World Bank Report on Vietnam’s Macroeconomic Situation

Taking Stock: An Update on Vietnam’s Recent Economic Developments (World Bank)

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Jun 5, 2008. Global macroeconomic conditions have deteriorated since the second half of 2007. In addition to a slowdown in industrial countries, there is considerable uncertainty in financial markets and a surge in the world prices of commodities. Rapid increases in the international prices of rice and oil are of particular concern for Vietnam. Export restrictions in the former case, and a freeze of the domestic price in the latter, have prevented a full transmission of these shocks to consumer prices. And a bumper harvest could help ease the pressure in the case of rice. But latent inflationary pressures will remain, adding to the social impact of higher prices in recent months.

Vietnam should benefit from higher prices for food, and especially rice, as it is a net exporter. However, less than half of Vietnamese households are net sellers of food and an even lower share is a net seller of rice. Because of the complex distributional impacts of higher food prices, sweeping responses may not be appropriate. Actions that depress the price of rice may assist urban populations, but disadvantage more than half of poor households in the Red River delta. As for cash transfers, they require good targeting. But in Vietnam good targeting works best among the rural poor and ethnic minorities, which are not the losers in the current situation.

To a large extent, however, the macroeconomic difficulties of Vietnam are homemade. Confronted with massive capital inflows in 2007, the government still chose to give priority to rapid growth. The monetary authority purchased large amounts of foreign currency to prevent the appreciation of the dong, and eventually failed to mop up the additional liquidity through the sale of bills. The growth in base money led to a rapid expansion in credit, mainly driven by joint stock banks. As a result, inflation accelerated and a real estate bubble developed. Ballooning imports of consumption goods added to an already large trade deficit, mainly associated with purchases of capital and intermediate goods. Investments by Economic Groups and General Corporations outside their core business fueled the asset price frenzy.

In response to this general deterioration of macroeconomic conditions, in February and March of 2008 the government switched its priority to stabilization. Measures were taken to reduce the growth rate of credit, with the objective of bringing it down to 30 percent by the end of the year. The stabilization package announced also included cutting government expenditures, stopping inefficient public investment projects, postponing new ones, and allowing greater flexibility of the exchange rate. The GDP growth target for 2008 was revised downwards, from 8.5-9 percent to 7 percent.

There are indications that this policy package is working, as the growth in non-food prices compared to the previous months, and the growth of monthly imports compared to the previous year, have started to decelerate. The stock market has cooled down and there is evidence that the same has happened with the real estate market. This suggests the need to persevere with monetary tightness.

However, the other components of the package need to be implemented as well. Fiscal adjustment is needed to avoid putting all the burden of stabilization on interest rates. Relying on monetary tightness only would keep asset markets depressed and make more vulnerable the joint stock banks which lent more aggressively for financial and real estate investments. Meanwhile, the inflation differential between Vietnam and its trading partners has resulted in an appreciation of the dong. A loss of competitiveness is not a welcome development at a time when the trade deficit is so large.

On the positive side, a determined implementation of the stabilization package would not result in a dramatic deceleration of economic growth. “Statistical” inertia implies that GDP growth in 2008 will remain strong, even if the 7 percent target is met for each of the remaining quarters of the year. From this perspective, the cost of taking a firm stance on inflation and the trade deficit would not be too high. For now, Vietnam can clearly afford to give priority to economic stability.

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