Manufacturing activity in Vietnam is heating up, reflecting growing exports to the eurozone and the US. But production has not kept up with demand. Inventories, already at record lows, are falling sharply. Output should accelerate in coming months, however, supporting a slight acceleration of Vietnam’s GDP growth from 5.4 per cent in 2013 to 5.6 per cent this year.
The acceleration of manufacturing is sector-specific and reflects increased foreign investment rather than a healthier domestic economy. Manufacturing’s increasing importance to Vietnam’s economy is because of strong growth rates and the decline of sectors such as agriculture, forestry, mining and construction. Real estate and construction have been affected most by tighter credit and slowing domestic demand.
The rise of manufacturing reflects strong inflows of foreign capital and the introduction of international production standards
The rise of manufacturing reflects strong inflows of foreign capital and the introduction of international production standards. This should help the economy pass through a difficult period of slowing investment and consumption.
However, during this period, a strategy to raise the competitiveness of domestic firms is also vital. A policy agenda is required to ensure domestic firms do not fall behind, whether by increasing their links to the supply chain, co-ordinating logistics to improve efficiency, or supplying more skilled labour. Without this, a sharp rise in labour costs could threaten economic instability.
Locally owned firms’ share of exports has declined since 2009. Although firms with foreign investors bounced back from the global financial crisis, exports from domestic firms are still underperforming. This partly reflects sluggish commodity prices but it also shows a fragile Vietnam that has yet to recover from years of inefficient capital allocation.
Vietnam is the only Asian country where exports continued to grow in double digits after the financial crisis. However, the increased manufacturing exports are mainly driven by phones and spare parts, which did not really exist before 2011. This reflects increased investment by foreign firms. These firms provide jobs and invest in infrastructure, but it is a reminder that Vietnam has not significantly moved away from being a primarily agrarian economy and that its future is far from certain.
Foreign direct investment is more positive for Vietnam’s economic stability, as shown by the country’s relative resilience during recent volatility in financial markets that affected nations too dependent on portfolio inflows for growth.
However, investment from overseas alone is not enough. A concerted effort to maximise its benefits is required. Prime Minister Nguyen Tan Dung has highlighted the importance of levelling the playing field and improving the skills of the labour force for competitiveness. This message shows policymakers recognise the bottlenecks of their economy. The questions now are about the timing and pace of reforms in the years ahead.
This research was first published on 6 February 2014.