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IMPACT OF THE REGIONAL CRISIS

ON THE VIETNAMESE ECONOMY
Dr. Tran Dinh Thien
(Institute of Economics)

1. In the recent past, unlike other economies in Southeast Asia, which are either hit by crisis, or suffer the direct
contagious effect of crisis, the Vietnamese economy is affected by the "lag" effect. In 1997, while growth in such
neighboring countries as Thailand, Indonesia, Malaysia, the Philippines, and Korea plummeted due to crisis, Vietnam
still enjoyed the growth rate of 8.2%. In 1998, while most of the other economies experienced negative growth, GDP of
Vietnam still grew at 5.8%, the highest in the region. This fact may hide some severity of the crisis impact on the
Vietnamese economy. Moreover, it influenced the oversight of the prospects of the Vietnamese economy in two ways:

a) It gives a feeling that the Vietnamese economy can firmly resist the crisis. This resistance is attributed to the
capability in policy making of the government or the economy's flexibility, which can inhibit negative impacts of crisis.
Some people even argue that the crisis has a negligible impact on the Vietnamese economy. This argument gained large
popularity at the time the crisis started and spread throughout the region (second half of 1997 and first half of 1998).
The implication is that the preparation measures for forestalling negative impact of crisis do not receive adequate
attention.

b) The "lag" effect of crisis on Vietnam implies that when crisis-ridden countries start recovering and resuming their
growth (Table 1) and make strong progresses in structural reform and enhancing their competitiveness, Vietnam's
growth rate start declining at and accelerated pace (Figure 1).

Table 1: GDP growth rate in Eastern Asia (%)

S. Singapore China ASEAN** Vietnam*** Indonesia Malaysia Thailand

Korea

1998 -5.8 1.5 7.8 -7.4 5.8 -13.2 -7.5 -9.4

1999* 8.0 5.0 8.0a 2.6 5.0 2.0 2.0 3.0

Increase - +13.8 +3.5 +0.2 +10.0 -0.8 +15.2 +9.5 +12.4

decrease****

* Estimated
**Calculated for Eastern Asia, excluding Singapore
***Used estimation of Vietnamese GSO.
**** Increase-decrease shows an annual growth rate.

a. New estimation of Chinese Central Bank

Source: ADB. Asian Development Outlook 1999.

This is actually a great threat to Vietnam since it is a more backward economy compared to many others in the region,
with much weaker competitiveness. A relative decline in growth rate would put Vietnam in a much more disadvantaged
position in the competition of the region, in opening and integration into the world economy, especially when the crisis-
hit but stronger economies start resuming their growth path with new quality.

Figure 1: Growth rate of GDP and inflation, 1991-1999

...for technical reasons, the figure will be implemented later on...

Source: Vietnam General Statistical Office (GSO)

The remarkable trend of the Vietnamese economy is currently the deceleration in growth rate

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2. Therefore, the crisis impact on the Vietnamese economy should be coined as a gradual increase in pressure, which
peaks in 1999.

A number of key questions should be asked: Without the crisis would the Vietnamese economy run into the current
growth deceleration and difficulties as it does now? If the answer is affirmative, it is necessary to determine the
contribution of internal weaknesses of the economy and external impacts.

A comparison of economic indicators of 1999 with previous years would help highlight the situation and the trend of
the economy under the region's crisis.

Why does crisis have a 'lag' effect on the Vietnamese economy? And what are the consequences?

A host of reasons explains about the lag effect of crisis on the Vietnamese economy, which is:

- Actual status of the Vietnamese economy: i) low baseline, ii) transition to market economy; iii) open and integrate to
the world and the region not long ago and not deeply enough, thus the interdependence of Vietnamese enterprises and
the world economy is limited.

- Financial factors reflect the level of development of the Vietnamese market:

The Vietnamese currency is inconvertible.

Vietnam does not have stock market and portfolio investment.

Vietnam has not liberalized the capital market.

The exchange rate is regulated by the government (no floating)

The banking system is weak and young and involves high risks. However, the reliance of enterprises,
especially private enterprises, on the banking system is weak due to the poor opportunity for accessing to the
banking system. In contrast, state owned enterprises, the symbiotic entity of the banking system, is carefully
nurtured by the government and thus have no or little concern about banking risks once these happen.

For those reasons, the region's crisis affect Vietnam only through a few "narrow channels" (trade and foreign direct
investment).

However, the strength of impact is becoming more apparent and its negative aspect is significant for the following
reasons:

+ Development potential of Vietnam is weak and fragile.

+ Internal weaknesses of the reformed economy have become more evident since 1996.

These are the two internal factors that explain the growth deceleration and growing difficulties in the economy. The
crisis impact on this trend is extremely important and has a "resonance" effect.

This point will be further clarified by the analysis of a number of growth trends of Vietnam over the recent years,
especially of 1999.

a/ Emergence of GDP growth deceleration trend before the breakout of the region's crisis (figure 1 and
table 2).

Table 2: GDP growth rate 1995-1998 (%)

1995 1996 1997 1998

GDP growth rate (%) 9.54 9.34 8.15 5.80

Decreasing of GDP growth ---- -0.2 -1.19 -2.35

rate (%)

+ Agricultural growth rate 4.80 4.40 4.33 2.73

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+ Industrial growth rate 13.60 14.46 12.62 10.25

+ Growth rate in services 9.82 8.80 7.14 4.22

Source: General Statistic Office

The economic growth deceleration trend in Vietnam started in 1996, or at least 2 years before the crisis broke out. The
discontinuity of growth can be explained by the following reasons:

First, during the early stage of reform, the growth rate achieved lent itself to that fact that Vietnam could radically
harness the existing resources, which were repressed by the centrally planned mechanism; and a number of large pre-
reform investment projects started giving their fruits

Second, the transition to market economy harnesses domestic economic forces and vigorously attracts foreign
investment.

However, after the high growth period (1990-95), when available elements have been fully exploited, the new relevant
foundation for market economy functioning, opening to the world, and international integration is not generated
accordingly. The institutional reforms and further economic policy reforms (for instance, financial and banking sector,
state-owned enterprise sector, investment mechanism, tax policies, and tariff) take place more slowly than otherwise
would required by the market process. The process of production structure shifting is still heavily influenced more by
discretions and administrative decisions of the government than by the market. This mismatch results in inefficiency of
the business sector, especially the state-owned enterprises, which represent the largest share in industry. A natural
implication is a delay in improvement of the already weak competitiveness of Vietnamese products in both domestic
and world market.

One of the most obvious evidence of inefficiency in the economy is the fast increase in the ICOR. While during 1990-
96, the ICOR was around 2.8-3.5; it rose to 4.9 and 5.4 in 1998 and 1999, respectively.

b/ Trends in export and import (table 3)

Table 3: Growth rate of export - import and Trade balance 1991-99

1991 1992 1993 1994 1995 1996 1997 1998 1999

Export 2.087 2.581 2.985 4.054 5.449 7.256 9.185 9.361 11.520
(mil. USD)
-13.2 23.7 15.7 35.8 34.6 33.1 26.6 1.9 23.0
Growth
rate (%)

Import 2.338 2.541 3.924 5.826 8.155 11.144 11.592 11.495 11.630
(mil. USD)
-15.0 8.7 54.4 48.5 40.0 36.7 4.0 -0.8 0.9
Growth
rate (%)

Net export 251 -40 939 1.772 2.706 3.888 -2.407 -2.134 -100
(mil. USD)

Source: General Statistic Office

General changes in the world market and the crisis-induced slumps of the East Asian market exert an extremely
negative impact on export, one of the strongest engines of growth of the reformed Vietnamese economy. The factors
that have the strongest impacts are:

- Demand from world and region market drop; especially demand for the major exports of Vietnam (primary
agricultural products such as rice, coffee, and rubber). World prices for these and other products, which are consumed
domestically such as sugar, paper, clothes, cement, and steel also drop sharply (Table 4).

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Table 4: world price changes of the major export products

of Vietnam

1996 1997 1998 4/1999

Commodities -4.2 0.0 -12.3 -8.0

Food and staple food 2.1 2.8 -13.6 -12.1

Coffee -19.1 54.7 -28.5 -13.0

Tea 9.9 35.1 4.3 16.7

* Foods 6.8 -3.5 -12.6 -12.7

Sugar -9.9 -4.9 -21.2 -32.9

Rice 5.0 -10.7 1.3 -16.6

Rubber -11.9 -28.3 -29.8 -9.3

Source: UNCTAD. Trade and Development Report, 1999.

The trend of price decline badly affects Vietnam partly due to the appreciation of the Vietnamese currency
compared to other currencies in the region, which depreciate as a result of crisis. Although the State Bank of
Vietnam has devalued the exchange rate (by about 12% in 1998-99), the competitiveness in exchange rate of
Vietnam was still low compared to other currencies in the region.

The world price decline and the appreciation of Vietnamese products in this way have resulted in a series of effect:

+ Weakening in competitiveness of Vietnamese products (through lower world price, less competitive exchange rate, an
low efficiency of state-owned enterprises).

+ Tension in the domestic market caused by the excess supply of Vietnamese goods (due partly to the rampant cross-
border smuggling) makes it more difficult to sell Vietnamese goods (Table 5).

+ The general price decline due to the slackening domestic demand and world price for the major exports of
Vietnam (which are also given high weight in the goods basket for CPI measuring, such as food) is such that
CPI steadily declines for consecutive 9 months of 1999 (from March to November) for the first time in 15
years. As a result, the inflation rate of 1999 is as low as 0.1%, versus 9.2% in 1998.

Table 5: growth rate of trade (%)

1991 1992 1993 1994 1995 1996 1997 1998

Growth rate of domestic 75.5 53.3 31.4 38.9 30.1 20.4 11.0 11.5**
retail
-13.2 23.7 15.7 35.8 28.3 33.1 26.0 2.4
Growth rate of Export

Notes: Domestic retail growth rate is based on current prices. Inflation rate in 1998 is higher than previous years,
therefore real growth rate of domestic retail in 1998 is lower, about 2,3%.

Source: General Statistic Office

This contributes to the further build-up of inventories. Many enterprises, especially state enterprises, cannot recover
their capital, thus cannot pay back their due debt owed to the bank, jobs and income of their employees suffer, and the
state budget is affected. The already weak banking system of Vietnam now becomes more vulnerable. Both the desire
for credit from businesses and the willingness to lend by banks are dampened.

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The declining export prices of agricultural products have a very negative impact on income and well-being of farmers,
who account for more than 70% of the country's labor force.

The narrowing trade deficit is mainly resulted from the drop in imports. In the long run, this is not a positive trend for
Vietnam - an economy in its first stage of industrialization. I would certainly affect the growth rates of subsequent
years. Moreover, the deceleration of import growth since 1997 implies that Vietnam does not seize the opportunity of
the declining world price in order to gain from imports.

In 1999 alone, while the world prices were declining, Vietnam's export kept on growing dramatically (at 23%). This is
brought by great efforts in export promotion.

c/ Drop in FDI

The FDI flow into Vietnam peaked in 1996, and subsided since then (from 1996, before the crisis broke out). This is
what we should concern about, since it shows that the attractiveness to FDI of the investment and business environment
in Vietnam is fading away (Table 6 and Figure 2). However, the region's crisis aggravates this trend. In 1999, the
registered FDI is less than 50% that of 1997 and 1998, and a little more than 20% that of 1996.

Table 6: Foreign direct investment

1993 1994 1995 1996 1997 1998 1999*

Approved Capital (mil. 2.978 4.071 6.616 8.661 4.514 4.059 1.700
USD)

Growth rate (%) ---- 36.7 62.5 30.9 -47.9 -10.2 -43.0

1999: estimated

Source: GSO

Figure 2: FDI inflow 1992-1999 (million USD)

...for technical reasons, the figure will be implemented later on...

The major causes are as follows:

- The major investors in Vietnam (from East Asia, accounting for 70-75% of total FDI) run into
big difficulties due to the crisis.

- The region's crisis has undermined international investors' confidence in Southeast Asia, and
Vietnam is not an exception.

- The investment environment of Vietnam is relatively less friendly than that in other countries in
the region after the crisis broke out, the relative costs become more adverse for Vietnam. This
disadvantage is magnified when the crisis-ridden economies start adjusting their structure and
recovering.

- The overall improvement in the business environment in Vietnam is slow, thus dampening the
investors' feeling. The weakness of the financial and banking sector, low efficiency of the state-
owned enterprises, and discrimination against the private sector are not resolved, complicated
procedures for foreign invested enterprises persist, and access to information is limited. These are
the factors that undermine foreign investors' confidence in the prospect of sustainable high
growth of the Vietnamese economy.

d/ Employment and income

The aforesaid economic situation results in bad consequences for income and employment in Vietnam in the
recent years.

Employment: The rate of underemployment rose significantly since 1997.

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The table shows that there is an extremely fast increase in unemployment in 1998-99.

Table 7: Unemployment in working age (%)

1996 1997 1998 1999

Total 5.88 6.01 6.85 7.04

By region 7.57 7.56 8.25 9.34

Red River Delta 6.42 6.34 6.60 8.72

Northeast 4.51 4.73 5.92 6.58

Northwest 6.96 6.68 7.26 8.62

Northern central part 5.57 5.42 6.67 7.07

Central coast 4.24 4.99 5.88 5.95

Central Highlands 5.43 5.89 6.44 6.52

Southeast 4.73 4.72 6.35 6.53

Southwest

Selected provinces and cities 7.71 8.56 9.09 10.31

Hanoi 9.33 7.06 6.80 9.29

Quang Ninh 5.53 5.42 6.35 6.64

Da Nang 5.68 6.13 6.76 7.04

Ho Chi Minh City 6.61 4.03 5.52 5.87

Dong Nai

Source: General Statistic Office

This is the result of the following trends:

- The population growth rate, thus labor force growth, of the previous years exceeds the job creation
capacity of the economy.

- High economic growth of 1988-1996 period was boosted by the promotion of capital-intensive, instead of
labor-intensive industries. This trend is most evident in the foreign investment sector where about every
US$40 000-45000 of investment is needed to create one new job. This is a very high rate, even for economies
with higher level of development. For Vietnam, the situation is even worse due to the high pressure of
unemployment. On the one hand, it needs to harness the comparative advantage of cheap and abundant
labor; on the other hand, there is a great need for creating many more new jobs.

- The drop in FDI from 1997 also contributes to the severity of unemployment. Many workers of foreign
invested companies are laid off. In addition, related job opportunities created by this investment are also
lost. These related jobs are even 3-4 times more than the direct jobs in FDI enterprises.

Apart from unemployment, underemployment in Vietnam is also serious. Although no official data is
available for unemployment, one obvious thing is that the rate of underemployment is fairly high. Based on
some surveys, in rural areas, where 75% of the labor force is, underemployment may be as high as 30%.

In 1999 alone, due to the economic situation ascribed above, more people become underemployed,
especially those who are involved in export and import. A typical example is Quang Ninh province where
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the rate of unemployment rose from 6.8% in 1998 to 9.29% in 1999. This is related to difficulties in the coal
export industry, where 800,000 people work. Jobs for these workers in 1999 become very uncertain. Most of
these 800,000 workers have no work for 2 to 4 months. Another case is Thai Nguyen Steel Plant, which
produces for the domestic market; in 1999 only 4000 out of 13000 workers are at work with the wage
reduced by more than two-third. In the sugar industry, 400,000 workers in sugar production (including
sugarcane growers and workers in sugar mills) face the same problem.

The immediate effect of underemployment is lower income for many workers. Though no official data is
available on income, one still can say that the average income of the majority in the population declines
sharply in 1999. There are 3 major reasons for this decline. First is underemployment. Second is that
enterprises are unable to pay full wages to their workers due to difficulties in selling their goods. Third is
the declining prices. This third reason has a special impact on the majority of farmers who account for the
largest share and earn the lowest income in the society.

Income for workers in almost all sectors suffers and in turn has a negative impact on goods consumption in
the market, thus worsening the imbalance of supply and demand for capital.

1. General remarks on the Vietnamese economy, based on the 1999 situation

The description above indicates that the Vietnamese economy in 1999 in general continues to worsen
compared to the previous years. There is little sign of improvement (which is confined to export growth
and inflation under control) and no prospect of fast and firm improvement. However, high export
growth in 1999 shows that Vietnam commits itself and is able to overcome the problems mentioned
above.

The slackening market in 1999 forces the government to focus on solving the "bottleneck" of the
market through "demand stimulus" measures (4 times of interest cut, increase in credit supply from
the state), amendment of the Law on Foreign Investment, introduction of VAT, promotion of state-
owned enterprise equitization, in order to improve the business environment, provide more incentives
to economic development, especially the private sector and the FDI sector.

However, the effectiveness of these measures in general is low (for demand stimulus), or at least the
time fame is not long enough for the to show effects (for structural adjustment measures).

The fact that "demand stimulus" measures - especially the 4 times of interest reduction in 1999 - have
little effect on the economy reveals the severity of the situation. The market reacts very mildly to these
policy changes. This shows that the economy risks to run into a vicious circle: large bank debt, high
rate of bad debt, difficult to sell goods, build-up of inventories, low demand and little desire for
investment from businesses and low willingness to lend by the banks, fiscal revenue becomes unstable,
lower income and less jobs, lower demand, etc. Consequently, the overall efficiency and
competitiveness of the economy go down, and attractiveness to foreign investment fades away. These
are the factors negatively affecting the prospect of the coming years.

The major reasons of this situation can be explained as follows:

A/ Structural: The structure more inclines to import substitution, rather than export orientation. The
most obvious evidence of this trend is focus of investment in capital-, instead of labor-intensive
industries.

B/ Institutional: State-owned enterprise reform is slow, investment decisions are made on

administrative principle rather than market; trade policy is highly protective, and trade liberalization
is slow, business environment does not create a "leveled playing field" for different economic actors,
and the financial and banking reform toward market is not strong enough.

C/ External: The international and regional economic situations are changing fast and exert adverse
impact on the Vietnamese economy, which is increasingly dependent on the outside world, while is
unable to have prompt and timely policy reaction.

2. Challenges and agenda for further reform in Vietnam

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A comparison with the economy of China (which has many similarities in terms of development conditions
and options of transitional economies) may highlight challenges facing Vietnam. Despite the impact of the
region's crisis, the Chinese economy maintains its high growth and attractiveness to FDI. China is the
largest competitor of Vietnam in many fronts. Therefore, given the trends described above, Vietnam
obviously is faced with great challenges in the coming years.

In addition, the fast recovery and the post-crisis institutional and structural reform in economies in the
region also put a high pressure on Vietnam.

Changes in the world economy and the region's market in the recent past and the forecast by the World
Bank and the IMF for the next few years suggest that the on-going movements can be very unpredictable
and may involve some risks for economic development of Vietnam.

Major challenges for Vietnam in the near future would be to avoid lagging further behind, to faster integrate
by more vigorously improving the overall competitiveness. By far and in the near future, trade and
investment are still the major engines of growth for the Vietnamese economy. Therefore, it is very critical
for Vietnam to enhance its competitiveness in two fronts: for attracting foreign investment and marketing
its products in both the world and the domestic market.

These challenges are extremely great. The focal point should be institutional issues as the key to strengthen
the domestic competitiveness and to integrate into the world. The objective should be to accelerate
institutional reform, and it should receive higher priority than would such other objectives as high output
growth.

In addition, one should also take into account other short-terms challenges, which is to resolve the
bottleneck of market and exit from the vicious circle where Vietnam finds itself now. Otherwise, Vietnam
could hardly achieve any strong move in structural adjustment and successful integration into the world.

However, the resolution of the current market bottleneck should base on a long-term vision, which is not to
reverse the development of market relations. This means that the objective should not be to resolve the
market bottleneck as soon as possible at the expense of the other objectives such as structural adjustment
and further economic institution reform toward market. In other words, "demand stimulus" measures that
would jumpstart the economy should be consistent with the requirement for promoting the improvement of
the business environment, opening, and international integration.

The major steps that the government should concentrate on for implementation are as follows:

Reform in policy and investment mechanism of the state, based on market principles;

Strengthen the financial and banking system, let state-owned commercial banks, which form the core
of the current banking system, operate on full market basis, namely to make more decisions and to be
more accountable for their own decisions;

Accelerate equitization of state-owned enterprises; channel state investment funding to the

development of infrastructure;

Create a more equal policy environment, which is in the nutshell of the business environment, in order
to encourage the private sector development, small and medium enterprises, and to be more friendly to
foreign investors. The focus is on policies and measures related to trade liberalization and a broader
coverage of VAT.

The firm commitment to these measures requires the government and businesses to have a longer-
term vision, concentrating the maximum efforts on overcoming short-term challenges, no matter
how great they are, the success in this mission is vital for the medium and long-term prospect of
the Vietnamese economy. Coming to the year 2000, the Vietnamese government should develop a
clear direction for taking these measures and commitments.

Hanoi, December 1999

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