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Page 1: International finance issue of Vietnam

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Heilbronn University

International Economics: International

Finance Issues of Vietnam

submitted to

Professor Gajanan

Written by

Hoa Nguyen (178121)

Jamie Learoyd

Summer Semester 2012

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Table of ContentsI/ 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

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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. Vietnam’s 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 Vietnam’s 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.

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II/ International finance issues in Vietnam

Vietnam’s economic situation begins to deteriorate rapidly as a consequence of

the Global crisis in 2008 the worst since the 1930’s 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 Vietnam’s 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: “Vietnam’s export revenues

fell 6.5% in November 2008 and a further 24% drop in January 2009 (year-on-

year”

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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 Vietnam’s 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 Vietnam’s 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.

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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,

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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 Vietnam’s

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)

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Composition of FDI into VietnamMost of the realised FDI was distributed to the manufacturing industry - account

for 42.7% of the FDI overall, oil and gas – account for 18.8%, hotel and tourism –

account for 8.1%, construction – account for 7.2%, offices and apartments (6.2%),

building urban areas and industrial zones (2.8%).

In the 1990s. FDI focus was mainly on import substitution industries. However

from 2000 on, the focus has shifted towards export manufacturing sector and

services sectors. There is also a radical change in FDI trend shifting focus to

industry and construction, services sector. During 2004-2007, total registered FDI

in industry and construction; and services sector increased with the rate of 74.9%,

and 56.0%, which was substantial in reference to the modest increase of

algriculture sector at 26.6%. Until october 2007, industry-construction and services

accounted for 94.2% of the realised FDI, while agriculture accounted for 5.8%.

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Foreign Invested Enterprise (FIE)

In the early 1990s, Foreign Invested Enterprise (FIE) had a trivial role in the

economy. However, since the mid 1990s, FIE has integrated in the economy, and

become an essentail part of the economy. In 1996, FIE employed 222,000

employees, accounted for 7.4% of the GDP, in 2006 FIE had 1,130,000

employees and accounted for 17.1% of the GDP.

FIE in Vietnam has become a driving engine for exporting sector, and the growth

of manufacturing industries, such as textiles, graments; machinery and equipment,

motor vehicle and transport equipment and many others.

b/ Official Developemnt Assistance

ODA is defined as "those flows to countries and territories on the DAC list of ODA

Recipints and to multilateral development institutions. ODA are capital inflows that

are provided by official agencies - for instance, state and local government or their

executive agencies. The purpose of ODA is to promote economic development

and welfare of develop countries. ODA is concessional in character and provide a

grant element of at least 25%, calculated at a rate of discount of 10%. (OECD

webpage),

ODA in Vietnam

ODA since being resumed in 1993, has played a significant role in investment and

GDP growth in Vietnam. The total ODA for Vietnam in term of commitment has

reached USD 41.2 billion during 1993-2007, USD 30.7 billion of which was gined,

and USD 19.7 billion has been implemented. In the period 1993-2005, ODA

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accounted for approximately 11.4% of the ttotal investment and also 50% of the

investment from State budget.

The allocation of ODA until recently, had been more concentrated in more

developed areas. However, there is a trend that ODA has gradually been

distributed more equally toward less developed areas which have been granted

more ODA.

ODA has focused on may sectors and areas, including: infrastructure

development, poverty reduction, human resources, development and institutional

improvement. Important laws such as Enterprise Law, Land Law, Invesetment

Law, Competition Law, and Anti-Corruption Law were also aided by ODA in their

formulation and consolidation. Another area that ODA helped ameliorate is the

managerial capacity of officials, personnel of ministries and others sectors.

Pitfalls in utilization of ODA in Vietnam

Vo et al (2008) in their paper point out several weakness and limitation in the

usage of ODA in Vietnam. ODA is often misunderstood as a “free gift” because

ignorance and limited awareness. Another issue is the passive role of

governmental agencies who are supposed to actively cooperate with donours.

This comes from the irresponsiveness in devising strategies, policies and

implement ODA into specific programs and projects. Weakness in arrangement

and paucity in human resources for ODA management also impede the

organizational and operational regulations of ODA-financed program. There are

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also many hindrance coming from the legal framework – for example,

inconsistencices between documents on ODA mobilisation, lack of enforcement

concerning regulatory documents on ODA utilization. Monitoring and evaluation

regarding to ODA are also problematic with appalling limitation: lack of strict

compliance, insufficient disciplinary actions in the sphere of financial reporting,

payments and settlement regulations.

c/Portfolio investment flows.

Vietnam has also recorded a boom time in foreign portfolio investment inflow since

2006 as foreign portoflio investors have shown increasing keen interst in Vietnam

equity market with the expectation of higher return asset. In 2006, foreign portfolio

inflows accounted for 2.2% of the GDP; yet only after a year, foregin portfolio had

expanded and accounted for 10.4% of the GDP in 2007. Around 70% of foreign

portfolio into Vietnam in 2006 was invested in stocks, bonds, real-estate; the other

30% was deposited in the banking system.The fervent and substantial foreign

present has partly trigger the financial boom and investments in the real estate

market.

3/ Exchange rate policyThe State Bank of Vietnam (SBV) has unofficially fixed the Vietnamese Dong

(VND) to US dollar depreciatiing proactively at the rate of 1-2%, mainly to adjust to

the difference between inflation rates of the two economies. The rate VND/USD

had the tendency to increase with at a moderate pace during 2006-2007. In 24

months, averat rate of commercial bank went from 15,900 up to 16,200 VND/USD,

a favourable condition in term macro economy. However, during the first quarter of

2008, VND appreciated against USD which led to subsequent chaos in foreign

exchang martket. (Farber et al, 2009)

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The USD/VND exchange rate in 2008 was surging dramatically. In May 2008, the

exchange rate was up to alsmost 18,000 VND/USD which kept on sliding up to

VND19,700 in early of June 2008. The sudden change led to scarcity of USD and

hindrance in exchanging from VND to USD. The exchange rates fluctuate in every

transaction. The spread was relatively vast, even reaching VND 1,00. Foreign

exhcange finally subsided in July 2008 when the free market rate and official rate

converge after stablising effort from SBV raising inter-exchange rate by 2%.

(Farber et al, 2009).

III/ Recommendation

One very important reform course for Vietnam is to persist on taking institutional

reform to continuously transform the state-led economic into a more efficienct

institution. This would involve not only reconfiguring the legal framwork but also

reforming the large State Owned Enterprise (SOE) and forging an effectual

administrative and enforcement system.

To start climbing up along the value chain is another imporant issue. Essentially,

Vietnam should diversify export product and consolidate non-price

competitiveness, attract more FDI, and also improve the infrastructure

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(transportational system, electricity), labour and management competencies.

Business environment should be refined; it is critical to create a liberal and neutral

evironment to attract more FDI. In mobilising and utilizing capital inflows, ODA

should be used more efficiently and in a transparent manner in order to increase

foreign participation.

Another issue is to consolidate and improve the monitoring system, namely the

financial supervision capacity. The BOP statistics need improving to enhance

accuracy and consistency, conforming to international standards. Only when their

quality is enhanced, the vulnerabilities and warning signal in the financial system

can be detected to devise necessary precaution.

Last but not least, a healthy financial system should be the focus in the economic

reform. What is required in Vietnam to reach that end includes improvement in

these areas: risk management, adopting international auditing and accounting

standards, recapitalise commercial bank, and enhance human resources capacity.

IV/References

Bishop, A. (2004). Essential Economics. Bloomberg Press.

Farber, A; Nguyen,T; Tran, D; Vuong, H. (2008) The financial storms in Vietnam's transition economy: A reasoning on the 1991-2008 period http://ideas.repec.org/p/sol/wpaper/08-023.html

Le, V. (2009) Global Crisis and Vietnam policy’s responses. http://www.eai.nus.edu.sg/Vol1No2_LeThiThuy.pdf

OECD website. Retrieved on 20 May,2012 from. http://www.oecd.org/document/4/0,3746,en_2649_34447_46181892_1_1_1_1,00.html#Definition

Trading Economics website. Retrieved on 20 May 2012 from

http://www.tradingeconomics.com/vietnam/inflation-cpi

Vo, T and Pham, Q.(2008) Managing Capital Flow: The case of Vietnam. ADBI Institute. http://www.adbi.org/discussion-paper/2008/05/16/2536.managing.capital.flows.vietnam/

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