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ASEAN Economic Bulletin Vol.26, No.1, April 2009 - Managing Success in Vietnam

ASEAN Economic Bulletin Vol.26, No.1, April 2009 - Managing Success in Vietnam

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ASEAN Economic Bulletin77Vol. 26, No. 1, April 2009
 ASEAN Economic Bulletin Vol. 26, No. 1 (2009), pp. 77–95
ISSN 0217-4472 print / ISSN 1793-2831 electronic© 2009 ISEASDOI: 10.1355/ae26-1f 
Managing Success in Vietnam
Macroeconomic Consequences of Large CapitalInflows with Limited Instruments
Jayant Menon
Vietnam has experienced spectacular economic growth over the past decade, and a lot of thishas been a result of massive inflows of FDI. Although much has been written on the impact of  FDI in developing countries, previous studies have generally ignored macroeconomicconsequences in cost-benefit assessments. These macroeconomic aspects can be particularlyimportant in transitional economies like Vietnam, where some of the instruments of macroeconomic stabilization may be blunt or unavailable. First, growth in capital inflowneeds to be accommodated by real exchange rate appreciations. In dollarized economies likeVietnam, the nominal exchange rate cannot be relied upon to deliver it, so inflation is usuallythe result. In dollarized economies, it is also difficult for the central bank to conduct openmarket operations, in order to sterilize large capital inflows, or mop up excess liquidity. Again, this could add to inflation. The combination of a young and inexperienced bankingsystem and a investment-hungry SOE sector only exacerbates the situation, and increases therisk of imbalances that can result in a crisis.
Capital inflow, Macroeconomic adjustment, dollarization, real exchange rates, transitionaleconomies, Vietnam.
Attracting foreign direct investment (FDI) hasbeen a key focus of market-oriented policyreforms in Vietnam. The thrust to encourage FDIis rooted in the belief that it can play a catalyticrole in supporting the process of economictransition, and act as a conduit for revitalizingthe private sector. Vietnam has experiencedspectacular economic growth over the past decade(Table 1). This has been achieved mainly by rapidgrowth in capital. Capital has been drawn intocountries such as Vietnam through reductions inrequired rates of return as a result of policies,which encourage FDI. Vietnam has policies thatrange from tax holidays to direct subsidies tomeasures designed to increase the security of foreign investment.Although much has been written on the role andimpacts of FDI in developing countries, previousstudies have focused on the direct developmental
ASEAN Economic Bulletin78Vol. 26, No. 1, April 2009
TABLE 1Macroeconomic Indicators
 Annual data and forecast 2004
Nominal GDP (US$ bn)45.452.960.971.090.489.699.3Nominal GDP (D trn)715.3839.2974.31,144.01,564.1
1,760.21,944.3Real GDP growth (%)
Expenditure on GDP (% real change)
Private consumption7.
b consumption7.
b fixed investment10.49.89.923.0
b of goods & services25.720.517.2
b of goods & services21.915.915.6
Origin of GDP (% real change)
Population and income
Population (m)82.783.584.4
b per head (US$ at PPP)1,932
2,8352,9343,058Recorded unemployment (av; %)
Fiscal indicatosr (% of GDP)
Central government balance3.
b public debt42.744.045.9
45.052.455.9Prices and financial indicatorsExchange rate D: US$ (end-period)15,77715,91616,05416,11417,33217,70217,545Exchange rate D: $ (end-period)21,35918,77521,18623,53122,18523,01322,896Consumer prices (end-period; %)
1.25.3Stock of money M1 (% change) of money M2 (% change)31.130.929.749.112.710.46.1Lending interest rate (av; %)9.711.
Current account (US$ m)
Trade balance2,2872,4392,77610,36014,18511,4309,289Goods: exports fob26,48532,44739,82648,56162,87040,51245,284Goods: imports fob28,77234,88742,60258,92177,05551,94254,573Services balance87229688941,3781,3741,205Income balance8911,2051,4292,1682,7001,4661,597Current transfers balance3,0933,3804,0496,4308,0026,4966,855Current-account balance9575601646,99310,2617,7745,235
External debt (US$ m)
Debt stock18,04919,21220,20221,850
23,16922,27822,939Debt service paid787957918944
1,0291,0261,065Principal repayments430519464533
International reserves (US$ m)
Total international reserves7,1869,21713,59123,74822,02116,73416,639
: a.Actualb.Economist Intelligence Unit estimates.c.Economist Intelligence Unit forecasts.S
: IMF,
 International Financial Statistics
ASEAN Economic Bulletin79Vol. 26, No. 1, April 2009
impacts of FDI, and generally ignoredmacroeconomic consequences. There arepotentially significant macroeconomic con-sequences of capital inflows, especially if suchflows are large and rapid, that need to beconsidered in an overall assessment of the costsand benefits of playing host to FDI. Thesemacroeconomic aspects can be particularlyimportant in transitional economies like Vietnam,where at least some of the instruments of macroeconomic stabilization may be blunt or unavailable. So far, such macroeconomicconsequences have been largely ignored, and thisstudy aims to overcome this limitation.The study is in two parts. The first will examinethe trends, determinants and impacts of FDI, whilethe second will examine issues relating tomanaging the macroeconomic consequences of FDI inflows. The paper is organized in sixsections. In order to provide the setting for the firstpart, we begin in section II with an overview of policy relating to FDI, focusing on recent reforms.Section III maps the trends and patterns of FDIinflows, including source country composition,and sectoral and geographical distribution.Evidence relating to the impacts of FDI on thehost economy is summarized in section IV.Section V deals with the macroeconomicconsequences of capital inflow. Large inflows of FDI can have wide-ranging consequences ontransitional economies, and unless managedcapably, can result in macroeconomic imbalancesand even crises. In dollarized economies inparticular, where the ability to conduct open-market operations or, more generally, implementan independent monetary policy, may be impaired,the result can be sharp rises in inflation. In thissection, we also examine what policies areavailable to transitional economies like Vietnam,where the full complement of macroeconomicinstruments may not be available. A final sectionconcludes.
II.Investment Policy
The opening of the economy to FDI was partof Vietnam’s “Renovation” (
 Doi Moi
) reformsinitiated in 1986. The Vietnamese NationalAssembly passed the first Law on FDI on29 December 1987. The law specified threemodes of foreign investor participation, namely(i) business cooperation contracts (BCC);(ii) joint-ventures; and (iii) fully foreign-ownedventures. Foreign participation in the fields of oilexploration and communications was strictlylimited to BCC. In some sectors such astransportation, port construction, airport terminals,forestry plantation, tourism, cultural activities, andproduction of explosives, joint ventures withdomestic state-owned enterprises (SOEs) wasspecified as the dome for foreign entry. Fullyforeign-owned ventures were to be allowedonly under special circumstances relatingprimarily to policy priorities for domesticindustrial development.The Government provided constitutionalguarantees against nationalization of foreignaffiliates and the revocation of ownership rights of enterprises. The incentives offered to foreigninvestors included exemption from corporate taxfor a period of two years, commencing from thefirst profit-making year, followed by a preferentialcorporate tax rate of between 15 per cent to 25 per cent in priority sectors (as against the standardrate of 32 per cent). Foreign investors werepermitted to repatriate after tax earnings subject toa 10 per cent withholding tax. Overseas remittanceof payments for the provision of technologyservices and repayment of principal and intereston loans were freely allowed. The specificemphasis on joint ventures with SOE as the primemode of foreign entry reflected the government’sdecision to use FDI as a vehicle for industrialtransition while ensuring state dominance in theeconomy. However, in 1990, the foreigninvestment law was amended to permit economicorganizations in the private sector to engage in joint ventures with foreign partners. In 1991,legislation was passed allowing ExportProcessing Zones (EPZs) to be set up, andgenerous incentives were provided to firmsinvolved in the production of goods for export.Procedures for the approval of investmentprojects were streamlined and fresh investment

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