Painful Adjustment

Following a period of overheating in 2009-2010, the introduction of austerity measures in early 2011 has instigated a sharp slowdown in credit and investment growth. This has both allowed to reduce macro imbalances (falling inflation, stronger external accounts) and hurt economic activity. The adjustment has also resulted in a partial materialization of credit risks in the banking sector. In the coming years, policy prudence and a deep restructuring of the bank and state corporate sectors are crucial to consolidate macro stabilization gains and allow an orderly deleveraging of the economy. Pending progress, which will take time, real GDP growth is expected to be sub-par and risks of macro-financial instability will remain high.

Macro stabilization gains and growth losses
Monetary policy tightening in 2011 and the introduction of lending limits, followed by mounting problems in the banking sector, have led credit growth to decelerate abruptly. It went down to 8% in June 2012 from over 30% y/y at the end of 2010 (excluding claims on the general government) and then remained in the 7%-to-9% range in H2 2012. This has had an immediate effect on real GDP growth, which slowed down to 5.9% in 2011 from 6.8% in 2010, and then to 5.0% in 2012 and 4.9% in H1 2013, which was the lowest rate since 1999. The slowdown has been widespread, but domestic demand clearly contributed the most to the downturn, with the fall in investment ratios and sluggish activity in construction-related sectors being the most constraining factors.

Slowing domestic demand and disinflation in food and housing prices have driven inflation down. Headline CPI inflation averaged 6.7% in H1 2013, down from over 18.6% in 2011. In turn, falling inflation has helped improve residents’ confidence in the local currency, thereby reducing capital flight. Meanwhile, the current account posted a surplus of more than 7% of GDP in 2012 after years of deficits, as a result of slower goods import growth but also resilient exports amid adverse external conditions (chart 1). In fact, Vietnam’s export growth has decelerated only moderately to 20% in 2012 and 17% y/y in H1 2013, down from 33% in 2011. The depreciation of the dong since 2008 has helped, but this good performance has also been largely supported by a robust increase in the production capacity of the high-tech export sector (especially phones and computer parts), fuelled by continued FDI inflows. For the sake of illustration, exports of computer and electronic components rose by 40% y/y in H1 2013, versus 16% for exports of textile, garments and footwear, and -2% for exports of crude oil.

As a result of the stronger balance-of-payments, the nominal VND/USD exchange rate has remained stable since early last year and foreign exchange reserves have been able to recover from their dangerously low levels of early 2011. Forex reserves doubled in a two-year period, amounting to USD24bn at the end of 2012. This is seen as sufficient to contain the risk of an external liquidity or currency crisis in the very short term. But the level of forex reserves still remains low, at no more than 3 months of imports, and further accumulation would be needed in the coming months in order to build a stronger cushion against external shocks.

BY Christine PELTIER

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