Vietnam’s economy forced to navigate rough seas this year

For more than two decades, economic prospects in Vietnam have been closely tied to export growth. While in the early years agriculture and light manufacturing led the way, the main drivers now are electronics, electrical machinery, and metals. Inbound foreign direct investment (FDI), which has risen at an annual average rate of 12 per cent since 2006, has financed Vietnam’s closer integration within East Asian production systems.

Jonathan Pincus, dean, Fulbright School of Public Policy and Management Fulbright University Vietnam

In recent years, China has emerged as an important investor, especially in computers, electronic equipment, rubber, plastics, and metal products. FDI from China to Vietnam has increased nine-fold since 2015, reaching a high of $4.59 billion in 2023. Although the headline number declined in 2024, an unknown share of the $6.3 billion from Singapore and $2.2 billion from Hong Kong is also of Chinese origin.

The government has set even more ambitious growth targets, and these could be attained if events break in Vietnam’s favour. For example, exports early in the year could receive a boost from frontloading of orders as buyers seek to avoid the cost of American tariffs should they be imposed later in the year.

But there are also downside risks, most of which are related to US trade policy. Its plan to impose reciprocal import tariffs from April is a concern. It is not clear how reciprocal tariffs are to be defined and calculated, which is a source of considerable confusion.

The actual level of tariffs could be extremely high or low, depending on which goods, taxes and non-tariff barriers are covered. It appears that the US will focus on countries with large trade surpluses with the US, including Vietnam, although even this is not certain.

Vietnam’s trade position will not weaken significantly if tariffs on Vietnamese goods are equal to or less than those levied against its competitors. The outcome depends mostly on diplomacy rather than economics. Vietnam’s case for lower tariffs would be helped if the country agrees to increase purchases of US goods like aircraft and liquefied natural gas.

At a more general level, America’s transformation from champion to foe of free trade is troubling for export-oriented economies like Vietnam. The international trade regime under the World Trade Organization never succeeded in creating a perfectly level playing field, but it did give smaller countries leverage to resist arbitrary behaviour by large trading partners. A weaker regime opens the way for big countries to use market access as a bargaining chip to reward friends and punish rivals.

Another downside risk for Vietnam is China’s lacklustre economic recovery. Although Vietnam runs a trade deficit with China, it is still Vietnam’s second most important export destination. Continued weakness in the property market could have a negative impact on Vietnamese exports of steel and other construction materials. China also ranks second among markets sending tourists to Vietnam, behind South Korea.

Weak demand in China also gives rise to an influx of cheap goods into Vietnamese markets, which is good for consumers and helps keep inflation under control, but is a problem for domestic producers.

Global trade tensions could spill over into currency market instability. The US dollar is now at the highest level adjusted for inflation since the 1980s, propped up by high inflation in the US and a reduced likelihood that the Federal Reserve will cut interest rates soon.

Tariffs on China, Canada, and Mexico will accelerate domestic inflation in the US, further delaying rate cuts unless the American economy stumbles into recession.

The positive effect of a stronger US dollar is that it makes exports to the US cheaper, which would counteract the effects of tariffs. However, a stronger dollar would also force interbank rates higher in Vietnam, especially if deposit growth remains slow. While higher interest rates strengthen the VND, they also represent a drag on the economy.

Vietnam has managed its external debt situation well, so a strong dollar should not cause distress among Vietnamese corporate borrowers. But it would raise the cost of imports, which would fuel domestic inflation. Essential commodities like food and fuel are priced in dollars, so the cost of these imports would rise.

The last time the US dollar was this strong, the US organised a global currency adjustment to lower the value of the dollar against the Japanese yen and German mark.

It is unlikely that America’s trading partners would agree to currency coordination of this sort at the same time that they are threatened with tariffs. China, Mexico, and Canada are more likely to view currency depreciation as a useful instrument to minimise the effects of American tariffs on existing trade flows.

This is precisely what happened after the first round of Trump tariffs in 2018. The appreciation of the dollar vis-à-vis the Chinese yuan cancelled the effect of the tariffs, reducing the impact on Chinese exports to the US.

Navigating these complex political and economic waters will put a premium on prudent macroeconomic management and skilful diplomacy. Counter-cyclical fiscal and monetary policies, building up foreign exchange reserves, and strengthening domestic financial institutions will help mitigate the risks associated with global economic uncertainty.

Deeper regional collaboration can also help hedge against the diminishing effectiveness of multilateral agreements and institutions.