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Vietnam: Selected Issues

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International Monetary Fund. Asia and Pacific Dept
Published Date:
July 2018
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Fiscal Rules in Vietnam: Calibration and Options 1

Vietnam follows a debt rule, with a statutory limit of 65 percent of GDP on public and publicly guaranteed debt (PPG). The authorities have so far adhered to the rule, but recent high deficits have brought PPG close to the limit. This note analyzes the appropriateness of the current debt ceiling, while taking into account fiscal risks, rising age-related spending costs and other contingent liabilities. It concludes that a debt rule remains appropriate in Vietnam, but PPG of 55 percent of GDP maybe a more appropriate target in the medium-term. The paper suggests an expenditure rule as an additional operational target,2 concluding that a first best option would be a nominal expenditure growth rule of 10–11 percent.

A. Public Debt and the Debt Rule

1. Vietnam follows a debt rule, with a statutory limit of 65 percent of GDP for public and publicly guaranteed debt (PPG). The authorities are committed to adhering to their debt rule; PPG debt has so far remained below the statutory limit in recent years (Figure 1). They are also committed to bringing the deficit down to more sustainable levels (from an estimated 4.5 percent of GDP in 2017 and 4.6 percent in 2018).

Vietnam: Historical PPG Debt and Overall Balance

(In percent of GDP)

Sources: WEO and IMF staff calculations.

2. However, PPG debt is close to statutory limits. It increased rapidly between 2011 and 2016, driven by fiscal deficits that jumped from an average 2 percent between 2000 and 2011 to an average 6.2 percent between 2012 and 2016. While ad-hoc measures and privatization receipts are likely to keep debt below 65 percent in the near- to medium-term, in the absence of further consolidation efforts, or in the case of adverse shocks, PPG debt could breach the debt limit within a few years. This paper analyzes the appropriateness of the current debt ceiling, while taking into account fiscal risks and other contingent liabilities.

3. In addition, Vietnam faces long-term demographic challenges. Vietnam has a rapidly aging population, with age-related spending needs estimated to increase by 8 percent of GDP by 2050,3 increasing pension outlays by 6.7 percent of GDP. In addition, according to World Bank projections, in the absence of further reforms, the current pension scheme is expected to run deficits as of 2030.4 Thus, Vietnam is likely to face the challenges of high fiscal costs of aging and demographic headwinds to growth at relatively low per capita income levels. These dynamics should be taken into consideration when calibrating fiscal rules.

B. Calibrating the Debt Rule

4. A statutory limit on PPG debt is appropriate for Vietnam because it can help ensure debt sustainability and trigger a fiscal response that limits repeated fiscal slippages, while providing an anchor for medium-term fiscal planning. As of 2015, about 70 countries worldwide had a fiscal framework with an explicit cap on public debt. Debt rules are generally set in gross rather than net terms, as in Vietnam, because it is difficult to know a priori which government assets are truly liquid, particularly in times of financial stress. Also, the concept of net debt is less transparent than gross debt and more difficult to communicate to the public.

5. The appropriate level of the debt target for Vietnam is one that is realistically calibrated to be aligned with Vietnam’s medium-term objectives. Calibration of the debt ceiling is done in three steps.

Step 1: setting a maximum debt limit. The maximum debt limit is the level beyond which a debt distress episode is likely to occur with heightened probability (for example, default, restructuring, or large increases in sovereign spreads). In this exercise, the maximum debt limit for Vietnam is set to 80 percent of GDP, similar to the limit for emerging economies in the MAC DSA (70 percent of GDP), plus 10 percent to account for public guarantees that enter the gross debt level to 100 percent, but are unlikely to be fully drawn.5 In fact, guarantees have rarely been drawn in Vietnam in the past (although debt restructuring was aided in alternative ways). This is why the analysis builds in an additional 10 percent buffer on top of the 70 percent of GDP maximum debt limit. As fiscal consolidation continues and the level of outstanding guarantees is reduced, a lower level of maximum debt limit could be considered in time. Similarly, as age related costs rise in the longer-term, a lower debt limit will be necessary to make room for future aging-related spending needs. The stochastic model calibrates a debt anchor based on short- to medium-term risk, therefore higher long-term costs cannot be modeled in the standard framework. To allow for the longer-term aging costs within this framework, the maximum debt limit should be set at a lower level by subtracting the estimated 8 percent of GDP age-related spending from the maximum debt limit (reducing it to 72 percent of GDP from 80 percent of GDP), which indicates the additional fiscal space needed for aging costs in the future.

Step 2: identifying macroeconomic shocks. The second step is to perform stochastic simulations to gauge the potential impact of macroeconomic and fiscal shocks on debt over the medium term. This requires estimating the joint distribution of GDP growth, the interest rates on government debt (both foreign and domestic), and the exchange rate. In the baseline, past economic performance is used for the forecast (past means and variances). Earlier research on stochastic simulations of debt trajectories includes IMF (2003), Garcia and Rigobon (2004), and Celasun et al. (2007).

Step 3: estimating the debt anchor in the baseline scenario. The third step identifies the debt anchor (i.e., the debt ceiling) accounting for macroeconomic shocks. The debt anchor is defined as that level of debt which will remain below the maximum debt limit (i.e. 80 percent of GDP for Vietnam; see Step 1) over the medium term with high probability, despite the potential for negative macroeconomic shocks identified in step two. A fan chart of Vietnam’s public debt-to-GDP ratio is generated from stochastic simulations (Figure 2), accounting for macroeconomic shocks discussed under Step 2.6 The initial year chosen for the simulations is 2017. The simulation is based on historical data for Vietnam, and suggests that a debt anchor of 66.5 percent could be sufficient to ensure that debt stays below the maximum debt limit of 80 percent with 90 percent certainty.

Vietnam: Public Debt Fan Chart

(In percent of GDP)

Source IMF Staff Estimates

Step 4: debt anchor accounting for fiscal risks. A lower debt anchor may be warranted than in the baseline scenario (Step 3) to accommodate a higher (than in the past) risk of a growth slowdown, increasing domestic interest rates and higher real exchange rate depreciation. Vietnam is also subject to the realizations of contingent liabilities in the form of adequately funding the deposit insurance system, local government borrowings, higher than expected costs of state-owned enterprise (SOE) and extra budgetary funds, costs of recapitalizing state-owned commercial banks, and non-guaranteed debt of SOEs.7 We also test the implications for higher aging costs in the future as outlined under Step 1, and lower the debt limit to 72 percent of GDP to calibrate the debt anchor accounting for long term age-related costs. Table 1 summarizes the resulting debt anchors under five different risk scenarios.

Table 1.Vietnam: Scenario Analysis
ScenarioDebt Anchor (% of GDP)
1) 5 percent realization of contingent liabilities58.8
2) Real GDP growth slowdown to 4 percent of GDP52.3
3) Scenario 2 + 2.5 percent realization of contingent liabilities50.1
4) Scenario 2 + real depreciation of 4 percent per year49.9
5) Age related spending (maximum debt limit of 72 percent of53.8
Source: IMF Staff Estimates.
Source: IMF Staff Estimates.

6. Each of these scenarios demonstrates that the presence of fiscal risks and contingent liabilities requires a lower debt limit than the current statutory ceiling. Scenarios 3 and 4 indicate that a combined growth and contingent liability shock (lower growth could increase bank recapitalization needs, for example), or growth and exchange rate shock would necessitate a debt target of below 55 percent of GDP in the medium-term. The results suggest that the authorities should aim at a target of 55 percent of GDP to account for fiscal risks and aging costs that could materialize in the medium to long term; the current 65 percent of GDP ceiling should be considered an upper bound.

C. Augmenting Debt Ceilings with Expenditure Rules (ERs)

7. While a debt rule provides a useful anchor for medium term fiscal policy, the debt rule should be augmented to provide operational guidance to fiscal policy in the short term. Operational rules target aggregates that the authorities have more direct control over, such as public expenditure, revenue and the budget balance. While not recognized officially as fiscal rules, Vietnam’s budget plan is subject to several thresholds, making the current fiscal framework in Vietnam potentially over-committed. Thresholds and floors determine the current balance, the overall balance, tax revenue, total spending (upper limit), capital spending (lower threshold), and others, some of which are specified annually, some as a medium-term perspective. In the current system, if one target underperforms, others will. For example, if public revenue underperforms, spending will have to be cut to reach the overall balance target, often done via capital spending, therefore missing the capital spending target. If the desired capital spending target is met, the budget balance target will not be reached. While these targets provide clear guidance for policy makers, they limit flexibility to respond to crises. The number of rules and targets also complicates communication, particularly if several targets are missed to compensate for one missed target. It would be preferable to replace these multiple targets with one or two shorter-term operational rules that is under the direct control of the government and has a close and predictable link to debt dynamics. In this paper, we suggest a ceiling on the nominal growth rate of expenditure rule (an expenditure rule). Appendix I provides more details on the principles of operational rules as well as on advantages and disadvantages of different types of operational rules.

Cross Country Experience on Expenditure Rules8

8. As of 2015, 46 countries had ERs, 14 of which were in emerging markets (EMs). ERs set limits on total, primary, or current spending, with limits applying to nominal or real expenditure. They are typically set in absolute terms (levels) or growth rates, and occasionally in percent of GDP, with a time horizon of three to five years.

9. The types of ERs in EM countries vary (Table 2). In most of the 14 countries, the ER is accompanied by a debt rule (Botswana, Brazil, Bulgaria, Croatia, Ecuador, Georgia, Namibia, Peru, Poland, and Romania). Half of the nominal and real growth rate ceilings are specified in terms of either potential or nominal GDP growth. The others are specified in absolute growth rates (independent of GDP). Of the 14 rules, 9 cover overall expenditures, the remaining 5 either current and/or primary expenditure. EMs with ERs specified in nominal growth rates are Bulgaria, Colombia, Poland and Romania, of which all but Colombia also have a debt rule.9

Table 2.Vietnam: 2015 Expenditure Rules in Emerging Market Economies
Public Expenditure Specified as …Number of Countries
Ratio to GDP (30–40%)4
Ratio to Revenue3
Nominal Growth Ceiling4
Real Growth Ceiling4
Growth Limited by Potential GDP Growth3
Growth Limited by Total GDP Growth1
Others1
Source: IMF FAD Fiscal Rules Database

Rule includes additional elements, such as a spending reduction over time. For example, in Croatia real growth in public expenditures cannot exceed potential GDP growth, and total expenditure also must be cut 1% of GDP per year, until the primary balance reaches zero.

Source: IMF FAD Fiscal Rules Database

Rule includes additional elements, such as a spending reduction over time. For example, in Croatia real growth in public expenditures cannot exceed potential GDP growth, and total expenditure also must be cut 1% of GDP per year, until the primary balance reaches zero.

Selecting the Right’ Expenditure Rule

10. An ER specified in terms of nominal growth rates would be appropriate for Vietnam. Expenditure growth could be calibrated on the basis of nominal GDP growth initially, but should be relatively independent of the GDP series during implementation. In addition, the ERs should be recalibrated every 3 to 5 years to account for underlying economic changes.

  • ERs defined in growth rates can support macroeconomic stabilization and improve compliance, whereas ERs set as a ratio to GDP tend to be procyclical. Moreover, compliance with ERs specified as nominal ceilings or nominal growth rate ceilings is significantly higher than those specified as a ratio to GDP or in real growth terms (Cordes et al., 2015),. Moreover, the government has less incentive to comply with the rules since accountability for non-compliance is reduced.

  • The ER rule should be formulated on overall public expenditure (at the general government level) to avoid creative accounting.

  • The ER should be defined in nominal terms for transparency and ease of monitoring and enforcement. Nominal targets also have better economic stabilization properties because they incorporate inflation developments. Expenditure targets in real terms can reduce the stabilization effect as compliance is not affected by inflation and it can foster strategic manipulation of the deflators to obtain additional spending room in the budget.

Calibrating Expenditure Rules

11. A 10 to 11 percent growth rate ceiling on a nominal expenditure rule would be consistent with a medium-term debt target of 55 percent of GDP. Table 3 summarizes the debt levels reached by 2023 under different budget deficits and expenditure growth rules (in nominal terms). The presented expenditure growth rates are calculated as the average expenditure growth for the first 5 years (2018–2023) under a given fiscal balance and assuming a stable revenue ratio at 23 percent of GDP. The initial debt level is set at the end-2017 level of 58.5 percent of GDP. The illustrative scenario assumes a long-term nominal interest rate of 7 percent, and a long-term nominal GDP growth rate of 10 percent. In the illustrative scenario, Vietnam’s debt would reach 54 percent of GDP by 2023, if the average deficit was 4.4 percent of GDP and expenditure growth around 10.7 percent on average over the next 5 years. This scenario is close to the consolidation scenario suggested in the 2018 Article IV, where the deficit is declining to 3 percent by 2023, with an average expenditure growth of 10.3 percent annually until 2023.

Table 3.Vietnam: Options for Expenditure Rules
ScenarioNominal GDP GrowthOverall DeficitNominal Expenditure Growth RuleDebt Level in 2023
Illustrative Scenario10%4.4%10.7%54%
Consolidation Scenario 1/10.5%Declining to 3 % by 202310.3%52.8%
Stronger growth12%5.1%11.2%54%
Weaker growth7%3.0%9.6%54%

The consolidation scenario mirrors the one presented in the 2018 Article IV Staff Report. It incorporates the negative GDP growth impact of fiscal consolidation with a multiplier of 0.3. The scenario also assumes the implementation of a tax policy reform in 2019, and a positive impact of public investment efficiency gains following PIM improvements to begin in 2020. The scenario further assumes structural reforms aimed at improving public spending efficiency and addressing bank recapitalization needs, which together with higher public investment is expected to increase real GDP growth by 0.4 percent over the baseline by 2023.

Source: IMF Staff Estimates.

The consolidation scenario mirrors the one presented in the 2018 Article IV Staff Report. It incorporates the negative GDP growth impact of fiscal consolidation with a multiplier of 0.3. The scenario also assumes the implementation of a tax policy reform in 2019, and a positive impact of public investment efficiency gains following PIM improvements to begin in 2020. The scenario further assumes structural reforms aimed at improving public spending efficiency and addressing bank recapitalization needs, which together with higher public investment is expected to increase real GDP growth by 0.4 percent over the baseline by 2023.

Source: IMF Staff Estimates.

12. Sensitivity analysis with respect to nominal GDP growth shows that deficit targets and expenditure growth rates can be relaxed or may need to be tightened depending on the economy’s growth performance. Given the possibility of a growth slowdown, increasing aging costs and the materialization of contingent liabilities, a prudent fiscal rule framework should an expenditure growth ceiling of 10–11 percent per year (tantamount to a limit to the overall balance of 3–4 percent of GDP).

Appendix I – Principles of Fiscal Rules

The system of fiscal rules should be anchored by a debt objective to preserve fiscal sustainability. The debt anchor is directly linked to fiscal sustainability, the main objective of the fiscal framework. The anchor should thereby inform medium-term expectations about fiscal policy, and is not meant to provide clear short-term guidance to policymakers. Public debt is inherently persistent and affected by many other developments besides changes in the overall budget balance. A well-anchored fiscal framework thus aims at bringing predicted public debt to or below the ceiling over the longer run. Short-term guidance, instead, should be given on the basis of operational rules, which concern variables under the direct control of governments and which serve to communicate the fiscal stance to the public, while having a close and predictable link to debt dynamics.

The fiscal framework should consist of a small set of rules. A debt rule serving as fiscal anchor should be combined with one or a few rules on operational variables under policymakers’ control, such as an expenditure growth limit or the budget balance. Parsimonious frameworks are more easily monitored and communicated to the public, building the government’s credibility. As such, the current fiscal framework in Vietnam might be over-committed and complicates communication, particularly if several targets are missed to compensate for one missed target. At the same time, it is not clear whether the number of operational rules should be limited to one.

Fiscal policy has numerous objectives, which are not as clearly defined as those of monetary policy (Leeper, 2015). Therefore, having one operational rule per key objective may be preferable to overloading a single rule with multiple tasks. For instance, a trade-off may emerge between the two objectives of ensuring long-term sustainability and protecting capital expenditure. In this case, two rules could be considered to combine a ceiling on total (current plus capital) expenditure, and current expenditure (see IMF 2018b), effectively adding one rule to the above described framework. IMF (2018b) provides some guidance on how to select the most appropriate fiscal rules.

The chosen rules should follow some general principles. They should assist the debt anchor in ensuring sustainability; they should ensure stabilization, i.e., they should not increase economic volatility through procyclicality; they should be simple, easily understood, and easy to monitor and enforce; they should provide clear operational guidance, meaning it should be possible to translate the rule into clear guidance in the annual budget process; and it should be resilient, i.e., it should be in place for a sustained period to build credibility and not be abandoned easily after a shock. The below table compares the advantages and disadvantages of different types of rules along these main criteria.

Relationships between the thresholds of the fiscal anchor and the operational rules should be transparent and grounded in economic analysis. Consistent calibration is essential to ensure unambiguous guidance to policy and effectively anchor expectations. As demonstrated in the paper, the debt ceiling should be set first, taking into account sustainability and sufficient buffers to absorb shocks to the public sector’s balance sheet (Ostry et al., 2010). Then the operational rules (on the fiscal balance and expenditure) can be calibrated from the debt ceiling to ensure consistency.

Correction mechanisms setting the adjustment path following a breach can be useful to avoid drifting away from the anchor. Without a correction mechanism, repeated breaches of budget balance or expenditure rules can cause debt to drift up and away from its long run objective. Correcting for such deviations strengthens the link between the debt anchor and the operational rules. Designing credible correction mechanisms requires a balancing act between keeping the anchor and avoiding abrupt corrections, especially when they make little sense economically.

Table 1.Vietnam: Pros and Cons of Operational Rules
Overall BalanceGolden
+ Easy to communicate/monitor+ Protect public investment
+ Clear operational guidance+ Intergenerational equity
– Can lead to procyclicality– Weak link to debt sustainability
– Could lead to changes in composition– Creative accounting
Cyclically Adjusted and StructuralOver the Cycle
+ Foster economic stabilization+ Good stabilization properties
+ Good operational guidance– May entail too loose/tight stance
– Difficult to compute and monitor– Difficult to monitor and enforce
Expenditure RulesRevenue Rules
+ Easy to communicate/monitor+ Raise revenues or limit tax burden
+ Allow macroeconomic stabilization– No direct link to debt sustainability
+ Clear operational guidance– Can lead to procyclicality
+ Can ensure debt sustainability if well designed
– Could lead to changes in composition
– May reduce incentive to mobilize revenues
Source: IMF 2018b.
Source: IMF 2018b.
References

    BaumAnjaAndrewHodgeAikoMineshimaMarialuzMoreno Badia andReneTapsoba. 2017. “Can They Do It All? Fiscal Space in Low-Income CountriesIMF Working Paper 17/110International Monetary FundWashington, DC.

    BudinaNinaTidianeKindaAndreaSchaechter andAnkeWeber. 2012. “Fiscal Rules at a Glance: Country Details from a New DatasetIMF Working Paper 12/273International Monetary FundWashington, DC.

    CelasunOyaXavierDebrun andJohathanOstry. 2007. “Primary Surplus Behavior and Risks to Fiscal Sustainability in Emerging Market Countries: A Fan-Chart ApproachIMF Staff Papers53 (3): 401.

    GarciaMarcio andRobertoRigobon. 2004. “A Risk Management Approach to Emerging Market’s Sovereign Debt Sustainability with an Application to Brazilian Data.” NBER Working Paper 10336National Bureau of Economic Research, Inc.CambridgeMassachusetts.

    CordesTillTidianeKindaPriscillaMuthoora andAnkeWeber. “Expenditure Rules: Effective Tools for Sounds Fiscal Policy?IMF Working Paper 15/29International Monetary FundWashington, DC.

    International Monetary Fund. 2003. “Sustainability Assessments—Review of Application and Methodological Refinements.” IMF Policy PaperInternational Monetary FundWashington, DC available at https://www.imf.org/external/np/pdr/sustain/2003/061003.htm

    International Monetary Fund. 2018a. “How to Calibrate Fiscal Rules? A PrimerFAD How-To Note.

    International Monetary Fund. 2018b. “How to Select Fiscal Rules? A PrimerFAD How-To Note.

    LeeperEric2015. “Fiscal Analysis is Darned HardCAEPR Working Paper #2015–021.

    LledóVictorSungwookYoonXiangmingFangSambaMbaye andYoungKim. 2017. “Fiscal Rules at a GlanceIMF Background Note March 2017.

    OstryJonathan.AtishGhoshJunKim andMahbashQureshi. 2010. “Fiscal SpaceIMF Staff Position Note SPN/10/11.

Prepared by Anja Baum (FAD). We are grateful for thoughtful comments from Mr. Nguyen Trong Nghia and the March 26, 2017 seminar participants from the Ministry of Finance.

The quantitative exercise follows the IMF’s How-to Note on “How to Calibrate Fiscal Rules: A Primer” (IMF, March 2018).

Selected Issues Vietnam. 2017. IMF Country Report No. 17/191.

The population growth rate is projected to fall close to zero at that point, with a working-age population share that already peaked in 2013. The share of the population age 65 and older (old-age population) will increase rapidly, although from low levels, and reach close to 3½ times the current level by 2050.

See also Ostry et al. (2010) and Baum et al. (2017) for a discussion on the maximum debt limit in light of fiscal space concerns.

This method was developed in Baum et al. (2017) and IMF (2018a).

Other contingent liabilities are estimated at: Deposit insurance (1.1% of GDP), costs of SOE and banking sector restructuring (1.5% of GDP), recapitalization of the State Capital Investment Corporation SCIC (0.3% of GDP), recapitalization of Vietnam Development Bank, VDB (0.5% of GDP). Local government borrowing is on the rise, and extra budgetary fund balance sheet risks and non-guaranteed SOE debt levels are not fully known.

Expenditure rules are becoming more prominent for consolidation purposes. The post-global financial crisis period has, for instance, seen a surge in the number of expenditure rules and the number of countries adopting them.

The information on fiscal rules in emerging markets is extracted from the IMF FAD fiscal rule database. See Lledó and others (2017) and Bova and others (2012) for an overview of the database and existing fiscal rules.

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