Poor governance stifling recovery

Vietnam’s economic performance in 2022 beat expectations, lifted by strong export growth and a recovery in domestic consumption after the difficult years of the pandemic. Robust demand growth at home and abroad helped economic growth achieve 8.02 per cent for the year, second only to Malaysia in East and Southeast Asia.

Jonathan Pincus, Senior international economist United Nations Development Programme

Unfortunately, the rebound lost steam early this year. Demand in Vietnam’s main export markets weakened as central banks raised interest rates to control inflation. The Fed Funds rate – the interest rate at which the US Federal Reserve loans money to commercial banks – rose from near zero in April 2022 to 5 per cent last month, the highest in 15 years. Despite interest rate hikes, inflation has remained high around the world, even as energy prices moderated.

As consumers grew more cautious, goods imports in the US, the European Union, China, Japan, and South Korea turned sharply negative from the last quarter of 2022. Vietnam’s exports fell 12 per cent in the first half of 2023 compared to the same period last year, according to preliminary figures from the General Statistics Office (GSO).

Weak external demand was compounded by domestic troubles. Domestic demand growth slowed as interest rates were raised to stabilise the foreign currency markets. A sharp downturn in the property market increased pressure on developers, many of which had taken on excessive debt during the COVID-19 pandemic.

The State Bank of Vietnam moved quickly in the final months of last year to calm the financial markets, but losses continued to mount in the property sector, with ripple effects on consumer and investor confidence.

GDP growth in the first half of 2023 was 3.72 per cent according to the GSO. The most recent projections from the International Monetary Fund forecast growth of 4.7 per cent for the year, much lower than the 5.8 per cent predicted in April.

Central banks lowered interest rates and flooded markets with cash during the pandemic to prevent mass bankruptcies. Businesses and households refinanced debt at lower rates and took out loans to tide them over until earnings returned to normal. The policy worked, keeping many businesses afloat that would have otherwise been forced into liquidation.

The negative effect of monetary easing was the creation of asset bubbles in the property and stock markets. The S&P 500 in the US more than doubled in value from the onset of the pandemic in March 2020 to its peak at the end of 2021. US house prices were up 42 per cent from December 2019 to June 2022 despite depressed household earnings.

These asset bubbles could not be sustained in the face of rising interest rates and tighter liquidity. Companies that had borrowed too much money during the pandemic, and investors who made speculative bets on risky assets, experienced financial distress.

Asset bubbles are a normal part of the business cycle. The problem for the macroeconomy is that falling asset prices have a negative effect on the balance sheets of financial institutions, prompting them to curtail lending to businesses and consumers.

Central banks can ease the adjustment process by extending additional credit to banks and other financial institutions against good assets. However, this process will not work if it is difficult to price the banks’ assets because the financial accounts of big borrowers are inaccurate or impartial.

The lack of corporate financial transparency is the main reason that secondary markets for bonds and loans have failed to take off in Vietnam. It is difficult to assign prices to financial assets if investors cannot be sure about the viability and stability of borrowers.

The public sector is not immune from these problems. During the pandemic, large state-owned companies provided an important public service by keeping prices for fuel, energy, food and other necessities stable for businesses and consumers.

These price stabilisation measures amounted to large-scale public subsidies, but they were not recorded as such in the national accounts. Instead, they appear as losses in the cash flows of these companies.

The government’s fiscal deficit never exceeded 3.4 per cent of GDP during the pandemic, much lower than other countries in the region. On-budget borrowing was kept at low levels, but at the expense of the balance sheets of large state-owned enterprises, which are now facing financial pressures.

If large state companies are financially overextended, they cannot undertake essential ventures. This could have a negative effect on growth because these companies operate in strategic sectors of the economy. State-owned commercial banks, which need to repair their own balance sheets, will not want to step in to paper over the cracks.

Lack of transparency is a short-term solution that always entails heavy long-term costs. Debt can be hidden in balance sheets for a while, but this does not make them disappear. More accurate and complete accounting, in both the public and private sectors, would increase the resiliency of the Vietnamese economy and promote the development of secondary capital markets, which are essential to increasing the supply of long-term, domestic finance.

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