International finance issue of Vietnam

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  1. 1. 1 __++ Heilbronn University International Economics: International Finance Issues of Vietnam submitted to Professor Gajanan Written by Hoa Nguyen (178121) Jamie Learoyd Summer Semester 2012
  2. 2. 2 Table of Contents I/ INTRODUCTION..............................................................................3 II/ International finance issues in Vietnam ....................................4 1/ Balance of Payments ..................................................................4 2/ Managing capital flows ...............................................................6 a/ Foreign Direct Investment.......................................................6 FDI in Vietnam................................................................................7 Composition of FDI into Vietnam...............................................8 Foreign Invested Enterprise (FIE) .............................................9 b/ Official Developemnt Assistance ..........................................9 ODA in Vietnam..............................................................................9 Pitfalls in utilization of ODA in Vietnam..................................10 c/Portfolio investment flows .........................................................11 3/ Exchange rate policy.................................................................11 III/ Recommendation.........................................................................12 IV/References .....................................................................................13
  3. 3. 3 I/ INTRODUCTION Before 1986, Vietnam was a central-planned economy in which the market force did not play a significant role, the country was closed to international trade. The results of these policies were an austere economic condition, a dismal standard of living compare to international standard. Apparently the old economic system no longer suited Vietnam; the global economy was changing: the derregulation of barriers in many countries, the increasing pace of international trade and globalisation. Aware of the circumstance, Vietnam has embarked on reforming the economy since 1986, moving toward a more market-oriented economy. Vietnam amended its Consitution in 1992, acknowledging the existence of private sector economy and legalizing the role of market. Over the past 25 years, the economy of Vietnam has been ameliorated, more freedom for people to trade, start up private firms. Vietnam has become more open to international trade. One notable example was its effort to become a member of WTO since 1995 which eventually led to the accession of Vietnam in 2007, becoming the 150th member of WTO. Poverty reduction, a major concern of macro policies in Vietnam, has recorded considerable accomplishmet. Vietnams GDP per capita,from a very low level of $210 in 1986, has increased to over $1100 by the end of 2010, a significant growth rate although Vietnams GDP per capita is still at a low level in comparison with international standards. Nevertheless, the policy makers in Vietnam has confronted many issues arising over the last 25 years. Many of those issues pertain to the macro settings of Vietnam, namely the international finance policy which is the ground for our discussion in this paper. What we would like to examine of Vietnam international finance policy are 3 core issues: exchange rate regime, current account, and managing capital flow. With each issue, we provide the some background theory for our analysis of the 3 issues. After that we looks at the development of the 3 issues in Vietnam.
  4. 4. 4 II/ International finance issues in Vietnam Vietnams economic situation begins to deteriorate rapidly as a consequence of the Global crisis in 2008 the worst since the 1930s resulting in high inflation, an increase in unemployment and an adverse effect on the Balance of Payments. 1/ Balance of Payments Firstly, the Balance of payments is a financial tool implemented by economists in the macro-environment as a way of measuring activity between governments, businesses and consumers in terms of imported and exported goods and services; an important measure on Vietnams position in the Global economy. However, we will pay close attention to the Current Account which is a component of the BOP. CA = (EX-IM) + NY + NCT . (*Current Acct = (Exports-Imports) + Net income abroad + Net cash transfer) With regards to Vietnam the major factor was the twin deficits: Trade deficit Fiscal deficit Figure 1.0) shows the drastic increase in the trade deficit consequential of the 2008 global crisis and the effect this brought to Vietnamese exports. Three of the major economies in the world, US, Japan and Europe who accounted for 60% of export activity in trading with Vietnam, also felt the strain. Therefore as one would expect each of these countries significantly decreased on their previously imported goods or services from Vietnam thus a significant decrease in export revenues. Trade deficit reached US$17.5 billion over 20% of GDP. Le (2009) explains: Vietnams export revenues fell 6.5% in November 2008 and a further 24% drop in January 2009 (year-on- year
  5. 5. 5 The Fiscal deficit is where government expenditure exceeds its revenues and with Vietnam we have a prime example of an economy that is not in equilibrium as their expenditure significantly outweighs its revenues. In 2008 the fiscal deficit accounted for 4.5-5% of GDP which signified the significant drop in external demand. Unemployment Moreover, the magnanimous losses in exporting led to difficult times for the businesses that produced and traded such product to the US, Japan and Europe, therefore many businesses could not guarantee employment within their organisations for much longer. According to reports from 41 of the 63 provinces and cities of Vietnam, 66,700 workers out of 45 million workers lost their jobs in 2008 pushing unemployment rate to 4.65% (Le, 2009). Inflation According to TradingEconomics website: The inflation rate in Vietnam was recorded at 10.54 percent in April of 2012. Historically, from 1996 until 2012, Vietnam Inflation Rate averaged 7.4000 Percent reaching an all time high of 28.2400 Percent in August of 2008 and a record low of -2.6000 Percent in July of 2000 Inflation in 2008 was in double figures and still is at present this is a cause for concern as less food will be eaten by the poor in a country with an annual per capita income of $835. These aforementioned factors have significantly hindered Vietnams economy slowing economic growth, sliding from 8.48% in 2007 to 6.23% in 2008 achieving the lowest rate of growth in the previous decade. Policy Responses Evaluating Vietnams financial issues within the economy in terms of trade, inflation and unemployment there has to be significant alterations to macro decisions if Vietnam is to get out of this economic demise.
  6. 6. 6 1. Place an emphasis on domestic products by subsidising businesses with start up costs or allowing them to offer cheaper alternatives. This will combat against the extreme importation that Vietnam currently run and in turn will circulate money within its own economy reducing the trade deficit. 2. Issue bonds and/or gilt-edged securities. Issuing bonds is an efficient means of producing cash flow and in effect allowing Vietnam to pay off any interest payments be this fixed or indefinite whilst also producing funds to inject into the economy. 2/ Managing capital flows Capital flows in Vietnam comprise of Foreign Direct Investment (FDI) inflows, Official Development Assistance (ODA), and Portfolio Investment Flows. In this part, we review each area by giving definitions and overviews on the circumstance in Vietnam. a/ Foreign Direct Investment Foreign direct investment is defined as investment in production in a foregin country. The investment is manifested in acquiring a firm in that foregin country, or setting up a new branch of an existing business. Mostly FDI comes from companies, rather than financial institutions, which are more likely to take indirect investment abrod - for example, purchasing a country's supply of shares and bonds. (Bishop, 2004). Globally, FDI grew fast during the 1990s, then it slowed down concurrently with the global economy in the first few years of the 21st century. Most of FDI flow from one OECD country to another; there is, however, a steadily increasing trend of FDI flow to developing countries, particularly in Asia. Mergers and acquisitions are also another worth-noting trend, as a popular form of FDI. (Bishop, 2004). Governments attitude nowadays toward FDI is relatively positive with the expectation that jobs, expertise and technolog will come along with investments,
  7. 7. 7 helping to invigorate the whole economy. Moreover, FDI is far more enduring than investment of financial investors which often turns out speculative and unstable. (Bishop, 2004). FDI in Vietnam In reforming an economy like Vietnam, attracting foreign investment is a crucial element, the Foreign Direct Investment was, therefore, passed in December 1987. This has stimulated FDI into Vietnam during 1988-2007, 9,492 FDI projects with committed capital of USD 83.2 billion totally.FDI inflows into Vietnam was also affected by the global economy. Since the Asian crisis in 1997, FDI into Vietnam after peaking in 1996 had dropped since then. (Vo and Pham, 2008) Since the 2nd half of 2004, however, the FDI turned around and has surged, arriving at more than USD 10 billion with committed capital of USD 21.3 billion. The surge in FDI recently demonstrates the confidence of investors in Vietnams economic renovation, its development prospect and international integration process. The rapid increase of FDI can also be attributed to investors intent toward a restructuring of FDI in Asia in labour-intensive industries for instance, garments and manufacturing from China to Vietnam. (Vo et al, .2008)