RS-05

PUBLIC DEBT AND

SUSTAINABILITY IN VIETNAM:

THE PAST, PRESENT AND THE FUTURE

PUBLIC DEBT AND

SUSTAINABILITY IN VIETNAM:

THE PAST, PRESENT AND THE FUTURE

PUBLIC DEBT AND SUSTAINABILITY IN VIETNAM:

THE PAST, THE PRESENT AND THE FUTURE

Research report RS - 05

Copy right © 2013 belongs to the Economic Committee of the National Assembly and UNDP

in Vietnam.

Any copy and circulation without permission of the National Assembly’s Economic Committee

and UNDP is copyright infringement.

PUBLIC DEBT AND

ITS SUSTAINABILITY IN VIETNAM:

THE PAST, PRESENT AND THE FUTURE

KNOWLEDGE PUBLISHING HOUSE

PREFACE

Vienam’s economy in the recent years has gone through a

long-termmacroeconomic instabilitiesdue to fundamental

shortcomings of the economy caused by the

over-prolongingextensive economic growth model. Despite the

period of high growth in the early 21st century, as well as Vietnam’s

joining the middle income countries in the world; the recent

movements of negative growth, high inflation, exchange rate, trade

deficit and budget deficit and rapidly increasing public debt are

worsening the macroeconomic indicators.

The current challenges of public debt highlight that it is now the

time to have a radical and comprehensive fiscal reform to guadually

reachieve budget equilibrium to secure the sustainability of public

debt and maintain economic stability in long-term. To be able to

provide these feasible policy recommendations, this research

undertaken by authors from the National Economics University, with

support of their collaborators, have put together great attempts to

perform a comprehensive assessment of the current situation and

offer a prediction of public debt, aiming at determining risks and

challenges in monitoring and managing public debt. The research

specifies in: international experience and lessons learnt for Vietnam,

analysis of current situation and negative impacts of trade deficit and

increasing public debt on macro variables, evaluation of risks and

sustainabilities of public debt, forecasting of Vietnam’s public debt in

different economic scenarios and provision of some policy options to

enhance transparency, supervisory and management of public debt

aiming at sustainability in the future.

This research is undertaken within the framework of “Support

for enhancing capacity in advising, examining, and overseeing

macroeconomic policies” project chaired by the National Assembly’s

Economic Committee and funded by UNDP. Opinions, analyses and

assessmentes presented in this report are given from the view of the

authors and donot necessarily reflect the view of the Economic

Committee, the Project Management Unit or United Nations

Development Program.

Dr. Nguyen Van Giau

Member of Standing Committee of National Assembly

Chairman of the National Assembly’s Economic Committee

This research is undertaken within the framework of “Support for enhancing capacity

in advising, examining, and overseeing macroeconomic policies” project chaired by

the National Assembly’s Economic Committee and funded by the United Nations

Development Program in Vietnam (UNDP).

Chairman of the Project Steering Committee:

Nguyen Van Giau

Chairman of the National Assembly’s Economic Committee

Project Director:

Nguyen Van Phuc

Deputy chairman of th e National Assembly’s Economic Committee

Project Vice Director:

Nguyen Minh Son

Head of National Assembly Office Economic Department

Project Manager:

Nguyen Tri Dung

Authors:

Pham The Anh

Dinh Tuan Minh

Nguyen Tri Dung

To Trung Thanh

The Authors wold like to express their sincere gratitude towards Mr. Nguyen

Van Giau, Nguyen Van Phuc, Phung Van Hung, Nguyen Minh Son, Do Ngoc

Huynh, Vu NhuThang, Vu Dinh Anh va Nguyen Tien Phong for their

comments as well as great support.

9

TABLE OF CONTENTS

ABBRIVIATIONS 11

INRTODUCTION 13

CHAPTER 1. DEBT CRISIS IN THE WORLD AND LESSONS

LEANT FOR VIETNAM

DEBT CRISIS IN THE EMERGING ECONOMIES IN 1980s AND 1990s 15

Debt crisis in Latin America in 1980s 15

Debt crisis in Mexico in1994 18

Financial crisis in East Asia in the late 1990s 20

Comparison between crises in 1980s and in 1990s and lesson learnt for Vietnam 22

PUBLIC DEBT CRISIS IN EUROPE 25

Course of the crisis and policy respones 26

lessons learnt for Vietnam 36

CHAPTER 2. BUDGET DEFICIT AND PUBLIC DEBT IN VIETNAM

CURRENT SITUATION OF BUDGET DEFICIT AND PUBLIC DEBT 39

Budget deficit and public debt rapidly accelerate 39

High tax collection rate 42

A number of unsustainable revenues 45

Prolonged high budget expenditure 48

Huge, scattered and inefficient public investment 52

Risks from SOEs 57

IMPACT OF BUDGET DEFICIT AND PUBLIC DEBT ON MACRO VARIABLES 59

Inflation 59

10

Interest rate 61

Trade balance and exchange rate 62

Growth 64

Hard landing 66

CHAPTER 3. STATE OWNED ENTERPRISES AND PUBLIC DEBT

POSITION OF SOE s IN THE ECONOMY 69

SOEs’ SOURCE OF CAPITAL 72

SOE’s PERFORMANCE 75

SOE’s EFFECTS ON PUBLIC DEBT 76

CHAPTER 4. ASSESSMENT OF PUBLIC DEBT

EMPIRICAL TREE METHOD AND ITS APPLICATION IN PUCLIC DEBT ANALYSIS 81

Objectives and methodology 81

Application in Vietnam’s context 89

DEBT SUSTAINABILITY ANALYSIS 94

Objectives and methodologies 94

The assessment 95

CHAPTER 5. PUBLIC DEBT FORECAST 111

CONCLUSION AND POLICY RECOMMENDATIONS 118

REFERENCES 124

11

ABBREVIATIONS

ADB Asia Development Bank

BRICs association of emerging economies

SOEs State Owned Enterprises

GDP Gross Domestic Production

GSO General Statistics Office

HNX Hanoi stock exchange

IMF International Monetary Fund

MoF Ministry of Finance

OECD Organisation for Economic Co-operation and Development

PCI Provincial Competitiveness Index

WB World Bank

ODA Official Development Assistance

FDI Foreign Direct Investment

EWS Early Warning System

NEER Norminal Effective Exchange Rate

VND Vietnamese Dong

UDS US Dollar

NPV Net Present Value

CPIA Country Policy and Institutional Assessment

12

13

INTRODUCTION

Vietnam’s economy had been undergoing a tremendous time

since the economic reform in the early 1990s. Economic growth kept

falling, from over 7.6% in period 2000-2007 to nearly 6.0% in period

2008-2011. Meanwhile, inflations remained high, which averagely

reached more than 14% per annual in the past five years. Trade

balance witnessed servere deficit as it sustainedly increased to over 10%

of GDP in several years. Remarkably, high budget deficit and rapidly

increasing public debt due to the consequences of prolonged policies

to stimulate economic growth through public expenditure continue to

be hidden risks that worsen macroeconomic indicators and threaten

the economic sustainability in the future. Budget deficit in the recent

years has reached almost 5-6% of GDP, while, according to MoF,

public debt and external debt respectively rose to 56.3% and 42.2% of

GDP in the end of 2010.

Moreover, poor management added to recent economic

difficulties have resulted in some SOEs’disapointing performance,

loss and driven them to the verge of bankruptcy. These SOEs might be

forced to seek the State’s bailout which shall affect the secure of

public debt in the future. The rapid increase of public debt along with

the deteriorating economic conditions are narrowing the

Government’s options to fly the economy out of the current downturn.

In the respective context, it is extremely essential to carry out a

comprehensive asessment of current situation of public debt and a

public debt forecast to identify risks and challenges in supervising and

managing public debt in the future.

14

Therefore, this research aims at the following objectives. First of all,

we synthesize and take in to account the causes as well as

consequences of public debt crises and the Governments’ policy

responses to typical public debt crises, to draw on lessons learnt for

Vietnam. Secondly, the study shall focus on the analysis of the current

situation and negative impacts of fiscal dificit and increasing public

debt on significant macro variables such as economic growth,

inflation, interest rate, exchange rate, trade deficit, etc. that Vietnam is

and may be encountering in the coming period. Thirdly, the study

conducts an assessment of risks and sustainability of Vietnam’s

public debt from several angles regarding solvency, macro-economic

instability, etc. to make a basis for the identification of crisis potential

and eveulate the sustainability of public debt in the future. Fortly, a

public forecast for the coming 15 years under different economic

scenarios shall will be conducted. And finally, the research provides

some policy options for the improvement of transparency,

supervisory and management of public debt towards sustainability in

Vietnam’s future.

15

CHAPTER 1 DEBT CRISIS IN THE WORLD

AND LESSONS LEARNT FOR VIETNAM

DEBT CRISIS IN EMERGING ECONOMIES IN 1980s AND 1990S

Debt crisis in Latin America in 1980s

Course of crisis

The Latin America’s debt crisis in the 80s also known as “The

decade of loss” had started since the 1970s. In that period, countries in

the Latin America such as Brazil, Argentina and Mexico had quite an

impressive development mainly from the large scale external debt,

aiming at developing domestic industries and improve the

infrastructure. Furthermore, this time witnessed the sharp rise in

petroleum price which had brought export countries huge amount of

money to invest in banks. Accordingly, financial institution lent

developing countries, especially Latin America’s nations, under easy

terms.

However, by 1980s, Latin American countries had faced

difficulties in huge debt payment. Since the middle of 1975-1982, the

public debts of Latin American countries to financial institutions and

World Bank increased at the annual public debt to GDP ratio of more

than 20% which raised the total debt from USD 75 billion in 1975 to

more than USD 315 billion in 1983. In particular, interest and

principal payment increase steadily from USD 12 billion in 1975 to

USD 66 billion in 1982 (The berge 1999).

Meanwhile in 1979, under the high inflation pressure, the United

16

States applied the contractionary fiscal policy leading to high interest

rate. Also, interest rate in the Europe increased highly that made the

US and Europe more attractive to foreign investment and Latin

American debts kept increasing its interest payment. Besides, the

global crisis in 1979 and 1980 affected the developing countries in

OECD. In specific, it had negative effects on export and growth rate

of debtors. They had to mobilized all posible resources to pay for the

debt which brought about the consequences of decreasing domestic

productivity and consumption (Hirst and Thompson, 2004). In

addtion, the huge loans of the government was used in a reckless and

corruption - related manner (Wade andVeneroso 1998).

So, Latin American countries were incapable of maintaining the

high economic growth rate and the foreign payable loan exceeded the

earning. The risk of public debt accumulation had lasted for years and

only exploded when the financial market realised that it was difficult

to receive the repayment from these countries. Most of the financial

institutions and World Bank refused or reduced the loans to Latin

American countries. Meanwhile, the majority of the loans are short

term and many countries faced difficulties in payments if institutions

refused to extend the duration. The billion dollar debt maturity soon

came and capital withdrawal from countries in the region and nations

that could not borrow more began.

The Latin American public debt crisis started in August, 1982

when Mexico declared insolvency, then a series of countries in the

region also stated the incapacity of repayment the external debt such

as Brazil, Venezuela, Argentina and Bolivia. In the crisis in the early

1980s, GDP growth rate of these countries were only above 2%,

decreased approximately 9% per capita (Palat 2003). Actual income

and living standard sharply decreased. The gap of the poor and the

rich increased 50% only from 1976 to 1983. Public debt crisis was one

the reasons for the collaspe of the dictatorships in the region such as

Brazil and Argentina.

17

Policies response

Latin American countries called for the support of international

organizations such as IMF and WB in order to continue to pay the

huge debt. However, in return, these countries must implement the

IMF’s harsh structure adjustmentpolicies such as contractionary

policy (reducing the budget to decrease budget deficit, maintaining

the low credit growth and decreasing spending and inflation),

devaluation domestic currencies to promote export and reformation

such as trade liberalization, privatization, removing the government’s

control and etc. to support the private sector and improve the

financial environment. At the same time, structure adjustment of WB

focused on reformation in depth and in long term. Under such harsh

requirements, Latin American countries suffered serious

consequences such as stagnant economic growth rate, low income

per capita, poverty and increasing gap of rich and poor.

The United State, where financial institutions and banks were

lenders of more than 30% of the public debt in Latin America also had

moves to deal with the crisis. In 1985, the US launched the Baker Plan

which allowed the debtors to reschedule and receive new loans with

the assumption that the problem was the low liquidity and loan

reschedule would solve the problem. However, debtors still couldn’t

make the payment and the situation was getting worse. The problem

now was clear: it was bankruptcy – incapability to pay- not low

liquidity that caused crisis. So the solution was to reduce the debt

scale not to postponed debt payment.

In 1989, the Brady Plan came out and the market oriented debt

rescale was executed. Latin American countries could buy back their

own debts at lower prices in secondary market via different

derivatives. The bailouts from IMF and WB could all use in this

mechanism. However, right after being launched, the plan ran into

18

several matters which then resulted in the incapacity to pay back loan

of some government. For instant, the unpaid interest as a part of the

debt would be put into pre-negotiation which would madethe amount

of interest doubled (to pay interest on the previous interests). In short,

the Latin America crisis lasted for a period and was gradually over in

the early 1990s when countries officially declared the end of “ the

decade of loss”, totally out of debt crisis and got started for the next

period.

Debt crisis in Mexico 1994

Course of crisis

After the crisis in the early 1980s, Mexico had been through a

decade of low growth rate and high inflation, the government applied

the trade liberization in 1985, gradually stablized the economy in the

late of 1987 and implemented the market economy. Such innovations

recovered the economy (the average growth rate of the period

1989-1994 was 3.1%). In 1993, inflation reduced to only one figure

for the first time in two decades. Along with growth rate, Mexico

started to attract foreign investment with a loose control and the

capital flow increased more and more. From 1984 to 1994, Mexico

received USD 94 billion from the foreign investment. Following up

was the breaking out of domestic credit but lack of effective

supervision. So by 1993, the economy went down (growth rate fell

from 4.5% in 1990 to only 0.4% in 1993 due to the appreciation of

the peso in comparison with the USD resulting in current account

deficit) which made many loans become a burden. Economic

recession came with the increasing bad debt situation.

By 1994, due to a high rise of the USD interest rate, Mexico faced

difficulties in attracting foreign investment and decided to devaluate

the peso ( instead of tighening policy to increase the interest rate) to

maintain foreign investors’s confidence. However, the devaluation of

the peso made investors less favorable to the T-bill in the peso

(so-called Cetes) and bought T-bill in USD ( named Tesobonos). While

19

the value of Cetes fell from USD 26.1 billion in 1993 to USD 7.5 in

1994, value of Tesobonos increased from USD 1.2 billion to USD 17.8

billion. However, the burden of responsibility in repaid the Tesobono

increased while the national reserve decreased brought about the

misbelief of investors. Moreover, this misbelief was strengthened by a

series of political and economic shocks and the peak was when foreign

exchange reserve was exhausted and the peso was annouced floating.

The consequence was the capital withdrawal from Mexico which

caused the economic crisis in this country.

Policy responses

Mexico was lucky when the US, IMF, WB and International

Payment Bank together had quickly and timely reaction supporting

Mexico with USD 40 billion to avoid the incapability of payment. In

particular, the payable amount of Tessobono which due in February of

1985 was USD 5.2 billion and USD 8.4 billion was paid from June to

August. Mexico avoided bankruptcy. In exchange, Mexico

implemented ambitious structure adjustments such as targeting to

reduce current account deficit to under 1% of GDP in 1995 by

tighening monetary and fiscal policies, or following policies of

privatizing and liberising business activities that once belonged to the

state, also applied strategies to protect the poor toward the negative

effects of economic structure adjustments. The economy of Mexico

gradually had recovered since 1996 with the growth rate of 5% and 7%

in the following years, the budget regained its balance, foreign

exchange reserve increased and current accout deficit was well

controlled.

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Financial crisis in East Asia in the late 1990s

Course of crisis

Right before the crisis in the 1980s and early 1990s, East Asian

and South East Asian countries had impressive developments and

growth with the high scale of foreign capital flow and high rate of

export. However, the financial liberation in 1990 failed to implement

national financial monitoring to control enormous private loans.

A high economic growth along with the high interest rate in the

East Asia attracted international investors to this region. Individuals

and corporations retained their private debts and majority of which

were short term debts 1 (Wade and Veneroso 1998). East Asian

countries needed loans or foreign investments to maintain

theirproductivity and growth (Hirst và Thompson2004). In 1996,

Indonesia attracted approximately USD 18 billion from the private

cash flow, Malaysia was USD 16 billion and Thailand 13 billion right

before the crisis (Grabel 1999). However, the credit boom due to loose

control over the usage of external investments which were mainly

invested in real estate and stock made these countries vulnerable to

reverse creditflow. In some countries (Thailand for example), such

risk increased because the fixed USD based - peg exchange rate

policy made financial institutions, banks, and enterprises prefer

short term loans in foreign currency for the reckless investment

decisions.

The East Asia’s financial crisis officially started in July 1997

with the collapse of the Thai Bath due to large scale capital

withdrawal. At that time, Thailand bore the burden of huge external

debt that made them go bankrupt before the Thai bath collapsed.

1 In Korea, most of the external debts were mobilized from private organisations. Total foreign

debt by 1997 was USD 154.4 billion (excluded loans from financial institutions), in ưhich, public

debt was USD 18.1 billion and short term loanwas USD 68.4 billion. In total, short term loans was

USD 112.2 billion and long term loan was USD 136.3 billion over the total loan of USD 248.5

billion.

21

Domino effect led to the strong and abnormal capital withdrawal

from the foreign investors making other currencies in the region

devaluate and many corporations go bankrupt (Hirst and Thompson,

2004), especially in real estate sector. The crisis spread to other

countries in East Asia. Indonesia, Korea and Thailand suufered the

worst damages; Hong Kong, Malaysia and the Philippines were

afftected at large scale. The financial crisis,then, had turned into a

serious economic recession.Devaluation of currencies, increasing

inflation and bad debt, bankrupcy of corporations and companies,

economic growth reducing and high unemployment rate (Indonesia’s

GDP decreased by 15% in a year, Thailand’s and Malaysia’s also

reduced by nearly 10% of GDP, while Korean and Hong Kong’s GDP

decreased by 3,8% and 2% respectively in the first quarterof 1998)

(Leblang 2005). The only outstanding pointwas the current account

surplus. Yet, it was due to the decrease in import but the increase in

export,thus the surlus in current account, in fact,demonstrated that

economic downturn led to decrease of import demand. However, most

countries recovered by 1999.

Policy responses

IMF had kicked off a rescue program of 36 billion USD in the

late 1997 and early 1998, as a part of all the bailout packages of 100

billion USD, so that the currencies of South Korea, Thailand and

Indonesia which have been badly affected by the economic crisis

could be stabilized. In exchange, the above – mentioned countries

had to carry out structure reform and implement of significant

policies to restore international community’s confidence and prepare

for economic recovery. According to which, this program includes

the following main contents: (i) Tightening monetary policy in

response to the rapid currency devaluation; (ii) Refunding and

restructuring financial and banking system, closing or merging

bankrupted banking organizations; (iii) MitigatingGovernment’s

interference in the market economy and increasing transparency in

management and implementation of macro – economic policies; (iv)

22

Carrying out cautious fiscal policies to reduce the dependence on

foreign savings,taking into account the expense of restructuring and

refunding banking system, redistributing resources from ineffective

public spending to more effectively performing sectors to decline

social cost of the crisis and promote social security.

However, there were quite a few critical these renovatios. Some

thought that in fact the crisi was more serious due to the demand of

IMF. For instance, IMF required the contractionary fiscal and

moneytary policies despite the decreased domestic demand which

push the country to further crisis. After several months, IMF changed

the policies and allowed these countries to loosen the policies. IMF

asked countries to increase the interest rate to attract foreign

investment and avoid the decrease in domestic currency value.

However, it had negative effect on companies’ credit. In addition,

IMF required to restructure the banking system and private sector

and also emphasized that the reformation should be enacted after the

crisis not in the crisis. For example, closing banks in Indonesia led to

the chaos and withdraw in this field and worsen the situation.

Comparison between crises in the 1908s and the 1990s – lessons for Vietnam

Both crises in Latin Africa and East Asia dued to the loan

exceeding. The problems of Latin America are huge and increasing

external debt of the government to serve the economic growth.

However, economic regression and increasing interest rate in America

and Europe made it hard for these countries to pay the

loan (Sachs1989). Besides, these loans are wasted and corrupt-related

(Wade và Veneroso, 1998) as they were made by the government

instead of the competiveness environment in private sector. In

contrast, the issue of the East Asia is in private sector. The current

capital flow affected the economic environment and sharply increased

the value of asset till it became instability. The asset buble finally

broke led to the bankrupt of corporations and individuals, incapability

of repayment and capital withdrawal (Hirst and Thompson, 2004).

23

Latin American and East Asian governments also were

differentiated from accounts and macro balance. Huge budget deficit

was quite popular in Latin countries and in the crisis most countries

had huge balance of payment deficit led to high inflation and instable

domestic macro economy (Sachs 1989). These imbalances were

resulted from the populist. Accordingly, these countries maintained

high public spending to solve the inequal distribution in income and

high raise living standard of poor people – this also was the political

pressure that led to the inappropriate in policy making. Increaing

public spending without encouraging domestic saving so the deficit

sponsored by foreign fund (Hayami 2003). Meanwhile, East Asia

countries encouraged domestic saving and showed the succeed in

increasing saving in the developing period (Hirst and Thompson,

2004). Accordingly, countries that did not facelargebudget deficit and

had equal or surplus balance of payment would have the sufficient

state reserve. These were also the reasons for the rapid recovery of

East Asia countries.

The above mentioned elements show that fundermental reasons

for the debt crisis in Latin American countries in the 1980s were the

combinations between the populist policies – over spending and

carelessly,ineffectively and corruptively borrowing from foreign

resources – which might be considered as a policyfailure (Hayami,

2003). On the other hand, financial crisis in the East Asia was a

market failure as it emerged from the liberization of international cash

flow under a peg exchange rate system without adequate supervision

to effectively control the national finance (Hayami, 2003). In other

words, private sector relied too much on oversea loans while the

government failed to control the indirect investment (financial

investment). In both scenerios, the countries became vulnerable to

risk of capitalwithdrawal made by investors. Once it had become the

truth, it would have been too late to tackle crisis.

The main reason of crisis in Mexico in 1994 was the combination

24

of peg exchange rate system and the steady credit expansion whose

majority were of low quality(Bordo and Schwartz, 1996) and under

this manner of understanding, the collapse of the peso was not so

different from the crisis in East Asian countries.

From the above reasons, lessons can be drawn on for Vietnam.

Firstly,reckless and ineffective government borrowing with the

probability of corruption while maintaining budget deficit for big

spendings is the first notion. Although most of Vietnam’scurrent debts

are from ODA of other countries with favorable interest and are

mostly long term ones, the ability to continue to receive such

favourables cannot be prolonged as Vietnam has made itself a middle

income country while facingquite a few risks from government

borrowing such as risk of long term risk, risk of foreign exchange rate,

etc. Secondly,in order to effectively control external borrowing,

suitable capital account should be opened along withhealth

improvement of the domestic finance – banking sector, and

simultaneously, a mechanism to monitor macro and micro finance is

essential to effectively control the credit of private enterprises as well

as private borrowing with government’s underwriting. Thirdly, all the

erupted crises relate to poor mechanism and structure of the economy

which particularly is demonstrated in: (i) existing problems in finance

and banking system, lack of effective supervision; (ii) lack of

transperancy in private businesses, “nepotism”,unseperation

ofownership and management; (iii) intransperent relationship

between the Government and major corporations, etc. Therefore, the

economic restructuring especially n finance and banking sector is an

critical and objective requirement to address similar crises. Forthly,if

the nation maintains the USD based – peg exchange rate system, the

economy shoud well prepare for the worst situations – by

implementing healthy and cautious macro economic policies,

developing firm banking system and building a sufficient foreign

reserve to face with currency speculation. However, not so many

countries can maintain the peg exchange rate systemonce a crisis

25

hasoccurred.

PUBLIC DEBT CRISIS IN EUROPE

The Euro, the single currency of the Eurozone, dream of many

politics and economists in the Post World War II, had officially be

relized in 1992 after European Union (EU) sanctioned the Maastricht

Conventrion. This markedsuch enormous progress in economic

integration in Europe. In order to become a member of the Eurozone,

an European country must meet the demand prescribed in the

Maastricht Convention regarding budget deficit, inflation, interest

rate as well as other requirements on currency.

Benefits brought about by the common currency to the Eurozone

are quite obvious. Yet, the challenges in maintaining and operating the

common currency – along with operating the policies at member level

and Union level – are not little. It could be clearly sên that economic

integration at a higher level – using the common currency – imposes

limitation to policy geographical balance of each member country in

responsing to the unfavourable economic- financial movements. On

the other hand, using the common currency requires the moneytary

policy to be applied in region level and benefit of each member

country may be trade off. Furthermore, som countries only satisfy the

conditions (E.g.fiscal requirements)when they join the Union, and

leave the monitoring of and sanctionsfor implementation of such

conditions after joining the Unioninmore difficulties. Finally, using

the common currency does not mean the implementation of macro

economic policies might not be in collaboration.

The above challenges were partly predicted even before the

official usage of the Euro, causing different oppinions on the benefits

and challenges of joining the Eurozone. As a matter of fact, England,

Switzerland and Denmark initially denied to join the zone for the

beginning. The European’s public debt crisis showed that these

countries,to some extent, were right.

Course of crisis and policy responses

26

Course of crisis2

The public debt crisi started in the Eurozone when the members

cannot response to domestic fiscal imbalance on their own. The very

first signals appeared in 2009. By November, after the debt crisis in

Dubai, concerns over the public debt in the Europe grew bigger. The

signal became more obvious after Greece admitted (on December) the

total debt of 300 billion Euro (approximately 113% of GDP), despite

their denial of incapacity of payment.

In 2010, the public debt crisis was getting worse. In January, EU

pointed out discrepanciesin public debt accounting process in Greece.

Budget deficit of this nation in 2009 was adjusted to 12.9% (instead of

3.9% as previously announced), which was four time higher than the

EU’s permitted level.EU also ruled out the probability Greece leaving

the Eurozone.Yet, concerns contibued to be raised for indebted

countries such as Portugal, Ireland, Greece and Spain. The Euro kept

on depreciating in comparison with other key currencies.

In 2011, the stress from public debt crisis continued to escalate.

In April, Portugal admited insolvency and called for the help from the

EU. The interest from Treasury Bill of Spain and Italia increased

steadily. Credit rating of Italia was deducted from A+ to A by

Standard&Poor’s in September. In the same month, there were

rumous of the posibility of debt erase and a stimulative package for

Greecesince they couldnot cut down on the state budge, yet the

attemnpt to put forward this solution did not succeed.

Since 2012, public debt crisis has been continuing and has yet

seen the positive sign of any improvement in the coming years. In

early January, Standard&Poor’s deducted the credit rating of France and

other 8 members as well as the rate of the European Financial Stablization

Fund. European economic growth was predicted to decrease 0.3% in

2012. Unemployment rate in March made a new record. Interest rate in

Spain and Italia kept increasing. In May, the situation in Greece was

2 Summazied from the reports of BBC.

27

getting worse when most of the people refused to implement the rescue

agreement with IMF and EU. After Greece failed to reach the agreement

of establishing a common government among parties, the vote had to be

retaken. By now, the establishing and re-undertaking vote for a new

government has been done. However, people are not very positive

aboutGreece’s outlook. In Spain, Bankia Bank needs a support of 19

billion Euro from the government. Interest rate in Spain continued to

increase in June indicating concerns about fiscal perspective of this

member..

Reasons

A variety of studies experts’ opinions shared different points of

view on reasons for the crisis in Europe. In general, there are several

major reasons. Foremost, this crisis shares the core reason with the

previous crises: they all followed a long period of high credit growth,

low interest rate for provision for risk, excess liquidity, high leverage,

increase in asset value and bubble in real estates sector. In particular,

loan in developing countries was increasing radiply in the 2000s – the

period of globalization in banking sector and interest (including the

provision for risk) was abnormally low3. Reports represented by the

Economists (2010) also stated that the ratio of loan to GDP in 10

developing countries were increasing from 200% to 300% in period of

1995-2008. More importantly, houseshold and Government shared

quite a huge part in the liability structures of these countries (Public

Debt, Figure 1). This is the most major and direct reason of the public

debt in the Europe.

Another critical reason related to the public debt crisis in many

European countries is the increase in spending and/or decline in state

revenue along without tightened control. Due to the financial crisis

and the global recession deriving from the US, a number of developed

economies in Europe had implemented economic stimulus policies

including fiscal policies (increasing revenue and decreasing

3See Minescu, A. (2011), Public Debt, The Debt Crisis - Causesand Implications.

28

expenditure). These policies did help recovering the economy at

national and regional level. Yet, they caused noticeable consequences

for implementing nations under the increasing pressure of budget

deficit and public debt. Some economies suffered from fairly

tremendous pressure due to (public) capital expenditure of the

previous years while economic benefits in terms of budget revenue

was inadequate. Greece is the typical example for nations who

borrowed to invest enormously in Olympic 2004.

Figure 1.1 Liability structure of some enonomies

Source: McKinsey (2010)

In a larger scale, the public debt crisis also derived from the poor

operation and collaboration defined since the formation of the zone.

Particularly, this coordination mechanism focused on moneytary

policy to build trust, maintain the value of the Euro and

institutionalize the execution of currency policyat regional level.

However, the harmonization could only be realized in terms of

moneytary (policies). Meanwhile, fiscal policies of European

countries were not relevantly harmonized. That reduced the

effficiency of coordination in moneytary policy on region-wide and

nation-wide scale. At the same time, the control over of fiscal

activities of a member country aiming at ensuring that such nation

meets the required standards as before they become a member of the

Eurozone was not effectively undertaken. Thus, most of violations of

fiscal disciplines could only be discovered after a fiscal year. It was

not a predictable issue, however, it did reveal when the common

currency is operated.

29

Finally, the prolonged cirisis that seemed to get more and more

severe in the past few years also origined from the response

collaboration mechanism of the Eurozone. In one hand, its

seriousness and spreadieng impacts were not sufficiently recognised,

partly because the politicians refused to publicly admit it. On the other

hand, member countries could not gain consensus over the

distinguishing of the reasons, points of view and rescue policies. The

difference in enhancing the growth rate and especially in responding

and dealing with the crisis were quite significant. For instant, whether

it was the contradictary or expansionary macro economic policy to be

chosen in the context that public debt and financial stability must be

solved while long-term remedies were not determined and

implemented, and the current measures focused on rescuing the

countries in difficulty to avoid the collapsion. Things were getting

more complicated as course of the crisis was worisome and outlook of

the Eurozone affected both regional and global economy.

Box 1.1. Lessons from Greece and the public debt crisis in Europe

Greece, after years od impressive economic growth rate thanks to the development of

service sector, is currently on the edge of brankyptcy due to the policy of spending without planning

and controlling during most of the past decade. Budget deficit of the nation reached 13.6% of GDP

and the current ratio debt/DGP is approximatelt 120% in 2009. Risk of insolvency leading to

domino collapse of involved financial organizations are main concerns that have been unstablizing

the global financial market over the recent times.

The core reason of the crisis derived from the policies to maintain the appreciation of the

Euro and low interest rate in most of the last decade in Eurozone. Taking advantages of which,

Greece easily borrowed the enormous loan of 400 billion USD. Many financial institutions,

including Goldman Sachs, contributed to this process by creating complicated financial contracts to

help Greek government covered its budget deficit. When the world economy was hit by crisis,

Greece also faced difficulties in debt payment and almost lost its capacity in controling the budget

30

deficit.

The crisis started in December 2009 when the new President of the Greek Society Party,

Mr. George A. Papandreou, claimed that his predecessor hid the huge budget deficit of this

country. State budget deficit was 12.7% of GDP not 3.7% as the former government predicted.

Investors got shocked. In early 2010, the worrry of Greece;s insolvency turned into the financial

panic when investors doubted the Geek government capacity in implementing firm measures as

commited to cut down on public expense. When the panic spreaded to the Ireland, Portugal and

Spain, leaders of the influenced countries in Europe such as Germany and France started to

worry about prolonged negative effects on the Euro. They commited to protect the common

currency of the zone but still there were several disagreements in bailout measure for Greece.

After months of arguments, in the end of May 2010, Euro country users and IMF agreed on a loan

of 110 biullion Euro in 3 years to rescue the on-the- edge- of- bankrupcy-economy. In exchange, Greek

government must commit to implement tighten policies including cutting down on public spending and

salary, increasing taxes and reducing pension. These strict policies faced the anger of the citizens when

1/3 of the labour force were in public sector. Many protests occurred causing chaotics, and pushing the

economy into stagnancy and recesssion.

Aafter receiving the stimulus package, still Greece faced many issues relating to seeking remedies

to boost economic growth in time to come. Apart from the current situation of high budget deficit

resulting in the increase in interest rate of Greek T-bill up to 12.4%, 4 times higher than that of German

T-bill; Greece were facing up with a weak economy with low competiveness. Diferentiating from

Germany, the increase in salary did not come along with the increase in productivity. Low competitiveness

led to the decrease in demand for Greek commodity which brought about the higher trade deficit.

Furthermore, as Greece used the common currency, they could not devaluate their currency to regain

competitiveness.

Even in the end of 2010, Eurostat discovered that Greece’s budget deficit in 2009 was

actually 15.4% of GDP, much higher than the ealier previously estimated figure of 13.6%. And the

ratio of debt/GDP was approximated 126.8% of GDP. With tough measuements, Greece somehow

succeeded when the budget deficit in 2010 decreased to 9.4% of GDP and predicted to be reduced

31

to EU‘s allowed rate whichs was 3% in 2013. However, Greek economy was going deeper into

recession. Economic growth rate in 2009 and 2010 were -2.0% and -4.5% respectively.

Meanwhile, unemployment rate kept rising rapidly from 10.2% in late 2009 upto 14.1% in late

2010. The Greek had to suffer from the consequences caused by decisions of careless spending

and information consealing made by their Government.

Consequences

Economic impacts of the European debt crisis were considerable.

It had directly caused EU members to lose trillions of dollars from

financial income through the devaluation of Euro in comparison to

other key currencies. On one hand, this negatively affected production

and consumption structure of the region, especially when imported

goods got much more expensive. On the other hand, the gathering of a

plenty of fiscal resources to prevent the breakdown in debtor nations

(Greece, Portugal, Spain, etc.) would reduce the public resources for

economy reconstruction after financial crisis and global economic

downturn period 2007-2008. In September 2011, statistics also

pointed out the first decline in growth of private sector in Euro

countries after two years. More importantly, as in the more intensive

and extensive integration of the global economy, public debt in the

Eurozone also caused noticeable difficulties for other economies.

By February 2012, the global economy outlook seemed rather

pestimistic. According to IMF’s forecast issued in January 2012 said

global economic growth could only reach 3.3% in 2012, which was

lower than the numberpredicted previously in September 2011 (4.0%).

Economic growth in the US was also adjusted to decrease respectively

from 2.7% (as forecasted in September 2011) to 1.8% (as forecasted

in January 2012), while the similar reduction was forecasted for the

Eurozone, to -0.5% from 1.1% as previously predicted. Price of

primary commodities was also foreseen to drastically fall.

In March and April 2012, the economy outlook was considered

32

to get, though just slightly, optimistic. IMF’s forecast in April 2012

said global economic growth would be 3.5% in 2012, with the growth

of the US and the Eurozone respectively at 2.1% and 0%. This

assessment was given considering the Eurozone’s temporary stability

and the US economy’s signs of recovery. Oil price remaied hard to

determine due to the lack of consensus in different assessment on

economy’s upturn/downturn in the last stage of 2012.

In addition to slow recovery of the US economy and increasing

risk of Greece leaving the Eurozone (and risk that this zone collapes)4,

Germany’s business sense index continued to fall in June, though not

as sharply as in May (3 percentage points) was also worth noticing.

This implied that the Europeancrisis semed to affect German economy

(due to 50% of export volume to Europe), though the impacts were not

so severe (low unemployment rate, raise in salary – unsimilar to the

situation of Greece, Spain, etc.)

If Greece left the Eurozone (regardingless to the collapse of

Euro), the loss that Eurozone’s and global economy might suffer

would be enormous, as same as the spreading impact to the economy

of other regions. Economic growth of developing and emerging

economies, including China, India might drop significantly (which

happened in the second quarter of 2012). Accoring to the review of

UNESCAP, as far as fiscal disciplines were strictly exercised in the

Eurozone, economic growth of Asia – Pacific region would decline by

6.5% in 2012 (lower than in basic scenario), before re-increasing in

2013. If the European countries performed ineffective debt resolution,

4Before the Greek election, IMF announced that the Europe had only three

months to resolve the crisis. After the election, the probability of Greece leaving

the Eurozone declined, yet Citi Group believed that scenario had high probability

of happenning (approximately 65-70%). The risk of crisis spreading due to huge

public debt and collapse of banks heightened in Spain, which was demonstrated

through the EU’s decision to spend 100 billion Euro for a rescue package, despite

the fact that Spain reassured that they only needed 16-62 billion Euro to prevent

the collapse of banks, and that they had just successfully issued 2 billion Euro

bonds (with a recorded interest rate).

33

the decline in growth of Asia – Pacific region would be even higher.

Particularly, in case that the Eurozon ecollaped, economic growth of

Asia – Pacific region would reduce to only 5.1% in 2012, before

decreasing to 4.2% in 2013. In all four scenarios, inflation would no

longer be a serious issue in Asia – Pacific region.

Table 1.1. Four scenarios for the Euro and respective impacts

GDP growth Inflation

2011 2012 2013 2011 2012 2013

Basic scenario 7.3 6.9 8.0 5.8 4.0 3.4

Scenario of strict fiscal discipline

(high probability)

7.3 6.5 7.4 5.8 3.9 2.9

Scenario of effective debt resolution 7.3 5.8 5.1 5.8 3.8 1.4

Scenario of collaspe of Eurozone 7.3 5.1 4.2 5.8 3.4 0.5

Source: UNESCAP.

On another hand, the crisis did not affect different economies in a

same way. In fact, great differences were detected between the crisis’s

impacts on major nations (German, France) and those on economies

directly influenced by the public debt storm (Greece, Ireland, Portugal

and Spain). The directly affected countries were still stuck in economic

downturn while Germany and France had managed to maintain

economic recovery since 2010 and only begun to suffer recession in the

recent years (as mentioned above).

In the view of a longer term, the European public debt crisis might

left behind enormous consequences. Firsly, public debt resolution

outlook was implicit and these concerns might affect the recovery of

both the Eurozone and other economies. The slower the resolution

process, the more severe the crisis impacts on real economies of Europe

and other regions. Secondly, in the worst scenario, the Eurozone’s

collapse might limit or even reverse attempts to perform regional and

global economic integration. Obviously, when a region with such a

34

powerful, adequate and effective institution as well as relatively

uniform development as the Eurozone felt to operate sustainably in

long-term, it could be challenging for other regions to move onto

higher forms of international intergration with no worries.

Policy responses

As mention above, the measures to deal with crisis in Europe

were only about handling temporary financial difficulties in Eurpean

nations to prevent spreading impacts on the entire Eurozone. At the

very beginning of crisis, EU has started to adopt relevant remedies. In

April 2009, EU had to requeste France, Spain, The Republic of

Ireland, and Greece to reduce budget deficit. January 2010, under the

pressure from EU, Greece was forced to announcefiscal austerity

measures in order to control budget deficit. By March and April of

2010, the Eurozone and IMF had to offer bail-outs and loans as

emergency responses. However, the situation showed now

improvements, forcing IMF and the Eurozone to agree upon the first

rescue package of €110 billion for Greece in May 2010 and another

€85 billion bailout in November 2010 for Ireland.

The above measures did not demonstrate much effectiveness and

the public debt crisis in the Eurozone kept worsening. In February

2011, Ministers of Finance of Eurozone’s member States gained

concensus over the establishment of a long-term relief fund

(European Financial Stability Facility) that valued at €500 billion. In

may, the Eurozone and IMF sanctioned a €78 billion relief for

Portugal. In June, Ministers of Eurozone’s member States requested

Greece to employ new fiscal austerity measures before obtaining the

next bailout loans. This, again, spread the rumour surounding the

probability of Greece leaving Eurozone. Yet, Greece managed to

impose such measures and was granted with an additional loan of €12

billion, followed by a €109 billion bailout from the Eurozone.in

August, the European Central Bankannouced that it would buy the

government bonds to reduce borrowing cost and mitigate spreading

impacts of the crisis on Spain and Italy. These nations themselves

35

must introduce fiscal austerity measures to reduce budget deficit, in

October, Ministers of Eurozone’s member States approved to

supplement an €8 billion for Greece.

In 2012, anti-disruption actions in the Eurozone were

continuously implemented, though in a difficul situation. Noticeably,

25 (out of 27) EU member States adopted new regulations to reduce

the probability of budget deficit breaking the stipulated ceiling. In

February, Greece was forced to ratified new fiscal austerity measures

while no remarkable outcomes were drawn on from the meetings

between Greece and private creditors. In March, the Eurozone

approved a €130 billion for the respective nation.

Recently, the four countries Germany, France, Italy and Spain

has agreedthat they would, in the next summit,mobilize leaders of

European countries to approve a plan of writing off the €130 billion

debt for economies in difficulty. Despite facing challenges, this was

the forst times after months, Spain, France ans Italy succeeded in

achieving Germany’s approval on the above mentioned plan. This

could be seen as a positive sign in the process of responding to

Eurozone breakdown probability, regardless consequences in

long-term.

However, the measures imposed so far focused only on

mitigating immediated financial difficulties (debt relief, debt

reduction, financial bailout lending) in several member economies of

Eurozone. Geographical balance of Introducing such remedies still

lingered on, particularly in the context that IMF and other economies,

including the association of emergings econimies (BRICs),

demonstrate commitment in various forms. Meanwhile, the

consideration of longer-term measures might have to wait untill the

immediate challenges in the region had been basically resolved.

Lessons for Vietnam

As an underdeveloped country who was in the conversion to

market economy, Vietnam still majorly relied on public investments

to achive development goals. Budget deficit on going in a long term

36

contributed to the rise of sovereign debt. By 31th of December 2011,

public debt of Vietnam was 54.9% and was estimated to be

approximately 55.4% of GDP5in 2012, which would demonstrate a

great raise in comparison to 36% of GDP in 2001 and 44% in 2005.

According to IMF and WB, Vietnam’s public debt, in spite of

crossing the psychological threshold of 50% of GDP, still stayed

within the safe range in middle term6. Besides, the National Assembly

also decided to raised the public debt ceiling – not exceeding 65% of

GDP by 2015. It was obvious that, technically, Vietnam’s public debt

had not yet reach the severe level as in some Eurozone’s member

States. However, the European crisis, to some extent, had direct and

indirect impacts on Vietnam, as Europe was one of Vietnam’s critical

partners in terms of economicsm trade and investment. Moreover, the

European public crisis as well as its main relevant causes make

valuable development lessons to Vietnam, particularly in the context

that development model mainly counted on public investment.

Firstly, Vietnam need to pay more attention to the conversion

growth model from “extentive” to “intensive”. In the past few years,

Vietnam’s growth majorly depended in investments (especially public

investments), among others, whose result was relatively high

investment rate at approximately 40-42% of GDP, or even 46.5% pf

GDP in 2007. At the same time, return on investment kept falling.

Vietnam’s ICOR ratio was remarkably high comparing to that of other

nations at similar level of development. That was the reason why

benefits from growth and increase in budget revenue could not fully

make up for the costs related to increased public investment and

public debt, at least in the short term. It could clearly be seen that there

would no longer be much policy geographical balance for public

investment which required public investment to perform better to

5Reference: Report No. 305/BC-CP on the current stuation Government’s public debt dated

October 30th, 2012 submitted to the National Assembly 6Reference: Central Institute for Economic Management’s report (2011).

37

alleviate pressure on public debt.

Secondly, it is a must for Vietnam to pay due attention tobudget

disciplines, mostly those relating to public spending and investment.

In addition to negative influences on macro-economic instability,

public investment is also leading to issues concerning scattered, waste

and inefficient investment. Tightening public investment disciplines

would reduce the scale of budget spending necessary for investment

goals, which shall help to stabilize budget deficit and also public debt.

Without the control of such disciplines, even the developed countries

in Eurozone could not avoide being hit by crisis despite relief in any

form. In Vietnam’s context, such rescue would be scarce and

controlling budget expenditure would be a recommended direction

instead of maintaining the current pattern of public spending and

investment. Strengthening public expenditure and investment

disciplines requires groups of remedies that include imrpoving the

performance of SOEs, restructuring public investment, and

determining appropriate development priorities, etc.

Thirdly, aiming at enforcing budget disciplines, it is required to

ensure transparency in information concerning public spending and

investment, which would also improving community supervision for

the performance of public investment and spending, contributing to

avoid risks related to public debt.

Fortly, Vietnam should also consider to coordinate policies

regarding macro-economic, particularly monetary and fiscal policies.

This is considered as an essential action to gain macro-economic

stability and then facilitate economic growth and generate resources

for public investment.

And lastly, it is suggested that Vietnam promote cooperation with

other nations in order to ensure financial security of the region. In the

context that international economic integration gets more and more

extensive and intensive, neighbors’ financial difficulties should

rapidly affect Vietnam’s economy and vice versa. Therefore,

proactive cooperation towards the region’s financial security would

38

be a good orientation to enhance capacity for responding to relevant

risks including those of public debt.

39

CHAPTER2

BUDGET DEFICIT AND PUBLIC DEBT IN VIETNAM

CURRENT SITUATION OF BUDGET DEFICIT AND PUBLIC DEBT

Budget deficit and public debt rapidly accelerate

Budget deficit and public debt are measured in various methods

globally. As being catergorized by level of authority, budged deficit

can be the difference between total revenue and total expenditure of

the central government, which that in some other nations also includes

local budget deficit. IMF, WB or other international organizations

recognize budget deficit as the difference between total revenue and

total expenditure, excluding principal payment, of both central and

local government. In the other hand, public debt is commonly

determined by the total value of borrowings and bonds issued or

guaranteed by the central government, local governments and SOEs,

at a certain time.

In Vietnam, annual budget deficit represents the difference

between total revevue and total expenditure of the central as well as

local government in the respective year. Meanwhile, total public debt

represents the sum of domestic and external debt raised by the public

sector, including central and local governments, but excluding SOEs

even the SOEs whose more than 50% is held by the State. Only debt

owned by SOEs which are guaranteed by the State is included in the

total amount of public debt.

Statistics regarding Vietnam’s budget deficit and public debt are

produced in various sources. The Final Accounts of State budget

prepared by the MoF itself presents two distinct figures of budget

40

deficit which are: (i) budget deficit including principal payment; and

(ii) budget deficit excluding principal payment. The fiscal panorama

indicates that Vietnam has been following policies designed to run

deficit to stimulate economic growth. Budget deficit has been

continuously maintained over the last decade and the average deficit

of the years since 2008 has gone higher than that of the previous years.

In specific, Vietnam’s average budget deficit, excluding principal

payment, in period 2003-2007 was merely 1.3% of GDP, which has

doubled and reached 2.7% of GDP in period 2008-2012, mainly due

to the fiscal policies aiming at boosting aggragate demand to avoid

economic downturn in the latter period. Meanwhile, Vietnam’s total

public debt rose from approximately 40% of GDP in 2007 to

approximately 56.3% of GDP in the end of 2010, slightly decreased to

54.9% of GDP in 2011, and was estimated to be 55.4% of GDP in

2012 due to high inflation. Simultaneously, external debt of the nation

increased from 32% to approximately 42% of GDP7.

Yet, these figures shall not reflect the nature of the prolonged

fiscal deficit in Vietnam currently. International organizations

provided far different numbers for Vietnam’s budget deficit in

comparison with what was reported by the MoF. Specifically for 2009,

budget deficit excluding principal payment as given in MoF’s report

was 3.7% of GDP while ADB and IMF produce was much bigger

numbers, which respectively were 3.9% and 7.2% of GDP. Averagely

in three years 2009, 2010 and 2011, Vietnam’s budget deficit ranked

one of the highest positions compared with other countries in the

region, at about 3.7% of GDP per annual. In comparison with the

relevant number of Indonesia, China and Thailan, Vietnam’s is

respectively more than 3 times, 2 times and nearly 1.5 times higher.

7Figures regarding budget deficit were provided in the MoF’s annua Final Accounts of State

budget; Figures regarding public and external debt were provided in the Government’s Report No.

305/BC-CP dated October 30th, 2012 on the situation of public debt.

41

Vietnam’s current accounting methods do not comply with

international practices. They makea large number of budget

expenditures made using Government Bonds for projects in the fields

of education, irrigation, health, etc. off balance sheet and do not

adequately include them in budget deficit and public debt as

international practices do. The inconsistency in fiscal accounting

procedure disables the statistics data to accurately reflect the real

situation Vietnam’s public debt, poses difficulties in information

verification for market participants and also in the international

comparison, assessment and risk management works in terms of

Vietnam’s public debt.

Table 2.1. Vietnam’s budget deficit through years (% of GDP)

2003 2004 2005 2006 2007 2008 2009 2010 2011

MoF1 -4.9 -4.9 -4.9 -5.0 -5.7 -4.6 -6.9 -5.5 -4.4

MoF2 -1.8 -1.1 -0.9 -0.9 -1.8 -1.8 -3.7 -2.4 -2.1

IMF -4.8 -1.2 -3.3 -0.2 -2.5 -0.5 -7.2 -5.3 -2.5

ADB -2.2 0.2 -1.1 1.3 -1.0 0.7 -3.9 -4.5 -2.5

Notes: MoF2: Budget deficit including principal payments;

MoF2: Budget deficit excluding principal payments;

Source: Synthesized from data from MoF, IMF Country Reports (IMF,

2005-2012) produced by authors; and Key Indicators (ADB, 2011)

Table 2.2. Vietnam’s public debt through years (% of GDP)

2003 2004 2005 2006 2007 2008 2009 2010 2011 Threshold

Total

public

debt

52.6 56.3 54.9 65.0

External

public

debt

28.9 29.9 27.8 26.7 28.2 25.1 29.3 31.1 30.9

External

debt 41.8 37.2 32.2 31.4 32.5 29.8 39.0 42.2 41.5 50.0

Notes: Public debt and external debt thresholds proposed by MoF.

Source: MoF.

42

Figure 2.1. Budget deficit of some Asian countries 2009-2010 (% of GDP)

Source: Key indicators (ADB, 2012).

Statistics data shows a remarkable difference between the annual

amount of Government bondsactually issued and the respective

number presented in State budget final ccounts. According to Hanoi

Stock Exchange, total annual value of bonds issued or guaranteed by

the central government for 2010 and 2011 was approximately 110

trillions dong, much bigger than the number reported in the State

budget final ccounts. Alos, a large amount of non-Government

guaranteed borrowings raised by SOEs is not presented in Vietnam’s

annual budget deficit and public debt as practiced and recommended

by many international organizations.

High tax collection rate

As presented in the State budget finalaccounts prepared by MoF,

averagely in the five year period 2006-2010, totalof revenues and

grants (excluding Brought forward revenues) of Vietnam was quite

stable at around 29.3% of GDP. If only revenues from taxes and fees

were taken into account (excluding grants and revenues from real

estate), this figure would be 26.2% of GDP. Continuing to exclude

revenue from crude oil, it would be approximately 20.3% of GDP.

Remarkably, proportion of revenue from crude oil in total budget

43

revenue was dereasing gradually, from about 6.9% of GDP in 2007 to

under 3.1% of GDP in 2011. This orives that proportion of other

revenues were rising. Revenues from taxes and fees, regardless that

from crude oil is currently at high level, in comparison to the figures

provided by other countries in the region. Specifically, averagely in

five years from 2006 to 2010, total reveue/GDP of China, Cambodia,

Thailand, the Philippines and Indonexia were respectively 19.6%,

14.8%, around 21.4%, 15.3% and 18.9%8.

Figure 2.2. Vietnam’s revenues (% of GDP)

Source: State budget final accounts and estimates 2003-2011.

8 Source: International Monetary Fund - IMF (2011), Some Tools for Public Sector Debt

Analysis,Chapter 9 in Public Sector Debt Statistics: Guide for Compilers and Users.

44

Figure 2.3. Reveues from taxes and fees in some Asian countries (% of GDP)

Source: IMF (2011).

Except for in 2009 when the Government adopted a series of

measures of tax reduction and exemption to boost gross demand,

Vietnam’s revenues from taxes and fees (excluding revenues from

crude oil, real estates and grants) had shown no signs of declining.

State budget final accounts in 2010 and first State budget estimates for

2011 signals that such rate would remain at 19.9% and 19.8% of

GDP.IMF’s figures show that in addition to the annual two-digit

“inflation tax”, Vietnam’s tax and fee to GDP ratio is1.2 to 1.8 times

as high as that of other countries in the same area.

Besides taxes and fees, Vietnamese enterprises have to pay quite

an amount for informal charges. A PCI survey in 2011 revealed that

among enterprises interviewed, although a decrease was seen, there

were more than 52% of them saying that they had to bribe the local

administrative staff; 7% of them spending up to 10% of their income

on informal charges. The report also stated that although petty

corruption seemed to decline, grand corruption tended to increase

through taking kickbacks (when signing contracts), public

procurement or lucrative realty deals. Concerning this aspect, 56% of

the firms bidding for government projects say that paying commission

is a common practice9.

9See 2011 PCI Report by VCCI.

45

The high tax revenue to GDPhas limited the ability of capital

accumulation, leading to a fall in development investment. It has also

resulted in tax evasions such as price transferring in foreign direct

investment (FDI) enterprises. Recent statistics have shown that FDI

accounts for 20% of GDP, but the FDI companies, except for

crude-oiled ones, contribute only about 10% of state budget. Many of

those enterprises have repeatedly claimed losses but expanded

the scale of investments at the same time. The fact that Vietnam

imposes a higher tax rate, compared with other countries in the region

impose has provoked abroad profit transferring

In spite of the high tax revenue to GDP, the public

infrastructureand social services in Vietnam are still far left behind by

those in many other countries. That Transportation systems are narrow

and deteriorates while hospitals are overloaded and the quality of

education is low, among others are headaching issues towards long

term economic development A high level of public expenditure has put

a pressure on state budget, requiring for high and increasingstate

budget revenue during the past years . The way of reducing budget

deficit through raising tax rate and tax base hardly seems to work.

Therefore, expanding revenue can only be done by increasing the rate

of obeying tax law, preventing revenue losses and smugglings.

A number of unsustainable revenues

MOF’ s annual state budget final account has shown that

Vietnam’s tax revenues and fees come from three main sources:

value-added tax, corporate income tax, import and export duties and

excise tax on imported goods., the proportion of corporate income tax

followed a downward trend, falling from36% in the years 2006-2008

to 28% in the years 2009-2011. Meanwhile, the proportion of the

value-added tax and import and export duties went up rapidly. The

proportion of revenues from import and export duties and excise tax

on imported goods climbs from 10% in 2006 to 18.4% and 14.5% in

2009 and 2010 respectively indicated not only a boom in

46

international trade but also reflected the high level of trade

protectionism in Vietnam10.

Table 2.3. The proportion of various taxes in the gross taxx and fee revenue

2003-2005 2006-2008 2009-2011

Gross taxes and fees/GDP 25 27 25

Corporate income tax 33 36 28

Value-added tax 22 23 29

Import and export duty 13 13 15

Others 33 29 28

Source: State budget final accounts and estimation in 2003-2011

In particular, the revenues from state-owned house sale and

land-use right transfer followed an upward trend in both volume and

proportion to gross revenues: going down from 9.3% in 2007 down to

6.6% in 2011 when state-owned properties were gradually depleted.

To have a closer look at the fiscal picture, we should also add a

measure of budget deficit excluding the sales of state-owned

properties. Including these revenues in calculating the budget balance

would reduce the severity of the budget deficit in the reported figures.

In spite of restricting current debts, selling state-owned properties for

expenditure may result in a reduction in public properties.

10Ever since Vietnam officially became a member of the WTO in 2007, the proportion of

revenues from import and export duties has risen in comparison with that in the previous period.

By the state budget settlement’s calculation, the proportion of revenues from import and export

duties and from excises on imported goods to gross export earnings followed a downward trend

the years during which Vietnam was in preparation for joining the WTO, falling from 2.3% in

2003, 2.2% in 2005 and 1.9% in 2006. However, the proportion seemed to increase after

Vietnam’s participation in the WTO: 2.1% in 2007, 2.6% in 2008 and 3.6% in 2009. In addition,

the same trend was seen in the proportion of revenues from value-add taxes on imported goods

to the value of imported goods: 2.6%, 2.5%, 2.3%, respectively, in 2004, 2005 and 2006; and

2.4%, 2.4%, 3.6%, in that order, in 2008, 2009, 2010. This trend can be explained by these

following reasons: the improvement in preventing tax losses and/or, the increasing proportion of

high tax-rated imported goods to imported goods while little progress was made on tax cut

process.

47

Likewise, the nature of revenues from crude oil and other

natural resources are the same as that from state-owned properties.

Natural resources are unstable as it may decline in the near future

since natural resources are finite. Specifically, the percentage of

revenues from crude oil in the state budget has experienced a

continuous decrease in recent years: they accounted for up to 28.8%

in 2006 but only 11.6% in 2011. In addition, revenues from

non-refundable aids should be excluded from calculation owing to it

short-term and unstable nature.

To capture a more detailed picture of the budget deficit, we omit

the temporary and unstable revenues which are gained by selling

state-owned properties from the gross revenue, and then re-calculate

budget deficit excluding principal payments. Table 2.4 shows the

degree of Vietnam’s budget deficit without principal payments...

Excluding temporary and unstable revenues, on average, annual

budget deficit accounts for 11.6% of the GDP during the period from

2006 to 2008 and 8.7% during the period from 2009-2011.

Obviously, Vietnam’s budget was in a very serious deficit despite the

fact that the ratio of the gross tax and fee revenues to GDP is greater

than other countries’.

48

Table 2.4. Budget deficit excluding unsustainable revenues (% GDP)

2006 2007 2008 2009 2010 2011 2012

Budget deficit excluding

principal payments

-0.9 -1.8 -1.8 -3.7 -2.8 -2.1 -3.1

Budget deficit excluding

revenues from grants -1.7 -2.7 -2.4 -4.2 -3.1 -2.3 -3.3

Budget deficit excluding

revenues from grants and

sales of houses and land

transferring

-3.5 -5.0 -4.7 -6.5 -5.3 -4.1 -4.5

Budget deficit excluding

revenues from grants, sales

of houses and land

transferring and crude oil

-12.1 -11.9 -10.7 -10.2 -8.9 -7.2 -7.5

Note: Revenues from sales of state owned houses and state owned land transferring consist

do not consist of land taxes, agricultural land use taxes and transferring land right taxes.

Source: Author’s calculations based on annual budget settlement.

Prolonged high public expenditure

During past years, public expenditure has been considered as

one of the most important motivations for boosting the economic

growth in Vietnam. However, the role of public expenditure in

economic growth remains controversial. Many researchers have

proved that if government spending is too low, economy will grow

extremely slowly because the implementation of contracts,

ownership right protection, and infrastructure development would be

faced with a large number of difficulties without the role of the

government. In other words, some of public expenditure is necessary

to ensure the economic growth. However, once government spending

exceeds a certain threshold, it will hinder economic growthdue to an

ineffective resource allocation, corruption, loses and private sector

crowding-out. Judging from empirical analysis, economists agree

49

that the optimal scale of public expenditure for developing

economies ranges from 15% to 20% of the GDP11. By comparison,

international figures by ADB have shown that Hong Kong, Taiwan,

Indonesia and Singapore are countries whose public expenditure

scales are the smallest and account for only 15-18% of the GDP.

Meanwhile, recently, the scale of public expenditure of Vietnam,

including investment expenditure and recurrent expenditure, has

been far above the optimal threshold accounting for more than 30%

of the GDP.

As ironical as it can be, 20 years after transforming from a

centrally-planned economy into a socialist-oriented market economy,

the scale of Vietnam’s government spending has increased sharply

from about 22% in 1990 to more than 30% of the GDP in 2010.

Certainly, economic achievements are not only determined by fiscal

policies, but they also depend upon policies on money, trade, labor,

etc. In fact, it is proved that it is the quality or the effectiveness of

government spending, not the scale that is the important factor which

determines the economic growth and the level of development in

every country. For instance, with more than anover-half-GDP scale

of government spending, Sweden, Denmark, France and England are

on top of high-income economies and developed societies. On the

contrary, Bangladesh and Cambodia, whose one-fifth of GDP is

government spending, are among the poorest countries. However,

fast rising public expenditure to the high proportion of GDP without

effectiveness is one of the main direct/ indirect reasons for

macroeconomic volatility in Vietnam. Due to the fact that much of

government spending are being used widespread in too many fields,

ameliorating the effectiveness of government spending is an

extremely tough mission. Moreover, this situation is believed to drive

the social resources from the effective private sector to the less

11 See Pham The Anh (2008), “Survey on relationship between government spenfding and

economic growth”, Economic Studies, November, 2008.

50

effective public sector. In the end, it will put pressure on future

revenues and gradually erase the motivation for producing in the

former.

Table 2.5. Scale of public expenditure in some Asian countries (% GDP)

1990 1995 2000 2005 2009 2010

Bangladesh 12.4 14.4 14.5 15.0 15.3 15.9

Cambodia 8.4 14.8 14.8 13.2 20.5 20.7

China 18.5 … 16.3 18.3 22.4 22.5

Hong Kong 14.3 16.4 17.7 16.9 17.8 17.4

Indonesia 19.6 14.7 15.8 18.4 16.7 16.5

South Korea 15.2 15.3 18.1 21.4 23.9 21.4

Laos 23.4 26.7 20.8 18.4 21.0 24.8

Malaysia 27.7 22.1 22.9 23.9 30.3 26.5

Pakistan 25.9 23.0 18.9 16.8 19.8 20.0

Philippines 20.4 18.2 18.1 16.9 17.7 16.8

Singapore 20.2 15.6 18.5 … 17.9 …

Taiwan 14.5 14.3 22.6 15.1 15.9 …

Thailand 13.6 15.4 17.3 18.5 20.8 20.4

Vietnam 21.9 23.8 22.6 27.3 31.8 30.7

Source: ADB (2011), Main economic indicators of Asia-Pacific.

Remarkably, while the proportion of recurrent expenditure to

public expenditure is quite high, the percentage of investment

expenditure is much lower. The proportion of investment expenditure

to public expenditure followed a slight-downward trend, dropping

from 30.2% in 2003 to 25.5% in 2010 and about 22.0% in 2011

thanks to a lot effort in stabilizing the economy through cutting

51

public expenditure. The proportion of recurrent expenditure to public

expenditure, which is lower than that of other countries in the region,

tended to go up quickly:from 51.9% in 2003 to 64.9% in 2010 and

67.2% in 2011. This reveals the complication and costly expenditure

of the bureaucracy.

Table 2.6 Budget expenditure the past years

Value

(thousand

billion

dongs)

Growing

rate (%)

%GDP

% public expenditure

Investment

expenditure

Recurrent

expenditure

Principal

payment

Other

spending

2003 197.6 … 29.1 30.2 51.9 9.6 8.3

2004 248.6 25.8 31.0 26.6 48.8 10.8 13.9

2005 313.5 26.1 33.3 25.3 47.8 10.7 16.2

2006 385.7 23.0 35.5 22.9 46.7 10.3 20.1

2007 469.6 21.8 37.2 22.2 49.4 9.5 18.9

2008 590.7 25.8 37.2 20.2 49.5 6.9 23.4

2009 715.2 21.1 39.4 25.4 45.7 7.4 21.5

2010 669.6 -6.4 31.6 25.5 64.9 8.1 1.5

2011 796.0 18.9 28.9 22.0 67.2 8.0 2.8

2012 903.1 13.5 29.2 19.9 72.1 5.6 2.4

Source: MoF’s annual implemented and estimated reports on state budget

52

Huge, scattered and inefficient public investment

Usually, public investment is defined as the spending of the state

sector in the form of physical capital on providing public goods and

social services such as roads, bridges, schools, hospitals, etc. The

source for public investment could be deducted from the state budget,

state credit, state bonds or foreign development aids. In Vietnam,

public investment also includes pure-business projects which are

performed by state-owned enterprises12.

Public investment and SOEs’ investment may have a direct

impact on public debt through the following ways: (i) government

borrows for investment (ii) government borrows for investment and

on-lending, (iii) government guarantees SOEs’ loans used for

investing, and (iv) direct/indirect local authorities’ loans. All of such

components, however, have not been separated and fully analyzed in

recent years.

In the years from 2001 to 2010, Vietnam’s gross social

investment was on top of the world’s, rising at the pace of 18.7%

each year and on average, accounting for 40.8% of the GDP. The

proportion of public investment, which has followed a downward

trend recently, occupied about 40% of the social investment. With

domestic savings and national savings making up 28.5% and 32.5%

of the GDP respectively, the rapid growing of social investment

including public investment have resulted in a large difference

between savings and investment13. This has led to a rapid expansion

in external debts and domestic money supply, in order to erase the

distance between savings and investment the past years.

Table 2.7. Gross social investment in the past years

12 According to the way to account the state budget in Vietnam, public investment made by

SOEs is not included in the annual budget deficit. Besides, only SOEs’ debts which are

guaranteed by the government is added to public debt.

13National savings equals (=) Domestic savings minus (-) Net income paid to foreigners in forms

of profits, dividends, etc and plus (+) Abroad net transfers, e.g., overseas remittances.

53

Value

(thousand

billion

dongs)

Growing

rate %GDP

Proportion (%)

State-owned

sector

Non

state-owned

sector

Foreign

sector

2001 170.5 12.8 35.4 59.8 22.6 17.6

2002 200.1 17.4 37.3 57.3 25.3 17.4

2003 239.2 19.5 39.0 52.9 31.1 16.0

2004 290.9 21.6 40.7 48.1 37.7 14.2

2005 343.1 17.9 40.9 47.1 38.0 14.9

2006 404.7 17.9 41.6 45.7 38.1 16.2

2007 532.1 31.5 46.5 37.2 38.5 24.3

2008 616.7 15.9 41.7 33.9 35.2 30.9

2009 708.8 14.9 42.2 40.6 33.9 25.6

2010 830.3 17.1 42.6 38.1 36.1 25.8

2011 877.9 5.7 34.6 38.9 35.2 25.9

2012 989.3 7.0 33.5 37.8 38.9 23.3

Source: GSO 2001-2011

54

Figure 2.4. Difference between savings and investment (% GDP)

Source: ADB (2011), Key economic indicators forthe Asia-Pacific

Regarding the funding, on average, in the past 10 years,

approximately 51.7% of annual public investment was funded by the

state budget while loans and SOEs’ capital, respectively, accounted

for 23.1% and 25.2% of public investment. Remarkably, the year

2010 witnessed a sharp decrease in the proportion of state budget

capital to public investment while that of loans experienced a

significant increase, doubling from 13-15% to 36.6% in 2012. Along

with a large scale, public investment spreads across a wide variety of

areas from public utilities such as national security and defense,

education, health, etc. or pure-business practice, for example,

mining, art and entertainment industry. Specially, the proportion of

public investment in realty, banking and finance, construction and

accommodation services to gross public investment increased

sharply from 1.9% in 2006 to about 4.8% in 2010. Public investment

was used rampantly not only in various areas but also in the same

area/field, which was proved by a large number of constructions such

as air/seaports, cement producing factories in each area/field.

Considered to be one of the main motivations for economic

growth, investment is less and less effective. According to Report on

Vietnam’s Competitiveness published by Asia Competitiveness

55

Institute, ICORs of Vietnam, which measures the additional units of

capital needed to create an additional unit of output are 4.8 and 5.414

in the periods of 2000-2008 and 2006-2008, respectively. These

figures are much greater than those of the newly industrialized

countries (NICs) during their transforming period from 1961-1980.

For instance, Taiwan’s ICOR was 2.7 and that of South Korea was 3.

More recently, the ICOR of Thailand in the years 1981-1995 was 4.1

and China’s was 4 during the period from 2001 to 2006. The

investment effectiveness of the state sector is even far lower than that

of the private sector and the foreign investment sector. According to

the report, the ICOR of the state sector is approximately 1.5 times as

high as the average figure of the economy. The lack of effectiveness

in public investment, especially in the SOEs’, has resulted in a low

degree of effectiveness of social investment.

14 Vietnam Competitiveness Report 2010, page 40.

56

Table 2.8. Investment of the state sector

Value

(thousand

billion

dongs)

Growing

rate %GDP

Proportion of capital source

State

budget Borrowings SOEs’

2000 89.4 16.2 20.2 43.6 31.1 25.3

2001 102.0 14.0 21.2 44.7 28.2 27.1

2002 114.7 12.5 21.4 43.8 30.4 25.8

2003 126.6 10.3 20.6 45.0 30.8 24.2

2004 139.8 10.5 19.5 49.5 25.5 25.0

2005 161.6 15.6 19.3 54.4 22.3 23.3

2006 180.1 14.5 19.0 54.1 14.5 31.4

2007 198.0 7.0 17.3 54.2 15.4 30.4

2008 209.0 5.6 14.1 61.8 13.5 24.7

2009 287.5 37.6 17.1 64.3 14.1 21.6

2010 316.3 10.0 16.2 44.8 36.6 18.6

2011 341.5 8.0 13.5 52.1 33.4 14,5

Source: General Statistics Office

57

Table 2.9. Public investment classified by econmomic fields

2006 2007 2008 2009 2010

Transportation 20.7 18.3 22.5 18.1 18.1

Water and electricity 14.6 13.2 12.6 16.8 16.7

Processing and mining industry 16.8 19.9 13.7 15.3 15.2

Science, technology, education, health 10.1 10.5 10.6 8.4 8.3

Communication, art and leisure industry 7.7 8.2 8.1 8.1 8.0

Politics, national security and defense 6.7 7.4 8.6 7.4 7.9

Agriculture, forestry and fisheries 7.1 6.7 7.2 5.9 5.9

Realty, finance, banking, insurance,

construction, accommodation --- 1.9 2.8 3.1 4.8

Others 14.5 13.0 13.7 15.2 15.1

Source: General Statistics Office

Risks of the SOEs

Oriented towards the key role of the economy, the SOEs have

been given various kinds of preferential treatment from the

government such as from an easier access to credit and lands,

exploiting natural resources, market and protectionism and among

others to political backing. Facts have shown that the SOEs have

made certain contributions to the country’s progress of

industrializing and creating employment, especially during the first

years of economic reform. However, that the SOEs have been

expanding business rapidly and taking part in most economic

activities, along with an inefficient and less transparent supervision

system, has led to lax management and severely declining business

efficiency in SOEs. This results in considerable risks to the national

economy. Besides the low level of investment effectiveness,

58

represented by the high ICOR, the SOEs have a limited capacity of

providing jobs for the economy. Statistics shows that despite holding

about 40% of investment, SOEs generate only 10% of employment.

On the contrary, the non-state-owned sector whose investment

occupies 35% of social investment creates up to 87% of new jobs for

the economy15.

In particular, of all the SOEs, state-owned groups receiving a

substantial amount of support of the government are targeted to be

the leading element in the economy. Nevertheless, instead of

concentrating on key activities, a number of state-owned groups have

developed a tangled network of hundreds of subsidiaries and joint

ventures. Their capitals are spread over diverse disadvantaged fields

including finance, banking, securities, realty, mining, construction,

etc. Let’s take Vinashin Business Group as a typical example.

Inefficient projects caused the Group to be sunk by debt and on the

edge of bankruptcy. The lack of supervision of senior leaders plus

poor management, as mentioned above, left doors open to a series of

ineffective activities of using capital such as using new borrowings to

pay off old debts and taking short-term debts to pay long-term ones or

investing working capital in long-term projects. Vinashin has been

restructured; however, the economy will surely still be in aftermath

of its huge loss over the next few years.

Behind lessons and experience learned from Vinashin’s case are

concerns about the effectiveness and financial health of other

government-owned corporations. Recently, the Government

Inspectorates have proclaimed that the Vietnam National Oil and Gas

Group (PVN) have made billion-dollar violations. PVN was allowed

to retain most of its after-tax income for the purpose of raising

investment funds, which were supposed to be spent on setting up

major petrochemical projects, expanding business and making capital

contributions to joint venture with petro bidders. Nevertheless, PVN

15Source: General Statistics Office 2000-2010

59

allocated a large capital to subsidiaries and joint venture carrying

inappropriate projects16.

THE IMPACTS OF BUDGET DEFICIT AND PUBLIC DEBT ON MACROECONOMIC VARIABLES

To clarify the impacts of budget deficit and public debt on

macroeconomic variables, including GDP growth, inflation, interest

rate, trade balance and exchange rates, we have carried out a

qualitative analysis of possible budget deficit transmission and

various solutions to financing them.

Inflation

Government expenditure which is not funded by tax revenues or

other kinds of revenue may be the culprit of excessive aggregate

demand and inflation. This situation is more likely to happen if

government spending is funded by surplus money supply that is

pumped into the economy. If a small part of fiscal deficit is financed

in that way, inflation will by no means occur. However, when the

funding is enormous and continuous for several years, the economy

will eventually get into a situation where the high inflation rate is

seen in a long time.

This channel can be simply explained through the key role of

money supply towards the economy in long term. The increase in

money supply may not accelerate the inflation if the economy is

growing and transaction demand for money is also going up at the

same time; or, other property markets are less attractive. The rise in

money supply can then be completely absorbed in the rise in money

demand; therefore, there will be no rise in the general level of prices

of goods and services. However, when the private sector are satisfied

with the amount of money they hold, a rise in money supply will

cause higher consumption; and, on condition that the aggregate

demand cannot catch up with such change, the prices will be pushed

16 According to the conclusion made by the inspectorates, PVN’s investment in finance,

insurance, banking, realty is worth up to 5600 billion dongs.

60

up until it reaches the balanced point. When the deficit is funded

through increasing money supply, those who are holding money are

considered to be imposed “inflation tax”.

In short term, the governments can take the full advantage of

funding budget deficit through increasing money supply because

price hardly makes a prompt response to the policy. Notwithstanding,

over time, when inflation occurs, the possibility of imposing inflation

tax will gradually be limited. It is because private sector will cut the

amount of money in hand to invest in other assets with stable value

such as gold or strong-currency. Consequently, the phenomenon of

“goldenization” and “dollarization” will become prevalent in the

economy.

In reality, Vietnam has experienced the same impacts in the past

years. Most of its fiscal deficit has funded by government bonds and

even money issued by Central Bank in the form of advancing state

budget 17 . However, a large number of government bonds and

government-guaranteed bonds are sold to big commercial banks.

They are then left in the state bank as a pledge in order for

commercial banks to take out money through open market operations

or rediscounting. Finally, this causes an increase in the money

supply, resulting in inflation. According to statistics of the Hanoi

Stock Exchange (HNX), the total amount of government bonds and

government-guaranteed bonds in circulation is about 336 thousand

billion dongs, equaling more than 13% of the nominal GDP and

nearly 12% of money supply M2 of the year 2011. Thus, besides the

private sector’s high demand for credit, public expenditure funded by

government bonds has also indirectly led to sharp increasing money

supply recently. The high rates of money supply growth and inflation

have made people invest in sustainable-valued properties such as

gold, strong currency and realty,resulting in volatility on theproperty

17 According to term 23, State budget Law 2002, an advance on the state budget aims to

temporarily dispose of the budget deficit according to the government’s decisions.

61

market and limited effects of the domestic monetary policies on the

economy.

Interest

Under no control of administrative limitation, interest is

deetermined by demand and supply in the capital market, where

household savings and business investment converge. Total of

government savings and private savings, also called national savings,

will reflect the supply while investment represents the demand of loan

market. Budget deficit results in a decline in government savings and

national savings, leading to a fall in capital supply and an increase in

the interest rate in the market. As a result, the increasing interest rate

brings about a decline in private savings. This situation is called

crowding out effect. In other words, excessive public spending is the

culprit of state budget deficit. Government is put under pressure to

borrow capital by issuing bonds, resulting in a lower amount of

available capital in the market that the private sector is supposed to

access with a low cost.

In recent years, the structure of loans in Vietnam has experienced

a change from external debts into domestic debts. By the end of 2011,

external debts accounted for 56% of total debts while domestic ones

occupied 43% of total debts and followed an upward trend. However,

this trend hardly seems to be a positive picture that Vietnam is less

dependent on foreign countries. In fact, it shows a fall in foreign

concessional loans. Because of a high interest rate of foreign

commercial loans , we had to switch over to domestic loans.

Nevertheless, that government borrowed a large number of domestic

loans crowded out private sector, leading to the lower economic

growth when 1 capital unit was not used effectively by the public

sector.

62

Figure 2.5. Government Bond issued over years (thousand billion dongs)

Source: HNX.

On average, in two years 2010 and 2011, the Government of

Vietnam borrowed more than 110 thousand billion dongs through

issuing domestic bonds. Such a figure is much greater than that for the

period of 2007-200918. Similarly, loan interest rate in the market in

the former period doubled that in the latter period. This situation is a

typical example of crowding out effect. More seriously, sometimes,

mobilization of domestic capital by issuing government bonds does

not naturally obey market law. In the years 2010 and 2011, with

ceiling interest rate of government bond fluctuating from 10% to

12%/ year and market interest rate being more than 20%, as usual, no

commercial bank is willing to buy government bonds. However, the

two year witnessed the most roaring success in issuing government

bonds. Behind this phenomenon was that commercial banks were able

to sell/ pledge valuable papers at Central Bank at low discount rates

before on-lending to those with insufficient liquidity for the sake of a

big profit. Consequently, capital was only transferred within banking

system instead of going into the private sector.

Trade balance and exchange rates

Consumers in a country are able to spend more than the value of

domestic products and services by importing goods from other

18 This figure includes both government bonds and government guaranteed bonds. (Source:

HNX)

63

countries. Thus, if the government expands expenditure without

imposing policies on restricting private spending, there will be an

increasing demand for imports and trade deficit. The relationship

between budget deficit and trade deficit can be simply decribed by the

following GDP calculation:

Y = C + I + G + NX (2.1)

In which: Y represents Gross Domestic Products (GDP); C

represents private consumption; I represents private investment; G

represents public spending; and NX represents trade balance.

National savings are the total of private savings (Y C) and

government savings (T G) , in which, T represent the gross tax

revenues. Therefore, national savings can be rewritten as follows:

S = Y - C - G (2.2)

Finally, combine (2.2) and (2.1), we can draw the relationship

among savings, investment and trade balance as follows:

S = Y + NX (2.3)

This equation shows that national savings equals private

investmet plus trade balance. The budget deficit reduces national

savings on the right-hand side, causing decrease in private investment

and/or net exports on the left-hand side.

A decline in private investment caused by the budget deficit can

be easily explained by crowding-out effect while an increase in

government spending on imports is the reason for a drop in net

exports. As a result of the increase in public spending and budget

deficit, the gross domestic consumption is higher than the domestic

output. In order to meet the demand for additional expenditure, both

domestic production and importswill go up, causing the trade deficit.

Especially, the budget deficit affects adversely trade deficit in

countries dependent on imported raw materials like Vietnam.

64

Figure 2.6. Savings, investment and trade deficit

Source: ADB (2011), Key economic indicators for the Asia-Pacific.

Budget deficit has other impacts on trade deficit. Importing

goods and services leads to abroad asset outflow. When imports

surpass exports, we have to pay an amount of foreign currency to

foreigners. They, then, invest such foreign currency in stocks,

corporate bonds, government bonds or real estate. As a result, when

budget deficit happens, Vietnam becomes a net importer of goods

and services and a net exporter of properties. Foreigners are holding

more and more domestic assets.

Budget deficit reduces the capital supply of private sector,

causing higher interest rate. When other factors are constant, higher

interest rates could attract external capital to flow to domestic market,

leading to increases in the supply of foreign currency and local

currency prices. However, in Vietnam, this impact is not enough to

offset the pressure of the currency depreciation due to serious trade

deficit. Furthermore, the inflow of capital from abroad is limited by

high inflation and unpredictable exchange rates in Vietnam.

Growth

Fiscal policy has effects on production growth through two

transmission channels. Firstly, it affects savings and investment, and

hence the national capacity of production in the long term. Secondly,

it results in changes in the effectiveness of resource utilization,

leading to changes in current output as well as growth in the future

65

In the context of recession, expansionary fiscal policy and a

certain amount of state budget deficit are believed to boost domestic

production by stimulating aggregate demand. This policy proves

effective in economies pursuing balanced budget policy. However, if

the economy has nearly reached the point of potential output and

experienced continuous budget deficit, this policy will bring about

limited results. Worst of all, an expansionary fiscal policy is the

culprit of high inflation, high interest rates, current account deficit

and financial instability, The lesson of stimulating aggregate demand

in Vietnam in 2009 and its consequence in the next two years are a

stark example.

In response to an increase in inflation and current account deficit

due to long-lasting deficit, Vietnamese government as well as others

usually imposes administrative interventions in controlling prices

and exchange rates. However, such methods result in the shortage of

aggregate demand because they distort domestic production factor

markets leading to unreasonable resource allocation. It is also

because the lack of imported inputs, limiting the capacity of

production and exportation. Over time, long-lasting expansionary

fiscal policy worsens current account balance and accelerates

inflation. Deterioration in belief in domestic currency and economy

will cause foreign capital outflows unless the government accepts to

suffer from drawbacks of tightening money supply and raising

interest rates in order to revive the belief in domestic currency.

Vicious circle of budget deficit – trade deficit – budget deficit may

occur when policies on price control and trade reducerevenues from

taxes, especially those from imported goods. This results in more

difficulties in shrinking budget deficit, so the policy on increasing

taxes or imposed new ones is the final solution to such a situation. As

a result, high taxes and fees discourage production in the private

sector, causing low or negative growth

66

Hard landing

“Hard landing” is a term reflecting the situation in which an

economy rapidly shifts from high growth to slow-growth and then

recession. This situation usually occurs when the government tries to

reduce budget deficit and control public debt. It may be too early to

put Vietnam in “hard landing” circumstance with the debt on GDP

ratio being at an average level, but necessary for orienting fiscal

policy towards long-term objectives.

Hard landing may happen when national debt increases so

quickly that foreign capital outflows is triggered. Firstly, as analyzed

above, budget deficit tends to cause trade deficit, which is made up

for by selling domestic properties to foreign investors. However,

foreign investors are willing to acquire the limited number of assets.

If twin deficit continues to occur, the demand for domestic assets will

be saturated and their price will witness a sharp decline. Secondly,

that fiscal deficit prolongs and public debt rises to a certain level will

contribute to investors’ fear for the risk of government’s insolvency.

As a consequence, both foreign and domestic investor liquidates

domestic assets. Finally, the country witnesses decreases in property

price and investment, a rise in interest rates, investment, and

domestic currency depreciation and skyrocketing inflation.

Not only does the higher interest rate worsen the situation where

placing heavier debt burden on government but it also reduces tax

revenues due to lower consumption demand. In response to such a

bankrupt risk, governments often quickly raise income tax and

property tax to achieve a surplus basic budget balance 19 .

Consequently, consumption is lower and lower, causing recession.

Another consequence of hard landing is a climb in inflation

through importing channel when domestic currency loses value

owing to outflow of foreign capital. In addition, Central Bank is put

19 Basic budget balance equals Gross Revenue minus Gross Expenditure, excluding principle and

interest payment of government

.

67

under high pressure to pay off debt, resulting in galloping inflation.

Finally, hard landing may result in a financial crisis. Property

pricesare on a fall and the burden of interest payment put a large

number of enterprises at risk of bankruptcy. Then, enterprises

bankruptcy, in turn, brings financial difficulties to the banking

system because of increasing bad debts. The worst scenario of this

situation is a credit crunch and bankruptcy of financial institutions

when the economy falls into recession like what the world

experienced during the 1930s.

68

CHAPTER 3

STATE -OWNED ENTERPRISES AND

PUBLIC DEBT

According to the Law on Public Debt Management coming into

effect from 1/1/2010, debts of State Owned Enterprises (SOEs) are

not accounted and under no control of Vietnam's public debt.

However, when many the SOEs make losses and on brink of

bankruptcy, threatening seriously security of national finance, debts

of the SOEs need analyzing deeply, regardless of whether they have

been guaranteed by the Government or not.

To achieve this, we try to point out potential risks of the SOEs’

debts to Vietnam’s current public debt. In particular, SOEs are related

to public debt in two terms of: (i) loans of the SOEs that are

guaranteed by the Government; (ii) loans from the Development

Bank, commercial banks or overlapping debts of big SOEs which

make a big loss but are unable to go bankrupt. According to External

debt newsletter No.7 (announced in July, 2011) published by

Ministry of Finance, the foreign state guarantee debt of SOEs in 2010

was 4,642.74 million USD, being equivalent to 14.3% of the total of

Vietnam’s external debt. There was a significant increase in this

figure from 1031.18 million USD in 2006 corresponding to 6.6% of

Vietnam’s external debt. For the second case, although being under

no guarantee, such SOEs are supported by the Government on a

regular basis when they make a loss and be unable to pay debts on

time.

To thoroughly look at this relationship, firstly, we considered the

69

position of SOEs in Vietnam economy. We found that the number of

the SOEs has reduced sharply but still accounted for a large portion

of the economy. Secondly, thanks to an easier access to funds,

especially due to state guarantee, SOEs tend to take numerous loans.

Meanwhile, the SOEs’ performance is not as good as the others. As a

results, the formers’ capacity of debt repayment is adversely affected.

In case the SOEs are not “permitted” to go bankrupt, the debts burden

public debt.

THE POSITION OF SOEs IN THE ECONOMY

In the first decade of the 21st century, Vietnam has made

remarkable progresses in the SOEs equitization. As a result, the

number of SOEs has experience a significant decrease. However, this

sector still holds quite a large proportion of economy.

According to the SOEs Restructuring Scheme of the Ministry of

Finance in 2012, until October, 2011, there were 1,039 the SOEs (100%

state capital) in whole country. They are distributed in 11 groups, 11

special corporations, 74 corporations and some independent

enterprises. Besides that, Vietnam has about 1900 joint stock

companies with more than 50% of state capital. Among 1,039 the

SOEs with 100% state capital, 701 ones were managed by local

authorities, including 236 public utility enterprises and 465 business

enterprises; 355 enterprises under control of Ministries and sectors

(in which: 193 enterprises in the fields of security, national defense

and public utility and 162 business companies; 253 enterprises under

the control of the Groups (in which 23 public utility enterprises and

230 business enterprises).

In the structure of Vietnam’s corporations on 31, December,

2010, SOEs made up an insignificant proportion of enterprises, but

held 32.6% of capital, 35.4% of the value of fixed assets and

long-term investment. By the end of 2009, they generated 37.8% of

the total profit before tax, contributing 37.4 % of Tax and state budge

revenue, creating jobs for 19.5% of the labor force (Table 3.1). .

70

Table 3.1. Some of the basic criteria of the SOEs sector, 2000-2010 (% of all

enterprises in the economy)

Year The

number of

enterprises

on 31/12

The

number of

employees

on 31/12

Capital

on 31/12

Fixed assets

and

long-term

investment

by 31/12

Taxes

and

Profit

before tax

State

Budget

Revenue

2000 13.6 59.0 67.9 55.8 42.7 50.6

2001 10.4 53.8 65.7 55.2 42.6 60.6

2002 8.5 48.5 62.1 56.0 41.7 52.5

2003 6.7 43.8 59.1 51.4 36.1 48.5

2004 5.0 39,0 56.3 48.3 36.5 39.7

2005 3.6 32,7 54.1 51.1 39.9 41.9

2006 2.8 28.3 51.5 55.5 36.5 37.6

2007 2.2 23.9 46.8 47.0 34.3 37.5

2008 1.6 20.9 44.7 47.6 33.1 27.7

2009 1.3 19.4 38.7 44.8 37.8 37.4

2010 1.1 16.7 32.6 35.4 -- --

Source:Enterprise Survey, GSO, 2001-2012.

As can be seen from Table 3.1, the proportion of the SOEs’

above criterions in the economy witnessed a downward trend in the

period. There are two reasons causing this situation. The first one was

the growth of the private sector including non-state enterprises and

foreign invesment enterprises. The second one was the equitization

of SOEs. Also, there was a dramatic fall in all of criterions until 2008

before a slight decrease. Interestingly, only in figure of taxes and

profit before tax and state budget revenue was a recovery seen in

2009. That is result of a leveling off of SOEs equitization since 2009.

Neverthless, the number of the SOEs transforming into joint stock

enterprises or limited debt companies (LLC) with more than 50%

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state capital rose by 64 % in the five years. As a result, these

enterprises account for 45.3% of all the SOEs in 2009 (Figure 3.1)

Figure 3.1. Legal structures and Management and control of the SOEs

Source: Pham Thi Thu Hang (2011)20.

During the conversion, the SOEs tended to withdraw capital

from labor-intensive fields and focused on capital-intensive and

technology-demanding fields such as heavy industry, elemental

services and finance. Consequently, the percentage of SOEs’

employees to the total declined from 32.7% in 2005 to 19.5% in 2009

(According to Pham Thi Thu Hang in 2011)

Despite a slight decrease, the proportion of contribution of the

state-owned sector stayed above 30% of annual GDP since 2001.

Particularly, it was estimated that the SOEs would contribute about

from 27% to 30% of annual GDP (after separating components

including state management, security and defense, activities of the

Party and organizations from “the state-owned sector”).

20See Pham Thi Thu Hang (2011), “Some trends of restructring Vietnamese SOEs”, Conferece on

SOEs Restructuring, Misnistry of Finance (2003-2011).

72

SOEs’ SOURCE OF CAPITAL

Capital of the SOEs is derived from three sources: state budget,

retained earnings and trade credit. According to statistics from the

state-owned groups and corporations, the state equity has increased

averagely by 17-18% per year from 2006, reaching 540 701 billion

VND in early 2011, the value of the state equity rose quickly and

continuously during the period due to an increase in operating profit

while new funded capital from the state owner was negligible,. The

state owned Groups and Corporations received quite a small amount

of capital from the state budget items (from 9% of the estimated state

budget expenditure corresponding to 22,700 billion VND in 2008 to

2.3%, corresponding to 9,790 billion VND in 2011)21.

Concerning credit, in the first period of the transition to the

market economy during the last years of the 20th century, the banks’

loans were devoted to the SOEs with over 50% of all credits.

However, after a downward trend, the proportion stayed at

approximate 30% of all credits (Figure 3.2).

Figure 3.2. The structure of credits in banks, 1995-2008

Source: WB’s Report, 2009.

Although all the SOEs and the others enterprises in the economy

operate equally in legal framework, in fact, some big SOEs are

enjoying significant advantages in using trade credits, state credits

21See Central Institute for Economic Management (2011). Scheme for enhancing perfromance of

SOEs.

73

and other capital resources. According to the scheme for

restructuring SOEs of Ministry of Finance in 2012, debit balance of

85/96 state-owned groups and corporations (excluding loans of

Vietnam Shipbuilding Industry Group – Vinashin) , was 1,044,292

billion VND by the end of 2010, being 1,65 times as large as their

equity. When adding 86,000 billion VND Vinashin’s debt as report of

the Ministry of Finance, debit balance of SOEs (excluding the nine

groups, corporations which have not provided data yet) was as much

as 54.2 % of GDP in 2009 (about 898.85 billion VND). According to

SOEs restructuring scheme (2012), credit outstanding balance of

only 11 state-owned Groups was 218.7 billion VND, accounting for

8.76% of the total credit outstanding balance in entire banking

industry and occupying 52.66% of all the SOEs’ total credit

outstanding balance in September, 2011.

Besides credits from commercial banks, SOEs usually receive

“soft” state budget whenever they face up with difficulty. A sheer

number of SOEs which were going bankrupt were supported by the

state in the forms such as additional capital, debt freezing, debt

rescheduling, balance transfer, debt write-off, etc. In spite of a fall in

the number of such SOEs, the amount of support went up many times.

For example, Vietnam Shipbuilding Industry Group – Vinashin had

outstanding debts of approximately 86,000 billion VND with 14,000

billion VND of due debts, but was unable to balance its cash flow.

However, by dint of supports such as balance transfer to (other SOEs),

debt rescheduling (Government guarantees) and additional capital

(raising the charter capital from 9,000 billion VND to 14,655 billion

VND), Vinashin continues operating. In 2010, the Ministry of

Finance received a proposal of the Ministry of Construction for

supporting some subsidiaries under Song Da Corporation which had

troubles in external debt repayment. Another instance was Dong

Banh Cement Joint Stock Company which is not only unable to repay

141 billion of principal and interest but also a lack of 607 billion of

debt repayment in the period 2011-2015. Similarly, Construction

74

Machinery Corporation and many other SOEs which cannot afford

repayments appealed for government’s support because their debts

are state guaranteed loans..

Because of advantages of preferential credits, the SOEs tend to

use more financial leverage than the others. Despite a downward

trend in recent years, the debt equity ratio (D/E) of the SOEs was 2.52

times in 2009. That was much higher than the figure of the private

sector (1.78 times) as well as the data of FDI enterprises (1.39 times).

Noticeably, the debt equity ratio of the central SOEs reached 3.5

times (Table 3.2). That was shown in the Scheme for Restructuring

SOEs of Ministry of Finance in 2012: there were 30 out of 85 Groups,

Corporation with debt equity ratio more than 3 times. Especially, the

figures for 7 groups, corporations including Industrial Construction

Corporation, Civil Engineering Construction Corporation No.1, No.5,

No.8, Military Petroleum Corporation, Thanh An Corporation,

Vietnam Expressway Corporation were over 10 times22.

Table 3.2. Debt ratio and financial leverage (%)

Debt equity ratio Debt/Asset ratio

2007 2008 2009 2007 2008 2009

SOEs 339.4 327.8 252.6 77.2 76.8 71.6

Private

area 178.9 181.4 187.2 63.9 64.1 65.0

FDI area 142.9 151.9 138.8 58.9 60.2 58.2

The SOEs’ capital focused mainly on processing industry,

production and distribution of electricity, gas and water; transport

industry; storage industry; communication industry, construction

industry and mining industry. Those sectors were holding over 80%

of the total capital of non-financial SOEs (Table 3.3).

22See ham Thi Thu Hang (2011), “Some trends of restructring Vietnamese SOEs”, Conferece on

SOEs Restructuring, Misnistry of Finance (2003-2011).

75

Table 3.3. Capital structure of non-financial SOEs (%)

Field 2007 2008 2009

Agriculture and forestry 4.46 3.41 3.78

Fishing industry 0.06 0.05 0.03

Mining industry 1.88 13.09 6.07

Processing industry 16.86 13.34 19.61

Production and distribution of electricity,

gas and water

18.16 21.81 17.9

Construction 13.69 11.51 9.74

Trading and repairing 18.71 14.82 19.98

Hospitality and restaurant 1.11 1.98 1.33

Transportation, storage and communication 20.8 16.6 17.17

Science and technology 0.05 0.03 0.03

Properties trading and consulting 3.12 2.72 3.25

Education 0.00 0.00 0.00

Health service and social relief activities 0.00 0.00 0.00

Sports and Culture 0.21 0.14 0.4

Individual and community services 0.72 0.51 0.71

Total 100 100 100

Source: Enterprise survey of GSO (2008-2010), calculated by authors.

SOE’s PERFORMANCE

By dint of state sector reforms, the SOEs gained higher

achievements in the past period. The number of the loss-making

SOEs witnessed a decrease with increasing profit in most SOEs.

GSO’s official figures showed that after climbing from 2.4% in 2000

to 4.3% in 2007, Return on equity (ROE) of the SOEs fell

significantly to 3.5% in 2008 and to 3.7% in 2009 owing to the

deterioration of the whole economy23 (Table 3.3).

23See Central Institute for Economic Management (2011). Scheme for enhancing perfromance of

SOEs.

76

Figure 3.3. Return on equity (ROE) of the SOEs

Source:Calculations made from EnterpriseSurveyof GSO (2010).

Nevertheless, capital efficiency of the SOEs is far lower than the

private ones. Regarding the data from the Enterprise Survey of GSO

in 2010, while the SOEs spent 2.2 capital units creating 1 profitable

unit, the figure for non-state-owned enterprises was just 1.2 capital

units and for FDI enterprises were 1.3 capital units. (1.5 capital units

were the average of entire Vietnamese enterprises).

In general, performance of equitized SOEs was more

outstanding than the other SOEs because the main target of them was

profitability. By contrast, SOEs in the public utility sector, agriculture

and forestry sector, local essential services and so on had the lowest

profitability ratio because of characteristics (non profitable).

The operation effectiveness of the state- owned groups and

corporations are still low. According to Scheme for Restructuring

SOEs of the Ministry of Finance in 2012, 16.5% of average internet

cost in the same year. Furthermore, 80% of the total of profit before

tax focused on few groups including Petrovietnam, Viettel, VNPT,

Vinacomin and VRG (Vietnam rubber group).

Statistics showed that the SOEs whose main sectors were

mining, agriculture and forestry, fishing, transport, storage,

communication operated more effectively than the other SOEs. The

SOEs with low ROE concentrated on construction industry,

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processing industry and manufacturing and supplying essential

product and services such as electricity, water, community service,

technology and so on.

Table 3.4. ROE of the non-financial SOEs in 2009.

Field

The proportion of

the non –financial

SOEs (%) ROE

Mining industry 6,07 22,10

Fishing Industry 0,03 21,27

Sport and Culture 0,40 19,43

Transportation, storage and

communication.

17,17 9,34

Agriculture and forestry 3,78 7,81

Properties trading and consulting 3,25 5,50

Hospitality and restaurant 1,33 5,46

Trading and repairing 19,98 4,38

Processing industry 19,61 4,01

Individual and community services 0,70 3,39

Construction 9,74 3,35

Science and technology 0,03 2,14

Production and distribution of

electricity, gas and water

17,90 1,44

Education 0,01 -0,58

Total 100

Source: Enterprise Survey of GSO (2010).

SOE’s EFFECTS ON PUBLIC DEBT

On one hand, description of the SOEs in various aspects show

that public debt SOEs’ debts have hardly played any havoc with

Vietnamese public debt. Nominally, the Government just guarantees

some external debts; the SOEs have to repay their remaining debts by

themselves. With the SOEs’ credit outstanding balance

corresponding about 55 -60% of GDP in 2009, state nominal

guaranteed loans made up only about 4.2 – 6.9% of SOEs’ credit

outstanding balance. Those enterprises completely are capable of

78

repaying their external debts, even when their bad debt level was very

high.

On the other hand, that SOEs receive “soft” state budget is

threatening Vietnamese public debt. When they are in difficulty, their

domestic loans will be supported by the Government through debt

freezing, debt rescheduling, balance transfer and debt write-off.

Consequently, government spending increases and the budget is

continuously in deficit. In order to offset government spending on

SOEs’ debt, government has to issue their bond. As a result, public

debt will increase.

The SOEs’ concessional loans from Vietnam Development

Bank (VDB) are a stark instance. VDB’s capital comes from issuing

valuable papers and receiving on-lending ODA, which accounted for

72.4% of VDB’s capital in 2009. Those loans were guaranteed by the

government or in other words, it is public debt. Majority of this

capital was given to SOEs as concessional lending for the purpose of

investment.

By virtue of the government ‘s economic stimulus package in

2009, after reaching to 8.9 % of VDB’s medium and long-term

investment lending in 2007, the rate of overdue debts and freezing

debts of VDB dropped to 3.75% in 2009. According to the State

Audit Report (published on 18, July, 2012) on business situation of

financial institutions, VDB’s bad debt ratio was 12.05% in late 2010.

With a continuous increase in bad debt ratio from 2010 to 2012, the

current figure for VDB may be much higher the reported figure.

Obviously, most of VDB’s bad debt came from state enterprises. This

will have a direct effect on VDB’s debts from issuing valuable papers

and ODA on-lending.

79

Table 3.5. Issuing valuable papers and mandating ODA investment of VDB in the period

2006-2009

Valuable

papers

issuing

(billion

VND)

Medium and

long-term

investment credit

On-lending ODA

The

proportion

of issuing

valuable

papers

on-lending

and ODA

(%)

Value

(billion

dongs)

Overdue

debts and

circle

debts (%)

Value

(billion

dongs)

Overdue

debts and

circle debts

(%)

2006 25.753 44.37 8,20 44.761 1,05 61,19

2007 49.588 51.528 8,90 50.803 0,01 74,34

2008 74.787 61.932 7,43 54.723 0,55 75,69

2009 74.178 72.687 3,75 55.114 0,78 72,39

Source: Annual Report 2006-2009 of VDB.

For SOEs’ loans from the commercial banks, in the worst

situation, the government takes the responsibility for repaying the

loans. Let’ s freezing debts (as in case of Vinashin’s debts at

commercial banks) as an example. The government has to spend an

amount of money on offsetting; balance transferring (to Vinalines

and PVN) may put the other SOEs in difficulties, finally burdening

the government; additional capital (as raising the Vinashin charter

capital from 9,000 billion VND to 14,655 billion VND) is from the

budget. Another instance is Dong Banh cement projects with $45

million loan from ANZ bank. Taken by Construction machinery

corporation (COMA) and Machines and industrial equipment

corporation (MIE), this debt was guaranteed by the Ministry of

Finance in case of losses and inability to repay the loan.

To sum up, as considering indirect impacts, the SOEs’ loans may

put a danger in Vietnamese public debt. As a result of spreading and

ineffective investment, it is easy for the SOEs to make losses as in

case of Vinashin, Vinalines or Song Da Group in the recent years.

80

When facing up with losses, those SOEs are unable to repay their

credits to commercial banks, VDB and foreign creditors on the due

date. Because such enterprises are so large that the government is

finally supposed to take responsibility for repayment.

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CHAPTER4

ASSESSMENT OF PUBLIC DEBT

EMPIRICAL TREE METHOD AND ITS APPLICATION IN PUCLIC DEBT ANALYSIS

Objectives and methodology

Objective of this section is using the empirical tree method with

data in a certain time to evaluate possibility of debt crisis in some

countries. This method application in public debt risk analysis was

used by Manasse and Roubini for their research for IMF in 2005.

Please note that this method is unable to analyze the situation related

to structure, maturity, interest, solvency, liquidity and so on of public

debt in general and external debt in particular, but can indicate a

country’s debt crisis probability because of the past empirical

evidences. Especially, this approach emphasizes the external debt.

Public debt’s potential risks related to structure maturity, interest,

solvency, liquidity and so on would be assessed in the following

section of Vietnamese public debt sustainability assessment.

Sample and definition debt crisis

Basing on a dataset containing annual observations for 47

emerging market economies from 1970 to 2002, Manasse and

Roubini constructed the empirical tree to analyze public debt risk.

Firstly, they defined that a country is in a “debt crisis’’ if it is

classified as being in default by International credit rating

organization Standard & Poor’s or if it receives a large

non-concessional IMF loan (where “large” means in excess of 100 %

of quota).

Starting with the ability to pay, whether a sovereign is insolvent

or not depends on its stock of debt relative to its ability to pay,

measured, for example, by GDP, exports, or government revenues. A

sovereign is solvent, if the discounted value of future primary

82

balances is greater or equal to the current net public debt stock.

Likewise, a country is solvent, if the discounted value of future trade

balances exceeds the current stock of net external debt. Flow

imbalances, such as primary or overall fiscal deficits, or trade and

current account imbalances matter as persistent flow imbalances lead

to an accumulation of debt and are inconsistent with the

intertemporal budget constraint; at some point, primary surplus and

trade surpluses are necessary to avoid insolvency. Therefore, flow

imbalances also affect ability to pay, for any given level of existing

debt. GDP growth and terms of trade shocks also affect the ability to

pay. The exchange rate regime and exchange rate misalignment

impact these debt sustainability considerations because an

overvaluation can cause an external imbalance that leads to debt

accumulation. Moreover, a currency crisis triggered by overvaluation

can lead to severe balance sheet effects if a large part of the debt is in

foreign currency; the stock of debt can sharply increase in real terms

after a large currency crisis.

Willingness to pay depends on the relative costs of defaulting or

continuing to service the debt. The main costs of defaulting are loss

of access to international capital markets and the potential output and

trade costs of default. Low output growth does not only affect the

ability to pay but also the willingness to pay. When growth is low,

being cut off from capital markets is less costly. Openness can affect

the costs of default and thus a country’s willingness to default or not;

more open economies will lose more from the economic disruptions

of international trade triggered by default. Measures of

macroeconomic policy stability, such as low inflation or slow money

growth, reflect policy credibility and predictability and thus influence

investors’ risk attitudes towards a country and their perceptions of the

country’s willingness to pay. Institutional and political factors affect

policy credibility, as well as a government’s willingness to pursue

policies consistent with a sustainable debt path. Political regime

change may lead to the emergence of a political party less committed

83

to service the debt; thus, the nearing of election may trigger investors’

flight and increase the likelihood of a crisis. Rule of law and respect

of property rights signals that a country’s government is more willing

to service its debt.

A debt crisis can also occur if a country is illiquid rather than

insolvent. Hence, liquidity measures, such as short-term debt over

reserves or M2 over reserves, are included in many recent models of

currency and financial crisis that stress the risk of a liquidity run.

Other measures of debt servicing needs, such as the external

financing gap or the interest burden of servicing the debt, may also

proxy for liquidity needs and the ability to refinance one’s debts.

The debt crisis explanatory variables

The explanatory variables can be grouped into three sets: (i)

macroeconomic fundamentals; (ii) variability indicators; and (iii)

political economy variable. To specify, Manasse and Roubini use

various measures of external debt and public debt, measures of

solvency and liquidity, regressors included in the IMF’s early

warning signals model (EWS) of currency crises as there is a possible

link between currency crisis and sovereign debt crisis.

Writer’s analysis showed that the various measures of external

debt (including debt servicing) are relatively low in no crisis years

followed by another no crisis year. They increase in the year before

crisis entry, and most measures increase even further within crisis.

The measures drop again in the year before a country exits from crisis,

though they are still higher than before the crisis. The measures of

public external debt follow the same pattern, suggesting that public

external debt is a possible driving force behind external debt

developments (as in many countries a large fraction of external debt

is public external debt).

The macroeconomic variables - including those from the IMF’s

currency crisis EWS - indicate a worsening of the macroeconomic

situation in the run-up to a crisis and within a crisis, and an

improvement in the situation when exiting from crisis. For example,

84

the current account deficit increases in the year immediately

preceding a crisis entry, stabilizes within the crisis, and improves

further in the year before exiting a crisis. Real growth falters in the

year before crisis entry while inflation spikes. The overall fiscal

balance, as well as primary balance, deteriorates in the run-up to

crisis. It is interesting to note that both the LIBOR as well as the U.S.

treasury bill rate increase in years preceding a crisis, suggesting that

tight monetary conditions in the G-7 area may reduce capital flows to

emerging market economies and thus contribute to debt servicing

difficulties (as it happened in 1982 for example).

The second set of variables is measures of volatility. We show in

Table 2 the coefficient of variation calculated over a moving window

of four years, for the surplus/GDP ratio, inflation, nominal and real

exchange rate and the terms of trade. Interestingly, the volatilities of

the real exchange rate and of inflation rise in the wake of a crisis, and

again in the midst of a crisis, while falling on the verge of the exit.

Finally, political economy variables are shown in the bottom

part of the table. The indexes of political rights, civil liberties and

freedom status, compiled by Freedom House (2002) take value on a

scale from one (most “free”) to seven (least “free”). There seems to

be no significant difference between in/out crises episodes. The same

applies to the political constraint indexes (Henisz, 2000). These

measure the number of player in the political arena with veto power,

who can block reforms. They range from zero (no veto players) to

one (impossible to reform the status quo). Again, there seems to be

little difference between in and out crisis episodes. The same applies

to the typology of electoral systems. The most frequent electoral

system across all cases turns out to be the number one, proportional

representation. More action seems to stem from the number of years

to next presidential election: entry and staying in crisis are on average

associated with upcoming elections, possibly indicating that political

uncertainty before elections plays a role in contributing to crises.

The number of crisis explanatory variables is quite large. To

85

build the Empirical Tree, out of 50 candidate variables, 10 predictor

variables turn out to be sufficient for classification and prediction:

total external debt/GDP ratio; short-term debt reserves ratio; real

GDP growth; public external debt/fiscal revenue ratio; CPI inflation;

number of years to the next presidential election; U.S. treasury bills

rate; external financial requirements (current account balance plus

short-term debt as a ratio of foreign reserves); exchange rate

overvaluation; and exchange rate volatility.

‘Risk/safe’ classification

Evaluation countries in sample to be whether in risk or not

depends on their value of mentioned variables. For example, a

relatively “safe” country type is described by a handful of economic

prerequisites: low total external debt (below 49.7 % of GDP); low

short-term debt (below 130 % of reserves); low public external debt

(below 214 % of fiscal revenue); and an exchange rate that is not

excessively over-appreciated (overvaluation below 48 %). Three

major types of risks are identified: (i) solvency (or debt

unsustainability); (ii) illiquidity; and (iii) macroexchange rate risks.

The debt unsustainability risk types are characterized by: external

debt in excess of 49.7 % of GDP, and together with monetary or fiscal

imbalances, as well as large external financing needs that signal

illiquidity as an element of debt unsustainability. Liquidity risk types

are identified by moderate debt levels, but with short-term debt in

excess of 130 % of reserves coupled with political uncertainty and

tight international capital markets. Macro exchange rate risk types

arise from the combination of low growth and relatively fixed

exchange rates. Each of these risk types differ in their likelihood of

producing a crisis.

Writer pointed out that this method, albeit simple, is useful to

analyze debt sustainability due to examining aspects of risk. For

instance, it is able to show that one country may be heavily indebted

but have a negligible probability of default, while a second may have

moderate values of debt ratios while running a considerable default

86

risk. The reason of this situation is that the joint effects of short

maturity, political uncertainty, and relatively fixed exchange rates

make a liquidity crisis in the latter much more likely than a solvency

crisis in the former. particularly if the large external debt burden goes

together with monetary stability, a large current account surplus, and

sound public finances.

The empirical tree

An empirical tree is a tree data structure in which each node has

two child nodes, using for classification and analysis. Manasse and

Roubini used the empirical tree to analyze public debt risk of

emerging market economies. The detailed contents of their empirical

tree are shown in Figure 4.1.

At first, the sample is split into two branches: (i) episodes with

high external debt (more than 49.7% of GDP) go to the right-here the

conditional crisis likelihood rise from 20.5% in the entire sample to

45.4%; and (ii) episodes with low external debt with default

likelihood of 9.7%. Episodes of high debt (more than 49.7% of GDP)

are further split into high and low inflation (above or below 10.5%).

The former incur the largest default frequency, 66.8 percent (see

terminal node 14). More than half of the crisis episodes in the sample

satisfy these two simple conditions. For example, the high external

debt plus high inflation was met ahead of the crises in Jamaica, Egypt,

Bolivia, Peru, Ecuador, Uruguay, Indonesia, Bolivia, Morocco,

Turkey, South Africa, Uruguay, Brazil, and Venezuela. Terminal

node 7 is the second in terms of number of crisis episodes in the

Empirical tree. Despite intermediate external debt levels (between 19%

and 49.7% of GDP), the joint effect of short-term debt (exceeding

130% of reserves), relatively rigid exchange rates (low volatility) and

political uncertainty (less than 5 years to the next national assembly

elections) conjure to raise the crisis likelihood to 41%.

By contrast, going down from the top to the left, towards

terminal node 3, one finds the circumstances that are more favorable

for reducing risk are low external debt, low short-term debt to

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reserves (below 130%) and low public external debt to total revenue

(below 210%), couple with the economy not being in a recession.

About 58.4% of all non-crisis episodes satisfy these conditions.

Based on the set of rules of this tree, the observation can be

classified as crisis-prone or not crisis-prone. A particular final node is

classified as crisis-prone (not crisis-prone), if the within-node

posterior probability of crisis is higher (lower) than intermediate

level in the entire sample.

88

Figu

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.1. E

mpi

rica

l tre

e

89

APPLICATION IN VIETNAM’S CONTEXT

With the aim of evaluating public debt risk on the application of

the Empirical Tree methodology, the researchers, at first, make

calculation of ten indicators that have most effect on public debt

crisis according to the Manasse and Roubini’s recommendation

(2005) for Vietnam. The calculation was made at the end of year 2011.

These indicators are shown in the Table 4.1 below.

Table 4.1. Some vietnam debt indicators (%)

Indicators 2011

1 External debt /GDP 41.50

2 Short-term external debt/foreign reserves 53.49

3 Real GDP growth rate 5.89

4 Public external debt/public revenue 116.84

5 Inflation rate 18.13

6 Number of years before a national assembly election ---

7 The U.S. treasury bill rate 0.02

8 External financing requirements/foreign reserves 89.55

9 Exchange rate overvaluation (VND/USD) 45.96

10 Exchange rate volatility (VND/USD) 9.4

Source: Ministry of Finance, GSO and IMF.

First,let’s have a look at the variables of insolvency risk or

external debt unsustainability of Vietnam. This risk is described by

indicators including external debt to GDP ratio, fiscal/monetary

90

imbalance, and current account deficit plus high short-term debt. At

the end of 2011, estimated external debt of Vietnam is about 41.5% of

GDP, which is within the safety threshold as recommended by the

international organizations such as IMF and WB. However, there was

serious fiscal imbalance along with constant budget deficit which has

even tended to soar in recent years. Besides, current account deficit is

another threat to the external debt insolvency of Vietnam in the future.

In the period of 2007-2011, in spite of a large amount of finance from

remittance flow, the high trade deficit resulted in an annual current

balance deficit of about 7.2% of GDP on average. The total estimated

value of current deficit during this period is about 32 billion USD,

which is equal to the total external public debt and about 2.5 times

higher than Vietnamese government’s foreign reserves at the end of

201124.

Figure 4.2. Budget and current account deficit in Vietnam (% of GDP)

Source: Key economic indicators for the Asia-Pacific, ADB (2011).

The second group of variables is related to liquidity risk. Despite

primarily characterized by relatively low or intermediate external

debt ratios, these episodes share a ratio of short-term debt to reserves

in excess of 130%, coupled with political uncertainty and tight

24 Vietnam Country Report number 12/165, 2012 by IMF estimated Vietnam’s foreign reserves

at the end of 2011 would be 13.5 billion USD.

91

monetary conditions in international capital markets. As estimated by

Ministry of Finance, the total external short-term debt of Vietnam as

at December 31, 2011 is about 6.8 billion USD, which is equal to

approximately 53.5% of foreign reserves at this time and nearly 34.0%

of that as at the end of the second quarter of 2012. This is because

most of the foreign debts of the Vietnamese Government have long

maturities with preferential interest rates. Moreover, stable political

and investment environment combined with ability to access to high

preferential capital, which is because of the fact that Vietnam is still

in the list of developing countries needing supports from

international organizations, are factors lowering risk of public debt in

short-term. The only risk factor to Vietnam short term debt

insolvency probably lies in the low foreign reserves which is just

equal to two months of import of the entire economy.

The last one is variables of macro-exchange rate risk. This is the

combination of low growth rate and relatively fixed exchange rate.

Vietnam obtains a rather high growth rate in the region and in the

world. In the past five years, despite facing global and domestic

economic shocks, Vietnam still achieved an average GDP growth rate

of approximately 6.5% per year. Although there has recently been a

decline in the growth rate of Vietnam, it is still a considerable

achievement when global economy has been facing lots of

difficulties. Not having to experience growth risk, Vietnam’s

economy has a quite high exchange rate instead. The overvaluation of

domestic currency together with rather rigid exchange rate regime

resulted in an increase of nearly 50% in the real VND/USD exchange

rate during the period 2001-2012. The first effect of this increase

contributed to the Vietnam’s current account deficit. Furthermore, it

raised the risk of currency attacks25.

Figure 4.3. VND/USD nominal and real exchange rate

25 See more in Reinhart, Carmen, 2000, “The mirage of floating exchange rates”, MPRA Paper

13736, University Library of Munich, Germany.

92

Source: GSO and IMF.

With the indicators in the Table 4.1, we can easily apply

Empirical Tree in Figure 4.1 in evaluating the risk of debt crisis in

Vietnam. Moving along the Empirical Tree, we find out the answer

for the following questions:

- “Does total external debt of Vietnam exceed 49.7%?” – Since

the answer to this is NO (about 41.5%), we move to the left and

ask the second question;

- “Does short-term debt exceed 130% of foreign reserves?” – As

the answer is NO either (approximately 53.5%), we continue

to move to the left;

- “Does external public debt exceed 215% of total public

revenue?” - The answer to this is NO again. The external

public debt is approximately 117% of Vietnam’s total public

revenue in 2011. Therefore, we go on moving to the left;

- “Does economic growth exceed -5.445%?” – The answer to

this is YES because Vietnamese economy still obtains positive

growth rate (5.89%). Hence, this Empirical Tree shows that at

the end of 2011 and at the beginning of 2012, Vietnam did not

fall/has not fell into the debt crisis prone.

The statistics on the current external debt indicates that Vietnam

will not face or has not faced to a risk of debt crisis. However, due to

a large deviation between statistics of Vietnam and that of

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international financial organizations, along with the fact that the

former are insufficient, some indicators in the Table 4.1 is rather

sensitive and volatile, especially Total external debt to GDP, External

public debt to total public revenue and Short-term debt to foreign

reserves. Then, the answer in each stage of the Empirical Tree might

vary. So, we assume different scenarios in order to evaluate the debt

crisis of Vietnam in the future.

Supposing that total external debt exceed 50% of GDP – a high

probability if Vietnam pursues too big and costly investment projects

such as North-South Expressway or costly infrastructure projects

without bringing about adequate economic efficiency, or at the time

when bad debt in state-owned enterprises is becoming a burden to the

state budget. Then, the answer to the question in the first stage of the

Empirical Tree is YES. Next, in the second stage, the answer is also

YES while Vietnam’s inflation rate in recent years has always been at

a threshold of two-digit. Thus, Vietnam will fall into the node 14 with

the probability of debt crisis up to 66.8%. A series of crises in the past

classified into this group include Jamaica in 1981 and 1987, Egypt in

1984, Bolivia in 1986, Peru in 1978, Ecuador in 1982 and 1999,

Uruguay in 1987, Indonesia in 2002, Bolivia in 1980, Morocco in

1983, Turkey in 2000, South Africa in 1985, Uruguay in 1990, etc.

The second scenario is that total external debt to GDP ratio is

less than 50%, but external public debt to total public revenue is 2.15

times higher. This scenario is quite likely to take place when

Vietnam’s total public revenue is down with some unsustainable

sources when the public debt growth rate is not tightly controlled or

enumerated sufficiently. In this scenario, Vietnam will fall into the

node 5 with the crisis probability of 55%.

Finally, the third scenario is the case when short-term debt

exceeds foreign reserves 1.34 times. Though this is less likely to

occur than the two first ones, the probability is not small at all when

the debt service of Vietnam is increasing, together with growing

commercial loans. Especially, this risk will dramatically increase if

94

Vietnam cannot improve the current balance and macroeconomic

environment in the upcoming years. With this scenario, the crisis

probability depends on some other factors, the flexibility of exchange

rate and the interest in the international market for example.

DEBT SUSTAINABILITY ANALYSIS

Objectives and methodology

The drawback of the Empirical Tree method above lies in the

fact that it only gives the probability/risk of a debt crisis at a certain

time based on the past statistics without indicating underlying causes

which can affect the sustainability of the national debt. Therefore, the

aim of this section is to conduct Debt Sustainability Analysis (DSA)

and assess fiscal risks associated to Vietnam public debt. This

analysis bases on the methodology developed by WB (2006) and

IMF (2011) for low-income countries26.Nevertheless, owing to the

fact that many statistics and debts have not been disclosed, we have

just tried to develop a framework for debt sustainability analysis of

Vietnam and given out recommends on information transparency to

support the management, monitoring and analysis of future debt.

More specifically, this method is aimed at some following objectives:

Evaluating the current status of public debt including

consideration of current scale, term structure, interest

rate structure: fixed or floating, currency structure and

creditors;

Locating the vulnerability of current debt structure or

policy risk, from which recommendations on

appropriate adjustments will be given; and

Forecasting the future public debt and giving out policy

recommendations in order to avoid collapse or stabilize

26See more in World Bank (2006), “How to do a Debt Sustainability Analysis for Low-Income

Countries” Debt Division, World Bank, Washington D.C, and International Monetary Fund

(2011), “Some Tools for Public Sector Debt Analysis”, Chapter 9in Public Sector Debt Statistics:

Guide for Compliers and Users.

95

public debt.

One country’s external public debt is considered as sustainable

if debt service (principal amounts and interest) are fulfilled without

using exceptional financing methods (such as exemption), or making

major adjustments to its revenue and spending balance. For low

income countries, it is difficult for them to meet their debt service

when creditors, including international organizations and other

governments, as well as donors do not make enough new loans or

donations to finance essential fiscal deficit. Besides, one can have

some troubles in fulfilling its debt obligations if the interest cost is

too high.

Although external debt often has large scale and is blamed for

being the main cause of debt crisis, domestic debt in developed

countries accounts for a considerable proportion. What’s more,

unlike external debt, domestic debt often has a very high interest rate

which is volatile by macroeconomic environment in low income

countries. Noticeably, domestic debt often has short maturity, so it

can lead to risks connected with annual demand for rollovers. As a

result, we are going to perform public debt sustainability analysis

based on information about both external and domestic debt.

The assessment

Vietnam’s debt structure

Total external debt reflects all debt services to foreign creditors

of both public and private sector of Vietnam’s economy. Total

external debt is divided into external public debt (including

Government external debt and Government guaranteed external debt

and non-Government guaranteed external debt (including that of both

public and private sector).

Total public debt is defined as total domestic and external debt

of public sector, including central and local level authorities’ debt

except for debt of SOEs, even those whose over 50% of capital is

owned by the state. Only debts of the Government-guaranteed SOEs

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are enumerated into total public debt.

Vietnam debt statistics are collected and computed from many

different sources and then presented in detail in Figure 4.4. Firstly, we

can see that the access to official sources of information as well as

updates of public debt, external debt and SOEs’ debt in Vietnam is so

difficult. The official source of information about Vietnam external

debt is provided via the only channel called Bulletin on external debt

periodically issued by Ministry of Finance every six months.

Nonetheless, information in this bulletin is not updated; even the

latest bulletin (The 7th Bulletin) has just poorly shown statistics on

external debt till the end of 2010. Other statistics on domestic public

debt especially SOEs’ debt have not been officially publicized in

detail. The data on debt of SOEs are collected and computed based on

the report of Ministry of Finance in National Assembly sessions and

outstanding loans statistics in banking system of the SBV; therefore,

it can lead to the fact that these statistics and figures may vary in time

of calculation. The very first challenge in Vietnam public debt

management is to build a system providing as well as administering

the information about public debt/external debt in a quick and

transparent manner. Perhaps, it is very essential for managers and

policy makers to acknowledge the risk management of public debt

today.

As of 2011, total Vietnam public debt was about 54.9% of GDP,

in which the external and domestic public debt were 30.9% and 24.0%

of GDP respectively. The corresponding figures for 2012 were 55.4%

of GDP, 29.6% of GDP, and 25.8% of GDP27. However, the biggest

potential risk to Vietnam public debt may not be debts recorded in

books. The bad debts of SOEs sector which are likely to be paid off

by the state budget are underlying threats to Vietnam public debt’s

sustainability. Specifically, the external debt of private sector, which

was mostly non-Government guaranteed SOEs, accounted for 10.6%

of GDP. In addition, SOEs’ debt in banking system as recorded in

SOEs restructuring Scheme of the Ministry of Finance (2012) also

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accounted for approximately 16.5% of GDP. If these figures are

included plus SOEs’ non-Government guaranteed domestic

bonds, Vietnam public debt will reach roughly 95% of GDP, far

exceeding the safety threshold (60% of GDP) as recommended by

international organizations such as the World Bank or IMF.

Figure 4.4. Vietnam debt structure (% of GDP) as of 2011

Sources: - External debt and public debt statistics updated from Report on the status of

public debt – Government 305/BC-CP 2012.

- Statistics on debt in banking system calculated from total outstanding loans of SBV.

- SOEs’ bank loans extracted from SOE restructuring Scheme of the Ministry of Finance

(2012), total debt of SOEs extracted from the written reply of the Ministerof Finance at the

4th session, the National Assembly XIII, May 11, 2012.

Term structure and interest rate

Being a low income country plus considerable economic

achievements helped Vietnam receive concessional loans with long

maturities and low interest rates from international organizations

during over the last decade. The simple calculations from the 7th

Bulletin on external debt of MOF show that as of December 31, 2010

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more than 76.4% of Government external debt had fixed preferential

interest rate below 3%. Owing to the fact that this bulletin did not

provide specifically interest rate of each debt, it was impossible to

calculate exactly the efficient interest rate (on average) of external

debt. However, the upper and lower thresholds of efficient interest

rate could be approximately estimated based on interest rate range

provided in that bulletin. The calculation result indicated that

efficient interest rate of Vietnamese government’s external debt was

in the range from 1.5 to 3.7%, less than one-third of 10.98% of that of

domestic debt. This implies the interest rate burden of Vietnam

external public debt is rather low while the domestic one is rather

high.

Nevertheless, it should be noticed that in the past few years, the

proportion of commercial loans in external debt with high interest

rate tended to increase. As of December 31, 2010, nearly 6.8% of

total Government’s external debt had interest rate amounted to 6-10%

and more than 7.0% of the total Government debt had floating

interest rate.

Besides, term structure of domestic public debt also leads to

significant risk. While external debts have maturities of up to some

decades, over 88.7% of Government bonds and

government-guaranteed bonds have maturities of only from 2 to 5

years. Consequently, the external debt service fairly covers through

years (about 1.5-2 billion USD/year), whereas, domestic obligations

are pent up in the near future (approximately 4.5-5 billion USD/year

in the next four years). Along with a possibility of increasing

essential budget balance deficit, Figure 4.11 shows a significant

pressure of issuing bonds to rollover in years to come.

Figure 4.5. Interest rates and proportion of external public debts as of Dec.31, 2010

99

Source: 7th Bulletin on external debt (MOF).

Figure 4.6. Interest rates and proportion of domestic Government bonds and

government-guaranteed bonds as of June 30, 2012

Source: HNX and author’s calculations.

Figure 4.7. Efficient interest rate of external public debt

Source: 7th Bulletin on external debt (MOF).

Figure 4.8. Efficient interest rates of domestic public debt

100

Source: HNX and author’s calculations.

Figure 4.9. Term structure of domestic government bonds and domestic

government-guaranteed bonds as of June 30, 2012

Source: HNXand author’s calculations.

Figure 4.10. Estimated external debt service as of December 31, 2010 (million USD)

Source: 7th Bulletin on external debt (MoF).

Figure 4.11. Estimated domestic Government bonds and government-guaranteed bonds

101

(thousand billion dongs)

Source:HNX as of June 30, 2012 and author’s calculations.

Table 4.2. Comparison between domestic debt (Government bonds and

government-guaranteed bonds) and external debt, 2012

Domestic debt External debt

Proportion 46.5% 53.5%

Average term 4.72 years ---

Efficient interest 10.98% 2.60%

Principal obligation 3.46 billion USD 0.97 billion USD

Interest obligation 1.98 billion USD 0.53 billion USD

Source: HNX, MOF and author’s calculation.

In brief, with a quickly increasing proportion in the recent years,

domestic public debt has posed risks of high interest rate plus its short

maturity. Only in 2012, the debt service amounted to approximately

U.S. $ 5.44 billion or equivalent to 4.5% of GDP in 2011. These are

the main causes of the fact that public spending outnumbers private

spending as well as high inflation due to the pressure of financing

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bonds by increasing money supply.

Currency and exchange rates structure

Although external debt can be charged at low interest rate, it

underlies lots of exchange rate risks. The devaluation of domestic

currency can push external debt burden up. According to the 7th

Bulletin on external debt, in many years, external debt structure of

Vietnamese Government in different currencies was relatively stable.

Classified in term of currency, as of December, 2010, external debt

structure of Vietnamese Government mainly composed of strong

currencies such as: JPY (38.8%), SDR (27.1%), USD (22.2%) and

EUR (9.2%). Debts in other currencies only accounted for a very

small percentage (under 3%). In term of creditors, Vietnamese

government’s big creditors included Japan (34.3% of total debt) and

international organizations, namely IDA (24.9%) and ADB (15.0%).

The United States and EU just respectively made up 0.3% and nearly

6.9% of total Vietnamese government’s debt, but debt in these

countries and region’s currencies amounted to major proportions.

This can be understood that the creditors tend to use strong currencies,

and debts in the strong currencies can impose high risks to external

debt due to currency appreciation from time to time.

Figure 4.12. Proportion of external public debt in different currencies

Source: 7th Bulletin on external debt (MoF).

Particularly, from the beginning of 2010 to the end of June, 2011,

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three key currencies including EUR, USD and JPY in Vietnam’s

external debt basket appreciated about 12%, 13% and 26%

respectively compared to VND. This indicates that external debt in

dong currency is rocketing and putting much pressure on budget

deficit and monetary policy. In order to draw an overall picture of

level of external debt’s exchange rate risk, the researchers made

calculations of nominal effective exchange rate (NEER) of VND in

comparison with others in Vietnamese government’s external debt

basket. The outcomes show that from 2002 to 2010, VND

depreciated up to 41% compared to these currencies. However, in

term of real value, that of these debts decreased while Vietnam’s

inflation amounted to 110% during the period. In other words, the

burden of Government’s debt was being shared to its own citizens

through inflation tax.

104

Box 4.1. Nominal effective exchange rate

Nominal effective exchange rate (NEER) is used to evaluate the appreciation/devaluation of a

domestic currency in comparison with a basket of other currencies. Hereby, NEER is computed based on

weighted average of nominal exchange rate of a domestic currency in Vietnam’s external debt basket. In

particular, NEER is computed as follows:

NEER = ∑ 𝑤𝑖𝑛𝑖=1

𝑒

𝑒𝑖

In which: “e” stands for VND/USD exchange rate; “ei” denotes foreign currency i/USD exchange

rate; “wi” is proportion of foreign currency i in the debt basket; and “n” is the number of kinds of foreign

currencies in external debt basket.

An increase in NEER implies that VND appreciates; by contrast, a decline in NEER reflects VND

devaluation combined with other 18 currencies in Vietnam’s external debt basket. When NEER is down, it

can be understood that external debt burden of Vietnam increases. The calculating result of NEER using

Vietnamese Government’s external statistics in the period of 2002-2010 is presented in Figure B4.1.

Figure B4.1. Nominal effective exchange rate (NEER) and CPI

Source: Author’s calculations based on statistics of MOF and GSO.

105

Box 4.2. Inflation tax

Normally, there are many different ways for governments to finance their budget deficit,

including: raising tax, borrowing and printing money. Assume that one Government decides to raise

money supply; this will lead to devaluation of its currency and an increase in price of goods and services

in the economy.

The price increase in this case is an invisible type of tax. Assume that the price increases 10%,

which lowers the purchasing power; it can be seen that the Government imposes 10% on people’s

income. Hence, inflation caused by printing money to finance Government’s spending can be called

inflation tax.

Despite reducing people’s real income, inflation tax seems not to face much backlash from the

public in the same way as a rise in income tax does. It is, therefore, specially prefered by Governments

whose Central banks lose their independence. The inflation tax is mostly imposed on people holding

cash or people with fixed nominal income. Normally, people who have low and middle income are the

most vulnerable due to the lack of risk prevention instruments as investment in gold, real estate and

foreign currencies.

Figure B4.2. Money supply and consumer price in Vietnam (In 2000: 100)

Source: ADB and GSO.

106

In Vietnam, the price of food always rises much faster than other items. Meanwhile, spending

on food accounts for a major proportion of the poor’s total spending. This implies that inflation tax can

ease the burden of public debt on the Government but at the same time, it is also transferring income

from the poor to the rich, which increasingly widens the rich-poor gap.

With the public debt of 54.9% of GDP at the end of 2011, which tends to increase when the

Government keeps obtaining annual budget deficit, the inflation continues to reduce the public debt to

GDP ratio. Advance from the next year’s budget and the SBV’s indirect acquisition of government bonds

are channels making money supply and inflation soar.

Debt burden indicators

In this section, we make comparison between debt service and

debt stock with various measures of Vietnam’s debt repayment

capacity.

Debt service refers to obligations of repaying principal and

annual interest. It reflects the sources Vietnam has to allocate

annually to meet its debt service and fiscal burden on private sector.

Comparing debt service with solvency yields the best indicators for

analyzing whether the country is likely to encounter any debt-serving

difficulties in the current period or not. This measure, however, is

likely to be inadequate for predicting future debt servicing problems,

since it is useless in calculating loans which may incur in the future.

Debt stock is a measure reflecting debt burden which also

takes account of debt settlement in the future. Debt stock can be

measured by nominal value or net present value (NPV) of the debt.

When being measured by nominal value, debt stock is total future

principal repayment, without involvement of its interest. When

being measured by NPV, debt stock is total discounted value of

future debt service flows. However, NPV also ignores changes in

debt repayment capacity from time to time. The current debt

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burden may not be a worry when one country’s debt repayment

capacity gradually rises in the time to come. Besides, just like

many other low income countries, Vietnam’s external debt is

mostly concessional debt with low interest rate and long maturity.

Therefore, NPV measure can more exactly reflect external debt

burden. Meanwhile, domestic debt is often charged at market

interest rate, so nominal value is often used when considering total

public debt. Debt’s NPV equation can be written as followings:

NPVt = DSt1

(1+r)1 +

DSt2

(1+r)2 +

DSt3

(1+r)3 + … (4.1)

Where: “DSt” refers to debt service due in time t and “r”

denotes a constant market interestrate, called the discount rate. The

NPV of a loan is smaller than its nominal value, if the interest rate

on the loan is smaller than the discount rate and vice versa.

Recent reports on Vietnam debt have not provided sufficient

information about debt service flow in the future. The Bulletin on

external debt of Ministry of Finance just provides external debt

service flow as of 2006. Meanwhile, with Vietnam external debts

maturities being up to 20-30 years, it is impossible to calculate

NPV. This is the reason why we use nominal value to reflect debt

stock in Vietnam debt sustainability analysis. The calculation of

NPV will be made when all sources of information are sufficiently

provided.

Repayment capacity can be measured by GDP, exports and

budget revenue. GDP captures the amount of overall resources of

economy, while export provides us with information about the

volume of foreign currencies can be used in debt repayment.

Besides, budget revenue can be seen as the government’s ability to

generate financial resources. Nevertheless, it should be noticed

that Vietnam’s export value depends much on imported materials

and machines. As a result, using total export value as a measure of

external debt repayment ability can provide less accurate

information.

108

As a common practice, external debt has often been compared

to GDP and export while public debt has often been compared to

GDP and budget revenue. Similarly, external and public debt

services are frequently computed in the relationship between

export and total public revenue. The debt indicators are computed

and presented in Table 4.3.

Table 4.3. Vietnam’s debt burden as of 2011 (%)

Indicators Percentage

External debt to GDP 41.5

External debt to Export 55.2

Public debt to GDP 54.9

Public debt to Public revenue 206.3

External public debt service to Foreign reserves 11.8

External public debt service to Export 1.7

Public debt service to Public revenue 21.6

Source: Author’s calculations from HNX and MOF.

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Table 4.4. Safety threshold of total external debt recommended by WB and IMF

Quality

of

Policies

NPV of debt in percent of Debt service in

percent of

Expor

ts GDP

Public

revenue

Export

s

Public

revenue

Weak 100 30 200 15 25

Medium 150 40 250 20 30

Strong 200 50 300 25 35

Vietnam’s 55.2 41.5 156.0 2.55 7.20

Source: - A Guide to LIC Debt Sustainability Analysis, WB (2006);

- Author’s estimation based on MOF’s statistics.

The basis on which WB ranks a country into the poor,

medium or strong policy is CPIA (Country Policy and Institutional

Assessment). In other words, the CPIA measures the extent to

which a country’s policy and institutional framework supports for

sustainable growth and poverty reduction. A country’s CPIA is

rated on a scale of 1 to 6. A policy’s performance is classified as

weak if its CPIA is lower than or equal to 3.25, or strong if the

CPIA is equal to or higher than 3.75. Vietnam was rated 3.86,

which means that the country was so close to the bottom of the

strong-rated group in 2010. However, high inflation and a decrease

of growth in 2011 as a result of tightened fiscal and monetary

policies are likely to put Vietnam’s CPIA fall down to “medium”.

Table 4.4 shows that some indicators reflecting the valueof

debt approached the warning threshold. Particularly, Vietnam’s

total external debt to GDP ratio exceeded the threshold

110

recommended to countries whose policy environment was rated as

medium, while external debt to public revenue was getting closer

to a level at which policy environment was ranked as weak. On the

other hand, regarding external debt service indicators, no matter

which group the country will be fall into, Vietnam’s external debt

service is still far below the warning thresholds recommended by

IMF and WB. This can be achieved by concessional loans from

international organizations.

Therefore, it can be seen that Vietnam’s public debt risk

comes mostly from domestic debt. Despite large scale, the annual

repayment burdens of external debt, in general, will be relatively

slight in the next years thanks to its low interest rate and long

maturity. Nevertheless, only when Vietnam stabilizes the

exchange rate, could this safety status be assured. This is, in turn,

determined by whether we can improve current balance and

maintain a low inflation in the future or not.

Contrary to the external debt, domestic public debt burden is

putting much pressure on annual fiscal balance. Specifically,

Vietnam’s current total public debt to public revenue ration

exceeds 206.3% of public revenue and the public debt service to

total public revenue ratio amounts up to over 21.6%. Specially,

domestic public debts with high interest rates and short maturities

impose much pressure on debt rollover. Annually, in the period of

2012-2014, just to pay off domestic principal and interest, Vietnam

is estimated to have to issue approximately 100 to 120 thousands

billion dong of government bonds and government-guaranteed

bonds, which nearly equals to over 15% of total public revenue.

111

CHAPTER 5

PUBLIC DEBT FORECAST

Budget deficit and public debt is sometimes essential to a

country, especially the developing ones with high demands for

infrastructure investment, or in periods when the economies need

stimulus packages to combat recession due to external shocks.

However, in addition to risks of a debt crisis, the prolonged budget

deficit leading to a sharp rise of public debt can affect a country’s

macroeconomic stability and prosperity.

For a clearer sight of the picture of public debt in the future,

we carry out simulation of public debt to GDP ratio in different

assumptions about budget deficit, interest rate, and inflation rate of

Vietnam from now to 2020. As defined, public debt is the

accumulation of deficits in the past and at present. Assume that

there is no money printing; the Government has to borrow to

finance its budget deficits by which new debts incur. As a result,

the increase in present value of public debt is shown in the

following equation:

∆𝐷 = 𝐺 − 𝑇 − 𝑟𝐷

(5.1)

Where: D is public debt, G denotes total Government

spending, T stands for total Revenues, and rD is repayment of

principal and interest. Dividing both sides of the equation (1) by

Gross Domestic Product GDP, we get: ∆𝐷

𝑌=

𝐺−𝑇

𝑌− 𝑟

𝐷

𝑌 (5.2)

Last but not least, noticing that ∆D/Y =

112

∆(D/Y)+(∆Y/Y)(D/Y), then we get the equation reflecting the

changes in public debt to GDP ratio through years as followings:

∆│𝐷

𝑌│=

𝐺−𝑇

𝑌+ (r – g)

𝐷

𝑌 (5.3)

Where: g = ∆Y/Y is nominal GDP growth rate. All variables

in the equation (3) are calculated in nominal value. This equation

can be understood that debt to GDP ratio will increase if

Government holds essential budget deficit, also called deficit

excluding repayment of principal and interest (G – T), or interest

rate on the principal is greater than nominal GDP growth rate.

In order to predict public debt, as noted in the equation (3), we

have to make prediction/assumption about the essential budget

deficit, (G – T), and the nominal GDP growth rate through years, g.

Firstly, the component (G – T) equals to total deficit minus interest.

Essential deficit is assumed based on its statistics in the past and

orientation of fiscal policy in the future. Interest in the years to

come is estimated according to figures on external public debt’s

interest rate as provided in the 7th Bulletin on external debt by

MOF plus estimation about interest on domestic Government

bonds. Secondly, estimation about nominal GDP growth rate is

based on different scenarios of real growth rate and inflation rate

of the economy in the period of 2011-2020.

We carry out simulation of the D/Y ratio by different

assumptions about macroeconomic environment. The effects and

assumptions of some important macroeconomic variables in the

standard scenario are summarized as follows:

Economic growth will lead to an increase in the total income

of the economy, and then help to reduce D/Y. In contrast, economic

growth in any year partially depends on the budget deficit. If the

Government increases spending or decrease tax for the purpose of

stimulating growth, the D/Y may reduce because of higher Y; or

D/Y may increase due to higher budget deficit. In the standard

scenario, we assume that in the period of 2012-2020, Vietnam will

113

achieve a growth rate of 6% per year on average.

Inflation is an invisible kind of tax, which can help to lower

D/Y as it can increase nominal GDP. However, it should be noticed

that inflation can reduce real value of debts mainly in domestic

currency. For debts in foreign currencies, an increase in inflation

always comes with a devaluation of the domestic currency and an

increase in external public debt burden. Besides, inflation is

affected by money supply, which has a close relationship with

budget deficit. In the standard scenario, we assume that Vietnam’s

inflation rate is 6% per year.

Exchange rate is closely related to D/Y because it has

influences on the burden of external public debt. The domestic

currency devaluation plays an important role to D/Y as external

public debt accounts for over 50% of Vietnam's total public debt.

In the standard scenario, we assume that in the period of

2012-2020, there will be an annual devaluation in nominal value of

VND by 5% compared to USD.

Interest rate is the cost of borrowing. The higher interest leads

to budget deficit, and then the higher public debt. Effective interest

rate of domestic public debt can be calculated in detail based on

information about the number of and yield of the outstanding

Government bonds and Government-guaranteed bonds. The

effective interest rate of external public debt in the future is

assumed to be equal to the average effective interest rate during the

period of 2002-2010 provided in the MOF’s 7th Bulletin on

external debt.

Essential budget deficit is calculated by taking budget deficit

excluding repayment of principal minus interest. For example, in

2010, Vietnam’s budget deficit excluding repayment of principal

was estimated to be 55,470 billion dong, approximately 2.48% of

GDP. If we take this figure minus 8,158 billion dong of external

debt interest payment (7th Bulletin on external debt) and 26,640

billion dong of interest on Government bonds (estimated by HNX),

114

we will get essential budget deficit of about 1.06% of GDP in the

same year. Today, Vietnam’s essential budget deficit is not

recognized in the annual budget estimates/finalization.

Furthermore, the estimation also encounters many difficulties

when numerous bonds are recorded as off-balance sheet accounts.

Even the figure of overall budget deficit also shows major

differences between the sources of international institutions such

as IMF and ADB and the Ministry of Finance’s.

Essential budget deficit mostly depends on subjective desires

of policy-makers in planning budget revenue-spending of a certain

year. From time to time, the budget deficit will be accumulated in

the current public debts. Thus, to be clearer about how the fiscal

orientation/plan affects the prospect of public debt in the future,

we carry out stimulation of public debt in 3 different basic

scenarios in the period of 2012-2020, respectively at the thresholds

of 1.0%, 2.0% and 3.0%. So as to achieve the threshold of 1% of

budget deficit to GDP per year, Vietnamese Government has to

implement far more prudent fiscal policy than they are doing

today.

In addition, we assume that external public debt to domestic

public debt ratio continues a slight downward trend, and then

remains stable at the threshold of about 1:1. Judging from the

above analysis, we can find out the factors that can increase or

decrease the public debt to GDP ratio including: (i) annual

essential budget deficit/surplus; (ii) domestic currency’s

devaluation/appreciation compared to foreign currencies in the

external public debt basket; (iii) decrease/increase in economic

growth rate; (iv) decrease/increase in inflation rate; (v) relative

decrease/increase in interest rate of public debt in the future to

nominal GDP growth rate.

115

Table 5.1. Economic scenarios, 2012-2020 (Unit: %)

Best Medium Worst

Growth 6.0 5.0 4.0

Inflation 6.0 7.0 8.0

VND/USD foreign exchange rate

change

4.0 5.0 6.0

New interest rate on domestic

debt

9.0 10.0 11.0

New interest rate on external debt 3.0 4.0 5.0

Source: Author’s calculations and assumptions.

Figure 5.1. Forecast of public debt/GDP ratio with essential budget deficit/GDP ratio = 1.0%

Source: Author’s calculations.

116

Figure 5.2. Forecast of public debt/GDP ratio with essential budget deficit/GDP ratio= 2.0%

Source: Author’s calculations.

Figure 5.3. Forecast of public debt/GDP ratio with essential budget deficit/GDP ratio = 3.0%

Source: Author’s calculations.

The best scenariois based on the assumption that Vietnam

would successfully bring the economy back to the orbit of stable

growth and moderated inflation thanks to reforms which help to

improve productivity of the economy. As the results, dong

devaluation and interest rate of new public debts would be kept at

low level.On the contrary, the worst one is based on the

assumption that Vietnam would fail to bring the economy back to

the right orbit. The economic growth rate would be low and mostly

because of total demand stimulation instead of higher productivity.

117

Then, inflation rate would be higher and dong would be devaluated

sharply every year. The medium scenario liesbetween these two

extremes.

The results of the public debt/GDP ratio forecast in the next

15 years are presented in the Figure 5.1 – 5.3. It can be seen that in

each scenario, the public debt/GDP ratio tends to increase because

of continuing essential budget deficit and the dong devaluation

compared to foreign currencies in the external public debt basket.

The slight or sharp increase in devaluation rate depends on our

assumptions about these factors.

Particularly, if budget deficit is kept at 1.0%of GDP each year,

the public debt/GDP ratio in 2020 will be 57.7%, 62.9%, and 68.5%

for best, medium and worst scenario respectively. If essential

budget deficit annually rises by 2.0% of GDP, the above numbers

will be amounted to 66.1%, 71.8%, and 78.0%. Finally, if essential

budget deficit sharply increases by 3.0 % of GDP each year, those

rates will be 74.5%, 80.8%, and 87.5%. In this case, a public debt

crisis would be unavoidable in every scenario of the economy.

It should be noticed that this simulation result was calculated

on basis of two assumptions. First, all public debts are fully

expressed in the figure of 54.9% of GDP at the end of 2011.

Second, the SOEs’ bad debts are not counted in that figure and the

Government might have to take responsibility in the future.

The research group also simulates public debt/GDP ratio

according to changes in each economic variable in each scenario.

The results show that when other factors are constant, each

percentage point of increase/decrease in inflation rate or

increase/decrease in economic growth rate compared to that in the

original scenario will cause the decrease/increase in public debt to

GDP ratio by 0.52, 0.60 and 0.69 percentage point every year

when essential budget deficit to GDP ratio equals to 1%; 0.58,0.66

and 0.76 percentage point when essential budget deficit to GDP

ratio equals to 2%; and 0.64, 0.73 and 0.84 percentage point per

118

year when essential budget deficit to GDP ratio equals to 3%

respectively in the best, medium and worst scenarios.

Similarly, each percentage pointof appreciation/devaluation

of domestic currency compared to original scenario would

raise/decline the public debt to GDP ratio by 0.60, 0.68 and 0.79

percentage point every year when the essential budget deficit to

GDP ratio equals to 1%; 0.66, 0.76 and 0.87 percentage point per

year when the essential budget deficit to GDP ratio equals to2%;

0.72, 0.83 and 0.95 percentage point when the essential budget

deficit to GDP ratio equals to 3 percent correspondingly in the best,

medium and worst scenarios.

The public debt prospect simulation indicates that in order to

have sustainable public debt rate, the Government needs to

maintaina balanced essential budget balance besides avoidinghigh

inflation. This could only be done by programs of cutting public

spending while current public revenue to GDP ratio is too high.

CONCLUSION AND POLICY RECOMMENDATIONS

The above analyzed fiscal and public debt challenges show

that it is time for Vietnam to carry out a thorough and

comprehensive fiscal reform in order to bring its budget to the

balanced status for assuring the debt sustainability and prolonged

economic stability. As usual, there are two approaches for policy

makers to carry out fiscal reforms: “gradual adjustment” or “sharp

correction once”. Advocates of "sharp correction once"approach

believe that fiscal reform process should be implemented

immediately and comprehensively as quicklypossible.In contrast,

proponents of the "gradual adjustment" approach say that the

adjustment process should be carried out gradually during a long

period of time in order to avoid too significant negative shocks to

the economy. With the current long-lasting budget deficit, no

matter how the safety threshold of public debt in general and

external debt are, Vietnam will soon hit those thresholds. Early

119

preparation for a long-term stable fiscal plan is essential to help the

economy avoid negative fiscal shocks in the future.

The main objective of the public debt management is to

consider strategy and debt structure-related risks, thereby making

policy orientation adjustments to maintain public debt

sustainability in medium and long term. Thus, in this section, we

are trying to suggest some policies for further discussion so as to

find out appropriate methods of managing current public debt and

budget deficit in Vietnam.

Establishing the Public debt Monitoring Committee

under the Finance and Budget Committee of the National

Assembly

The establishment of the Public debt Monitoring Committee

allows close, subjective and independent public debt monitoring

and management. The Public debt Monitoring Committee is

empowered to access to all information about public and external

debt of other Ministries in public sector, including Ministry of

Finance, SBV, SOEs, etc. The information must include details of

the scales, maturities, interest rates, currencies, strategies, etc. of

all domestic as well asexternal debts. This will be the basis for

public debt supervisors and managers can monitor, analyze and

supervise the total debt of the public sector and then give

appropriate policy advice to the National Assembly.

The Public debt Monitoring Committee has to carry out and

support the Finance and Budget Committee to quarterly propose

the Overall report on public debt monitoring and management to

the National Assembly. This report must summarize the latest

updated information and cover discussions about policy and

market developments. Also, the Public debt Monitoring

Committeehas the authority to coordinate and collaborate with

stakeholders; and right to implementessential processes

ofadministration, auditing, accounting and reporting.

120

Establishing a system of debt safety indicators

To strengthen the fiscal discipline, it is necessary to set up a

system of indicators regulating on debt limit in terms of quantity

and flows of repayment. These limits can be presented in both

nominal value and in percentage of important macroeconomic

variables. The scope of limitation applied is divided by each type

of debt: total public debt, external public debt, domestic public

debt, and total external debt. Normally, the limit to the total debt is

expressed as a percentage of GDP and export, and limit to the debt

service is expressed as a percentage of total tax revenue and

foreign reserves or limit of annual debt to capital expenditure ratio.

However, the important thing is that the National Assembly

must provide reasonable limits. If too low, they can hinder the

Government in implementing necessary reactions during the crisis

because the adjustment or approval of new regulations takes time.

Conversely, if the limit is set at too high level, they are pointless.

Once issued, the fiscal disciplines of the government need closely

monitoring by the Public debt Monitoring Committee.

Debt accounting according to international standards

In order to exactly assess the practice and then propose

appropriate strategies of debt management, the accounting of

budget and public debt must be performed transparently following

international standards. The off-balance sheet expenditure

accounts must be absolutely avoided. The budget deficit measures,

except for unsustainable revenues and revenues from sale of

property, need further calculations for accurateassessment of

current fiscal situation. In addition, the budget burdens arising in

the future, such as pension payments or health insurance, should

also be included in the forecasts of the budget deficit to get a more

accurate picture of public debt outlook in the medium and long

term.

121

Due to its potential risks to public debt, the SOEs’ debt should

also be sufficiently calculated, analyzed and reported in the current

definition of the public debt in Vietnam. The analysis and

assessment of the SOEs’ debt should be considered as an

inseparable part of the report on Vietnam's public debt.

Enhancing domestic debt market

Enhancing, both primary and secondary, domestic

government bond market is very important. In short-term, the

Government may have to accept high domestic borrowing cost for

the development of the Government bond market. However, time

by time, once this market develops and has higher liquidity, the

Government can mobilize capital at a low cost. The development

of the market will help the Government to mobilize capital with

long maturities, fixed interests and especially in domestic currency.

Therefore, the risks related to interest rates, exchange rates and

rollovers will be minimized. In addition, the growth of the

secondary Government bond market will also be followed by the

development of the corporate bond market, as the Government

bonds is the standard for determining the risk of other debt

instruments.

Orientations on public spending cut

To reduce public spending, we need to have a comprehensive

assessment of the effectiveness of public spending in different

sectors, not just purely look at the numbers of increase or decrease.

We should not make mistake by cutting allexpenditures by a

certain fixed proportion. Cuts must be based on the evaluation and

screening ofinefficient spending programs/projects with low

priority, or fields where the private sector can operate better. In

addition to reallocating capital expenditures toward more efficient

direction, current expenditure which is estimated to be over 3.6

122

times higher than capital expenditure in 2012 should also be

reviewed and cut drastically.

Reducing proportion and numbers, enhancing

governance and transparency of the SOEs

In order to efficiently behave to the SOEs, we need to classify

enterprises with purely public purposes, for instance, enterprises in

security-defense sector combined with those operating in business

to earn profits. A comprehensive assessment of the effectiveness of

the SOEs in terms of profit, technology, job creation, budget

contributions, etc. need carrying out based on the principle of

transparency in information about business operation.The number

and proportion of the SOEs should be targeted descending via

thoroughequitization process of enterprises operating in the

business line, regardless of whether theyare operating well or not,

and at the same time creatingfavorable conditions for private

enterprises to participate in all markets.

Also, it is necessary to strengthen the accountability of

representatives of state capital in the SOEs. Especially, there is a

need to apply financial and accounting standards of listed

companies to the SOEs. Their financial statements must be

publicized as listed enterprises’. The debt and debt classification

of the SOEs need regularly reporting for assessing the underlying

risks to public debt.

Tax system reform

Finally, tax system should be reformedto ensure criteria for

sustainable, efficient, fair and transparent revenue. The tax burden

needs properly reducing adjustment. However, this level of

reasonability depends very much on the process of public spending

cut. Thetoo high tax burden will make the tax system less effective

123

because it encourages tax evasion and distort the resource

allocation. Tax and fee system should be reviewed to avoid

overlapping. The taxes should be adjusted to ensure social security

for low-income people, to encourage savings and limit

consumption, especially imported luxury consumer goods.

124

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Productivity Centre;

Vietnam's Provincial Competitiveness Index Report 2011;

Wade, Robert and Frank Veneroso. The Asian Crisis: The

High Debt Model versus the Wall Street-Treasury,

IMF Complex. New Left Review. March/April 1998.

133

3-23;

Will This Time Be Different? By authors: Carlos A. Primo

Braga and Gallina A. Vincelette, World Bank;

World Bank (2006), A Guide to LIC Debt Sustainability

Analysis;

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Analysis for Low-Income Countries. Debt Division,

World Bank, Washington, DC;

World Bank (2009), Vietnam Development Report 2009:

Mobilization and use of capital.

134

PUBLIC DETB AND

SUSTAINABILITY IN VIETNAM:

THE PAST, PRESENT AND THE FUTURE

Published by:

HAO CHU

Edited by:

BICH THUY NGUYEN

Printing edited by:

NAM HOANG

Book cover painted by:

THAI DUNG

ISBN: 978-604-908-669-4 1000 printings, size 16x24 cm in Ha Phat Printing Company.

Registratio KHXB No. 180-2013/CXB/15-04/TrT. Publishing

decision No.: 15/QĐLK - NXB TrT of Director

ofKnowledgePublishing House on 10/05/2013. Printed and

deposited 2th quarter of 2013.

135

The “Support for capability improvement of macroeconomic policy advisory,

verification, and monitoring” project is run by Economic Committee of National

Assembly and the technical assistance of the United Nations Development Program

(UNDP). The objective of the project is to improve capability of macroeconomic

advisory, verification and monitoring agencies through activities of: (i)

training/educating to improve capability; (ii) carrying out research, policy

dialogues on macroeconomic issues; (iii) enhancing and institutionalizing

coordination and cooperation mechanism among the project beneficiary agencies,

including the Economic Committee of National Assembly, Center Party Office,

Government Office, State President Office, National Financial Supervisory

Committee and Vietnam Academy of Social Sciences.

The supporters of the project are a network of Institutes, Universities, Centre for

Economic Research, including Vietnam Institute of Economics, Centre for Analysis

and forecasting (under Vietnamese Academy of Social Sciences), Central Institute

for Economic management (CIEM), University of Economics (under Hanoi

National University), Hanoi National Economic University, National Centre for

Information and Socio-economic Forecast (under the Ministry of Planning and

Investment), Development and Policies Research Centre (DEPOCEN –

Independent Research Centre) and Macroeconomic Advisory Group (MAG).

In recent times, the Project has supported to establish many dialogue forums

between Members of Parliament, policy makers with domestic and foreign

economic experts on urgent macroeconomic issues of the country. After each

conference, or seminar, concrete proposals, in form of Policy Note were sent to

Members of Parliament and the above beneficiary agencies for more discussion and

consideration in the process of policy formulating. Typically, the Spring Economic

Forum, Autumn Economic Forum, “10 proposals for macroeconomic stabilization”

received a lot of positive assessment from Members of Parliament and economic

experts.

The second priority is to conduct a series of research based on empirical evidence

related to macroeconomic issues which are receiving much concerns of policy

makers, namely exchange rate, public debt, calculations of potential productivity,

etc. Also, the policy recommendations from the research were proposed to the

Members of Parliament and policy makers in form of Policy Brief.

136

“Support for capability improvement of macroeconomic

policy advisory, verification, and monitoring” project

ECONOMIC COMMITTEE OF NATIONAL ASSEMBLY

37 Hung Vuong, Ba Dinh, Hanoi

www.ecna.gov.vn