Vietnam: Asia’s Rising Star?

20 June 2019

The escalating trade war between the USA and China has already taken its toll on the global economy, with the export-oriented manufacturing sector hit hardest. And, it’s not just the US and China feeling the pain. The following Chart highlights the slump in exports world-wide, especially in the open Asian economies. The Chart, however, illustrates that Vietnam has proven very resilient. Indeed, not only are exports still rising handsomely, but Q1 2019 GDP advanced 6.8% (following an enviable 7.1% expansion last year), and industrial production has advanced at a 10% clip during Q2 2019. In particular, while US imports from China have slumped 13% this year, Vietnam has taken advantage of the opportunity: American purchases have soared 40%. What lies behind this impressively resilient economic performance? And, if the Sino-US trade conflict becomes protracted, can Vietnam emerge as a new trade/investment hub in Asia?

Doi Moi: Reaping the Rewards of Reform

After decades of war and economic mismanagement, Vietnam remained a desparately poor country in the 1980s: indeed, per capita GDP was a mere $200 per year in 1986. In response, Vietnam launched its Doi Moi reform (renovation) campaign. The strategy was based upon three crucial transformations: shifting from a state-run to market economy, opening up to the global economy for trade and investment, and transitioning from subsistence agriculture to export-oriented manufacturing.

How successful has Vietnam been in achieving these goals? The Chart above illustrates Vietnam was a virtually closed economy at the outset of the reforms. Now, exports stand at 100% of GDP, which exceeds all of the large, open Asian economies. During this time, Vietnam has joined ASEAN (involved in all of the organisation’s foreign trade agreements), the WTO, signed the Trans-Pacific Partnership, and reached a landmark FTA with the European Union.

Likewise, the Chart above indicates Vietnam’s early achievement in transitioning towards a market-oriented economy. Since 2000, in particular, the share of investment from state-owned enterprises has declined sharply. Meanwhile, private investment has risen, now exceeding the public sector’s share. And since WTO membership in 2007, the stake owned by foreign investors also been on the rise.

Vietnam’s success in expanding the export-oriented factory sector was led by a dramatic surge in manufacturing productivity (driven by higher private/foreign investment). Equally important, however, have been the huge efficiency gains in the agricultural segment (Chart above), which has freed labour to transition from rural poverty to better paid factory jobs.

As a result of these achievements, the Chart above highlights Vietnamese GDP growth is poised to outpace all other Emerging Market economies (except perhaps India). Importantly, the benefits of Vietnam’s success have been relatively widely shared. The following Chart, for instance, illustrates that following sharp declines, poverty is low compared to other EM nations. Measures of inequality, e.g. Gini coefficients, indicate the degree of inequality is also lower than in other countries at a similar stage of development.

Is Vietnam’s impressive performance sustainable? Economists estimate an economy’s long-term growth prospects by adding gains in labour supply, capital stock (e.g. investment) and productivity. Vietnam’s demographics are favourable, e.g. the population is growing 1% annually. The following Chart illustrates a large percent of the population remains in rural areas. Rising agricultural efficiency will free up workers adding to overall labour force gains.

Likewise, the following Chart illustrates that labour productivity is not only strong, but appears to be gathering momentum as the inefficient state sector shrinks.

Finally, the next Chart indicates that capital spending is booming, with both the private sector and government (e.g. infrastructure) contributing.

In addition, reforms and a relatively low corporate tax rate have led to surging Foreign Direct Investment (next Chart). The final Chart illustrates the huge role FDI has played in Vietnam’s capital spending expansion in comparison to other regional rivals. Putting the pieces together, I estimate Vietnam’s long term growth potential at about 7%. To answer the original question: yes, Vietnam’s growth is sustainable!

Trade War: Is Vietnam the Victor?

There are two major ways Vietnam will gain from a protracted Sino-US trade dispute. First of all, with tariffs raising the price of Chinese goods for American consumers, US imports from Vietnam may increase to satisify the seemingly insatiable American demand, e.g trade is diverted to Vietnam. As mentioned, this is already occurring — US imports from Vietnam are up 40% this year.

Another perhaps more important possibility, would be if Multi-national corporations shifted production to Vietnam from China. I think this is quite likely, if the trade conflict is prolonged. As discussed, Vietnam already has been attracting considerable FDI lately (8% of GDP per year). The Table above, however, illustrates that most of the inflows come from other Asian countries, excluding China. I am certain US, Chinese, and European (especially after the recent FTA) manufacturers will eventually follow suit if the outsourcing option in China is curtailed.

Likewise, the Chart above illustrates the role Vietnam has been playing in the global supply chain. Much Vietnam’s exports to China (its 2nd largest trading partner) are phones and computers parts and other electronics. Eventually, China sells the final products to the USA and the rest of the world. Meanwhile, much of Vietnam’s exports to the USA (its top export destination) are low value-added products, e.g. clothes, etc. In the future, it is very easy to imagine US consumers buying their phones from Vietnam after Chinese and other manufactures relocate to Indo-China.

In practice, however, there are no victors in a trade war. Collectively, China and the USA account for nearly 40% of Vietnamese exports. If these two giant economies slow, Vietnam will also suffer. Furthermore, Vietnam’s $40 billion bilateral trade surplus with the USA may eventually gather the attention of the Trump administration trade vigilantes, especially as this gap is like to widen substantially. The low US export/import ratio with Vietnam may suggest US market access is not fully reciprocated. Indeed, while Vietnamese tariffs have fallen sharply since joining the WTO, non-tariff barriers have been expanding.

Challenges Ahead: Further Micro & Macro Reforms Needed

The World Economic Forum (WEF) ranks countries in terms of competitiveness. The Chart above highlights Vietnam’s steady improvements, but also underscores there is much still to do. The following Chart identifies key priority areas for future reform. Infrastructure, skills and higher education (which would improve rankings for innovation and business sophistication), and financial sector development will be crucial areas for government policies.

Improvements in goods market efficiency are likely to require further reductions in the size of the bloated state sector. Despite shrinking during the past 30 years, the SOEs still account for 30% of GDP, 40% of investment, and 80% of overall assets.

In order to sustain reform momentum, the benefits must continue to be widely shared. The following Chart indicates that foreign-owned firms are outperforming both SOEs and domestic firms. There are many potential reasons for this gap, but maintaining support for reform will be endangered if a small, foreign sector is seen as reaping the rewards. Nearly 80% of the workforce has no vocational or technical skills. While some progress has been made in improving skills and training, further gains are urgently needed to ensure growth benefits are widely shared.

Deficiencies in the financial sector could also become a headwind. The following Chart indicates Vietnamese banks’ return on assets is low compared to other Asian countries. In addition, the recent sharp rise in credit/GDP has raised concerns (Final chart). However, as the credit ratio remains in line with other emerging markets, I am not overly concerned about a repeat of the earlier liquidity-driven property bubble.

Likewise, some observers worry about Vietnam’s fiscal position. The government has set a ceiling for the debt/GDP ratio of 65%. However, the combination of strong growth and recent budget cuts should keep the ratio below this threshold in coming years. Boosting needed spending on infrastructure and education, however, will require tough choices on spending priorities in the future.

Strategic Considerations
  • Reflecting the achievements of the Doi Moi reforms, I estimate Vietnam’s GDP growth potential at 7% — the highest in Asia, except India.
  • I expect the trade-weighted Vietnamese Dong to depreciate in line with inflation differentials or less. In other words, I expect the real FX rate to be stable or appreciate, reflecting Vietnam’s strong productivity performance (Chart above).
  • I expect FDI inflows will remain strong, and will accelerate if the Sino-US trade war is protracted. If re-elected, the Trump administration will take aim at the widening bilateral trade imbalance.
  • Despite capital inflows and its current account surplus, Vietnam’s low level of international reserves leaves it vulnerable to a full-blown EM crisis, which I do not expect in the coming year.