V. Trade Policy Developments and the Need for Reform1
1. Despite a reduction in the number of goods subject to formal quantitative restrictions since 1994, Vietnam’s trade system remains highly restrictive. Trade is restrained by high and frequently changed tariffs, many import quotas and bans, and extensive bureaucratic impediments. Protection has been further heightened by the difficulty in obtaining foreign exchange for imports competing with domestic production.
2. Although such protection is intended to promote “strategic” industries, the effect has been to promote inefficient import substitution. Chronic overcapacity, uneconomic production scales, and high costs are common. These problems are not transitory, because the import substituting industries are not competitive and have little prospect of exporting. Such industries impose substantial costs on all sectors of the economy, especially agricultural exports, and contribute little to employment.
3. Given the costs of the current trade system, it is essential that protection is phased out. Key aspects of a trade liberalization strategy that emphasizes the early removal of nontariff barriers (NTBs), with appropriate transitional arrangements and supporting actions to reduce the level of tariff protection, are presented in the final section. However, it will also be important to complement these reforms with the domestic liberalization, especially of business registration, trading rights, and investment regimes, to enable foreign and domestic investors to take full advantage of the new opportunities.
B. Overview of the Current System
4. Vietnam’s trade regime results in very high levels of protection over a broad range of products. The combination of pervasive NTBs and relatively high tariffs make Vietnam’s trade system one of the most restrictive of Fund members. With the increase in the average tariff in 1999, Vietnam is rated 9 on a scale of 1-10 (with 10 being the most restrictive).2 This section outlines the main elements, and changes to Vietnam’s trade system in 1998 and early 1999.
Foreign trading rights
5. Restrictions on foreign trading rights are one of the main measures that have distorted trade flows by permitting informal trade controls and allowing certain SOEs to earn large rents. Although the number of enterprises with trading rights gradually increased over the 1990s, these rights were largely confined to large SOEs for products related to the production of the enterprise. Only a few SOEs have general trading rights (to import unrelated products). This limitation was enforced by skill and working capital requirements, and the need for the approval of the local People’s Committee (local government) who often have their own trading enterprises.
6. With the issuance of Decree 57, in July 1998, the opening up of the trading rights regime was initiated for domestic enterprises by removing the skill and working capital requirements for registering as a trading enterprise. However, the right to engage in trade was based on an enterprise’s business license, which rarely specified the general import/export business. Nevertheless, the number of enterprises registered to trade increased from about 3,000 to about 30,000 as more production enterprises decided to trade in their own products.
7. Several additional steps are needed to fully liberalize trading rights. Regarding domestic enterprises, the link to business registration emphasizes the need to reform this system which has hindered many aspects of private sector development.3 Business registration and changes to the business activities should only involve notification and not approval, and business licences should only be required for activities that require regulation for health, safety or environmental reasons. These changes would enable enterprises to readily enter into the import/export field, which should be broadly defined, and not in terms of specific commodities. Foreign invested enterprises continue to have restricted trading rights as a result of the Foreign Investment Law and its requirement to precisely specify the line of business in the joint-venture contract. Such contracts could be revised, but the domestic partner of the joint-venture is often the main SOE importer for related products.
Quotas and licensing
8. Despite the general policy of regional economic integration, trade controls have been tightened over the past year. This approach reflects the government’s view that such trade controls are an effective means of limiting the impact of external shocks by saving foreign exchange and improving business confidence by complying with pressures for additional protection by new producers of import substitutes, including joint ventures. However, reliance on trade controls clearly increases the cost structure of the economy, especially because many import substitutes are key products whose increasing costs have very significant downstream effects.
9. According to Decree 57, ten types of imports are subject to licensing. These are: petroleum and oil, fertilizer, motor cycles, cars of 15 seats or less, steel and iron, cement, sugar, paper, alcohol, and construction glass. All of these goods, except for petroleum, complete with domestic production, and quotas have generally been set at very low levels, typically zero. At the start of 1999, eight additional categories of goods were temporarily added to the list of licensed goods, in order to protect the balance of trade (electric fans, ceramic and granite tiles, ceramic consumer goods, packaged in plastic, liquid caustic soda, bicycle, refined vegetable oil, and some plastics). The latter group of goods all had import substitutes available, and several were in support of newly established production.
10. In addition, consumer goods imports, for which licensing requirements were removed at the start of 1998, continued to be subject to impediments to trade. The requirements of consistency with the business registration and funding only by importers’ foreign exchange (which became scarce after the imposition of the foreign exchange surrender requirement) have continued to limit imports. Moreover, in April 1999, the issuing of letters of credit for imports of consumer goods and other materials (such as steel and PVC) was banned.
11. Vietnam also continues to have a large range of products subject to the specialized management by individual ministries, including chemical substances, medicines and medical equipment, and recording and broadcasting equipment.
Tariffs and other taxes on imports
12. At the start of 1999, Vietnam introduced a new tariff schedule that reduced the maximum standard tariff rate from 60 percent to 50 percent, except for a few sensitive products,4 and the number of rates was reduced from 14 to 10. However, the average tariff increased slightly, from 13.8 percent to 15.5 percent, as the number of items at the 40 and 50 percent rates were increased (Figure V.1). The new tariff schedule also introduced a three column system consisting of an ordinary rate (50 percent above the preferential rate), a preferential (most favored nation and the generally applied) rate, and a special preferential rate applying to goods from countries where there is a special preferential rate negotiated (e.g., under the ASEAN Free Trade Agreement (AFTA)). Since many rates are set at zero, the dispersion of the tariff structure affords very high levels of effective protection.
Figure V.1.Vietnam : Distribution of Tariff Rates, 1998-99
13. Vietnam maintains some customs surcharges, which are often levied on an ad hoc basis. Surcharges of 2-10 percent are levied on certain iron and steel products, and at times, they have also applied to fertilizers. Often surcharges are used to offset price fluctuations in international markets and avoid losses to SOEs which may have imported such products at higher prices.
14. A special consumption tax is implemented to give additional protection to certain products. Although in principle it is levied on both imports and domestic production, the tax can be waived or reduced for industries experiencing losses. This tax, which is levied at 100 percent for motor cars and 60 percent for beer producers, is currently waived for domestic producers because of their losses.
15. Due in part to the need to have procedures to contain smuggling, the Vietnamese customs procedures are very cumbersome. However, these procedures, including crack-downs on corruption and the use of a stamp system,5 have not constrained smuggling, which remains very significant. Moreover, a considerable amount of tax revenue is lost not only at the border, but also on downstream transactions. Minimum prices are used for about 20 types of products and the valuation system remains far from the WTO standard.
16. The authorities have made some progress in reforming export trade arrangements during 1998 and in early 1999. Some small private sector rice traders were given a small allocation of rice export quotas. Also, 20 percent of garment export quotas to the EU were auctioned for the first time in January 1999. Export taxes were eliminated for all products (notably rice) except crude oil and scrap metal, in stages during 1998.
C. Costs of Protection Inefficiencies of the industrial sector
17. The government has recently stated that its objectives are to maintain social and political stability, develop an efficient industrial sector, promote agriculture and rural development, expand consumer demand, and promote employment.6 Trade restrictions and tariffs have been used to support targeted industries, assisted by preferential access to bank credit and tax exemptions. But the impact on the economy of the import substitution policy has been largely negative.
18. Although price liberalization and protection have fostered a rapid growth in industrial GDP, averaging about 14 percent over the past 5 years, there are considerable weaknesses in this performance. This growth has been associated with a sharp increase in the investment to GDP ratio from 18 percent to 26 percent, but despite this substantial capital deepening, the growth in industrial employment has remained under 2 percent, and unemployment has been rising. After five years of rapid growth, the manufacturing sector accounts for only 20 percent of output and 9 percent of employment.
|Agriculture forestry and fishing||25.2||68.8|
|Construction and other industry||13.3||3.6|
19. The protective system and the strong emphasis on import substitution has had a detrimental impact of Vietnam’s industrial structure. At the end of the 1980s, the manufacturing sector was small and based on out-of-date equipment. During the 1990s, protection was used to encourage the development of a more modern manufacturing sector. However, the focus on import substitutes has meant that this sector remains very inefficient, despite the more modern equipment, because of the small scale of production. Box V.1 describes some of these developments in the protected sectors.
20. Few enterprises in the protected, industrial sectors have shown a profit. Although many enterprises were financed through direct foreign investment, there is still a significant financial impact on Vietnam. About 40-50 percent of the investment was financed by debt which still needs to be serviced. Moreover, the failure of investors to make a profit impacts on Vietnam’s reputation as a destination for investment.
21. The losses suffered by producers in protected industries are not likely to be transitory. In most cases, more joint-ventures have entered the market than could operate efficiently (partly because they were not aware of the other deals being made). In other cases, many SOEs tried to become more efficient by simply purchasing new equipment, but failed because a larger scale of production is needed in many industries and there was no rationalization of producers. Since they are too inefficient to export, many will never be able to build up economies of scale.
Indirect costs on agriculture
22. Protection has also imposed large indirect costs on other sectors, especially agriculture. Only a small part of these costs is visible to downstream users; while most costs are small increments for other sectors, aggregated costs for the economy are substantial.
- The real value of farmers’ incomes is reduced when they have to pay higher prices for protected final manufactured products (workers protected sectors get higher wages than in free trade).
- Agricultural (and other) exporters do not benefit from export competitiveness when exchange and trade controls have been used to avoid exchange rate depreciations.
- The rural sector pays more for protected important inputs such as transport equipment and fertilizer and face a limited choice of products. Fertilizer quotas are estimated to directly add about 0.2 percent of GDP to costs (Box V.2).
- Rice farmers receive lower prices for the products under rice export quotas which give distribution rents to quota holders, (mainly SOEs). Although the government rationalizes these quotas using the food security argument, this is misplaced. Rice production significantly exceeds domestic consumption and any shortages that lead to increased domestic prices can be readily offset by imports from neighboring countries, especially Thailand.
- State domination in other agricultural sectors, such as rubber, coffee, and tea, also limits their export potential.
Box V.1.Protection and Key Industrial Sectors
The following key industries have developed through very high levels of import protection in recent years and remain extremely inefficient:
- Motor vehicles: Import bans attracted 14 manufacturers (11 are still operating) to invest about $600 million with a declared capacity of about 170,000 cars per year. However, only about 5,000 cars were sold in 1998. Production is essentially for assembly, and the local component industry is almost non-existent, but the government is trying to establish one. Even with domestic prices at about three time the duty free price, all manufacturers are losing money.
- Motor cycles: Import bans on fully assembled and CKD kits have attracted three large Japanese producers, plus a number of other assembly operations. The market for motor cycles is relatively large, with annual sales of about 350,000 units per year, but there is also sizeable over capacity. High tariffs and bans on some types of kits have been imposed to promote the component industry, adding to costs and reducing quality. Domestic prices are more than twice the international price.
- Bicycles: Imports were liberalized in 1998 and made subject only to tariff protection. However, this was not sustained and licensing was reinforced in 1999. Bicycles are manufactured by a few SOEs with old equipment producing outdated styles. Considerable restructuring would be needed to make these producers internationally competitive.
- Cement and Steel: The production of steel and cement has expanded recently as new joint-venture production has been added to the existing state-owned enterprises. Some of the latter have also borrowed extensively from state banks to expand their production, but other SOEs continue to use antiquated equipment. With the recent slump in domestic and foreign demand, these industries have been hard hit and import bans are being used to shelter them. Although Asian steel and cement producers are taking strong adjustment measures, adjustment in the Vietnamese enterprises has been comparatively mild. On average the plants are operating at about 40 percent of capacity. The current price of steel and cement in Vietnam is about 60 percent above the f.o.b. import price.
- Fertilizers: Import quotas of fertilizer are linked to the state management of this essential commodity, and a credit allocation is also provided. Quotas are allocated exclusively to key SOEs. The domestic production of urea fertilizer is small and antiquated. Recently joint-venture plants producing more advanced types have opened, and import bans were introduced for these products. Generally, the domestic fertilizer price is 20-25 percent above the free trade price, reflecting both the restriction of imports and the reliance on SOEs for distribution.
- Sugar: Until 1994, Vietnam did not have a significant sugar sector, which was created as a result of a decision to achieve self sufficiency by 2000. With concessional credit, many new sugar refineries have been built, but these exceeded the growth of the sugar cane sector, and were sometimes located in relatively poor sugar growing areas. Thus, while some refineries have the potential to be internationally competitive, many have little chance of doing so. To protect the sugar sector, quotas have been placed on both refined and raw sugar, raising prices to about 25 percent above the import price. Downstream activities such as the confectionary industry have become uncompetitive.
Box V.2.Vietnam: Costs of Protection in the Agriculture Sector
Recent research has estimated the costs of protection in Vietnam’s agriculture sector and the potential benefits of trade liberalization. In particular, it has been shown that the doubling of rice production in the period since 1980 was linked directly to the degree of liberalization of land laws, trade, and input and output markets.1 Nonetheless, large distortions continue to exist in the rice, sugar, and fertilizer sectors.
- Annual rice export quotas, which arise from a concern for food security, lower the domestic price received by farmers and, hence, transfer income from farmers to urban consumers. Recent studies estimate that the removal of the rice quota would increase national income by US$225 million (1 percent of GDP), and that over 5 million tons of rice could be exported, a significant expansion from the current 3.6 million tons.2 Quota elimination would benefit the majority of the rural population, especially the poor, if other restrictions on competition are eliminated that would reduce the returns to middlemen. Increased income would make food more affordable for the rural poor.
- Sugar policy has been used as a strategy of rural industrialization and development of regions with lower agricultural potential than the two deltas. The pattern of import restrictions is constantly shifting from tariff, to quota, to import ban, resulting, in some years, in over-supply of sugarcane (e.g., in 1997), and in others in undersupply (e.g., in 1998). Currently, the wholesale price of sugar is about 25 percent higher than the import price, and the effective rate of protection is around 90 percent.3 The latest analysis shows that trade liberalization would make sugar available at a 22 percent cheaper price, increase the real income by US$92 million (½percent of GDP), and would maintain domestic production of sugarcane.
- With domestic production providing only 13 percent of total use, fertilizer imports have been critical in meeting the needs of Vietnam’s agriculture. However, because of a quota system, the domestic price of fertilizers is about 70 percent higher than the price of imports from Indonesia (average during 1990–96), and 40 percent higher than the price of imports from Eastern Europe, costing Vietnam about US$38 million per year (0.2 percent of GDP) in direct costs. (Goletti (1998)). A more liberalized import system that allows competition would lower prices to farmers, reduce the rents to privileged importers, and result in more prompt delivery.
Indirect costs on the service sector
23. Protection also creates a large bias against the service sector, which has the greatest potential for supporting employment growth and expansion in other sectors. There are almost 2½ times the number of employees in the service and construction sectors than in manufacturing. The relative contribution of manufacturing can be seen even more starkly in construction where 30,000 workers and 10,000 workers are engaged in cement and steel production, respectively, but 900,000 workers are employed in the formal construction sector. Liberalizing imports of cement, steel, and other building products would reduce the input costs of construction and increase the demand for workers in this sector. Similarly, lowering the cost of transport equipment and construction can help promote tourism by making the provision of international quality facilities and services more competitive. Liberalizing the imports of small buses would also improve the private provision of public transport, especially in the older cities with many small streets. Effectively liberalizing the import of consumer goods would promote the distribution sector.
D. Key Issues for Trade Liberalization
24. Although the Vietnamese government has stated that for an efficient industrial sector to develop, protection must be selective, conditional, and temporary,7 Vietnam’s trade system, as noted above, remains one of the most highly restrictive and interventionist, with considerable costs to the economy. Many countries, including other ASEAN countries have been progressively liberalizing their trade systems (Figure V.2) and Vietnam cannot afford to be left behind.8 International experience suggests that adjustment costs are minimized by undertaking reforms in a comprehensive and phased framework. Thus trade reform should be:
Figure V.2.Trade Policies in ASEAN Countries, 1985-1999
Source: IMF staff estimates.
Significant and front loaded, within a well-defined multi-year framework;
- Applied to all sectors without any scope for new increases in protection;
- Based on the rapid elimination of all NTBs, with the genuine and up front liberalization of trading rights and reduction in the tariff protection;
- Not offset by other administrative devices, especially domestic regulations and foreign exchange control;
- Complemented by related reforms to promote private sector development, especially liberalization of domestic regulations to reduce the high costs of business; movement towards current account convertibility; and a flexible approach to direct foreign investment.
- Accompanied by a flexible exchange rate policy to restrain excessive import demand without the need for exchange controls;
- Accompanied by well-targeted safety nets for displaced workers, through retraining and the other safety nets, including those planned under SOE reform.
25. In the process of liberalizing imports, the highest priority should be given to the early removal of NTBs, which could be replaced by transitional tariffs in some cases. This approach would both reduce the distortion in trade flows, and reduce one of the main sources of bias in favor of SOEs and against the private sector. Such a policy should be implemented in a pre-announced plan to show that a broad range of sectors will have to bear some adjustment, and to reduce the pressure for exemptions to reform.
26. Given the restrictiveness of NTBs, their removal may need to be facilitated by some transitional instruments. Box V.3. lists some examples of transitional instruments used in other countries in the region.
Box V.3.Approaches to Phasing out Quantitative Restrictions
International experience highlights a range of approaches that can be used to phase out quantitative restrictions (QRs):
- One-off elimination of quotas, without replacement by tariffs--as was done for most of Indonesia’s NTBs in the first year of the recent Fund arrangement.
- Removal of import licensing requirements--for instance, by Thailand--on 31 items (some two-thirds of all items subject to such requirements) between 1992 and 1995.
- Progressive raising of quotas to nonbinding levels.
- Auctioning of quotas in conjunction with their expansion to obtain revenue, make the allocation process transparent, and to obtain a benchmark for the tariff equivalents of quotas. This approach was used in Australia and New Zealand.
- Replacement of quotas with tariffs (not necessarily at equivalent levels), as in the Philippines where restrictions were removed on agricultural products.
- Conversion of quotas to tariff quotas, i.e., through two tariff rates--a lower rate (in-quota rate) applied to specified volume of imports and a higher rate (out-of quota rate) applied to any imports above that volume, then reducing the out-of-quota tariff rates to the in-quota tariff rates. This method was used by Thailand, and the Philippines (as well as many other countries) in the context of the conversion of quotas for agricultural products into tariffs at the beginning of 1995.
- On some sensitive and relatively high valued products, such as motor cars and motorcycles, the auction of quotas for the fully assembled product may help to introduce competition and determine equivalent tariffs.
- For products such as steel and cement, where the domestic price is less than double the import price, transitional tariffs should be applied relatively quickly. Even if the tariff protection is marginally less protective than the current import bans, these sectors should start to catch up with the adjustment in other countries.
- For some other products, such as fertilizers, the import restrictions should be eliminated immediately to end the bias against agriculture, and not replaced with tariffs.
- There should be a full liberalization of trading rights so that any product not subject to a quantitative restriction (other than those indicated for health, safety, and environmental reasons) should be freely imported with the payment of the appropriate taxes on duties.
- The goods subject to the specialized management of ministries should be sharply reduced and only applied to those products with a substantial risk for health, safety, and the environment.
27. Other import related liberalization measures should accompany the removal of NTBs:
- Tariffs and the number of tariff rates should continue to be reduced. Although the removal of quantitative restrictions would need to be facilitated in some cases with transitional tariffs, these should be kept to a minimum. At the same time, there is a need for other tariffs to be reduced to promote the shift to a more open economy and reduce the scope for trade diversion under AFTA.9
- Customs procedures should be streamlined to improve the flow of goods in and out of Vietnam, which is essential for developing an outward-oriented economy.
- WTO consistent procedures for clearance, import valuation, and trade classification should be adopted as soon as possible. Customs fees and port charges should be based on published schedules and limited to the cost of the services.
28. Trade reforms need to be supported by a broad range of complementary policies to maximize their benefits and reduce any adjustment costs. Domestic liberalization and policies to develop the domestic and foreign invested private sector are crucial, as are SOE and banking reforms.
29. Export expansion is also a key complementary policy and participation in bilateral and multilateral trade agreements are important for this objective. The liberalization under AFTA could be a significant boost to exports. A low wage economy, such as Vietnam, can obtain very large employment gains in a free trade area, if other costs are also reduced by liberalization and administrative reform, and market-based rents and utility prices applied, and if new investment can be attracted. For example, Mexico’s export growth rose significantly after joining NAFTA, and Eastern European countries hope to also benefit from eventual inclusion in the European Union. Trade liberalization that would gain access to the US market, especially for garments, would also help to cushion the impact of restructuring in other sectors. WTO membership would also help Vietnam’s export prospects and progress at trade liberalization would facilitate Vietnam’s membership drive.
30. With liberalization, sectors would be rationalized and need not disappear completely and overnight. In most sectors, the very efficient producers could survive if domestic deregulation enabled them to reduce their costs. Greater flexibility in the market would result in considerably fewer producers in many sectors, e.g., motor vehicles, motorcycles, steel, electronic goods, and cement. Such a rationalization would improve the scale of operation of the surviving domestic firms and help them to be competitive with imports. Also, instead of continuing to develop or assemble finished goods, some enterprises would gradually shift towards globally integrated production, in line with the trend observed in many emerging markets.
Center for International Economics (1998) Vietnam’s Trade Policies 1998 (Canberra: Center for International Economics).
McCartyAdam (1999) Vietnam’s Integration with ASEAN: Survey of Nontariff Measures Affecting Trade (Hanoi: UNDP).