Vietnam Risk overview May 2013

OVERALL ASSESSMENT [The Economist Intelligence Unit]

Operating risk in Vietnam is moderate. Security risk is very low, as neither internal nor external threats are a serious concern. The ruling Communist Party will maintain its tight grip on power for the foreseeable future. Corruption is endemic and poses a serious problem for foreign firms operating in the country. The judicial and regulatory systems are opaque, taxes in some instances are high, financial risk is rising, labour relations have worsened and infrastructure is inadequate. Vietnam's membership of the World Trade Organisation, which took effect in early 2007, has resulted in measures to liberalise trade and investment, and these will serve to make the operating environment more predictable. Macroeconomic stability cannot be assured given the current imbalances in the economy.

Security risk

Security risk is very low. Sporadic outbreaks of civil unrest are unlikely to become widespread, affecting the main commercial districts and posing a threat to business or foreigners. Land seizures to make way for development projects, often without adequate compensation for those evicted, are a source of growing anger in rural—and even some urban—areas. Moreover, there are sporadic incidents between religious groups and government authorities. Any protests are likely to meet with a strong response from the security forces, a strategy that carries with it a risk of inflaming resentment in the absence of any political accommodation of public grievances. Organised crime is increasing in Ho Chi Minh City, the business capital, but the risk of violent crime towards foreigners is low, and there is little risk of kidnapping and extortion affecting foreign business operations.

                      Tensions rise in the South China Sea

Moderate likelihood; Moderate impact; Intensity =9
Despite strengthening diplomatic and economic ties with China, a major area of disagreement that remains is the sovereignty of the islands in the South China Sea; both countries claim the Spratly and Paracel archipelagos and (more importantly) the surrounding seabed, which is believed to hold substantial hydrocarbon reserves. Several recent developments suggest that security in the South China Sea remains a potential flashpoint. In March Chinese patrol boats fired flares at four Vietnamese fishing vessels operating near the Paracel Islands, although the Vietnamese authorities claim that firearms were used. At around the same time, Chinese naval vessels expanded their normal patrol range to encompass James Shoal, just south of the Spratly Islands and only 80 km off the coast of Malaysia. Vietnam has been incensed by China's plans to ferry tour groups to the Paracels. In response, Vietnam is making a bid to strengthen a number of its regional alliances, and especially those with the US and an increasingly assertive Japan. Vietnam is also pushing for multilateral negotiations between the ten-member Association of South-East Asian Nations (ASEAN) and China, but China which prefers to deal with each ASEAN country separately and significant progress towards a binding ASEAN-China code of conduct for the South China Sea is unlikely. In the meantime, the risk of further incidents at sea, potentially including military skirmishes, remains high. Firms should be aware of the potential for disruptions to business if bilateral relations deteriorate rapidly.

Political stability risk

The Communist Party of Vietnam (CPV) engineered a seamless transition to a new leadership during its national congress in January 2011, and it will maintain its firm grip on power for the foreseeable future. The prime minister, Nguyen Tan Dung, was re-elected to serve a second term in office (from mid-2011), but continued economic underperformance has weakened his influence. As Mr Dung loses influence, the National Assembly (the legislature) is likely to play a more prominent role in holding the government and ministers to account. However, political leaders lack public accountability, and the process of policy formulation within the party remains highly opaque.

Government effectiveness risk

Government effectiveness is severely undermined by endemic corruption among public officials. The widespread lack of transparency and accountability is a major risk to doing business. Although the leadership appears intent on improving the situation, the entrenched nature of the problem will mean that progress is slow. Moreover, the quality of the bureaucracy will remain poor and will continue to hinder investment prospects, despite ambitious plans for administrative reforms. The planned implementation of key economic reforms, particularly of state-owned enterprises (SOEs), continues to be subject to opposition from protectionist lobbies and conservative members of the party, and a high degree of state control of key sectors of the economy will remain. However, equitisation (part-privatisation) is set to continue.

Legal & regulatory risk

The judiciary is not held in high esteem; there is no system of common law and decisions are often arbitrary. Interference in the legal process and the bribing of judges to serve particular interests is common. Contractual arrangements are backed by the force of law but the legal system is complicated. Contractual disputes often involve a prolonged period of negotiation preceding any attempt to resolve the matter in court. Abuses of copyright and industrial property are widespread and enforcement is weak, although the government has been strengthening the legislative and regulatory framework to enforce intellectual property rights. The risk of foreign assets being expropriated is limited. On the regulatory front, there are concerns that price controls affecting foreign firms could be introduced.

Macroeconomic risk

Vietnam's long-term economic growth prospects remain positive, but there are growing concerns about stability in the next few years. GDP growth slowed in 2011 amid a period of rapid inflation and some policy tightening; changed consumer expectations led to a further slowdown in 2012. The Economist Intelligence Unit expects another year of relatively slow growth (by Vietnamese standards) in 2013. Consumer price inflation will remain relatively rapid, at around 7.3% a year in 2013-14. On eth positive side, Vietnam recorded a substantial trade surplus in 2012. Although more rapid import growth will erode the trade surplus from 2013, the improved outlook for the current account will ease downward pressure on the dong.

Foreign trade & payments risk

Membership of the World Trade Organisation (WTO), which took effect in 2007, will ensure that the government continues with trade liberalisation measures. However, protectionist sentiment remains strong, particularly in state-owned enterprises (SOEs), and this may delay the implementation of liberalising reforms. The removal of tariff and non-tariff barriers is unlikely to be smooth. There are considerable regulatory restrictions for both capital inflows and outflows. The government has abolished the foreign-exchange surrender requirement, but some other regulations introduced in the wake of the 1997-98 Asian financial crisis have still not been eased. Some loosening of capital-account restrictions is likely, but full capital-account liberalisation is not expected in the next few years.

The government sacrifices free-trade opportunities to protect the state sector

High likelihood; Low impact; Intensity =8
The US has dangled a carrot before the Vietnamese government in the form of possible membership of a new free-trade bloc, the Trans Pacific Partnership (TPP). However, as a condition for joining, the US would like to see Vietnam curb the competitive advantage that it confers on its SOEs. The recent plight of one such SOE, the Vietnam Shipbuilding Industry Group (Vinashin), adds weight to the US's desire to eliminate such market distortions. Vinashin almost collapsed under the weight of debts of around US$4.4bn in 2010, and it has since defaulted on some of its foreign obligations. There are also problems at other SOEs, which have often depended on government-directed lending from state-owned banks to pay for their rapid diversification into non-core and often unprofitable businesses. State-mandated lending to SOEs has also reduced the volume of credit available to more efficient private firms, potentially setting back the country’s economic development. In addition, SOEs often choose to procure supplies or do business with other SOEs, instead of with the private sector. Yet, to reorient the economy away from the state sector in the manner that the US wishes would represent a major policy shift on the part of the Vietnamese government. As a result, the US pressure may prove counterproductive, with the Vietnamese government unwilling to co-operate and withdrawing its interest in the TPP altogether. Foreign investors should expect little or no progress to be made on Vietnam's TPP negotiations in the next two years.

Financial risk

The dong is managed under a crawling-peg exchange rate system, but owing to massive downward pressure on the currency, the authorities had to devalue the exchange rate on a number of occasions in the past two years. The stockmarket is volatile and remains an insignificant source of finance. Foreign participation in the financial sector will gradually improve under the conditions of Vietnam's membership of the World Trade Organisation. The government holds stakes in all major banks, and as a result it would be in a position to provide financial support were any bank to come under pressure. This limits the likelihood of a run on banking sector deposits.

Tax policy risk

Reforms to the corporate tax system were introduced in 1999 and there has been some tinkering with the legislation since then. The current unified standard corporate tax rate is 25%. The Law on Foreign Investment offers a range of tax incentives for investors, but these are largely offset by the high tax levels elsewhere. Personal income tax rates are the least competitive aspect of the tax regime, although the government has made some changes to improve this. Currently, the burden is particularly severe for foreign companies employing Vietnamese professionals who have historically looked to their employers to pay their tax bill (probably because most Vietnamese do not pay tax). Value-added tax (VAT), which was introduced on January 1st 1999, has been simplified.

SCENARIOS

The complexity and opaqueness of the tax system cause frequent and harassing tax inspections

High likelihood; Moderate impact; Intensity =12
Tax regulations are not transparent; companies are often unaware of which taxes they should be paying. The government, in turn, believes many businesses are evading tax payments, and conducts frequent—sometimes harassing—tax inspections. Personal income tax rates for better paid Vietnamese national employees are also very high. However, the government has amended the personal income tax regime by raising the threshold and removing the top rate. Corporate tax has been reformed; a unified rate of 25% is currently in place. Certain preferential rates will still apply. VAT, which was introduced on January 1st 1999, has also been reformed. Companies should note that advice from a tax specialist is essential (although even this may not be sufficient to avoid problems). Companies should also consult embassies, business associations or local chambers of commerce for help in lobbying the government for improvements.

                  Tax rates are raised

Moderate likelihood; Moderate impact; Intensity =9
In an attempt to make Vietnam's operating environment more competitive vis-à-vis its regional neighbours, the corporate income tax rate was cut to 25% in January 2009, down from 28% previously. However, there is a risk that the government may be forced to raise the rate of taxation, given the poor outlook for government finances. The tax regime is inadequate and in need of a major overhaul. Indeed, the personal income tax base is small. The General Department of Taxation is poorly prepared for the additional administrative burden of enforcing a new personal income tax regime designed to address the current inadequacies. This is a reflection of the fact that the pool of individuals eligible to pay personal income tax is expected to swell dramatically to around 12m, up from around 1m primarily high-income earners currently. The government's budget balance is expected to remain in deficit throughout the forecast period, and there are questions as to how the government will meet its financing gap. Firms should be aware that the corporate income tax rate could be raised in response to inadequate revenue collection on the part of the government, while personal income taxes, particularly for high earners, could also increase. Given the highly complicated nature of Vietnam's tax regime, it is advisable for companies to seek professional tax guidance. In addition, monitoring government statements regarding levels of taxation could also prove useful.

Labour market risk

Trade unions are a powerful political and economic force in Vietnam, but they are not independent of the government. Strikes are only legal under onerous conditions, and the incidence of illegal strikes is rising. With the increasing presence of foreign and foreign-invested firms in Vietnam, the labour code has, among other measures, lifted the restriction that foreign-invested enterprises had to recruit through authorised employment agencies. Companies wishing to employ unskilled labour should have few problems, but the availability of appropriately skilled or professional labour outside the main urban centres is limited. In practice, hiring and firing is less restricted than it appears on paper. However, the government is sensitive to large lay-offs, even if there are good economic reasons for them.

SCENARIOS

Strikes at foreign-invested firms cause some manufacturing facilities to close

Low likelihood; High impact; Intensity =8
Outbreaks of labour unrest will become more common in the coming years, as concerns about high inflation have created tensions in the industrial sector, with workers demanding wage increases to keep pace with the higher cost of living. According to the International Trade Union Confederation there were around 1,000 illegal strikes in 2011, up from 423 in 2010. Most of the strikes in recent years have occurred in foreign-invested enterprises, notably in garment and textile factories, and in Ho Chi Minh City (the business capital), Binh Duong and Dong Nai. Since 2006 Vietnam's labour market has shown an edge of volatility, with tens of thousands of workers in southern industrial parks and export-processing zones going on strike. More than 90% of disputes brought before the courts for settlement end with employers having to re-employ or compensate workers. However, the government has also passed a law that could force illegal strikers to pay up to three months of wages to their employers. A consultation process with union leaders regarding contract details may go some way towards preventing disputes. However, if the incidence of strikes worsens, damaging business profitability, it could force foreign firms to reconsider their operations in Vietnam. The closure of a major foreign-owned manufacturing facility would likely have a severely negative impact on further foreign investment in such facilities in Vietnam.

Firms are unable to recruit or retain skilled labour

High likelihood; Moderate impact; Intensity =12
The overall quality of the labour force is improving, but skilled labour is not plentiful and the labour force remains best suited to labour-intensive manufacturing. Vietnam is also short of managerial talent, leading to higher salaries for these employees. Demand for workers, both skilled and unskilled, is high, particularly in the country's industrial zones, export-processing zones and major cities. It is common for foreign firms operating in Vietnam to complain that retaining skilled employees has become increasingly difficult. Over 90% of the population is literate, but actual skill levels remain low compared with other countries in the region, largely as a result of an outdated educational system that is in need of significant reform. This has led to demand for labour far outstripping supply in some sectors. The government will need to focus on improving the education system as well as providing opportunities for vocational training. Foreign firms are likely to play a significant role in developing Vietnam's workforce by providing on-the-job training as well as supporting vocational programmes. Firms should be aware that recruitment of skilled Vietnamese labour could be difficult and costly.

Infrastructure risk

Although improving, Vietnam's infrastructure is poor and presents serious risks to business. This reflects wartime damage and decades of underinvestment during the era of central planning. Work is urgently needed on the energy transmission and distribution system, including extending the network to remote areas where many communities are still without electricity. The standard of the rail network will remain poor, but the government is upgrading the country's ports and airports. Significant extension of the road network is unlikely but a high proportion of major roads are paved and there will be further improvements to the main road arteries, making inter-provincial travel easier. Telephone density, especially the number of mobile phones, is increasing steadily, and this will continue. Internet access is also growing rapidly, and Internet service providers have ambitious expansion plans for broadband development.

What, specifically, would larger ports in Vietnam do?

1) Larger ports would reduce or eliminate the need for transshipment of Vietnamese exports, restoring the comparative advantage of Vietnam’s cheap and relatively educated labor force. Right now, most goods exported from Vietnam to major markets are transshipped elsewhere in Southeast Asia onto larger vessels, adding costs to goods that Vietnam is able to produce more cheaply than China, Thailand, and other regional manufacturers. Depending on fuel prices, these additional shipping and handling costs eliminate some of the comparative advantage Vietnam offers investors and manufacturers, increasing shipping costs by as much as 28 percent.

2) In northern Vietnam, an improved port would bring Western Chinese exports to market faster and more cheaply. A deep water port near the northern Vietnamese city of Hai Phong would cut 800 kilometers off the shipping route of goods coming out of Western Chinaiii, giving foreign businesses further incentive to use Vietnam as a second regional base to offset the cost and risk of investing in China.

3) Improved ports would allow Vietnam to become a transshipment and consolidation point for goods coming in and out of China. Bigger ports would allow Vietnam to enter the transshipment market with competitive prices that could entice shippers away from more expensive transshipment points such as those in Singapore and Hong Kong.

4) A deep-water port in Central Vietnam would eventually allow for goods coming out of northern Thailand, Laos, and Burma to be consolidated with international shipments, as well as easier export of Vietnamese oil. The Vietnamese Government estimates that a central port would save Vietnam 1.5 billion USD a year in shipping costs for oil exports.

5) Better ports would allow Vietnam to fully realize its domestic manufacturing potential in the South, home to its large manufacturing base, by eliminating the major export bottlenecks currently experienced by domestic and international producers.

6) Better ports would allow southern Vietnamese ports to become a major shipping hub for Cambodia, southern Thailand, and the larger Southeast Asia region. While there is probably not enough demand for a third major hub-like Singapore and Hong Kongvi, Vietnam could offer competitive rates that attract shippers serving specific routes. This demand for and use of expanded Vietnamese ports does not suggest that Vietnam will ever rival the two major  shipping hubs in Hong Kong and Singapore, or that it should. Hong Kong and Singapore are so far advanced in capacity and technology that there is no point in trying to match them.

However, Vietnam can integrate itself into regional shipping routes, shortening those routes where possible, eliminate its own transshipment costs, and make the export of goods out of the Southeast Asia landmass more economical and feasible. Beyond Vietnam’s own domestic situation, several global trends in shipping support the argument for bigger and better ports in Vietnam. First, ships are becoming enormous, since larger ships can save an exporter millions in fuel costs. Second, the global economic recession has driven the price of shipping down to record lows, making sea transport extremely attractive to exporters in companies of all sizes. In fact, despite the global recession, the number of exported and imported goods coming in and out of Vietnam’s major ports in the South has increased ten percent in the last year. Finally, as we are seeing now, Asia is the preferred place to park idle ships and warehouse idle goods waiting for shipment.xi In good times and in bad, having large, deep ports with plenty of berthing and storage space is a huge economic opportunity for an economy structured as Vietnam’s is.