Tran Thi Tuyet, who sells pork from a small stall on the edge of Hanoi’s bustling Old Quarter, should be happy: the market price of Vietnam’s staple meat has nearly doubled in the last 12 months.
But the sharp price rise has been driven by suppliers and, with families feeling the pinch of Asia’s highest inflation rate, tracking at 23, she is struggling just to maintain profit margins. With her income static and the cost of living increasing rapidly, she feels the same pain as her hard-up customers.
“Before, I could cook a meal for my family of four for only 50,000 dong ($2.38), but now even 100,000 dong is not enough,” she says.
From the wet market to the stock market, Vietnam is battling a severe inflation crisis for the second time in three years. But soaring prices are only one of the symptoms of the deeper challenges facing Vietnam’s transition economy.
The Communist government has achieved an impressive annual GDP growth rate of 7% over the past decade as it has moved from central planning towards a more market-based economy. But, economists say, in the rush to meet ambitious growth targets, Vietnam’s leaders were too eager to expand credit, channelling much of the cheap money to inefficient and wasteful state-owned companies.
Since the global financial crisis hit Vietnam’s export-dependent economy in 2008, this fundamental imbalance has been ruthlessly exposed, leading to two inflation crises, a vicious cycle of currency devaluations and the near collapse of one of the country’s biggest state-owned companies, shipbuilder Vinashin.
Last year, all three major credit rating agencies – Fitch, Moody’s and Standard & Poor’s – downgraded Vietnam’s sovereign debt, citing rising fiscal and trade deficits; weak external finances and continuing downward pressure on the country’s currency, the dong.
It is a far cry from the heady days of 2006, when foreign investment bankers and portfolio investors were rushing to get into Vietnam, which was hyped as the next Asian Tiger.
“This is absolutely the worst it’s been since 1997,” says Ralf Matthaes, Vietnam managing director for global market research group TNS. He says interest from international clients has dried up and that, after expanding revenue by 30% in 2010, he’ll be lucky to get half of that growth this year.
Vietnam’s leaders have been forced to take a major reality check. The key question now is whether they have the political will to make the painful decisions that are necessary to restore credibility.
EXCESS GROWTH
When inflation started accelerating again during the second half of 2010, donors such as the World Bank and prominent local economists warned that the government had to cut spending and tighten monetary policy. But, in the run-up to the Communist party’s five-year leadership election in January, policymakers were reluctant to ease off the gas.
No sooner was the party’s national congress over, than the government, headed by Nguyen Tan Dung, the prime minister and the most powerful of Vietnam’s triumvirate of top leaders, moved to devalue the dong by around 9%, and unveiled a package of fiscal and monetary tightening measures known as Resolution 11.
Large interest rate hikes and a cap on the growth of credit, which expanded from 60% to 120% of GDP over the last five years, have helped to stabilize the dong. But there has been little evidence of cuts in public investment. Furthermore, despite the fact that consumer inflation soared to 23% year-on-year in August, the highest level for three years, the government has signalled that it may soon give in to pressure from ailing businesses to reduce borrowing rates.
Investors have urged the government to stay the course if it is serious about stabilization. “The government needs to keep tight monetary policy and stay on top of supply and demand issues in the gold market,” says Matt Hildebrandt, an economist at JP Morgan in Singapore.
The inflation rate is a proxy for people’s confidence in the economy, he says, and when the rate accelerates, the Vietnamese tend to sell the dong and buy dollars and gold, which have traditionally been seen as more reliable stores of value.
Vietnam is one of the world’s biggest per capita consumers of gold. Le Xuan Nghia, vice-chairman of the National Financial Supervisory Commission, estimates that Vietnamese citizens could be holding as much as 1,000 tonnes of the metal.
Last year, the IMF calculated that Vietnam suffered an unidentified outflow of $9–10 billion, which Ben Bingham, the IMF’s resident representative in Hanoi, believes was caused by “residents shifting from dong into dollars and gold and putting it under the mattress”.
Regular devaluations in Vietnam’s centrally managed currency, which is pegged to the dollar, have made foreign investors more reluctant to come to Vietnam.
To win back the confidence of investors and ordinary citizens alike, the government must demonstrate “that it is committed to long-term rather than short-term growth”, says one senior Vietnamese banker for a leading state-owned bank.
With commercial borrowing rates having risen above 20% a year, many companies are struggling to survive. But he urged the government to let weak businesses fail and suffer the consequences, such as rising unemployment.
INVESTOR APPEAL
Once bitten, twice shy, foreign portfolio investors have been wary of Vietnam’s budding capital markets since the equity market collapse of 2007 and 2008, although net foreign indirect investment recovered last year to $1 billion after net outflows of $230 million in 2009 and $2 billion in 2008.
But direct investment has been a far more significant and stable source of hard currency, particularly in the manufacturing sector. Vietnam attracted $9.6 billion in foreign direct investment pledges in the first eight months of this year, down 26% on the previous year, according to the government statistics office. But realized FDI rose slightly to $7.3 billion, compared to the same period last year.
Factory bosses say Vietnam’s appeal stems from its young, literate and numerate workforce, its favourable location between China and south-east Asia and, crucially, its cheap wages – with factory workers paid around $100 a month, compared to $300 in southern China.
Shoes and garments were Vietnam’s two biggest exports in 2010, a year when Vietnam overtook China as the biggest single supplier of footwear to US sportswear brand Nike, according to the company’s annual report.
In addition to the contract manufacturers who make shoes, clothes and furniture for global brands, a growing number of electronics makers such as Canon, Intel and Panasonic have been setting up their own factories in Vietnam. Nokia, the mobile phone giant, is planning to open its first factory in Vietnam next year.
“The macroeconomic situation is not having a big impact on foreign direct investment, which has remained at around 9–10% of GDP in recent years,” says Antonio Sequeros, Ho Chi Minh City-based consulting manager for Tractus Asia, a management consultancy that has advised multinationals looking to invest in Vietnam’s electronics, garments and mining sectors.
It is not all plain sailing though, with many workers suffering because of the high inflation. With Vietnam’s authoritarian system proscribing independent trade unions, wildcat walkouts have been on the rise. As they tend to own the biggest factories and operate on thin profit margins, foreign manufacturers have been hit hardest – 10 out of the 72 factories at the Japanese-run Thang Long Industrial Park on the outskirts of Hanoi have suffered strikes this year, according to the management.
But most disputes are resolved relatively quickly, with workers often winning higher wages. Aside from these self-contained strikes, Vietnam has seen little of the general social unrest or panic that has hit other countries suffering from high inflation.
As well as the flood of foreign investment into export-focused manufacturing, Vietnam has seen a steadier inflow of foreign money focused on tapping the expanding local market, from heavy industry to services and retail.
Vietnam has one of the fastest-growing middle classes in the region, according to the Asian Development Bank, which classifies those with consumption expenditures of $2–20 per person per day as middle class. Consequently, many multinational companies remain keen to tap into Vietnam’s consumer economy.
Although Vietnam joined the World Trade Organization in 2007, foot-dragging over liberalization in some sectors such as retail and omnipresent corruption and red tape make it difficult for multinationals to break into Vietnam. But investors with longer-term horizons have been moving in.
Since the start of the year, drinks group Diageo has agreed to take a $51.6 million stake in Halico, a local spirits manufacturer, and Kohlberg Kravis Roberts, the US buyout firm, has agreed to take a $159 million stake in Masan Consumer, Vietnam’s biggest maker of fish sauce, in the country’s biggest private equity deal to date.
SIGNIFICANT CHALLENGES
But despite Vietnam’s undoubted potential and achievements, future success is not a given in an increasingly competitive world. In addition to overcoming the current instability at a time when finances are weak, with foreign exchange reserves – which are considered a state secret – thought to cover less than two months’ imports, Vietnam also faces longer-term development challenges.
Echoing sentiments expressed by the World Bank and other advisers to the Vietnamese government, Sequeros of Tractus Asia says Vietnam will have to revamp its infrastructure and education system if it wants to move up the manufacturing value chain beyond basic assembly of electronics and stitching of shoes and clothes.
More broadly, economists and diplomats believe that Vietnam will need to beef up its institutions and governance if it is to create the right preconditions for continuing longer-term growth, now that it has already reached “lower-middle income” status, according to World Bank criteria, with an average GDP per capita of $1,200 per year.
In a secretive state that eschews transparency and allows little public dissent, that will be no easy feat. Vietnam’s Communist leaders, who are happier doing backroom deals and staged photo opportunities than engaging in open debate, will have to alter their approach substantially.
In doing so, it will not be easy for Vietnam to match its average growth rate of 7% per annum over the last decade, economists believe. This year, the government is targeting 6% GDP growth, while independent economists think growth could fall to 5%.
“Next year should be a better year, with growth between 6.1% and 6.2%, and then we hope to see it return to the trend line of around 7% from 2013,” says Alan Pham, chief economist at VinaSecurities, a local brokerage based in Ho Chi Minh City.
But, Pham and other observers agree, such an optimistic recovery outlook is based on the government delivering on its many commitments.
“Vietnam is at a crossroads,” says Pham Chi Lan, a former government adviser who now works as an independent economist. “Unless we continue to reform, we can’t continue developing at such a rapid pace.”