Thursday, April 8, 2010

Vietnam Feels Free-trade Downside

With the implementation of the Vietnam-United States bilateral trade agreement and accession to the World Trade Organization (WTO), Vietnam's economy is now integrated into the global trading system. Trade in goods now represents over 150% of gross domestic product (GDP). Between 2001 and 2008, Vietnam's exports of goods more than tripled, reaching nearly US$63 billion in 2008. The global recession pushed Vietnamese exports down to less than $57 billion last year, but they are forecast to bounce back this year as demand in the US and other key markets improves. Even so, that is not easing concerns over Vietnam's rising trade deficit, which in 2008 reached 12.8% of GDP. While steady trade deficits are not necessarily bad, particularly when they entail the import of growth-enhancing machinery and technology, Vietnam's case is problematic for several reasons.

Vietnam imports large quantities of raw materials and parts to fuel its export machine, notably the garment and footwear industries. This demonstrates that the country lacks essential supporting industries that would help it reap bigger economic benefits from exports and further the process of industrialization. Heavy reliance on imported inputs also makes it more vulnerable to external market forces, including fast fluctuating commodity prices. Vietnam's rising trade deficits with China since 2001 are a particular cause for concern. In 2009, the deficit with China was greater than $11 billion, accounting for over 91% of Vietnam's overall trade deficit.

The challenge of Chinese imports, already threatening the development of homegrown industries, may increase as Vietnam engages in further trade liberalization through the Association of Southeast Asian Nations-China Free Trade Area, which will allow an even greater percentage of Chinese goods into its market duty free by 2015. The trade deficit also reduces the scope for macroeconomic maneuvering. Last year, when key sources of foreign exchange inflows - including foreign direct investment (FDI) and overseas remittances - declined sharply, the government was forced to run down foreign exchange reserves to cover still high import bills. In an attempt to preserve dwindling reserves and rein in the trade deficit, the government engineered two currency devaluations - of 5.4% in November 2009 and 3.4% in February this year.

These interventions have failed to narrow the trade gap. For the first quarter of 2010, imports increased almost 38% in value while exports decreased 1.6% compared with the same period last year. The Economist Intelligence Unit forecasts that Vietnam will run a trade deficit of $13.3 billion this year, equivalent to around 13.4% of a forecast GDP of $99.3 billion. The devaluations have complicated Vietnam's efforts to contain inflation. Expansionary monetary and fiscal policies, countercyclical measures taken at the height of the global economic downturn to boost growth and maintain employment, resulted in 5.3% GDP growth last year, but led to new inflationary pressures.
As the dong has weakened, the price of imported inputs and products has increased and driven inflation higher. The government has targeted an inflation rate of no greater than 7% for this year. Few analysts believe it can achieve this, in spite of some measures to curb price increases and plans to rein in previous expansionary policies. The absence of easy solutions for curbing the trade deficit is rooted in the economy's main growth drivers. Vietnam's exports are still heavily concentrated in labor-intensive and commodity-based products. In general, these are relatively low value-added goods, making it difficult to boost overall export values in order to shrink the trade deficit. Nor does the government have a readily apparent plan to build up supporting industries to foster the production of higher value-added goods. Efforts to promote some import-substituting products have not gained traction due to deep-seated economic inefficiencies and competitive pressure from low-cost producers in China.

Vietnam's increasingly affluent middle class also tends to prefer imported products over domestic ones when they can afford them. Thus strong demand for imported consumer goods has contributed to the country's stubbornly high trade deficit. Economists say the only way to close the import gap is faster restructuring of the economy in ways that improve competitiveness. Deeper reform of the state-owned sector, which currently accounts for nearly 35% of GDP, would help. State-owned enterprises have wide range of privileges, such as favorable access to credit and subsidies, but are overall highly inefficient. Forcing state-owned enterprises to become more efficient and play by market rules would lift a significant drag on the economy.

Vietnamese economic policymakers also need to come up with a meaningful action plan to promote supporting industries in line with broader development needs. Japan has shown a willingness to help. With the implementation of the Vietnam-Japan Economic Partnership Agreement there will be opportunities to engage in joint production of high value-added products for export to the Japanese market. Without a deeper commitment by the country's leaders to reform and restructuring, imports will continue to outpace exports and contribute to instability and risk in Vietnam's still transitional market economy. By Anh Le Tran teacher of economics and management at Lasell College in Massachusetts in the United States.

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