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Vietnam

Author(s):
International Monetary Fund
Published Date:
April 1998
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I. Introduction

1. This paper contains background material on banking sector reform, state enterprise reform, external trade liberalization and tax reform. The new government attaches high priority to pursuing structural reforms in these four areas, although the extent and timing of measures has have not yet been determined. A common theme that emerges from the studies is that substantial progress was made in implementing reforms during 1988-92 to facilitate the transition from a centrally planned to a market oriented economy, which helped to secure strong macroeconomic performance. However, as the reform process decelerated, the underlying performance in each area consequently deteriorated.

2. Banking sector reforms were focussed on the creation of a two-tier banking system, the establishment of private sector banks, rationalization of the interest rate structure and improvements in prudential and supervisory regulations. However, state commercial banks still dominate the banking system, non-performing loans are increasing, monetary policy continues to rely heavily on direct controls, and money markets remain rudimentary. Moreover, state enterprises continue to receive borrowing privileges, including obtaining loans without collateral, easier access to foreign currency loans and subsidized interest rates.

3. State enterprise reforms were directed towards reducing the number of firms through mergers and liquidation, eliminating virtually all budgetary subsidies and sharply cutting the size of the labor force. This resulted in large productivity gains and strong output growth, as well as much increased net contributions from the sector to the government budget. However, in the absence of further reforms, the overall financial performance of the state enterprises has deteriorated over the past three years.

4. External trade liberalization was concentrated on the dismantling of export bans, quotas and taxes to promote trade to the convertible currency area, the replacement of quantitative import controls with tariffs and the gradual opening of trading activities to private business. However, Vietnam continues to nurture selected domestic industries behind trade protection, especially in sectors dominated by state enterprises. The maximum import tariff rate remains high, these are many tariff bands, import licensing of consumer goods is extensive and other quantitative import controls still exist.

5. Tax system modernization was instigated through the passage of legislation to introduce a range of direct and indirect taxes and replace the administrative decrees under which most government revenue had been secured through negotiation with individual firms, primarily state enterprises. While strong revenue growth in relation to GDP was achieved through 1994, the ratio subsequently declined, mainly reflecting the smaller contribution of the state enterprises which continue to provide about one half of total revenue.

II. Financial Sector Reform1

6. Banking reforms implemented in Vietnam during 1988–92, like market-oriented reforms in other areas, were substantial and contributed to solid macroeconomic performance. The reform effort has since waned and the incomplete reforms have weakened the banking system. The regional currency crisis is likely further to strain its fragile condition. As many of the problems of bank soundness can be traced to the poor performance of state enterprises, a thorough reform of that sector emerges as a major precondition for the rehabilitation of the financial system. This chapter reviews the structure of the banking system and money markets, provides an assessment of recent banking and monetary system reforms and outlines the priority areas for further action.

A. Banking System Structure and Regulation

7. Vietnam initiated banking reforms in 1988–89, when the monobank system that served the needs of the centrally planned economy was split into a two-tier banking system, consisting of the State Bank of Vietnam as the central bank and four state commercial banks. In 1990, rules on the sectoral specialization of these banks were removed, and entry into the banking system was liberalized. In subsequent years, interbank markets were initiated for both foreign exchange and short-term domestic funds, and guarantees and other procedures were introduced to help secure lending. The structure of interest rates was rationalized, the reserve requirements and the refinancing rate were each unified, and the government introduced treasury bill auctions.

8. As a result of these reforms, the banking sector expanded considerably and banks began offering a broader range of services (Box I.1). However, the reforms moved more quickly on the surface than at their core. In particular, state commercial banks still account for 80 percent of deposits and their lending remains subject to political direction. State enterprises continue to receive borrowing privileges, including obtaining loans without collateral, easier access to foreign currency loans, and subsidized interest rates. Accounting practices make credit evaluation problematic and off-balance sheet liabilities (especially letters of credit) have emerged as a major source of risk. Collateral rules exclude urban land and make foreclosure virtually impossible. Bankers have little experience with the functioning of market-based financial systems. A number of joint-stock banks are experiencing difficulties as a result of fast credit expansion based on inadequate risk appraisal.

9. Operations of commercial banks and other financial institutions are supervised by the State Bank of Vietnam. Prudential regulations provide for off-site and on-site inspection, set prudential limits on lending, and stipulate minimum capital requirements. However, supervisors appear to encounter difficulties in enforcing these rules. Excessive lending to shareholders primarily state enterprises is a particular problem for joint stock banks, as regulations limiting credit to a single borrower can be easily circumvented. There have been delays in conducting international standard audits of the major banks, which are crucial to provide a more accurate assessment of banks’ financial positions and facilitate the formulation of restructuring plans.

Box I.1.Vietnam—Banking Institutions

At the end of 1996, Vietnam’s banking system included four state-owned commercial banks, 52 joint-stock banks, 23 branches of foreign banks, four joint-venture banks, 62 representative offices of foreign banks, and 68 credit cooperatives. There were also close to 900 people’s credit funds, two finance companies, and one government-owned insurance company.

State-owned commercial banks

  • Industrial and Commercial Bank of Vietnam (Incombank), whose operations include: mobilizing funds, making local and foreign currency loans, trading in foreign exchange, processing local and international payments, trading in gold and silver, consulting, and providing computer services.

  • Bank for Foreign Trade of Vietnam (Vietcombank) dominates trading in foreign exchange and offers the following services: financing trade, letter of credit operations, making bank guarantees, processing international payments, offering credit card facilities, and making loans and accepting deposits.

  • Bank for Investment and Development (Indebank) is responsible for mobilizing funds for development investment projects, providing equity participation in development projects, dealing in foreign exchange, and providing medium- and long-term lending.

  • Bank for Agriculture and Rural Development, whose operations are generally limited to the agriculture sector. It also operates the Bank for the Poor, a government funded low income credit scheme.

Joint-stock banks

Shareholders of joint-stock banks are state-owned commercial banks, state-owned enterprises, and private entities. Most of the joint-stock banks were established during 1991-93.

Foreign bank branches

Foreign bank branches operate mainly in foreign currencies, especially in the area of trade finance, as they may accept only a limited amount of domestic currency deposits.

Joint-venture banks

The four joint venture banks—which are partnerships between a state commercial bank and a foreign bank—are subject to the same restrictions on deposit taking as foreign banks.

10. The National Assembly approved in December 1997 two new laws relating to the operations of the central bank and the commercial banks. However, the new legislation will not become effective until October 1998. Although the full text of the legislation is not yet available, there are indications that the degree of independence of the State Bank would remain limited, with the National Assembly retaining the authority to set monetary policy. Moreover, supporting regulations on foreign exchange operations, loan loss provisioning and risk adjusted capital adequacy ratios still need to be finalized and issued.

B. Monetary Instruments and Money Markets

11. On the monetary policy side, the State Bank progressively gained the ability to restrain credit creation during the first half of the 1990s. This allowed tighter monetary policies to stabilize the exchange rate and reduce inflation. Monetary control was facilitated with the introduction of bank-by-bank credit ceilings in 1994, improvements in the required reserve arrangements, and a reduction in the role of state bank refinancing credit (Box I.2). Domestic bank financing of the budget has been avoided since 1992 and the rate of growth of credit to state enterprises was curbed. Real interest rates on household deposits were made positive in 1989, and the interest rate structure was largely unified by 1995 (Statistical Annex, Table 26).

12. Despite this progress, it is clear that further reform is needed to strengthen monetary management. In particular, there is a need to move away from direct controls over credit to freer financial markets and indirect instruments of monetary policy. While much attention has been focused on the still-distant stock market, the money market remains fragmented and the interbank foreign exchange market has ceased to function in recent months. Treasury bill auctions are not yet well-established as the authorities still place caps on the maximum level of interest rates, and interbank credit is impaired by a lack of confidence among banks.

13. Moreover, the State Bank’s success over the past years in keeping monetary policy on track to meet the objective of low single-digit inflation through administrative limitations on lending by banks has resulted in banks holding substantial liquid funds. Partly as a result of large outstanding central bank credit the state commercial bank reserves are equivalent to about 10 percent of total liquidity are presently held in poorly remunerated balances at the central bank. This puts pressure on bank’s income positions and on interest rate spreads, and on treasury bill rates as banks compete for an outlet for excess liquidity.

Box I.2.Vietnam—Monetary Instruments

Credit ceilings

The State Bank of Vietnam has used bank-by-bank credit ceilings since 1994 in order to help achieve targets for the growth of monetary aggregates and credit. The ceilings initially were imposed only on the state-owned commercial banks, but later were extended to other banks. The criteria used to determine each bank’s credit ceiling have not been made public. In 1996, the authorities introduced provisions that permit banks to trade their credit ceilings; however, no trading has been recorded to date.

Required reserve ratios

The required reserve ratio was unified across institutions and types of deposit at 10 percent in 1995, except for domestic currency deposits with a maturity of over 1 year; up to 30 percent of the requirement can be met with vault cash.

Refinancing facilities

The State Bank of Vietnam uses a collateralized refinance facility to onlend to state commercial banks. The refinancing rate has been unified since 1994. The State Bank also operates a very short-term facility for meeting the liquidity needs of the state commercial banks which arise from their clearing operations.

Treasury bill auctions

Beginning in mid-1995, some treasury bills have been auctioned off to allow market forces a greater role in determining interest rates. These bills are mostly bought by the state commercial banks. Other bills and bonds issued by the State Treasury of Vietnam for the most part are sold to the non-bank public.

Interest rates

Real interest rates on household deposits, and real lending rates for both working and fixed capital, have been fairly consistently positive throughout the reform period, and real interest rates on enterprise deposits have been positive since 1995. The authorities removed the turnover tax on banks in 1995 but replaced it with a limit on banks’ net interest income—effectively a spread limit—of 0.35 percent per month. Bank loans are subject to an interest rate ceiling for short-term loans, presently set at 1 percent per month.

C. Evolution of the Banking System

Financial intermediation

14. Reforms introduced since the late 1980s on the whole had a beneficial impact on financial sector development. Net domestic assets of the financial system expanded from about 11 percent of GDP in 1992 to 20 percent of GDP in 1996 (Statistical Annex Table 21). Domestic currency deposits increased at an annual rate of 35 percent over the same period. A smaller proportion of total credit was directed to the state enterprise sector; their share of outstanding credit was 51 percent at end-September 1997, compared with over 90 percent in 1990 (Statistical Annex Table 24).

15. Nonetheless, Vietnam’s financial system remains relatively shallow. The ratios of broad money to GDP and total deposits to GDP, which stood at 25 percent and 16 percent, respectively, at end-1996, are much lower than in other ASEAN countries. The currency-to-deposit ratio exceeded 60 percent at end-September 1997. More generally, the banking system still is far from performing the key roles of a market-based system: processing information about investment opportunities, spreading risk through asset diversification, and providing liquidity services through asset transformation. This is in large part due to the fragmented money market and an adverse yield curve that discourages long-term credit.

Bank soundness

16. Available data indicate a steady deterioration in banks’ balance sheets since 1995, partly related to the loss of impetus in the reform process. At the end of September 1997, banks classified about 13 percent of total loans as overdue, compared with less than 8 percent at the end of 1995 (Statistical Annex Table 25). While the increase in the proportion of overdue loans partly reflects a one-time adjustment due to the stricter implementation of loan classification criteria since the beginning of 1997, overdues have continued to rise subsequently. State commercial banks frequently roll over credits that cannot be repaid, especially to state enterprises, and the upward trend in nonperforming loans stock banks is equally worrisome. Given the banks’ weak capital base, these developments raise concerns in the event of a slowdown in economic growth or additional adverse economic shocks.

17. Banks are almost certainly in worse condition than indicated by their financial statements. The problem of rising overdues may be overshadowed by still deeper problems because banks are allowed to roll-over past-due loans without limit especially for state enterprises, and can provide loans to state enterprises on an unsecured basis. In addition, roughly one-third of total credit is extended in foreign currency, of which over 70 percent is to state enterprises. While the banks’ direct exposure to foreign exchange risk is limited by prudential regulations, their indirect exposure is very high, as the state enterprises have in most cases used foreign currency loans for domestic operations, and do not have access to instruments that would allow hedging of the exchange risk.

18. Several other developments over the past year raise additional concerns about the soundness of the banking sector. Two of the four state commercial banks were caught up in highly publicized fraud-related scandals and there have been several cases of defaults on letters of credit and payment delays by the joint-stock banks and the state-owned Vietcombank. While the authorities eventually directed banks to regularize the situation and further tightened regulations to prevent a recurrence, these incidents have had an adverse impact on creditor sentiment.

D. Next Stage of Reform

19. The next stage of financial system reform requires mutually supporting programs to restructure problem banks, establish a more effective framework for prudential regulation and bank supervision, and develop indirect monetary policy instruments and promote the use of money markets. While decisive reforms to improve the performance of the state enterprises are vital to ensuring the viability of the banking system, other measures are also needed. For the state commercial banks the first steps are the completion of audits and the implementation of restructuring plans to address recapitalization; independence for bank managers from political pressure; the possible break-up of each bank into smaller and more viable entities; and partial or full privatization. For the joint stock banks, early action to merge or close unviable institutions is essential.

20. Together with the restructuring of the banking system, it will be important to improve the ability to monitor the banks and deter or detect the emergence of further problems. The strategy in this area would include greater central bank supervisory powers; risk-adjusted capital rules and loan-loss provisioning requirements in accordance with internationally accepted standards; and improved accounting standards. Greater reliance on indirect instruments of monetary control should be accompanied by the elimination of formal interest rate spreads, the gradual implementation of adjustments to the discount rate to guide interest rates policy, the increased availability of auctioned treasury bills to establish a market-based interest rate, and the initiation of open market operations to facilitate liquidity management.

III. State Enterprise Reform2

A. Introduction

21. Vietnam made important strides in reforming the state enterprises as part of the first phase of its transition. The impressive growth of the economy during the early 1990s was assisted by the market mechanisms that were introduced in the public sector to improve efficiency in the use of productive resources. However, the authorities have continued to favor a dominant role for the state enterprises as they pursue their goal of a socialist-oriented mixed economy operated on market principles. This has in practice meant that while the state sector has been freed from some of the controls of central planning, a level playing field with the private sector has not yet been established.

22. The decisive thrust of the market-oriented reforms of the state enterprises occurred during 1988-92, and these measures greatly improved enterprise financial performance through 1994. Since then, the reform process has stalled. State enterprises still enjoy privileged legal status; receive explicit and implicit preferences in access to credit, land use rights, fiscal and regulatory treatment; and enjoy targeted trade protection. In addition, a range of hurdles must be overcome for new private firms to become established, providing even stronger protection against domestic competition. Despite these advantages, it has become increasingly evident over the last three years that enterprise performance has deteriorated markedly, reflecting deep-seated structural problems, both in enterprise management and their operating environment.

23. It is necessary to recapture the lost momentum of the reform process. If high economic growth is to be sustained, continued productivity gains will need to be found. The state enterprise sector is an area from which substantial improvements should be expected. The government that took office in September 1997 has identified further reform of the state enterprise sector as one of its principal objectives including the divestiture of many enterprises; the closure or merger of nonviable enterprises; and steps to strengthen financial discipline and increase the efficiency of the rest. This note reviews the reform process to date and its impact on enterprise performance, and outlines the necessary next steps.

B. Role and Performance of State Enterprises

24. The number of state enterprises was reduced in a series of mergers and liquidations from 12,000 to 6,000 between 1988 and 1992, and their labor force was cut from 2.7 million to 1.7 million (Table III.1). Nevertheless, the sector’s contribution to GDP increased from 25 percent to 27 percent during this period, and further to 30 percent of GDP in 1994, in contrast to the experience of most other transition economies at that time. While these figures reflect the coming-on-stream of oil production and the pensioning-off of old or disabled workers, they still reflect a marked improvement in labor productivity and overall efficiency.

Table III.1.Vietnam: Selected Data on State Enterprises, 1989-96 1/
19891990199119921993199419951996
Number of enterprises12,0006,5456,2646,0195,9626,025
Of which: Industry and construction3,0202,7622,5992,2682,0302,0021,9581,880
Value added (percent of GDP)24.823.924.427.428.629.532.131.9
Of which: Industry and construction14.514.215.117.619.019.319.919.6
Excluding oil12.810.59.811.913.915.116.015.6
Industrial production (percent change)-2.56.111.820.614.614.713.612.2
Excluding oil-8.9-0.56.716.115.115.013.811.2
Investment in state industry (percent of GDP)3.42.42.53.35.44.63.13.1
State nonagricultural employment3,3062,9902,7602,6382,6402,6192,7072,841
Of which: Industry and construction905808704686703699754763
State share of nonagricultural employment31.226.122.619.419.415.915.415.4
Government revenue (percent of sectoral GDP)32.336.133.039.241.241.030.730.5
Excluding oil30.432.830.732.135.035.725.024.5
Net budgetary revenue from state enterprises 2/4.46.97.99.911.211.69.39.2
Credit outstanding (trillions of dong)3.65.39.112.415.920.524.126.8
Annual percentage change111.147.171.936.327.728.917.611.3
Of which: Overdue (trillions of dong)1.61.91.72.1
Contracting of commercial foreign loans (millions of U.S. dollars) 3/194141477495
Sources: Vietnamese authorities; and staff estimates.

Includes only enterprises directly held by central and local government, and excludes a substantial number of enterprises held by central organizations (such as the Party) or through shareholding by government organs or by other state enterprises.

Tax and nontax revenue less budgetary transfers. See Table 1 of Chapter V.

Excludes borrowing of joint ventures; short-term borrowing; and L/Cs with maturities over 1 year. With the exception of 1993, almost all of this borrowing was for a term of over five years. Data for 1993 cover only the second half of the year.

Sources: Vietnamese authorities; and staff estimates.

Includes only enterprises directly held by central and local government, and excludes a substantial number of enterprises held by central organizations (such as the Party) or through shareholding by government organs or by other state enterprises.

Tax and nontax revenue less budgetary transfers. See Table 1 of Chapter V.

Excludes borrowing of joint ventures; short-term borrowing; and L/Cs with maturities over 1 year. With the exception of 1993, almost all of this borrowing was for a term of over five years. Data for 1993 cover only the second half of the year.

25. The financial results of the sector improved considerably as a result of the reforms. Net transfers to the budget from the enterprises, which had been about zero in 1988, increased steadily to 12 percent of GDP in 1994 because of the elimination of most subsidies and much higher tax collections. The improved cash flow position was confirmed by slower growth in bank credit to the enterprises, concomitant with an increase in investment. The difficulties with arrears that occurred in many transition economies were largely avoided.

26. Despite a slowing of the reform process, output growth remained rapid during 1995-97. State enterprises now contribute about one-third of GDP, although employment has been held below 2.0 million, equivalent to only 15 percent of nonagricultrual employment (Statistical Annex, Table 12). However, a substantial part of recent growth reflects the government policy of encouraging foreign investors to form joint ventures with state enterprises. This is achieved by limiting the ability of foreign firms to establish wholly-owned Vietnamese operations in a range of areas and making it relatively difficult to obtain access to land and credit and overcome administrative hurdles without the preferences afforded to the state enterprise partners. Many joint ventures are highly profitable and employ the latest technology, especially in the highly competitive export sector.

27. However, several factors suggest that the overall financial performance of the sector weakened over the past three years. Performance has been especially weak in the capital intensive sectors of the economy that are dominated by state enterprises including cement, chemicals and steel; anecdotal evidence exists of a large build up of inventories in this area. Second, budgetary contributions declined to less than 10 percent of GDP in 1995-96 (Statistical Annex, Table 17) and 8.5 percent through the first three quarters of 1997. A large share of budgetary contributions originate with a very small share of the total number of enterprises and many enterprises are loss making. Third, there has been a marked increase in the amount of overdue loans to the banking system by the state enterprises and instances where they have defaulted on deferred payment import letters of credit.

C. Reforms During 1988-923

28. During the 1980s, the rapid expansion of credit to state enterprises contributed greatly to excessive overall credit growth and very high inflation. The absence of an effective budget constraint meant that state enterprises could bid aggressively for the inputs they needed, safe in the knowledge that their financing requirements would be readily accommodated by the banking system and the government budget through large subsidies. Several attempts to address the imbalances in the economy failed due to the weakness of enterprise discipline.

29. The initial reforms were motivated by the objective of correcting this disappointing experience. A first key element of them was a substantial increase in enterprise autonomy. Managers were given the authority to set most prices, select appropriate mixes of inputs and outputs, lay off excess workers as long as they followed the guidelines for compensatory payments, and broadly determine their investment programs. Other important changes were to establish a legal framework that was more supportive of their operations; subject all enterprises to more uniform rules of taxation; allow more enterprises to establish trade links or use trade companies of their own choice rather than a prescribed trade channel; and expose all enterprises to more foreign competition through liberalizing the trade regime.

30. The critical element was the decision to harden the budget constraint. Most subsidies to enterprises were sharply cut with the price liberalization and the unification of the exchange rate in 1989. Budgetary funding of working capital and other capital was retained only for a small group of firms experiencing the largest shocks following the CMEA collapse. Implicit interest rate subsidies were removed by gradually raising real lending rates. Bank credit was made more limited for loss-making enterprises, and this measure was backed up by restrictions on bonus and welfare payments by enterprises in arrears. Several tax laws were passed that provided a more solid foundation for the taxes assessed on enterprises and thereby limited the ex post negotiations of tax liabilities, which was a main element in the earlier softening of budget constraints.

D. Policies During 1993-97

31. The successes flowing from the reforms in 1988-92 period removed much of the impetus and interest for further action. Developments over the past few years are increasingly indicating that the inherent weaknesses in the sector have now overtaken initial productivity gains, resulting in deteriorating financial performance. Few market-oriented initiatives have been launched and these have been slow in implementation. A number of steps represent a reversal of earlier hardening of budget constraints, and other key measures to introduce more competition and transparency have been delayed (notably trade liberalization and tax reform). There also appears to be a tendency toward meeting the worsening performance of firms with an increasing number of ad-hoc preferential measures, rather than by measures to address the underlying weaknesses.

32. The State Enterprise Law was passed in 1995, after having gone through a process of 15 redrafts, to provide a coherent blueprint for strengthening the sector by limiting the state’s financial responsibility for commercial enterprises, establishing rules to control the creation of new enterprises, improving the monitoring and supervision of enterprises, and allowing greater managerial autonomy. However, it took another two years after passage for the necessary implementing regulations and circulars to be issued by government ministries. The requirements of the legislation still need to be carried out, especially in the areas of financial and budget reporting practices, mergers, liquidation and dissolution of enterprises.

33. Enterprises were placed in 1995 under the direct supervision of a new department of the Ministry of Finance rather than under the line ministries. However, the Ministry of Finance does not have access to sufficient financial data on the sector or adequate capacity and experience to oversee the large number of enterprises. The end result is considerable remaining state interference in their commercial operations, especially with regard to investment decisions. At the same time, a lack of management accountability and financial discipline allows overstaffing and excessive wage levels.

34. The government also created in 1995 the National Investment Fund to provide preferential credits for selected sectors and disadvantaged regions. Although both private and public sector firms are in principle eligible for loans from this fund, in practice close to 90 percent of the total volume of loans has gone to state enterprises. Moreover, it is not clear that loans are assessed adequately before being granted. While the fund is small and intended to be phased out by 2000, it still represents a bias against the private sector.

35. During 1995-96, nearly half of the state enterprises were grouped under 18 big holding companies known as General Corporations (see Box III. 1). In addition, some 80 smaller groupings known as Special Corporations were formed. The goals of these corporations were to reap economies of scale, to limit both monopoly powers and disorderly competition, and to conserve government administrative. Contrary to intention, the grouping of enterprises has introduced a degree of monopoly power and rent-seeking activity. Their creation has reduced efficiency by lowering the flexibility and the autonomy of production decisions of individual firms, and reducing the rewards for healthy firms to operate profitably. These corporations frequently cross-subsidize their constituent firms when problems emerge. The heads of the corporations can also be instructed to carry out specific government projects.

Box III.1.General Corporations

Electricity Corporation of Vietnam

Coal Corporation of Viet Nam

Vietnam Petroleum Corporation

Cement Corporation of Vietnam

Vietnam National Shipping Lines

Vietnam Airline Corporation

Vietnam Post and Telecommunication Corporation

Vietnam Rubber Corporation

Vietnam Steel Corporation

Vietnam Coffee Corporation

Vietnam Tobacco Corporation

Vietnam Paper Corporation

Vietnam Textile and Garment Corporation

Northern Food Corporation

Southern Food Corporation

Vietnam Chemical Corporation

Vietnam National Gem and Gold Corporation

Vietnam Railways Union

36. The program to equitize or partially privatize state enterprises has barely started, although the government issued a decision to proceed with a pilot project as early as 1992. An equitized company would be corporatized and brought under the company law. Crucially, it was to have mixed ownership, with shares sold to workers and to outside investors, but with the state retaining a significant stake as well. The program was opposed by many local authorities, because of concerns about losing the contribution of profitable firms to their budget; by managers, fearing the prospect of losing control over their enterprises; and by workers, managers and officials, all of whom were uncertain about the consequences of equitization, especially with respect to employment. Lack of guidelines for the equitization process and the scarcity of expertise needed to value the firms also slowed the process. Thus, only 17 enterprises have been equitized to date, of which 5 are in industry, 5 in agriculture, 4 in transportation, 2 in construction, and 1 in tourism.

37. Outstanding bank credit to the state-owned enterprises has remained high, at 52 percent of total nongovernment credit in mid-1997, despite measures that succeeded in slowing its rate of growth in recent years (Statistical Annex, Table 21). These included the application of bank-by-bank credit ceilings since 1994, including sublimits on the extension of credit to state enterprises. Moreover, the State Bank raised the refinancing rate for the state-owned commercial banks up to the banks’ maximum lending rate, thus discouraging banks from using this facility to fund cheap loans to state enterprises. Nevertheless, many loans have continued to be made without adequate risk appraisal, as evidenced by the rise in nonperforming loans (Statistical Annex, Table 25). The amount of outstanding credit denominated in foreign currency, which represents 50 percent of total credit to state enterprises (Statistical Annex, Table 24) is of particular concern in view of the recent weakening of the exchange value of the dong.

38. During 1997, the number of ad-hoc measures introduced to support state enterprises rose considerably. Steps back from commercially oriented lending, which could impair banking system soundness, included the elimination of collateral requirements for state enterprises when borrowing from a state-owned commercial bank; permitting lending to loss-making firms if a sound business plan is presented; and allowing the roll-over of outstanding credit to enterprises that are facing repayment difficulties. Implicit budgetary support to the sector increased through permitting increases in tax arrears, injecting new working capital from budgetary resources, and initiating the restructuring or write-off of overdue loans to state-owned commercial banks. Temporary import bans were imposed on selected goods that are produced by state enterprises.

E. Agenda for Further Reform

39. A concrete action plan is needed to implement the new government’s stated medium-term objectives for state enterprise reform, which include a reduction in the number of firms by one-half and in employment by one-third by the year 2000. The government has indicated its intention to equitize 150-200 firms by end-1998 and it would be useful to publish the full list at an early date and to accelerate the pace of equitization to meet the government’s own goal. Regulations should be prepared to permit the equitization and privatization of large enterprises (which represent one-third of the total number of enterprises). A simplified procedure could be introduced to permit the full divestiture of small enterprises at auction or through employee buyouts.

40. Consideration should be given to dissolving several general corporations that are primarily engaged in business ventures that could be carried out efficiently by the private sector and breaking up and equitizing some of the other conglomerates, either as a single unit or by selling shares of individual firms. The textile and garment corporation, with over 100,000 employees, is almost certainly too large for maximum efficiency in this area. Other candidates for dissolution include the cement, tobacco, and food processing corporations. The government should not establish any new general and special corporations and remaining conglomerates should be subject to private sector competition.

41. All business state enterprises should face hard budget constraints and the array of special privileges ended. This should include the removal of the implicit differences in tax treatment, the reinstatement of collateral requirements for lending to state enterprises, limiting the availability of bank credit to non-profitable enterprises, abolishing subsidized interest rates, eliminating preferential access to land use rights by state enterprises, easing entry restrictions to foster competition from private firms and ending the use of trade policy to shelter specific state enterprises. Major state enterprises should be monitored monthly, all enterprises should be required to publish financial statements annually and loss making enterprises should be closed or restructured with new management.

IV. External Trade Liberalization4

A. Reform Objectives

42. Vietnam started reducing tariff and nontariff barriers to international trade in the late 1980s along with other reforms to facilitate the transition from a centrally planned to a market-based economy. Prior to that, most decisions on foreign trade had been made administratively by the central authorities in the context of official protocols generally negotiated annually with CMEA countries. All external trade was handled by a small number of state trading organizations, and was controlled tightly through shipment-by-shipment licenses. Import and export quotas for virtually all goods were allocated administratively to selected state enterprises and cooperatives. A complex system of multiple exchange rates delinked international prices from prices officially set in Vietnam.

43. The dismantling of trade barriers has proceeded more rapidly on the export side, consistent with the aim of expanding and diversifying the export sector following the loss of CMEA markets. Nevertheless, a number of export bans, quotas and taxes remain in effect, most of which provide discriminatory advantages to state enterprises. For the same purpose, there are still important barriers to entry for private businesses. In particular, enterprises are required to have staff with appropriate skills and minimum working capital equivalent to $200,000 to engage in foreign trade. An approval from the local People’s Committee (local government), who often have their own trading enterprises, is also required before business licenses are issued to private firms.

44. Progress in reducing import tariffs and quantitative import restrictions has been modest in recent years confirming that Vietnam has not abandoned efforts to nurture selected domestic industries behind trade protection, especially in sectors dominated by state enterprises. The authorities acknowledge that such industries may not have sufficient incentives to improve product quality and cut costs, and this strategy may lead to resource misallocation and encourage rent-seeking. However, they take the view that dismantling of many of these barriers can only be completed gradually, in conjunction with improved retraining facilities and a more comprehensive social safety net.

B. Export Restrictions

45. Priority was given from 1989 to the removal of export barriers in order to encourage sales to the convertible currency area. Quotas were removed in that year on all but 7 exported goods (rice, coffee, peanuts, rubber, coconut meat and oil, logs and lumber and metals and metal waste) and the number of export commodities subject to duties was cut from 30 to 12. Export subsidies were eliminated with the unification and devaluation of the exchange rate. State enterprises were no longer obliged to fulfill their minimum export targets vis-à-vis CMEA partners before being authorized to export to the convertible currency area.

46. Most remaining export bans and quotas were eased in a gradual manner during 1990-97 but not entirely eliminated. Export bans have been retained—partly for environmental, health and security reasons—on several types of goods (weapons, ammunition, explosives, drugs, toxic chemicals, logs and certain wood products). Export quotas have been kept on rice to limit private sector participation in the trade. Quotas also apply to textiles and garments to the European Union, Norway, Canada and Turkey because of stipulations by the market countries, in accordance with the Multi-Fiber Agreement. The garment and textile export quotas are allocated mostly to state sector producers. Export shipment licenses continue to be required for rice, timber and crude oil. Export taxes are imposed on rice (1 percent), timber (10-15 percent), bamboo (20 percent), crude oil (4 percent) and scrap metals (35-45 percent).

C. Import Tariffs

47. Import tariffs were first introduced in 1988 with the enactment of the Law of Import and Export Duties; until then, trade related fiscal revenues were mostly direct contributions from state trading enterprises. Tariffs were initially imposed on 124 commodities, with rates of between 5-50 percent. The maximum tariff was increased in 1989 to 120 percent for some luxury goods, but the tariff coverage was reduced to 80 commodities. Subsequently, the tariff gained importance as an instrument to protect domestic industries; the maximum rate was increased to 150 percent in 1993 and 200 percent in 1994. The coverage of the import tariff was progressively increased to more than 3000 items. In 1996, the maximum tariff for most items was lowered but it remains high at 60 percent.5 In addition, a new 100 percent excise was imposed on imported cars to encourage domestic production.6

48. The tariff rate structure is complex with almost 30 bands, and rates are subject to frequent and piecemeal adjustments often in response to perceived short-term economic needs of specific industries. At the same time, many commodities are exempt from customs duties, often based on negotiations for individual investment projects. Typically, changes are designed to favor state enterprises.

49. It is recognized that such a tariff structure is not consistent with an efficient business climate, especially because it increases the burden of customs administration. The perception that protection and exemptions can be obtained through negotiation, especially for state enterprises, impedes competition and increases the resources devoted to lobbying activities. Frequent and often unannounced rate adjustments jeopardize policy stability and transparency, thereby reducing the incentive to invest. The tariff system’s budgetary goal also appears adversely affected by the complex system. Protection is further raised because of the use of government reference prices for import valuation purposes.

D. Quantitative Import Controls

50. Early reform efforts to reduce quantitative import controls started with the removal of bans except for commodities where environmental, health, and security concerns were considered to be important. These presently cover drugs, toxic chemicals, undesirable cultural material, firecrackers and toys harmful to children, cigarettes, used consumer goods (excluding motorcycles and cars with less than 12 seats), vehicles with right-hand drive, and used spare parts of automobiles and motorcycles.

51. Commodities subject to quotas were reduced to twelve groups in 1989, and then gradually to five groups in 1996 (cement, petroleum products, fertilizer, sugar and steel). Construction glass and paper products were added in 1997. The value of import quotas for each of the controlled commodities is derived through an attempt to equate projected domestic demand with the sum of domestic supply (based on projected production and existing stocks) and imports; this is essentially a legacy of material balancing under central planning. Since producers of the controlled commodities are mostly large state enterprises, limited imports protect them by assuring domestic markets at a reasonable price for their products. Large established state enterprises are also given priorities in the allocation of imported goods under permits.

52. The government maintains strict import licencing over a wide range of consumer goods. While the authorities announced an intention to convert them into tariffs in early 1997, this action was not implemented. Import shipment licenses, which used to be employed to manage all imports, were largely eliminated in early 1996. However, line ministries retain the power to certify imports of certain goods for health, safety and environmental reasons including mineral and ores, pharmaceutical products and live animals. This system can easily be used to restrict imports.

53. Non-tariff barriers continue to be applied flexibly at the discretion of the authorities. Temporary import bans on certain consumer goods, and cars and motor bikes were often imposed during the early 1990s depending on the market demand situation. Following a sizable trade deficit in 1996, the authorities again increased the use of quantitative restrictions to stem import growth. Temporary import bans were introduced during May-July 1997 for selected commodities purportedly with large domestic stocks, including cement, certain types of transparent glass, paper, steel, automobiles with less than 12 seats, motorcycles, sugar, bicycles, electric fans, beer, beverages, and confectionery.

E. Next Steps

54. The future reform agenda for Vietnam’s trade policy should focus on making the trade regime more open and neutral and eliminating the discretionary element from the way the system is managed. This will promote the dismantling of nontransparent protection for selected state enterprises, encourage competition and product improvements, and provide consumers with wider and less expensive choices. It will also reduce the potential scope for smuggling and corruption. Without progress on the trade liberalization front, state enterprise reform objectives will not be met; protected state enterprises will continue to have performance problems, investment will continue to be inefficient and the burden of future adjustment will consequently be larger.

55. Steady reduction of the maximum tariff rate is a high priority action. Vietnam has made commitments under the ASEAN Free Trade Agreement with regard to tariff reductions in the period up to 2006 but has claimed many exemptions to slow the pace of import liberalization (Box 1). The number of tariff bands also needs to be reduced to less than 10 as soon as possible, with a view to reducing it further to 3-4 within a limited period of time. Virtually all of the remaining quantitative restrictions should be eliminated. Discontinuing the system of import permits based on balancing domestic demand and supply would reduce the ability of the government to protect poorly performing state enterprises.

56. Existing export quotas should be auctioned so that the most efficient exporters could fill these quotas and the authorities capture the rent associated with the MFA restrictions imposed externally. Entry to foreign trade business should be further liberalized through the removal of the staffing and minimum working capital requirements.

V. Tax Reform7

A. Introduction

57. Vietnam started to modernize the tax system in the late 1980s along with other measures to transform the centrally planned economy. Until then all taxes were based on administrative decrees rather than enacted laws. Three quarters of revenues were transfers from state enterprises, collected in the form of turnover tax, profit tax, commodity tax (excises), and depreciation allowances (Table V.1). However, these distinctions meant little in practice as the authorities had full control on prices of inputs and outputs, and the total amount of transfers to the budget was negotiated between government officials and individual enterprises. The surplus of state enterprises was enhanced by explicit budgetary subsidies, easy access to low interest credit and inexpensive imports from CMEA countries.

Table V.1.Vietnam: Revenue Structure, 1988-96(In percent of GDP)
198819891990199119921993199419951996
Total domestic revenue13.116.016.114.418.321.624.023.222.9
Tax revenue3.44.54.411.613.217.419.019.019.5
State enterprises0.00.00.07.68.29.39.18.58.8
Nonagricultural private sector1.41.81.71.41.82.52.72.93.1
Agricultural tax1.01.30.81.01.21.00.70.70.7
Taxes on international trade1.01.51.91.62.04.35.96.05.8
Joint-ventures and others0.00.00.00.00.00.30.71.01.1
Nontax revenue9.711.511.72.85.14.25.04.23.4
State enterprises8.49.29.51.32.52.52.91.31.0
Other nontax revenue1.32.32.21.52.51.82.12.92.5
Memorandum items:
Net transfer from state enterprises-0.14.46.97.99.911.211.69.39.2
Tax and non-tax revenue from state enterprises8.49.29.58.910.811.812.19.89.7
Budgetary transfers to state enterprises8.54.82.61.00.90.60.50.50.5
Sources: Ministry of Finance and staff estimates.
Sources: Ministry of Finance and staff estimates.

58. During 1989-91, a number of laws were enacted to replace the old decree-based taxes. The new taxes related to import and export duties, turnover tax, excise tax, profit tax, agriculture land use tax, and tax on the transfer of land use rights. There were also ordinances on income tax for high income earners, natural resource tax, and land and housing taxes. These actions were designed to raise sufficient fiscal revenues to support critical infrastructure and human capital development, while introducing elements of a modern tax system for a market economy. In addition, the authorities improved tax administration, including more systematic efforts to collect from non-state enterprises.

59. Fiscal revenue increased from 13 percent of GDP in 1988 to 24 percent in 1994 and more than 80 percent of total domestic revenues by then comprised tax collection (Table V.1). Taxes on international trade increased from about 1 percent to 6 percent of GDP, as tariffs replaced quantitative trade restrictions. Taxes on non-state enterprises and joint ventures increased from less than 2 percent to 4 percent of GDP, reflecting increased private and foreign business activities. Revenue from state enterprises increased from 8-9 percent to 12 percent of GDP boosted by structural reforms that strengthened their financial performance and rapidly increasing revenues from crude oil. In combination with drastically reduced subsidies, the sector’s net contribution to the budget increased from zero in 1988 to 12 percent of GDP in 1994.

60. Since the peak in 1994, budgetary revenue has declined by 4 percentage points to 20 percent of GDP. This is closely linked to the deterioration in the financial performance of the state enterprise sector. The authorities also reduced the tax burden on the sector so that more earnings could be retained and invested by the enterprises. As part of these efforts, the authorities announced at the Party Congress in 1996 that a formal revenue cap of 20-21 percent of GDP would be adopted. While this cap was later officially removed, the authorities have continued to lower revenue mobilization from state enterprises by reducing the collection of capital user fees,8 and introducing accelerated depreciation of assets (which benefit only capital intensive state enterprises). In addition, they have continued to negotiate with state enterprises on a discretionary basis often to reduce tax payments of enterprises in financial difficulties9. This means that the tax system continues to lack in transparency.

B. Structure of the Tax System

61. The present composition of budgetary revenue is about 60 percent in the form of indirect taxes, 20 percent in the form of direct taxes and 20 percent in the form of nontax revenue. Overall revenue performance continues to depend crucially on contributions from the state enterprise sector. Two thirds of turnover tax and excises is collected from state enterprises; an additional 9 percent of total revenue is collected from foreign investors who often form joint ventures with state enterprises; and direct taxes are dominated by enterprise profit tax. While the sectoral origin of international trade taxes and taxes on land use or transfers of land use rights cannot be identified with the current data base, it can safely be assumed that majority of these taxes are also paid by state enterprises.

Taxes on goods and services

62. Domestic taxation on goods and services, which now yield 12 percent of GDP, consists of the turnover tax and the special consumption tax (excises that used to be called special commodity tax). The turnover tax was first introduced in 1953 with rates that differed by product, region, and ownership (state or non-state). A new turnover tax was enacted in July 1990, as a cascading tax covering a broad range of products including producer inputs, consumer goods, and services. The number of rates was reduced in 1995 from 18 rates ranging from zero to 40 percent to 11 with the highest rate reduced to 30 percent but the system remains complex. Agricultural products, excisable goods (at the production phase where the excises apply) and financial services were exempt from the tax. From 1991, retailers and wholesalers were given an option to be taxed on profit margins at higher rates rather than pay the tax on full turnover.

63. Special consumption tax (excise) is levied ad valorem on the producers’ ex-factory prices of socially undesirable goods and some imports. Excisable goods were reduced from 22 categories in the early 1990s to 6 categories (cigarettes, beer, other alcoholic beverages, cars, gasoline and firecrackers, use of which is currently banned). Of these, the only domestic products subject to excise are cigarettes, beer, alcoholic beverages and firecrackers. Imported cars and gasoline were added to the list in 1996. Excises that are not levied equally on domestic products and imports could have an anomalous impact on protection. In particular, the recently imposed 100 percent excise on imported cars increases the protection of foreign-invested domestic assembly lines significantly.

Income and profit taxes

64. Revenue from personal income tax is limited to less than 1 percent of GDP. The tax introduced for the first time in 1990 has separate schedules for Vietnamese nationals rates of which are 0-60 percent, and for foreigners living in Vietnam with the maximum rate of 50 percent. The threshold income for taxation for Vietnamese is very high at the equivalent of about six times per capita income. The definition of taxable income is also narrow despite recent improvements. The tax base excludes interest and rental incomes and is largely limited to wage income of workers in the modern corporate sector, especially those employed in foreign invested firms. However, Vietnamese with higher than a specified level income (D 8 million or $700 per month, net of regular income tax payment) are taxed an additional 30 percent on the excess income (called supplementary tax); for these taxpayers, the marginal rate exceeds 70 percent.

65. Taxation of the enterprise sector which is equivalent to 3 percent of GDP, has been streamlined in phases. Profit tax for nonstate enterprises during the 1980s had ten rates for each of three sectors (production, commercial and services). The Law of Profit Tax (1990) imposed essentially the same schedule for both state and non-state enterprises and the rate structure was simplified. Still, there are currently three rates (25 percent for heavy industry, mining and forestry, 35 percent for light manufacturing and 45 percent for services). In addition, enterprises are levied an excess profit tax of 30-40 percent when their profits exceed a ceiling set by the authorities. Small household businesses pay 1-2 percent of turnover as profit tax (in addition to turnover tax), and pay an excess profit tax of 25 percent when their taxable income exceeds a fixed sum. Foreign invested firms, in accordance with the Law on Foreign Investment, face different and lower tax rates (10, 20, and 25 percent), but they pay 5-10 percent tax on profit remittances. Both domestic and foreign firms presently enjoy fiscal incentives—new firms are entitled to tax holidays of 1-4 years (depending on the sector and location) from the first year of profit followed by a 50 percent tax reduction for a period of similar length.

C. Future Reform Agenda

66. The increase in revenue in relation to GDP in the early 1990s was a major achievement for an economy with very low per capita income. However, subsequent progress in reform has been limited, the tax structure remains complex, revenues are still on state enterprises dependent and coverage of the private sector is inadequate. Moreover, the authorities continue to use taxes as instruments to realize their short- and medium-term priorities on a discretionary basis. The next steps of tax reform thus need to increase the efficiency of the tax system by lowering rates and rate dispersion, broadening the tax base, enhancing consistency among different tax instruments and applying equally the same tax schedules to all individuals and enterprises. Transparency in tax management should be increased in particular by reducing the authorities’ capacity to use taxes on a discretionary basis and emphasizing the improvement of tax administration in order to discourage evasion and inefficiency.

Value-added tax

67. The National Assembly voted in 1997 that a value-added tax (VAT) with three positive rates (5, 10, and 20 percent) would be implemented from January 1999. The Fund’s Fiscal Affairs Department is providing technical assistance for its effective implementation. In this regard, appropriate implementing decrees and regulations need to be drafted carefully to limit the number of initial VAT payers consistent with the resources of the tax administration, rely on voluntary compliance and self-assessment, and permit a single declaration of imports to be made at Customs for value-added tax excises and customs duties and collection of all these payments prior to the release of goods from Customs. In the longer run, considerations should be given to simplifying the VAT rate structure preferably to one positive rate and a zero rate for exports. Furthermore, the categories of goods and services to be exempt from VAT could be reduced.

68. Excises should be levied equally to domestic and imported commodities to avoid unintended or anomalous impacts on protection. Motorbikes and other petroleum goods (only gasoline is excised now) should be added to the list of excisables, which would enable the tax to function as an instrument for pollution control, resource conservation and equity. This addition would also serve to increase budgetary revenues.

Enterprise income tax

69. The National Assembly passed in 1997 the Enterprise Income Tax Law to become effective at the beginning of 1999, with a view to equalizing the tax burden on all enterprises. It provides for unification, in principle, of the rate applied on the income of all domestic firms at 32 percent. However, there are still a number of special rates including 50 percent for oil and gas industries; 33-50 percent for those engaged in exploitation of rare and precious natural resources; and preferential rates ranging from 15-25 percent. An additional 25 percent tax will be paid by businesses deriving high income due to what are called preferential business conditions, such as monopoly positions. Foreign invested firms will continue to enjoy lower rates based on the Law of Foreign Investment.

70. The next stage of reform for the authorities is to make uniform the enterprise income tax rate for both domestic and foreign firms. This means elimination of many of the income tax rates for domestic firms other than 32 percent, including the excess profit tax. The same standard rate should be applicable to foreign invested firms and the profit remittance tax removed. The authorities should continue to limit the use of tax holidays and preferential rates for new firms, and make them strictly time bound. Finally, there should be no room for a state enterprise to negotiate informally the amount of tax it pays.

71. The marginal rate for personal income tax is above 70 percent when supplementary tax is taken into account—much higher than that of the new enterprise income tax rate—which may encourage switching of declared income from personal to enterprise income tax. The authorities have stated that personal income tax structure need to be simple and the rate for the highest income bracket needs to be adjusted to be close to the corporate income tax rate. The government has already decided to discontinue the supplementary income tax in 1998 and intends to include interest and rental incomes into the taxable base in the near future. Any practice of separate taxation of irregular income will be discontinued. In addition, given the relatively high threshold of personal income, consideration should be given to lowering it to enlarge the tax base.

This chapter was prepared by Wayne Camard and Dubravko Mihaljek.

This chapter was prepared by Wayne Camard and Erik Offerdal.

Developments during this period are summarized in Dodsworth et. al., 1996, Vietnam: Transition to a Market Economy, IMF Occasional Paper No 135 (Washington: International Monetary Fund).

This chapter was prepared by Hisanobu Shishido.

Second hand clothes still carried a tariff rate of 100 percent. Some types of soft drinks and bicycles also carry rates higher than 60 percent.

Excises had previously been levied only on domestic production of cigarettes, alcoholic beverages and firecrackers. Since imports of these products were negligible or prohibited, the excises per se were not a factor significantly affecting protection.

This chapter was prepared by Hisanobu Shishido.

Although called fees, they are equivalent to interest payments on government contributed capital assets of state enterprises.

The authorities have also resorted to ad hoc trade restrictions and credit policies to protect state enterprises. These policies jeopardize both efficiency and revenue performance.

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