Vietnam's Lack of Industrial-Deepening Could Undermine Their Strong Economy

Unlike many countries in Asia, and indeed in the world, Vietnam is for the moment blessed with a raft of positive economic news. However, beneath the surface, structural issues and a lack of industrial deepening continue.

Exports have been growing at Eighteen percent year-on-year and 10 percent year-to-date. Expenses in foreign direct expense rose by some 9.6 % year-on-year with Samsung, in particular, manufacturing not only its smartphones but also TV and computer displays in Vietnam.

The PMI (purchasing managers’ index) has been consistently above Fifty in the June quarter, indicating continuous expansion in the production sector. Furthermore, the leading indicator — new orders minus inventory — rose sharply, suggesting that there will be a pick-up in production in the second half of 2015.

Domestic demand — which has been stressed out for some years — has also picked up, as indicated by credit development of around 17 percent year-on-year. To top it all, Vietnam’s major export market, america, moved a step closer to the Trans-Pacific Partnership (TPP) agreement by giving The president the Trade Promotion Authority on 29 June 2015. This is a mandate to fast track industry deals that the US Congress cannot later amend, only approve or reject. In reaction, the Vietnamese government announced the abolition of the 49 percent foreign ownership cap on many industries — with the exception of some key sectors, including banking.

Ironically, the actual strong export growth is occurring against a background of admiring real effective exchange rates previously few months. There is a peg to the US dollar for the Vietnamese dong. So as the actual dollar appreciates against main world currencies (such as the pound and the euro), the dong has also appreciated against a trade-weighted basket of currencies, despite minimal devaluations against the US dollar associated with 1–2 percent in recent months.

The reduction in international tourism of a few 12.6 percent year-to-date, as well as by a sudden increase in imports, likely prompted the nominal devaluations — from equipment and equipment to vehicles — resulting in an estimated trade deficit of US$3.7 billion in May 2015. However, perhaps in order to maintain confidence in the dong as well as in macroeconomic stability generally, the State Bank of Vietnam governor has announced that the dong will not devalue against the buck by more than 2 %. Both the interbank and parallel rates are currently within the official trade rate band.

With the prospect of even stronger export data within the coming months, together with the Twelfth National Congress of the Communist Celebration of Vietnam in the first half of 2016, it is unlikely that the Two percent commitment will reverse.

In the short run, rather than trade rate adjustments, it is likely that attempts to arrest the fall-off within international tourism will take the form of cuts in visa fees or increased efficiency within visa processing. However, the actual surge in imports is more challenging. The import of luxury goods such as cars could see administrative measures. Yet a surge in imports of machinery, materials, and intermediate inputs coinciding with a improvement in manufacturing exports clearly indicates that Vietnamese production value-added depends very much on the country’utes cheap labour, with fairly little backward linkages in terms of commercial deepening.

For instance, until recently Vietnam’s textiles industry had been predominantly state-owned along with low productivity. So the surge in garments exports meant that garment manufacturers imported yarns, fabric as well as machinery from abroad (mainly China) in order to get the quantity and the quality they need to satisfy the changing rapidly fashion world. Likewise, with the improvement in the manufacture and export of mobile phones by foreign-invested businesses such as Nokia and Straight talk samsung, the screws and plastic covers for the cell phones are imports, as there are no Vietnamese firms creating these products locally.

The lack of industrial deepening is clearly a longer-term problem for which exchange rate changes cannot be an adequate solution. Certainly, the stance of the State Bank in maintaining its hard-won confidence in the dong and in macroeconomic stability could be warranted. However, this is if the implementation of banking and state-owned enterprise (SOE) reforms gets attention. It is here that the exemption of the banking sector from the abolition from the 49 percent foreign investment cap is a concern, as this could indicate a reluctance to drive ahead with reforms from the banking sector. It is also not known what other sectors are being excused from the abolition of this cap.

In brief, if the US dollar is constantly on the appreciate against major world currencies, and if the industry balance in Vietnam continues to deteriorate, there could well be pressure around the dong to devalue.

To a certain extent, the State Bank could do this and still maintain the 2 % commitment by changing the actual nominal peg from the dollar to some basket of trade-weighted currencies. However this may be only cosmetic. The actual problem lies in the inability of Vietnamese firms to support export booms through increased production of materials, advices and machinery locally in upstream industries — or simply a lack of commercial deepening.

For a sustainable solution to the problem of import surges leading to trade deficits in Vietnam, architectural reforms are needed to get state-owned companies out of domains that should be purely private and to improve the productivity of the remaining SOEs.

Strong export development in Vietnam masks underlying challenges is actually republished with permission from Eastern Asia Forum