Report No. 13143-VN Viet Nam Public Sector Management and Private Sector Incentives An Economic Report September 26, 1994 Country Operations Division Country Department I East Asia and Pacific Region A W7- q~. . ,~~~~~~~~~~V 'A~~~~~~~~~~~~~ -. ,~~~~~ -- -4 0 ,,Z-, ig - w~~~~~~~~~~~~~~~~~~~~'-t W!~~~~~~~~~~~~~~~~~~~~~~~~~~., The Vietnamese currency is the do= (D). Calendar 1993 Augt 1994 US$1.00 = D10,640 US$1.00 D11,000 D 1,000 =US 0.09 D 1,000 =US$ 0.09 Insca Yea January 1 - December 31 Weights and Measure Metric System IUst of Acronnns ADB - Asian Development Bank ASEAN - Association of Southeast Asian Nations BFT - Bank for Foreign Trade BHS - Brussels Harmonized System BID - Bank for Investment and Development BOT - Build, Opate, and Transfer BOO - Build, Own, and Operate CMEA - Council of Mutual Economic Assistance CPI - Consumer Price Index DFI - Direct Foreign Investment DGPT - Directorate General of Post and Telecommunication EPR - Effective Protection Rate List of Acronyms (continued) EPZ - Export Processing Zone GDP - Gross Domestic Product GNP - Gross National Product HCMC - Ho Chi Minh City ICB - Industrial and Commercial Bank ICOR - Incremental Capital Output Ratio IDA - International Development Association ILO - International Labour Organizadon IMF - International Monetary Fund JV - Joint Venture LSMS - Living Standards Measurement Survey MIGA - Multilateral Investment Guarantee Agency MOF - Ministry of Finance NGO - Non-Govermmental Organization NIE - Newly Industrialized Economy ODA - Official Development Assistance OECD - Organization of Economic Cooperation and Development OECF - Overseas Economic Cooperation Fund PCF - Popular Credit Fund PIP - Public Investment Program QR - Quantitative Restriction RSB - Rural Shareholding Bank SBV - State Bank of Viet Nam SCCI - State Committee for Cooperation and Investment SIDA - Swedish International Development Authority SOCB - State-Owned Commercial Bank SOE - State-Owned Enterprise SPC - State Planning Committee UNDP - United Nations Development Programme VBA - Viet Nam Bank of Agriculture VNLSS - Viet Nam Living Standard Survey VIET-NAM PUBLIC SECTOR MANAGEMENT AND PRIVATE SECTOR INCENTIVES ECONOMIC REPORT Table of Contents Page No. Summary ...................................... i I. MACROECONOMIC DEVELOPMENTS .................... I A. Introduction .......................................... 1 B. Macroeconomic Performance .......... ..................... 3 C. Budget Developments . ................................... 6 D. Monetary Policy and Inflation Control ....... ................... 10 E. Balance of Payments and the Exchange Rate ...... ................ 13 F. Growth Prospects and Financing Requirements ..................... 15 II. PUBLIC SECTOR MANAGEMENT ......... .................... 20 A. Budget Management and Central-Local Relationships ..... ............ 21 B. Government Expenditure .................................... 31 C. State Enterprise Reform ................................... 37 m. INCENTIVES FOR SAVINGS AND INVESTMENT ................. .. 45 A. Development of Legal Infrastructure ........ ................... 46 B. Reform of the Financial System ......... ..................... 50 C. Foreign Trade Policy ...................................... 8 D. Foreign Investment Regime . ................................. 66 IV. POVERTY REDUCTON . ................................... 79 A. Economic Growth and Poverty Reduction ....... .................. 79 B. Public Expenditures and Poverty ........... .................. 85 C. Rural Finance and Development ........... .................. 100 This report was prepared on the basis of an economic mission that visited Viet Nam in March/April 1994. The report was written by a team led by David Dollar and including Reza Amin, Richard Bird, Gerry Caprio, Michael Finger, Pierre Guislain, Hendrik Koppen, Natalie Lichtenstein, Jennie Litvack, Ray Mallon, Glenn Pederson, Govinda Rao, and Thang Long Ton. The mission would like to express its gratitude to the State Bank of Viet Nam and to other ministries and agencies that assisted in the preparation of this report. The peer reviewers for the report were Daniela Gressani and Shanta Devarajan. The report was discussed with the Government of Viet Nam in September 1994 and revised and updated on the basis of those discussions. TABLES. FIGURES AND STATISTICAL APPENDIX TABLES 1.1 Growth Rates of GDP and Major Sectors, 1990-94 ........................ 4 1.2 Summary of Budgetary Operations, 1990-94 ............................ 8 1.3 Consumer Price Inflation ........................................ 10 1.4 Macroeconomic Indicators and Projections, 1990-99 ....................... 16 1.5 External Financing Requirements, 1991-99 ............................. 19 2.1 Share of Provincial Expenditures in Total, 1992 . ........................ 24 2.2 Draft Budget Law Proposals on Assignment of Expenditure and Revenue Responsibilities ..................................... 27 2.3 Consolidated Govermnent Expenditure, 1989-94 .......................... 33 2.4 Government Investment, 1993-94 ................................... 35 3.1 Taxation of Bank Intermediation .................................... 56 3.2 US Dollar Value of Vietnamese Exports to Convertible Currency Areas: Share and Growth Rate of Selected Products ............. 59 3.3 Tariff Rate Increases - August 15, 1993: Selected Products .................. 63 3.4 Tariff Rates on Imports of Small Passenger Cars and Motorcycles ................................ .......... 64 4.1 Incidence of Poverty ........................................... 80 4.2 Real Per Capita Expenditures By Region .............................. 81 4.3 Poverty Under Different Growth Scenarios ............................. 83 4.4 Norms for Determining Current Expenditures for Standardized Items in Provinces, 1994 ..................................... 91 4.5 Per Capita Expenditures in Provinces Classified According to Income Categories, 1993 ..................................... 92 4.6 Per Capita Revenues: Targets and Estimates ............................ 94 4.7 Expenditure on Special Central Programs in Provinces ...................... 97 FIGURES 1.1 Savings and Investment, 1990-94 ................................... 5 1.2 Real Interest Rates ............................................ 12 1.3 Exchange Rate and Inflation, 1989-93 ................................ 14 3.1 Financial Depth in Selected TEs .................................... 52 3.2 Credit to Private Firms ......................................... 53 4.1 Provincial Revenue and Expenditure per Capita, 1992 ...................... 96 STATISTICAL APPENDIX . 108 VIEINAM pUBLIC SECrOR MANAGEMENT AND PRIVATE SECTOR INCENTIVES SUMMARY 1. Viet Nam has been carrying out an ambitious adjustment and reform program since 1989 and is making a steady transition to a market economy. The country achieved some notable successes during the 1989-92 period, despite a lack of international financial support. Initial structural reforms included decollectivization of agriculture, price liberalization, unification and devaluation of the exchange rate, and hardening of the budget constraint for state enterprises. At the same time the fiscal deficit that was the root cause of inflation was reduced through a combination of tax reform, elimination of subsidies, and expenditure restraint. These reforms produced good results. Real GDP growth accelerated from 5- 6% in 1990-91 to 8% in 1992-93. At the same time inflation was brought down from 68% in 1991 to 18% in 1992 and 5% in 1993. 2. While Viet Nam's achievements are impressive, there are weaknesses in both the economy and the reform program that should not be overlooked. The country remains one of the poorest in Asia, with per capita GNP below US$200 in 1993. Concerning the reform program, Viet Nam is moving from the relatively easy price liberalization measures to more difficult structural reforms, such as restructuring state-owned banks, privatizing public firms, and streamlining the trade regime. Furthermore, fiscal restraint during 1990-91 was to some extent the result of holding down all expenditures rather than making choices among public services. With improved revenue and greater access to international finance, all of these expenditure categories have grown, leading to a reemergence of fiscal problems. Both the fiscal and external deficits grew alarmingly in 1993. Tighter fiscal and monetary policies were introduced in 1994 to deal with the emerging macroeconomic problems, and these policies will need to be maintained in order to ensure that the economy remains on a stable growth path. 3. Viet Nam's macroeconomic management was good during a period of austerity. This belt tightening yielded results and put the country in a good position to shift from adjustment to growth. The country is fortunate to have a substantial volume of foreign resources - both private investment and ODA - available to support its development. These resources provide both an opportunity and a challenge to Viet Nam. The foreign resources have the potential to make the economy's development more rapid. Managing both the macroeconomic and microeconomic impact of these resources, however, will be a new challenge for the government, and for the larger society. 4. This economic report reviews developments with Viet Nam's economy and reform program during 1993-94 and assesses the economy's prospects for growth in the medium term. While foreign resources can assist the country's development, sustained growth will depend primarily on Viet Nam's own ability to generate savings to finance investment. Thus, the report focuses on a number of strategic choices that policy-makers face as they try to strengthen both public and private savings and to spur the economy's development. A unifying theme of the report is that many of these choices involve the issue of centralization versus decentralization. In many ways decision-making in Viet Nam remains highly centralized. This system is working fairly well at the moment. However, the economy right now is quite a simple one. There are only a few important imports, a small number of major foreign investment projects underway, and a handful of aid projects being implemented. - 11 - 5. If Viet Nam makes full use of the domestic and foreign resources available for development, then the complexity of the economy will grow very rapidly. The number of important exports and imports will multiply, and hundreds of large investment projects could be implemented simultaneously. In this case, the current, highly centralized decision-making will inevitably become a severe bottleneck for development. Thus. the most important strategic choice that the government faces is whether to give uD some control and to decentralize decision-making in return for a faster pace of development. Decentralization would have other benefits as well. The current system is not only a growing bottleneck, but also by extension a breeding ground for corruption, because corruption is one way to move decisions through the bureaucracy. 6. The general tension between centralization and decentralization can be seen in a number of specific areas: * the respective roles of central and local authorities in raising revenue, planning public expenditure, and regulating the economy; * ongoing efforts by the government to allocate credit through the commercial banks; 3 the complex system for managing imports through permits, licenses, and tariffs; and e cumbersome procedures for licensing foreign investment. These are the main topics covered by the report. The conclusion of the analysis is that in each area Viet Nam would be well served by introducing greater decentralization. In the fiscal area, this means clearly assigning some revenues and expenditures to local levels. For the banking system and the regime for foreign trade and investment, this means accelerating the liberalization of the economy and shifting the government's focus from control to pmotion. In other words, instead of trying to control all of the decisions, the government should concentrate on establishing an incentive regime that promotes efficient decisions by households and firms. 7. These ideas are not new in Viet Nam. The government is already moving in these policy areas. Nevertheless, the issues of decentralization and liberalization remain controversial, and progress is at best gradual. The main purpose of the report is to contribute to this policy dialogue in Viet Nam by analyzing the benefits that a strategic shift from control to promotion would yield, and by malking specific recommendations for reforms that would realize these benefits. 8. One of the reasons why decentralization and liberalization remain controversial in Viet Nam is that the government is very concerned about regional inequalities. The report examines this issue in several ways. First, it reports major results from a representative household survey carried out by the govermnent with technical assistance from the World Bank and financing from UNDP and SIDA. This survey yields up-to-date information on poverty and income distribution in Viet Nam. Second, the report analyzes how government expenditures and policies can be used to promote relatively balanced growth throughout the country, in order to bring about a more rapid reduction in poverty. - iii - Macroeconomic Performance 9. On the surface Viet Nam's macroeconomic performance was good in 1993, with robust growth of 8.1% and a decline in consumer inflation to 5.2%. There were some underlying problems, however, that required corrective actions early in 1994. The fiscal deficit increased significantly, to 6.2% of GDP, a level that the government had difficulty financing. On the monetary side, domestic credit increased by nearly 60%. This rapid expansion of credit did not lead to immediate inflation because it financed a surge of imports. However, the level of the resulting trade deficit - as well as the level of the fiscal deficit - was not sustainable. 10. Viet Nam went through a period of austerity in 1990-91, during which time its current account deficit declined to virtually zero: in other words, no foreign resources were available to the country. The situation has changed dramatically in the past two years, and there are now large commitments for direct investment projects and for aid-financed infrastructure projects. Relatively little of this potential funding actually disbursed in 1993, however. Disbursements of concessional loans, for example, were less than US$250 million. The government in the meantime increased its expenditure, mostly on infrastructure and social spending, but did not have adequate financing for these expenses. A major part of its problem was that it misjudged the amount of aid money that would actually disburse, and then had to rely on commercial sources to fund its deficit. In the monetary area, the State Bank allowed rapid growth of credit to producers, who in turn purchased imports. There were not adequate extemal flows to cover the resulting deficit, however, with the result that it was paid for by a drawdown in gross reserves of the banking system - something that can be done only once. Thus, the financing for both the fiscal deficit and the extemal deficit in 1993 was precarious. 11. Viet Nam can look ahead several years to a time when inflows of direct investment and ODA could contribute very substantial financing for development, provided the macroeconomy continues to be well managed. Through its fiscal and monetary policies, however, the government tried to push rapid expansion in advance of this financing. This expansionary policy threatened to reignite inflation. Early in 1994 the government moved to strengthen its macroeconomic policies. It restrained the growth of public expenditure and tailored its deficit to match the availability of concessional ODA; and it limited the expansion of domestic credit through bank-by-bank credit ceilings, higher interest rates on refinancing and on foreign currency loans, and stricter reserve requirements. This adjustment program yielded quick results. The fiscal deficit is projected to be sharply lower in 1994, less than 3% of GDP. Credit growth also decelerated. And the external deficit is projected to decline to about 5% of GDP, a level that can be sustained over the medium term. The sound macroeconomic policies created a favorable environment for growth, which accelerated to an 8.7% rate. 12. Investment and savings. One of the most positive macroeconomic developments for Viet Nam in 1993 was the large increase in investment, a growth of 41% in current prices and 32% in constant prices. As a result, the investment rate has increased from 15.1% of GDP in 1991 to 19.4% in 1993. The increased investment in 1993 came both from budgetary investment in infrastructure and from investment in commercial activities. The public investment program has rebounded from a low of 2.8% of GDP in 1991 to 7.0% in 1993. The other 12.4% of GDP in investment last year came from autonomous state enterprises, joint ventures between the public and private sectors, and private firms and households. The division between the public and private sectors in Viet Nam is not always clear, so that it is difficult to determine the extent of purely private investment in the economy. - iv - 13. While the increase in investment in 1993 was positive, developments in the area of savings were not encouraging. The increase in national savings has been one of the most important achievements during Viet Nam's reform program. In the revised national accounts, savings are estimated to have increased from 3.2% of GDP in 1989 to 16.3% in 1992. This development confirms that households have the same strong predilection to save that is observed throughout East Asia. Stabilization of the economy, strengthening of property rights, and improvements in the banking system combined to bring forth these savings and to channel them to productive uses. In 1993, however, national savings declined to 11.2% of GDP. Of this five point decline in the savings rate, about one-fourth can be attributed to a decline in government savings and three-fourths to a decline in savings outside of the government sector. Reversing this decline is an immediate and important task for economic policy that will require actions both on the government budget and on the incentives that encourage households and firms to save and invest. Strengthened fiscal and monetary policies in 1994 have already made a contribution, with domestic savings projected to rise to 15% of GDP for the year. 14. Budget developments. Viet Nam's budgetary situation in 1993 was characterized by sharp increases in both revenue and expenditure and by an expansion of the fiscal deficit. Revenue mobilization by the government has been a notable area of success during Viet Nam's adjustment program. Total revenue increased to 22.3% of GDP in 1993 and a projected 25.4% of GDP in 1994, up more than 10 points of GDP since 1991. Revenue increases of this magnitude are unusual. In fact, the experience of other countries shows that such large increases are often followed by some downward adjustment in future years. Hence, the government should be cautious in its fiscal planning and not assume that further large gains will be forthcoming. 15. While Viet Nam's tax reform has been successful in raising revenue, it has made less progress with other goals, in particular, reducing distortions. The focus of tax reform now needs to shift toward making the tax code more neutral in its effect on incentives. The turnover tax, for example, creates poor incentives because of its cascading effect on producers. The government is planning a comprehensive and phased reform of its overall tax system. It will first simplify the turnover tax by reducing the number of rates, and eventually replace it with the less distorting value added tax. As part of its tax reform the government will consider modifications to the profit tax as well. This tax is very high and is an impediment to firms reinvesting their earnings. The tariff code also needs to be reformed. It too has a wide range of rates, creating poor incentives and difficulties for administration. 16. Turning to the expenditure side of the budget, during 1990-91 the government reduced its spending as part of the campaign to halt high inflation. During this austerity period a number of adjustments were made that should help the long-term growth of the economy. The military was reduced in size, with about half a million soldiers demobilized. Subsidies to state enterprises were curtailed, which had a positive effect on their productivity. The austerity, however, also made it difficult for the government to supply a range of important services that are needed for the economy and the society to develop. Investment in infrastructure, for example, declined to a very low level, and there were problems with the delivery of social services as real civil service salaries declined in the face of inflation. 17. The government has moved in the past two years to turn this situation around and to increase its development expenditure. While these investments in infrastructure and human resources are necessary in the medium term, the rate of growth of government spending was too rapid in 1993. Real government spending essentially doubled between 1991 and 1993. That rate of growth threatened macroeconomic stability, and in 1994 the government had to modify its spending plans in order to bring - v - its deficit under control. Viet Nam is a poor country that clearly has a lot of needs, but they cannot all be met at once. One of the main messages of this report is that the government must carefully set priorities and manage its expenditures. 18. The fiscal deficit was a problem in 1993 because it was large relative to low-cost sources of financing. Reducing the fiscal deficit was at the heart of Viet Nam's disinflation program in 1990 and 1991, during which time the deficit was reduced to 3.8% of GDP. Starting from that point, it made sense for the government to allow the deficit to gradually expand as aid resources became available. The returns to public infrastructure projects in Viet Nam are very high, and deficit financing is a sensible strategy as long as the government controls its debt in light of its servicing capacity. 19. Expenditure increased too rapidly in 1993, however, opening up a deficit that the government had difficulty funding. The deficit was equivalent to about US$800 million. The net flow of concessional loans, on the other hand, was quite small, creating a serious financing problem for the government. To its credit, the government did not resort to inflationary sources of finance. It did, however, borrow significant amounts from domestic and international commercial sources at high interest rates. This high-cost borrowing will impose substantial interest costs on the budget in the future. 20. The initial 1994 budget had similar problems, projecting a large increase in expenditure and optimistic forecasts of ODA disbursements. During the year, however, the government adjusted the budget several times, as it became clear that the ODA inflow for the year would be quite low, including only about US$200 million in concessional loan disbursements. The government introduced tax and expenditure measures that resulted in a decline in the fiscal deficit to a projected 2.7% of GDP. As a result of these strong measures the government did not need to rely excessively on the domestic banking system or international commercial borrowing. To keep its fiscal house in order the government of Viet Nam needs to do a better job of managing its expenditures and controlling its deficit. The expanding ODA commitments from multilateral and bilateral donors should lead to growing concessional inflows. The government needs to plan carefully the priority projects to be financed from ODA and to move quickly to implement these projects. This strategy would allow the fiscal deficit to expand modestly as ODA disbursements increase. It is recommended that the government manage its deficit to match the financing available from concessional loans, plus a small amount of domestic borrowing. The government has begun selling treasury bills, which is useful for the development of domestic capital markets. It would be prudent, however, to rely to only a small extent on the issuance of T-bills for financing, as domestic interest rates remain quite high. 21. Monetary developments. Notwithstanding a surge in credit, which helped to underwrite the strong growth noted above, in 1993 Viet Nam achieved one of the best performances among transitional economies with respect to inflation reduction. An important task for the authorities is to consolidate these gains and to develop the monetary policy instruments that will permit effective control of inflationary forces. The sharp deceleration of inflation, to 5.2% in 1993, appears somewhat paradoxical in the face of the rapid growth of money and credit. Domestic credit rose 58.7%, led by a near tripling of credit to the non-state sector. Several factors appear to have helped reduce inflationary forces. First, the authorities liberalized imports, as witnessed by the running down of foreign exchange reserves, thereby providing increased competition and a safety valve for demand pressures. Second, with a large part of the population in agriculture, Viet Nam faces a more elastic supply of labor to the rest of the economy in comparison with other transition economies, where a larger percentage of workers are in heavily subsidized jobs in industry and hence have little desire to seek other employment. - vi - 22. The State Bank's tools for controlling inflation have been central bank refinancing, interest rates on refinancing and on deposits and loans, and reserve requirements. In early 1994 the State Bank moved to slow down the growth of credit, as some of the above factors cannot be depended on to continue to hold down inflation, and also as part of the program with the IMF. The State Bank put in place bank-by-bank credit ceilings as a temporary measure for achieving global credit targets. This tool is highly effective for implementing monetary policy in the short term, but ultimately leads to disintermediation of the formal financial sector if maintained too long. Within the next few years these individual bank credit ceilings should be replaced by auctions of refinancing lines and deposits at the central bank, and then by the use of repurchase agreements. Although the authorities are interested in developing primary and secondary treasury markets so as to permit open market operations, even most developed countries have markets of insufficient depth for this purpose and instead prefer the use of repurchase agreements. Before this development of instruments can be fully effective, however, the State Bank needs to move as rapidly as possible to improve the payments system and to encourage the greater use of dng-denominated payments instruments. Additionally, insuring the soundness of individual banks will increase their willingness to trade with one another, a prerequisite to indirect methods of monetary policy implementation. 23. Balance of payments and the exchange rate. Viet Nam's balance of payments situation in 1993 was characterized by an extraordinary surge in imports, which grew by 46.4% in constant prices. To some extent these imports were financed by the increasing flows of direct foreign investment and private remittances and should be viewed as a positive sign of improving confidence in the economic situation. The rapid growth in imports was also positive in that it reflected continued trade liberalization moves on the part of the government. The magnitude of the increase, however, was alarmingly high. This excessive growth of imports was fueled by the easy credit policies of the State Bank and by the increase in government expenditure, including capital projects financed by commercial overseas borrowing. As a result, the current account went from near balance in 1992 to a deficit of US$ 1.1 billion (8.3% of GDP) in 1993. The corrections in macroeconomic policies in early 1994 - in the direction of tighter fiscal and monetary policies - resulted in a slowdown in the growth rate of imports to 12.6%. At the same time, sound macroeconomic policies and strengthened incentives for exporters led to an acceleration of the growth rate of exports from 12.4% in 1993 to 23.3% in 1994. Thus, the external deficit is projected to decline to about 5% of GDP in 1994, a level that can be sustained over the medium term. 24. The govermnent's exchange rate management has been fairly good. Producers can buy foreign exchange easily from commercial banks to finance current account transactions. The official rate is set through foreign exchange trading floors and deviates little from the parallel rate. The exchange rate has been remarkably stable for about two years now, in the range of 10,500-11,000 do per U.S. dollar. The net interventions of the State Bank in the foreign exchange market have not been large. Nevertheless, in the second half of 1993 the State Bank sold foreign exchange to support the dng. This policy is not recommended for two reasons. First, official reserves are quite low, so that net selling cannot go very far before the government will run out of reserves. Second, given the moderate inflation of the past two years, intervention to stabilize the nominal exchange rate resulted in appreciation of the real exchange rate. This was probably one factor limiting the competitiveness of Viet Nam's exports in 1993. If there is pressure toward devaluation in the foreign exchange market, then the State Bank should allow this depreciation to occur, intervening only to smooth out movements. Stability in the exchange rate is desirable, but should be pursued through macroeconomic tools, not through intervention. In - vii - particular, the growth rate of domestic credit will have to be controlled more carefully if stability of the exchange rate is to be achieved. Growth Prospects and Financing Requirements 25. On the surface Viet Nam's macroeconomic performance was good in 1993. But, a look below the surface revealed a number of disturbing developments. Government expenditure rose at a rapid rate, and most of this was for recurrent items, not investment. As a result of the increase in spending, the government had a deficit that it had difficulty financing. There was also a large increase in the external deficit: some of this financed investment, but much of it financed consumption. The decline in national savings from 1992 to 1993 was a major concern for the government. 26. Viet Nam still has good growth prospects, but it needs to make some adjustments in its policies if it is to realize its potential. The fundamental problem is that the government is still trying to do too much. This can be seen at the macro level in excessive government expenditure that threatens macroeconomic stability; at the micro level the public sector is crowding the private sector out of a range of activities that the private sector could well undertake. For Viet Nam to grow successfully, the government will need to focus its activities more sharply and to give greater scope to the private sector to expand. The more prudent fiscal policies introduced in 1994 are an important step in the right direction, but they need to be complemented by further structural reforms to improve the incentives for saving and investment. 27. The government's medium-term target for growth is 8%. The government would like to see the economy grow even more rapidly, in the 9-10% range, if that can be achieved without sacrificing macroeconomic stability. These growth targets are ambitious and will be a challenge to achieve. Viet Nam has been able to grow at 8% for several years with only a moderate investment rate. There are three factors that can explain this outcome. First, some large, fixed investments of the mid-1980s, in oil and hydropower, came on line in the early 1990s, so that some of the increments to GDP were based on these earlier investments. Second, the initial response of the economy to the removal of distortions - especially in services and in agriculture - permitted large increases in output based on only minor additional investments. Third, labor-intensive manufactures have been a leading sector, particularly in 1993-94, and this exploitation of comparative advantage is an efficient development strategy that requires relatively little investment. The first two of these factors are clearly temporary; as their effects wear off, greater amounts of investment will be required to sustain the growth rate. The third factor - exploiting comparative advantage in labor-intensive industries - is more permanent. The experience of the successful East Asian Newly Industrialized Economies has shown that export-oriented industrialization is an efficient strategy that generates a relatively large amount of output from a given level of investment. 28. The report examines a number of growth scenarios for Viet Nam, assuming that the investment rate required to generate a given rate of growth gradually increases. To maintain growth in the 8% range, the investment rate in these projections rises from 20% of GDP in 1994 to 26% by 1999. To meet this goal would require a significant increase in domestic savings. The projections here hold the current account deficit to the 5-6% of GDP range, a level that can be financed from reliable sources, notably direct foreign investment and official development assistance. Given this inflow of foreign savings, sustained 8% growth would require an increase in the national savings rate from 15% of GDP in 1994 to 20% by 1999. A second scenario indicates the likely outcome if the savings rate does not rise so dramatically: in this case the growth rate of GDP decelerates to 6.0% by the end of the decade. - viii - 29. Thus, at the heart of a high-growth scenario for Viet Nam is the need for a significant expansion of domestic savings. The government can contribute to this directly by building up its own savings, which were less than 1% of GDP in 1993. Government revenue is already large relative to GDP. As high tax rates distort investment, production, and consumption decisions, further increases in revenue should be pursued cautiously. For this reason a strategy to improve government savings must include expenditure restraint. In order to meet its savings target the government will have to carefully set priorities and reallocate spending away from inefficient uses. 30. There is clearly great potential to increase the savings of households and firms. High private savings have been one of the keys to rapid growth throughout East Asia, and increasing private savings in Viet Nam will be necessary to sustain a high growth rate. Households have substantial liquid savings, but these funds are not channeled to a sufficient extent into productive investment. That the national savings rate declined during a year in which the economy was growing well is a disturbing sign, indicating that there are substantial problems with the incentive regime for savings and investment. Thus, the strengthening of incentives - through further reforms of legal infrastructure, the financial system, and the regime for foreign trade and investment - is another crucial part of the reform agenda. 31. Financing requirefnents. While increases in public and private savings in Viet Nam will be the primary sources of financing for new investment, the economy will also require greater inflows of foreign savings if high growth is to be sustained. Direct foreign investment could provide a growing source of financing, and measures to improve the environment for foreign investment are discussed below. Viet Nam also needs an expanding volume of aid flows to assist with financing economic and social infrastructure. Significant commitments have already been made, and the government should move quickly to implement these projects and to accelerate disbursements. The early experience with project implementation reveals that aid management procedures are cumbersome and need to be streamlined if a large investment program is to be realized. At the same time, there is a need for further commitments from donors, as well as for a better mix between quick-disbursing program loans and project commitments. The requirement for quick-disbursing support in 1995 is about US$400 million. IMF resources and an IDA structural adjustment credit should provide the bulk of the necessary financing. In addition to multilateral sources, about US$120 million of quick-disbursing financing from bilateral donors is required for 1995. The planned Consultative Group meeting in November 1994 will provide an opportunity to solicit these quick-disbursing funds to cover the gap in 1995. In addition, it will take new project commitments of around US$1.5 billion annually in order to gradually build up disbursements to levels that would meet Viet Nam's financing requirements for the medium term. Public Sector Management 32. Viet Nam will grow more successfully if it can establish an efficient division of labor between the public and private sectors. The resources that the government has at its disposal are limited. Therefore, it must target its expenditures carefully to priority public services. The private sector can be counted on to invest and produce in a wide range of sectors, provided an appropriate incentive framework is in place. There are other services, however, that the private sector cannot or will not produce in adequate amounts. Development will be more rapid if the government f-cuses its expenditure on these services, most of which fall into the broad categories of infrastructure an, uman resource development, and leaves other activities to the private sector. - ix - 33. Budget mnagement. A first important issue of public sector management in Viet Nam concerns the budget, specifically (1) the process of preparing and managing the budget, and (2) the current pattern of government expenditure. Studies of goverment expenditure in different sectors have revealed that efficiency of expenditure is currently low. In the transport sector, for example, the govermnent is planning major new investments, while at the same time not providing adequate resources for operations and maintenance (O&M) of existing infrastructure. Infrastructure bottlenecks are universally acknowledged as a key problem holding back the development of the economy. Sufficient expenditure on O&M is more important than construction of new facilities for two reasons: (1) it is the only measure that would improve the infrastructure situation immediately and (2) without it, construction of new facilities will not be efficient, as they will not be properly utilized. 34. The imbalance between capital and O&M funding is just one example of inefficiency in public expenditure. In order to improve the effectiveness of government spending more broadly, Viet Nam needs to reform the institutions and procedures for preparing and managing the budget. In the process, it will be important to increase the transparency of the budget. It is difficult to make specific recommendations to improve the efficiency of expenditure because the budget lacks sufficient detail. The government needs to introduce a proper economic and functional classification of expenditures. This wIll set the stage for conducting a thorough Public Expenditure Review to analyze the effectiveness of different programs in meeting their objectives. On the basis of this review the govermnent will be able to identify inefficient programs that can be cut. 35. An important factor contributing to inefficiency in public expenditure is that the fiscal system is overly centralized. The central government attempts to control the details of spending at all levels of government, which is neither practical nor efficient. The proposed enactment of an organic budget law next year provides the opportunity to introduce more efficient decentralization. It is recommended that responsibility for basic education and health be assigned to the local level. The central government can ensure that all provinces have sufficient resources for these expenditures through specific-purpose transfers. It is further recommended that local government be given more discretion over the expenditures assigned to them and a more stable revenue base to finance these expenditures. Tax-sharing rules should replace the current system of annual revenue negotiations with the center. In the longer term, Viet Nam should consider introducing even greater decentralization, allowing localities to raise some revenue through their own taxes. A system of general-purpose transfers can be used to ensure that poor provinces have adequate resources to meet their expenditure needs. 36. Publc investment program. The increased level of domestic and external resources has enabled the government to expand its investment program, which is now targeted to economic and social infrastructure. An important reform in recent years has been to remove from the capital budget support for commercial firms in cement, power, and other sectors that can finance their investment through borrowing. While the general focus of the capital budget is appropriate, the system for preparing the investment budget needs to be improved. Criteria for project selection are not clear, planning is not done on a multi-year basis, and investments have been chosen without adequate concern for the related implications for the recurrent budget. To ensure that resources are allocated to priority investments, the government should prepare a multi-year public investment program (PIP) that looks beyond the annual budget horizon. The PIP should establish priorities among investment proposals by developing procedures and strict criteria for selecting projects. In general, efficient public investments are those that are complementary to private sector development and situated in a well-defined sectoral strategy. The sectoral strategies in turn should be developed primarily on the basis of the economic rates of return to - x - different potential investments. The PIP should be closely linked to the budget to ensure that it is realistic in terms of (1) domestic and extenal resources available for the investment budget and (2) the provision of funds in the recurrent budget to finance related operating and maintenance costs. 37. State enterprise reform. The effort to sharpen the focus of public expenditure needs to be complemented by a thorough program of state enterprise reform. A large number of state-owned firms produce goods and services that could be provided by the private sector. Public support for these enterprises is thus inefficient. The government should concentrate its financial support on a small number of strategic firms producing public services, such as power and water. It is recommended that the government plan to gradually divest the other, non-strategic enterprises. 38. The government has introduced an initial set of measures to harden budget constraints of public firms, including the elimination of subsidies from the budget, interest rate reforms that reduced implicit subsidies through the banking system, and the principle of equal taxation of state and private firms. These policies led to a rationalization of the sector, and several thousand loss-making firms were liquidated. Now that most loss-making firms have been closed, the immediate issue on the state enterprise reform agenda is to create a level playing field between public and private firms in the competitive sectors. This would set the stage for privatization of state firms. An important step toward creation of a level playing field was the passage of the bankruptcy law, applicable to both state and private firms. 39. For non-strategic firms, it is recommended that the company law be amended to enable state enterprises to reorganize as single shareholder companies, placing them under the same legal framework as private companies. The process of reorganizing non-strategic firms as companies should take about two years. To manage that process and to manage the government's shares in these companies, a ministry-level agency or holding company should be established. As a result of this change, the state's ownership in these firms would no longer be exercised by line ministries. These reforms would enable the government to accelerate the completion of its pilot program of 'equitization," in which shares of enterprises are sold to workers and the general public, and to prepare a broader program of privatization. 40. Concerning strategic firms, the government plans to submit to the National Assembly during 1995 a state enterprise law to stipulate the management and operational structure of these firms and to specify how the government will exercise ownership rights in them. In the meantime the government should improve the accounting, auditing, and monitoring of these firms, concentrating initially on the largest firms, many of which will eventually be classified in the 'strategic' category. The creation of a general department of state enterprises within the Ministry of Finance in early 1995 should facilitate this task. 41. The reform of the Public Investment Program can be an important support to these state enterprise reforms. Public investment in state enterprises, through the budget or through subsidized or guaranteed loans, should be restricted to firms providing important public services. The shareholding companies fully or partially owned by the government should find their own investment funds without government support or guarantees. - xi - Incentives for Saving and Investment 42. Viet Nam is in transition from a system of central planning to a market economy. In a centrally planned system the government tries to manage all production and investment decisions. In a market economy, on the other hand, the role of the state is more focused. The government must provide a range of services that cannot be provided by private firms or that are not likely to be provided in adequate amount by private firms. Other goods and services can be produced by the private sector in a market economy. In these sectors, however, the state still has an indirect role, namely to provide an efficient overall incentive framework for saving, investment, and production by households and firms. 43. Legal reform. At the heart of the incentive regime is the legal system, which protects property rights and regulates commercial transactions. The government has recognized that a successful transition to a market economy requires the development of an appropriate legal framework, which will inevitably take some years to complete. The gradual process of putting into place the necessary elements of such a system has included a new constitution and the enactment of legislation in the areas of contract, company, land, and bankruptcy law. That process is now accelerating with the enactment in June 1994 of a labor code to protect employees and employers alike as the labor market develops and a domestic investment promotion law to provide incentives for the domestic private sector comparable to those for foreign investors. The legislative agenda for the 1995-96 period includes a basic civil code as the legal foundation for the system as whole and a commercial law to facilitate business activity, as well as the implementing legislation needed to give full play to the land and bankruptcy laws enacted in 1993. Amendments in the company law and the enactment of a state enterprise law as part of the State Enterprise Reform Program would strengthen the legal basis for competition between public and private firms. 44. Importantly, a major transformation is underway this year in the mechanism for the settlement of economic disputes, which is central to the effectiveness of the legal framework. The people's courts at the national and provincial levels established economic courts in July 1994 to adjudicate economic disputes and exercise functions under the bankruptcy law. These developments highlight the need for training of legal personnel to staff these new functions as well as for the strengthening of Viet Nam's growing legal profession. A number of technical assistance programs are starting up in Viet Nam which are intended to assist both in the preparation of legislation and in the training of legal professionals. 45. Flnancal sector. The financial sector can play a key role in spurring savings and investment, but the sector's ability to mobilize savings and finance investment is currently limited by several problems. These weaknesses include bad debts in the state-owned commercial banks that threaten the solvency of the system; poor accounting and management practices in these banks; and high taxation of intermediation which discourages expansion, especially of new banks. In addition, a poor check- clearing system and shortages of large denomination notes discourage use of domestic currency. As a result, 'dollarization' of the economy is a problem. 46. The four state-owned commercial banks inherited a significant amount of bad debt when they were separated from the State Bank. More importantly, it is not clear what the quality of recent lending is as supervision of banks is weak. The capacity of both the central bank and the state-owned commercial banks is currently being strengthened through technical assistance from the Fund, the Bank, ADB, and bilateral donors. An important complement to this work is determining the exact scope of the non- performing loans in the banks' balance sheets, which would require independent portfolio audits. These - xii - audits would set the stage for a program to clean up the bad debts and to ensure that banks are adequately capitalized. In order to minimize the fiscal cost of such a program and to increase competition in the sector, it is recommended that this program include at least partial privatization of the statowned banks. 47. One of the most positive features of Viet Nam's financial sector reform has been the entry of about 60 new banks, mostly private, both domestic and foreign. This entry has the potential to create a vibrant banking sector. The expansion of these banks is hampered, however, by high taxation, especially the turnover tax assessed on banks' net interest income. This tax in practice discriminates against newly established banks because they have little deposit base and initially fund their lending primarily by equity. Thus, they have interest income but little interest cost, so that the effective tax rate is extremely high. This burden is passed on to borrowers in the form of high interest rates and discourages the expansion of the private banking sector. It is recommended that banks be exempt from the turnover tax in order to improve the incentives for commercial banks to expand their operations. 48. By reducing inflation the authorities have taken the hardest steps to encourage resource mobilization. They should now introduce other measures to encourage the use of domestic currency and deposits, specifically an increased supply of larger denomination notes - of course draining an equal amount of smaller value notes - and an improved check clearing system. The State Bank must make it attractive for firms and households to use dng-denominated instruments if 'dollarization' is to be reduced. 49. Foreign trade policy. The experience of successful economies in the region has demonstrated the importance of openness to the international market in order to spur efficiency and growth. Liberalization of foreign trade is thus a key element of a successful program to strengthen incentives and to improve the enabling environment for the private sector. The government has removed nearly all quantitative restrictions and replaced them with tariffs. Furthermore, the system of export and import permits and licenses has been gradually liberalized, with the result that the private sector - especially in manufacturing - now has better access to foreign trade. A number of concrete liberalization measures were introduced in 1994, including elimination of shipment licenses for exports. The government is exploring the possibility of joining GATT and recognizes that remaining impediments to imports will have to be largely removed before it can do so. Thus, the program of reducing administrative barriers to trade will continue, with plans for phasing out shipment licenses for imports during 1995-96. 50. An important remaining barrier is the use of permits to manage imports of 15 major commodities. These permits are used to meet two objectives that could be better pursued through other instruments. In the case of key inputs such as fertilizer and cement, the permits are used flexibly with the objective of ensuring adequate supplies to the economy. It is recommended that these permits be replaced with a system of monitoring inflows and publishing timely information, so that trading companies can respond quickly and efficiently to incipient shortages. For consumer items such as refrigerators, the import permits are used to control consumption. It is recommended that these permits be replaced by special excise taxes. An import barrier is the wrong instrument here, as it encourages inefficient production. 51. In addition to administrative barriers, another sig-ificant trade distortion is the tariff code. Viet Nam's current code differs significantly from those in p-ze in leading exporting countries. It is very complex, containing a large number of rates from 0% to 200%. Furthermore, rates have been - xiii - frequently changed. The tariff code should be revised as a matter of urgent priority. The objective in the medium term should be a tariff code with a small number of rates, and a maximum rate no higher than 30%. As an interim step the government may want to make a less drastic change. A realistic first step would be to lower the top rate to 60%. However, it is important to announce now that the ultimate goal is to reduce dispersion of effective protection to very low levels, so that producers will make efficient investment decisions. 52. Foreign investment. In the area of foreign investment, the government has likewise made substantial progress in liberalization, but significant impediments remain in place. Cumbersome procedures and bureaucratic requirements for the negotiation of contracts, issuance of related licenses, and implementation of projects are singled out by most investors as major problems in this area. The government has already taken some measures to reduce these bottlenecks. In addition, the following measures to streamline the investment process are recommended: (1) decentralization of issuance of licenses for small projects to provinces or regional SCCI offices; (2) reduction in the number of agencies and levels of government involved in the license approval process and in the issuance of other permits required to undertake the investment; and (3) elimination of the requirement for feasibility studies, at least for small projects. 53. Foreign investors face significant difficulties in securing land use rights and are further hampered by the inability to mortgage these rights. This situation would be improved by the organization of land use right auctions (open to foreign as well as domestic investors). In addition, regulations concerning foreigners' use of land are expected to be issued by end-1994, and it is important that these regulations allow foreigners to mortgage and transfer land use rights. 54. The government realizes that Viet Nam's continued growth will depend to a large extent on the development of supporting infrastructure. State enterprises in the power, telecommunication, and transport sectors have not been able to finance all of the infrastructure investment required to sustain the economy's robust growth. Thus, the government intends to invite the private sector, including foreign investors, to complement public investment in these critical sectors. The government is in the process of studying how some of these sectors or parts thereof could best be opened to competition. Povert Reduction 55. Viet Nam embarked on its economic reform program with the primary objective of raising general living standards. In order to pave the way for long-term gains in per capita incomes, the government initiated a thorough structural adjustment program. Unlike the populations of many other transition economies undergoing market reforms, the majority of the Vietnamese people benefited immediately from the change in policies: with 80% of households engaged in agricultural activities, decollectivization and price liberalization resulted in higher incomes and improved living standards for most of the population. Despite strong gains in per capita income in recent years, however, Viet Nam remains a very poor country. 56. Poverty profile. The recently completed Viet Nam Living Standards Survey (VNLSS) highlights three important features of poverty in Viet Nam: * The overall incidence of poverty is extremely high; the consumption level of 51% of the population is below a widely used international poverty line. Even in the relatively - xiv - prosperous Mekong Delta, half the population survive at per capita consumption levels below this poverty line. * There are significant regional disparities in living standards throughout the country. Poverty incidence ranges from 33% in the southeast to 71% on the north central coast. * Rural areas throughout the country are much poorer than urban areas (i.e., 57% rural poverty incidence versus 26% urban). Rural poverty accounts for 90% of the poor. Poverty incidence figures are much higher in Viet Nam than in China (9%), Indonesia (15%), or Thailand (16%). Twenty or 30 years ago, these countries had poverty rates similar to Viet Nam's current level of about 50%. Several decades of rapid growth, however, have resulted in sharp declines in the proportion of their populations living below the poverty line. 57. Although Viet Nam's consumption based poverty rate is very high, other important welfare indicators such as education and health status are much better than in many other low-income countries. Viet Nam's literacy rate is a remarkable 88%, a rate comparable to countries with five times the per capita GNP of Viet Nam. Under five mortality is about one-third that of other low-income countries, and life expectancy is 67 years. Malnutrition rates, on the other hand, are very high with almost half the children under age five stunted; this is reflected in the consumption based measure used to form the poverty line. 58. Although Viet Nam has a high incidence of poverty, the distribution of income is relatively equitable. The gini coefficient, which measures the degree of income inequality, is 36%. This places Viet Nam among the more equitable of East Asian countries. Recent gini coefficients for other countries in the region, for example, are 33% in Indonesia, 36% in China, 41% in the Philippines, 43% in Thailand, and 48% in Malaysia. Inequality in countries in other regions of the world is even higher, with gini coefficients as high as 59% in some Latin American countries. 59. While Viet Nam began its transition to a market economy with a relatively equal distribution of income, a disturbing development in the past few years is that growth rates of different regions of the country have varied enormously. Furthermore, there is a clear pattern in which relatively poor areas are growing slowly. The two poorest regions, the north central coast and the north mountains, are growing at about 3% per year, whereas the prosperous southeast is expanding at the annual rate of 15%. 60. Results of simulations illustrate how growth will impact on poverty reduction in Viet Nam. If Viet Nam achieves its targeted 8% annual growth rate and if the unequal growth rates of different regions continue throughout this decade, the national incidence of poverty would decline to 29% by the year 2000. If growth were more balanced and reached 8% in each region of the country, on the other hand, then the poverty rate would decline more rapidly, to 23% by 2000. Of course, the extent of redistribution required to achieve 8% growth in all regions of the country could well result in a lower aggregate rate of growth. This trade-off between equity and growth is complicated, and ultimately decisions depend on social preferences and political pressures. Nevertheless, this simulation illustrates an important point about growth and poverty reduction in Viet Nam. The vastly different growth rates among regions result in significantly lower poverty reduction, than if growth were more evenly spread throughout the country. Poverty reduction will be quicker if regional growth is more evenly distributed. Finally, under a scenario in which the economy grows more slowly, at 6% per year, 35% of the - xv - population would still be poor in the year 2000. Thus, the country's success in reducing poverty will depend on (1) the overall growth rate and (2) the extent to which growth is balanced among regions. 61. Policies and programs to reduce poverty. The government can have a strong impact on the extent to which poor households participate in growth through its expenditures and policies. A number of public services are strongly pro-poor in the sense that poor households benefit disproportionately from these services, which in turn enable households to increase their income and rise out of poverty. Primary education and preventative health services are pro-poor in this way. 62. The central government in Viet Nam takes responsibility for financing and delivering these services. The service delivery system does not work well in practice, however, and results in underfunding in poor areas. As noted in the earlier discussion of the fiscal system, it is recommended that provision of basic education and health services be assigned to the local level. The central government can ensure universal provision of these key services through specific-purpose transfers to finance education and health. These transfers could take the form of matching grants that are progressive (i.e. require a higher contribution from wealthier provinces). 63. There are other important services that the government provides that will influence poverty reduction. One of the interesting results of the VNLSS is the extent to which household income - and hence the ability to rise out of poverty - is related to the existence of key infrastructure such as rural roads, inland waterways, and irrigation. In general, people who live near such infrastructure have higher living standards and have been better able to take advantage of the market reforms than those who do not. For example, the data show that those people living in communities located near an all-weather road (i.e. passable year round) have significantly higher per capita income than those not living near such a road. They are significantly more likely to have a permanent market located in their village; to engage in more than one economic activity; to leave the village to seek work; to sell agricultural surplus; and to be served by public transport. The VNLSS data indicate that each of these factors is significantly and positively correlated with living standards. 64. The provision of infrastructure through the PIP is another part of the budget that is overly centralized. All investment projects have to be approved by the center. In practice, local governments have a better appreciation of the infrastructure needs in their areas and should be allowed more discretion in determining expenditure priorities. In general, the centrally managed PIP should cover large projects whose benefits are national or regional. The criteria for selecting such projects should focus primarily on economic rate of return. The central government can help promote more balanced growth by ensuring that provinces have adequate resources from which to finance small-scale infrastructure projects at the local level. 65. Local governments should be provided with adequate resources and sufficient flexibility to address local needs. If rehabilitation of key infrastructure is a priority, local governments should be able to reallocate resources from elsewhere in their budget to focus on the item of urgency. The central government can enable provinces (particularly poorer provinces) to support their own investments and maintenance by allocating resources for investment and recurrent costs via a general grant. This grant can be distributed to provinces based on criteria such as population, per capita income, cost of delivering services, and local tax effort. By devolving more autonomy to local governments to support the investment and operation of infrastructure of local priority, efficiency of public expenditures would rise. Appropriate local infrastructure would enable households in these areas to participate more effectively - xvi - in the market economy. The data suggest that all factors of production would be used more efficiently and would generate higher household earnings if accompanied by adequate infrastructure. 66. The government can influence poverty reduction through its policies as well as its expenditures. Development of the financial system is particularly important to spur poverty reduction. As Viet Nam's poverty profile clearly indicates, the incidence of poverty is much higher in rural than in urban areas. Access to credit is a constraint to rural poverty alleviation. Owing to inadequate collateral and high transaction costs, poor households have traditionally lacked access to formal credit and have consequently relied on costly informal credit. Even with the heavy reliance on the informal sector, the credit gap in the rural sector is large and will likely remain that way until fundamental constraints are removed, competition is enhanced, and public confidence in the banking system is restored. 67. A system of rural credit delivery is continuing to evolve in Viet Nam from the old state bank structure towards a more diverse set of rural financing institutions. The Bank for Agriculture continues to play a major role in this changing structure, though several alternative private financia institutions have begun to emerge in rural Viet Nam. The strategy of the State Bank is to license new institutions that will supplement the efforts of the state banks. Foremost has been the replacement of the former rural credit cooperatives with private, rural shareholding banks and Popular Credit Funds during 1992-93. These new institutions face significant challenges; nevertheless, their emphasis on rural savings mobilization, outreach, lower transaction costs, and access of the poorer households offers important lessons for rural financial development. The Popular Credit Funds are an innovation which should be expanded to other provinces according to the plan of the State Bank. Conclusign 68. The key to sustaining a high growth rate in Viet Nam will be the expansion of domestic savings as a source of financing for growing investment. The government can contribute directly by carefully managing its expenditures so as to generate growing savings. The government has an important indirect role as well through its influence on the incentive regime for households and firms. Following up on the impressive reforms that have been implemented to date, further measures are required to develop legal infrastructure and the financial system and to liberalize foreign trade and investment. The rapid growth promoted by these reforms will result in a rapid increase in living standards and decline in poverty in Viet Nam, the ultimate objective of the renovation program. Poverty reduction can be accelerated through measures that encourage broad-based growth of rural and urban areas throughout the country. Fiscal reforms to ensure that important pro-poor services are well provided will be at the heart of an effective poverty alleviation strategy. I. MACROECONOMIC DEVELOPQfENIS A. Introduction 1.1 Viet Nam has been carrying out an ambitious adjustment and reform program since 1989 and is making a steady transition to a market economy. The country achieved some notable successes during the 1989-92 period, despite a lack of international financial support. Initial structural reforms included decollectivization of agriculture, price liberalization, unification and devaluation of the exchange rate, and hardening of the budget constraint for state enterprises. At the same time the fiscal deficit that was the root cause of inflation was reduced through a combination of tax reform, elimination of subsidies, and expenditure restraint. These reforms produced good results. Real GDP growth accelerated from 5- 6% in 1990-91 to 8% in 1992-93. At the same time inflation was brought down from 68% in 1991 to 18% in 1992 and 5% in 1993. 1.2 While Viet Nam's achievements are impressive, there are wealnesses in both the economy and the reform program that should not be overlooked. The country remains one of the poorest in Asia, with per capita GNP below US$200 in 1993. Concerning the reform program, Viet Nam is moving from the relatively easy price liberalization measures to more difficult structural reforms, such as restructuring state-owned banks, privatizing public firms, and streamlining the trade regime. Furthermore, fiscal restraint during 1990-91 was to some extent the result of holding down all expenditures rather than making choices among public services. With improved revenue and greater access to international finance, all of these expenditure categories have grown, leading to a reemergence of fiscal problems. Both the fiscal and external deficits grew alarmingly in 1993. Tighter fiscal and monetary policies were introduced in 1994 to deal with the emerging macroeconomic problems, and these policies will need to be maintained in order to ensure that the economy remains on a stable growth path. 1.3 Viet Nam's macroeconomic management was good during a period of austerity. This belt tightening yielded results and put the country in a good position to shift from adjustment to growth. The country is fortunate to have a substantial volume of foreign resources - both private investment and ODA - available to support its development. These resources provide both an opportunity and a challenge to Viet Nam. The foreign resources have the potential to make the economy's development more rapid. Managing both the macroeconomic and microeconomic impact of these resources, however, will be a new challenge for the government, and for the larger society. 1.4 This economic report reviews developments with Viet Nam's economy and reform program during 1993-94 and assesses the economy's prospects for growth in the medium term. While foreign resources can assist the country's development, sustained growth will depend primarily on Viet Nam's own ability to generate savings to finance investment. Thus, the report focuses on a number of strategic choices that policy-makers face as they try to strengthen both public and private savings and to spur the economy's development. A unifying theme of the report is that many of these choices involve the issue of centralization versus decentralization. In many ways decision-making in Viet Nam remains highly centralized. This system is working fairly well at the moment. However, the economy right now is quite a simple one. There are only a few important imports, a small number of major foreign investment projects underway, and a handful of aid projects being implemented. -2 - 1.5 If Viet Nam makes full use of the domestic and foreign resources available for development, then the complexity of the economy will grow very rapidly. The number of important exports and imports will multiply, and hundreds of large investment projects could be implemented simultaneously. In this case, the current, highly centralized decision-making will inevitably become a severe bottleneck for development. Thus. the most important strategic choice that the government faces is whether to give UD some control and to decentralize decision-making in return for a faster Race of development. Decentralization would have other benefits as well. The current system is not only a growing bottleneck, but also by extension a breeding ground for corruption, because corruption is one way to move decisions through the bureaucracy. 1.6 The general tension between centralization and decentralization can be seen in a number of specific areas: * the respective roles of central and local authorities in raising revenue, planning public expenditure, and regulating the economy; * ongoing efforts by the government to allocate credit through the commercial banks; e the complex system for managing imports through permits, licenses, and tariffs; and * cumbersome procedures for licensing foreign investment. These are the main topics covered by the report. The conclusion of the analysis is that in each area Viet Narn would be well served by introducing greater decentralization. In the fiscal area, this means clearly assigning some revenues and expenditures to local levels. For the banking system and the regime for foreign trade and investment, this means accelerating the liberalization of the economy and shifting the government's focus from control to promotion. In other words, instead of trying to control all of the decisions, the government should concentrate on establishing an incentive regime that promotes efficient decisions by households and firms. 1.7 These ideas are not new in Viet Nam. The government is already moving in these policy areas. Nevertheless, the issues of decentralization and liberalization remain controversial, and progress is at best gradual. Tne main purpose of the report is to contribute to this policy dialogue in Viet Nam by analyzing the benefits that a strategic shift from control to promotion would yield, and by making specific recommendations for reforms that would realize these benefits. 1.8 One of the reasons why decentralization and liberalization remain controversial in Viet Nam is that the government is very concerned about regional inequalities. The report examines this issue in several ways. First, it reports major results from a representative household survey carried out by the government with technical assistance from the World Bank and financing from UNDP and SIDA. This survey yields up-to-date information on poverty and income distribution in Viet Nam. Second, the report analyzes how government expenditures and policies can be used to promote relatively balanced growth throughout the country, in order to bring about a more rapid reduction in poverty. 1.9 One of the important conclusions of the report is that it is possible to combine elements of fiscal decentralization with centrally managed transfers that ensure that poor regions receive adequate public services. The report recommends this kind of system for Viet Nam. Such a system would - 3 - promote rapid growth - which is the most effective method of reducing poverty in the long run - while at the same time ensuring that there are also targeted programs to address the immediate problems of poverty in Viet Nam. 1.10 The report is organized as follows: The remainder of this chapter reviews recent economic developments and prospects for growth in the next few years. It provides the macroeconomic context in which to view the strategic issues taken up in subsequent chapters. Chapter 2 focuses on issues of public sector management, including the budget, the public investment program, and reform of state enterprises. The following chapter examines several issues that are at the heart of the incentive regime for producers: legal reform, the financial system, and the regime for foreign trade and investment. The final chapter presents a poverty profile for Viet Nam and information on income distribution and regional inequalities. It also reviews the system of inter-governmental transfers and their effectiveness in addressing issues of poverty. B. Macroeconomic Performanoe 1.11 On the surface Viet Nam's macroeconomic performance was good in 1993, with robust growth of 8.1% and a decline in consumer inflation to 5.2%. There were some underlying problems, however, that required corrective actions early in 1994. The fiscal deficit increased significantly, to 6.2% of GDP, a level that the government had difficulty financing. On the monetary side, domestic credit increased by nearly 60%. This rapid expansion of credit did not lead to immediate inflation because it financed a surge of imports. However, the level of the resulting trade deficit - as well as the level of the fiscal deficit - was not sustainable. 1.12 Viet Nam went through a period of austerity in 1990-91, during which time its current account deficit declined to virtually zero: in other words, no foreign resources were available to the country. The situation has changed dramatically in the past two years, and there are now large commitments for direct investment projects and for aid-financed infrastructure projects. Relatively little of this potential funding actually disbursed in 1993, however. Disbursements of concessional loans, for example, were less than US$250 million. What happened in 1993 is that the government increased its expenditure, mostly on infrastructure and social spending, but did not have adequate financing for these expenses. A major part of its problem was that it misjudged the amount of aid money that would actually disburse, and then had to rely on commercial sources to fund its deficit. 1.13 In the monetary area, the State Bank allowed rapid growth of credit to producers, who in turn purchased imports. There were not adequate external flows to cover the resulting deficit, however, with the result that it was paid for by a drawdown in gross reserves of the banking system - something that can be done only once. Thus, the financing for both the fiscal deficit and the external deficit in 1993 was precarious. 1.14 Viet Nam can look ahead several years to a time when inflows of direct investment and ODA could contribute very substantial financing for development, provided the macroeconomy continues to be well managed. Through its fiscal and monetary policies, however, the government tried to push rapid expansion in advance of this financing. This expansionary policy threatened to reignite inflation. Early in 1994 the government moved to strengthen its macroeconomic policies by: * restraining the growth of public expenditure and tailoring its deficit to match the availability of concessional ODA; and * limiting the expansion of domestic credit through bank-by-bank credit ceilings, higher interest rates on refinancing and on foreign currency loans, and stricter reserve requirements. 1.1S This adjustment program yielded quick results. The fiscal deficit is projected to be sharply lower in 1994, less than 3% of GDP. Credit growth also decelerated. And the extenal deficit is projected to decline to about 5% of GDP, a level that can be sustained over the medium term. The sound macroeconomic policies created a favorable environment for growth, which accelerated to an 8.7% rate. 1.16 GDP growth. The economy's growth remained strong in 1993, with real GDP increasing 8.1 % (Table 1.1). This result was a small decline from the 8.6% growth of 1992. Construction - which is visibly booming in urban areas - was the fastest growing sector (18.3%). Industry (12.1%) and services (9.4%) also continued to expand rapidly. Growth of agricultural production, on the other hand, was disappointing, up only 3.8% over 1992. 1.17 These sectoral results point up one of the important elements of Viet Nam's growth, that is, its sharp concentration in urban areas in general and in Ho Chi Minh City in particular. Economic results in Ho Chi Minh City were once again close to spectacular. The real GDP of the city increased 13.9%, with balanced expansion of manufacturing, services, and construction. The city's foreign trade expanded an even faster 18%. Nearly one-third of Viet Nam's increase in GDP in 1993 came from Ho Chi Minh City, which has 5% of the country's population. Table 1.1: GROWTH RATES OF GDP AND MAJOR SECTORS 1990-94 (1989 Prices) ITEM 1990 1991 1992 1993 1994 Est. (Percentage Change) GDP at Market Prices 5.0 6.0 8.6 8.1 8.7 Agriculture 1.5 2.2 7.2 3.8 5.5 Industry 2.5 9.9 14.6 12.1 12.1 Services 10.3 8.3 7.0 9.4 9.3 Construction 4.7 5.1 11.0 18.3 17.5 Source: General Statistical Office. -5- Figure 1.1: SAVINGS AND INVESTMENT 1990-1994 18.0 16.0 14.0 '6 10.0 8.0 *6.0 4.0 2.0 0.0 Foreign Ntonal Public Non- Savings Savings Investment Government Investment E1990 01991 M1992 U 1993 1994 1.18 Investment. One of the most positive macroeconomic developments for Viet Nam in 1993 was the large increase in investment, a growth of 41 % in current prices and 32% in constant prices. It should also be noted that the General Statistical Office has revised upward the investment figures for the period 1991-93. This correction is very welcome; last year's economic report remarked that an investment rate of 12% of GDP for an economy growing at a 7% annual rate was implausible. The revised series has the investment rate at 15.1% in 1991, rising to 17.0% in 1992 and 19.4% in 1993. 1.19 Even with this upward revision, the Incremental Capital Output Ratio (ICOR) was 2.2 in 1993, rather low in comparison to other developing countries. The State Planning Committee believes that official figures still understate total investment, so that in reality both the investment rate and the ICOR are higher than indicated by these figures. Even with further upward revision, however, the ICOR would still be below the level of 3-4 commonly found in other developing countries. There are three factors that can explain Viet Nam's low ICOR. First, some large, fixed investments of the mid-1980s, in oil and hydropower, came on line in the early 1990s, so that some of the increments to GDP were based on these earlier investments. Second, the initial response of the economy to the removal of distortions - especially in services and in agriculture - permitted large increases in output based on only minor additional investments. Tlird, labor-intensive manufactures have been a leading sector, particularly in 1993-94, and this exploitation of comparative advantage is an efficient develop strategy that tends to keep the ICOR low. - 6 - 1.20 The first two of these factors are clearly temporary; as their effects wear off, the ICOR will rise, requiring greater amounts of investment in order to sustain the growth rate. The third factor - exploiting comparative advantage in labor-intensive industries - is more permanent. The experience of the successful East Asian Newly Industrialized Economies has shown that export-oriented industrialization is an efficient strategy that tends to keep the ICOR low, so that a relatively large amount of output is generated from a given level of investment. 1.21 The increased investment in 1993 and 1994 came both from budgetary investment in infrastructure and from investment in commercial activities (Figure 1.1). The public investment program has rebounded from a low of 2.8% of GDP in 1991 to around 7.0% in 1993-94. The other 12-13% of GDP in investment came from autonomous state enterprises, joint ventures between the public and private sectors, and private finms and households. The division between the public and private sectors in Viet Nam is not always clear, so that it is difficult to determine the extent of purely private investment in the economy. 1.22 Savings. While the increase in investment in 1993 was positive, developments in the area of savings were not encouraging. The increase in national savings has been one of the most important achievements during Viet Nam's reform program. In the revised national accounts, savings are estimated to have increased from 3.2% of GDP in 1989 to 16.3% in 1992 (Figure 1.1). This development confirms that households have the same strong predilection to save that is observed throughout East Asia. Stabilization of the economy, strengthening of property rights, and improvements in the banking system combined to bring forth these savings and to channel them to productive uses. This increase in savings more than made up for the decline in foreign financing available to Viet Nam, so that investment could increase quickly during a period in which the economy's utilization of foreign savings was in decline. 1.23 The use of foreign savings had dropped to nearly zero by 1992, as a result of the lack of foreign sources of financing. This situation changed dramatically at the end of 1992, and in 1993 the inflow of foreign savings grew to more than 8% of GDP. As discussed in more detail in Section D below, much of this came from unreliable sources of financing. This sudden inflow of foreign resources seems to have crowded out domestic savings. After several straight years of increases, national savings declined from 16.3% of GDP in 1992 to 11.2% in 1993. Of this five point decline in the savings rate, about one-fourth can be attributed to a decline in government savings and three-fourths to a decline in savings outside of the government sector. Reversing this decline is an immediate and important task for economic policy that will require actions both on the government budget and on the incentives that encourage households and firms to save and invest. Strengthened fiscal and monetary policies in 1994 have already made a contribution, with domestic savings projected to rise to 15% of GDP for the year. C. Budget DeveloRments 1.24 Viet Nam's budgetary situation in 1993 was characterized by sharp increases in both revenue and expenditure and by an expansion of the fiscal deficit (Table 1.2). Concessional flows to finance this deficit were minor, so that the government had to rely on expensive sources of finance, both domestic and foreign. In 1994 the government introduced tax and expenditure measures to reduce the deficit. The government will have to mana its deficit carefully in the next few years, controlling expenditures to match available sources of funding. 1.25 Revenue. Revenue mobilization by the govermnent has been a notable area of success during Viet Nam's adjustment program. Total revenue increased to 22.3% of GDP in 1993 (of which 0.8 percentage points came from foreign grants). This collection was up from 19.0% of GDP in 1992 and 13.5% in 1991. Thus, over a two-year period the government increased its revenue by nearly 10 points of GDP. Revenue increases of this magnitude are unusual. In fact, the experience of other countries shows that such large increases are often followed by some downward adjustment in future years. Hence, the government should be cautious in its fiscal planning and not assume that further large gains will be forthcoming. 1.26 In addition to increasing its revenue, the government is also relying on a more diversified revenue base. Oil revenue barely increased in 1993, so that its share in total revenue declined to about one-sixth. For the first time, the profit tax overtook the turnover tax as the main domestic source of tax revenue. And import duties nearly tripled as a result of the surge in imports combined with more effective collection of tariffs (Appendix Table 5.2). 1.27 Several years ago it could be said that Viet Nam's tax collection was low, and that this was especially true for some types of taxes. Import tariffs, for example, were only 5% of the value of imports. This situation has been rectified in the past two years. In 1993 import duties amounted to 15.8% of the value of imports. The government now needs to be careful about further attempts to increase revenue. In the case of imports, the current average tariff collection is appropriate and additional increases are likely to hurt the economy by creating disincentives to export and import. 1.28 While Viet Nam has achieved more diversification in the types of taxes from which it obtains revenue, its tax base is still narrow in the sense that most revenue comes from state enterprises. Revenue from state enterprises is nearly three times higher than tax collections from private firms, even though more than half of GDP comes from the private sector. 1.29 While Viet Nam's tax reform has been successful in raising revenue, it has made less progress with other goals, in particular, reducing distortions. The focus of tax reform now needs to shift toward making the tax code more neutral in its effect on incentives. The turnover tax, for example, creates poor incentives because of its cascading effect on producers. In an attempt to minimize the distortions from cascading, Viet Nam's turnover tax is extremely complex with many different rates. This complexity creates problems for administration, and in fact the government is only successful at collecting the tax from the firms that it owns. Turnover tax collection from the private sector is minor. 1.30 The government is planning a comprehensive and phased reform of its overall tax system. It will first simplify the turnover tax by reducing the number of rates, and eventually replace it with the less distorting value added tax. As part of its tax reform the government will consider modifications to the profit tax as well. This tax is very high and is an impediment to firms reinvesting their earnings. The tariff code also needs to be reformed. It too has a wide range of rates, creating poor incentives and difficulties for administration. This reform is taken up in more detail in Chapter 3, under the discussion of foreign trade. 1.31 In summary, the tax system in Viet Nam now places a significant portion of GDP in the hands of the government, to fund its activities. Further large increases in revenue as a share of GDP are not likely to occur, and in fact would not be desirable. The government should concentrate now on reforming the tax system in order to create better incentives for production. This reform will spur the growth of the economy and ensure that revenue collections are robust as development proceeds. - 8 - Table 1.2: SUMtARY OF BUDGETARY OPERATIONS, 1990-94 Budtx 1990 1991 1992 1993 1994 (Perecet of GDP) Revenue (inc. Grants) 14.7 13.5 19.0 22.3 25.4 Tax Revenue (Private Sector) 2.3 2.6 3.5 4.1 Tax Revenue (State Enterpriss) 8.7 7.7 10.3 11.5 12.3 External Trade Taxes 1.8 1.4 2.0 4.3 Other Non-Tax Revenue 2.0 1.8 3.3 2.5 1.5 Current Expenditure (cxc. Interest) 14.7 11.4 14.0 18.8 18.8 Wages and Salaries 4.2 2.6 Other 10.5 8.8 Cital Expenditure 5.1 2.8 5.8 7.0 7.2 Overall Pimary Balance -5.1 -0.7 -0.8 -3.5 -0.6 Interest 3.0 3.0 2.9 2.7 2.1 Overall Balance (Accrual Bais) -8.1 -3.8 -3.7 -6.2 -2.7 Overall Balance (Cash Basis) -5.8 -1.5 -1.7 -4.7 -2.5 Finaning 5.8 1.S 1.7 4.7 2.5 Foreign Loans and Grants (Not) 3.0 1.0 2.4 1.4 0.9 Domestic Loans (Net) 2.8 0.5 -0.7 3.4 1.5 State Bank (Not) 2.0 0.9 -2.0 1.5 Government Socurities (Net) 0.3 -0.4 1.3 1.9 Source: Ministry of Finance. -9- 1.32 Expenditure. Government expenditurehas increased even more rapidly than revenue during the past two years. During the 1990-91 period the government reduced its spending as part of the campaign to halt high inflation. During this austerity period a number of adjustments were made that should help the long-term growth of the economy. The military was reduced in size, with about half a million soldiers demobilized. Subsidies to state enterprises were curtailed, which had a positive effect on their productivity. The austerity, however, also made it difficult for the government to supply a range of important services that are needed for the economy and the society to develop. Investment in infrastructure, for example, declined to a very low level, and there were problems with the delivery of social services as real civil service salaries declined in the face of inflation. 1.33 The government has moved in the past two years to turn this situation around and to increase its development expenditure. While these investments in infrastructure and human resources are necessary in the medium term, the rate of growth of government spending has been too rapid. Real government spending essentially doubled between 1991 and 1993. That rate of growth threatened macroeconomic stability, and in 1994 the government had to modify its spending plans in order to bring its deficit under control. 1.34 Viet Nam is a poor country that clearly has a lot of needs, but they cannot all be met at once. One of the main messages of this report is that the government must carefully set priorities and manage its expenditures. The increased tax revenue noted above and the growing flow of aid mean that the government has substantial resources at its disposal. These resources will not yield much benefit, however, if the government tries to do too many things at once. How well the economy develops in the next few years will depend to a large extent on how well the government sets priorities and manages its expenditure. This topic is taken up in detail in Chapter 2, which examines the budget system, the roles Qf local and central government, current expenditures, and public investment. 1.35 Fiscal deficit and financing. The fiscal deficit was a problem in 1993 because it was large relative to low-cost sources of financing. Reducing the fiscal deficit was at the heart of Viet Nam's disinflation program in 1990 and 1991, during which time the deficit was reduced to 3.8% of GDP. Starting from that point, it made sense for the government to allow the deficit to gradually expand as aid resources became available. The returns to public infrastructure projects in Viet Nam are very high, and deficit financing is a sensible strategy as long as the government controls its debt in light of its servicing capacity. 1.36 Expenditure increased too rapidly in 1993, however, opening up a deficit that the government had difficulty funding. The deficit was equivalent to about US$800 million. The net flow of concessional loans, on the other hand, was quite small, creating a serious financing problem for the government. To its credit, the government did not resort to inflationary sources of finance. It did, however, borrow the equivalent of US$400 million from domestic sources at high interest rates. It also resorted to about US$200 million of commercial international borrowing. This large amount of high-cost borrowing will impose substantial interest costs on the budget in the future. 1.37 The initial 1994 budget had similar problems, projecting a large increase in expenditure and optimistic forecasts of ODA disbursements. During the year, however, the government adjusted the budget several times, as it became clear that the ODA inflow for the year would be quite low, including only about US$200 million in concessional loan disbursements. The government introduced tax and - 10- expenditure measures that resulted in a decline in the fiscal deficit to a projected 2.7% of GDP. As a result of these strong measures the government did not need to rely excessively on the domestic banking system or international commercial borrowing. 1.38 To keep its fiscal house in order the government of Viet Nam needs to do a better job of managing its expenditures and controlling its deficit. The aid commitments made at the Donor Conference of November 1993 should lead to growing concessional inflows. The government needs to plan carefully the priority projects to be financed from aid sources and to move quickly to implement these projects. This strategy would allow the fiscal deficit to expand modestly as ODA disbursements increased. It is recommended that the government manage its deficit to match the financing available from concessional loans, plus a small amount of domestic borrowing. The government has begun selling treasury bills, which is useful for the development of domestic capital markets. It would be prudent, however, to rely to only a small extent on the issuance of T-bills for financing, as domestic interest rates remain quite high. D. Monetary Policy and Inflation Control 1.39 Notwithstanding a surge in credit, which helped to underwrite the strong growth noted above, in 1993 Viet Nam achieved one of the best performances among transitional economies with respect to inflation reduction. An important task for the authorities is to consolidate these gains and to develop the monetary policy instruments that will permit effective control of inflationary forces. This includes developing indicators and instruments, as well as skills in interpreting and utilizing them. 1.40 Although the sharp deceleration of inflation is clear, the exact measurement of this change varies significantly depending on the index used and the time period chosen. Inflation from the producers' view (measured by the GDP deflator) fell to 13.2% in 1993, from 73% and 35% in 1991 and 1992, respectively, while from consumers' perspective it was only 8.3% last year - and a mere 5.2% on a December/December basis, the lowest rate among transitional economies. A key factor accounting for the five percentage point gap between the two (annual average) indices reflects the stabilizing presence of imports in the CPI basket. Table 1.3: CONSUMER PRICE INFLATION (Percent Change) Category 1992 1993 Food 19.5 (7.8) 6.4 (6.9) Non-Food Goods 38.0 (14.1) 6.1 (3.1) Services 44.8 (41.0) 23.4 (18.9) Overall CPI 37.7 (17.5) 8.3 (5.2) Note: Annual averages, with December/December data in parentheses. - 11 - 1.41 The slowdown in inflation was broadly based, as each major component of the CPI decelerated (Table 1.3). Output-based measures also reveal a widespread deceleration, with the largest increases last year in construction (29.8%) and the categories of finance, state management, tourism (all 24-25%), and the smallest rises in industry (9.4%) and agriculture (4%). 1.42 The sharp deceleration of inflation appears somewhat paradoxical in the face of the rapid growth of money and credit. Domestic credit rose 58.7%, led by a near tripling of credit to the non-state sector. M2 increased a more modest 19%, reflecting the running down of net foreign assets. Although financial depth declined slightly - from 26.5% to 25.8% of GDP - last year, n M2, which excludes foreign currency deposits, rose from 18.5% to 20% of GDP, and broader measures of financial depth showed even larger gains (Chapter 3). This increase in the use of the dng is consistent with a fall in inflation expectations and the seemingly still high real interest rates available to depositors. 1.43 Several factors appear to have helped reduce inflationary forces. First, the authorities liberalized imports, as witnessed by the running down of foreign exchange reserves, thereby providing increased competition and a safety valve for demand pressures. Second, with a large part of the population in agriculture, Viet Nam faces a more elastic supply of labor to the rest of the economy in comparison with other transition economies, where a larger percentage of workers are in heavily subsidized jobs in industry and hence have little desire to seek other employment. Moreover, especially in view of the large part of credit growth (about one-fourth) accounted for by the Agriculture Bank, it is likely - given the 4-5% per month interest rates in the informal sector - that part of the rapid advance in credit represents a reallocation away from the informal sector.1' Thus this part of credit expansion is probably offset by an unrecorded fall in informal credit. Lastly, not all increases in output will have the same inflation impact: although real GDP has risen by 43% since 1989, gross capital formation has registered an impressive 141 % jump, and anecdotal evidence suggests that most of this increase has been highly productive. It is therefore to be expected that capacity is rising faster than demand, putting downward pressure on inflation. 1.44 Part of the explanation for the surge in credit is that it reflected an easing up from the very tight conditions in 1992. Real interest rates have declined steadily, using a forward-looking measure of consumer prices (Figure 1.2), and were lower still - with long-term rates under 10% by the end of 1993 - if the GDP deflator is employed. The SBV both lowered nominal interest rates and eased up on reserve requirements. In 1992, the authorities had been 'recommending' an added 20% in reserves, mostly held in settlement accounts at the SBV, beyond the 10% minimum required reserves. This moral suasion was eased during the year, and total reserves fell from 25.5% of deposits at the end of 1992 to 20.6% at the end of 1993, while refinancing from the central bank rose about 40%. With supply conditions easy and demand robust, a surge in credit was the result. 1.45 The SBV's tools for controlling inflation have been central bank refinancing, interest rates on refinancing and on both deposits and loans, and reserve requirements. In early 1994 the SBV moved to slow down the growth of credit, as some of the above factors cannot be depended on to continue to hold down inflation, and also as part of the program with the IMF. Although the SBV could raise reserve requirements, the financial sector already is heavily taxed (Chapter 3), and this tool is inefficient in that it forces banks to call in loans and thereby disrupt projects already underway. Indeed, consistent with the longer term development of the financial sector, the authorities moved in early 1994 to ease Officials in the Agriculture Bank confirmed that many of their customers are replacing informal sector loans with credit from their bank. - 12 - further the pressure to hold excess reserves and made the 10% required ratio significantly less binding. In order to offset this expansionary move, the SBV put in place bank-by-bank credit ceilings as a temporary measure for achieving glocal credit targets. In the short term this tool usually is highly effective for implementing monetary policy but ultimately leads to disintermediation of the formal financial sector if maintained too long. Figure 1.2: REAL INTEREST RATES 60 50 E E 40 c U30 ~20 10 0 C%d Cd4 C14 c') c' 9) 0) CD CY) I I~~c I I! I n ~ ~< < 0 The December 1992 amendments to the foreign investment law and the ensuing regulations of April 16, 1993, removed much of the discrimination in favor of joint ventures and against 100% foreign enterprises. Investors appear to have reacted quicldy to these changes with joint ventures in total approvals dropping from an average of about 80% by number for the period of 1988-1992 to about 65% in 1993, replaced by growing numbers of 100% foreign-owned enterprises. 3.82 Care should be taken in interpreting these numbers, however, as they may give an overly positive picture. First, they include project equity as well as debt, with equity representing on average about 55% of total project capital and debt 45%. Second, they include the Vietnamese contribution to joint ventures, typically in the form of real estate contributed by state-owned enterprises. As joint ventures account for about 75% of projects and the local share averages about 25 to 30% of the equity, about 11-12% of these totals are in fact not foreign investment but domestic investment. Third, equity contributions are often inflated by the foreign as well as the domestic partners. Fourth, these numbers reflect approvals for licensed investments, of which some will never be formally committed, some will never be carried out, and others will be carried out on a smaller scale. As of mid-March 1994, over 130 projects worth about US$650 million had already been canceled by SCCI, i.e. their license had been revoked, most often for failure to implement the project. 3.83 Actual implementation, which includes investments in cash or kind, amounted to US$2.1 billion by end-1993, or about 28% of total project amount. Using a one year lag, the implementation rate by end-1993 would increase to 44% of the value of projects licensed by end-1992. If one considers that these amounts tend to include the full amount of the Vietnamese contribution to joint ventures, which is typically in the form of land and buildings, it becomes clear that project implementation rates are low. I' Indeed, the foreign investment law and regulations do not allow the constitution of joint sock companies by foreigners or with foreign equity. Similarly, the company law prohibits any foreign ownership of shares in Vietmese companies. Enterpnses with foreign capital can thus only be established as limited liability companies under the foreign investment law, whose capital, unlike that of joint stock companies, is not divided into tradeable shares. A foreign investor can only sell his equity interest in a joint venture with the unanimous consent of the joint venture's board e with the approval of SCCI; SCCI approval is also required in the case of transfer by an investor of his interess in a business cooperation contract or a 100% foreign-owned company. Despite these srict restrictions on capital mobility, a number of close-ended investment funds have been established in recent years with the pnmary purpose of investing in Viet Nam. Tney invest in a range of foreign invested projects, typically as minority passive partners and are bound by the same restrictions on transfer of their interests. IV As mentioned below, these many different incentives are not always consistent and may conflict with each other. - 68 - It is interesting to note that these implementation rates are above average for oil and gas projects (at 57%, or twice the average, and representing one-third of project implementation) and finance projects (at 70%, but representing only 5% of total project implementation) and below average for tourism (16% rate, 12% of project implementation) and industry projects (25%, representing a bit less than one-third of total project implementation). One hypothesis to explain these sectoral differences is that joint venture projects and projects involving land acquisition and site clearance are more difficult to implement (for reasons detailed below). Excluding the oil and gas sector, the implementation rate would drop from 28 to 23 %, and from 44 to 39% with a one-year lag. 3.84 Looking at the employment side, job creation from foreign invested projects has been very limited to date, at best. By end-1993, less than 46,000 jobs had been created. Assuming a one-year lag between implementation and job creation, this would imply an investment cost per job created of close to US$24,000; with a two-year lag the amount would still be close to US$14,000, which is still very high for a low-income country such as Viet Nam. The official emphasis and priority given by the government to the use of the latest technologies in foreign invested projects, as reflected in official government pronouncements and in screening criteria for foreign investments (see below), may account for some of this high cost. 3.85 Since 1988, a total of 45 provinces and cities (out of 53) have had licensed foreign investment projects. HCMC, Vung Tau and Hanoi have taken the lion's share. Foreign investment increased, however, significantly in the north of the country in 1993 and early 1994, partly as a result of greater efforts by local authorities to create an attractive environment for investment. The sources for investment in Viet Nam are quite diverse; investors from over 30 countries have obtained investment licenses. The year 1993 saw an increase in the share of Korean and Japanese investors, which can be in part attributed to the establishment of diplomatic relations with Korea and to the resumption of official Japanese aid and the end of the U.S. embargo. From a project and sector point of view, 1993 has seen a number of very large projects, including two cement plants (and a third in the first quarter of 1994), and large hotel and real estate projects. 3.86 Finally, to put foreign investment into Viet Nam in perspective, it is useful to make some comparison with other countries in the region. The net inflow of DFI into Viet Nam was US$300 million in 1993. This absolute amount is quite small, about 1 % of all the foreign investment in East Asia. Net inflows (1992 data) into some of the other countries is the region were US$11.2 billion to China, US$4.1 billion to Malaysia, US$2.1 billion to Thailand, and US$1.8 billion to Indonesia. However, VietNam's economy is much smaller than these other ecowmies, so that DFI relative to GDP is rather large in Viet Nam, at 2.3% in 1993. Figures for these other countries (1992 data) are 2.2% of GDP in China, 7.2% in Malaysia, 1.9% in Thailand, and 1.4% in Indonesia. Thus, foreign investment into Viet Nam has grown rapidly and is now significant relative to GDP; at the same time, the absolute level is small relative to total foreign investment in East Asia, and there is wide scope to increase foreign investment into Viet Nam. IMpediments to Foreign Investment 3.87 Despite these positive developments, significant impediments remain. If not removed or reduced in the coming years, these could become serious bottlenecks for sustained growth of foreign investment in the country. They are discussed below under the broad headings of problems in procedures and bureaucracy, property related issues, remaining problems in the legal and incentive framework for ------- - --- - 69 - foreign investment, and sector-specific issues related to foreign investment in the infrastructure sectors. In a sense, there is a danger that the relative success encountered in recent years may disguise the need for change. This section will discuss a few areas of concern and suggest ways to address these. 3.88 Procedures and bureaucracy. Cumbersome procedures and bureaucratic requirements for the negotiation of foreign investment contracts, the issuance of related licenses, and the implementation of projects are singled out by most investors and observers, as well as senior government officials, as one of the major problems in the area of foreign investment in Viet Nam. 3.89 These problems, which deal with the full range of licenses and permits required to implement projects, and are thus only in part related to SCCI, include: * too many agencies and too many levels of government involved on the Vietnamese side; these typically include about eight central government agencies, the local government, the concerned union of enterprises and the concerned SOEs; * too much information requested in the early stages of the approval process at a great cost to investors; * much of the information requested and of the controls made by Vietnamese officials pertain to non-esential aspects of the transaction; projects need to meet too many criteria; * Vietnamese officials do not always have the expertise or skills to evaluate projects; X the evaluation process denotes a strong central planning approach, with Vietnamese officials detrmining whether specific investments are needed or not, based on their own analysis of demand and supply in the country or region and on their assessment of the capabilities of local enterprises; this tendency seems to have been reinforced by a recent practice to develop master plans for foreign investment by sector and geographic area; 3 SCCI and other agencies have too much discretion in decision-making; * the absence of uniform interpretation of foreign investment rules and regulations adds to the arbitrary nature of the process; * foreign investors in practice must hire local consultants who may not always have the skills required to contribute to the substantive preparation of the project, but have access to key officials; * in order to limit processing delays, foreign investors may have no choice but to enter into a joint venture with a well connected Vietnamese party (often an SOE);W W' According to a wrvey of foreign-invested uuterpriso conducted by the Saigon Time (March 24-30, 1994, p. 21) it took 100% foreign-owned enterpriees about two yeas, or twice u long u joint vtres, to receive the necesary 1ieene. - 70 - * corruption under various forms appears to be prevalent and increasing, as reported by foreign investors, the press, and senior govermnent officials. 3.90 Many of these problems are bound to increase with the growth in the number and volume of foreign investment requests. A system that may have been suitable in the first wave of foreign investment (1988-1990), when anmnal foreign investment licenses issued over a three-year period amounted to 214 in number and US$1.5 billion in volume, is no longer suited when in a single year 268 projects have been approved for a total amount of US$2.7 billion, as was the case in 1993. Furthermore, the experience gained in these six years of implementing the foreign investment law should allow the government to relax the approval system. 3.91 To reduce these bottlenecks, the government has already taken some measures, which may not always be optimal, however. Even though, for example, the measures announced by a March 1994 joint communique of SCCI and the Hanoi People's Committee include some useful streamlining of the licensing and approval process for real estate and other investments in Hanoi, they also provide that small projects such as hotels with less than 50 rooms and office buildings of less than 3000 square meters or US$3 million in value will no longer be entertained. Although this will certainly reduce the work load and hence the delays in processing applications, it does not address the core of the problem and will preclude many projects that would have been of great benefit to the economy of Hanoi. One of the strengths of Viet Nam is its web of small and medium enterprises; hampering the development of such enterprises does not appear to be good policy. A better approach would have been to expedite and streamline the approval process for small projects that raise no important policy issues. 3.92 The regulations for export processing zones include a streamlined one-stop investment approval mechanism, which is said to function well at least in the two EPZs of HCMC (Tan Thuan and Linh Trung). It is too early to draw any conclusions from the short operational life of EPZs, but if this streamlined investment approval process indeed works well, it could be used as well for projects outside the EPZs. 3.93 Additional measures to streamline the investment process that the government may wish to consider are as follows: * A distinction should be introduced between the award of a foreign investment license and the award of tax, customs and other benefits allowed under the foreign investment law. This could be done by establishing a two-track investment approval system. First, a fast track procedure would result in the automatic award of a license to investors who do not request special tax, customs or other incentives for their project. The only condition for the award of this type of license would be the observance of all legal conditions as set forth in the law and applicable regulations. Such projects would only need to be reviewed by SCCI and, in case of small projects, by local SCCI branches or local governments. Licenses would have to be issued in a short time frame (say one month) and could only be denied on the basis of the non-conformity of the project with criteria established in the law and regulations. Investors should be able to appeal a rejection to an economic court. The second track, to be followed by investors who wish to receive some or all of the benefits or incentives authorized by law, would consist of a streamlined version of the existing system. It may be restricted to specific sectors of the economy and/or regions of the country. Investors who want to invest in sectors where the government feels no additional - 71 - foreign investment is needed (e.g. restaurants, breweries) could do so at their own riscs, without special incentives. This dual system would focus the largesse of the government only on those sectors or areas where it feels what foreign investment is needed and would not take place (or not in sufficient volume) without such incentives. * The number of agencies and levels of goverment involved in the license approval process and the issuance of other permits required to undertake the investment should be reduced. * The issuance of licenses for small projects should be decentralized to provinces or regional SCCI offices; if the govermnent is concerned about the consistency of license decisions, it could issue guidelines requiring the concerned authorities to license projects meeting specified criteria; licenses issued in violation of these criteria could be suspended by or at the initiative of the central govermnent. * Specific guidelines should be prepared detailing when the concerned authorities are bound to issue a license. The number of project evaluation criteria and the amount of information requested from potential investors should be reduced. In this context, the requirement of feasibility studies should also be abolished, at least for small projects; indeed, these are costly to prepare and rarely provide the type of information needed to assess a project. Where feasibility studies are still required, the information to be included in such studies should be limited to what is essential to decide on the issuance of a license. 3.94 Role of various agencies. As mentioned above, no fewer than eight agencies (and often more) are automatically involved in the screening of all foreign investment proposals. Previous Bank reports have already indicated that this is excessive, redundant and ineffective. It may be useful to mention the role of some of these agencies to illustrate how their intervention is no longer adapted to the needs of a market economy. 3.95 The Ministry of Science, Technology and the Environment is amongst these agencies. It is supposed to evaluate the technology offered by the foreign investor, as well as the environmental aspects of the proposed project. It is not clear why the proposed technology would need to be screened. An investor is normally better able to judge what equipment and technology best suit the needs of its company. This is certainly the case when the investment is in a 100% foreign owned company, but also when it is in a joint venture. Some argue that the ministry should check on the technology to make sure that the Vietnamese partner (usually a state enterprise) does not get cheated. One should, however, distinguish between the choice of the appropriate technology and the fair value of the concerned equipment. On the first question, one would imagine that the Vietnamese partner will in general be more familiar with the technology used in his sector than ministry of technology officials; on the second, it is 2' If the govenmet insists on limiting foreign investment in crtain (non-defense related) sectors, it would by far be preferable to auction off sch licens to the highest bidder radter than banning such investment altogether. Such bans ar rarly effective, - forg investor can easily enter into agreements with Vietnamese citizens to act a in-between (or front man) for them; this is already happening in a number of sectors where foreign investment is banned or discouaged. - 72 - difficult to imagine how the ministry could have good access to current market prices for a very broad range of equipment and technologies. A contract with an international company specialized in evaluation and control would be a better way to achieve this objective (the inspection or control fee could be borne by the importer). 3.96 Vietnamese officials seem overly concerned by the frequent import of second-hand equipment or equipment based on old technology and have made repeated statements about the need to import only state of the art technology. Although this may be an appropriate approach in a few cases, it may not be in many others and may result in the apparent capital-intensive bias of toreign investment noted above. Favoring high-technology investments in a country whose main competitive advantage is qualified and inexpensive labor may indeed be a misguided policy. Many foreign investments are further hampered by restrictive rules on licensing of technology, whose real effect seems to be to slow down the transfer of technology into the country, i.e. exactly the opposite of what was intended. 3.97 The State Planning Committee is another important agency for reviewing foreign investment decisions. In reviewing a foreign investment proposal, SPC will inter alia examine the demand and supply conditions prevailing in the concerned sector. If it considers that the existing and/or approved capacity levels are adequate to meet the anticipated demand, it will most likely oppose the project and cause its demise. But in a market economy, it is the investor who assesses demand and supply conditions and who takes the risk of insufficient markets for its products. One of the reasons for the demise of the command economies across the world was precisely the inability of the command mechanisms to accurately forecast and balance supply and demand. The most important role for the state in this context is to make information available to investors to help them make such assessments. In addition, as mentioned above, the state may choose to use its fiscal and other incentives to stimulate investments in specific sectors or regions. 3.98 The concerned sector ministry also gets to review the foreign investment applications. As this ministry is, however, also the supervising authority of state enterprises in its sector, it may try to block projects which threaten the viability of its enterprises by increasing competitive pressures. As a reviewer of foreign investment projects, the sector ministry has a serious conflict of interest between promoting the sector it is in charge of and defending the interests of the enterprises it owns or supervises. The proposals to separate supervision of state enterprises from line ministries (paras. 2.90-2. 100) would eliminate this conflict of interest. 3.99 Property issues. Land-related issues are of major concerifo many foreign investors. Foreigners have a difficult time acquiring land use rights and often have to rely on a Vietnamese partner for that purpose, even though the law was recendy changed to allow them to acquire long term land use rights in their own right. The price of such land use rights has recendy skyrocketed, and the cost and time required to acquire land has been mentioned as a major reason for not going ahead with some investment projects. Such costs often include compensation of displaced farmers or occupants (up to 50 times the annual value yielded by their crops in the case of projects wiLh a duration of 50 years), relocation costs, site clearance costs, etc. Although this is normally the responsibility of the Vietnamese partner in joint ventures, the joint venture partners often end up sharing these costs. In addition, unclear zoning regulations in many areas (cities especially) and overlapping responsibilities for the award of building licenses add confusion to the process. - 73 - 3.100 Weak mortgage and collateral mechanisms hamper all private investors, but foreign ones in particular. It appears that, as of this writing, foreigners can only get mortgages on land use rights in the context of BOT projects (in which they can obtain such land free of charge); as no such project has yet been licensed, it is not possible to assess whether this right to mortgage land use rights is effective and enforceable. 'he government is considering plans to issue regulations allowing the mortgaging of land use rights by foreign investors as part of the implementation of the new land law. In this context, foreigners should also be allowed to sell or transfer their land use rights. Problems also seem to be encountered with respect to the mortgaging of buildings, primarily with buildings contributed by the state or state enterprises as capital contribution to joint ventures. In order to make mortgages and other forms of collateral effective, institutional mechanisms will need to be put in place for their registration and enforcement. 3.101 Foreign and non-state domestic investors are currently at a disadvantage relative to SOEs and other government bodies in acquiring land use rights for the purposes of productive activities. The organization of auctions of land use rights (open to foreign as well as domestic investors) would be one way to improve access to needed real estate. The government may also wish to consider auctioning from time to time excess land and buildings owned by the state or SOEs that are presently not used to their full potential. Such auctions would help create a fair market for real estate and would provide additional revenues to the government while giving the private sector (domestic and foreign) better opportunities to acquire the real estate they need to carry out productive investments. In addition, in order to increase the liquidity of the real estate market, SOEs should be charged market prices for the use of the land they occupy.1 This would encourage them to relinquish surplus land. 3.102 IAg framework for foreign investment. By and large, Viet Nam has a good legislative framework for foreign investment. Some problems remain, however, as well as areas for improvement. Of particular concern are the regular changes and amendments in laws, regulations, decisions, circulars or announcements applicable to foreign investors, which may affect the viability of a project. Moreover, these are often not announced publicly in advance of effectiveness, and investors have complained about the difficulty of finding out when relevant new rules are promulgated. Also, new rules are not always clear or consistent with other parts of the legal framework, nor are they consistently interpreted or applied. All this creates a high degree of uncertainty, which is detrimental to private investment. All new rules and regulations applicable to business activity should be broadiy published prior to becoming effective. Enough time should be given to businessmen to familiarize themselves with these new rules and to adapt their business activities accordingly. In addition, in the case of rules applicable to foreign investors, a notice of their publication could be published in the English language press in Viet Nam; this is currently done in some but not all cases. The frequency of change in rules governing business activity (including changes in tax and customs schedules) should be reduced. Greater stability in these rules would allow enterprises to plan their activities without undue uncertainty and would hence encourage investment. 3.103 Current regulations applicable to joint ventures are unduly restrictive and are seen by many investors as a major problem in running joint ventures and as one of the key factors in decisions not to I In some inoosc, the governmt could also contribute the right to uw the needed land s capital of the SOE. - 74 - invest in Viet Nam. The requirement of unanimity of the joint venture's board members for all major decisions affecting the organization and operation of the joint venture are mentioned by many investors as a major problem. It may indeed be very difficult to get agreement of all board members on all important decisions and this requirement often leads to the maintenance of the status quo. In fast changing times, as is clearly the case of Viet Nam during its transition to a market economy, but more generally also as a result of the globalization of the economy, companies need to be very flexible to adapt to changing market conditions and to seize opportunities without being limited by the least dynamic partner, who may in fact own only a small share of the joint venture's capital. Unanimity rules may prevent such flexibility and hence hurt the company's prospects. 3.104 In addition, joint ventures (and other forms of enterprises) should be allowed to create subsidiaries, which does not appear to be allowed at present. This could become a major step in the creation of Vietnamese conglomerates, which the government wants to promote (paras. 2.96-2.98). Allowing joint ventures to form subsidiaries (fully or partially owned) would also give the Vietnamese partners in such joint ventures the opportuniy to learn how to manage company groups, before attempting to launch purely Vietnamese groups, which may not be very successful given the current state of development of Vietnamese business (state-owned as well as private). To facilitate the creation of such groups of enterprises, foreigners should also be allowed to buy shares in Vietnamese joint stock companies, sometlhing that is not allowed at present (para. 2.85). 3.105 Other areas in which the joint venture regime could be improved include: 3 repealing or relaxing restrictions on sale or transfer of equity interest in joint ventures; e using independent evaluators to determine the value of contributions to joint ventures made by foreign and local partners, especially for joint ventures with large capitalization; and * developing mechanisms to match local and foreign investors; in this context, Vietnamese enterprises may need some assistance to assess the soundness of their proposed foreign partners, as a number of joint ventures have foundered due to the inability of a financially weak foreign partner to deliver on its commitments. 3.106 More generally, differences and artificial barriers between legal regimes applicable to different types of investment, based on the origin of the invested capital (private domestic, foreign and/or state), may have had their justification initially but have now outlived their usefulness and should be abolished in favor of a single set of rules and regulations applicable to all enterprises, irrespective of owlership (paras. 3.19-3.20). Laws, regulations and administrative practices governing business activity should be harmonized into a single system providing a level playing field for all investors. The current system of discrimination between enterprises is not even consistent, as each group has special benefits and special burdens, which encourages investors to choose a specific capital structure solely for the purposes of obtaining special advantages. It also creates unnecessary rigidit that prevents the growth and development of enterprises and may prevent the development of larger business groups in Viet Nam. The government is considering streamlining and leveling the current uneven playing field with a view to harmonize rules and incentives applicable to different categories of businesses and, eventually, to have a single framework applicable to all enterprises, irrespective of the source of their capital. - 75 - 3.107 At present, there is no adequate dispute settlement mechanism in place in Viet Nam to deal with disputes between investors and the state (including ministries, local governments and state-owned enterprises). Viet Nam is planning to accede to the New York Convention on international arbitration and to the Washington Convention on settlement of investment disputes between a state and foreign investors. In addition, enactment of an ordinance on the recognition and enforcement in Viet Nam of foreign arbitral awards is high on the authorities' agenda. ' Most issues involving foreign investors are currently settled through some form of negotiation between the investors and the concerned authorities. This ad hoc approach will become more and more difficult to pursue as the economy and the volume of investment grow and, with them, the occurrence of problems or disagreements. In view of the lack of a functioning enforcement and dispute settlement mechanism and of the absence of adequate exit mechanisms, most investors see their investment as a sunk cost which they may never be able to retrieve. As a result, they have to count on high profits to recover their initial investment plus a reasonable margin. The establishment of proper enforcement, recourse and dispute settlement mechanisms would reduce the cost of investing in Viet Nam and hence benefit the economy at large. Foreign Investment in Infrastructure 3.108 Bottlenecks in infrastructure are unanimously described as the major obstacle to growth, private sector development and foreign investment, the main problem being the inadequate supply of infrastructure services (transport, telecommunications, power, gas, water), in terms of availability as well as quality. In this context, the December 1992 amendments to the foreign investment law included a new article introducing the concept of Build-Operate-and-Transfer (BOT) contracts for infrastructure projects. The enactment in November 1993 of special regulations for BOT projects is one of the more important innovations in the foreign investment regime during the past year, and deserves to be discussed in greater depth. A more detailed circular 'guiding the implementation of the regulations on investments in the form of Build-Operate-Transfer contracts' was issued by SCCI in February 1994. 3.109 A BOT project is a 'project approved by the government for the purpose of constructing and carrying on a business operating infrastructure projects"; 'at the end of its term, the project shall be transferred to the Government of Viet Nam without compensation." The decree in effect establishes a special foreign investment regime for BOT projects, different from and more generous than that applicable to the three traditional forms of foreign direct investment. It includes generous tax and customs benefits, guarantees the convertibility of d n" earned through operation of a BOT project into foreign currencies, authorizes the use of real estate (including buildings and land use rights) and other assets of the BOT company as collateral or mortgage, exempts the right to use land from the payment of rents, sets forth procedures for the tender, evaluation and selection of BOT contractors and negotiation of BOT contracts, stipulates what needs to be covered by BOT contracts, provides for arbitration based on the laws of the country chosen by the parties in case of disputes, and provides that SCCI will issue licenses for BOT projects upon approval of the Prime Minister. BOT contracts can be signed by the private BOT company with a ministry, general department, or People's Committee of a province or city. '7' The government has recently decided to join the Multilateral Investment Gwurantee Agency (MIGA). This should furither improve the foreign investment climate and offer investors new options for insuring their investments. - 76 - 3.110 No BOT project has yet been licensed as a BOT project, although some BOT-type project have been approved prior to the issuance of the new BOT regulations. These include a BOO (Build-Own- Operate) power plant in Hiep Phuoc near HCMC and a BOT tollroad in the same area. These two projects support inter alia the Tan Thuan Export Processing Zone and are sponsored by the same Taiwanese investor, the first as a 100% foreign owned company (in association with other Asian investors) and the second in joint venture with a Vietnamese partner. In the telecommunications field, Telstra of Australia has entered into a business cooperation contract with DGPT that is in part similar to a BOT in that Telstra is responsible for building and financing specific telecommunications facilities whose property will revert to the government without compensation at the end of the ten-year contract; DGPT, however, is technically the operator of the equipment, rather than Telstra, which provides operational assistance to DGPT. Telstra shares nternational telecommunications revenues with DGPT. (- her examples exist in the transport and telecommunications sectors of BOT-type arrangements that have . en licensed on an other legal basis. 3.111 Even though it may be too early to assess these new BOT regulations, a few points can already be mentioned. The authorization to mortgage assets of the BOT company is an essential and very positive part of these new regulations. The circular, however, restricts the use of the mortgaged assets after they have been transferred to the mortgagee (typically a bank) to the continuation of the implementation of the project and seems to stipulate that in case the BOT company is liquidated the payment of salaries, insurance and taxes would have precedence over the payment of the loan secured by the mortgage. A secured creditor, however, should have priority over other creditors when it comes to allocating the right to the proceeds from the sale of the secured asset. 3.112 A potential problem in the implementation of BOT projects is the overlapping responsibilities of the different government bodies. Potential BOT investors have to negotiate in parallel with the government body that will enter into the BOT contract (e.g. the Ministry of Energy for a power plant) and SCCI which will be issuing the license. Furthermore, it is not entirely clear what the role of the concerned power company is with respect to the discussion of BOT projects; as it will most likely be signing the power purchase agreement, which constitutes the key agreement in a BOT package, its role should not be underestimated. Mechanisms will need to be set up to ensure better coordination among these different state bodies, for example by establishing for each major BOT project an ad hoc committee responsible for preparing, reviewing, negotiating and authorizing the contract on behalf of the state. The government should speak with one voice vis-a-vis investors. 3.113 From the experience gained so far, as well as from similar infrastructure projects carried out under the form of joint venture or business cooperation contracts, it appears that such projects are often not properly evaluated from an economic point of view. Contracts are signed and licenses issued on the basis of what is largely a short-term financial analysis, which typically indicates that the government will get a new or improved infrastructure at no or little immediate direct cost to the Treasury. Little or no attention is given to the assessment of various options for the private provision of such infrastructure services. The possibility and desirability of introducing competition in these sectors is, for example, rarely examined. This may not be so surprising in view of the agencies involved in screening and negotiating these projects. Indeed, the two most influential agencies end to be the concerned sector ministry, which has a tendency to defend the current monopoly struct -., and SCCI which has poor capacity to perform economic analysis and sees its role primarily as fosLering foreign investment. In some cases, however, the country would be better served by abolishing existing monopolies and - 77 - promoting private competition against the incumbent 4tate monopolies rather than by BOT-type contracts lincking the private BOT company closely to the state monopoly. 3.114 As BOT projects are very complex in nature and in view of the lack of experience of government agencies in this area, the government would be well advised to appoint a team of international advisers to help in the preparation and negotiation of such deals. These advisors, who would typically include lawyers and financial and economic experts, would be paid by the government. The costs incurred in this way are minimal relative to the cost to the country and the budget of (i) choosing the wrong option for private delivery of infrastructure services; (ii) poorly negotiated deals, or (iii) protracted negotiations due to the novelty of this approach and the inexperience of civil servants. Such advisors should not only help the government in preparing and negotiating BOTs, but also other large contracts in the infrastructure area, including for example joint ventures and business cooperation contracts for roads, ports, power plants and telecommunications systems. To date, much of the advice given to the government on BOT issues was provided on a pro bono basis by law firms and other consulting firms. This ad hoc approach may have been appropriate to launch the process but can no longer satisfy the government's needs for expert and independent advice. 3.115 The government should seek long-term assistance from international experts in developing BOT and other schemes to promote private investment in infrastructure sectors. Such assistance could, for example, include an analysis and evaluation of options for private investment in sectors that have so far been managed by state enterprises or other public bodies, the design of sector reform programs, the identification of promising projects, the preparation of project-specific tender documents and contractual documents, assistance in negotiation of BOT and other private infrastructure schemes, preparation of promotional material to attract foreign investment in these sectors, and strengthening the Vietnamese institutions responsible for tendering, negotiating, supervising and regulating these projects. 3.116 Foreign investment in mining. There is very little foreign investment to date in the mining sector, primarily due to the absence of a mining law (many drafts have been prepared) and/or mechanisms guaranteeing that a company investing in exploration costs would also get the mining concession. Viet Nam has mineral resources which could attract a significant amount of foreign investment if the right conditions are put into place. Summary of Recommendations 3.117 Viet Nam's performance in the field of foreign investment is strong but should not give the authorities any reason to rest on their laurels. Significant problem areas remain that need to be addressed. First, the rapid increase in the number of foreign investment applications and in the related volume of investment demand a revised, streamlined and simplified process for foreign investment project approval and implementation. This process should to the extent possible be automatic, transparent and predictable. The level of discretion given to government authorities needs to be reduced; a broad range of projects should be approved automatically without detailed government evaluation, which should be limited to very large projects and projects requiring major incentives or benefits; overlapping jurisdiction and unclear boundaries between government agencies, various levels of government, unions and enterprises need to be abolished in favor of a system with fewer actors, a clearer allocation of responsibilities and better coordination; reasonable efforts should be made to limit opporunities for corruption; and recourse or appeal mechanisms need to be established, as well as sanctions against officials who hinder the implementation of economic reform programs decided at the highest levels. - 78 - 3.118 Second, a better functioning market tfor land use rights and improved mechanisms for collateral, including registration and enforcement, as well as removal of discrimination against foreign investors in these areas, would further help improve the overall environment for foreign investment in Viet Nam. 3.119 Third, with respect to foreign investment in the infrastructure areas, which may become increasingly critical to the success of the government's economic reform program, due attention will need to be given to the possibility of introducing competition in some of these infrastructure sectors, state monopolies may need to be dismembered, and contract and project award procedures will need to be streamlined and accelerated. Here again, technical assistance will be required. 3.120 In summary, Viet Nam has been very successful in attracting foreign investment. There are, however, a number of areas were progress is required to sustain this level of interest in the country. With some changes, Viet Nam should be able to increase the actual implementation rate and volume of foreign investment and to use such foreign inflows more efficiently. A significant share of new commitments could come from infrastructure projects which are much more complicated to develop, negotiate, and implement than industry or tourism projects, for example, and will require the development of new approaches and capabilities. - 79 - IV. POVERTYRED1aQN 4.1 Viet Nam embarked on its economic reform program in 1989 with the primary objective of raising general living standards. In order to pave the way to long term gains in living standards, the government implemented a thorough structural adjustment program. Unlike the populations of many other transition economies undergoing market reforms, the majority of the Vietnamese people benefited immediately from the change in policies: with 80% of households engaged in agricultural activities, land contracting and price liberalization resulted in higher incomes and improved living standards for most of the population, despite significant public sector layoffs. However, much of the success of the structural adjustment program was due to fiscal restraint which reduced public investment and expenditures on important services such as health and education. 4.2 Throughout this report two main areas for government focus have been stressed so that macroeconomic objectives can be achieved: (1) public sector management, and (2) the incentive structure for private savings and investment. This chapter examines the impact of the resulting macroeconomic growth on poverty and living standards in Viet Nam. Rapid growth by itself will have a strong impact on poverty reduction. There are also ways in which government expenditure and policies can accelerate the growth in incomes of the poorest households. The chapter makes recommendations aimed at strengthening the impact of growth on poverty reduction. 4.3 The chapter is divided into three parts. The first part examines the current poverty situation and the implications of economic growth on poverty reduction throughout this decade. It also looks at different aggregate growth scenarios. The second part of the chapter examines two essential topics related to public sector management: The first is the need to direct public expenditures to areas in which poverty is high and to devolve decision-making about local investments to local government. The second topic of importance is inter-governmental fiscal relations and the need to ensure adequate levels of financing at each level of government to enable the delivery of important pro-poor' services throughout the country. The third section of this chapter concerns the development of a rural financial system which can effectively mobilize local savings and provide much needed credit to households and small enterprises. A. Economic Growth and Poverty Reduction 4.4 The Viet Nam Living Standards Survey (VNLSS) highlights three important features of poverty in Viet Nam: * The overall incidence of poverty is extremely high; the consumption level of 51% of the population is below a widely used international poverty line. Even in the relatively prosperous Mekong Delta, half the population survive at per capita consumption levels below this poverty line. * There are significant regional disparities in living standards throughout the country. Poverty incidence ranges from 33 % in the southeast to 71% on the north central coast. * Rural areas throughout the country are much poorer than urban (i.e. 57% poverty incidence in rural areas versus 26% in urban areas). Rural poverty accounts for 90% of the poor (Table 4. 1). Table 4.1: INCIDENCE OF POVERTY (Headcount measure, in percent) REGION RURAL URBAN TOTAL N. Mountains 63 34 59 Red River Delta 55 1S 49 N. Centml Coast 74 42 71 Cental Coat 54 36 49 Ccntal Highlands 50 - 50 South Est 45 17 33 Mckong Delta 52 28 48 AVERAGE 57 26 51 Note: Regions consist of the following provinces: N. Mounains - LAo Cai, Yen Bai, Ha Giang, Tuyen Qung, Cao Bag, Lag Son, Bac Thai, Vinh Phu, Son La, Hoa Binh, Ha Bac, Quang Ninh; Red River Delta - Ha Tay, Hanoi, Hal Phoag, Hai Hung, Thai Binh, Ninh Binh, Nam Ha; N. Centml Coast - Thanh Ho&, Nghe An, Ha Tinh, Quang Binh, Quang Tn, Thua Thien; ntral Coaft - Quang Nam, Quang Ngi, Binh Dinh, Phu Yen, Khanh Hoa, Ninh Thuan, Binh Thuan; ContT1 HiPlands - Gia Lai, Dac Lac, Lam Dong; South East- Song Be, Tay Ninh, Ho Chi Minh City, Dong Nai, Ba Ria; Mekong De1lt - Long An, Tie Giang, Ben Tre, Vinh Long, Tra Vinh, Dong Thap, An Giang, Kien Giang, Can Tho, Soc Trang, Minh Hai. 4.5 Average per capita annual expenditure in Viet Nam was found in the survey to be 1,373 thousand 4g=; yet those in the north central region spend less than a half (974 thousand dong) of what those in the southeast (2,008 thousand dQ21 spend. In addition to regional disparities, intra-regional differences in living standards, and specifically urban-rural differences, are very pronounced. Urban per capita expenditures are much higher than rural, on average 1,741 thousand dg for urban and 1,189 thousand QBg for rural. Indeed, the urban areas in the poorest regions of Viet Nam are still more prosperous than the rural areas of the wealthier provinces (except for the southeast where the rural areas are thriving) (Table 4.2). It is important to note that in this analysis adjustments have been made for differences in regional price levels. - 81 - Table 4.2: REAL PER CAPITA EXPENDITURES BY REGIONS (Thousand dSg REGION RURAL URBAN AVERAGE North Mountains 936 1,415 1,007 Red River Delta 1,151 2,457 1,349 North Coast 934 1,401 974 Centrl Coast 1,239 1,951 1,457 Caenutl Highlands 1,159 - 1,159 South EFst 1,610 2,509 2,008 Mekong Delta 1,300 2,453 1,506 Weighted Average 1,189 1,741 1,373 (US$129) Note: * Expenditures have boe adjusted for regional price differences. 4.6 Over half of Viet Nam's population fall under a poverty line constructed on the basis of a basket of goods in which the food items reflect local consumption pattens and contain 2,100 calories per person per day and the non-food items reflect the cost of basic goods consumed by people who just reach the poverty line. How does this incidence of poverty compare to other countries?1' A comparison of poverty incidence indicates that poverty is much higher in Viet Nam (51% rural) than in China (99%), Indonesia (15%), the Philippineg (21 %), or Thailand (16%). While the poverty rate of Viet Nam is much higher than these other countries, it is important to note that all these countries had poverty rates similar to Viet Nam's only a few decades ago. 1' It must be noted that crows-country comparsons - even ths basd on identical mrthods - are at best approximate sinc the baskt of essential food and non-food items (dtermined by the food and non-food consumption pattens of those attaining 2,100 calories) is priced locally to determine the poverty line. Therefore, each country's poverty line involves a different baskt of goods. Idlly, to make intemational compaisn, the basket of goods should be adjusted for content and converted via purchasing power parity exchange rates into measures which can be compued acro countries. This information is unavailable at presont for Viet Nam. Neverthls, other country examples (using a poverty line based on 2,150 calories per person per day) are provided here to give a rough assesm_nt of how Viet Nam compare to other East Asian countries. - 82 - 4.7 Although Viet Nam's consumption based poverty rate is very high, other important welfare indicators such as education and health status are much better than in many other developing countries. Viet Nam's literacy rate is a remarkable 88%, a rate comparable to countries with five times the per capita GNP of Viet Nam. Under five mortality is about one-third that of other low-income countries. Immunization coverage rate is reported to be 88%, double the rate found in other comparable countries, and life expectancy is 67 years. Malnutrition rates, on the other hand, are very high with almost half the children under age five stunted; this is reflected in the consumption based measure used to form the poverty line. 4.8 Incidence of poverty is high, and average per capita expenditures are low. The distribution of consumption in Viet Nam, however, is relatively equitable, with a national gini coefficient of 36%. Gini coefficients in other developing countries range from 23% in Hungary, to 59% in Guatemala. Most East Asian countries are in the 33-45% range (e.g. Indonesia 33%, Malaysia 48%, the Philippines 41 %, Thailand 43%). China, a country to which Viet Nam's development experience is often compared, had a gini of 33% in 1985, which climbed to 35.5% in 1990 after 5 years of rapid growth. Prospects for Growth and Poverty Reduction 4.9 As Viet Nam continues to deepen its reform program, the government targets annual growth rates of about 8%. Given national population growth rate of 2%, this would mean an annual growth in per capita income of 6%. If Viet Nam does grow at this rate, what will be the implications for poverty reduction? This will depend on the extent to which the poor share in the growth process. It is possible to estimate the implications of different growth paths on poverty reduction in Viet Nam. This section reports the results of such an analysis and highlights the policy implications.Y 4.10 Results of simulations examining the impact of different growth scenarios are shown in Table 4.3. The base case scenario of 8% is contrasted to a high growth rate case of 10% and a lower growth case of 6%. This analysis illustrates the dramatic impact of aggregate growth on poverty reduction. If Viet Nam achieves its targeted 8% annual growth rate, and if the unequal growth rates of different regions continue throughout this decade, the national incidence of poverty would decline to 29% by the year 2000. This means that almost half of the poor in Viet Nam today would rise out of poverty by the decade's end. If the economy grows more rapidly at 10%, the incidence of poverty would decline to 25%. Under a scenario where the economy grows more slowly at 6% per year, 35% of the population would still be poor in the year 2000. 4.11 Two factors contribute to poverty reduction in any country. The first is the pace of economic growth - the faster a country grows the quicker poverty reduction will come. The second is the distribution of household income (or consumption) - the more equally distributed, the more likely the poor are to share in the growth process and rise out of poverty. In Viet Nam, regions generally are I 'me impact of growth on poverty alleviation is pmjected using the foUowing data and specifications: (1) the distribution of houwhold consumption data from the Viet Nam Living Standards Survey (a proxy for houehold income) and (2) regional poverty lines constructed usng the Cost of Basic Needs Methodology' (Ravallion, 1994). Furtermore, in these scenarios it is assumed that differt regions of the country grw at differaet rates, reflecting the actual dispersion in regional growth rate observed in 1993. - 83 - Table 4.3: POVERTY UNDER DIFFERNT GROWTH SCENARIOS (Headcount Incidence) 1993 Resioial Growth in Growth Per Capita 2000 2000 2000 Rcgion Income Gini 1993 6% Growth 3% Growth 10% Growth Northen Uplan - Rural 3.08 1.80 24.5 62.8 56.9 50.S 45.0 - Urban 25.2 34.3 27.8 23.3 20.3 Red River Dola - Rural 4.60 2.60 26.3 55.0 43.8 36.2 29.0 - Urba 30.3 15.4 11.2 3.2 5.7 North Centd - Rurl 2.50 0.30 24.7 73.6 71.9 67.7 66.3 - Urban 31.1 42.4 34.2 30.9 27.3 Central Coast - Rurl 6.28 4.21 30.7 54.0 32.9 28.3 20.9 - Urban * 31.3 36.0 19.1 14.5 10.6 CaKral Highlands - Rual 11.34 9.34 29.5 50.1 15.1 9.6 6.0 Southes - Rural 14.30 12.30 36.7 45.2 4.5 1.4 0.6 - Urban 16.15 14.15 33.1 17.1 1.4 0.5 0.2 Mekong Deha - Rural 7.73 5.73 29.9 52.0 24.3 16.7 10.3 - Uran * * 40.3 21.4 15.4 11.0 7.5 7.5% 5.5% 36.4% 50.9% 35.0% 29.0% 25.0% Note: * Regional growth rtes are adjused to reflect the different auegate growth scenuios. growing at vastly different paces (ranging from 2.5% per annum in the north central, to 15% in the southeast), and have disparate distributions of consumption (gini coefficients ranging from 25% to 42%). Those regions with the lowest incidence of poverty tend to have the most inequitable distribution of consumption and are also those growing most rapidly; conversely, those regions with the highest incidence of poverty currently have the most equal distribution and face the slowest pace of economic growth. 4.12 An examination of poverty measures in 1993 indicates that there are major differences in poverty (1) between regions, and (2) between rural and urban areas in all of Viet Nam's regions. While aggregate reductions in poverty would be large under any of the three growth scenarios above, regional poverty reduction will differ greatly due to the vastly disparate regional growth rates. By 2000, the regional differences remain stark, as do urban-rural differences; however the magnitude of poverty becomes much less severe in some areas. Indeed analysis illustrates clearly that poverty reduction will be very gradual in the slow growing regions, despite their more equal distribution, whereas it will be very quick in the fast growing areas, despite their more inequitable pattern of consumption.Y For example, y' Annual GDP growth rates for 1993 in each region (aggregate growth of 7.5%) are scaled up proportionately to equal aggregate growth of 8% and ame asmed to remain the same until 2000. Regional distributional data is disggregated into rural and urban; however, for lack of more doeild data, region specific GDP growth mtes are applied to both mral and urban areas (except in the cae of the souda region, whorm urban Ho Chi Minh City i separated from the rural ares). - 84 - while the distribution of per capita consumption in the north uplands is currently the most equitable in Viet Nam (gini coefficient of 25%), the rate of economic growth in this region is also relatively slow at 3.1% in 1993. If the growth rate does not accelerate and enable greater per capita consumption, 2000 51% of rural, and 24% of urban residents in the north uplands will still suffer from poverty. On the other hand, the southeast has the most inequitable distribution of consumption in rural Viet Nam (gini of 37%) and among the worst for urban areas (gini of 33%); but it is growing quickly at an average annual rate of 15%. If the same distribution and growth rates persist, poverty in this region could be almost eliminated by 2000. 4.13 If the economy were to grow at an aggregate annual rate of 8%, and each province were to continue to grow at the same rate it did in 1993, national poverty incidence would decline from 51% to 29%. If, however, all regions were to grow at the national average, 8%, poverty incidence would decline to 23%. Of course, the extent of redistributionrequired to achieve 8% growth in all regions of the country could well result in a lower aggregate rate of growth. This trade-off between equity and growth is complicated, and ultimately decisions depend on social preferences and political pressures. Nevertheless, this simulation illustrates an important point about growth and poverty reduction in Viet Nam. The vastly different growth rates between regions result in significantly lower poverty reduction, than if growth were more evenly spread throughout the country. Poverty reduction will be quicker if regional growth is more evenly distributed. 4.14 Viet Nam's poverty profile indicates clearly the large difference in poverty between rural and urban areas in every region of Viet Nam. While some regions will grow more rapidly than others, it will be important for the rural sector to participate in its region's growth in order to achieve the magnitude of poverty reduction reported here. 4.15 The above analysis highlights several important aspects of poverty in Viet Nam and has implications for poverty alleviation efforts. Poverty is extremely prevalent in Viet Nam, but is much more common in rural than urban areas. General rural development must be the first order of focus for poverty reduction efforts. Broad based economic growth will lead to major reductions in poverty. Indeed, projections estimate that poverty will almost be halved by the year 2000 under current growth rates. But the analysis also indicates that if the present pattern of regional growth and distribution remains unchanged, poverty will remain a very serious problem in some areas, whereas it will become much less serious in other areas. Thus, efforts targeted to these very poor, slow growing regions are also needed. 4.16 As suggested in Chapter 2, cost-benefit analysis should be the starting point for all economic investments in Viet Nam, and only those investments with a positive rate of return should be considered. However, given the vastly different regional growth rates and their implication for poverty reduction, viable investments in slower growing areas with high poverty incidence should also be considered. While the opporunity cost of selecting projects with lower (but positive) rates of return can be significant, poverty reduction should come much quicker if poorer areas share in growth. - 85 - 4.17 Efforts should differ by region depending on the principal constraints faced in that area. For example, viable projects in the poorest region of Viet Nam, the north central coast, may involve investments in irrigation which would improve agricultural productivity greatly while reducing vulnerability to natural calamities. The second poorest region, the north mountains, also has land that is underutilized but for different reasons. Poor roads, inadequate agricultural extension, and lack of access to capital all limit the ability of farmers in the hilly areas to switch from annual crops to the more lucrative (and environmentally safe) perennial crops. Thus, improving the availability of these services should be the focus for this region. And in the Red River Delta, where agricultural land is used far more efficiently than anywhere else in Viet Nam, plots of land are so small that households would have to diversify their activities to rise out of poverty. They are currently constrained from doing so owing to a severe credit shortage in the rural areas. Financial policies that would encourage savings and enable medium and longer-term investments would permit households to engage in other activities and raise living standards. 4.18 Efforts at broad based economic growth and regional development are presently limited, however, by a Public Investment Program that does not focus sufficiently on rural areas; by a system of intergovernmental finances which limits the ability of local governments to implement the appropriate development strategy; and by a rural financial system which does not provide the right incentives for private sector growth. The first two subjects are taken up in Section B and the third is addressed in Section C.# B. Public Expenditures and Poverty Public Expenditures that Benefit the Poor 4.19 The VNLSS data clearly indicate a high prevalence of poverty throughout Viet Nam. The analysis in Section A indicates that if rural areas participate equally in regional growth, poverty reduction can be substantial in some regions. This indicates the need for (1) broad based rural development, and (2) targeted efforts (investment and/or assistance) for certain areas. 4.20 Constraint to poverty reduction: rural infrastructure. Areas with a high incidence of poverty are often constrained by the availability or quality of the factors of production: land, labor, and capital. The development of these factors is closely tied to the existence of key infrastructure such as rural roads, inland waterways, and irrigation. There are many indications that people who live near such infrastructure have higher living standards and have been better able to take advantage of the market reforms than those who do not. For example, the data show that those people living in communities located near an all-weather road (i.e. passable year round) have significantly higher average per capita expenditures than those not living near such a road (1,269 thousand donM compared to 1,010 thousand Y' For a more comprehensive discussion of (1) intergovanmental fil relations and (2) nual development (and the need to invest in physical infrastrut and human rources as well u target particularly ppoor sevices and areas), swe 'Viet Nam: Poverty Asaesamt and Straegy Report', Fall 1994. For a more comprehensive discussion of financial issues, see 'Viet Nam Financial Sector Study", Fall 1994. - 86 - gQg. They are significantly more likely to have a permanent market located in their village; to engage in more than one economic activity; to leave the village to seek work; to sell agricultural surplus; and to be served by public transport. The VNLSS data indicate that each of these factors is significantly and positively correlated with living standards (at least at a 95% confidence level). 4.21 The existence of an all-weather road also appears to affect labor mobility, which is significantdy related to economic status. On average, households in communities with labor mobility (i.e. which report to have residents that sometimes leave the village to seek work elsewhere) have per capita expenditures of 1,256 thousand d= compared with 975 thousand for communes without labor mobility. Again, we see that people in communities characterized by labor mobility, engage in more economic activities, and are more likely to have ready access to an all-weather road. 4.22 While one must be cautious not to draw causal relationships between any of these factors, the proximity of an all-weather road is associated with the existence of permanent markets, enterprises, economic diversification, labor mobility, and higher living standards. However, whether economic status preceded or succeeded the availability of infrastructure is unclear. Experience from other countries indicates that transportation is a prerequisite for increases in agricultural productivity and rural development more gerT -ally. Aggregate studies for groups of countries have confirmed the important positive impact of rural roads on crop and livestock output, crop area and yield and fertilizer demand. In the absence of good transportation, agricultural development is hindered in several ways: prices for inputs are higher and output lower; marketing of high value perishable products is impossible, and access to new technology and information is more limited. In Viet Nam, as elsewhere, the presence of all- weather roads seems to improve the flow of goods, services, and information. This leads to greater economic diversification, labor mobility (in and out of the household's home village), more productive use of farm land, and higher living standards. While the VNLSS data unfortunately do not include information on rural waterways, the latter serve a vital role for households in the two main deltas. As with rural roads in other areas, inland waterways serve as the vital channel for the flow of information, goods and services to rural households. 4.23 Irrigation is another key type of infrastructure which directly affects the household's use of land, and therefore agricultural productivity. Indeed, land and irrigation are by far the most important influences on farm production, according to econometric estimates of a paddy rice supply function using the VNLSS. Irrigation is found to add substantially to land value: the difference between zero and 100% irrigation amount to 645 kcg/ha. Not surprisingly, access to irrigation is correlated positively with living standards. Yet, the provision of irrigation services has undergone a transition since the economic reforms were initiated and the role of the commune changed. Today, responsibility for providing irrigation services remains vague. Some districts appear to assume responsibility and fund district level irrigation systems. Smaller scale commune irrigation systems, however, appear largely unfumded. Potential for 'micro irrigation schemes appears great, particularly in some parts of the country. For example, micro irrigation schemes could improve the reliability of irrigated water supply significantly, enlarging the command area by 10-20%. With an effective extensioni service, appropriate varieties, good seed and access to inputs, production increases of 50% or more could be attained. However, improvements in local finance, including incentives to mobilize local resources, are needed to support such efforts. - 87 - 4.24 Implications for public ependitures. The VNLSS data clearly indicate that access to infrastucture is associated with household economic status. Currently, investment projects (including cost-effective local rehabilitation projects) are all decided by the central government. The decision criteria used to select investment projects in the past has been vague. The central government should continue to manage carefully the public investment program for large projects (i.e. where benefits exceed the boundaries of one province); however, local governments should be assigned responsibility for local investments so that they can reflect local needs. Such decentralization should produce greater efficiency in decision-making and implementation. 4.25 Local governments should be provided with adequate resources and sufficient flexibility to address local needs. If rehabilitation of key infrastructure is a priority, local governments should be able to reallocate resources from elsewhere in their budget and focus on the item of urgency. The central government can enable provinces (particularly poorer provinces) to support their own investments and maintenance by allocating investment and recurrent cost resources as part of a general grant. The distribution formula for this grant should include basic indicators of provincial need; reflect different costs of delivering services through the country; and contain a component for fiscal effort to encourage local resource mobilization, where possible. By devolving more autonomy to local governments to support the investment and operation of infrastructure of local priority, efficiency of public expenditures would rise. Appropriate local infrastructure would enable households in these areas to participate more effectively in the market economy. The data suggest that all factors of production would be used more efficiently and would generate higher household earnings if accompanied by adequate infrastructure. Intergovemmental Fiscal Relations: Fundin¢g Pro-Poor' Services 4.26 Pro-poor services throughout Viet Nam are underfunded; this problem is particularly acute in the poorer areas. Improvements in the system of inter-governmental finances could help ensure that each level of government, even in the poorer provinces, is adequately funded - and provided with sufficient expenditure and revenue raising autonomy - to support local investments and their ongoing operation and maintenance. Since poor provinces are less able to mobilize additional local revenues to support services, well designed intergovernmental transfers are particularly important. 4.27 Two main categories of problems exist with the system of intergovernmental finances in Viet Nam: (1) the extent of centralization, and (2) the design of the system. First, the high degree of centralization in Viet Nam reduces both the efficiency of expenditures and the incentive for formal local resource mobilization. Second, regardless of centralization, wealnesses in the design of the system - e.g. weak assessment of expenditure needs (i.e. expenditure norms unrelated to cost or local capacity); inaccurate estimates of revenues, and the resulting inadequate level of transfers - leaves local governments underfunded; their ability to deliver important services depends on factors outside the formal system (i.e. community contributions). Ironically, the system designed to be highly centralized, is in fact quite decentralized since the ability to deliver many local services depends on local circumstances. 4.28 What is the role of sub-national govermments in undertaking expenditure policies targeted to reduce poverty? Potential inter-provincial mobility of population can limit the efficacy of sub-national governments in undertaking redistributive policies. Nevertheless, sub-national authorities have a comparative advantage in identifying the poor; deciding which local investments and recurrent expenditures are most appropriate, given their limited resources; and delivering services to communities - 88 - within the province. They may also be more efficient providers both of social and community services such as health and water supply and economic services such as agricultural extension, irrigation, and roads. Local governments may thus play an important role in deciding and implementing expenditure policies, including those intended to alleviate poverty. 4.29 Concern is sometimes expressed about the possible effects of decentralizing public sector activities owing to the poor quality of local government administration in many developing countries. To a considerable extent, however, each country gets the local government it wants. In Viet Nam local government officials, like those anywhere, respond to the incentives with which they are faced. If those incentives discourage initiative and reward inefficiency, then it should come as no surprise to find inefficient local governments. The answer to this problem, if it is one, is to alter the incentive structure to make it possible and attractive for honest, well-trained people to make a career in local government. Similarly, one answer to local governments that make 'wrong' decisions is to provide an incentive structure that leads them, in their own interests, to make the 'right' decisions, that is, decisions that are both economically efficient and politically acceptable. The fiscal arrangements needed to achieve this result will promote accountability and provide incentives for the cost-effective provision of public services. To the extent local governments are best suited to providing the services needed to accelerate economic growth and reduce poverty, they should therefore have a greater role both in raising revenues and in allocating expenditure, subject to the provision of adequate incentives to ensure that they do so in a responsible and efficient way. 4.30 As discussed in Chapter 2, a proposed Organic Budget Law which addresses central and prI vincial responsibilities is expected to be discussed in the National Assembly in October 1994. If the National Assembly passes this law, the budget process will become more formal and transparent. This will facilitate and improve budget implementation and thus will be a significant achievement. However, the proposed law only provides for modest decentralization and, in fact, increases the centralization of health and education. The proposal only sets the broad outline for the budget process and subsequent implementing regulations will define the details of the system. Iherefore, this is an opportune time to review the existing system of intergovernmental finances and examine how improvements in its design would facilitate the delivery of local services which are critical to the poor. Design of Intergoernm Finances 4.31 Resources provided to local governments should be on terms that encourage both local fiscal effort and efficient implementation, while at the same time recognizing adequately the considerable divergence in the capacities of governments in different regions of the country. Ihis calls for reallocation of some spending and taxing powers between the center and provinces and a carefully designed system of intergovernmental transfers. This section discusses the issues which should be addressed in the design of an 'ideal" system of intergovernmental finances, and describes the current system in Viet Nam. 4.32 Whereas many expenditures are more efficiently made by local governments, most taxes are more efficiently collected by central governments. Therefore, an essential ingredient of the fiscal structure in most countries is also a system for transferring resources from the central to the local governments. An ideal set of intergovernmental fiscal arrangements, for example, might include the following elements: (i) adequate resources in the hands of local governments as a whole, from a - 89 - combination of local taxes and central transfers, to enable them to carry out their assigned functions; (ii) a transfer system that ensures each individual local government has sufficient resources to provide essential functions at an acceptable standard, provided local taxes are imposed at reasonable rates; (iii) sufficient flexibility in setting local taxes and charges so that local governments can respond to the preferences, special problems, and resource endowments prevailing in different regions; (iv) but at the same time, sufficient incentive to ensure that local fiscal effort is maintained at reasonable levels and that local budgets are managed efficiendy; and (v) special central transfers to finance minimum levels of spending on particular programs considered of national importance. 4.33 Such an ideal system is seldom found in practice, and certainly not in countries such as Viet Nam in which traditionally a unified budget has been employed as a tool to implement central planning. Nonetheless, an essential but often unduly neglected part of the transition towards a more market-oriented economy is precisdy a change in the budgetary and intergovernmental system. From this perspective, it may prove useful to keep this 'ideal' in mind as a point of reference. 4.34 Expenditure. The assignment of expenditures to different levels of government in Viet Nam is based on a resolution of the Council of Ministers passed in November, 1989, as subsequently amended. These expenditure assignments largely follow the principles of efficiency (i.e. assigned to the level at which most benefits accrue). Local governments are responsible for law and order, while national government is responsible for national defense. Major universities are under the central government, while primary and secondary schools are covered at the provincial level. Major hospitals are national, while provincial and district hospitals and commune health centers are provincial. Major economic services (e.g., large flood control and embankment projects, interprovincial irrigation, and national highways) are central responsibility, but smaller scale services of this type are local responsibility. One notable exception to all categories of expenditure is that of public administration. The size of local civil service and their wages are determined by the center - thus eliminating flexibility in the budget of the largest single line item. As with recurrent expenditures, large investment projects, the benefits of which spill over to a number of provinces, are central responsibilities, while small projects benefiting mainly the residents of a province are undertaken by the provinces. Most investment projects - down to the commune level - however, must be approved by the central government. 4.35 The provinces currendy employ the districts primarily as their spending agencies. They are given a share in public enterprise taxes (profits tax, turnover tax and depreciation from state enterprises). The provinces directly spend most of the capital expenditures, and the responsibility of districts is mainly to execute small investment projects and to maintain the assets within their jurisdiction. Similarly, communes are allowed to retain 10% of revenue from agricultural taxes and in addition receive a small grant, mainly for holding meetings. Most development works are directly undertaken by the provinces, and minor works are executed by the communes, often with voluntary contributions (mostly in kind) by the community itself. 4.36 The preparation of the expenditure budget at the provincial level is critical to daermining the amount of transfer sent from the center to the province (in the case of poorer provinces), or sent from the province to the center (in the case of wealthier provinces). Insrestment decisions are made by the center (ine ministries and SPC) based on the proposals submitted by various provinces and the line ministries at the center, as well as the budget constraint. The process of project selection is both complicated and non-transparent, but considerations such as the need to finance continuing projects, - 90 - relative back-wardness of the provinces, priority of the projects as perceived by the central government itself, and relative ordering of the projects made by different provinces influence investment allocations. In addition, the provinces may increase investment outlay if they raise more than the targeted (budgeted) revenues in respect of taxes assigned to them. 4.37 The process of determining currnt expenditures is complex. The budget circular sent to the provinces details the norms to be employed for projecting different items of expenditure. These 'standardized norms are applied to expenditure items such as education, culture and information, training (higher education), sports, health, and administration. In the case of maintenance expenditures on infrastructures such as roads, bridges, embankments and irrigation works, standardized norms (on a per capita basis) cannot be applied, so expenditures are projected on the basis of specified norms for each item. The norms are developed for each expenditure item on the basis of the discussion among the Ministry of Finance, State Planning Committee and the relevant central ministry taking into account the estimated cost of providing the service as well as the budget constraint. In most cases, population is the major factor taken into account but different weights are assigned to population in different areas. The budget circular for 1994, for example, distinguishes among five different categories: (i) Cities, (ii) Plains, (iii) Midland and Coastal areas, (iv) Low Mountains and Remote areas, and (v) High Mountains and Islands. In principle, this distinction is supposed to take account of differences in the needs as well as varying unit costs of providing these services. In practice, after provincial budgets are formulated based on the 'budget constuined cost of providing services (via norms for each line item), provincial budgets are negotiated once again accommodating the budget constraint. 4.38 If properly designed, a system of establishing expenditure 'norms' may constitute a useful component of a transfer program, when combined with a measure of local capacity to meet costs out of own resources. The norms can be used for (1) assessing local expenditure needs based on assigned responsibilities, then (2) dearmining provincial revenue requirements, and then (3) determining intergovernmental transfers. Such norms might, for instance, take into account differences in the cost of providing a nstandardo level of services in different regions. Such costs might vary with population density, the terrain, and other factors. In Viet Nam, as in several other countries (e.g., Russia, Denmark) an attempt is made to 'cost out' the resources required to deliver each and every line time of expenditure and then norms are set as a way of determining each province's revenue requirement. 4.39 The standardized norms for 1994 for various items of expenditure are shown in Table 4.4. In the case of education, for example, the normative per capita expenditures vary from D 26,700 to D 42,800. Since provinces may contain more than one type of area, each province is required to project its education expenditures on the basis of its composition of population in terms of the different categories. - 91 - Table 4.4: NORMS FOR DETERMIING CURRENT EXPENDITURES FOR STANDARDIZED ITEMS IN PROVINCES, 1994 L NORLMS EASED 014 CATEGORIZATIO OP REGION MIDLAND LOW MOUNrAIN AND MOUNTAIN AND EXPENDrrURE rrEMS UNrr CIrEES PLAINS COASTAL AND REMOTE ISLANDS 1. Education: gm per 37,500 26,700 29,400 33,500 42,S00 Capita 2. Culutre & Infonnation gog per 3,750 2,500 2,940 3,350 4,2S0 Capita 3.Sport ggper I,40 1,250 1,150 700 960 capita 4. HeaJt durper capita i) Preveiive 4,750 3,340 3,700 4,170 5,340 ii) Curtive 10,520 7,520 8,720 9,400 12,030 5. Adminiramtion Mn Am Per I) Ptovincial earloyee 9.5 6.7 3.2 13.3 - i) Diswict inpayroll 7.5 6.7 5.5 11.0 12.0 .. ORMN RM FQR .ALL REGIOW- EDUCATON Nt4Dt AM: SCIENCE PEDAGOOY PEDAGOGY- AGRI, ECONOMIC CULTURE LEVEL OF EDUCATION & -GENERAL HIGHER FORESMRY, & LEGAL AND TECH FISHERIES AFFAIRS ARTS & HEALTH 1. Coge& Universty 3.3 4.0 2.7 3.9 3.3 4.2 2. Technic (3 yn, high 2.4 2.5 - 2.1 1.9 3.0 swbool gaduate) 3. Vocatioel 2.9 - - 2.4 - 2.9 4.40 While norms can be useful for constructing provincial budgets which reflect expenditure needs, the budget constraint necessitates that line items are then negotiated between the center and the province. In the end, provincial budget expenditures (1) differ from the norms on which they were supposed to be based; and (2) are set too low to reflect actual costs, given current expenditure patterns. For example, in Thanh Hoa province, where cyclones are a recurring phenomenon, the sanctioned budget - 92 - for strengthening and maintaining 937 km of embankments is generally only about 10% of what is requested by the province - which itself is only a fraction of what is actually needed for its proper maintenance. Even after mobilizing community help by way of voluntary labor, the province is thus able to select only the very weakest segments of embankment every year for strengthening. In order for allocated resources to meet the most important local needs, greater local expenditure autonomy is necessary to enable reallocation of resources between line items and within line items. 4.41 Table 4.5 indicates the different per capita expenditures budgeted for different items. As explained in the next section on revenues, actual expenditures exceed budgeted expenditures considerably. Table 4.5: PER CAPfTA EXPENDITURES IN PROVINCES CLASSIFIED ACCORDING TO INCOME CATEGORIES, 1993 High Income' Middke Iowan' Low Iome' Eapedture Pmvinca (Per Povince (Per) Peovince (Per Capita GDP) > Capita GDP) >300 Capita GDP < Al Pro- 430,000 4=ng -450,000 I= 300,000 2K viyca 1993 (B_ ffa_M) 1. Capia expenditure 27.0 14.0 19.9 19.9 2. Working capital and subsidy to SOE& 12.4 2.8 2.4 5.6 3. Curnit expendiu, of which 139.2 73.9 32.5 100.6 Oi Bcooomicervce 40.4 11.1 13.7 21.9 (i) Education 26.5 21.3 23.3 23.0 (iii) H.akh 14.7 9.3 4.4 11.3 IV) Tnig Nd wciaific rsearch 6.2 4.0 9.S 4.3 (v) O0hen 31.4 32.7 31.3 39.6 4. Total expenditure 173.6 95.7 104.7 126.6 Naow: 1. The high income provinces am: Ba Ria-Vung Tau, Ho Chi Minh City, Hanoi, Dong Nai, Kien Giang, Quang Ninh, Khanh Hoa, Hai Phong, Hoa Binh, Vinh Long, Tr Vinh, Long An, An Giang, Can Tho, Minh Hai, and Dac Lac. 2. The middle incme province ac: Tien Giang, Yen Bhi, Soc Trang, Bac Thai, Tay Ninh, Bcn Tre, Song Be, LAm Dong, Dong Thap, Quang Nam, Hai Hung, Vinh Phu, Thanh Hoe, Nun Ha, Thai Binh, Kon Tun, Lai Chau, Phu Yen, and Ha Tay. 3. Th low income provinc are: uLng Son, Ninh Binh, Tuycn Quang, Ha Bac, Ninh Thuan, Gti Lai, Thua Thien, Quang Binh, Binh Dinh, Binh Thuan, Cao Bang, Quang Tri, Nghe An, Quang Ngi, Ha Tinh, Ha Giang, LAo Cei, and Son LA. Source: Muintry of Piunac and State Planning Commic. 4.42 The wrm system has not been able to ensure that expenditure needs are well assessed or that provinces are provided with sufficient resources to cover the cost of delivering the assigned expenditure items. Although the norms apparently attempt to take some account of cost differences, it is not clear that the central government has adequate cost information on which to base the norms. - 93 - Moreover, the chosen indicators of need' could be improved. In the case of education, for example, costs are specified on per capita basis and not on the basis of population in the school-going age group or the number of students. Most importantly, despite calculation of the provincial budget based on line item norms, the reality of the budget constraint leads to negotiation of all provincial budgets. Provinces are left with a budget which no longer reflects the costs of delivering each service. As a result, provincial resources (retained taxes and intergovermnental transfers) are insufficient to cover the expenditures assigned to them. Moreover, provinces have very little flexibility to allocate resources to items of local priority. Personnel and salary decisions are centrally mandated, and thus the single largest recurrent cost item is out of provincial control. Provinces are not authorized to reallocate expenditures between line items, from say 'sports and culture" to 'road maintenance" even if the latter is seen to be of greater importance at that time. 4.43 The idea of the norm system (i.e., costing out each line item) is well-founded and if done accurately is the most precise method for allocating resources. Nevertheless, in reality most countries (including Viet Nam) which have tried this system have encountered difficulties with (1) its complexity and (2) matching total required costs with total available resources. As a result, the following steps are encouraged for intergovernmental design: (1) clearly assign expenditure responsibilities to each level of government; (2) determine what proportion of total revenues is required by the sub-national level to deliver the services assigned to it; (3) assess local revenue capabilides; and (4) use general purpose transfers from the center to make up the difference between local expenditure needs and revenue capabilities. As discussed below, the requisite transfers can be implemented via matching grants in a way that encourages local revenue efforts (paras. 4.56-4.57). 4.44 The benefit of general purpose grants - rather than the specified grants currently used - is that local governments have greater flexibility in spending. The sum of resources provided in a general purpose grant is broadly based on the cost of delivering services for which the province is responsible; yet actual expenditures are not mandated by the center. Thus actual expenditures can reflect local needs and preferences. It should be noted, however, that there is little rationale for making all grants unconditional. Not only does the central govermnent have a legitimate interest in what is done with its grants, but the nation as a whole also has a legitmate concern in ensuring that services provided by local governments such as education and health are available throughout the country at minimum standards. There is therefore a case for at least limited conditionalit, for example, by requiring that some grant funds should be spent on e.g., education or health or by requiring local governments receiving such grants to provide services of at least a specified quality and level. To ensure adequate resources to deliver these services, a detailed costing exercise is necessary. Thus, current norms would be modified and used to provide specified transfers for select local services of national importance. Given the overall budget constraint facing all local govermments, the efficiency of expenditures should improve when local governments are permitted to allocate resources according to local preferences. Moving towards broader indicators of need makes sense for general purpose grants and then certain items deemed to be of national importance (e.g., education and health) can be ensured through progressive matching grants, but specified to ensure a minimum level of provision. 4.45 Revenue projections. The expenditure budgets of provinces are influenced by the revenue projection for domestic resources. Analysis of revenue projections, however, reveals that the tax department consistently tends to underestimate revenues. The tax department tends to set targets which can easily be reached. Underestimation is in the interest of provinces as well, for, once a tax is assigned - 94 - Table 4.6: PER CAPITA REVENUES: TARGETS AND ESIlMATES Per Capita Revenues - 1993 Targets Latest Increase in Percentage Estimates Estimates over Increase Targets (Thousand Dog)4 High income provinces 656.43 758.10 101.67 15.5 Middle income provinces 95.43 111.19 15.76 16.5 Low income provinces 54.53 69.92 15.39 28.2 All provinces 278.60 323.89 45.29 16.3 Source: State Planning Committee and Ministry of Finance to a province for the year, collections in excess of projections provide some flexibility in the use of funds. On the other hand, the State Planning Committee would like to have high revenue targets so as to have a larger investment budget. Often, the projections of the tax department and State Planning Committee differ widely, requiring the Prime Minister to take the final decision. Even after such negotiations, however, as Table 4.6 shows, for the last three years, actual collections have exceeded targets in every single province. 4.46 Although a larger share of some of the taxes collected in higher income provinces goes to the center and though in relative terms the increase in richer provinces was actually lower than in poor provinces, nonetheless in per capita terms, the richer provinces still retained higher excess collections and consequently had higher per capita expenditures. Estimated expenditures in per capita terms exceeded the budgeted amount by D 51,670 in high income provinces, by D 26,800 in middle income provinces, and by D 31,030 in the low income provinces. The actual distribution of public expenditures among provinces thus differed from the approved budget. 4.47 The net effect of this complex system appears to promote a fair degree of equity in the allocation of expenditures among different provinces. Data on the provincial distribution of central government expenditure are not available. Although it is quite possible that the allocation of central expenditures offsets any equalizing effects of provincial government expenditures, only the latter can be analyzed here. In general, per capita provincial expenditures are much higher in more prosperous provinces. For example, budgeted current expenditures in 1993 varied by a factor of six between Ho Chi Minh City - 286 thousand dng per capita - and Thua Thien Hue in the very poor North Central Coast region - 49 thousand dun per capita. In the aggregate, per capita expenditures in the high income provinces was 26% above average in 1991, 31% in 1992 and about 41% in 1993. Interestingly, however, the distribution of current expenditures on health and education was markedly more even. - 95 - Moreover, per capita expenditures in low income provinces were, on the whole, slightly higher than hose in the middle income provinces. To some extent this reflects the equalizing effect of the present system of intergovernmental transfers as well as the fact that some of the centrally determined salary scales of provincial employees are higher in more remote regions, thus raising nominal expenditures in those regions. 4.48 In short, there is considerable redistribution occurring among provinces: wealthier provinces relinquish locally collected resources to the center, while the poorer provinces receive funds from the center which enable them to spend more locally than they would if they had to rely on their own locally collected resources. Figure 4.1 illustrates the findings. Despite this cross-subsidization, however, the tight budget constraint coupled with very limited local expenditure flexibility prohibits many local governments from delivering services important to their economic development. 4.49 Specific purpose transfers. In recent years, the central government has introduced a number of special programs, as shown in Table 4.7, to cope with the perceived inadequacy of provincial spending in areas to which the center wishes to give priority. Such programs are designed by the center but implemented through the local governments. They are thus similar to the specific purpose (non- matching) transfers seen in other countries, although the expenditures on these programs are shown only in the central budget. Expenditure on all these programs taken together amounted in 1993 only to 1615 billion 4M, or about four percent of total expenditure, with one-third of this figure being accounted for by reforestation. Many of these programs are directed to very specific activities, and the expenditure is spread so thinly across various sectors and provinces that it is unlikely to have any significant impact. In addition to these special programs, the central government also administers pensions to war veterans through the provinces: in 1993, expenditure on this item alone amounted to D 2374 billion, or far more than the total of all the programs shown in Table 4.7. Although in Viet Nam these specific purpose transfers are non-matching, generally such transfers have been found to be more effective when the recipient local govenments - the provinces, in this case - are required to make matching contributions. Particularly when there remain significant disparities between localities even after the distribution of general purpose grants, as is likely to be true in Viet Nam in view of the paucity of resources available, higher subsidies Oower matching rates) may be appropriate for low-income provinces with larger concentrations of poverty. 4.50 One of the schemes specially targeted to alleviate poverty is the subsidized loan program introduced by the Treasury and implemented through the Ministry of Labor to create employment for the unemployed. The program was introduced in mid-1992 and the government has budgeted to spend about D 250 bn in 1994. The loans are given to individuals (D 50 bn) and to small enterprises and workshops (D 200 bn). Presently the scheme covers Hanoi and Ho Chi Minh cities and in mountainous low density provinces. Loans for self-employment at subsidized interest rates are given after scrutinising the applications submitted to the Provincial Peoples' Committees. The small enterprise loans, however, are not directly targeted to the poor, but are given to generate employment. In these cases too, the applications are evaluated by the Peoples' Committees. In both cases, the loans carry monthly interest rate of 0.5% for loans up to one year, 0.4% for loans up to two years, and 0.3% for loans up to three years. 4.51 While the introduction of the employment program is a welcome development, the program itself suffers from a number of shortcomings, most importantly that it is not targeted directly to the poor. - 96 - First, this is still a pilot program introduced in the two cities and only a few provinces. In fact, incidence of poverty in the two major cities is relatively low. Second, though the loans to enterprises are ostensibly given to generate employment, the recipients themselves can be quite affluent and there is no way to ensure that these enterprises in fact generate the number of jobs proposed, once the loan is received. Third, as the Peoples' Committee guarantees the loans, in the ultimate analysis it is the repayment capacity and possibly political influence and not intensity of poverty that determines the beneficiary. Experience from many countries indicates that subsidized interest rates rarely benefit the poor since competition for these funds becomes keen and the poor lack the political and economic clout to compete successfully. Figure 4.1: PROVINCIAL REVENUE AND EXPENDITURE PER CAPITA, 1992 10 7 - ~ ~ ~ ~ ~ 4- 4~~~~~~~~~~-. 2 5 5.5 6 6.5 7 7.5 8 8.5 GDP per Capia (Log Scale) * Log Rewnue o Log Expendiure -P Predictd log expendkure - -- - Predicted bg revenue 4.52 The current employment program is not directly targeted at the poor; a public works scheme that would serve the very poor would be mnore appropriate. The sometimes acute seasonality of incomes, and the dire shortage of infrastructure, suggest that public works schemes may be a promising option for alleviating both transient and chronic rural poverty in Viet Nam. Public employment schemes offer unskilled work at low wages. Since only those who have no better alternative participate, such schemes are self-targeting. In many countries, this targeting mechanism has proved to reach the poor well. 4.53 Reoranizing intergovernmental rscl arrangemets for poverty alleviation. Inter- governmental fiscal arrangements in Viet Nam need to be reoriented in order to improve the consumption standards of the poor, particularly those living in the poorer areas of the country. Poverty alleviation through economic growth requires that the supply of social and economic infrastructure responds adequately to the increasing demands of the expanding market economy. Appropriate fiscal decentralization can help in this task. - 97 - Tab1 4.7: FENWDrrlRE ON SPECIAL CNTRAL PROGRAIS IN PROVIEN (Bfilu Dong) PROGRAM 1993 1994 (Aaual) (Budg&td Ein) 1. Education 216 430 (i1) Popang pmay educaon ad qread of lieac 30 40 (u) Educafio for mmziuin a 60 S0 (nii) Sepaon of punay swhoos from mmeooy hool SO SO (iv) Inprovwent in clm room - 100 (v) Elintion of 3rdnl iinswhoob 70 100 (vi) Boo and Nawspe for nmuntRin pupils a 1S (vii) bVIovrmn in econday schoob 6 25 (via) CorUter educon for ichools 20 2. Trining Prosgrm 10 105 (i) Impn vanat in thing m l N 10 15 (ii) Conmutr for schols 20 (iii) Uppgding basic marials 20 3. Medmm ad heakh psogVam 132 305.2 Oi UNICEF wer mipply psogrn for nwuntin rpg - 15.4 (ui) Anti-aslara progmam 52 70 (mii) Ani-oker pm 30 59.3 (tv) Inunuizatio prognra 15 25 (v) Anti-WI progrm 10 40 (vi) Upgrading mtrial baa 25 70 (vii) Esblishins heat e eam en in non-ezifat s 25.5 4. Proplation and famly plumig pWogm 93 225 3. Culurl nd information prop. - 30 (i Infonration an cukural actvitis for the cominwme - 10 CH) File maing, renovaion an developing - 10 (mi) Cult and hiial heriae rrdui- 10 6. Child cam 2 30 7. Job prgrun 300 250 B. &port for Kbhmr, Chai d othe minoite 10 30 9. Admiiration of bou y m g 30 42 10. Price swpport policy for qped cowmuoditi 170 250 11. Project 327; Rfomgtio 554 610 12. Aniiaocl evil. prow 60 70 (i) Arti-opia paMios 50 50 (ii) Abolion of pr&wtion 10 20 12 IEJT - 98 - 4.54 Local governments should have much more expenditure autonomy than at present. Investment decisions which affect only local communities should be decided locally, rather than centrally, as is the case at present. Similarly, since resources are limited, local governments should have greater autonomy to adjust local spending (on most items) to reflect local preferences and realities. Provinces might be allocated a sum of money with which to provide services assigned to their level. This sum should be determined based on available resources and a distribution formula which includes considerations such as population, cost of delivering services, per capita income etc. This broad approach may need repeated fine-tuning if it appears that the wrong variables, or not enough indicators, have been chosen. 4.55 One aspect of greater fiscal autonomy is the power to raise revenues. At present, the provinces can increase their spending only when the actual collection of revenues assigned to them exceeds the budgeted targets. As the tax department is not entirely within their jurisdiction, provinces thus have little flexibility in raising revenues. Moreover, the provinces do not have the right to determine the rates of any taxes. If provinces are to be able, within centrally determined limits, to determine the level and composition of their spending, they will need more independent revenue-raising authority. Of course, the power to levy taxes whose bases are mobile across different provinces should remain with the center, and local governments should be restrained from imposing taxes that will basically be exported to other areas. The basic principles of local revenue assignment are: (i) Local own-source revenues should ideally be sufficient to enable at least the richest local goverments to finance from their own resources all local services primarily benefiting local residents (as opposed to those with significant externalities such as education); and (ii) to the extent possible, local revenues should be collected from local residents only, preferably in relation to the perceived benefits they receive from local services. 4.56 When transfers are needed to finance local expenditures, they should provide incentives for local revenue mobilization and, as a rule, allow for some degree of equalization. The critical point is that local governments must, if they are to be held accountable for their actions, have some responsibility for determining tax rates. This would both allow them to vary rates to collect larger revenues to finance higher levels of public services if they so choose and at the same time allow the central government to design its transfers in such a way as to ensure that local fiscal efforts were not discouraged by the receipt of such funds. Vesting the provinces with at least some independent revenue-raising authority is essential to establishing a linkage between revenue raising and expenditure decisions at the margin. Tax administration is currently centralized (and creating local tax collection capacity at this time is unrealistic) and central collectors will have far greater incentive to collect central taxes rather than a separate local tax. Thus, as mentioned in Chapter 2, a promising option would be to permit local governments to "piggyback' onto national tax bases (i.e., add an additional rate to an already existing tax collected by the center). This would permit local govermments to collect additional revenue and enable the delivery of services which correspond to local preferences and abilities. 4.57 Of course, if local govermments are vested with the power to levy important taxes, inevitably richer provinces will collect larger revenues. To offset this disequalizing effect, as just noted, transfers can be designed to provide sufficient revenues to local govermments to carry out a 'standard* (minimum) set of local expenditure, as set for example by a revised method of determining expenditure needs, provided they levy taxes at average national rates. If they lower taxes below this level, they are not rewarded by higher transfers: the result is thus that local residents are penalized. If, on the other hand, they raise taxes above the required level, then total expenditures may be increased. The precise design - 99 - and implementation of such a transfer system would require further study, but it should certainly be feasible in Viet Nam, if desired. 4.58 Sensible local government decisions require a greater degree of stability and certainty in financial arrangements than now prevails. Uncertainty in revenues renders planning for the medium term difficult. In addition, larger revenue collections in a province in one year have typically resulted in higher targets for the next year and appear in at least some cases to result in a lower provincial share of turnover taxes. In Hanoi, for example, revenue collections in 1993 were higher than the previous year by over 50% and exceeded the budget estimates by 15 per cent. Much the same happened in 1992. Consequently, the share of turnover tax accruing to the city was reduced from 70% in 1992 to 36% in 1993 and was further reduced to just 6.3% in 1994. The new budget law should improve matters somewhat by introducing some stability in these tax-sharing arrangements. A more scientific method of forecasting revenues and expenditures would also be an improvement, although this too is a matter for further study. As in the case of transfers, simpler and more transparent arrangements in demining investment allocations are also needed. 4.59 Another area where reform seems needed is in regard to the special programs initiated by the center. Most of them are so small they seem unlikely to have any significant impact on anything. It would seem more sensible to focus on a few programs that might have an impact on poverty reduction. Providing family planning, and adult literacy, for instance, are programs that would appear useful from this perspective. Given the nationwide externalities from spending on human capital formation, provincial initiative in these areas may be encouraged by specific purpose matching grants. There may also be a place for such grants, at higher rates of subsidization, in mountainous regions and for ethnic minorities. If the provinces are given the right to levy and collect some taxes, introduction of specific purpose transfers with matching resource requirements can result in greater provincial participation and help to augment more resources for their special programs. The correct matching rate is, in this approach, set by the size of the spillovers. Basically, a matching grant program designed to encourage the optimal provision of public services should therefore vary primarily with the nature of the activity, that is, depending on the level of associated externalities. Since, however, no country has achieved full equalization of local fiscal capacities, a uniform matching level offering the same "price" to all local governments will yield non-uniform responses in rich and poor localities. Even if revenue bases are fully equalized, need or cost differentials may require an equalization element in matching grant formulas. For example, per capita grants for roads in sparsely populated and mountainous regions should as a rule be larger simply because the per capita cost of achieving any particular standard of road service will obviously be higher. 4.60 The evolution of intergovernmental fiscal arrangements should build on the existing system to the extent possible by minimizing its undesirable effects and imparting the necessary autonomy, incentives and accountability to various levels of government. The key elements in this process would include the following: * devolution of some independent revenue-raising authority to local governments, in particular, the right to set the rates of some local taxes; * creation of a more adequate method of resolving vertical and horizontal imbalance through revenue sharing arrangements and general purpose grants; - 100 - * identification of activities for which specific purpose transfers should be made and determination of the matching requirements that should be established for different provinces; * provision of adequate stability in intergovernmental fiscal arrangements. 4.61 A system along these lines should prove much more responsive to the changing needs of an emerging market economy while providing social and economic infrastructure in an efficient manner. On paper, Viet Nam currently has a highly centralized public sector; in practice, however, the way the system works is to produce unplanned decentralization which basically places the poorer provinces in a relatively weaker position. Moreover, local government in rural areas throughout Viet Nam have insufficient resources to provide key public services to their populations since the cost of providing these services has not been calculated and thus revenues are inadequate to deliver the services. More formal decentralization in a coordinated and coherent framework along the lines sketched above would be a substantial improvement and could prove a major step towards the implementation of more effective policies for poverty alleviation. C. Rural Flnance and Develonment Developing a Rural Financial System to Improve Access to Credit 4.62 With poverty heavily concentrated in rural areas, development of this sector is critical to poverty reduction in Viet Nam. Decentralization of certain public expenditures (investment and recurrent) and an improved system of intergovernmental finances would help local governments provide key public services in rural areas which would help households respond to market incentives and stimulate rural development. But households are greatly constrained by lack of capital. At present, there are features of the rural financial market - namely in the imposed interest rate structure and high access costs to obtaining credit - which limit the ability of households to borrow funds. Removing these constraints would help create the appropriate incentive structure which could both encourage households to save and invest, and enable and encourage rural financial institutions to lend. This section discusses the present situation in rural finance and explores what improvements could lead to greater access to capital for households and ultimately, a more vibrant rural economy. 4.63 With over 80% of Viet Nam's population residing in rural areas, agricultural activities account for a significant share of Viet Nam's employment, production, and exports. The sector has also played a lead role in the transition to a market-based economic system and in the formation of private farms. This transition has unleashed a major upward shift in the demand for capital in the private sector of agriculture, which has exceeded the capacity of the agricultural banks to respond. In this same interval the rural financial institutions also went through significant restructuring. At this juncture short-term credit for working capital dominates the type of financing offered through both the banks and informal lenders. Formal credit is severely rationed because of the inability of the banks to mobilize sufficient savings, and owing to interest rate controls exercised by the State Bank of Viet Nam (SBV). 4.64 As Viet Nam's poverty profile clearly indicates, the incidence of poverty is much higher in rural than in urban areas. Access to credit is commonly believed in Viet Nam to be a serious constraint - 101 - to poverty alleviation. Owing to inadequate collateral and high transaction costs (including travel and time), poor households have traditionally lacked access to formal credit, and have consequently relied on costly informal credit. Even with the heavy reliance on the informal sector, the credit gap in the rural sector is large and will likely remain that way until fundamental constraints are removed, competition is enhanced, and public confidence in the banking system is restored. 4.65 A system of rural credit delivery is continuing to evolve in Viet Nam from the old state bank structure (within which the Viet Nam Bank for Agriculture operated) towards a more diverse set of rural financing institutions. The VBA continues to play a major role in this changing structure, though several alternative private financial institutions have begun to emerge in rural Viet Nam. The strategy of the SBV is to license new institutions that will supplement the efforts of VBA. Foremost has been the replacement of the former rural credit cooperatives with private, rural shareholding banks (RSBs) and Popular Credit Funds (PCFs) during 1992-93. These new institutions face significant challenges; nevertheless, their emphasis on rural savings mobilization, more outreach and lower transaction costs, and access of the poorer households offers important lessons for rural financial development. Indeed, the VBA is beginning to learn this lesson as well, and has stepped up its outreach efforts for both savings and lending. 4.66 VBA. The VBA remains the dominant formal credit institution in rural Viet Nam. It maintains an extensive rural branch banking system which serves not only its primary role as a direct lender, but also that of an indirect lender through 'economic organizations' (such as cooperatives) and other rural financial institutions (such as the rural shareholding banks). Thus, the VBA exerts a strong influence on rural financial conditions. In August 1993, there were: 5 regional offices, 51 provincial branches, 413 district branches, and 150 sub-district (commune-level) branches. In addition the VBA created 995 'deposit-taking units" which operate at the commune level. Although the VBA is currently a universal bank with authority to lend in various sectors, it remains a highly specialized, agricultural bank with a loan portfolio that is dominated by short-term, production loans to farm households, with an average size of US$122. Overall, short-term loans represented about 90% of total VBA loans outstanding at end-1993. The VBA maintains a monopoly position in a large number of the rural districts. This suggests both a high level of credit risk exposure due to the implied high level of loan concentration in agriculture, and a lack of effective competition for the VBA in the rural areas. 4.67 There are a number of positive developments in the provision of rural credit through the VBA which generally reflect a shift away from financing the state-owned enterprises and towards financing private households and businesses: new loan volume to private borrowers grew from about D 355 billion in outstanding loans at the end of 1991 to about D 3,923 billion at the end of 1993. In 1992, the VBA provided credit to only about 9% of the potential private, rural borrowers in Viet Nam. Based on end-of-year 1993 loans outstanding, the corresponding percentage of households receiving credit through the VBA had increased to about 20% of rural households. 4.68 The VBA is beginning to develop greater operational efficiency and outreach through a rationalization of its rural network and innovations in rural lending. It has begun to experiment with the extension of banking services to rural areas through the establishment of sub-district transactions offices and the formation of mobile-banking teams which visit villages in the district on a frequent basis. The transactions offices appear to provide better access for rural households by allowing more frequent savings deposits and withdrawals and loan repayments. The mobile-banking teams are primarily used - 102- to initiate loan applications. The acal loan approvals and disbursements require the borrowers to visit a bank office for final loan signatures and the actual receipt of funds. So while these efforts are able to reduce the transaction costs of loans, the district-based lending still entails some access costs. 4.69 VBA's expanded programs are going in the right direction; nevertheless, they represent a rather fragmented approach to the general problem of insufficient rural financial services. The loan approval process places a heavy emphasis on collateral of the borrower and not the earnings and cash flows of the enterprise. The emphasis on collateral is in sharp contrast with the fact that: most loans are short-term; all loan transactions are in cash; and the default rate (the contingency for which loans are secured with property) is generally extremely low. A shift of lending orientation in the VBA and olher rural banks to cash flow and earnings-based lending is highly recommended. Other Rural cial Intitutn 4.70 Popular aedit funds (PCF). PCFs are commune-level credit institutions which were introduced during 1993 into 14 provinces (73 districts and 173 communes) on an pilot basis by the SBV. Since the VBA was unable to fill the void created by the failure of the rural credit cooperatives in 1990- 91, the creation of the PCFs was part of the SBV's strategy to increase the access of small farmers to production credit. The PCF scheme is modeled after the Caisse Populaire system in Quebec, Canada, and is built around a Central Credit Fund (with plans to eventually include a set of Regional Credit Funds at the provincial level). The Central Fund is to safeguard the local PCFs against the covariant risks to which they are exposed because of the local and highly specialized nature of their loan portfolios. The Central Fund receives 40% of its capital through the SBV and the balance through shares held by the local and regional units. The plan is to expand the scheme from 62 open local funds (out of 83 authorized funds in early 1994) to over 200 in 1995. 4.71 The scope of financing operations of the PCFs in early 1994 was quite limited - as were the funds they managed. The PCFs provide only short-erm credit through small working capital loans. The average loan size among PCFs visited in the north varied from 250,000 to D 1 million (the smallest loan reported was just D 50,000 - approximately USS 5). A majority of PCF loans are for farming activities such as crop production and livestock raising. The current credit market niche of the PCFs is to meet small farmer credit needs. Similarly, the credit shareholding cooperatives are oriented to small farms with a heavy emphasis on lending to the rural poor households in their service areas. In each case the service area is quite small which suggests that the funds will also remain small for some time. 4.72 Funding of the PCFs occurs primarily through member shares and deposits. This is a strong feature of the PCFs as rural financial institutions. Deposit growth was rapid at the onset of their operations, but still represented only about 60% of loans outstanding in February 1994. In aggregate the PCFs maintain extremely high lending positions at about 170% of their deposits and 90% of their total deposit and equity funds. However, even with those illiquid positions, the PCFs generate relatively modest operating profits because of controls placed on their deposit and lending rates by the SBV. The PCFs are allowed to lend at spreads of 1 %/month over their cost of funds. In addition to deposit funds the Central Credit Fund has reportedly loaned about D 5 billion to the PCFs at a rate of 2%/month and the PCFs were allowed to on-lend at 3%/month. - 103 - 4.73 The PCF system currently exhibits three features which are highly appropriate for rural credit in Viet Nam: local access of borrowers and savers through the control of transactions costs, risk- sharing across local lending units, and emphases on savings mobilization and loan repayment. As the system evolves, it will be characterized by numerous commune-level units because of the orientation to providing access for small, rural borrowers and savers to financial services. Future growth in the number of clients, the number of local PCFs (as the system expands to other provinces and districts), and the range of financial services are expected to create pressures within the PCF system to develop a set of intermediate-level institutions which can effectively deal with the administrative aspects of credit delivery, funds mobilization, and risk-sharing. Three alternative systems could be considered: a 3-level system including central (CCF), regional (RCF) and local (PCF) units; a 2-level system consisting of RCFs and PCFs with the role of the CCF redefined to be just the insurance and risk-management agency of the system; or a 2-level system where the CCF continues to operate as it does currently but the PCFs are reorganized into district-level units with commune-level offices for disbursement and collection. The second alternative provides some advantages over the other two schemes. First, it more clearly defines the unique role of the CCF with respect to system risk management. Second, it decentralizes the administrative functions of the CCF to the regional level without creating a third layer in the system. Thus, it is potentially more flexible, cost-efficient and competitive than a 3-level institution. 4.74 Rural shareholding banks (RSBs). RSBs have also been gradually taking the place of the old rural credit cooperatives in rural areas. The majority are located in the south and by the end of 1993 there were 44 RSBs licensed through the SBV. Their numbers have increased gradually over time: 5 (in 1991), 18 (in 1992) and 21 (in 1993). Since many of the RSBs have only recently been formed the ownership remains concentrated in the hands of a few large shareholders. RSBs that were visited reported about 50-60 shareholders with a few shareholders having large share positions. 4.75 In most cases the RSBs are focused on lending to farm households in their service areas. For example, in the south the primary emphasis of RSBs has been on rice crop intensification, land- leveling, and development of fruit gardens. The proportion of RSB credit flowing to rural traders and others is relatively small at approximately 15-20%. RSB loans carry short maturities and are generally of small average size (D 1-3 million). An additional feature of the RSBs is their relatively stronger emphasis on lending to poor rural households. Although the definition of a poor household varies somewhat across the country, the proportion of funds loaned by the RSBs to the poor significantly exceeds the proportion of poor households in the districts in which they operated. This is in contrast to the loan portfolios reported by the VBA district and provincial offices where the poor represented a minor borrower category. The RSBs have also been financial innovators. They have utilized joint-liability, group-based lending to rural borrowers and they have simplified their lending procedures. In addition they have attempted to expand savings mobilization by combining the savings and credit activities of their customers. 4.76 Large proportions (50-80%) of RSB funds are directly obtained from the VBA at rates of 2.6%/month. The RSBs onlend those funds to farmer households at 3.0%/month. In effect the RSBs are operating as service centers for the VBA and their dependency on the VBA for funds means that they do not effectively compete with the VBA. In fact, the RSBs report that they meet 10-30% of the estimated credit needs in their areas, which is nearly identical with the percentages quoted by the VBA districts. The funding problem of the RSBs emanates in significant part from the deposit interest rate limitations imposed by the SBV and the lack of access to financial markets. Savings mobilization efforts - 104- of the RSBs are also thwarted by the fact that the primary savers are traders, who represent a relatively small clientele of the RSBs. The emerging strategy of these RSBs is to expand the offering of shares to existng shareholders and traders to develop a larger financial base from which to lend. That strategy appears to be warranted given the small numbers of existing shareholders in these istitutions. 4.77 ATe RSBs are legitimate financial institutions and they will need greater access to funds in the future if they are to achieve their objective of extending the availability of credit and financial srvices to the rural population and provide a source of competition in those markets. The SBV should explore: (1) the development of aa interbank funds market with flexible interest rates and access provided for the RSBs and (2) the development of a system of correspondent banking to expedite the flow of funds and increase the capacity of RSBs to meet the demands of larger mral customers. Additionally, the SBV should consider providing direct access of the RSBs to an SBV rediscount facility so that the RSBs could expand their lending capacity and reduce their dependence on the VBA. Either or both of these measures could help to reease the severe funds constraint under which the RSBs currently operate. 4.78 Group lnding. Formation and utilization of group-lending programs has become fairly widespread within the VBA, RSBs, and PCFs. Group-lending appears to be well-suited to the set of social mores that exist at the commune level. In addition, those lending arrangements are socially consistent with the cooperative forms of credit insdtutions that formerly existed in the rural areas. Group lending often takes the form of joint-liability whereby full loan repayment is a collective responsibility of the group and existing loans must be fully repaid before any additional funds are provided. Borrower groups have been formed from members of the Women's Union, the Farmers' Association, veterans groups, etc. Group lending reduces the transaction costs associated with making and collecting many small loans, since groups provide some cost economie of size in the lending process. At this time the cost advantages of group transactions are being partially realized on the lending fide, but similar advantages would accrue to the institutions if groups were also used for sauvins mobilization. 4.79 Joint-iability, group-lending also potentially improves the access of the rural poor to credit, since joint-liability serves as a form of guarantee to the lender which reduces the importance of tangible collateral in the lending arrngement. While this benefit should accrue to the poor, in reality many groups still require member collateral (e.g., the house or personal property). There are indications that a significant percentage of the farmers have not been able to establish clear use rights to land because of disputed ownership and the inability of the Peoples' Committees to resolve those disputes quickly. While group-lending schemes generally improve the access of rural households to formal credit, the fundamental problem still remains that there is a severe rationing of formal credit in the rural areas. As a result, a borrower group frequently receives funds for only a fraction of the borrowing request it makes to the VBA and the balance must be found through avenues such as informal credit. 4.80 Informal fiance. Despite the VBA's emphasis on private household loans, and the growing importance of PCFs and RSBs, growth in demand for those loans continues to far out-distance the ability of the VBA and other formal nrual lenders to respond with funding. As a result, the informal credit market remains a significant source of credit in the rural areas. 4.81 Previousy, informal credit markets were suppressed in Viet Nam. The recent economic liberalization has, however, contributed to the resurgence of informal credit institutions and markets. The informal agents (moneylenders, relatives, merchants, and friends) are unregulated and unsupervised in -105 - their financing activities. The diverse financial agents which comprise the informal segment of the rural financial sector currently meet a significant part of the overall production and consumption financing requirements of the rural population. The recent Viet Nam Living Standards Survey (VNLSS) indicates that 72% of households which take loans, borrow from the informal sector, only 20% from the formal, private or government banks, and 6% from cooperatives. Since average loan size was nearly identical for informal and formal loans in the survey, the implication is that these percentages also approximately represent the loan market shares captured by the informal and formal segments - about 70% and 30%, respectively. 4.82 Informal lenders serve a very important role in the rural sector filling a critical gap created by VBA limitations. These include: * very high transaction costs due to ineffective operation in the more remote rural areas; * inadequate size of VBA loans necessitates gap filling with informal lending; * short maturity of VBA loans creates cash flow difficulties and necessitates informal borrowing as bridge financing to repay; * VBA loan collateral requirement creates a barrier to entry for some poor, rural households which lead them to informal lenders. 4.83 Despite efforts by the VBA and other rural financial institutions to expan4 access, informal lenders will remain an important source of rural, agricultural financing owing to the continuation of policy and capacity constraints on the government banls. 4.84 Rural interest rat.. The SBV sets reference interest rates for all financi institutions. The VBA, RSBs, and other formal lending institutions operating in the rural area onlend at rates that are derived from those reference rates. The basic structure of the SBV rates is one of increasing term structure on deposits, but an inverted term structure on loans. 4.85 Two problems arise out of the observed interest rate structure for VBA's loans. First, the observed variation in short-term loan rates is quite small given the likely differences in credit risk that are present between groups of short-term borrowers. For example the 2.7-3.0% range applies to farmer., traders, and processors - each of which pose quite different production and market-related risk for the VBA's loan portfolio. This observed small variation in short-term rates suggests that differences in credit risk are not being appropriatey evaluated by the VBA district offices, and training in credit evaluation procedures may be warranted. The interest rate guidelines of the SBV may also be creating an undesirable effect on the way in which short-term loan rates are applied. The 2.5%/month rate sets an artificial minimum on the short-term rate below which the VBA districts are hesitant to go, even though high-quality borrowers merit such lower rates. Thus, rates are typically varied only slightly above that rate level and do not reflect true credit quality spreads. 4.86 The second major issue is the inverted rate structure for medium-term loans. Clearly, the SBV's 1.2%/month reference rate on medium-term loans does not reflect maturity or credit risk premia, and acts as a barrier to more effective intermediation in the medium- and long-term segment of the rural - 106- credit market. Given that banks cannot mobilize long-term deposits at those low rates, lending short-term deposits on a medium-term basis at the SBV rate would result in a negative spread for the banks and expose them to potentially significant interest rate risk. Adding to this dilemma is the recent decrease of both short-term and medium-term interest rates by 0.3%/month. That decrease actually penalized the medium-term segment of the market more than the short-term segment, because it reflected a 20% reduction in the medium-term loan rate, but only a 14% reduction in the short-term loan rate. 4.87 Although there is variation in the interest rates which informal lenders charge, short-term (1-2 month) informal rates are usually reported to be in the 6-10%/month range or about 2-3 times the level of comparable VBA rates. The VNLSS results suggest that these rate relationships differ by maturity and by comparison with formal lenders. For example, informal lender monthly rates are comparable to private bank rates, but are about three times higher than the rate available at the government banks. The corresponding interest rates on 1-year loans place private bank loan rates at about the same level as informal rates, but informal loan rates are 5-6 times those at the government banks. Thus, there is greater dispersion in longer term loan rates than among short-term rates. This may be due to the lack of competition at the longer maturities. Adding to this dispersion is the fact that the SBV has enforced an inverted interest rate structure on government bank loans (so that medium- and long- term interest rates are lower than short-term rates) while informal rates reflect a more normal term structure. 1 4.88 Recommendations. The availability of medium- and long-term credit needs to be improved as part of an overall strategy to strengthen rural financial services. Long-term loan availability does not appear to be a collateral-based problem. Rather, the banks are hesitant to lend on terms which exceed their existing deposit maturities owing to uncertainty about interest rates. To address this problem the SBV needs to reconsider its existing interest rate policy which inverts the term structure of loan rates. The SBV and commercial banks need to develop a strategy for increasing the maturity of deposits and encouraging depositors to respond. Finally, the banks should consider ways in which to extend the maturity of short-term loans from their existing 3-4 month duration to periods of 9-12 months - particularly where livestock loans are involved. 4.89 Measures should be taken to increase the efficiency of financial intermediation in the rural financial sector by injecting greater competition and through innovations. Currently, the VBA dominates the sector and is not efficient in its operations. The PCFs are an innovation which should be expanded to other provinces according to the plan of the SBV. However, the strategy to develop a third layer of regional funds in the PCF system should be re-evaluated at this dynamic stage of institutional development. Growth and expansion of the PCF system should emphasize flexibility, cost-efficiency, and competitiveness. The SBV should assist the RSBs in their efforts to increase rural lending. The RSBs need an alternative to VBA financing and assistance in developing strategies for deposit mobilization. Access to a domestic inter-bank funds market would provide the RSBs with another source of loanable funds. As a second measure, the SBV should consider providing direct access of the RSBs to SBV refinancing facilities. If the PCFs and RSBs are lower cost providers of financial services (as expected), gains in the intermediation process associated with an expansion of activity by both financial institutions would accrue to the rural clients of the banks in the form of lower interest rates. 4.90 An innovation to gain operational efficiency would be for the banks to integrate their savings mobilization and credit delivery functions. The focus could be on a more effective use of rural client - 107 - groups. A second innovation would be to devise the means by which the RSBs could develop co- financing arrangements for rural borrowers where the loan requests exceed the lending capacity of an individual bank. A third innovation would be to develop ways in which to link the activities of the informal financing sector with those of the formal lending institutions. The primary advantage would be lower cost of credit delivery, particularly for small rural loans. A final efficiency measure would be to eliminate the role of the local Peoples' Committees in the credit approval process. Their role can be more effectively fulfilled by the banks, the courts, and the private sector. - 108 - STATISTICAL APPENDIX Page No. Table 1.1 Population ...................................... 109 Table 1.2 Population by Sex and by Province ...................... 110 Table 1.3 Total Employment by Sector, 1986-93 .................... 111 Table 2.1 National Income and Estimated GDP, 1986-91 ............... 112 Table 2.2 Gross Domestic Product by Industrial Origin at Market Prices, 1989-1993 ..................... 113 Table 2.3 Fixed Investment ......... ........................ 114 Table 2.4 State Investment Outlays in Industry ............... ...... 115 Table 2.5 State Investment Outlays in Agriculture .............. I ...... 116 Table 3.1 Balance of Payments, 1986-1993 ........................ 117 Table 3.2 Merchandise Exports by Commodity and by Destination, 19861993 .118 Table 3.3 Major Imports by Commodity and by Origin, 1986-1993 ............................ 120 Table 4.1 Monetary Survey, 1986-93 ........................... 122 Table 5.1 Summary of Budgetary Operations, 1986-93 ................ 123 Table 5.2 Government Revenue, 1986-93 ......................... 124 Table 5.3 Functional Classification of Current Expenditures, 1986-93 .125 Table 5.4 Economic Classification of Current Expenditures, 1986-93 ......................... 126 Table 5.5 Government Capital Expenditures, 1986-93 ................. 127 Table 6.1 Retail Price Index ......... ........................ 128 Table 6.2 Consumer Price Index by Commodity Groups ............... 129 Table 7.1 Agricultural Production ............................. 130 Table 7.2 Industrial Crop Production and Yields .................... 131 Table 7.3 Foodgrain Production and Yields ........................ 132 Table 8.1 Industrial Production and Number of State Enterprises ............................. 133 Table 8.2 Major Industrial Products ............................ 134 - 109 - Table 1.1: POPLTLATION Year Population Growth Rate ('000; mid-year) (%) 1975 48,030 2.57 1976 49,158 2.35 1977 50,295 2.31 1978 51,436 2.27 1979 52,574 2.21 1980 53,700 2.14 1981 54,722 1.90 1982 55,687 1.76 1983 56,655 1.74 1984 57,692 1.83 1985 58,868 2.04 1986 60,249 2.35 1987 61,750 2.49 1988 63,263 2.45 1989 64,774 2.39 1990 66,233 2.25 1991 67,774 2.33 1992 69,405 2.41 1993 70,918 2.18 Source: World Bank, Population and Health Department. Revised bsed on the 1988189 Census, and most recent data. Geneal Sticda Offee, Staical Data of the Socialist Republic of Viet Nam, 198-1991, Ststical Publishing Hous, 192. General Statistical Office, Economy and Finance of Viet Nam, 1986-1992, Statistical Publishing Houe, 1994. - 110 - Table 1.2: POPULATION DY SEX AND DY PROVINCE (thousad per}ns) 1992 1991 Population Region/Province Population Totel Male Female Ha Noi - Hai Phonf: Ha Noi 2.099.6 2,093.0 1.013.2 1,081.5 Hai Phong 1.556.6 1,516.8 733.0 7u3.8 Sub-Totl 3,656.2 3.611.8 1,746.2 1.865.6 Northern Mountaiuu: Ha Giang 507.2 489.9 243.5 246.4 Tuyen Quang 614.4 597.2 296.5 300.4 Cao Bang 614.5 591.5 2u.3 303.2 Lang Son 656.8 643.6 313.0 330.6 Lai Chau 485.7 467.6 230. 237.6 LAo Cai 517.7 491.5 241.1 249.7 Yen Bai 621.4 610.4 300.3 310.1 Bac Thai 1,117.8 1082.6 530.3 552.3 Son La 753.4 726.8 356.3 370.5 Hoa Binh 697.5 722.9 351.3 371.6 Vinh Phu 2.160.0 2.097.7 994.8 1.102.9 Ha Bac 2.218.4 2.172.9 1.039.0 1.133.9 Quang Ninh 878. 84J.2 426.7 421.5 Sub-Total 11,843.6 11.542. 5,612.1 5,930.7 Red River Delta: Ha Tay 2.177.5 2.130.0 1,004.5 1,125.5 Hai Hung 2.613.6 2,554.5 1.201.9 1.352.6 Thai Binh 1.740.6 1.705.4 800.7 904.7 Nam Ha 2.537.6 2,473.7 1,171.2 1.302.5 Ninh Binh 821.5 800.1 3U3.8 416.3 Sub-Total 9.390.8 9,663.7 4,562.1 $.101.6 North Central Cost Thanh Hoa 3.243.5 3,152.9 1.514.0 1.658.9 Nghe An 2,620.9 2.561.9 1.24$.5 1.313.4 Ha Tinh 1,265.8 1,234.5 5L.l 643.4 Quang Binh 71Lo 693.2 336.4 356.8 Quang Tri 507.4 490.8 234.0 256.8 Sub-Total 8,355.9 8,133.3 3,924.0 4.209.3 South Central Coast Thua Thien - Hue 950.4 92.9 441.5 479.4 Quang Nam - Da Nang 1.M.5 1.796.3 837.2 959.1 Quang Ngai 1,122.5 1090.4 509.9 580.5 Binh Dinh 1,339.6 1292.0 613.3 678.7 Phu Yen 01.7 670.5 325.7 344.8 Khanh Hoa 901.2 871.7 419.9 451.1 Nin hThuan 834.5 412.0 200.4 211.6 Binh Thuan 436.8 23.6 400.3 423.3 Sub-Total 8.150.2 7.77.4 3I748.2 4.129.2 Central HiaMands: Gi Lai 713.6 773.8 32S 391.5 Kon Tum 241.1 149.8 74.3 75.5 Dac Lac 1.126.9 1,072,3 556.4 515.9 Lam Dong 722.3 693.0 339.6 353.4 Sub-Total 2,t03.9 2.68.9 1,352.6 1.336.3 Ho Chi Minh City and Enviros: Ho Chi Minh City 4.181.6 4.075.7 1.919.3 2,156.4 Song Be 1.057.4 1,017.0 497.1 519.9 Tay Ninkh 84.5 877.0 396.9 430.1 Dong Nai 1,721.6 1.742.4 817.6 5$.8 Bari& - Vung Tau 636.4 532.1 269.8 262.3 Sub-Total 8,445.5 *.194.2 3.940.7 4.253.5 Mekone Delta: Long An 1.,1.4 1,177.1 576.8 600.3 Dong Thap 1.433.t 1,401.6 662.1 739.5 An Giang 1.a568 1.849.7 905.1 944.6 Tien Giang 1.590.2 1,157.4 733.6 23.8 Ben Tre 1.2".1 1.264.3 600.6 663.7 Vinh Long 1,023.2 1,003.9 474.5 529.4 Tr Vinh 919.2 901.1 425.8 475J3 Can Tho 1.741.7 1,695.0 812.8 32.2 Soc Trang 1.146.3 1.123.9 54.3 59.6 Kien Giang 1.296.5 1.266.0 610.0 656.0 Minh Hai 1,682.1 1.642.6 7u.9 u3.8 Sub-Total 15.214.3 14.52.6 7.124.4 7.755.2 Grand Total 0.40$,) 67.774.0 33209.1 34 46 uCc: DI.M do not sad i 5u ed total, 1 s o. pommbia keIual. d ofmilitN . .. Sorec 1992: Geactl Sulllakl O0.ce im y _d Plsa dVIc Na sn. 3969.1994: 3991: maigicl Yeaok. 1991. - ill - Table 1.3: TOTAL EMPLOYMENT BY SECTOR, 1986-93 (rhousands of Perons) Rev. Prel. 1986 1987 1988 1989 1990 1991 1992 1993 Total Employed Labor Force 27,399 27,968 28,477 28,941 30,294 30,974 31,819 32.716 State Sector 4,028 4,091 4,052 3,101 3,421 3,144 2,975 2,923 Cooperatives 19,730 20,283 20,658 19,750 20,414 18,071 18,629 Private 3,641 3,594 3,768 5,390 6,459 9,759 10,215 Stat Soctor Employm 4,028 4,091 4,052 3,801 3,421 3,144 2,975 2,923 (by unit) Government 1,369 1,383 1,359 1,295 1,241 1,228 1,194 1,185 Central 343 337 327 282 253 279 264 262 Local 1,026 1,046 1032 1,013 988 949 930 923 Stat Enterpris. 2,659 2,708 2,693 2,506 2,180 1,916 1,781 1,738 Cetral 1,278 1,226 1236 1,188 1,091 1,018 978 956 Local 1,380 1,482 1457 1,318 1,089 898 803 782 Employment by Sector Productive Sector 25,553 26,054 26,497 27,061 28,328 28,973 29,783 30,591 Industry 2,918 3,047 3,150 3,241 3,392 3,394 3,450 3,522 Consruction 883 825 856 795 818 820 825 848 AgriCAdture 19,798 20,246 20,446 20,698 21,689 22,276 22,998 23,684 Forestry 178 173 211 197 206 207 210 214 Transportation 450 429 443 455 476 480 484 496 Telecommunications 38 42 40 40 37 47 51 51 Trade and Supply 1,259 1,268 1,331 1,606 1,681 1,719 1,735 1,776 Other 31 24 21 29 30 30 30 Non-Productive Sector 1,846 1,915 1,980 1,880 1,965 2,001 2,037 2,125 of which: Science 64 57 60 60 53 49 48 48 Education 706 750 830 768 863 804 825 848 Arti nd Culture 38 46 45 43 45 46 46 46 Public Hedth 300 297 305 288 303 309 318 327 Finance, Inurance, State Management and Othen 273 289 247 721 701 793 799 856 Note: Figures are rounded. Source: Gnerad Statistical Office. - 112 - Table 2.1: NATIONAL INCOME AND ESTIMATED GDP, 1986-1991 (Billion of Dong at 1982 Price) 1986 1987 1988 1989 1990 1991 Agriculture 84.6 84.8 88.3 95.5 96.9 96.8 Forestry 1.4 1.7 1.7 1.7 1.8 1.9 Industry 48.4 52.6 57.7 56.3 58.2 61.1 Commerce 23.4 24.3 25.9 26.7 27.9 29.4 Transport and Communications 3.1 3.5 3.5 3.2 3.4 3.7 Construction 5.0 5.3 5.2 5.4 5.7 6.0 Other 3.6 3.7 3.9 3.9 4.1 4.2 Ntional Income a/ 169.6 178.7 190.3 194.1 199.6 206.0 Non-Material Service and Depreciation b/ 61.1 61.0 61.6 77.9 87.0 95.0 GDP at 1982 Prices c/ 230.7 239.7 251.9 272.0 286.6 301.0 GDP at Current Price. cJd/ 636.0 3,099.0 13,266.0 28,135.0 41,848.0 76,707.0 Implicit GDP Deflator 2,757 12,929 52,664 103,438 146,015 254,841 (1982 = 100) e/ (Paeentg Change) Nadtionl Income 3.3 5.4 6.5 2.0 2.8 3.2 Agriculture 1.4 -3.4 4.7 7.5 1.5 -0.1 Industry 4.6 8.6 9.8 -2.5 3.3 5.1 Note: In 1989, the General Ststscal Office (SO) insttuted the United Naion' System of Natona Accounts (SNA). The Material Product Sygtem (MPS) is no longer available. The SNA eries are presented In Table 2.2. Figures are rounded. a/ The tem 'natonal income' refers to the MPS. The basic difference with the United Nations' SNA is that the MPS does not include non-material services or depreciation. b/ Includes etimate of unreported economic activitie. c/ Bank staff estimte. dl New Dong. e/ Proxied by average increae in consu prices. Source: General Statiical Office, Statstc Data of the Socialist Republic of Vietnam, 1976-1990, Hanoi: Statsical Publishing Houae, 1991 and Bank staff catimate. - 113 - Table 2.2: GROSS DOMESTIC PRODUCT BY INDUSTRIAL ORIGIN AT MARKET PRICES, 1989-1993 (Billions of Dong) Rev. Rev. 1989 1990 1991 1992 1993 (in 1989 Prices) Goods Agriculture and Forestry 11471 11641 11894 12751 13235 Industry 5366 5499 6042 6925 7766 Construction 1077 1128 1186 1317 1558 Other Production 347 360 370 381 399 Services Transport and Communications 709 743 792 842 897 Trade 3311 3485 3654 3877 4109 Finance, Insurance, and Banking ) .. 368 448 496 578 State Sector ) 5855 2627 2841 3040 3322 Other Services ) .. 3667 4059 4362 4871 Groas Domestic Product 28135 29529 31286 33991 36735 Growth RatC 8.0% 5.0% 6.0% 8.6% 8.1% (Billions of Current Dong) Goods Agriculture and Forestry 11471 15625 30314 36468 39998 Industry 5366 8169 15193 23956 29371 Construction 1077 1929 3059 6179 9423 Other Production 347 356 744 1045 1476 Services Transport and Communications 709 1330 2860 4662 6036 Trade 3311 5576 9742 15281 17549 Finance, Inurance, and Banking ) .. 710 1108 1567 2318 State ScCtor ) 5855 4084 6807 9718 14402 Other SCrvices ) .. 4151 6880 11659 15998 Grom Domestic Product 28135 41848 76707 110535 136571 48.7% 83.3% 44.1% 23.6% Note: In 1919, the 4eneml Statistical Office (OSO) instituted the United Nations System of Natiosl Accounts (SNA). The SNA eries pmeseted here are based on the most current officii version. Since these ries ar new. they bave been going through everal estimates and are still being revised and Improved. This is the series as of May 12, 1994 Source: General Statistical Office and Bank Staff estimates. - 114 - Table 2.3: FIXED INVESTMENT 1986 1987 1988 1989 1990 1991 1992 (Billions of Dong) Gross Fixed Investment 20.56 16.02 16.80 17.53 19.60 21.76 30.46 (Percent of National InCome) 12.1 9.2 9.1 9.0 9.9 By Type of Management A. Central 12.10 9.40 10.80 12.31 11.60 13.07 19.96 B. Local 8.46 6.62 6.00 5.22 6.50 8.69 10.50 By TVye of Outlay A. Construction Assembly Works 14.98 11.97 12.59 12.19 14.82 14.53 21.69 B. Machinery & Equipment 2.96 2.43 2.60 3.04 2.88 5.51 5.76 C. Other 2.62 1.62 1.60 2.31 1.90 1.72 3.01 By Sector A. Productive Sector 16.70 12.79 14.38 14.82 15.36 18.06 25.73 a. Industry 7.34 6.98 7.77 8.80 7.53 9.57 14.67 - Heavy InduStry 5.47 5.25 .. .. - Light Industry 1.86 1.72 .. .. b. Agriculture & Forestry 5.03 3.21 3.82 2.73 3.35 3.41 3.86 c. Transportation & Communications 3.32 1.85 2.27 2.80 3.92 4.47 6.77 d. Other 1.01 0.75 0.52 0.49 0.57 0.61 0.43 B. Non-Productive Sector 3.86 3.23 2.41 2.71 5.63 3.71 4.73 a. Housing and Community Services 1.76 1.32 0.95 1.10 1.68 1.08 1.33 b. SciencC, Education, Public Health and Social Welfare 1.32 1.29 1.24 1.32 2.12 2.04 0.96 C. Other 0.79 0.62 0.22 0.28 0.44 0.59 2.44 (Percentage) Gross Fixed Investment 100.0 100.0 100.0 100.0 100.0 100.0 100.0 By TYPe of Management: A. Central 58.9 58.7 64.3 70.2 59.2 60.1 65.5 B. Local 41.1 41.3 35.7 29.8 33.2 39.9 34.5 By Type of OUtlay: A. Construction Assembly Works 72.9 74.7 75.0 69.5 75.6 66.8 71.2 B. Machinery & Equipment 14.4 15.1 15.5 17.3 14.7 25.3 18.9 C. Other 12.8 10.1 9.5 13.2 9.7 7.9 9.9 By Scctor: A. Productive SeCtor: a. Industry: 35.7 43.5 46.3 50.2 38.4 44.0 48.2 - Heavy Industry 26.6 32.8 .. .. - Light Industry 9.1 10.8 .. .. b. Agriculture & Forestry 24.5 20.1 22.8 15.6 17.1 15.6 12.7 c. Transportation & Communications 16.2 11.6 13.5 16.0 20.0 20.5 22.2 d. Other 4.9 4.7 3.1 2.8 2.9 2.8 1.4 B. Non-Productive SeCtor: a. Housing and Community Services 8.5 8.2 5.7 6.3 8.6 5.0 4.4 b. Science, Education, Public Health and Social Welfare 6.4 8.1 7.4 7.5 10.8 9.4 3.2 c. Other 3.8 3.9 1.3 1.6 2.2 2.7 8.0 Note: a/ Official priccs at wvhich investment expenditues are calculated. Theme are somewhat higher than the 1982 fixed prices, but do not fully reflect price developmens in the economy. Figures are rouDded. Source: General Statistical Office and 0so, Statistical Data of the Socialist Republic of Vietnam, 1976-1990, 1991, 1992 - 115 - Table 2.4: STATE INVESTMENT OUTLAYS IN INDUSTRY 1986 1987 1988 1989 1990 1991 1992 (Millions of Dong at 1982 Prices) Grou Fixed Investment 7522.0 6719.7 7629.7 8654.4 7415.3 9397.3 14667.2 Energy & Combustibles 3809.0 3788.0 4142.9 5857.9 4268.9 4537.0 9591.7 Metallurgical 67.0 71.6 83.9 8.1 205.7 216.1 154.6 Machinery 540.0 285.6 320.4 387.0 184.0 202.2 132.1 Chtmical Industry 376.0 512.1 892.7 618.2 692.5 413.0 369.6 Contruction Material, Earthenware, Porcelain, Glassware, Wood Products, Cellulose Paste and Paper Products 873.0 734.0 808.7 821.1 578.1 1430.3 1269.6 Food and Foodstuffs 898.0 735.0 503.6 353.5 734.4 1075.4 1212.4 Weaving, Leather, Sewing, and Dyeing 446.0 289.0 488.3 283.6 249.0 420.3 513.0 Printing and Cultural Products 29.0 20.3 15.3 13.1 97.4 24.2 711.1 Other Industries 484.0 284.1 373.9 311.8 405.3 1078.8 713.1 (Percent) Gross Fixed Investment: 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Encrgy & Combustibles 50.6 56.4 54.3 67.7 57.6 48.3 65.4 Metalurgical 0.9 1.1 1.1 0.1 2.8 2.3 1.1 Machinery 7.2 4.3 4.2 4.5 2.5 2.2 0.9 Chemical Industry 5.0 7.6 11.7 7.1 9.3 4.4 2.5 Contruction Matcrial, Earthenware, Porcelain, Glassware, Wood Products, Ccllulosc Paste and Paper Products 11.6 10.9 10.6 9.5 7.8 15.2 8.7 Food and Foodstuffs 11.9 10.9 6.6 4.1 9.9 11.4 8.3 Weaving, Leather, Sewing, and Dyeing 5.9 4.3 6.4 3.3 3.4 4.5 3.5 Printing and Cultural Products 0.4 0.3 0.2 0.2 1.3 0.3 4.8 Other Industries 6.4 4.2 4.9 3.6 5.5 11.5 4.9 Source: General Statistical Office. Table 2.5: STATE INVESTMENT OUTLAYS IN AGRICULTURE 1986 1987 1988 1989 1990 1991 1992 (Billions of Dong at 1982 Prices) Gross Fixed Investment 4.533 3.213 3.823 2.734 3.352 3.406 Detailed Composition Agriculture 1.535 1.574 1.595 2.176 2.966 2.974 Irrigatior. 2.515 1.346 1.631 .. .. Forestry 0.483 0.293 0.597 0.559 0.386 0.432 Note: For 1988 and 1989, theme is no dat in 1982 prkce, so dhares from current price data are usd. Source: General Statisdical Offlce mad Statiscal Data of the Socialist Republic of Vietnam. 1976-1990, 1991, and 1992. -117- Table 3. 1: BALANCE OF PAYMIENTS. 1986-193 Rev. 1986 1987 i988 1989 1990 1991 1992 1993 I/ (US$ million) Exports, Total 494 610 733 1320 1731 2042 2475 2850 Convertible Area 307 430 465 977 1305 1855 2475 2850 Non-Convertible Area 187 150 268 343 426 187 Imports, Total -1121 -1184 -1412 -1670 -1772 -2105 -2535 -3505 Convertible Area -453 -465 403 -985 -1208 -1846 Non-Convertible Area -667 -719 -809 -68s -564 -259 Trade Balance -627 -575 -679 -350 -41 -63 -60 -655 Convertible Area -146 -35 -138 -9 97 9 Non-Convertible Area -480 -540 -541 -341 -138 -72 Services and Transfers -28 -49 -72 -237 -218 -69 51 -214 Interest Payments -68 -58 -146 -208 -238 -248 -282 -327 Imputed Interest on Arrears -26 -36 -7 .. - - PrivateRemittcancs 30 10 4 9 50 36 Freight and Insurance 1 -2 ..- Official Transfers 27 17 13 .. 88 55 64 194 Others 9 20 63 -38 -11 88 as 330 Current Account Balance -655 -624 -751 -586 -259 -132 -8 -869 Convertible Area -174 -84 -196 -218 -121 -60 Non-Convertible Area -480 -540 -555 -368 -126 -72 Capita Account Balance 363 378 405 300 122 --60 271 -161 Disbursements 517 574 727 763 233 65 487 241 Convertible Area 10 28 60 87 . Non-Convertible Area 507 546 667 675 . Scheduled Amortizations -265 -233 -363 -350 -279 -256 -435 -644 Convertible Area -237 -166 -197 -134 . Non-Convertible Area -27 -67 -166 -216 . Amortization of Debt Relief . . . . . Short Term LoLns (Not) III 37 41 -213 48 -89 -41 -58 Direct Foreign Inve-stment .. . . 100 120 220 260 300 Errors and Omissions -23 -51 26 67 -6 142 5 -76 OveraUl Balance -315 -297 -320 -220 -142 -50 268 -1106 FinanciaL. 315 297 320 220 142 50 -268 1106 Change in NFA (excl. IM)2 . .. -110 -159 -276 -463 527 IMF Credit (Not) -4 . ..-6 -39 Gold Revaluation.. . * * Debt Rescheduling .. . . 34 . Change in Arrears 317 297 320 296 301 332 195 617 Memorandum Items: Transferable Rubles per US$ 2.55 2.55 2.40 2.40 2.40 2.40 Note: Figures are rounded. II Figures for 1993 are preliminary. Source: Data provided by the Vietinames authorities and Bank staff estimates. - 118 - Table 3.2: MERCHANDISE EXPORTS BY COMMODITY AND BY DESTINATION, 1986-93 Rev. 1936 1917 198S 1989 1990 1991 1992 1993 (USS Million) Total Exwrts 494 610 733 1.320 1.732 2.042 2.475 2.850 Convertible Area 307 430 465 977 1.257 2.024 2.475 2.850 Rice .. .. .. 316 272 225 300 340 Quantity (000 tona) .. .. .. 1,405 1,455 989 1,860 1,700 Unit Value (USS/ton) .. .. .. 225 187 228 161 200 Petroleum .. 30 79 200 390 581 756 799 Quantity (000 tons) *- 235 680 1,517 2,600 3,917 5,400 6,150 Unit Value (USS/ton) .. 128 116 132 150 148 140 130 Coal 29 10 13 21 38 48 47 70 Quantity (000 tons) 550 182 650 S46 1,075 1,173 1,580 2,000 Unit Value (USS/ton) 53 55 20 38 35 41 30 35 Rubber 2 6 6 14 16 50 54 68 Quantity (000 tons) 6 6 6 20 20 63 68 85 Unit Value (USS/ton) 333 1,000 1,000 700 800 789 800 800 Tea 4 2 3 3 2 14 16 20 Quantity (000 tons) 2 2 3 3 2 10 13 16 Unit Value (USS/ton) 2,000 1,000 1,000 1,000 1,000 1,370 1,231 1,250 Coffee 2 24 25 31 25 74 86 104 Qutity (000 tons) 5 12 16 36 28 94 96 115 Unit Value (USS/ton) 400 2,000 1,563 861 893 795 900 900 Marine Products 95 113 124 133 220 285 302 378 Quantity (000 tons) I 1 12 13 15 29 67 72 90 Unit Value (USS/ton) 8,636 9,417 9,538 8,867 7,586 4,254 4,194 4,200 Agriculture&Forestry 110 138 197 211 203 440 434 492 Products of which: * Cashew Nut .. .. .. .. 13 26 41 42 Quantity (000 tons) .. .. .. .. 25 30 52 53 Unit Value (USS/ton) .. .. .. .. 508 850 799 792 0 Meat .. .. .. .. 28 45 21 26 Quantity (000 tons) .. .. .. .. 16 25 12 15 Unit Value (US$/ton) .. * Pepper .. .. .. .. 12 18 15 15 Quantity (000 tons) .. .. .. 9 16 22 20 Unit Value (USS/ton) .. HandicraftR I Light 65 30 18 20 20 224 321 400 Indusrial Goods of which: * Textilcaand Garmets .. 240 156 .. 20 156 221 350 Others .. 77 .. 28 71 83 158 200 - 119 - Table 3.2: MERCHANDISE EXPORTS BY COMMODITY AND BY DESTINATION, 1986-93 (Continued) Rev 1986 1987 1988 1989 1990 1991 1992 1993 (Mllions of Transferable Rubles) 4on-Convertible Area 480 450 644 824 1.139 43 Coal 5 2 2 2 .. Quantity (O0O tons) 202 118 S0 29 .. Unit Value (T.R.lton) 25 17 40 69 .. Rice .. .. .. 4 39 9 Quatity (000tons) .. .. .. 20 170 44 Unit Value (T.R./ton) .. .. 200 229 209 Rubber 28 22 26 30 .. Quanfity (000 tons) 30 35 32 38 .. Unit Value (T.R./ton) 933 629 813 789 .. Tee 13 14 4 19 .. Quantity (000 ton) 9 8 3 12 .. Unit Value (T.R.hton) 1,444 1,750 1,333 1,583 .. Coffee 14 4 7 43 60 2 Quantity (000 tons) 13 15 14 20 30 1 Unit Value (T.R.lton) 1,077 267 500 2,150 2,000 2,000 Marine Products 12 .. .. .. Agriculture & Foreetry 105 160 205 260 285 Products Others 303 248 400 466 755 32 ource: [MF snd World Bank, from data provided by the Vietbnee authorities. - 120 - Table 3.3: MAJOR IMPORTS BY COMMODITY AND BY ORIGIN, 1986-93 Rev. Rev. 1986 1987 1988 1989 1990 1991 1992 1993 (IJSS Million) Total Imports 1.121 1.184 1.412 1.670 1.772 2105 2,535 3.505 From the Convertible Area 453 465 603 985 1,431 1.859 2.535 3,505 Petroleum .. .. .. .. 356 485 615 716 Quantity (000 tons) .. .. .. 2,400 2,572 3,075 3980 Unit Value (USS/ton) .. .. .. 148.3 188.6 200.0 179.9 Fertilizers 94 98 72 46 210 246 320 150 Quantity (000 tons) 686 702 400 506 2233 2425 1600 1020 Unit Value (US$/ton) 137.0 139.6 180.0 90.9 94.0 101.4 200.0 147.1 Steel 96 157 271 na 23 25 104 150 Quantity (000 tons) 320 380 453 n 200 113 260 500 Unit Value (USS/ton) 300.0 413.2 598.2 n 115.0 221.2 400.0 300.0 Machine- and Spare Parts .. .. .. .. .. .. 100 549 Others 263 210 260 939 842 1103 1396 1940 of which: * Cotton Textiles .. .. .. .. 102 32 23 40 Quantity (Mil. mt) .. .. .. .. 23 29 25 30 * Raw Cotton .. .. .. .. 38 61 13 16.5 Quantity (000 tons) .. .. .. .. 62 32 10.6 12 *Wheat .. .. .. .. 32 36 59 62 QuanUty (000 tons) .. .. .. .. 116 150 283 300 * Car and Trucks .. .. .. .. 50 12 39 60 Quantity (number) .. .. .. .. 5240 1320 3502 5000 ' Sugar .. .. .. .. 3 5 4 5.5 Quantity (000tons) .. .. .. .. 60 14 13 20 ' MSG .. .. .. .. 40 45 53 55 Quantity (000 tons) .. .. .. .. 24 30 38 40 - 121 - Tablc 3.3: MAJOR IMPORTS BY COMMODITY AND BY ORIGIN, 1986-93 (Continued) 1986 1987 1988 1989 1990 1991 1992 1993 Memo Item: (Millions of Transferable Rubles) Non-Convertible Area 1 702 1.726 1942 1.643 1.353 621 Petroleum Products 492 531 556 449 288 Quantity (000 tons) 2,028 2.100 2,200 2,305 1,320 Unit Value (T.R./ton) 242.6 252.9 252.7 194.8 218.2 Cotton Textile 25 23 21 20 23 Quantity (Mil. meter) 32 29 27 29 30 Unit Value (T.R./metcr) 781.3 793.1 777.8 689.7 766.7 Fertilizers 321 327 328 380 193 24 Qatity (000 tons) 2,059 2,100 2,120 2,450 1,072 182 Unit Value (T.R./ton) 155.9 155.7 154.7 155.1 180.0 131.9 Raw Cotton 53 62 65 75 91 Quantity (00 tons) 41 48 50 52 62 Unit Value (T.R./ton) 1,292.7 1,291.7 1,300.0 1,442.3 1,467.7 Steel Products 71 72 a8 104 55 17 Quantity (OO tons) 282 285 350 373 200 62 Unit Value (T.R./ton) 251.8 252.6 251.4 278.8 275.0 274.2 Sugar 8 12 7 10 8 Quantity (OOOtons) 55 85 50 70 60 Unit Value (T.R./ton) 145.5 141.2 140.0 142.9 133.3 Others, unclassified a/ 732 699 877 605 695 580 Note: a/ Consists mainly of capital and intermediat goods. Source: RMF, from data provided by the Victnamee authorities. - 122 - Table 4.1: MONETARY SURVEY, 1986-93 Prd. 1986 1987 1913 199 1990 1991 1992 1993 (Billions of Dong; End of Period) Foreign Asts (Not) -23 210 284 1004 2626 3503 10593 5610 Nd Donmtic Auab 135 261 2285 6417 3731 11798 16550 26678 of which: Domestc Cradt 153 532 2633 6717 9960 14112 17122 27166 Oovernat (Not) 19 S0 669 2600 4032 3956 1913 3957 Non-Financial Public Enterprises 117 376 1709 3606 5308 9129 12439 15511 Cooperadve. 13 44 171 511 620 1026 2770 7698 Private Busine"as and Househlds 4 32 84 .. .. Other tems (Net) -18 -271 -348 -301 -1229 -2314 -572 -488 Tota LLquidty (M2) 111 471 2569 3S75 11357 20301 27144 32289 Currncy Outsde Banks 55 205 1024 2352 373S 6419 10579 14218 Dcposs (in Doag) 54 237 1303 4127 3943 5528 3352 10665 Deposib (in foreign currancy) 1 29 242 2096 3680 8354 8213 7406 (Chage in Pecnt from Previous Year) Forcign Ads (Not) 210.3 15.7 28.0 18.9 51.7 10.3 -18.4 Domestc Credt 342.1 446.6 159.0 37.3 36.6 14.8 37.0 Govenmen (Not) 55.1 125.3 75.1 16.7 -0.7 -10.1 7.5 Non-Financial Public Entorprises 233.9 2S3.3 73.8 19.8 33.6 16.3 11.3 Cooperative 21.0 27.0 13.2 1.3 3.6 8.6 18.2 Privat Businees and Housholds 25.2 11.1 -3.3 .. Total Liquidty (M2) 324.6 446.1 233.7 32.4 78.7 33.7 19.0 of which: Currmcy Outside Banks 134.6 174.3 51.7 16.1 23.6 20.5 13.4 Memorandum Items: Savings Deposis (Billions of Dong) 7.0 53.0 152.0 .. .. Currency a//ODP Rao b/ 4.1 4.4 4.2 6.6 6.0 5.9 Liquidity (}M2)iDP Ratio bl 8.2 10.0 10.5 24.2 18.2 18.8 Domenic Credia/ODP b/ 11.3 11.3 10.8 19.0 16.0 13.0 Note: Figure re rounded. a/ Currenq In circulation. b/ GDP in Drher 1989 pricea. Source: State Bank of Vitnam and IMF estimate. - 123 - Table 5.1: SUMMARY OF BUDGETARY OPERATIONS. 1986-93 Actual Rev. 1986 1987 1988 1989 1990 1991 1992 1993 (Bilions of Dong) Revenue 84 379 1740 3899 6153 10353 21023 30500 Tax Revenue 18 68 451 1099 1698 2814 5480 11016 Transfer fromStetcEnterprises 60 285 1110 2244 3620 6189 11913 16085 Other Non-Tax Revenue 5 27 179 556 835 1080 2782 2401 Grants .. .. .. .. .. 270 848 998 Current Expenditure (cxc. Interest) 82 393 2141 4338 6156 8728 15452 25700 Wagea and Salaries 6 30 255 1290 1744 2001 .. 8921 Subsidics 18 151 812 .. .. Other 58 212 1074 3048 4412 6727 .. 16779 of which: Operaion and Maintenance 20 57 80 245 290 428 .. 595 Capital Expenditure 38 120 673 1626 2124 2135 6450 9600 OveraU Prunary Balance -36 -134 -1074 -2065 -2127 -510 -879 -4800 Interest (Scheduled) b/ 1 2 26 817 1242 2333 3218 3675 Interest (Paid) b/ .. .. .. 48 310 650 1000 1710 OveraU Balanec (Accral Basis) -37 -136 -1100 -2882 -3369 -2843 -4097 -8475 Overall Balance (Cash Basis) -37 -136 -1100 -2113 -2437 -1160 -1879 -6510 Financing 37 136 1100 2113 2437 1160 1879 6510 Foreign Grants and Loans (Net) ce 14 43 370 414 1264 767 2673 1925 Utilization .. .. .. 1073 1860 1335 3481 3158 Short-Term .. .. .. .. .. Medium- and Long-Term .. .. .. .. .. Amortization .. .. .. 659 596 568 808 1233 Domestic Loans (Net) 23 92 467 1700 1173 393 -794 4585 State Bank (Net) 23 89 450 1931 832 689 -2208 2044 Government Securities (Net) 0 3 17 -231 341 -296 1414 2541 Gros Issue 0 3 .. .. .. Amortization 0 .. .. .. .. Arrears .. .. 263 .. .. (Percent of GDP) Revenue 13.2 12.2 11.3 13.8 14.7 13.5 19.0 22.3 Tax Revenue 2.9 2.2 2.9 3.9 4.1 3.7 5.0 8. I Transfers from State Enterprises 9.5 9.2 7.2 8.0 8.7 8.1 10.8 11.8 Other Non-Tax Revenue 0.8 0.9 1.2 2.0 2.0 1.4 2.5 1.8 Current Expenditure (exc. Interest) 12.9 12.7 14.0 15.4 14.7 11.4 14.0 18.8 Wages and Salaries 0.9 1.0 1.7 4.6 4.2 2.6 Subsidies 2.9 4.9 5.3 0.0 0.0 0.0 Other 9.2 6.8 7.0 10.8 10.5 8.8 of which: Operation and Maintenance 3.2 1.8 0.5 0.9 0.7 0.6 Capital Expenditure 5.9 3.9 4.4 5.8 5.1 2.8 5.8 7.0 OveraU Primary Balance -5.7 -4.3 -7.0 -7.2 -5.1 -0.7 -0.8 -3.5 Interest (Scheduled) b/ 0.2 0.1 0.2 2.9 3.0 3.0 2.9 2.7 Interest (Paid) b/ 0.2 0.7 0.8 0.9 1.3 Overall Balance (Accrual Basis) -5.8 -4.4 -7.2 -10.2 -8.1 -3.8 -3.7 -6.2 Overall Balance (Cash Basis) -5.8 -4.4 -7.2 -7.5 -5.8 -I.5 -1.7 -4.8 Financing 5.8 4.4 7.2 7.5 5.8 1.5 1.7 4.8 Foreig Grant and Loans (Net) c/ 2.2 1.4 2.4 1.5 3.0 1.0 2.4 1.4 Domestic Loans (Net) 3.6 3.0 3.0 6.0 2.8 0.5 -0.7 3.4 State Bank (Net) 3.6 2.9 2.9 6.8 2.0 0.9 -2.0 1.5 Government Sccurities (Net) 0.0 0.1 0.1 -0.8 0.8 -0.4 1.3 1.9 Arrears .. .. 1.7 .. .. Notc: a. For 1916-U, fiures include mortization. Source: Minhstfy of FinaCe and sff estimtat. - 124 - Table 5.2: GOVERN MENT REVENUE, 1986-93 Actua Rev. 1986 1987 1988 1989 1990 1991 1992 1993 (Bill-ins of Doug) Soft Enterprises: 60 215 1110 2244 3620 5927 11383 15279 - Taxe and Tmnfers 57 270 1028 2029 3112 5305 9106 12615 - DeprcIaion 3 15 32 215 508 622 2277 2594 Non-State Sector: 12 50 320 736 965 1977 3816 5533 - Agricdural Tax 4 12 136 30C 298 707 1294 1351 - Non-Agr4cutura Tax: a 38 184 428 667 1008 1992 3376 Turnovw Tax 3 16 72 160 262 250 582 863 Profit Tax 2 11 33 73 IS 161 420 593 Peronanl ICOme Tax .. .. .. 62 153 184 License Tax 0 1 23 24 31 .. 72 112 Comunodlitl Tax 1 2 21 72 75 69 22 16 Wholeade Tax 1 3 a IS 32 Slaughter Tax 0 2 10 16 26 35 45 52 Lad Tax .. .. .. 5 IS0 Othew 1 3 17 65 123 426 680 1376 - Other Taxes .. .. .. 262 530 806 Extrnal Trade: 6 17 131 363 733 1099 2194 5900 - Non-Conuneci lmport Tax 6 17 56 109 126 - tmport and Expor Dutle .. .. 75 254 607 1099 2194 5900 Joint Venture. .. .. .. .. .. 389 Other Roenuwe 5 27 179 556 835 1080 2782 2401 Gants .. .. .. .. .. 270 848 998 Totd Raven-u (inc. Gnuax) S4 379 1740 3899 6153 10353 21023 30500 (Percen of GDP) State Enterprise: 9.5 9.2 7.2 8.0 8.7 7.7 10.3 11.2 - Taxe and Trnsfers 8.9 8.7 6.7 7.2 7.4 6.9 8.2 9.3 -Derciaio 0.5 0.5 0.5 0.8 1.2 0.8 2.1 1.9 Non-Statc Sector: 1.9 1.6 2.1 2.6 2.3 2.6 3.5 4.1 - Agricultna Tax 0.6 0.4 0.9 1.1 0.7 0.9 1.2 1.0 - Non-Agricultural Tax 1.3 1.2 1.2 1.5 1.6 1.3 1.8 2.5 Extemnal Trade: 1.0 0.6 0.8 1.3 1.8 1.4 2.0 4.3 - Non-Commrcial Import Tax 1.0 0.6 0.4 0.4 0.3 0.0 0.0 0.0 - Import and Expt Duties 0.0 0.0 0.5 0.9 1.5 1.4 2.0 4.3 Joint Venturs .. .. .. .. .. .. .. 0.3 Other Revenue 0.8 0.9 1.2 2.0 2.0 1.4 2.5 1.8 Grants .. .. .. .. .. 0.4 0.8 0.7 Total Rev..oc (Jac. Giants) 13.2 12.2 11.3 13.8 14.6 13.5 19.0 22.3 (Pecent of Total Revenue) Stat Enterprise: 72.2 75.1 63.8 57.6 58.8 57.2 54.1 SO.I - Taxe and Transfer 68.0 71.2 59.1 52.0 50.6 51.2 43.3 41.6 - Deprecition 4.2 3.8 4.7 5.5 8.3 6.0 10.8 8.5 Non-State Sector: 14.5 13.2 18.4 18.9 15.7 19.1 18.2 18.1 - Agriculnral Tax 4.6 3.2 7.8 7.9 4.8 6.8 6.2 4.4 - Non-Agricndutral Tax 10.0 10.0 10.6 11.0 10.8 9.7 9.5 11.1 External Trade: 7.4 4.6 7.5 9.3 11.9 10.6 10.4 19.3 - Non-Commerci Import Tax 7.4 4.6 3.2 2.8 2.0 0.0 0.0 0.0 - Import and Export Dutim .. .. 4.3 6.5 9.9 10.6 10.4 19.3 Joint Vcrtun .. .. .. .. .. .. .. 1.3 Other Revenue 5.9 7.1 10.3 14.3 13.6 10.4 13.2 7.9 oCnts .. .. .. .. .. 2.6 4.0 3.3 Source: Mbistry of Finane and staff esdmase. - 125 - Table 5.3: FUNCTIONAL CLASSIFICATION OF CURRENT EXPENDITURES, 1986-93 Actual Rev. 1986 1987 1988 1989 1990 1991 1992 1993 (Billions of Dong) General Administrative Service 5.4 18.8 144.0 460.0 676.0 1290.0 2404.0 3245.0 Economic Services 20.5 58.1 149.0 389.0 523.0 784.0 1490.0 2997.0 Agriculture 1.5 .. .. .. .. Forestry 0.5 .. .. .. .. Industry 1.2 .. .. .. .. Transportation, Cooperative, Public Works, and Other 17.3 .. .. .. .. Social Service 19.4 70.8 345.0 1252.0 1998.0 3343.0 6245.0 10854.0 Education 8.1 30.7 85.0 317.0 439.0 748.0 1495.0 2910.0 Health 3.3 13.2 74.0 209.0 368.0 636.0 1136.0 1656.0 Pensions, Social Relief 6.8 21.8 113.0 448.0 695.0 1278.0 2374.0 4135.0 Other 1.2 5.0 73.0 278.0 496.0 681.0 1240.0 2153.0 Intercst due a/ 1.1 2.1 2.6 817.0 1242.0 2333.0 3218.0 3925.0 Intereat Paid .. .. .. 48.0 310.0 651.0 1000.0 1710.0 Other (inc. Subsidies and 38.5 245.0 1503.0 2237.0 2959.0 3311.0 5313.0 8604.0 exci. Contingency) Total Current Expenditures 83.8 392.7 2141.0 4386.0 6466.0 9379.0 16452.0 27410.0 (Cash Basis, incl. Interest) (Perccat of GDP) General Administrative Service 0.8 0.6 0.9 1.6 1.6 1.7 2.2 2.4 Economic Services 3.2 1.9 1.0 1.4 1.2 1.0 1.3 2.2 Social Service 3.1 2.3 2.2 4.5 4.8 4.4 5.6 7.9 Interest due a/ 0.2 0.1 0.0 2.9 3.0 3.0 2.9 2.9 Interct Paid .. .. .. 0.2 0.7 0.8 0.9 1.3 Other (inc. Subsidies) 6.1 7.9 9.7 8.0 7.1 4.3 4.8 6.3 Total Current Expenditures 13.2 12.7 13.9 15.6 15.5 12.2 14.9 20.1 (incl. Interct) Note: a/ For 1986-88, figures include amortization. Source: Ministry of Fiance and staff cetimates. - 126 - Table 5.4: ECONOMIC CLASSIFICATION OF CURRENT EXPENDITURES, 1986-93 Actual Rev. 1986 1987 1988 1989 1990 1991 1992 1993 (Billions of Dong) Wage and Salaries 5.5 29.5 255.0 1290.0 1744.0 2001.0 .. 8921.0 Subsidies 18.2 150.9 812.0 .. .. .. .. 170.0 Food Procurement 12.4 104.3 486.0 .. .. Production 2.3 8.2 51.0 .. .. Exports 3.5 38.4 275.0 .. .. Interest due a/ 1.1 2.1 26.0 817.0 1242.0 2333.0 3218.0 3675.0 Interest paid a/ .. .. .. 48.0 310.0 651.0 1000.0 1710.0 Other 60.1 212.3 1074.0 3048.0 4412.0 6727.0 .. 16609.0 Working Capital for SOEs 1.2 13.8 88.0 128.0 68.0 .. .. 680.0 Administrative Expenses 4.8 14.7 30.0 63.5 181.0 241.0 .. 2752.0 Medical and Social Benefits 2.5 9.7 47.0 124.0 295.0 433.0 .. 2024.0 Education and Scholarship 3.8 14.4 37.0 83.0 261.2 385.0 .. 2111.0 Operation and Maintenance 20.1 57.1 80.0 245.0 290.4 428.0 .. 595.0 Residual b/ 27.7 102.7 792.0 2404.5 3316.4 5240.0 .. 8447.0 Total Current Expenditures 83.8 392.7 2141.0 4386.0 6466.0 9379.0 16453.0 27410.0 (Cash basis; exc. Coat.; IDc. Interrst) (Percent of GDP) Wage and Salaries 0.9 1.0 1.7 4.6 4.2 2.6 .. 6.5 Subsidies 2.9 4.9 5.3 .. .. .. .. 0.1 Food Procurement 2.0 3.4 3.1 Interest due a/ 0.2 0.1 0.2 2.9 3.0 3.0 2.9 2.7 Interest paid a/ .. .. .. 0.2 0.7 0.8 0.9 1.3 Other 9.4 6.8 7.0 10.8 10.5 8.8 .. 12.2 of which: Operation and Maintenance 3.2 1.8 0.5 0.9 0.7 0.6 .. 0.4 Residual d/ 4.3 3.3 5.1 8.6 7.9 6.8 .. 6.2 Total Current Expenditures 13.2 12.7 13.9 15.6 15.5 12.2 14.9 20.1 (Cash basis; exc. Cot.; Inc. latermst) Note: s/ For 1986-88, interet includes amortization. b/ Primarily spending on national defense. Source: Ministry of Finance and staff estimates. - 127 - Table 5.5: GOVERNMENT CAPITAL EXPENDITURES, 1986-3 Rev. 1986 1987 1988 1989 1990 1991 1992 1993 (Billions of Dong) Industry and Construction 12.4 51.7 319.0 766.0 745.8 48.9 2284.0 5692.0 Agriculture and Forestry 5.4 13.6 52.3 68.1 112.8 70.3 345.0 266.0 Irrigation 2.7 9.6 37.7 130.9 243.6 244.1 456.0 623.0 Transportation and Communications 5.4 13.5 76.0 197.0 323.3 335.3 612.8 1020.0 Commerce and Services 1.1 3.9 32.0 47.0 90.9 22.7 16.8 27.0 Non-Productive Sector a/ 6.3 23.5 105.0 410.0 424.8 367.0 789.7 763.0 Contingency Fund b/ 2.5 4.3 48.0 .. 0.0 135.9 Other 2.0 0.4 3.0 7.0 5.9 566.3 451.5 1209.0 Unsllocatcd .. .. .. .. 177.0 344.3 1494.2 Total Capital Exoenditure 37.8 120.4 673.0 1626.0 2124.0 2135.0 6450.0 9600.0 (Percent of GDP) Industry and Construction 1.9 1.7 2.1 2.7 1.8 0.1 2.1 4.2 Agriculture and Forestry 0.9 0.4 0.3 0.2 0.3 0.1 0.3 0.2 Irrigation 0.4 0.3 0.2 0.5 0.6 0.3 0.4 0.5 Transportation and Communications 0.8 0.4 0.5 0.7 0.8 0.4 0.6 0.7 Commerce and Services 0.2 0.1 0.2 0.2 0.2 0.0 0.0 0.0 Non-Productive Sector a/ 1.0 0.8 0.7 1.5 1.0 0.5 0.7 0.6 Contingency Fund b/ 0.4 0.1 0.3 0.0 0.0 0.2 0.0 0.0 Other 0.3 0.0 0.0 0.0 0.0 0.7 0.4 0.9 Unallocated .. .. .. .. 0.4 Total Capital Expenditure 5.9 3.9 4.4 5.8 5.1 2.8 5.8 7.0 Note: a/ Includes education, health, culture, finance and governmnent. b/ Stockpiling of key commodities and materials. Source: Ministry of Finance and staff estimates. Table 6.1: RETAIL PRICE INDEX (Rate of Change from Previous Year; in Percent) Item 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 General Price Index 125.2 169.5 195.4 149.5 164.9 191.6 487.3 301.3 308.2 74.3 36.4 32.7 37.7 8.3 Foodgrain and Foodstuff 133.8 152.0 182.0 155.1 155.0 191.6 553.2 314.6 367.3 43.0 .. .. 28.1 6.3 Foodgrain 121.0 146.3 152.3 134.4 162.0 288.3 254.2 405.1 446.4 30.0 .. .. 5.5 -3.5 Foodstuff 138.5 152.6 135.6 157.3 152.0 181.8 591.6 287.3 340.5 50.0 .. .. 34.5 10.3 Other Consumer Goods 117.8 195.1 205.4 138.8 179.9 190.8 492.7 289.3 265.0 101.0 .. .. 44.9 23.0 Agri-Production Materials 131.8 127.0 194.3 119.7 139.3 204.4 650.8 291.7 269.0 101.0 .. Official Price Index a/ 109.3 202.0 241.3 142.8 155.3 210.9 457.4 289.9 313.2 b/ b/ b/ b/ b/ Foodgrain and Foodstuff 116.7 160.0 217.9 150.1 155.1 210.8 546.4 311.2 378.5 Foodgrain 105.7 144.1 168.3 135.0 151.7 365.2 227.9 416.8 458.7 Foodstuff 125.3 161.0 225.6 153.1 158.9 195.2 602.5 272.4 344.4 Other Consumer Goods 107.1 236.0 245.9 130.9 157.2 210.3 395.5 274.9 237.6 Agri-Production Materials 101.4 122.0 250.0 101.5 153.2 220.9 592.0 270.2 287.6 Free Market Price Index a/ 143.8 147.4 165.0 157.5 176.3 154.7 532.3 337.5 294.3 b/ b/ b/ b/ b/ Foodgrain and Foodstuff 142.5 147.8 164.2 159.5 154.5 160.2 568.9 322.5 341.0 Foodgrain 131.9 148.6 143.8 134.1 173.0 147.0 458.3 353.2 382.4 Foodstuff 145.0 147.6 166.4 163.3 149.0 163.1 573.4 317.0 335.2 Other Consumer Goods 146.5 154.0 163.9 150.3 217.4 146.8 536.1 352.9 217.1 Agri-Production Materal 141.1 131.1 166.0 163.9 126.9 179.5 791.7 342.1 315.0 Note: a/ The weighbts of the official and free market price indices in the general price index are adjusted annually. The weights for 1988 were 0.743 and 0.257, respectively. b/ With price reforms in 1989, there is no longer any ditinction between official and free market price indices. Source: DdtA provided by the Victnamese authoritie. - 129 - TABLE 6.2: CONSUMER PRICE INDEX BY COMMODrTY GROUPS: Monthly Growth Rates Total Agr Proc Manu- Year Month Goods Food Products Food factures Services Dec 1991 Jan 14.30% 19.10% 15.80% 20.60% 14.30% 4.30% Feb 8.84% 11.92% 14.59% 11.11% 8.84% 7.38% Mar 0.16% -2.33% 0.53% -3.43% 0.16% 2.41% Apr 2.41% 3.07% -2.92% 5.72% 2.41% 1.39% May 3.21% 4.47% 1.39% 5.70% 3.21% 1.81% Jun 1.67% 0.78% -0.30% 1.38% 1.67% 1.69% Jul 2.69% 2.90% 3.44% 2.73% 2.69% 1.50% Aug 3.64% 3.65% 3.77% 3.59% 3.64% 2.62% Sep 3.79% 2.65% 2.28% 2.82% 3.79% 2.47% Oct 3.11% 1.87% 0.35% 2.87% 3.11% 1.40% Nov 5.97% 4.19% 2.50% 5.21% 5.97% 3.15% Dec 6.25% 4.99% 4.40% 5.13% 6.25% 4.99% 1992 Jan 4.19% 4.00% 4.47% 5.75% 4.19% 6.17% Feb 5.20% 7.03% 1.61% 9.84% 5.20% 7.41% Mar 0.00% -2.40% -3.60% -1.79% 0.00% 2.80% Apr 0.80% 0.21% -2.09% 1.06% 0.80% 1.21% May 0.79% 0.59% -2.39% 2.23% 0.79% 4.54% Jun 0.00% -0.69% -5.30% 1.91% 0.00% 0.69% Jul 0.10% -0.21% -1.89% 0.50% 0.10% 1.70% Aug 0.00% -0.21% -1.28% 0.27% 0.00% 2.18% Sep -0.21% -1.29% -4.55% 0.32% -0.21% 1.04% Oct - 0.68% -1.19% -5.45% -0.72% -0.68% 2.86% Nov 2.00% 1.98% 4.80% 0.59% 2.00% 2.42% Dec 1.19% 0.11% 0.53% -0.27% 1.19% 2.10% 1993 Jan 1.58% 1.88% 2.74% 1.81% 1.58% 2.41% Feb 2.01% 4.80% 3.62% 5.56% 2.01% 1.67% Mar -0.59% -0.40% 2.00% -1.18% -0.59% 0.72% Apr -0.30% 0.30% 0.49% 0.21% -0.30% 0.29% May 1.19% 1.31% 1.88% 0.77% 1.19% 2.91% Jun -0.59% -0.60% -3.83% 1.10% -0.59% 1.30% Jul -0.35% -0.10% -2.77% 1.34% -0.54% 0.18% Aug 0.35% 0.50% 0.07% 0.66% 0.10% 1.42% Sep -0.25% -0.50% -0.37% -0.98% 0.10% 0.77% Oct -0.50% -0.80% -1.32% -0.58% -0.10% 0.63% Nov -0.30% -1.01% 0.00% -1.50% 0.45% 1.69% Dec 0.80% 1.43% 4.09% 0.00% 0.30% 3.50% - 130 - Table 7.1: AGRICULTURAL PRODUCTION Prdl. 1986 1987 1988 1989 1990 1991 1992 1993 < o(Millions of Dong at 1982 prices) > < (1989 MiUion Dong)-> ro.a Output 96,044 96,383 100,602 108,030 109,405 15,358,792 1,560,475 17,059,197 Crop Cultivation 72,342 70,628 75,969 31,943 82,364 11,511,701 12,331,464 12,597,516 Food Crop. 49,702 47,701 53,118 58,336 .. 7,541,957 8,280,914 Industra Crop. 22,640 22,927 22,851 23,606 .. 1,913,293 1,903,383 Animan Husbandry 23,702 25,755 24,598 26,162 27,062 3,847,091 4,276,311 4.461.681 of which: Livestock a/ 14,067 15,420 14,487 15,664 .. 2,000,186 2,261,195 (Thousands of metric tons) Foodgrains b/ 18,379 17,529 19,583 21,516 21,488 21,989 24,214 25,00c Paddy 16,003 15,103 17,000 18,996 19,225 19,622 212,590 22,300 Other 2,376 2,426 2,583 2,519 2,263 2,367 2,624 2,7CC Memorandum Items: AreaCultivated (000ha) cl 6,812 6,710 6,968 7,090 7,111 7,448 7,707 7,692 Fertilier Avalability (000 tons 1,631 1,542 1,833 1,985 .. Foodgrain Output per Capitas (kg 301 281 307 332 323 323 346 357 Note: e/ Excluding poultry. b/ Paddy equivalent. c/ Foodgrains. Source: General Statistical Office. - 131 - Table 7.2: INDUSTRIAL CROP PRODUCTION AND YIELDS Est. 1986 1987 1988 1989 1990 1991 1992 1993 Production (000 metic tons) Jute 54.5 57.5 36.8 34.3 29.0 25.2 26 28 Rush 97.5 104.2 83.7 81.2 78.0 54.0 77.0 75 Mulberry 56.9 53.9 45.7 56.9 99.0 103.0 143.0 160 Sugarcane 4964.6 5470.3 5700.4 5344.6 5400.0 6130.9 6,437 6,656 Peanuts 211.1 231.6 213.9 205.8 218.0 234.8 227 240 Soybeams 84.7 95.8 85.3 82.0 85.0 80.1 80 81 Tobacco 33.4 33.4 35.5 23.9 17.6 40.4 27 32 Tea 30.1 29.0 29.7 30.2 30.9 33.1 36.2 39 Coffee 18.8 20.5 31.3 40.8 45.2 67.0 71.8 74 Rubber 50.1 51.7 49.7 50.6 52.0 64.6 67 70 Coconut 711.4 790.9 856.5 922.1 .. Area Cultivated (000 ha) Jute 26.1 32.0 17.1 15.7 13.0 10.4 11.6 12 Rush 16.9 17.0 17.5 14.4 11.4 9.4 11.0 10 Mulberry 6.7 6.7 5.7 6.5 11.0 13.9 Sugarcane 125.2 136.9 142.1 131.3 135.0 141.1 Pean4tr 224.5 237.8 224.4 208.6 210.0 196.2 Soybeau 106.5 118.1 103.0 100.2 105.0 115.4 Tobacco 36.2 38.8 39.5 28.0 22.0 30.8 Tea 58.1 59.2 59.1 58.3 60.0 60.0 62.9 Coffee 65.6 92.3 111.9 123.1 119.3 115.0 103.7 Rubber 202.0 203.7 210.5 215.6 221.7 220.6 212.4 Coconut 157.7 199.3 210.6 206.3 212.3 214.2 204.1 Average Yield (Metric ton/Ha) Juie 2.1 1.8 2.2 2.2 2.2 2.4 2.2 Rush 5.8 6.1 4.8 5.6 .. 5.7 7.0 Miulberry 8.5 8.0 8.0 8.8 9.0 7.4 8 ugarcane 39.7 40.0 40.1 40.7 40.0 43.5 P=ikuts 0.9 1.0 1.0 1.0 1.0 1.2 Soybeans 0.8 0.8 0.8 0.8 0.8 0.7 Tobacce 0.9 0.9 0.9 0.9 0.8 1.3 Tea 0.5 0.5 0.5 0.5 .. 0.6 0.6 Coffee 0.3 0.2 0.3 0.3 .. 0.6 0.7 Rubber 0.2 0.3 0.2 0.2 .. 0.3 0.3 Coconut 4.5 4.0 4.1 4.5 .. 0.0 0.0 Source: General Statistical Office, Statistical Data of the Socialist Republic of Vietnam, 1991. - 132 - Table 7.3: FOODGRAIN PRODUCTION AND YIELDS Et. 1986 1987 1988 1989 1990 1991 1992 1993 Production (000 metic tons) 18,379 17,529 19,583 21,516 21,488 21,989 24,214 25,000 By Product Paddy 16,003 15,103 17,000 18,996 19,225 19,622 21,590 22,300 Spring and Summer Crop 9,127 8,029 10,353 11,603 11,956 11,506 14,063 14,272 Winter Crop 6,876 7,074 6,647 7,394 7,269 8,116 7,527 8,028 Subsidiary Crops */ 2,376 2,426 2,583 2,519 2,263 2,367 2,624 2,700 By Region North b/ 7,688 7,620 8,369 8,955 8,448 7,835 9,701 10,640 South 10,691 9,909 11,214 12,561 13,040 14,154 14,513 14,360 Mekong Delta 8,203 6,576 7,743 9,024 9,608 10,464 11,067 10,840 Area Cultivated (000 ha) 6,812 6,709 6,968 7,090 7,111 7448 7,707 7,692 By Product Paddy c/ 5,689 5,588 5,726 5,896 6,028 6,303 6,475 6,466 Spring and Summer Crop 2,743 2,732 2,876 3,133 3,290 3,543 3,727 3,896 Winter Crop 2,946 2,856 2,850 2,763 2,738 2,760 2,748 2,660 Subsidiary Crops s/ 1,123 1,121 1,241 1,194 1,083 1,145 1,232 1,226 By Region North b/ 2,442 3,170 2,465 2,481 3,224 3,301 3,398 3,390 South 3,247 3,540 3,262 3,415 3,887 4,147 4,309 4,302 Mekong Delta 2,291 2,254 2,314 2,445 2,625 2,846 2,966 2,962 AverTae Yield (Metric ton/Ha) 2.70 2.61 2.81 3.03 3.02 2.95 3.14 3.25 By Product Paddy 2.81 2.70 2.97 3.22 3.19 3.11 3.33 3.45 Spring and Summer Crop 3.33 2.94 3.60 3.70 3.63 3.25 3.77 3.66 Winter Crop 2.33 2.48 2.33 2.68 2.65 2.94 2.74 3.02 Subsidiary Crops a/ 2.12 2.16 2.08 2.11 2.09 2.07 2.13 2.20 By Region North b/ 3.15 2.40 3.40 3.61 2.62 2.37 2.85 3.14 South 3.29 2.80 3.44 3.68 3.35 3.41 3.37 3.34 Mekong Delta 3.58 2.92 3.35 3.69 3.66 3.68 3.73 3.66 Fertilizer Availability d/ Quantity (000 metric tons) 1631 1542 1833 1985 2511 3026 3089 3100 Average per Ha (Kg/Ha) 239 230 263 280 .. Notc: a/ In paddy equivalent. bt The North is defined as comprising the 17 provinces north of Da-Nang. c/ Pertaining to sown area, taking into sCcoUDt multiple cropping. d/ Nitrvgcnous fenilizer. ammonin sulphate (SA) equivalent. Not all the availabie fertilizer s used for foodgmin production. For 1990, figures include nitrogenous d posphatic fertilizen. Source: Genenl Statistical Office, Sutistical Data of the Socialist Republic of ViCtnam, 1976-90, 1991. 030, Statisical Datu of Agriculture, Porestry and Fishery, 1935-1993, 1994. - 133 - Table S. 1: INDUSTRIAL PRODUCTION AND NUMBER OF STATE ENTERPRISES item 1987 198U 1989 1990 1990 1991 1992 1993 (Mill of Donu at 1982 prices) (Bis of 1989 Dong) GroT. Industri Producdon 130,551 137,819 133,311 137,506 14,011 15,471 18,117 20,300 Bv Sector Heavy Industry 37,265 41,272 40.560 47,972 5,213 6,283 7,756 Light Ildustry 93,216 96,5U 92,751 89,534 8,721 9,188 10.361 Bv Tvye of Manaeement 120,551 137,819 133,311 137,506 14,011 15,471 18,117 20,300 Central 39,S35 44,413 47,020 54.224 6,438 7,43S 9,155 Loca 81,015 93,406 86,291 83,212 7,573 8036 8,962 Bv Industri Branches 121,711 137.819 133,311 137,506 14,011 15,471 18,118 20,300 Energy Combucible 7,353 7,800 11,220 15,072 2,597 3,242 4,124 4,609 Metallurgy 1,089 2,Q57 2,041 2,313 219 319 406 488 Machinery 18,606 23,851 20,707 20,860 870 866 963 1,049 Chemical Indusry 12,080 12,991 12,209 13,626 920 1,114 1,355 1,592 Other Mnufacuring .1 24,465 24,496 21,107 22,856 2,355 2,541 2,864 3,116 Food and Foodstuffs 32,458 36,573 31,303 36,013 5,040 5,378 6,140 6,982 Weaving, Leaher, 20,392 23,437 21,982 21,215 1,555 1,S52 1,764 1,856 Sewing.nd Dyeing Printig and Cukural 498 715 699 719 97 1Oo 121 152 Products Other Indusries 4,840 5,830 5,036 4,692 357 344 368 456 Number of Entervrias 31 3.092 3.020 27 LZ LP9 2.268 Heavy Industry 1,579 1,449 1,450 1,314 1,384 1,192 990 Light Industry 1,578 1,643 1,570 1,378 1,378 1,407 1,278 By Tyve of Mansement 3,157 3,092 3,020 2,762 2,762 2,599 2,268 Central 682 681 666 589 589 546 537 Local 2,475 2,411 2,354 2,173 2,173 2,053 1,731 Note: a1 ludiam c_esuctic. =iil, .arheswa, pamlaic. sIawsze, woo, fomt produzU, celuies part, sd paper inaas. Souce: aeral dstla cal e ksadtical Dat uo Swcals RapIIc ef Via, 1976-0, 1991. Oerl kadtdaic Service, SasJtia Dta ofdo Soia Rqpk of Veataa, 19M691. 192. - 134 - Table 1.2: MAJOR INDUSTRIAL PRODUCTS item 1986 1987 1988 1989 1990 1991 1992 1993 EnerfY mectricity (MiU. KWh) 5.656 6,194 6,955 7,948 9,053 9,307 9,799 10,928 Coal (Ml. Tons) 6.2 6.8 6.8 3.8 4.2 4.7 5.0 5 Crude Oil (Ml. Tons) - 0.2 0.7 1.5 2.7 4.0 5.5 6 Raw Material Steal(O00tons) 66.5 69.1 74.1 84.5 101.5 141.0 175.0 236 Chromium 3.2 4.0 2.6 4.0 4.6 6.0 36.0 35 Manufacturing Goods Meaworking, Machine Tools (Pice) 1,208 1,190 1.115 928 730 Electric Rotang Engins (Piece) 15,149 13,846 19,833 11,900 9,900 9,S65 13,923 21,363 Transformea (Piece) 447 720 80 1,648 2,612 1,964 1,310 WSWr Pump (Pkse) SSO 690 1.336 1,357 430.0 412 330 360 Rice MiL Equipment (Piece) 1,302 1,176 1,209 859 800 657 706 820 Ploughs and Harrow a(Piece) 323 352 316 161 172 190 188 Chemcal Fertilizers (000 tons) 516 481 502 373 327 405 507 661 :sctidcds (000 tons) 7 12 5 7 9 10 11 9 Bicycle Tire (000 pieces) 10,586 12,028 11,275 7,589 S,632 9.80S 8,458 8,144 Bkycle Tubes (000 pieces) 4,501 5,622 6,431 5,270 8349 8,533 9,177 9,100 Cemcnt (000 tons) 1,526 1,635 1,954 2,088 2.546 3,111 3,926 4,413 Bricks (Ml. peces) 3.283 3,332 3,807 3,519 3,567 3,825 4,274 4,370 Consumer Goods Glau and Glas Products (000 toes) 60 53 53 51 52 32 37 47 Porcelin (Mi. plece) 169 185 208 134 140 136 130 168 Sawn Wood (000 cubic metea) 1,680 1,488 .. .. .. Matchs (Mil psckts) 146 138 117 58 94 151 184 Paper (000 tons) 90 88 88 66 79 107 112 128 Salt (000 tons) 763 S47 851 645 625 583 542 488 Sea Fish (000 tons) 563 561 629 683 667 666 679 737 Sugar (000 tons) 346 340 366 376 376 372 365 341 Beer (Mil.l tcr) 87 87 98 85 88 103 114 cigt (Mil. peckt-s) 1,118 99S 888 1,164 1,250 1,298 1,524 1,604 Te.(000tons) 19 22 24 25 24 23 22 28 Fibsh ace (Mil. ltan) IS8 155 176 159 156 IS0 148 Textile Fbean (000 tons) 52 57 62 56 59 40 43 40 Cotton Fabrics (MU. metern) 357 357 384 336 311 298 276 225 Cotton Fabric for Mosquito Ne (Ml. mete 109 113 106 62 67 36 86 Soap (000 tons) 72 74 52 40 54 68 71 78 Note: a/ Stae enterpriss. Source: General Stadiical Offie, Stadidical Data of the Socaist Republic of Vietnam, 1976-90, 1991. 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