Efforts to Improve Fiscal Consolidation in Response to Economic Difficulty

According to the report, after a prolonged period of heightened turbulence, Vietnam’s economy is gradually entering a more stable macroeconomic environment. Pressures on the exchange rate have continued to decline in the first quarter of 2012, as confidence in the dong has gradually picked up. The unofficial exchange rate has remained close to the lower edge of the plus/minus 1 percent band around the official rate since the 8.5 percent devaluation of the Vietnamese dong against US dollar in February 2011. The increased supply of US dollars in the market has enabled the State Bank of Vietnam (SBV) to replenish foreign exchange reserves in the first months of 2012, which are reportedly at nearly 7.5 weeks of imports.

 

Government measures have led to a sharp decline in credit growth. Official non-performing loans have increased from 2.2 percent of assets at the end of 2010 to 3.6 percent in March 2012, but are likely to be higher if measured by international accepted standards. Monetary tightening has also added liquidity stress in some smaller banks. In response to this, the authorities have provided liquidity and other support to ailing banks.

 

Maintaining macroeconomic stability remains the government’s priority. Economic growth is expected to be around 5.7 percent, and year-end inflation is forecast to decline to below 10 percent in 2012. In a move to shore up the economy, SBV reduced policy interest rates by 200 basis points in March and April (from 15 to 13 percent) and announced further reductions of at least 100 basis points every quarter during 2012. Cooling demand and slow credit growth should dampen the inflationary impact of the rate cuts, which at the same time should help ease financing cost of the private sector.

 

The government is making efforts at fiscal consolidation, following expansionary policies in 2009 and 2010 in response to global financial crisis. For 2012, the budget deficit is expected to widen to 6.0 percent of GDP, but the government may be able to keep it below this since past revenue performance is consistently understated. Maintaining fiscal discipline is a priority to help relieve the burden on monetary policy as the economy begins to stabilize, and to help maintain debt sustainability over the medium-term.

 

Vietnam’s public debt is likely to remain sustainable if the economic recovery continues and the authorities remain on the current path of fiscal consolidation. The World Bank’s Low-Income Country Debt Sustainability Analysis shows that Vietnam remains at a low risk of debt distress. However, the largest source of uncertainty to debt sustainability comes from implicit obligations to state-owned enterprises, which are not captured under government and government-guaranteed debt statistics. A reliable estimate of such liabilities is not available, which limits the government’s ability to manage associated risks. The authorities are stepping up efforts to collect reliable and up-to-date information on contingent liabilities (mostly in the state-owned enterprise or SOE sector) and to monitor and manage potential fiscal risks.

 

The unresolved problems in the banking sector are likely to remain a source of concern for Vietnam in the coming years. The SBV has stepped up its supervision efforts and raised minimum capital requirements in response to concerns about the health of the banking sector. On March 1, the Prime Minister issued Decision 254 on “Restructuring credit institution system in the 2011–15 period.” The decision provides a framework to deal with weak banks and sets out a number of targets to be achieved by 2015. It sets out a number of restructuring options including letting the SBV directly acquire the equity of weak banks, increasing the ownership limit for foreign banks in domestic credit institutions, encouraging healthy banks to buy good quality assets and loans from weak banks, and allowing banks to sell their bad debts to the Debt and Asset Trading Company. However, the actual implementation of the plan, the restructuring options to consider, and the related implications are still under discussion. Preparations for a Financial Sector Assessment Program are also underway.

 

Vietnam’s near-term policy challenge is to maintain macroeconomic stability and restore confidence among investors, while also addressing longer-term structural reforms. Even if only a subset of the announced structural reforms is implemented steadfastly, Vietnam should return to a more sustainable macroeconomic environment while laying the foundations for greater efficiency and productivity to drive medium- and longer-term growth.