Inflation, high rates batter Vietnam's small businesses

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Men work at Haya furniture factory outside Hanoi June 15, 2011. Haya boss Nguyen Manh Hung said he reduced production capacity by half compared with the same period last year due to the poor market situation and lack of financial sources as he continues to pay a 24.5-percent annual bank loan. Picture taken June 15, 2011.

As Vietnam fights to beat back raging inflation, many of its small and mid-sized businesses -- disadvantaged even in good times -- are struggling to survive the battle.

Just ask Ngo Thi Bau, general director of Nguyen Tam Foci Garment Co Ltd, which a Vietnamese consumer magazine for years dubbed one of Vietnam's 100 strongest brands.

This year, plunging revenue has led Bau to lay off 60 percent of her Ho Chi Minh City-based firm's 400 workers. Her business has been battered by sharply higher consumer prices and the sky-high interest rates -- up to 20 percent -- that borrowers now face.

"It's impossible to make a profit in manufacturing," said Bau.

Small businesses matter, as in the past decade they have become a key part of Vietnam's economy. They account for 96 percent of all companies and account for 40 percent of gross domestic product, according to the Small and Medium Enterprises Association.

Bau said sales at her garment business cratered as people have skipped non-essentials as they have been forced to spend more on basic needs. Annual inflation in June has been nearly 21 percent. In May and again in June, food costs surged nearly 30 percent from a year earlier, while transport was up about 20 percent.

National retail sales were up a paltry 6.4 percent in the January to May period, discounting for inflation, state media reported. In 2010, full-year retail sales rose 24.5 percent.

"We are in a tough situation, like others," said Bau. "Many factories have closed down since earlier this year. My factory is running irregularly."

But the pain that Vietnam's small and medium-sized enterprises (SMEs) are enduring runs deeper than this latest macroeconomic rough patch, with roots in policy shortcomings that experts say need to be addressed if the country is to shift to a more balanced and dynamic economic model.

Vietnam's reform drive has spawned hundreds of thousands of small and medium enterprises, whose association says these account for half of all non-farm jobs.

But these firms are underdogs of the business world, third-class citizens behind state-owned and foreign invested firms, and they are bearing the brunt of inflation and tight monetary policy.

For the past five years, the government has tried to create state-owned conglomerates similar to South Korea's chaebols. These get preferential access to capital and have tight links to officials, valuable in Vietnam's environment of vague regulations. Firms in which foreigners are investors generally are bigger, have higher profiles and get support from their embassies.

Former central bank governor Cao Si Kiem believes one-third of the workers at small enterprises could lose their jobs this year, at least temporarily. An ex-government advisor thinks 30 percent of such firms have stopped operating since the end of 2010.

Vu Kim Hanh, director of the Business Studies and Assistance Center, Vietnam's first privately run business promotion agency, said she has been shocked by the volume of complaints, even from companies that normally avoid making noise.

Smaller businesses "are being ambushed from 10 sides," she said.

Difficult to grow

Last month, deputy director of a center promoting small and medium-sized businesses at the state-backed Vietnam Chambers of Commerce and Industry, challenged a conference room full of company bosses to climb the value chain, but was swiftly reminded why that isn't happening.

"Why don't we make photocopy machine parts with higher profits instead of competing in the production of dustbins?" Dinh Manh Hung asked.

A retort rocketed back. "We don't have money to buy technology," said Nguyen Van Nghi, director of an iron casting and machinery company.

A recent Ministry of Planning and Investment survey reported that only one third of small and mid-sized businesses, known as SMEs, were able to access bank credit while three quarters wished to.

"SMEs are stuck," said Pham Thi Thu Hang, director of the SME promotion center. "They cannot grow beyond their small size due to lack of credit and technology."

In many countries, smaller businesses drive innovation in sectors like high-tech and biotech and are supported by a range institutions, from incubators and banks dedicated to helping them to clear bankruptcy laws and strong industry associations.

Vietnam has almost none of these, experts say. Its small companies are chronically under-funded and under-supported, with industrial policy favoring large firms usually linked to the state.

The smaller businesses "are generally in sectors with very small margins and very low tech. So, where are those businesses that are going to start moving into higher value-added, more sophisticated products and services?" said Jonathan Pincus, dean of the Fulbright Economics Teaching Program in Ho Chi Minh City.

"Those are bigger companies, but to get big is very difficult here. If you want to get into sectors where the margins are a bit bigger it's quite difficult for these little firms to both get the capital and then also to fend off the incumbents."

Vietnam's biggest firms are state-owned or otherwise close to the government and benefit from those connections, he said.

A handful of genuinely competitive private firms have managed to grow, but they tend to have done so with the help of foreign venture capital or private equity.

Marco Breu, managing partner of McKinsey & Co.'s fast-growing Vietnam office, says the "low hanging fruit" that has fueled Vietnam's growth in the reform era has mostly gone. The government's new challenge is to do more to foster SMEs as it tries to re-position the economy.

"If you look at Thailand, Indonesia and some of the other ASEAN markets they have all successfully established institutions and opportunities that are helpful to the SMEs," Breu said.

"To be competitive, Vietnam needs to take up the challenge of creating a dynamic SME sector."

Like poison

Vietnam's macroeconomic woes are only making matters worse.

Inflation has soared, hitting 19.8 percent in May from the same month last year, and it is likely to rise. The government has responded aggressively, cranking up policy rates by hundreds of basis points and ordering banks to slow credit growth.

The net effect on inflation so far has been very limited, creating a kind of worst case scenario for companies struggling to cope with high inflation and high interest rates.

Even small companies that could get bank credit might not dare.

"Taking bank loans is like drinking poison for SMEs," said Kiem, the former central bank governor who is chairman of the Small and Medium Enterprises Association.

Only companies that could not afford fine for breaking contracts have been borrowing. Handicraft, textile and garments and footwear -- some of the country's biggest export sectors -- were among the most challenged, he said.

The government has offered some support, and some business owners find encouragement in a debate over the favored position of state-owned enterprises that flared in the wake of the near-bankruptcy of state shipbuilder Vinashin last year.

But the effects are likely to be minimal. Finance Minister Vu Van Ninh has said that small enterprises and state enterprises have a level playing field.

To help her garment business, Bau is hoping the government will delay collection of compulsory employee insurance payments, which add up to 28 percent of wages, which average VND3 million to 4 million ($145-194) a month.

In April, the government agreed to delay collection of income tax for private companies, but Kiem said that was more of a "morale booster" than a move with real impact.

Pham Thi Thu Hang of the center promoting small business agreed.

"Delaying income tax is good," she said, "but it doesn't mean much if there is no income to tax."

Hanh, the center's director, worries about the future of many of the roughly 1,000 recognized Vietnamese brands created in the 15 years since the economy opened to private investment

Tough as business is now, Bau is determined to keep her garment showrooms in Hanoi and Ho Chi Minh City open, saying "If we, like many other SMEs, close down, when and how can Vietnam have long lasting brands?"

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