This 2016 Article IV Consultation highlights that Vietnam's economy has experienced solid growth with low inflation, reflecting policy attention to maintaining macroeconomic stability. Economic performance was robust through most of 2015, driven by rapid export growth, foreign direct investment, and strong domestic demand. Manufacturing and exports moderated near year-end, reflecting slowing external demand. Inflation declined below 1 percent in 2015 before ticking upward in early 2016 owing to higher food and administered prices. For 2016, growth is projected to moderate to about 6 percent, reflecting the adverse agriculture shock, lower external demand, and spillovers of tighter global financial conditions.
1. Our authorities appreciate the continued engagement with the Fund and thank the mission team for the constructive and candid policy discussions during Vietnam’s Article IV mission. The discussions centered on policies conducive for the next phase of reforms to achieve Vietnam’s full growth potential.
2. The authorities welcome staff’s recognition of Vietnam’s significant economic progress and reiterated their commitment to sound macroeconomic policies and structural reforms. Macroeconomic policy has focused on preserving macroeconomic stability, whilst achieving strong economic growth that would improve the standard of living of the Vietnamese population. As acknowledged in the report, Vietnam has experienced solid growth with low inflation in recent years and has made excellent progress in achieving the Millennium Development Goals, such as poverty eradication, universal primary education and gender equality.
3. Despite the encouraging developments, the authorities are mindful of the need to address domestic and external risks and emerging challenges, including legacy risks and widening imbalances. The authorities are therefore fully committed to continue pursuing fiscal prudence, sound monetary management and financial stability, while intensifying structural reforms to maintain macroeconomic stability and sustain strong growth. The authorities broadly concur with staff assessment and agree with many of the recommendations put forward in the report.
Recent Economic Developments and Outlook
4. Prudent macroeconomic management has been key to Vietnam’s macroeconomic stability and strong economic performance over the years. Despite significant uncertainties and headwinds, Vietnam is able to maintain overall economic stability and sound fundamentals. Economic growth was robust last year with real GDP growth of 6.7 percent, supported by sound macrofinancial policy settings and strong domestic demand. In the first quarter of this year, growth moderated to 5.5 percent, due to severe drought and land salinization as well as a slowdown in industrial production following slower global trade. However, the authorities remain cautiously optimistic of achieving the growth target of 6.7 percent in 2016. The new government is committed to accelerate reforms as part of the medium-term socio-economic plan and believes its strong policy efforts would improve productivity and business sentiment. This, together with reform outcomes that have started to materialize, will help achieve the 2016 growth target.
5. Although the near-term outlook is broadly positive, there remain challenges from both external and domestic fronts. Downside risks on the domestic front include deeper impact of drought and land salinization on agricultural production, inadequate fiscal consolidation and prolonged non-performing loan (NPL) resolution. These domestic risks could be exacerbated by external shocks, including more volatile global financial conditions that could lead to capital outflows and higher domestic interest rates; weak global growth prospects and changes in the structure of global trade which could undermine exports; and persistently lower oil prices.
6. Global developments are being closely monitored and policies are formulated to reap the benefits from future opportunities and counter unexpected shocks. Vietnam has made significant progress in promoting finished-goods exports, which continue to benefit from China’s rebalancing. The new flexible exchange-rate regime has been effective in acting as a shock absorber against external shocks, safeguarding macroeconomic stability and allowing an increase in international reserves. The authorities also see merit in accelerating the implementation of the Trans-Pacific Partnership and other regional and bilateral trade agreements as they would help to improve domestic productivity, support export market expansion and facilitate structural reforms.
7. Fiscal consolidation is a critical element in the authorities’ effort to improve the resilience of the economy. This is especially in view of the declining trend of revenue as a share of GDP and the increasing public and publicly-guaranteed (PPG) debt. The Ministry of Finance is developing a Medium-term Budget and Finance Plan (MBFP) for 2016–2020 for submission to the government and subsequently, to the National Assembly for approval in October 2016. The Plan will provide details on measures to gradually reduce the fiscal deficit to an average of 4 percent of GDP for the period and to 3 percent of GDP by the year 2020. At the same time, the aim is to keep the PPG debt below 65 percent of GDP.
8. The authorities note staff’s medium-term growth-friendly consolidation scenario and would take careful consideration of staff’s recommendations. The authorities recognize that in the absence of effective revenue enhancing measures, the burden of fiscal adjustment will be borne mainly by capital expenditures, which could undermine future growth. They concur with staff’s analysis of the challenges in achieving the targets of reducing deficit and PPG debt, including reduction of tariffs and tax exemption owing to trade agreements and lower non-tax revenue from dividend because of SOEs equitization.
9. In recent years, fiscal policy has been expansionary, focusing on cushioning the impact of moderate global growth, enhancing competitiveness, attracting investment, and removing obstacles for businesses. To support economic activity, Vietnam has implemented some tax exemptions, deferral and reduction in some taxes and fees, and some other revenue measures. While these measures may seem to directly reduce revenue, the authorities consider such negative effects on revenue to be negligible, as these measures have helped stabilize the economy by smoothening consumption, attracting new investments, supporting businesses, and thus creating conditions to raise revenue in the medium term.
10. Despite unfavorable external conditions, the revenue from domestic activities has been increasing, averaging 13.1 percent of GDP during 2006 - 2010, and 14.1 percent during 2011 - 2015. In addition, the revenue structure has shifted positively, with rising share of domestic revenue to total revenue, from 52.3 percent during 2001 - 2005 to 68 percent during 2011 -2015. In 2015, this share was 74 percent and is expected to be higher than 80 percent during 2016 - 2020.
11. The authorities concur with staff on the need to arrest the rise in PPG debt. While staff estimates PPG debt to increase to 62 percent of GDP in 2016 and to 70 percent in the medium term, the authorities have a more optimistic view. They emphasize their commitment to maintain PPG debt below the legal limit of 65 percent of GDP and view that the risk of debt distress as being under control. The MBFP for 2016–2020 contains necessary measures to ensure the PPG debt ratio remains below 65 percent of GDP.
12. The authorities broadly concur with staff’s recommendation on policies to enhance revenue and improve efficiency of expenditure. The authorities are currently formulating policies to raise revenue and are optimistic that these revenue enhancement measures will be implemented starting next year, thus contributing to narrowing the fiscal deficit. These include simplification of tax procedures and amendments to corporate income tax incentives to bring it in line with international practice. The plan is also to broaden the personal income tax base, adjust the tax rates as well as reduce the number of goods and services exempt from VAT and the number of goods and services subject to the 5 percent taxable group, with the ultimate aim of eliminating this group and applying a common VAT rate. They also plan to increase excise tax coverage, and adjust environmental protection tax rates, while the introduction of property tax is under study. On the expenditure side, the focus is to lower the current expenditure by reducing the public sector wage bill, promoting financial autonomy in public sector and increasing participation of non-state agents in delivering public services, especially in education and healthcare. In addition, efforts are underway to rationalize public investment expenditure and improve the efficiency of public investment projects. The authorities are planning to request Fund’s technical assistance on tax policy with a focus on revenue strengthening measures.
13. While the authorities see the merit in enhancing financial capability of state-owned commercial banks and resolution of NPLs, the inclusion of bank recapitalization funds in the fiscal consolidation process is difficult and need to be thoroughly considered. The authorities note staff’s recommendation to use budget resources upfront for banking sector recapitalization needs and the potential benefits of doing so. Nevertheless, the estimated amount of 2½ percent of GDP for banks’ recapitalization needs to be carefully calibrated and a roadmap for bank recapitalization will need to be established and approved by the authorities before implementation. The total cost should be within the capacity of the budget and consistent with the plan to lower the fiscal deficit and keep PPG debt below 65 percent.
Monetary Policy and Foreign Exchange Management
14. The State Bank of Vietnam’s (SBV) monetary policy stance in 2016 is to support the government’s objective of maintaining macroeconomic stability, achieving economic growth target, keeping inflation rate below 5 percent and ensuring the resilience of the banking system. The SBV will continue to coordinate monetary policy closely with fiscal policy and other macroeconomic policies. The SBV will stand ready to tighten monetary policy should inflationary pressures arise. On the other hand, if growth is slowing further and underlying inflation stalls, the SBV may consider monetary policy easing. On staff’s recommendation to establish an interest-rate corridor as a channel for policy transmission, the SBV is undertaking further research on this and would implement it as conditions warrant.
15. The SBV views the 2016 credit growth rate target of 18 - 20 percent as appropriate, given the growth projection of 6.7 percent in 2016, and is consistent with the target of keeping inflation below 5 percent. However, this credit growth target may be adjusted in line with actual developments and that achieving this target will not be at the expense of credit quality as the authorities remain committed to ensuring that NPLs remain below 3 percent of total loans. Recently, the SBV issued an instruction to banks to prioritize credit for the productive sectors, such as manufacturing, agriculture and export. Credit to real estate and other potentially risky sectors is being closely monitored. That said, Vietnam’s high creditto-GDP ratio reflects its bank-based economy, with businesses depending mostly on bank lending given the relatively underdeveloped capital markets. The authorities view that the use of these administrative measures are still necessary under the current conditions in order to maintain control over excessive credit growth.
16. The authorities are encouraged by staff’s acknowledgement of their efforts to adopt a more flexible exchange rate regime and agree with staff’s recommendation to allow for more flexibility, in response to heightened global financial volatility. Being a highly open economy, greater exchange rate flexibility provides a necessary buffer for Vietnam to withstand external shocks. Following the adoption of a more flexible exchange rate regime, in the first few months of 2016, speculative activity moderated sharply contributing to ample foreign currency supply and hence, a stabilization of the exchange rate and rebuilding of international reserves.
17. In the authorities’ view, shifting the monetary policy framework toward using inflation as the nominal anchor is appropriate but requires thorough preparation and is conditional on initial settings. This includes consideration of financial market development and strength of monetary operation and liquidity forecasting capability of the SBV. The current monetary policy framework already aims at controlling inflation as a primary objective, which in turn, contributes to maintaining macroeconomic stability and sustainable growth. The SBV continues to review and assess potential enhancements to its monetary policy framework and will take staff’s recommendation into consideration with a view to enhance monetary policy efficiency and will seek Fund’s technical assistance if necessary.
Macroprudential and Banking Policy
18. Progress has been made in developing the macroprudential framework and a number of steps on banking sector reform have been taken. With proposed macroprudential tightening measures, tightening of regulations on lending and dividend payments at weak banks, and strengthening supervision, the authorities anticipate that they will be able to mitigate potential systematic risks. Recently, the SBV issued a circular regulating prudential ratios for the operations of credit institutions and foreign bank branches. Accordingly, the risk index of receivable lending for real estate will be raised from 150 percent to 200 percent, effective January 2017. The new circular also specifies a roadmap to reduce the maximum ratio of short-term funds used for medium and long term loans from 60 percent currently to 50 percent in January 2017 and to 40 percent in January 2018.
19. The issue of high level of impaired loans still lingers, which poses the challenge of weak profitability of banking sector. In response, the Vietnam Asset Management Corporation (VAMC) has been established. The authorities have a plan to increase the capital of the VAMC. In March 2016, the authorities have amended the Decree on establishment, organization and operation of the VAMC, which provided legal basis to buy and sell NPLs at market value. The detailed plan of this operation was elaborated in Decision No. 618 of the SBV in April 2016, which would improve resolution incentives for VAMC’s operation.
20. The authorities welcome staff’s recommendation to tighten macroprudential policies, but stress the importance of appropriate timing and necessary conditions. While the authorities share staff’s view on key elements, including accelerated NPLs loss recognition and resolution in banks and at the VAMC, they are of the view that using budget resources to recapitalize state-owned commercial banks and enhancing equitization of these banks require careful consideration. To further strengthen financial stability, the authorities are finalizing a macroprudential framework and improving systemic risk supervision.
21. The authorities broadly agree with staff’s policy recommendations to intensify the pace of structural reforms. The new government is committed to implementing its policy agenda without delay and reaffirmed the increasing use of market-based mechanism for economic reform. As such, a number of reform measures are underway to facilitate structural adjustment and improve the business environment. In May 2016, the government issued a Resolution on Supporting and Developing Enterprises by 2020 to develop and improve economic institutions and create a business investment environment conducive to business growth as a driving force of the economy. The Resolution outlines administrative reforms and specific tasks of each ministry and government agency, aimed at creating a favorable environment to support start-ups and innovative enterprises, ensuring the right to do business, equal right to access resources and business opportunities of enterprises, reduction in business costs, and protection of the legitimate rights and interests of enterprises.
22. The authorities recognize the importance of boosting productivity and longer-term growth potential. To that end, structural reform is necessary to strengthen the spillover of productivity gains in the foreign-invested sector to the domestic economy, which can be achieved by improving the integration between foreign-invested sector and domestic suppliers. In particular, strengthening domestic-sector competitiveness would facilitate such productivity spillovers from foreign-invested sector.
23. SOE reform will be accelerated in the 2016–20 period, including greater transparency and disclosure, accelerated equitization, and improved inter-agency coordination. Good progress has been made in developing the legal framework for SOE reform, including strengthened supervisory capacity. SOEs are subject to regulations on supervision and State capital management, besides being subject to the Enterprises Law like all other enterprises. As regard to SOE equitization proceeds and their use, the authorities see the mechanism as transparent as the Ministry of Finance is required to report regularly to the government and are subject to established regulatory framework.
24. The effects of an aging population could negatively impact growth via its implications on productivity and fiscal burden. As the share of Vietnam’s working-age population to the overall population has already started to decline, the authorities concur with staff’s analysis and will work on policy measures to increase labor mobility appropriately and undertake further measures to enhance productivity.
25. The authorities will continue to pursue sound macroeconomic policies which have supported economic growth and stability. The Vietnamese economy’s strong fundamentals, together with commitment to prudent policies, will provide solid foundation to meet future challenges, with the country’s long-term potential and competitiveness to be further enhanced by the steadfast implementation of structural reforms. The degree of these reforms and their implementation will be appropriately paced to achieve the desired outcomes while minimizing unintended consequences.
26. Finally, the authorities appreciate the ongoing Fund advice and technical assistance, and look forward to continued support by the Fund in their reform endeavors.