Public Information Notice No. 06/05

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Vietnam

January 24, 2006

On October 7, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Vietnam.¹

Background

Vietnam's overall macroeconomic performance has remained strong since the conclusion of the 2004 Article IV consultation. Real GDP growth picked up to 7.7 percent in 2004, and it remained robust at about 7½ percent year-on-year (yoy) during the first half of 2005. With the abatement of the supply shocks that led to a spike in food prices in 2004, inflation has shown some signs of moderation, although it has remained high relative to recent years, at about 7½ percent (yoy) as of July 2005. Despite a recent slowdown of garment export growth from the very high rates recorded in the past two years, continued strong performance of other exports, and buoyant remittances and tourism receipts, mitigated the impact on the current account. With sustained inflows of ODA and FDI, the overall balance of payments has thus remained in comfortable surplus. Gross international reserves have risen from US$6.3 billion at end-2004 to US$7.1 billion as of end-June 2005, although the import cover of reserves has remained low, at about 8½ weeks of imports.

Credit growth surged to 42 percent in 2004, and remained high at 39 percent as of May 2005, despite some tightening measures taken by the State Bank of Vietnam (SBV). Lending by the state-owned commercial banks (SOCBs) continued to expand rapidly in support of the government's official growth target. An announcement by the SBV in January 2005 that exchange rate depreciation would be limited to 1 percent in 2005 encouraged sustained growth in foreign-currency borrowing. Broad money growth rose to 30 percent in 2004, before edging down to a rate of 27 percent (yoy) in May 2005.

The fiscal position appears to have improved in 2004 and early 2005, but heavy reliance on off-budget operations and continued quasi-fiscal operations through the SOCBs make it difficult to assess the underlying strength of the public finances. The official budget deficit narrowed from about 2 percent of GDP in 2003 to less than 1½ percent of GDP in 2004. Surging net oil receipts contributed to continued favorable fiscal performance in the first half of 2005. The overall fiscal deficit (the sum of the official budget and off-budget investment expenditure) narrowed from 7.2 percent of GDP in 2003 to 4½ percent of GDP in 2004 leading to a slight decline in the debt stock to 41 percent of GDP. However, the improvement in the public finances is clouded by the recent augmentation of the government's off-budget investment program for 2005-2010 to 110 trillion dong (15½ percent of 2004 GDP). In addition, slow progress in SOCB reform, together with high credit growth, has likely led to a large build-up of bad loans and contingent government liabilities in the banking system.

The government has recently signaled its intention to speed up the pace of structural reform. In the important banking system, the SBV's loan classification, provisioning, and prudential standards were tightened in April 2005, and the government aims to develop plans for the SOCBs' reform and recapitalization during the latter part of the year. State-owned enterprise (SOE) reform appears to be moving forward through share auctions and a narrowing of the list of sectors reserved for the state, and the authorities continue to work diligently toward WTO accession.

The outlook for the rest of 2005 is broadly positive, provided that monetary and fiscal policies can be appropriately reined in. Real GDP growth is projected to be about 7½ percent, on strong consumption and a rebound in FDI in anticipation of Vietnam's WTO accession. However, inflation would remain higher than in recent years, at around 7 percent by end-2005, and reserve coverage would remain low. The main risk to the outlook would be continued reliance on a loose monetary policy, and an easing of the fiscal stance, which could increase short-term pressures on inflation and heighten external vulnerability. Over the medium-term prospects for sustained, higher-quality growth and poverty reduction remain broadly positive but hinge critically on macroeconomic discipline and market-oriented structural reforms. Assuming appropriate policies, growth is expected to remain robust in the range of 7 - 7½  percent, with inflation falling to around 3½ percent. However, the public debt stock could rise sharply over the next few years as the government covers the costs of the needed recapitalization and reform in the SOCB and SOE sectors.

Executive Board Assessment

Executive Directors welcomed Vietnam's continuing transition toward a market economy, and commended the authorities for the robust growth and significant poverty reduction achieved in recent years despite a number of exogenous shocks. Directors noted that structural reforms and prudent macroeconomic policies have made Vietnam an increasingly attractive destination for foreign direct investment, and that the external current account deficit is comfortably financed by private and official capital inflows. At the same time, Directors observed that the reserve coverage is low and, while inflation has shown some signs of moderation since mid-2004, it has accelerated recently, and is now expected to reach 8 percent in 2005. Directors encouraged the authorities to adopt a more flexible, market-oriented policy framework under the new Five-Year Socio-Economic Development Plan, centered on promoting private sector-led growth, achieving macroeconomic stability, and improving the quality of public investment. They stressed the need for more prudent macroeconomic policies, improved public sector financial management, accelerated reform of state-owned enterprises, and fair and transparent laws and regulations.

Directors noted that the near-term economic outlook is favourable but subject to risks. They cautioned the authorities that pursuit of an ambitious short-term growth target will likely exacerbate inflationary pressures and weaken the external reserve position. In addition, given the uncertain loan quality and weak balance sheets of the state-owned commercial banks, continuing high credit growth could give rise to large quasi-fiscal liabilities that could threaten medium-term debt sustainability.

Directors welcomed the authorities' intention to slow credit growth. However, they noted that the recent policy actions by the State Bank of Vietnam (SBV) are unlikely to be sufficient for this purpose, and may be sending mixed signals to the market. They urged a more concerted effort to tighten liquidity, with a number of Directors calling for a discontinuation of the practice of encouraging state-owned banks to finance large state-owned enterprise projects in order to achieve the authorities' growth target. Directors stressed the need to strengthen the monetary policy framework, including through greater central bank independence and focus on the objective of price stability.

While recognizing that there is no evidence of significant exchange rate misalignment and that a fixed exchange rate regime may have helped to anchor inflation expectations in the last year, Directors welcomed the authorities' intention to explore in a forward-looking manner ways to introduce more flexible exchange rate management. Several Directors noted that greater exchange rate flexibility will facilitate adjustment to exogenous shocks, reduce external vulnerability, and create incentives for economic agents to improve their management of exchange rate risks. They advised that exchange market intervention be limited to addressing disorderly market conditions, and that full use be made of the flexibility embedded in the current exchange rate system. Directors welcomed the authorities' positive efforts to accept the obligations of Article VIII of the Fund's Articles of Agreement, and to remove all remaining exchange restrictions subject to approval under this Article.

Directors welcomed the strengthening of the fiscal position in 2004, while expressing concern about the government's continued reliance on off-budget operations. They urged continued fiscal consolidation to help curb inflation and ensure public debt sustainability. Given the projected gradual decline in oil-related receipts from 2007 onwards, Directors called for urgent action to reduce the non-oil fiscal deficit. To this end, they suggested that a good portion of the oil revenue windfall be saved and that, in light of the recent sharp increase in public wages, investment and domestically-financed on-lending be contained in the period ahead, including through a review of off-budget expenditures. Directors also stressed the importance of reforms to improve the tax system, strengthen tax administration, rationalize public expenditure, improve project selection, and better integrate the capital and recurrent budgets. They also encouraged the authorities to move toward the adoption of best practices in the area of fiscal transparency, including by adopting integrated systems of accounting and reporting for all budget and off-budget operations and for all public debt and contingent government liabilities.

Directors considered reform of the state-owned commercial banks to be crucial to efforts to improve growth prospects and maintain fiscal sustainability in the medium term. They therefore supported the authorities' actions and plans to strengthen banking supervision, liberalize the banking sector, and improve the governance of banks. In this regard, Directors welcomed the recent tightening of prudential standards, including the adoption of regulations to bring loan classification and provisioning in line with international standards, and plans for development of a financial sector reform roadmap. They encouraged the authorities to ensure that the planned resolution of the nonperforming loans of the state-owned banks is based on accurate and reliable estimates of capital shortfalls. Furthermore, while supporting the authorities' plans to equitize the main state-owned banks, Directors emphasized that this should be accompanied by the elimination of residual policy lending, the improvement of banks' incentives to operate on a commercial basis, and the strengthening of the SBV's supervisory authority. A few Directors also encouraged the authorities to allow strategic investors to take over bank management to improve governance and increase efficiency.

Directors welcomed the recently-issued anti-money-laundering decree and encouraged the authorities to pursue full membership in the Asia Pacific Group on Money Laundering. They stressed the importance of strengthening the regime for combating the financing of terrorism, including by amending the criminal code so as to criminalize terrorism financing.

Directors urged the authorities to step up the restructuring of other state-owned enterprises as well, particularly the larger ones. Important needed reforms include equitization, the curbing of government interference in management and investment decision-making, and the provision of incentives to operate on a commercial basis.

Directors appreciated the authorities' commitment to international economic integration, and stressed that an open trade and investment regime and fair and transparent laws and regulations are key to promoting private-sector-led growth. In this regard, they supported Vietnam's objective of achieving WTO membership, and urged the authorities to pass and implement the legislation aimed at creating a level playing field and a more liberal and transparent investment regime. Liberalization of administered prices will be essential to remove distortions and production bottlenecks, and, together with reform of state-owned enterprises, including banks, should serve to support the government's fight against corruption.

Directors urged the authorities to improve the reliability, timeliness and dissemination of economic data. This is especially important with respect to money and banking statistics, off-budget fiscal activities, and public debt and contingent liabilities.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.