Vietnam, more than many other Asian countries, ought to benefit from labour-intensive manufacturing firms looking to diversify from China. It is attractive not just from a labour-cost perspective, but also for its growth potential. However, the worry is that geopolitical tensions with China will dampen Vietnam’s prospects.
The country’s exports are gaining global share thanks to both foreign and domestic investment. However, it is at a crossroads. On the one hand it must further liberalise trade barriers through free-trade agreements such as those with Korea, the European Union and the Trans-Pacific Partnership, while on the other it needs to improve logistics infrastructure, reduce the shortage of skilled labour, and increase supply chain management capability while facilitating links with foreign firms.
The issue in Vietnam is not rates but rather the structure of the economy and we believe it will have to be leaner and more efficient to be competitive in the future
Although Vietnam’s manufacturing activity may slow in coming months, new orders are strong, reflecting both high external demand and manufacturers shoring up demand with low prices.
The worry is whether new investment continues to flow in. Foreign investment is crucial for sustaining growth but domestic investors still make up the bulk of investment.
Future domestic investment will have to be more efficient to lessen the dependence on investment from abroad. There are signs that the Vietnamese government is becoming more cost conscious to increase the efficiency of its investment: monetary and fiscal stimulus designed to mitigate the slowdown in external demand caused by the global financial crisis resulted in high inflation and debt. Future public investment will be centred around economically vibrant areas of the country and on targeted industries.
From a growth perspective, the short-term economic impact of the recent turmoil should be limited. But tourism will be hurt, albeit temporarily: as elsewhere, Chinese tourists with rising incomes have increased their visits. Total tourist arrivals to Vietnam, up 26.1 per cent in 2014 prior to the tension, are expected to slow before normalising. Retail sales also slowed in May.
The long-term impact of the tensions with China is best analysed through the trade relationship between the two countries. Vietnam’s exports to China – mainly raw commodities such as rubber, crude, coal and fruits – comprised 11 per cent of total exports in 2012. But China is Vietnam's largest import source with most of the goods comprising inputs for textile production, such as fabrics, yarn and machinery.
Although Vietnamese policymakers were concerned about the limited localisation of inputs, they implemented few concrete measures. The recent tensions could accelerate the pace of policy reforms to increase domestic capability and link to the global supply chain.
The domestic garment and textile industry is aiming for a localisation rate of 60 per cent by 2015. This is necessary for Vietnam to reduce its dependence on imported inputs, and to meet the Trans-Pacific Partnership’s requirement for stronger domestic content in exports.
The silver lining of this year’s conflict may be that the Vietnamese government accelerates its economic reforms. The central bank has already reduced rates to facilitate domestic demand. But whether or not it keeps interest rates on hold this year, the issue in Vietnam is not rates but rather the structure of the economy and we believe it will have to be leaner and more efficient to be competitive in the future.
This research was first published on 2 June 2014.