Vietnam's Macroeconomic Context and Issues for Monetary Policy Management

CHAPTER 2:

CURRENT STATE OF MONETARY POLICY TRANSMISSION

THROUGH CREDIT CHANNELS OF VIETNAMESE COMMERCIAL BANKS

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2.1. MACROECONOMIC CONTEXT AND MONETARY POLICY MANAGEMENT OF THE STATE BANK OF VIETNAM

2.1.1. Vietnam's macroeconomic context and issues raised for monetary policy management

2.1.1.1. Macroeconomic context

a/ Vietnam's macroeconomic situation

During the period 2002 - 2007, Vietnam's economy grew strongly with an average growth rate of 7.88%/year, an average inflation rate of 7.53%. On the supply side, this prosperity was achieved thanks to the large contribution of all three factors: technology, labor, and investment capital. On the demand side, government spending, the birth of the 2005 Enterprise Law, the 2005 Investment Law, the 2006 Commercial Law, the signing of the Vietnam - US Bilateral Trade Agreement, and Vietnam's official membership of the WTO in 2007 and the support of a loose monetary policy have encouraged abundant resources in the private sector and the foreign-invested sector to participate in the production and business process. The stable political situation combined with the Government's orientation to promote rapid economic development in the period of 2006 - 2010 has made economic actors optimistic about the future economic prospects and these expectations are clearly reflected in the consumption and investment behavior of the entire Vietnamese economy. However, this economic thinking has contributed to the Vietnamese economy in the period of 2008 - 2015 having to suffer the negative consequences of this period of hot growth.

Figure 2.1: Vietnam's economic growth by sector

10%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

GDP Agriculture, forestry and fishery

Industry and Construction Services

Source: General Statistics Office

Economic leverage, mainly the Government’s loose monetary and fiscal policies, along with abundant investment capital and labor, has accelerated Vietnam’s economic growth while investment in technology and labor quality has not received adequate attention. The inevitable consequence of this situation is that investment efficiency is decreasing (high ICOR, especially in the state-owned economic sector – see Figures 2.2 and 2.3), the level of financial risk in the economy is increasing (public debt at the macro level, the level of risk in the financial system, and financial leverage of the enterprise system at the micro level), and asset bubbles are gradually forming (excess money leading to the explosion of the real estate and stock markets). Mistakes in corporate governance thinking, along with low and inefficient investment in core production factors, have caused the competitiveness of the Vietnamese economy to decline sharply while its ability to withstand shocks from within the economy has increasingly weakened [20]. Combined with deeper integration into the regional and international economy, the vulnerability of the Vietnamese economy to external shocks has also increased significantly [7].

Figure 2.2: ICOR coefficient of Vietnam and some countries in the region

Figure 2.3: ICOR coefficient by economic sector

Area has

Non-state economy Domestic economy

Myanmar

water

Cambodia

Philippines

Foreign State

Malaysia

Vietnam

China

Indonesia

0 2 4 6 8 0 2 4 6 8 10 12

2015e 2014 2013 2012 2011 2010 2014 2013 2012 2011

Source: International Financial Statistics Source: General Statistics Office

Although the high inflation rate in late 2007 and the first half of 2008 was successfully controlled thanks to the drastic implementation of Resolution No. 10/NQ-CP on measures to control inflation, stabilize the macro economy, ensure social security and sustainable growth , this is a warning for the thinking of economic growth in breadth, relying mainly on investment of the Vietnamese economy. Indeed, the delay in recognizing the need to innovate the growth model from the State and the business system, along with the desire to regain economic growth momentum after the economic recession in 2008, has made the Vietnamese economy pay a "quite high" price in the period from 2011 to the present [1]. Economic stimulus policies (interest rate support, increasing

The policies (including public investment, tax reduction) of up to 8% of GDP implemented since 2009 have only brought about a short-term recovery, hiding the shortcomings in the quality of economic growth. In other words, these macroeconomic policies (implemented according to Resolution No. 01/NQ-CP in 2009 and Resolution No. 03/NQ-CP in 2010) are temporary in nature to cope with the current difficult developments without solving the inherent weaknesses of the economy.

At this time, macroeconomic instability continued to accumulate, stemming from four basic macroeconomic imbalances: imbalance between investment and savings, between budget revenue and expenditure, between export and import, and between money supply and money demand.

Firstly, the attempt to promote economic growth through increasing investment capital has caused the imbalance between savings and investment and the debt burden of the economy to increase [15]. The gap between savings and investment, between capital mobilization and capital use in the money-credit market and the stock market has created pressure on the interest rate level in the economy and increased the debt burden on the private sector and the State (the interest rate level in the period 2008 - 2015 was always higher than the interest rate level in the period 2005 - 2007 regardless of whether the growth rate of money supply was high or low). Macroeconomic instability, erratic inflation and the absence of a medium- and long-term capital market are factors contributing to the increase in interest rates in addition to the pressure from the investment-saving gap.

Second, not only has credit to the private sector increased rapidly, but public debt, government debt and foreign debt have also increased sharply since 2009. Although public debt has not exceeded the safety threshold, the potential risks from debts of the state-owned enterprise sector that are unable to pay and must be paid by the state budget are very worrying. Furthermore, the lack of a public debt management strategy, especially controlling public debt at a safe level and using public debt effectively, is a matter of concern for the economy in the future [15].

Third, foreign trade activities, after a period of trade surplus for three consecutive years from 2012 to 2014, returned to a trade deficit of 3.2 billion USD in 2015, creating pressure on the exchange rate. Exports continued to increase with the export/GDP ratio constantly increasing, but the efficiency brought to the economy was not high. The export value added of foreign-invested sectors was low due to mainly processed goods while the domestic sector still had a strong trade deficit, showing the dependence on foreign markets of domestic production and consumption (low localization rate). In addition, the structure of foreign trade by economic sector showed that the foreign-invested sector accounted for 61% and 56% of export and import turnover, mainly relying on imported raw materials for processing with low added content. The supporting industry was underdeveloped.

is a major obstacle to improving export quality (restricting foreign enterprises from investing and transferring technology to Vietnamese enterprises).

Fourth, the imbalance between money supply and money demand and the excess of credit aggravate the situation of inefficient capital allocation, unimproved production capacity and competitiveness, leading to a decline in the capital absorption capacity of enterprises. Meanwhile, the weaknesses of the financial system in terms of ownership, scale, credit structure, capital safety, asset quality, and the imbalance in terms of maturity and currency in the balance sheet are not addressed but only temporarily concealed through credit expansion and TTS. Ineffective control of money supply leads to increased inflation (in 2008 and 2011) and a decline in public confidence in the domestic currency. The devaluation of the domestic currency leads to dollarization and goldification of the economy, causing complex fluctuations and potential instability for the financial system and the economy. The domestic currency market is affected by instability in the foreign currency and gold markets, especially when there is massive public speculation in foreign currency and gold. This connection has caused the interest rate level in the economy to lack stability in both the short and medium term, negatively affecting the investment demand of the economy. The ability of the State Bank to control the currency market is also significantly affected [3].

The consequences of policy mistakes (at both the State's macro-management level and the corporate governance level) stemming from mistakes in economic thinking about the growth model are rising inflation, economic recession, a severely weakened business system, and a financial system facing many major risks, with the potential for systemic instability... However, it can be affirmed that these weaknesses have not only been formed since 2009 until now, but have appeared since the previous period and only become clearly revealed when all the weaknesses in the economy appear together. The Report on the Assessment of the Results of the Implementation of the Socio-Economic Development Tasks for the 5 Years of 2011-2015 and the Orientation for the Socio-Economic Development Tasks for the 5 Years of 2016-2020 stated that “controlling inflation and ensuring major balances of the economy are not really sustainable… budget deficit is still high… the contribution of the domestic economic sector to export growth is low… credit quality is not high… capital, securities, and real estate markets are not developing synchronously, recovering slowly, and still have potential risks” .

The consequence of the above weaknesses is that, except for a slight recovery thanks to the Government's stimulus policy in 2009 and 2010, Vietnam's economy has been in a downward trend since 2008. Since the period of 2005 - 2007 with an average growth rate of nearly 7.2%/year (according to 2010 comparative prices), until 2014, there has not been a year when the economic growth rate reached over 6.5%/year. Meanwhile, the economy

Countries around the world, the emerging economies in Asia, and countries in the ASEAN region have all witnessed a certain recovery (see figure 2.4). The report “Assessment of the results of the implementation of the socio-economic development tasks for the 5 years 2011-2015 and the direction of the socio-economic development tasks for the 5 years 2016-2020” stated that “economic recovery is still slow, growth has not reached the set target; growth quality in some aspects is still low. The development gap compared to countries in the region is still large… Growth quality in some aspects is still low, improvement is slow; production technology is largely backward. The contribution of total factor productivity (TFP) to growth is still limited, the capital utilization ratio (ICOR) is still high. National competitiveness has not been improved much, especially in economic institutions, infrastructure and technological innovation”.

Figure 2.4: Economic growth of Vietnam, some countries in the region, ASEAN - 5 1 region and the world

15%

10%

World

Eme & dev Asia

ASEAN-5

Cambodia

China

Indonesia

PDR Tuberculosis

Malaysia

Myanmar

Philippines

Thailand

Vietnam

Before the crisis (2001 - 2007) During the crisis (2008 - 2011)

After the crisis (2012 - 2015)

Source: World Economic Outlook, IMF

Obviously, the economic decline in Vietnam is no longer caused by external factors but mainly by internal weaknesses and instabilities of the economy. GDP growth is still on a trend of higher quarters than the previous quarters, but this growth rate is still lower than the plan approved by the Government and the National Assembly, especially the achievement of the average growth plan for the period 2011 - 2015. What is more worrying is that this stagnant period has lasted for more than 3 years, from the third quarter of 2011 to 2014, showing that the Vietnamese economy has not yet escaped the bottom of the slow growth graph. This situation reflects that efforts to restructure the economy and regain the strong growth period as before have only had short-term effects and have not created breakthroughs. Report "Assessment of the results of implementing the socio-economic development tasks for the 5 years 2011 - 2015 and orientations"

1 ASEAN - 5 includes 5 countries: Indonesia, Malaysia, Philippines, Thailand, and Vietnam.

The report on the 5-year socio-economic development tasks 2016-2020 stated that “economic restructuring associated with growth model innovation is still slow. The growth model is not clear enough. Economic development depends heavily on capital, resources, and low-skilled labor.”

b/ Changes in Vietnam's economic policy management

The need for innovation in economic thinking and growth models (instead of just solving the phenomenon as was done in the previous period) has been agreed upon by all political levels and the entire society. From 2011 to now, the change in policy management thinking has been clearly shown in the goals of the Government's Resolutions, such as the goal of curbing inflation and stabilizing the macro-economy has been identified as a key and urgent goal and task (Resolution No. 11/NQ-CP in 2011); shifting to prioritizing curbing inflation, stabilizing the macro-economy, maintaining growth at a reasonable level associated with innovation in the growth model and restructuring the economy... (Resolution No. 01/NQ-CP in 2012); and continue to affirm the strengthening of macroeconomic stability... promote the implementation of 3 strategic breakthroughs associated with economic restructuring, transforming the growth model (Resolution No. 01/NQ-CP in 2013); continue to stabilize the macro economy, control inflation; achieve reasonable growth and improve the quality, efficiency and competitiveness of the economy on the basis of promoting the implementation of 3 strategic breakthroughs associated with growth model innovation, restructuring the economy (Resolution No. 01/NQ-CP in 2014); strengthen macroeconomic stability, focus on removing difficulties for production and business activities. Strongly implement strategic breakthroughs, restructure the economy associated with growth model transformation, improve efficiency and competitiveness, strive for higher growth than in 2014 (Resolution No. 01/NQ-CP in 2015).

However, policy mistakes (and untimely awareness) along with external difficulties (global economic growth slowdown, public debt crisis in Europe, and slowing growth of economic locomotives in Asia) have caused the business system in particular and the Vietnamese economy in general to suffer unexpected consequences. Accepting the trade-off between inflation control, macroeconomic stability and economic growth requires implementing "shocking" solutions for the business system and the financial system [7]. Tight monetary policy to control inflation has caused liquidity stress at commercial banks, leading to stagnation of credit capital for the business system. Limited credit sources, high interest rates while economic entities adjust their investment and consumption behavior (a result of economic downturn, negative economic outlook, and changes in thinking) have caused the business system to face dual difficulties (input capital and the ability to consume output products and services).

Growth model innovation is understood as the process of transforming from a growth model based mainly on breadth to a growth model based on depth based on improving growth efficiency. This requires solutions to improve the efficiency of resource allocation and use, focusing on science and technology and high-quality labor. To do so, economic restructuring is an essential task to improve the efficiency of resource allocation and use in the economy. On that basis, the process of restructuring Vietnam's economy includes three focuses: restructuring public investment based on Directive 1792/CT-TTg on strengthening the management of investment capital from the state budget and government bonds , restructuring the credit institution system according to the Project on Restructuring the Credit Institution System for the period 2011 - 2015 , and restructuring state-owned enterprises according to the Project on Restructuring State-owned Enterprises focusing on economic groups and state-owned corporations for the period 2011 - 2015. These are the correct decisions that the Party, the State and the whole society have chosen, aiming at a sustainable economic development, ensuring social security.

However, the restructuring process has only brought about initial results, without much dramatic change, and at the same time it requires time and resources to completely handle the weaknesses, which are the consequences of the previous period. The socialist-oriented market economy institution is still entangled, and has not really become a strong driving force for socio-economic development. However, the viewpoint of shifting from extensive growth to intensive growth, focusing on improving the efficiency of resource use is the right viewpoint for the goal of sustainable economic development. Decision No. 339/QD-TTg of the Prime Minister approving the "Overall economic restructuring project associated with transforming the growth model towards improving quality, efficiency and competitiveness in the period 2013 - 2020" once again affirms the determination of all political levels and the whole society in the fundamental reform of the Vietnamese economy. Report "Assessment of the results of implementing the socio-economic development tasks for the 5 years 2011 - 2015 and the direction of economic development tasks"

- The 5-year social development plan 2016 - 2020" has identified the general goal as "Promoting the implementation of strategic breakthroughs, restructuring the economy associated with innovation of the growth model, improving productivity, efficiency and competitiveness" and setting out the main tasks and solutions "Innovating the growth model towards rapid and sustainable development in the context of a market economy and increasingly deep international integration. Effectively combining breadth and depth of development, focusing on depth of development, enhancing the application of scientific and technological advances, mobilizing and effectively using domestic and foreign resources, constantly improving productivity, quality, efficiency, competitiveness... Continuing to synchronously and effectively implement the overall project on economic restructuring and

restructuring industries and fields... Effectively combine breadth and depth of development, focus on depth of development, enhance the application of scientific and technological advances, mobilize and effectively use domestic and foreign resources, constantly improve productivity, quality, efficiency, and competitiveness... Continue to synchronously and effectively implement the overall project of restructuring the economy and restructuring industries and fields".

2.1.1.2. Issues arising from monetary policy management

Based on the analysis of Vietnam's macroeconomic context and the socio-economic goals set by the Government, some urgent requirements for the SBV's monetary policy management in the 2011-2015 period include:

Firstly, regarding the direction of monetary policy and the ultimate goal of monetary policy, the monetary policy management of the State Bank must aim to control inflation at a reasonable and stable level, creating an important foundation for macroeconomic stability, creating conditions to improve the efficiency of capital mobilization and allocation in the economy. This requires that low inflation rates must be maintained not only in the short term but also in the medium and long term, thoroughly overcoming the situation of pursuing short-term goals such as economic growth and abandoning long-term goals.

Second, regarding the selection of intermediate targets for monetary policy, international experience and operational practices in Vietnam show that money supply and credit are not necessarily the targets that need to be achieved when wanting to control inflation. Moreover, setting an annual credit growth target and trying to achieve this target has in itself created considerable pressure on the monetary policy management of the SBV in particular and the entire banking system in general in providing capital for the economy (credit is the main capital supply channel). When inflation becomes stable, choosing interest rates as an intermediate target in monetary policy management is a suggestion that needs to be considered for application. Moving forward, the SBV needs to eliminate administrative measures on interest rates to move towards complete price control, perfect the SBV's guiding interest rate tool and form a standard interest rate for Vietnam.

Third, regarding the use of monetary policy tools, the State Bank needs to be proactive, flexible, and timely in using and coordinating tools, especially interest rates and regulating the amount of money supply. In the context of macroeconomic fluctuations and the financial system fraught with unpredictable risks, the use of administrative tools is necessary to ensure timeliness and efficiency. In addition, the State Bank needs to effectively coordinate open market operations, foreign exchange markets, and gold to regulate the amount of money supply reasonably in the context of having to simultaneously implement many goals (increasing foreign exchange reserves to ensure system liquidity, controlling inflation). However, in order to gradually limit and eventually eliminate administrative tools, the State Bank needs to effectively coordinate open market operations, foreign exchange markets, and gold markets to regulate the amount of money supply reasonably in the context of having to simultaneously implement many goals (increasing foreign exchange reserves to ensure system liquidity, controlling inflation). However, in order to gradually limit and eventually eliminate administrative tools, the State Bank needs to effectively coordinate open market operations, foreign exchange markets, and gold markets to regulate the amount of money supply reasonably in the context of having to simultaneously implement many goals (increasing foreign exchange reserves to ensure system liquidity, and controlling inflation). However, in order to gradually limit and eventually eliminate administrative tools, the State Bank needs to effectively coordinate open market operations, foreign exchange markets, and gold markets to regulate the amount of money supply reasonably in the context of having to implement many goals at the same time (increasing foreign exchange reserves to ensure system liquidity, and controlling inflation). However, in order to gradually limit and eventually eliminate administrative tools, the State Bank needs to effectively coordinate open market operations, foreign exchange markets, and gold markets to effectively ...

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