Capital Flows and their Impacts

III.1 Foreign Direct Investment Inflows

The Foreign Investment Law was passed in December 1987. During 1988–2007, Viet Nam attracted 9,492 FDI projects with committed capital of USD 83.2 billion in total, 52.7% of which were realized.¹¹ After reaching a peak in 1996, FDI inflows into Viet Nam had declined since Asian crisis. However, since the 2nd half of 2004, it has expanded rapidly, reaching more than USD 10 billion and USD 21.3 billion in terms of commitments in 2006 and 2007, respectively (Figure 12 [ PDF 113.1KB | 1 page ]). The sudden increase of FDI in these recent years reflects investors' confidence in Viet Nam's reform and international integration process and development prospect as well as the restructuring of FDI in Asia in some labor-intensive industries such as outsourcing logistics, electronics, garments and manufacturing from PRC to Viet Nam.¹²

Until the end of 2007, the realized (accumulated) FDI was allocated in the manufacturing industry (42.7%), oil and gas (18.8%), hotel and tourism (8.1%), construction (7.2%), offices and apartments (6.2%), building urban areas and industrial zones (2.8%) (Figure 13 [ PDF 113.1KB | 1 page ]).

In the 1990s, FDI was concentrated in import substitution industries. However, since 2000, there has been a trend towards the export manufacturing sector and services sectors. The share of FDI in total export turnover (excluding oil exports) accounted for only 23.4% in 1996 and 22.2% in 2000, but then rose sharply to 36.9% in 2006 (Table 14). There has been also a radical change in the FDI trend in recent years. Almost all registered FDI in Viet Nam has changed structurally and has become focused on industry and construction and the services sector. During 2004 and 2007, the total registered FDI in these two sectors increased 74.9% and 56.0%, respectively, compared to a modest increase in the agriculture sector at 26.6% (Table 13 [ PDF 91.7KB | 1 page ]). As a result, until October 2007, the total registered FDI in these two sectors accounted for 94.2% of the total, while that in agriculture accounted for only 5.8%.

In the early 1990s, the foreign invested enterprise (FIE) sector played a rather insignificant role in Viet Nam's economy. But since the mid-1990s, it has become an integral part of the economy. In 1996, FIEs directly employed 222,000 workers and accounted for 7.4% of the GDP. In 2006, these figures increased to nearly 1,130,000 employees and 17.1% of the GDP (Table 14 [ PDF 91.7KB | 1 page ]). As mentioned earlier, the FIE sector is currently a driving force for Viet Nam's exports and the development of various manufacturing industries such as textiles and garments; machinery and equipment; office, accounting and computing; electrical machinery and apparatus; radio and communication equipment and apparatus; medical, precision, and optical instruments; motor vehicle and transport equipment; and furniture (Appendix A [ PDF 607.8KB | 1 page ]).

However, FDI still has limited spillover effects and benefit sharing in the regional production network. Viet Nam generally exhibits a similar trade pattern as in the cases of other East Asian economies, but only at the early stage (Box 2 [ PDF 101.9KB | 1 page ]).

III.2 Official Development Assistance

Official development assistance (ODA) was resumed in 1993 and, together with FDI, has also significantly contributed to investment and GDP growth in Viet Nam. From 1993– 2007, total committed ODA for Viet Nam reached USD 41.2 billion, of which USD 30.7 billion (or 74.5%) was signed, and USD 19.7 billion (or 47.9%) was disbursed (Figure 15 [ PDF 101.9KB | 1 page ]).

In the years from 1993–2005, ODA represented about 11.4% of the total investment and 50% of the investment from the State budget (MPI 2005). Until recently, ODA allocation in Viet Nam had been in favor of more developed areas. But it has gradually been allocated in a more equal manner: less developed areas also tended to receive more of the ODA allocation.

Table 15 [ PDF 99.1KB | 1 page ] points out the sectors and areas that ODA has focused on. They include infrastructure development, poverty reduction (particularly in isolated areas), human resources development and institutional improvement. ODA has supported the enhancement and formulation of various important laws such as the Enterprise Law, the Land Law, the Investment Law, the Competition Law and the Anti-Corruption Law. ODA-financed projects also helped strengthen the managerial capacity of officials and the personnel of ministries, sectors and localities, and improve their professional and English levels substantially.

Despite encouraging achievements with resulting remarkable increases of ODA so far, the mobilization and utilization of ODA has been exposed to a typical set of weaknesses and limitations, including:¹⁴

• Limited awareness and understanding on the nature of ODA, which is in many cases understood as a “free gift;”
• Slow materialization/concretization of directions, guidelines, policies and strategies on ODA mobilization and utilization into specific programs and projects, leading to passive role of governmental agencies in their cooperation with donors in a number of cases;
• Weak institutional arrangement and human capacity for ODA management and utilization. Human resources involved in ODA-financed programs and projects remain weak in professional capability, international cooperation skills and foreign languages. Organizational and operational regulations of ODA-financed programs and project management units remain inadequate;
• ODA management and legal framework for utilization exposes many constraints: inconsistencies between regulatory documents on ODA management and utilization and those on ODA allocation; lack of enforcement regarding regulatory documents on ODA mobilization and utilization; inadequate harmonization in ODA management processes and procedures of Viet Nam and donors, reducing investment efficiency and increasing transaction costs; and
• Limited monitoring and evaluation with regard to ODA projects and programs. This limitation is arguably due to the lack of strict compliance and inadequate disciplinary actions with regard to financial reporting, payments and settlement regulations.

III.3 Portfolio Investment Flows

The development and outlook of Viet Nam's economy and securities market has been appealing to many foreign investors. Foreign portfolio investment (FPI) inflows, together with the presence of a number of foreign investment funds, became a real new phenomenon in 2006. Foreign portfolio inflows accounted for 2.2% and 10.4% of the GDP in 2006 and 2007, respectively (Appendix B [ PDF 169.5KB | 2 page ] ). Foreign portfolio investors have shown a keen interest to invest in Viet Nam's equity market due to their appetite for higher riskhigher return assets and prevailing liquidity in the global economy.

There were 436 foreign investors as of 2005, including 38 institutional investors and 389 individual investors. However, the number of foreign accounts increased by nearly twenty-fold from 2005 to 8,140 in 2007. The trading volume of foreign investors is rather high, accounting for 21% of the total market trading volume in 2006. This number increased to 29% by the end of 2007. In 2007, the trading value increased significantly to around 55% of market trading value (Dang, 2008).

In 2006, there was around USD 1.3 billion of FPI in Viet Nam, of which 70% was invested in stocks, bonds and real estate, and 30% was held as deposits in the banking system. In 2007, FPI increased sharply to USD 7.4 billion (Appendix B).

The exuberance and sizeable foreign participation, including overseas Vietnamese in Russia and Eastern Europe, has contributed to pushing up the financial boom and investments in the real estate market.

• In May 2007, foreigners accounted for a 25% share of HOSE capitalization or just under USD 4 billion (Figure 16 [ PDF 131.8KB | 1 page ]). This amount is higher than actual inflows as it incorporates capital gains since the inflows took place.
• Equity acquisition has been considered a partnership strategy for investments in various areas, especially in financial activities, real estate, energy and infrastructure development.
• Since the 2nd half of 2006, the appetite of foreign investors has shown more favor towards both government and corporate bonds. The participation of foreign investors has contributed to the growth of a secondary government bond market in Hanoi. As previously mentioned, there are 75% and 95% of EVN bonds and Vinashin bonds, respectively, that have been sold to foreign investors.

The above-mentioned increase of FPI was further explained by the transfer items on the BOPs. Private remittances increased substantially, from 0% of the GDP 1990 to 5.1% of the GDP in 2000, and further to 6.2% of the GDP in 2006 and 8.7% of the GDP in 2007 (Appendix B). The IMF (2006) supports the portfolio approach for Viet Nam because remittances appear positively correlated with the favorable economic conditions in Viet Nam, its overall investment climate and relaxation of the regulatory environment, particularly in the late 1990s.¹⁵ Anecdotal evidence has shown that a large proportion of remittances has recently been used for investment in real estate and the stock market.

III.4 Capital Inflows and Macroeconomic Stability

In the last five years, there were high trade deficits but much less the CA deficit as in the mid-1990s. An exception is 2007, which had a very high CA deficit, reaching 9.9% of the GDP. Furthermore, the way of financing trade deficits in recent years has also been altered. In the mid-1990s, trade and CA deficits were largely funded by FDI. But since 2005, remittances and portfolio inflows have played an increasing role in financing trade deficit.¹⁶ Also, as a result of huge capital inflows, foreign exchange reserves have recently accumulated rapidly, increasing from USD 3.0 billion in 2000 to USD 11.5 billion in 2006, and further to a record-high of around USD 23 billion (32.3% of the GDP) by the end of 2007.

Since the agreement on debt restructuring with the Russian Federation in 2000, Viet Nam's external debt has decreased substantially. In relative terms, the total external debt as a proportion of the GDP went down from 41.1% in 2000 to about 30.2% in 2006 and 30.8% in 2007 (IMF). The debt service ratio (5–6% recently) is well within a controllable level. There are, however, some concerns:

• Debt-induced financing has constituted a majority of capital inflow, and hence, the costs of financing CA deficit may increase;
• FDI inflow has also entailed considerable commercial loans;
• Capital utilization efficacy, especially in the public sector, is low. Moreover, the issue of Government bonds on the international market for lending to the SOEs is always associated with the moral hazard problem; and
• Errors and omissions in the BOP are high due to statistical errors which may reflect shortcomings in controlling short-term capital flows (Figure 17 [ PDF 120.1KB | 1 page ]). Furthermore, to a given extent, it also slows up the trading volume in Viet Nam.

As mentioned before, a surge in capital inflows, especially during 2006–2007, was also associated with domestic credit expansion, higher inflation and asset prices. But the outcomes, to a significant extent, have been dependent on responses of key macroeconomic policies.

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