Thai Van Can and Dinh Truong Hinh
In the aftermath of the Great Recession in 2008 from which the global economy is still recoiling, Vietnam itself is confronting pressing economic imbalances. An integrated economic program consisting of the following consistent policies, if rigorously implemented, would help to address those imbalances expeditiously while avoiding resorting to administrative control measures which could cause long run problems. It would also help the country attain macroeconomic stability and moderate growth in 2011, and elicit strong, sustainable, and quality growth in the medium term.
Specifically, the government needs to urgently establish credibility to its economic reform program by: (1) Tightening monetary and fiscal policies to lower aggregate demand through cuts in bank credit to wasteful, unproductive and speculative purposes, especially investments by the state-owned-enterprises (SOEs), and cuts in government recurrent expenditures of similar nature; (2)Adopting a flexible and competitive exchange rate policy through adhering to a crawling peg to the US dollar to ensure a more predictable exchange rate and judicious management of capital inflows; (3)Undertaking deep structural reforms to enhance domestic competition through creating an enabling business environment, improving the quality and efficiency in the product market, deep reforms of SOEs, changing the structure of production by moving from resource-intensive and lower-cost to higher value-added production, and providing adequate infrastructure for growth; (4)Reforming education and employment policies without delay to equip the work force with modern and practical skills for rapid industrialization. Economic theory and experience show that the success of economic policies is enhanced by the credibility of the Government to honor its commitments. This credibility, once domestically established, would reassure investors from abroad of the country's creditworthiness. It could only be gained through: (a) vigorous efforts to reduce corruption, enhance transparency in government accounts, and improve open communication to the public; (b) commitment to reduce inequality in income and in access to social services especially in health and education; and (c) establishing an adequate social safety net to help the poorest deal with shocks such as the recent rising food prices, floods, and other urgent social issues.
If the above program is preannounced and implemented in a transparent manner without delay, all the current problems such as accelerating inflation rate, widening fiscal and current account deficits, rising indebtedness to GDP, dwindling foreign exchange reserves, and capital flight would stop. The country credit rating would improve, support for other Government policies would be enhanced, and risks of further deterioration greatly minimized.
In the aftermath of the Great Recession which started in 2008, countries around the world have embarked on restructuring their economies to build stronger institutional and physical infrastructure to resume fast and sustainable growth, create employment, and to compete more successfully. In this new environment, Vietnam should tackle without delay the current pressing economic imbalances to reestablish macroeconomic stability and ensure rapid, sustainable, quality growth in the years to come.
Vietnam is confronting pressing economic issues that need to be resolved expeditiously and credibly. The macroeconomic issues include high inflation, continuing depreciation of the exchange rate, and large trade and budget deficits while the structural issues stem mainly from the inefficiencies in the use of capital, labor, and in policies to promote long term growth.
These issues are systemic and were not caused by the 2008 Great Recession. The boom years preceding 2008 merely served to disguise those issues to long term, sustainable growth. Business-as-usual is no longer an option. Without swift and appropriate action, the macroeconomic and structural challenges will only worsen.
The major and also common causes of Vietnam's macroeconomic issues are well known: excessive expansionary monetary and fiscal policies coupled with inconsistent and hesitant policy stance. This combination has resulted in high inflation, exchange rate depreciation, widening trade deficit, and lower economic growth.
In the past three years, monetary policy has been substantially loose. The annual rate of bank credit expansion has far exceeded the liquidity required for transactions in the economy. For example in 2009, expansion of bank credit was 40%, far exceeding the growth rate of GDP, indicating monetary expansion was way ahead of economic activity, therefore contributing to inflation. The large excess of credit expansion over GDP growth rates might reflect the weaknesses in the conduct of monetary policy and in the effectiveness of the banking system in carrying out its intermediation operations. The large excess of credit expansion over GDP growth rates might reflect the weaknesses in the conduct of monetary policy and in the effectiveness of the banking system in carrying out its intermediation operations.
Expansionary fiscal policy also added to price increases. The budget deficit reached 9% of GDP in 2009 and almost 6% in 2010, with a high total public investment of 10% of GDP in 2010. This investment rate had been maintained for several years and is likely to be unsustainable.
The high inflation rates, once taking hold, tended to persist because policy credibility was lacking. The market was not convinced that, on the basis of previous experience, policy to reduce inflation could be sustained. The tightening of credit expansion in 2008, had somewhat reduced the high inflation rate (20%). But that tight policy stance was substantially reversed in 2009, following the usual pattern of credit expansion that far exceeded the real GDP growth rate; the excess in that year was large (some 28 percentage points above the GDP growth). As a consequence, inflation started to rise in 2010, feeding the expectation of continued inflation. As actual inflation had eroded the purchasing value of the VND, the expected continued high inflation rates led to the expectation of further loss of the VND value. As a consequence, the market exchanged the VND for more stable values to be found in real estate, gold, or foreign exchange, notably the US dollar. The vicious circle led to further depreciation of the VND.
Inconsistent and hesitant policy stance has also been a major problem. The last three years witnessed frequent changes in the policy stance leading to confusion and uncertainty for market participants. In 2008 at the outset of the global crisis, an expansionary monetary policy was adopted to accommodate the fiscal stimulus program (5% of GDP). Credit growth accelerated to 40 percent (y/y) toward end-2009 (up from 25 percent in 2008). In late 2009, the authorities shifted the policy priority from growth to stability, and adopted a number of measures including driving the interbank interest rates sharply to as high as 18 percent at one point. The credit growth slowed considerably, and GDP growth dropped from 7% in 2008 to 5.8 % in 2009. In April 2010, the pendulum swung to the other side: to secure the GDP growth target of 6½ percent, the government began to strongly encourage banks to lower commercial lending and deposit rates, and started to bring downward pressure to bear on short-term interest rates through its open market operations (OMOs), reducing them to around 7 percent since mid-April. Given the six-month time lag between monetary decisions and their effects on the real sector, this created much confusion to market participants.
Inflation also reflected structural inefficiencies that tended to put pressures on prices by raising aggregate demand through high investment, without a corresponding increase in aggregate supply. The challenge is to increase the productivity of public and private investment to generate real, non-inflationary and sustainable growth. There are several causes of low productivity. Capital is used inefficiently as indicated by the ICOR or incremental capital-output ratio. For Vietnam, this measure shows that 7 units of capital investment are required to produce 1 unit of output, while China and India invested only 5 units. Part of the high ICOR was indicative of corruption and waste, which has long been a concern of the authorities. Waste and inefficiency were pervasive in budgetary outlays and in the SOEs (including the conglomerates (tong cong ty), especially in their investment projects which were not usually subject to rigorous appraisals. Many SOEs would incur losses if the preferences (such as free land, priority access to bank credit, subsidized interest rates) they received from the government, were appropriately valued at market prices. Part of the high ICOR was indicative of corruption and waste, which has long been a concern of the authorities. Waste and inefficiency were pervasive in budgetary outlays and in the SOEs, including the conglomerates (tong cong ty), especially in their investment projects which were not usually subject to rigorous appraisals. Many SOEs would incur losses if the preferences (such as free land, priority access to bank credit, subsidized interest rates) they received from the government, were appropriately valued at market prices.
Low productivity is also driven by the inefficient use of human resources, stemming from the low-skilled labor force and a backward education system and policy. These concerns have often been voiced by foreign companies who have invested in VN and by the government. Ad-hoc government interventions in the commodity sectors also create inefficiencies. Despite much progress achieved in recent years, major inefficiencies still remain and will remain unless the role of the state is defined and restricted appropriately.
Crucial for private investment, the business environment is still constrained by inadequate transparency and predictability. Entrepreneurs function more effectively it they can access to complete, reliable, and timely information on economic activities and performance, but this information is still scarce, notably those related to budget and government plans for land use. The application and enforcement of laws and regulations need to be more predictable.
The issue of state-owned enterprises (SOE) dominating industrial sectors remains pervasive. Even when SOEs have been opened up to part-private ownership, they continue to receive preferential treatment, including access to bank credit, lower interest rates, which tends to crowd out the private sector initiatives, mainly composed of small and medium enterprises (SMEs). Production in many sectors is divided between the large, often SOEs, and many formal and informal SMEs. Much of the success in rising industrial countries such as China has been due to the strong linkages in production between the large and small firms in the private sector. In Vietnam, the dominant SOEs and FDI firms often are not integrated with the smaller firms through backward and forward linkages in using domestically produced inputs or intermediate products. As a consequence, the final products have little value added, technology and expertise are not shared, and the economy fails to move up the structural transformation ladder. FDI tends to take advantage of cheap labor to produce low value-added goods, with little room or prospects for moving up to higher value-added. The risk is that, as soon as wages of low-skilled labor in Vietnam become higher, foreign investors will take their businesses to other countries having lower wages. This increases the importance of improving labor productivity and the transfer of skills, technology and knowledge between FDI and domestic small firms. This will not happen unless the SOEs are reformed.
An Integrated Program for 2011 and the Medium Term
Many of the above issues are well-known and the Government has been active in discussing the solutions. However, beyond those discussions, an integrated program, with a clear time table for implementation in 2011 and in the longer time frame of the medium term to address those macroeconomic and structural issues, needs to be adopted. In an increasingly integrated world, and given the current economic imbalances in Vietnam, the proposed economic program for 2011 and for the MT, would have five main objectives: (1) Reducing the high inflation rate; (2) achieving strong, sustainable, and quality economic growth in the medium term by immediately launching necessary structural reforms; (3) increasing foreign exchange reserves by narrowing the trade deficit; (4) providing employment to an increasing labor force through reforms of SOEs and promotion of private sector growth; and (5) strengthening the credibility of the Government to deliver on its policy commitments through results. with a clear time table for implementation in 2011 and in the longer time frame of the medium term to address those macroeconomic and structural issues, needs to be adopted. In an increasingly integrated world, and given the current economic imbalances in Vietnam, the proposed economic program for 2011 and for the MT, would have five main objectives: (1) Reducing the high inflation rate; (2) achieving strong, sustainable, and quality economic growth in the medium term by immediately launching necessary structural reforms; (3) increasing foreign exchange reserves by narrowing the trade deficit; (4) providing employment to an increasing labor force through reforms of SOEs and promotion of private sector growth; and (5) strengthening the credibility of the Government to deliver on its policy commitments through results.
1) On the demand side, monetary and fiscal policies need to be tightened to reduce the growth of aggregate demand, thus reducing inflationary pressures. Fiscal policy should aim at a significant cut in the overall budget deficit by at least 3 percentage points per year, until the consolidated budget deficit is reduced to about 3%. The current budget deficit at 6% of GDP is an underestimate of the true consolidated budget deficit because it does not take into account the contingent liabilities arising from losses of the SOEs. To this end, government should review and rationalize the budgetary operations to: (i) cut wasteful and unproductive expenditures, including freezing SOEs investment for 2011; (ii) improve the screening of investment to weed out wasteful and unproductive investment; (ii) use domestic and concessionary external borrowing to finance only those projects of the central Government, provincial and local governments, and SOEs, that would have the rates of return higher than the borrowing costs; and (iii) coordinate fiscal policies between the central Government and provincial and local governments to ensure consistent policies. This rationalization would reduce the currently high debt/GDP ratios. Total and external indebtedness of 56.6% and 44.3% of GDP at end 2010 are considered high and risky because of the inefficient use of those debts and because of weaknesses and transparency issues with economic management. Ultimately, success in this area depends on fundamental reforms of SOEs (below) and how fast these reforms can be carried out given the entrenched vested interests.
Action should be taken to halt the rapid expansion of bank credit to prevent wasteful, unproductive and speculative investments (e.g. real estate). This cut would be applied to all borrowers, and particularly to loss-making SOEs. The interest rates would be reduced in line with the reduction in the inflation rate. Reforms could be expeditiously implemented to introduce inflation targeting, to strengthen the capacity of the central bank to conduct monetary policy and to enhance the efficiency of the banking sector in its intermediation activities. The interest rates would be reduced in line with the reduction in the inflation rate. Reforms could be expeditiously implemented to introduce inflation targeting, to strengthen the capacity of the central bank to conduct monetary policy and to enhance the efficiency of the banking sector in its intermediation activities.
2) Exchange rate policy would aim at navigating between managing the economy-wide impact of capital inflows on the one hand and promoting exports on the other. Vietnam should adopt a crawling peg to the US dollar to ensure a more predictable exchange rate. Under this exchange rate regime, VN surplus with the US would likely to be sustained and the deficit with China would tend to narrow because the expected continued appreciation of the Chinese currency relative to the US dollar. It should be noted that unless the underlying demand and supply conditions clear the market, any attempt to peg an artificial exchange rate will not work and would lead to serious losses of reserves. Similarly, experience everywhere in the world has shown that administrative control measures such as price or exchange rate controls would not work and only lead to inefficiencies in the long run. Under this exchange rate regime, VN surplus with the US would likely to be sustained and the deficit with China would tend to narrow because the expected continued appreciation of the Chinese currency relative to the US dollar. It should be noted that unless the underlying demand and supply conditions clear the market, any attempt to peg an artificial exchange rate will not work and would lead to serious losses of reserves. Similarly, experience everywhere in the world has shown that administrative control measures such as price or exchange rate controls would not work and only lead to inefficiencies in the long run.
3) Structural reforms would aim at making Vietnamese products more competitive. The above macroeconomic policies can only be sustainable if supported by deep structural reforms aimed at raising Vietnamese productivity in the industrialization process. Increase in competitiveness would be achieved by: creating an enabling business environment; improving the quality and efficiency in the product market through SOEs reforms, rationalizing investment projects and equitizing the vast majority of SOEs; reviewing policies toward FDI aiming at attracting high quality projects with backward and forward linkages to domestic production; changing the structure of production to help a sustainable reduction in the trade deficit through increasing the value added of exports; and finally, accelerating the provision of needed infrastructure for light manufacturing and tourism.
Reforms of SOEs have always been difficult everywhere, but more particularly so in Vietnam where the vested interests intersect. A first and important step is to identify the reform priority: there is no reason for government intervention in the areas where the private sector is flourishing such as the light manufacturing sector (garments, food processing, etc.). In China, fewer than 2% of the light manufacturing enterprises are SOEs. Next, the remaining SOEs should be re-evaluated using the market failure test and classified into three groups: those that need to be sold off immediately; those that need to be reformed before selling off; and those that need managerial reforms. The last group needs to limit its activities to its core competence. The SOE comprehensive reforms also need an appropriate institution: there is an urgent need for an independent, profit-oriented privatization agency staffed with foreign experts who have no interest in the domestic financial transactions. Proceeds from selling these SOEs should go directly into funding for higher education.
4) Education reforms and employment policy should aim at providing the economy with an educated, skilled and flexible work force.. Countries with very good education systems have taken concrete steps in recent years to improve further their education systems to prepare for future keen competition in the global economy. Fundamental reforms are needed at all levels of the education system. Tertiary education reforms could begin through pilot projects where colleges and universities selected would have complete choice in setting curriculum, in hiring and firing teachers, and in recruiting and placing students in the job market. Successes in these pilot projects would spread out to the rest of the tertiary sector like wildfires.
The above policy package is necessary, but not sufficient to generate credibility, which is central to the success of the program. Economic theory and experience show that the success of economic policies is greatly enhanced by the credibility or trust that policies will be implemented as committed. Credibility will thus provide certainty and change market participants' behaviors that will become favorable to the achievement of the program objectives. The policy package needs to be accompanied by policies to combat and reduce corruption that has long been discussed; increase transparency in government accounts, and open communication to the public, including the press. Policies should also reduce inequality in income and in access to social services, such as health and education, beginning with elimination of any discriminatory or favoritism practice to any particular groups. Policies should also aim at reducing pollution and protecting the environment as these would negatively affect the quality of economic growth for all and especially for the lower income groups. Finally, social safety net policies designed to mitigate the adverse impact of external shocks such as the recent rising food prices, floods and natural disasters should be given priority.
The details of the program should be preannounced and rigorously implemented as scheduled, and with no slippages or subsequent reversals. The program thus implemented would reduce uncertainty, and would ensure the attainment of the program objectives. Inflation and macroeconomic imbalances such as the trade and fiscal deficits and internal and external debts would be reduced, foreign exchange reserves would increase, the flight from the VND to gold, the US dollar or real estate would stop; and credibility of the Government to honor its commitments, would be strengthened. The country credit rating would improve. A strong, sustained and high quality economic growth would be achieved, and support for other Government policies would be greatly enhanced.
The ultimate measure of a country's successful economic policy is for every Vietnamese, regardless of family background, income status, age, or sex to have the opportunity to earn a decent living and to have a good education and high quality health care without having to go abroad. Vietnam's potential is unlimited if policies are designed and implemented effectively.
Both authors have worked for a number of years as international economists in Washington, D.C.
 For 2009, the real GDP growth and inflation targets were officially set at 6.5% and 7% respectively, thus nominal GDP was to grow about 14% and bank credit to growth about the same rate. Any excess of bank credit growth over that rate would induce an inflation rate in excess of the target rate of 7%. For actual estimates ,see International Monetary Fund, Vietnam-2010 Article IV Staff Consultation Report, at http://www.imf.org/external/pubs/ft/scr/2010/cr10281.pdf, p.26
 Inflation expectation was found to be a significant determinant of inflation and monetary policy measures took about half a year to have an impact on the real sector, see Nguyen, Thi Thu Hang and Nguyen, Duc Thanh "Macroeconomic Determinants of Vietnam's Inflation, 2000-2010: Evidence & Analysis," WP-09 (VEPR, Hanoi, Dec.2010), http://vepr.org.vn/en/index.php?option=com_content&task=view&id=710&Itemid=342
 For a more detailed analysis of structural issues in Vietnam, see Nguyen Xuan Thanh, Vu Thanh Tu Anh, David Dapice, Jonathan Pincus, Ben Wilkinson, "The Structural Roots of Macroeconomic Instability," Ash Institute of Democratic Governance and Innovation, John F. Kennedy School of Government (September 2008), http://www.innovations.harvard.edu/showdoc.html?id=146101
 World Bank , "Taking Stock: An Update on Vietnam's Recent Economic Developments," Consultative Group Meeting, Dec 7-8, 2010, (Hanoi, Vietnam), p.8, http://siteresources.worldbank.org/INTVIETNAM/Resources/TakingStockEngDec2010a.pdf
The necessity of an integrated policy package with global and financial linkages was a main recommendation of the International Monetary Fund Conference on Macro and Growth Policies in the Wake of the Crisis, March 7-8, 2011 , see http://www.imf.org/external/np/seminars/eng/2011/res/index.htm
 This deficit would be consistent with a sustainable level of debt as projected in World Bank , "Taking Stock: An Update on Vietnam's Recent Economic Developments," Consultative Group Meeting, Dec 7-8, 2010, (Hanoi, Vietnam), http://siteresources.worldbank.org/INTVIETNAM/Resources/TakingStockEngDec2010a.pdf
 On February 17, 2011, the VN central bank announced cuts in the rate of credit expansion and an increase in the interest rates to control continued inflation in 2011.
 On February 11, 2011 with the 7% devaluation of the VND, the central bank indicated its intention to pursue a more flexible exchange rate regime.