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 problems and a lack of industrial deepening persist.

Exports have been growing at 18 percent year-on-year and 10 percent year-to-date. Disbursements in foreign direct investment rose by some 9.6 percent year-on-year with Samsung, in particular, manufacturing not only its smartphones but also TV and computer screens in Vietnam.

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 problems and a lack of industrial deepening persist.

Exports have been growing at 18 percent year-on-year and 10 percent year-to-date. Disbursements in foreign direct investment rose by some 9.6 percent year-on-year with Samsung, in particular, manufacturing not only its smartphones but also TV and computer screens in Vietnam.

The PMI (purchasing managers’ index) has been consistently above 50 in the June quarter, indicating continuous expansion in the manufacturing 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 depressed for some years — has also picked up, as indicated by credit growth of around 17 percent year-on-year. To top it all, Vietnam’s major export market, the United States, moved a step closer to the Trans-Pacific Partnership (TPP) agreement by giving President Barack Obama the Trade Promotion Authority on 29 June 2015. This is a mandate to fast track trade deals that the US Congress cannot later amend, only approve or reject. In response, 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 strong export growth is occurring against a background of appreciating real effective exchange rates in the past few months. There is a peg to the US dollar for the Vietnamese dong. So as the dollar appreciates against major world currencies (such as the yen and the euro), the dong has also appreciated against a trade-weighted basket of currencies, despite nominal devaluations against the US dollar of 1–2 percent in recent months.

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

With the prospect of even stronger export data in the coming months, together with the 12th National Congress of the Communist Party of Vietnam in the first half of 2016, it is unlikely that the 2 percent commitment will reverse.

In the short run, rather than exchange rate adjustments, it is likely that attempts to arrest the fall-off in international tourism will take the form of cuts in visa fees or increased efficiency in visa processing. However, the 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 surge in manufacturing exports clearly indicates that Vietnamese manufacturing value-added depends very much on the country’s cheap labour, with relatively little backward linkages in terms of industrial deepening.

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

The lack of industrial deepening is clearly a longer-term challenge for which exchange rate adjustments cannot be an adequate solution. Indeed, the stance of the State Bank in maintaining its hard-won confidence in the dong and in macroeconomic stability could be justified. 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 of the 49 percent foreign investment cap is a concern, as this could indicate a reluctance to push ahead with reforms of the banking sector. It is also not known what other sectors are being exempted from the abolition of this cap.

In short, if the US dollar continues to appreciate against major world currencies, and if the trade balance in Vietnam continues to deteriorate, there could well be pressure on the dong to devalue.

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

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

Strong export growth in Vietnam masks underlying challenges is republished with permission from East Asia Forum