Taking Stock: An Update on Vietnam's Recent Economic Developments (June 2011)

This edition of ‘Taking Stock’ – a semi-annual publication from the World Bank – attempts to understand the recent macroeconomic changes in Vietnam. It documents changes to the macroeconomic outcomes and policies with a view to inform policy discussions in the country. The analysis is mostly retrospective in nature, though discussions on prospective challenges and outlook are also briefly mentioned. Developments in the global economy in general and in the EAP region in particular are juxtaposed against Vietnam’s own economic.

EXECUTIVE SUMMARY

i. In the last few years, Vietnam’s macroeconomic situation has followed a predictable pattern. When faced with external shocks the authorities have opted to protect the country’s rapid growth rate, even if it meant tolerating higher levels of macroeconomic instability. This has meant modest growth slowdowns and frequent episodes of overheating. So when the economy started to overheat in late 2010 following the delayed withdrawal of the fiscal and monetary stimulus put in place in 2009, few expected a determined response from the government to stem the ensuing macroeconomic volatility.

ii. The current episode of macroeconomic instability has been as severe as the previous overheating episode of mid-2008. We constructed a summary measure of acroeconomic instability – Vietnam Index of Macroeconomic Stability (VIMS) – based on the movement of four variables, namely nominal exchange rate, international reserves, inflation rate and nominal interest rate. Our measure shows that the degree of macroeconomic instability during the current episode did come quite close to mid-2008, but has not surpassed it yet. But unlike 2008, when the level of instability increased sharply and fell immediately, instability has persisted over a longer period of time during the current episode – from November 2010 to February 2011 – exposing Vietnam’s economy to a prolonged period of nervousness and uncertainty.

iii. The government has succeeded in restoring significant level of macroeconomic stability in the past few months. Following the successful completion of the XIth Party Congress in January and the celebration of the Lunar New Year in early-February, the authorities moved swiftly to address the macroeconomic problems facing the country. The dong was devalued by 9.3 percent against the US dollar on February 11, 2011, and Resolution 11 was approved on February 24, 2011. Resolution 11 contains a wide range of bold, mutually reinforcing and consistent monetary and fiscal policy targets and commits the government to undertake several structural measures including reform of the state-owned enterprises (SOEs), improving communication with the market and protecting the poor from future episodes of macroeconomic instability.

 

iv. Efforts to stabilize the economy, while well begun, are only half done. Despite initial skepticism, the measures adopted under the Resolution 11 have started to show results towards regaining Vietnam’s macroeconomic stability. The parallel market has disappeared and for the first time in three years, the dong is trading in interbank market below the official central rate. The State Bank of Vietnam (SBV) has started to purchase dollars in the inter-bank market, thereby building up much needed international reserves. Vietnam’s sovereign bond spreads have steadily declined in the past few months. But there are plenty of macroeconomic risks in the system that can easily reverse the hard-earned gains of the past three months.

v. Therefore, initial success notwithstanding, the authorities need to remain vigilant against premature withdrawal of stabilization measures. The implementation of Resolution 11 VIETNAM - TAKING STOCK June 2011 3 has not gone uniformly well: efforts to rein in investment budget have been less forthcoming, reforms of the state-owned enterprises have not been fully spelled out and measures aimed at better communication with the market have been slow and hesitant. With growth expected to slow down in the second and third quarters of 2011, there could be demands from various quarters to relax monetary and fiscal policies and to go slow on structural reforms. Capitulating to such demands could prove costly for the economy. Instead, the authorities have an opportunity to rebuild Vietnam’s credibility by steadfastly and effectively implementing Resolution 11 until the following three milestones are achieved: (i) inflation is brought down to a stable, single-digit rate; (ii) foreign exchange premium is completely eliminated; and (iii) the level of international reserves is adequate to finance at least 2.5 months of prospective imports.

vi. We expect gradual improvement in Vietnam’s economic situation during the second half of 2011. The inflation rate is expected to peak in Q2 and then gradually fall to around 15 percent by the end of the year, as the full impact of policy tightening takes hold. The current account deficit is expected to be around 5 percent of GDP and the foreign exchange market should remain stable in the foreseeable future. With macroeconomic stability gradually returning, internal capital flight should subside in 2011, helping SBV to accumulate reserves faster. The output growth, after slowing down in Q1 and Q2, is likely to pick up strength by year end. We expect economic growth in 2011 to be slightly under 6 percent, with significant upside potential in 2012. However, our outlook is exposed to a number of downside risks. Those risks include premature withdrawal of stabilization measures, resurfacing of problems in the banking and state-owned enterprise sectors and continued increase in global commodity prices or a full blown sovereign debt crisis in Europe and its contagion effect on the rest of the world.