43509 TAKING STOCK An Update on Vietnam’s Recent Economic Developments PREPARED BY THE WORLD BANK For the Annual Consultative Group Meeting for Vietnam Hanoi, December 6-7, 2007 The preparation of this report was led by Viet Tuan Dinh under the general guidance of Ajay Chhibber and Martin Rama. Administrate assistance was provided by Dung Thi Ngoc Tran. CURRENCY EXCHANGE RATE: US$ = VND 16,115 GOVERNMENT FISCAL YEAR: January 1 to December 31 ACRONYMS AND ABBREVIATIONS ASEAN Association of Southeast Asian Nations BIDV Bank for Investment and Development of Vietnam BOT Build-Operate-Transfer CIT Corporate Income Tax CPI Consumer Price Index FDI Foreign Direct Investment GDC General Department of Customs GDP Gross Domestic Product GSO General Statistic Office HOSE Ho Chi Minh City Stock Exchange HASTC Hanoi Securities Trading Center IMF International Monetary Fund IPO Initial Public Offering JSB Joint-Stock Bank JSC Joint-Stock Company LUC Land Use Certificate MHB Mekong Housing Bank MPI Ministry of Planning and Investment MOF Ministry of Finance ODA Official Development Assistance P/E Price/Earnings Ratio PIT Personal Income Tax SBV State Bank of Vietnam SCIC State Capital Investment Corporation SOCB State-Owned Commercial Bank SOE State-Owned Enterprise VAT Value Added Tax VBARD Vietnam Bank for Agriculture and Rural Development WTO World Trade Organization TABLE OF CONTENTS Summary Growth and investment remain strong................................................................................ 2 Solid performance of non-oil exports ................................................................................. 5 Imports are growing even more rapidly.............................................................................. 7 Wider current account deficit but higher foreign reserves.................................................. 9 Inflation accelerates .......................................................................................................... 10 Credit growth picks up...................................................................................................... 13 Bond yields decline on foreign buying ............................................................................. 15 Capital inflows challenge monetary policy....................................................................... 15 Fiscal balance remains manageable .................................................................................. 16 A bigger but more volatile stock market........................................................................... 18 Figures Figure 1: Ownership Shares in Implemented Investment.................................................. 3 Figure 2: FDI Commitments and Disbursements ............................................................... 4 Figure 3: FDI Inflows as Percent of GDP........................................................................... 4 Figure 4: Export Share of GDP........................................................................................... 5 Figure 5: Destination of Non-oil Exports .......................................................................... 6 Figure 6: Average Import Price of Selected Items.............................................................. 9 Figure 7: Source of Imports ............................................................................................... 9 Figure 8: Trade and Current Account Balances............................................................... 10 Figure 9: Vietnam External Debt...................................................................................... 11 Figure 10: Consumer Price Index ..................................................................................... 12 Figure 11: World Commodity Price Index ....................................................................... 12 Figure 12: International and Domestic Price of Gasoline................................................ 13 Figure 13: Growth of Key Monetary Aggregates ............................................................. 13 Figure 14: Change in Budget Revenue ............................................................................ 17 Figure 15: Composition of Budget Revenue ................................................................... 17 Figure 16: Vietnam Stock Price Index.............................................................................. 20 Tables Table 1: GDP Growth by Sector........................................................................................ 2 Table 2: Export Structure and Growth................................................................................ 6 Table 3: Vietnam Garment Exports .................................................................................... 7 Table 4: Import Structure and Growth............................................................................... 8 Table 5: Stock Markets at a Glance .................................................................................. 19 Table 6: Top Ten Listed Companies at HOSE ................................................................. 21 SUMMARY Vietnam’s growth performance remains strong. The Gross Domestic Product (GDP) growth is anticipated to surpass 8 percent for a third year running. Domestic investment and private consumption have been robust and non-oil exports have experienced high growth. Foreign direct investment (FDI), boosted by Vietnam’s accession to the World Trade Organization (WTO), has soared. The stock market, though still small by regional standards, has grown rapidly to reach above 40 percent of GDP, mainly thanks to recent Initial Public Offerings (IPO) of large companies. A strong increase in imports of inputs and machinery has led to a larger trade deficit, widening the current account deficit. Yet, foreign reserves have shown a record rise in 2007. And the budget deficit keeps within the government’s plan in spite of a decline in oil revenues. Sustaining this solid performance will require a timely implementation of the commitments made for the WTO accession, appropriately addressing hardships as they arise. Progress in banking reform will also be crucial; attracting strategic investors to the state-owned commercial banks (SOCBs) and strengthening financial sector supervision are the key priorities in this respect. Looking forward, especial attention should be devoted to the risk of mixing financial and commercial interests within large economic groups. An adequate organization of the markets for infrastructure services is also needed to prevent economic groups from holding a dominant position and undermining competition. Short-term macroeconomic developments have been less impressive. Inflation has risen and price pressures remain, although the annual rate for 2007 may still remain in the single digits. Banking credit has expanded rapidly, with joint- stock banks (JSBs) recording the fastest credit growth. This raises concerns both about excessive liquidity and about the quality of lending. While stock market prices have somewhat stabilized, thanks to a series of minor corrections, the pressure may now be on real estate prices. In light of rapidly growing capital inflows, the government has chosen to avoid a major appreciation of the dong, to avoid damaging competitiveness. The decision also appears to reflect a concern about possible currency mismatches on the balance sheets of enterprises and financial institutions, and the limited financial instruments to hedge against exchange rate risk. But monetary policy has not been adjusted accordingly. The authorities’ attempts at sterilizing the effects of capital inflows have met with limited success. This calls for a reconsideration of the current mix of exchange rate and monetary policies. Recent macroeconomic developments also highlight the need for an improved environment to conduct open-market operations. 1 Growth and investment remain strong GDP grew by 8.2 percent in the first nine months of the year, compared with 7.8 percent in the same period of 2006 (Table 1). With growth having remained strong in the fourth quarter, the government’s target of 8 percent is likely to be exceeded. Table 1: GDP Growth by Sector 2004 2005 2006 9M-05 9M-06 9M-07 Total GDP 7.8 8.4 8.2 8.1 7.8 8.2 Agriculture, forestry & fishery 4.4 4.0 3.4 4.1 3.3 3.0 Industry & construction 10.2 10.7 10.4 10.0 9.9 10.2 Industry 10.5 10.6 10.2 10.3 10.1 10.2 Mining 9.3 1.0 0.8 7.6 2.5 0.3 Manufacturing 10.9 13.1 12.4 11.0 12.1 12.5 Construction 9.0 10.8 11.1 8.9 8.8 10.1 Services 7.3 8.5 8.3 8.2 8.0 8.5 Retail trade 7.8 8.4 8.6 8.1 8.3 8.3 Source: General Statistics Office (GSO). The combined agriculture, forestry and fisheries sector grew 3 percent in the first nine months of 2007, despite continuing to face unfavorable weather events, including typhoons and drought conditions. Value added from seafood recorded an increase of 9 percent to meet rising export demand. This also compensated for the slowdown in the poultry and livestock sub-sector, due to the impact avian influenza and other animal disease outbreaks in recent years. In the first nine months, industrial value added grew 10.2 percent year-on-year. Value added in the mining sector rose only 0.3 percent due to a decline in crude oil production, but manufacturing and construction remained buoyant. The service sector has also recorded a high growth rate in the first nine months of the year (8.5 percent) thanks to a strong performance of retail trade, tourism, transportation and financial services. Retail and wholesale trade, which contributes nearly one-third of the value added in the services sector, expanded by 8.3 percent. Within the industrial sector, the turnover of the domestic private sector expanded 21 percent while that of state-owned enterprises (SOEs) grew 10.3 percent year-on-year. The retail sales index, an indicator of consumption, grew by nearly 23 percent in the first 10 months of 2007 compared with 20.5 percent in the same period of 2006. The share of the state sector continues to decrease and represents only about 11 percent of total retail trade by now. 2 Total investment rose by 16.3 percent in the first nine months of 2007. For the whole year, the government’s estimate of implemented investment, which is different from the standard national accounts measure of gross capital formation, is expected to cross 40 percent of GDP, an increase of around 17 percent in nominal terms. A breakdown of implemented investment shows an increase in the share of the domestic private sector in the last five years (Figure 1). Investment by the domestic private sector increased by nearly 28 percent in 2007 and now accounts for about 17 percent of GDP. The Ministry of Planning and Investment (MPI) reported 38,550 new business registrations in the nine months of 2007 with an invested capital of about 303 trillion Vietnam dong, or 3.2 times higher than the same period of last year. Figure 1: Ownership Shares in Implemented Investment 100% 80% 60% 40% 20% 0% 2002 2003 2004 2005 2006 2007e State Non-state domestic Foreign Source: GSO. FDI commitments surged to 15 billion U.S. dollars by the end of November 2007 (Figure 2). This is above the record 12 billion U.S. dollars of 2006, and represents a 38 percent increase compared to the same period last year. MPI projects that total FDI commitment could hit 16 billion U.S. dollars this year. FDI commitments have clearly received a boost from Vietnam’s accession to the WTO. Investors have viewed WTO membership as not only offering wider investment opportunities, but have also been comforted by the predictability and “lock-in” to policy reforms that it entails. Vietnam has proven a rising star in the Asia region for FDI attractiveness. The recent World Investment Prospect survey of UNCTAD ranked Vietnam as the sixth most attractive location in the world by trans-national companies. The Asian Business Council ranks it third in the world in terms of attractiveness for investment attraction to Asian groups in the 2007-2009. While foreign investors have had a generally positive view on the new investment and enterprise regime ushered in by the enacting new Unified Enterprise and Common Investment laws in 2006, Vietnam still needs to address a lot of issues to sustain it as a 3 truly attractive investment destination. One challenge for Vietnam now is to upgrade its infrastructure especially in areas such as transport, ports, and power that investors have often pointed to as constraints. Figure 2: FDI Commitments and Disbursements 16 Committed Implemented 12 US$ billion 8 4 0 2001 2002 2003 2004 2005 2006 2007e Source: MPI. FDI disbursements, including domestic borrowing of foreign enterprises rose by 14 percent on the year to the end-November 2007, representing about 6.5 percent of GDP. This has resulted in Vietnam outperforming China and Thailand (Figure 3). Figure 3: FDI Inflows as Percent of GDP 8 Vietnam China Thailand 6 percent 4 2 0 2002 2003 2004 2005 2006 2007e 2008-11/f Source: Economic Intelligence Unit. 4 While investment by foreign companies and by the domestic private sector has increased strongly, disbursements from the capital state budget are still low, reflecting the slow preparation and implementation of public investment projects. Solid performance of non-oil exports During 2001-06 Vietnam’s exports grew at an average annual rate of nearly 22 percent in value terms. The ratio of merchandise exports to GDP increased both for total and non-oil exports. Currently, total exports account for roughly 72 percent of GDP (Figure 4). Figure 4: Export Share of GDP 80 70 Total Non-oil 60 percent 50 40 30 2000 2001 2002 2003 2004 2005 2006 2007e Source: GSO. Exports continued to grow at nearly 19 percent year-on-year in the first 10 months of 2007 (Table 2). This is in spite of a significantly smaller role of crude oil exports, due to production capacity constraints. As of October, oil export volumes had decreased by 10 percent in annual terms, causing export values to fall by 7.5 percent. It is noteworthy that the increase in the value of oil exports in the last two years was driven almost entirely by prices, rather than quantities. On the other hand, the year 2007 saw a strong pick-up in exports of agricultural products, garments, electronics and computers. Seafood and aquaculture exports, while recording a high increase, have faced food safety concerns related to antibiotic residues and to environmental problems in the breeding areas. 5 Table 2: Export Structure and Growth Value Share in percent Growth in percent (USD million) 10M- 10M- 2005 2006 2005 2006 2006 2007 2007 Total export earnings 39,826 100.0 100.0 100.0 22.4 22.8 18.6 Crude oil 8,265 22.7 20.8 16.8 30.1 12.1 -7.5 Non-oil 31,562 77.3 79.2 83.2 20.3 25.9 25.8 Rice 1,276 4.3 3.2 3.5 48.2 -9.3 12.7 Other agricultural 3,632 7.9 9.1 9.6 20.2 42.0 32.5 commodities Seafood 3,358 8.4 8.4 7.9 14.1 22.6 10.8 Coal 915 2.1 2.3 1.9 88.4 36.6 0.0 Garment 5,834 14.9 14.6 16.4 10.3 20.6 31.1 Footwear 3,592 9.4 9.0 8.2 13.0 18.2 9.9 Electronics & computers 1,708 4.4 4.3 4.4 32.7 19.7 23.0 Handicraft 630 1.8 1.6 1.5 9.2 10.9 18.8 Wood products 1,933 4.8 4.9 4.9 37.2 23.7 22.4 Other 8,684 19.3 21.8 24.9 20.5 38.7 38.5 Source: General Department of Customs (GDC) and GSO Figure 5: Destination of Non-oil Exports 25 2005 2006 2007e share of non-oil exports 20 15 10 5 China Japan ASEAN EU US Source: GSO and GDC. Among Vietnam’s trade partners, the United States is the biggest importer, absorbing above a fifth of total Vietnam exports, and nearly a quarter of non-oil merchandise exports. It is followed by EU, Japan and ASEAN countries (Figure 5). 6 Overall, industrial countries absorb about two thirds of Vietnamese exports. Export growth could therefore be affected in the event of a substantial economic downturn in the developed world, and particularly in the US. The sub-prime crisis, the associated credit squeeze and rising oil prices could lead to a cyclical downturn, potentially affecting Vietnam. However, the overall effect should be modest. Garment exports remained strong in the first ten months of 2007, growing by 31 percent year on year compared with 20.6 percent in the whole 2006, due mainly to a much improved performance in the US market (Table 3). This improved US performance resulted both from a better utilization of quotas and an expansion into non-quota exports. Garment exports to the US rose by 37 percent and accounted for 58.4 percent of total garment exports in the first nine months of 2007. Table 3: Vietnam Garment Exports Growth in percent Share in percent 2005 2006 9M-07 2005 2006 9M-07 Total 10.3 20.6 28.8 100.0 100.0 100.0 Key markets France 13.6 37.8 2.4 2.1 2.4 1.9 Germany 4.4 35.7 15.5 4.9 5.5 4.7 Holland 26.2 46.6 9.6 1.6 2.0 1.6 Japan 13.7 3.9 11.3 12.5 10.8 9.2 Spain 25.2 29.7 21.5 1.7 1.9 1.6 UK 56.8 43.7 22.2 3.2 3.8 3.5 US 5.2 17.0 37.0 53.8 52.2 58.4 Source: Based on data from GSO and GDC. Two other export categories have shown strong growth in the last three years, albeit from a low base. These are wood products and electrical goods and components. Wood products received an initial fillip in 2004 in supplying the US when Chinese exports of wood furniture were restrained by antidumping proceedings. Since then, their value has tripled and their market is much more diversified market. Imports are growing even more rapidly Imports grew by 30.5 percent, on an annual basis, in the year to October 2007 compared with 15.7 percent in 2005 and 21.4 percent in 2006 (Table 4). This growth is driven by a strong investment demand and by the input needs associated with industrial expansion. Imports growth attained 55 percent in the case of machinery and equipment, 7 fueled by the purchase of high-value items for power plants and the oil refinery, as well as aircraft and train locomotives. It attained 58 percent in the case of steel and 42 percent in the case of computers and electronic components. Imports of fabric also rose by a sharp 35 percent, reflecting the input requirements of garment exports. Automobile imports rose steeply too, perhaps a sign of the emergence of a high-consumption group in Vietnam. Table 4: Import Structure and Growth Value Share in percent Growth in percent (USD million) 10M- 10M- 2006 2005 2006 2007 2005 2006 2007 Total import value 44,891 100.0 100.0 100.0 15.7 21.4 30.5 Petroleum products 5,970 13.6 13.3 12.2 40.6 18.8 16.0 Final Goods Machinery and equipments 6,628 14.3 14.8 17.3 0.6 25.5 57.8 Computer and electronics 2,048 4.6 4.6 4.9 27.1 20.0 41.7 Pharmaceuticals 548 1.4 1.2 1.2 22.5 9.2 27.5 Intermediate and raw materials Garment & leather materials 1,951 6.2 4.3 3.7 1.3 -14.5 9.6 Iron & Steel 2,936 7.9 6.5 7.8 13.9 0.2 56.2 Fertilizer 678 1.7 1.5 1.5 -22.2 5.9 21.7 Plastics 1,866 3.9 4.2 4.1 22.2 28.2 29.3 Fabrics 2,985 6.5 6.6 6.8 24.5 24.4 34.6 Chemicals 1,042 2.3 2.3 2.4 26.7 20.4 33.7 Chemical products 1,007 2.3 2.2 2.1 19.2 19.7 24.0 Automobiles (CKD/IKD) 213 2.5 0.5 2.2 40.5 -76.6 88.3 Yarns & fibers 544 0.9 1.2 1.3 0.2 60.2 33.9 Pesticides 305 0.7 0.7 0.6 15.9 25.3 18.8 Cotton 219 0.5 0.5 0.5 -12.1 31.0 23.5 Paper 475 1.0 1.1 1.0 46.1 31.2 23.5 Other 15,475 29.8 34.5 30.7 14.9 40.4 19.0 Source: GDC and GSO. The higher international prices of steel, plastics, petrol, fertilizer and weaving yarns amounted to an increase in Vietnam’s import bill by roughly one billion dollars (Figure 6). The impact of higher oil prices, on the other hand, was not as strong as in the previous year, as refined petroleum products now account for only 16 percent of imports. China has become the biggest single supplier to Vietnam. Its share in total imports has risen from around 13 percent in 2004 to nearly 19 percent in 2007. The high share of ASEAN countries is to a large extent accounted for by imports of refined petroleum products (Figure 7). 8 Figure 6: Average Import Price of Selected Items 50 40 10M-2006 10M-2007 30 percent 20 10 0 -10 Petroleum Fertilizer Yarns & Fiber Steel & Iron Wheat products Source: GDC and GSO. Figure 7: Source of Imports 30 25 2005 20006 2007e 20 15 10 5 0 ASEAN China Japan Europe US Source: GDC and GSO. Wider current account deficit but higher foreign reserves The trade deficit had narrowed in previous years, from 6.4 percent of GDP on an f.o.b. basis in 2003 to 0.9 percent in 2006. However, in 2007 it widened again due to the rapid growth of import values, and is estimated to reach 6 percent of GDP by the end of the year (Figure 8). The current account deficit can be expected to exceed 3 percent of GDP this year, compared to 0.3 percent of GDP in 2006. 9 Figure 8: Trade and Current Account Balances 2 0 percent of GDP -2 -4 -6 -8 2002 2003 2004 2005 2006 2007e Trade balance Current Account balance Source: GDC and World Bank However, the balance of payments situation of Vietnam remains sound, with the current account deficit largely financed by non-debt creating FDI inflows, official development assistance (ODA) and private remittances. In relation to both FDI and ODA, the high levels of commitments mean that actual inflows could be greatly accelerated if there were concerted efforts to ease implementation constraints. ODA disbursement amounted to 1.6 billion U.S. dollars in the first 10 months of 2007. Portfolio inflows also witnessed a sharp increase in 2006 and early 2007, attracted by rapidly developing capital markets, including a booming stock market. Private remittances are estimated at more than 5 billion dollars, mainly from overseas Vietnamese and laborers abroad. As a result of large capital inflows, foreign exchange reserves have built up quite rapidly, increasing from 11.5 billion U.S. dollars at the end of 2006 to an estimated record-high of around 21 billion U.S. dollars by the end of 2007. The external debt to GDP ratio, estimated to stand at 31 percent at end of 2007, is expected to decline gradually in coming years (Figure 9). With nearly two-thirds of this debt on highly concessional terms, the ratio of debt service to exports will remain very low, at about 5 percent. Vietnam is therefore considered at a country at a low risk of external debt distress. Inflation accelerates One of the salient macroeconomic developments of the past months has been the acceleration of inflation, which has generated considerable debate among policy makers on the most appropriate response strategy. 10 Figure 9: Vietnam External Debt 35 External debt (nominal) NPV of external debt 30 percent of GDP 25 20 15 2006 2009 2012 2015 2018 2021 2024 2027 Source: Joint Debt Sustainability Analysis, IMF and WB. NPV stands for Net Present Value. The Consumer Price Index (CPI) increased by 10 percent in the year to November, or 9.5 percent from beginning of the year. The annual figure for 2007 will be far above the target of the government which tries to keep the increase in the CPI below the growth rate of GDP (Figure 10). Figure 10: Consumer Price Index 20 15 percent 10 5 general food & foodstuffs non-food 0 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Source: GSO Given Vietnam’s very open economy, and an exchange rate policy amounting to a peg to the dollar, part of the acceleration in inflation is related to the increase in the price 11 of internationally tradable goods. The index for food and foodstuff products grew by 13.9 percent on an annual basis, the fastest increase since April 2005. The impact of higher commodity prices is amplified by the methodology used in Vietnam to compute the CPI, which may give excessive weight to food items. The international prices of agricultural products have increased steadily in recent years (Figure 11). This in turn affects domestic prices, given how open the Vietnamese economy is by now. In addition, there are quality improvements which are not easily captured by price indices. The average export price of Vietnamese rice, for instance, increased from 265 U.S. dollars per ton in 2005 to about 325 U.S. dollars in 2007. This represents nearly 98 percent of the export price of rice from Thailand, compared to only 90 percent in 2005. The domestic prices of food in Vietnam have also increased due to supply shocks, including animal disease outbreaks and severe floods in the central provinces. Figure 11: World Commodity Price Index 350 300 Oil Agriculture Metals Price index (Jan 2003 = 100) 250 200 150 100 50 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Source: World Bank. Other tradable goods have fueled the rise of domestic prices in Vietnam, including steel, cement and petroleum products. In relation to the latter, the government has tried to absorb part of the price increase, by providing a subsidy on diesel and gasoline prices (Figure 12). This policy is motivated by the fear that passing through higher oil prices, especially for diesel, to the domestic market will result in a substantial increase of the CPI. A total of 500 million U.S. dollars were allocated to the gasoline subsidy in the state budget, of which some 140 million U.S. dollars had been disbursed by the end of October 2007. However, the retail price of gasoline was increased by 15 percent (from 11,300 dong per liter to 13,000) in November 22, when the international price of oil approached 100 U.S. dollars per barrel. The retail price of diesel was also increased (from 8,600 Dong per liter to 10,200). 12 Figure 12: International and Domestic Price of Gasoline 160 Singapore FOB price Vietnam retail price 140 Price index (Jan 2006 =100) 120 100 80 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Source: Singapore FOB price is based on the U.S. Department of Energy. Credit growth picks up There are also concerns that an excessive loose monetary policy might have fueled increases in the prices of non-tradable goods. Credit growth had been contained in previous years, slowing down to 25 percent in 2006. But since July of that year the acceleration is perceptible, reaching about 40 percent by December 2006 (Figure 13). Figure 13: Growth of Key Monetary Aggregates 65 55 45 percent 35 25 15 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Credit grow th Deposit grow th Broad money Source: State Bank of Vietnam (SBV) and International Monetary Fund (IMF). 13 Credit growth of SOCBs has stood at a relatively subdued 23 percent over the 12 months to August while that from JSBs has increased at 77 percent. Such rapid growth raises concerns in relation to the quality of their loans. JSBs have reported strong profits both in 2006 as well as in the first half of 2007. Several of them have increased their capital levels to meet the newly established requirement of 1 trillion dong by 2008, and 3 trillion dong by 2010. Others are planning to do so. Adding to the buoyancy of this segment, SBV has received numerous applications for establishment of new JSBs. However, the authorities have been concerned that some banks may simply be taking advantage of the stock market euphoria to increase their capital without adequate business plans. A recent regulation therefore directs banks wishing to raise capital to provide detailed business plans which also specify the return on equity and dividend ratios expected after the capital increase. Under its WTO commitments, Vietnam has also agreed to permit 100 percent foreign-owned banks after April 1, 2007. The regulations for implementing this commitment have, however, not been finalized yet. Reportedly, four foreign banks have already expressed their strong interest to establish fully-owned operations in Vietnam. After a long wait, several SOCBs are getting nearer to equitization. The Bank for Foreign Trade of Vietnam (Vietcombank) and Mekong Housing Bank (MHB) hired internationally reputed advisors to help with their equitization process. Their IPOs are expected to occur in the last quarter of 2007. The equitizations of the Bank for Investment and Development of Vietnam (BIDV) and the Industrial and Commercial Bank (Incombank) have also made headway and both are in the process of hiring advisors. Their equitizations are expected in the fourth quarter or early in 2008. The state is expected to eventually retain a 51 percent stake in the banks, with foreign ownership to be restricted to 30 percent. The reduction in state share is expected to be in steps, with a decline to no less than 70 percent in the first stage. But the much awaited increase in the stake allowed to a single foreign investor fell short of expectations. It was anticipated that for strategic investors the cap would be lifted from the current level of 10 percent to 20 percent, but the limit has been set at 15 percent. In selected cases the Prime Minister may grant permission for a 20 percent stake. There has also been some disappointment with the negotiation with strategic investors in the case of Vietcombank. After allegedly having conducted discussions with three such investors, the government came to the conclusion that the share price they offered was too low. The sequencing between the IPO and the direct sale to strategic investors was thus reverted. It is expected that 6.5 percent of Vietcombank’s capital will be auctioned at the Ho Chi Minh City Securities Exchange (HOSE) before the end of 2007. This sequencing has the advantage of allowing a transparent “price discovery” before direct negotiations with strategic investors are engaged. But the experience with the equitization of Bao Minh, a large insurer, shows that this approach is risky and strategic investors may not be found subsequently. 14 Bond yields rise Beginning in the second half of 2006, foreign buyers started to show an interest in Vietnam Government bonds. The resultant inflows and higher demand, led to a decline in the 5-year government bond yields from around 8.75 percent in the first half of 2006 to 8.34 percent by November 2007. The annual coupon on the 5-year bond slipped to 6.5 percent in March 2007, but moved up to 8.3 percent at the auction in November 12, 2007. At a policy level, the government has been trying to build the five-year bond as a liquid benchmark issue through big-lot auctions. The treasury will also stop retail issuance of bonds to individual investors to reduce transaction costs. At present there is considerable fragmentation, with over 400 series of bonds, resulting in shallow and illiquid secondary markets. Bond consolidation would be an important step to facilitate open-market operations in the future. Meanwhile, the spread on Vietnam’s only sovereign bond over comparable US treasuries, widened to 200 basis points in November 2007, from about 110 basis points earlier in April. The bond was issued in October 2005 at a spread of 256 basis points. The recent widening of spreads is in line with the trend observed for emerging market paper more generally. In March 2007, Moody' s s had changed its outlook for Vietnam' Ba3 foreign-currency government bond rating from stable to positive. In September, Standard & Poor' s foreign currency rating by one notch to BB. The s upgraded Vietnam' rating agency also lifted Vietnam dong rating to BB+ from BB and the outlook on the ratings is stable. Encouraged by the success of the first sovereign bond, and given large investment needs, the government is considering to raise another 1 billion dollars through a new sovereign issue which will be lent to PetroVietnam, Vietnam Shipping Lines (Vinalines), Song Da Construction Corporation and Vietnam Machinery Installation Corporation (LILAMA). However, this issuance could be postponed until an “appropriate time” to avoid the current turbulence in the world capital market. Capital inflows challenge monetary policy Deposit growth at both SOCBs and JSBs has remained high, with an average of more than 50 percent over the last 12 months. With deposit growth far exceeding lending, banks have experienced a build-up of liquidity. The rapid increase in deposits has implied a sharp rise in broad money growth, from 25 percent per year by mid-2005 to 42 percent in August 2007. SBV expects credit growth to slow down in the coming months, and targets an annual increase of 30 percent for the year as a whole. But for now, the main instrument to reduce credit growth has been to increase reserve requirement for banks (from 4 to 10 percent, effective on June, 2007). Over the last 12 months, the growth in base money underlying the rise in broad money supply has resulted predominantly from the build-up of foreign assets. Large capital inflows have complicated the implementation of monetary policy, confronting 15 Vietnam with what is sometimes called the “impossible trinity” of simultaneously maintaining a fixed (or nearly fixed) exchange rate, an independent monetary policy and an open capital account. Increasing capital inflows have put pressure on the exchange rate to appreciate. In January 2007, the SBV widened the trading band for the dong-dollar rate from ± 0.25 percent to ±0.5 percent. Vietnam dong appreciated against the dollar around 0.4 percent in April for the first time since July 2004. The authorities have so far been unwilling to allow a greater appreciation out of concern for the competitiveness of exports. They have thus intervened in the market by purchasing foreign exchange. It is reported that SBV purchased around 9 billion U.S. dollars in the first half of 2007. Such intervention in the foreign exchange market has resulted in a build-up of reserves. Their level may attain a record high of about 21 billion U.S. dollars this year, an increase of roughly 10 billion from last year. Whether capital inflows will be sustained partly depends on international developments. The outbreak of US sub-prime crisis has had little adverse impact on East Asia so far. Preliminary assessments suggest that direct exposures of East Asian financial institutions to sub-prime risks are limited. Risks could increase, however, if the global instability and tightening of credit markets intensifies and leads to further declines in prices of various other structured assets held by the banks. For now, efforts to temper currency appreciation have the unwanted side effect of reducing the SBV’s ability to pursue an independent monetary policy. Unless it is sterilized, accumulation of reserves to prevent an exchange rate appreciation leads to an expansion in the money base. SBV has made efforts in this direction, selling securities to partially mop-up the excess liquidity created by foreign exchange purchases. In some countries, sterilization is a concern for central bank balance sheets as, typically, reserve assets have a lower return than the interest paid on the securities issued to absorb liquidity. Until recently, this was not a concern yet in SBV’s case as its bills carried a low interest rate. But this in turn resulted in difficulties to place the securities, hence to effectively mop up excess liquidity. To address this problem, the SBV has allowed interest rates to rise appreciably in recent months. Fiscal balance remains manageable In the first 10 months of 2007, overall budget revenues and expenditures had attained 81.4 percent and 78.5 percent of their respective targeted levels. Revenues from crude oil exports have been dampened by the fall in oil prices in the first half of 2007. As of end-September they have only fulfilled two thirds of the revenue plan for the whole 2007. By contrast, budget revenues from non-oil sources have increased above expectations (Figure 14). 16 Figure 14: Change in Budget Revenue 60 percent 40 20 -20 Oil VAT Trade CIT PIT Property Source: Ministry of Finance (MOF). Figures are year-on-year, for the first nine months of 2007. The resulting change in the structure of tax revenue may be reflecting a deeper trend. While revenue from Corporate Income Tax (CIT) and excise taxes keeps its position roughly unchanged, the share of Value Added Tax (VAT), Personal Income Tax (PIT) and property-related revenue, on the other hand, are growing, albeit in some cases from a low absolute base (Figure 15). Figure 15: Composition of Budget Revenue 2006 2007 Estimate Source: MOF. Contrary to many predictions, the share of trade-related revenue has not declined, in spite of tariff reductions related to the implementation of WTO commitments and the continuation of those under the ASEAN Free Trade Area. This is partly due to the fact 17 that tariff reductions under the WTO are not very large. More importantly, imports are surging so that tariffs apply to a wider tax base. Moreover, the government has begun to implement a customs modernization program that will not only facilitate trade but is also expected to improve revenue collection. The increase in the share of property-related revenue could be indicative of a deeper trend. Such revenue is sourced from fees charged on the assignment or transfer of Land Use Certificates (LUCs) as well as land rentals. The implementation of the new Land Law, which brought land valuation closer to market prices and improved the allocation of LUCs, has probably had an impact. On the expenditure side, minimum wage hikes have become an important contributor to the increase in recurrent outlays in the last three years. The minimum wage applying to government employees has been raised by a cumulative 256 percent since January 2003. The latest increase, effective from the beginning of 2008, raised minimum wages by 28.6 percent, from 450 to 540 thousand dong per month. Adjustments should continue at a fast pace in the coming years, to narrow further the minimum wage gap between domestic and foreign invested sectors. This gap contradicts the national treatment principle of WTO, and is to be reduced to zero by 2010 as part of international commitments. At present, the minimum wage in foreign invested enterprises is 710 thousand to 870 thousand dong per month. The domestic minimum wage also serves as the basis for the adjustment of government pensions and other social security payments. The resulting pay rise for state employees cost the government 6.2 trillion dong in the final quarter of 2006, and is expected to cost another 26.6 trillion in 2007. The government’s budgeted increments in the wage bill in connection to salary reform have been set at 16 to 17 percent of recurrent expenditures for 2007. The 2007 target for the budget deficit, defined as revenue (excluding carry-over from the previous year) minus on-budget expenditure, is about 3.4 percent of GDP. On current trends, this objective remains attainable. A quarter of the deficit is expected to be financed by external sources and the rest by domestic sources. On-lending of ODA receipts by the government to enterprises or agencies implementing projects is expected to amount to 1 percent of GDP in 2007. Other items which contribute to public or publicly guaranteed debt include the on-lending of resources raised domestically, through the Vietnam Development Bank, the issuance of bonds to finance infrastructure expenditures in the transport, irrigation, and education sectors, bonds issued by provinces to finance local infrastructure. Including these items, public debt is projected around 43 percent in 2007, a level considered to be within manageable limits. A bigger but more volatile stock market Vietnam’s stock market has experienced a dramatic boom over the last two years. At the end of 2005, only 41 firms were listed, with a market capitalization of less than 1 billion U.S. dollars, or 1.2 percent of GDP. By November 20, 2007, the number of listed firms had risen to 221, of which 125 on the HOSE and 96 in Hanoi Securities Trading 18 Center (HASTC). Capitalization on both markets has reached nearly 29 billion U.S. dollars, or above 40 percent of the estimated GDP for 2007. However, a substantial part of the recent growth in capitalization has stemmed from the IPOs of large companies in November 2007, rather than from an increase in stock prices (Table 5). Table 5: Stock Markets at a Glance 2006 2007 HaSTC HOSE Total HaSTC HOSE Total Number of stocks 87 106 193 96 125 221 Market cap (USD billion) 4.6 9.2 13.7 7.4 21.3 28.7 Market cap/ GDP (percent) 7.5 15.0 22.5 10.4 30.0 40.4 PE ratio (weighted) 26.0 28.7 27.1 29.4 25.2 26.2 Foreign holding (percent of total) 14.2 26.9 22.7 16.0 24.9 24.9 Average trading value (USD million) 1.2 8.9 10.1 15.1 50.2 65.3 Source: HOSE and HASTC. Data as of November 20, 2007 Whether the market is overvalued remains a hotly debated issue, but overall the fears of a crash, potentially complicating monetary and exchange rate policies, have receded. Compared to GDP, stock market capitalization remains much below that of India or China whose ratio has surpassed 100 percent these days. Price-to-earnings ratios are not unusually high for a rapidly growing economy. They tend to be inflated by the fact that data on prices are current while data on earnings are usually available with a considerable lag. The earnings of listed companies have actually been increasing very rapidly. After a period of exuberance until March 2007, the market now appears to be settling, although through a series of ups and downs (Figure 16). A major state-owned insurer, Bao Minh, did not do well at its much anticipated IPO. The announced listing of several large state-owned enterprises and commercial banks in the coming months could exert substantial downward pressure on equity prices. The government is even considering postponing some of those listings for fear of depressing stock prices too much. The list includes companies like Vietcombank and MHB. In addition, BIDV, Incombank, and perhaps even the key Vietnam mobile operator, Mobifone, may be listed later, in 2008. 19 Figure 16: Vietnam Stock Price Index 1,200 1,100 1,000 900 800 700 Jan-07 Feb-07 Apr-07 May-07 Jul-07 Aug-07 Sep-07 Nov-07 Source: HOSE. Data as of November 20, 2007 Foreign players have remained net buyers, and more of them seem interested in joining. It is estimated that foreign holding amounts to about a quarter of total market capitalization of HOSE or about 5.3 billion U.S. dollars. This amount is higher than the actual inflows as it incorporates the capital gain since the inflow occurred. The foreign holding amount is also a subject to daily change according to daily transactions in the stock market. It is noteworthy that the stock market capitalization is dominated by a dozen of blue chip companies. The 10 largest account for 55 percent of total listed shares and 61 percent of total market capitalization in HOSE (Table 6). Asian Joint Stock Commercial Bank (ACB) is the biggest company by market capitalization. Currently valued at about 2.6 billion U.S. dollars, it accounts for 22 percent of total outstanding shares and 36 percent of total market capitalization of HASTC. Fluctuations in the share prices of blue chip companies affect the overall market index significantly. 20 Table 6: Top Ten Listed Companies at HOSE (by Market Capitalization) Shares State Foreign Market EPS Stock outstanding No Company name share share Cap ($ (000’ P/E symbol (million) (%) (%) bn) VND) Phu My Fertilizer and 1 DPM 380 60.1 8.3 2.0 n/a n/a Chemical corp. Vietnam Diary 2 VNM 175.3 47.6 44.7 1.9 5.3 32.5 Products company Saigon Thuong Tin 3 STB 444.9 0.0 30.0 1.8 2.4 26.6 JS bank Financing and 4 FPT Promoting 91.9 7.3 21.7 1.4 7.5 32.7 Technology 5 SSI Saigon Securities Inc. 79.9 0.0 28.1 1.3 13 19.6 Pha Lai Thermal 6 PPC 326.2 67.8 13.0 1.2 3.0 20.6 Power company Petro Drilling and 7 PVD 110.1 36.5 22.1 1.1 4.5 34.6 Service company 8 HPG Hoa Phat Group 132 0.0 10.8 1.0 n/a n/a 9 VIC Vincom Group 80 0.0 3.8 0.8 8.1 19.2 Tan Tao Industrial 10 ITA 79.9 0.0 34.1 0.7 4.9 27.5 Park Development Source: HOSE. Data as of November 20, 2007 21