bills in 1995. At the end of the year, and several times in the first quarter of 1996, the SBV held tenders for its own bills. Unlike the treasury bills, SBV bills were offered at a fixed price equivalent to around 9 percent. The principal aim of the bill issue was to reduce the excess reserves held by the commercial banks. The bills, however, were not issued in sufficient quantities to make more than a modest contribution to the problem of excess reserves, as none of the three bill tenders was fully subscribed. On the basis of this experience, the State Bank decided following the third auction that it was unwilling to bear the fiscal cost of these bills and allowed the outstanding bills to run off, which they did by the end of March 1996.

The commercial banking system

The state commercial banks

116. Reform of the four state commercial banks is a major task, and work is underway in a number of areas. Reform is proceeding most rapidly at the operational level, including conversion of the banks into corporations, reductions in cumbersome management structures, improvements in lending procedures, and improvements in accounting and information systems. A major loan default at a large bank publicized in April 1996 led all of the banks to redouble their efforts to ensure the creditworthiness of borrowers. International audits of the four banks have begun, and the first audit, of the Agricultural Bank, has been completed. The audit for the Agricultural Bank, while of limited usefulness in assessing the balance sheet of the bank because of shortcomings in misting Vietnamese accounting practices, has provided additional impetus for internal reform at the bank.

117. A serious problem for these banks is that their policies can be affected by national development policy and are not always guided by commercial considerations. These banks were created by splitting-off departments of the State Bank of Vietnam in 1990, and top posts continue to be filled by senior officials of the State Bank. The Agricultural Bank, in particular, has been the channel for the government’s subsidized loan programs, and now provides the facilities for the Bank for the Poor, where all such programs have been concentrated. The Bank for Investment and Development provides long-term loam for public investment projects at lower than market interest rates, and ODA loans and State Bank refinancing account for a majority of the bank’s outstanding loans.

Domestic banks

118. Most of the 52 joint-stock banks were established between mid-1991 and mid-1993. While these private banks have grown rapidly, they face a number of difficulties. In the absence of deposit insurance, the joint-stock banks have to pay a premium on deposit rates of 2-3 percent per annum over the rates at the state commercial banks, as the popular belief is that the Government would not permit the state banks to fail (depositors suffered major losses in the early 1990s when many credit cooperatives did fail). On the lending side, uncertainties in the legal system, especially with respect to collateral (see below) have indeed made domestic lending more risky. Shortcomings in bank supervision, make it difficult to assess individual bank soundness. In addition, there is no system for classifying loans or taking adequate provisions against them. However, Vietnam’s rapid economic growth has helped to keep bad loans from becoming a major problem at most banks.

119. Although considered private enterprises, most of the joint stock banks’ shareholders are state enterprises, who in many cases are also important customers of the banks. The banks are subject to prudential regulations set out in the 1990 Braking Ordinance, and are subject to both offsite and onsite inspection by the State Bank of Vietnam (as are the four state commercial banks). Weakness in accounting data, both in the books themselves and on their customers, hampers the effectiveness of these inspections. The State Bank is still working, however, both to improve the quality of the joint-stock banks within the framework of the Banking Ordinance, and to prepare new legislation that would improve the scope for prudential regulation of the commercial banks.

Foreign banks

120. While dozens of foreign banks have opened representative offices in Vietnam, mainly to handle trade finance transactions for their home-country customers, only 22 foreign banks have been permitted to open branches in Vietnam, as the State Bank of Vietnam has been selective in allowing foreign banks to conduct full banking operations. Foreign bank branches that have opened have tended to operate mainly in foreign currencies. They are restricted in the amount of dong deposits that they can accept from Vietnamese individuals and firms who are not also borrowers from the bank. This limit has been set at 20 percent of the bank’s capital, though it will be increased to 25 percent effective January 1997. In practice, this limit has not been binding for many banks, as foreign banks have avoided the risks associated with local currency lending. Instead, foreign banks have concentrated on trade finance and lending that carries an explicit or implied (by way of a guarantee from a state commercial bank) government guarantee. Despite these limitations, foreign banks have grown rapidly in recent years, and now account for 12-15 percent total banking system deposits.

C. Legal Reform and Private Sector Development

Legal system

121. Since the beginning of doi moi, laws have been passed introducing market principles into virtually every area of economic life. Box 7 provides a list of major legislative achievements. One of the most important of the recent legislative initiatives is the introduction of a new Civil Code, which came into effect on July 1, 1996. While not all of the implementing regulations needed to support it have beat issued,23 it makes important strides in improving the legal framework in many areas, such as property rights, including new regulations protecting intellectual property; contract law; and the transferability of land (see below). The Civil Code also gives citizens the right for the first time to sue the Government, and an Administrative Court system to hear such cases has been established.

Vietnam: Major Legal Reforms under Doi Moi

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122. While the progress in overhauling the legal system is impressive, many of the laws included in Box 7 have been amended—some several times—since they were first passed. This reflects recognition of the need to further relax remaining state controls and to provide greater clarity than the original law provided. A shortcoming of the legal system continues to be ambiguity and conflicting requirements in legislation, and among various ordinances, circulars, decrees, and ministerial decisions. The result is a legal system that is still not transparent and affords substantial discretion to government officials. In addition, legal requirements on the private sector still tend to be stringent.

123. Box 8, which lists the steps required for a domestic investor to establish a new business, illustrates one of the major problems facing potential entrepreneurs: complex entry regulations, which, among other things, stipulate minimum capital requirements to form a company in each individual line of business. Companies wishing to engage in additional lines of business must subsequently have their licenses amended, meeting the applicable rules for the new line of business. In addition to entry restrictions, private businesses face a number of other difficulties. Gaining access to land, all of which is owned by the state, is among the most important.

The Steps in Establishing a Business

Stringent administrative requirements are applied to the establishment of new business, and the approval process can take many months, assuming the applicant meets the legal requirement for starting a business, including the industry-specific minimum capital level. The necessary steps, which may be supplemented by additional documentation requirements on the part of the relevant line ministry, include:

  • Entrepreneur must prepare extensive documentation, including a “business plan,” and submit it to the Ministry of Justice.

  • Entrepreneur must open escrow account.

  • Ministry of Justice forwards opinion to the local People’s Committee.

  • Local People’s Committee rules on license.

  • Entrepreneur must register with the Arbitration Authority.

  • Entrepreneur must apply to police for security clearance.

  • Public announcement must appear in the newspaper.

  • Business license tax must be paid.

Land policy

124. The December 1987 Land Law, which allowed agricultural cooperatives to distribute land use rights to individual families, was instrumental in boosting rice output and was one of the cornerstones of the first stage of doi moi. The Land Law was substantially revised in 1993. While all land continues to be owned by the state, the new law set out the rules for the allocation of long-term land use rights, including (i) the right to use; (ii) the right to transfer; and (iii) the right to usufruct (to reap the return to investment in land). It also identified several categories of land for the purpose of regulation, setting rents, and taxation. The basic regime became one of quasi-ownership, with rights granted for periods from 15 years in urban areas up to 50 years for some agricultural land.

125. In February 1995, a Government decree (18/CP, 2/13/95) required all long-term land use rights on commercial properties to be transformed into land leases. The new regulation effectively nullified the quasi-ownership of urban land. The regulation has hurt financial sector development, because land use rights could no longer be used as collateral, and the development of the market in land-use rights. This is particularly important since state enterprises gained access to land use rights in the initial allocation, and the effective closing of the market has prevented private firms, who have no land to begin with, from acquiring it. In August 1996, following the promulgation of the Civil Code, the State Bank of Vietnam issued new regulations specifically permitting the use of land use rights as collateral for loans from domestic banks. The regulations eased some of the problems created by 18/CP, but it is not yet clear how extensive these improvements will be.

Foreign investment

126. Another building block of Vietnam’s doi moi reforms was the Law on Foreign Investment passed in December 1987, which has been revised three times, most recently in October 1996. Foreign investment may take several legal forms, of which the most common is the joint venture. Joint ventures must have at least 30 percent local participation, which is most commonly contributed in the form of land use rights for the venture. As a result of their easier access to land use rights and other perquisites of the state, most joint ventures are formed with state enterprises.

127. The regulatory regime for foreign investment provides a number of incentives, generally similar to those found elsewhere. They include (i) a tax holiday; (ii) tariff exemptions for import of machinery and raw materials; and (iii) lower profit taxes for investments in broadly-defined “priority industries.” However, a lengthy approval process and a difficult operating environment, particularly with respect to the legal system, have put off many investors, though improvements were made in the approvals process in 1994. One of the most serious problems has been a provision stipulating that all major decisions of a joint venture must be approved unanimously by the Board of Directors, effectively giving the right of veto to the local partner.

128. The salient features of the latest revisions, the first since 1992, include: (i) lengthier tax breaks than previously, and preferences for joint ventures establishing their own subsidiaries; (ii) a reduction in the number of decisions requiring unanimity on the Board of Directors; and (iii) an updated list of priority sectors, banned sectors, and sectors from which wholly-foreign ventures are excluded.

D. Trade Policy

129. Over the past three years, there has been gradual progress toward trade liberalization. However, while tariff rates are now moderate, imports are still covered by potentially restrictive nontariff barriers, and the trade system in general lacks transparency.

130. The authorities have broadly followed an export-oriented development strategy, including membership in the ASEAN Free Trade Area and an application for WTO membership. Although there has been fast growth of both exports and imports, import substitution is still thought important for a number of commodities, and remaining restrictions exist mainly to provide protection.

131. Policy measures since 1993 have focused on the removal of major nontariff barriers and tariff reform. For nontariff barriers, the following steps were taken:

  • Abolition of export shipment licenses (July 1994); abolition of import shipment licenses (January 1996);

  • reduction in coverage of import permits (quotas) from 15 to 7 commodity groups in December 1994 and further to 5 (petroleum products, fertilizer, sugar, steel, and cement) in December 1995;

  • reduction in coverage of export quotas to rice only (1994);

  • liberalization of licensing procedures to engage in foreign trade (gradual).

Tariff reform has consisted of a reduction in the maximum tariff from 200 to 60 percent (effective January 1996), with corresponding excise taxes imposed.

132. The principal remaining restrictions come from import certification or licensing requirements for most finished goods. Many are justified on the basis of broad definitions of health, safety, and environmental concerns. Restrictions on import wholesaling and distribution also remain in place. In practice, however, remaining restrictions do appear to be operated in an increasingly flexible manner, as the annual plan targets on which they are based get revised during the course of the year in response to changing market conditions. Smuggling, especially of consumer goods facing higher tariffs, is considerable.

Import certification and licensing

133. In January 1995, the authorities lifted shipment-by-shipment licencing requirements, opting instead for import certification and licensing requirements that varied by type or purpose of import.24 The new regulations lift the requirement for a license for each shipment individually. The Ministry of Trade continues to be responsible for issuing licenses for each shipper and each commodity. Most goods remain subject to certification or licensing. However, the degree of control exercised by the authorities is highly variable:

  • Import bans are applied to a limited number of commodities mainly for national security and health reasons.25

  • Approximately 20 percent of imports come in under import permit (quotas).

  • The overall share of consumer goods in imports is regulated.

  • Line ministries have responsibility for regulating a limited list of goods to ensure conformity with regulatory requirements.

  • Certification of FDI-related imports is performed to ensure investors are not overstating the value of investment.

  • Raw materials and intermediate inputs are not subject to certification.

  • Machinery and equipment imports by the domestic private sector are free of certification requirements.

134. There appears to be considerable scope for discretion on the part of the authorities in the implementation of these requirements. However, the rapid growth of imports suggests that foreign trade regulations are not proving to be a major obstacle to importers.

Import tariffs

135. Vietnam’s current import tariff rates range from zero to 80 percent, with 27 rates applied to various commodity groups which are classified on the basis of the Harmonized System. Although the tariff system is established in legislation, the administration has discretion in setting rates for individual products within specified bands, and adjustments are typically made twice per year. The most recent legislative change to the tariff system became effective in January 1996, when the maximum tariff was lowered from 200 percent to 60 percent, thereby eliminating a large number of tariff bands. Goods affected by the reduction included primarily vehicles, beverages, and tobacco. At the same time tariffs were reduced, these goods were made subject to excise taxes to offset the reduction in tariffs. An 80 percent rate was, however, reintroduced in August 1996 for light trucks. The simple average tariff rate is about 18 percent, but the effective rate in 1995 is estimated at 10 percent as many commodities are exempted from customs duty. Lower tariff rates are applied to raw materials, intermediate goods, and machinery and equipment, while higher rates are generally applied to consumer goods. In addition, both the Foreign Investment Law and the Domestic Investment Law provide extensive tariff exemptions on imports for approved investments.

Quantitative Measures of Tariff Protection

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Source: Vietnamese authorities and staff estimates.

Export restrictions

136. Restrictions on exports are very limited. Shipment licences for exports were removed for all commodities except for rice, timber, and petroleum in July 1994. The remaining shipment licences were abolished in February 1996, at the same time that shipment licenses were lifted from imports. At present, rice and textile products are still subject to export quotas. The latter quota is maintained in the context of voluntary export restriction agreements with Canada, the EU, and Norway. Apart from drugs, wild animals, toxic chemicals, and weapons, export bans are applied to a limited number of commodities such as antiques, logs, semi-finished timber products for cultural or environmental reasons. Certain exports require certification from line ministries; for instance, exports of minerals and ores require certification by the Ministry of Industry, and exports of wild animals and plants are subject to certification by the Ministry of Agriculture and Rural Development. Export taxes (ranging from 0 to 45 percent) are levied on certain commodities, including forestry products and minerals.

E. Foreign Exchange System

137. One of the key elements in Vietnam’s success in its export-led growth strategy has been the maintenance of a market-based official exchange rate.26 This policy has been continued within the new institutional framework of the interbank foreign exchange market which was introduced in October 1994. The buying and selling rates are allowed to move within a band of 0.5 percent on either side of the official reference rate stipulated daily by the State Bank, though, in practice, daily movements have been much smaller. The market has been functioning smoothly. Since its opening, the State Bank has intervened periodically, though by creating expectations of exchange rate stability it has been able to limit the need for intervention on a daily basis. The volume of foreign exchange transactions, which was initially less than $2 million per day, increased to $44 million per day in August 1996, reflecting improved public confidence in the market. Nevertheless, the market itself continues to be dominated by the Bank for Foreign Trade, which holds 40 percent of all foreign currency deposits and may participate in as much as 90 percent of all trades in the interbank market.

138. Over the past ten years, the authorities have gradually loosened foreign exchange controls on current account transactions through many regulations issued on a piecemeal basis. The resulting system is not transparent and commercial banks often require guidance from the authorities on interpretation of procedures for sale of foreign exchange.

139. Vietnam currently maintains restrictions on the availability of foreign exchange for payments and transfers for certain invisible transactions. The restrictions include a limit on payments for travel, which was raised from $5,000 per trip to $7,000 per trip at the beginning of 1996. In addition, a tax is assessed on profit remittances of foreign-invested firms. The tax is equal to 10 percent of the profit to be remitted, with a reduced rate of 5 or 7 percent for large investors in priority industries. This tax is designed in part to recapture the reduced profit tax rate offered to foreign investors. Foreign exchange for foreign-invested companies (other than those producing certain import substitutes or engaged in certain infrastructure work) are also subject to foreign exchange balancing requirements, though the State Bank may make exceptions based on an assessment of the country’s foreign exchange situation.

Vietnam: Recent Economic Developments
Author: International Monetary Fund