The ups and downs of Vietnam’s economy

Last week the World Bank reported that the direct impact of the global financial crisis on Vietnam is minimal. Its banks are neither exposed to “toxic” products nor owned to a large extent by exposed foreign banks. Such favorable situation is a result of learning the lessons of a domestic financial turmoil happened in 2008. 

Last year Vietnam faced a wide range of economic difficulties, including asset price bubbles, skyrocketing inflation, a widening trade deficit and tight credit markets. Financial analysts predicted that the country was heading for a “currency crisis,” similar to that of Thailand's baht in 1997. 

For example, the Morgan Stanley wrote that if Vietnam didn’t depreciate its currency, the dong could collapse by the end of the year. Deutsche Bank promises a 30% fall in the dong. Merrill Lynch reported that the inflation would cause massive capital flight. 

What can we see now? Merrill Lynch is sold to Bank of America to avoid collapse. Deutsche Bank and Morgan Stanley are facing significant financial losses. On the contrary, Vietnam is demonstrating the economic stability. The country has managed to beat its inflation and defend the dong. 

Even though experts are still arguing about this amazing result, Vietnam's strategy has proved to work well enough to avoid a financial meltdown in the country. How did they manage to do it? And can their methods help them to escape from the global financial crisis that has swept through developed countries?

The domestic financial crisis of 2008 

Until 2008, Vietnam was among the economies that showed the highest economic growth. Innovative reforms, international economic integration and accession to the World Trade Organization by the end of 2006 resulted into a boom of trade and banking industries. 

Due to the amazing economic growth, Vietnam captured attention of foreign investors. During 2007, the country received nearly 20 billion dollars, with about 6 billion dollars actually disbursed. It was a huge amount in comparison with Vietnam’s 80-billion-dollar economy. 

However, just one year later, the focus shifted from high expectations about Vietnam’s economic development to gloomy assessments of its macroeconomic instability. In particular, during the period from March to July 2008 the situation in the country became pessimistic, which was a topic of much debate. 

The experts were divided into two camps according to their assessments of the risks and problems. The first stated that Vietnam was experiencing a serious financial crisis, even before the rest of the world. The symptoms included depreciation of dong, skyrocketing inflation and lack of liquidity in the banking system. 

The second camp believed that Vietnam was not in crisis yet, but nevertheless it faced very serious macroeconomic problems. Some experts even suggested that the crisis in Vietnam would be very similar to the situation in Thailand in the Asian crisis of 1997-98.

Why did the beneficial economic situation lead to financial meltdown? 
•    Large foreign investments over the past couple of years caused dong to go up. It threatened the competitiveness of Vietnam's exports. 
•    Trying to hold the currency exchange rate down, the State Bank started to purchase dollars from other banks with dong. This strategy led to inflation because Vietnamese banks flush with dong. 
•    Vietnam needed foreign investments to finance its trade deficit. The disruption of foreign inflows didn’t allow the country to import materials for economic growth. 
•    Financial institutions granted too many loans. As a result, interest rate hikes hurt consumers and the banking industry. 
•    High worldwide prices for food and oil made prices in the country go up. In addition, Vietnam, as one of the largest rice exporters, barred new exports of rice due to food security concerns. It caused world rice prices to increase. 

Trying to solve the problems, Vietnam's government decided to interfere. They shifted their priorities from economic growth to stabilization in March 2008 and then to economic support in November. 

The government froze prices on basic materials such as steel and gasoline. It increased banks' capital requirements to soak up a portion of the excess currency. The government also did something that was difficult to understand for other countries. They told financial institutions to stop granting so many loans. And they told giant State-owned enterprises to cut down unnecessary spending. 

This strategy was very successful. The macroeconomy revealed some positive signs. First of all, these measures resulted in the slowdown of inflation, improved balance of payments and the solution of liquidity problem. The credit crunch helped to decline trade deficit. In their turn, slowing inflation and a modest trade deficit have let the country avoid a collapse in investors’ confidence. 

However, Vietnam has not escaped macroeconomic instability yet. Obviously, Vietnam needs more measures and reforms to improve the situation. It is particularly important as the global economy goes into severe recession. 

Global financial crisis

This year Vietnam is facing new pressures. The main difficulties for the country are the global financial crisis, the reduction in investments and the negative effects from a fall in global commodity prices and trade. 

Demand for Vietnamese exports has significantly declined due to the recession in the US and Europe. Experts suggest that the downward trend would continue. It can result into factory closures and job cuts.

The government has responded by loosening credit and reducing the prime interest rate to 10%. In addition, they told banks to lend money to agricultural exporters at a low interest rate. It will let farmers buy machinery and equipment for production and trade promotion. The government also pays attention to healthcare, education and creation of new jobs. 

Another solution is a large stimulus package which will provide interest rate subsidy of 4% for short-term, medium and long-term loans for enterprises in 2009. Cheap bank credit and loan guarantees can balance the decline in demand.
Regarding the impact of the global financial crisis on Vietnam, the President of the country said the government has adopted right measures to beat inflation and stabilize the macroeconomy. The country is well placed to withstand the global financial turmoil.

According to the World Bank’s report released in Hanoi on April 7, Vietnam’s GDP will raise at 5.5% in 2009. However, they also warned that the nation’s economy may face difficulties caused by insufficient demand in global markets. Cheap bank credit will not encourage companies to produce goods if there is no demand for them.

Even taking into consideration these economic difficulties, Vietnam may be less affected by recession than other countries. The country is likely to get out of the global economic crisis even faster than China, which is said to escape from the crisis in the next few months. You think that this prognosis is too optimistic? The gloomy predictions of the financial experts in 2008 turned out to be not as accurate as the optimistic predictions of the Vietnam government.