The End of the Vietnamese Miracle

So much for the next Asian success story.

BY GEOFFREY CAIN | JULY 11, 2012

HO CHI MINH CITY – In what was once one of Asia's most exciting emerging markets, Nguyen Van Nguyen sees only gloom ahead. Since 2008, his business in southern Vietnam's economic capital has suffered through two volatile bouts of inflation, peaking in August 2011 at 23 percent -- at the time, Asia's highest inflation rate. Now he's only accepting small overseas orders for Binh Minh, his once-thriving bamboo-screen factory in Ho Chi Minh City, to hedge against price fluctuations. He says customers in Australia, Europe, and the United States have decreased their orders following weakening global demand. Production costs across the industry have risen approximately 30 percent while customers are only willing to pay about 10 percent more, says Dang Quoc Hung, vice president of Association for Handicraft and Wood Industry in Ho Chi Minh City. Nguyen's hiring fewer workers for the summer high season and cutting their pay to about $120 a month, down from $200. "We can only work at a slow speed, and things are hard now," he lamented in late June.  
The Communist Party of Vietnam would prefer that investors see cases like Nguyen's as simply one-off local effects of the global economic slowdown, not of a systemic weakening. In the two decades since the Communist Party instituted economic reforms in 1986, annual GDP growth averaged a remarkable 7.1 percent. Indeed, four years ago, Vietnam seemed like the next Asian success story. Before joining the World Trade Organization in 2007, the country's leaders pledged to do even better, speeding up a vast restructuring and privatization of their wasteful state-owned enterprises (SOEs), a process they euphemistically called "equitization." The International Monetary Fund predicted in 2007 that cheaper imports as a result of WTO accession could contain inflation, and that structural reforms could level the playing field between local and foreign competitors. But on Hillary Clinton's visit to the capitol Hanoi earlier this week, Prime Minister Nguyen Tan Dung was forced onto the defensive, promising favorable conditions for foreign investors as he tries to keep the "Vietnam miracle" alive.
Over the past decade, rising labor costs in China meant that its days as the factory of the world were numbered. Stable Vietnam, with its young, cheap workforce and serviceable infrastructure, seemed like the logical next choice. Foreign investment poured in throughout the mid-2000s, with net inflows more than tripling to $9.6 billion in 2008 from two years earlier. Vietnam was the "next Asian tiger in the making," said Goldman Sachs. "Foreign investors didn't care about governance or policy. They were driven by low labor costs," says Edmund Malesky, a political economist at the University of California at San Diego who focuses on Vietnam.
Ignoring the politics, it turned out, was a costly oversight. Few businesspeople predicted the Vietnam of 2012: a country struggling with a weak currency, inflation, red tape, and cronyism that has led to billions of dollars of waste -- and home to a government that makes decisions like building oddly placed ports or roads that serve little economic value.
Things started to turn south when Vietnam embarked on a $100 billion expansion in the domestic credit stock from 2007 to 2010, a program accelerated by the 2008 economic crisis. Instead of being directed towards private businesses, the government channeled the funds to politically connected SOEs, who used them to expand fervently into areas outside of their expertise, creating an increased demand for resources that fedinflation. Flush with cash, they were able to drive out smaller, more efficient competitors. The massive state-run shipbuilder Vinashin, which employed some 60,000 workers and oversaw 28 shipyards, diversified into almost 300 units, including motorbike manufacturing and hotels, after it raised an additional $1 billion from international investors in 2007. Officials hoped it would drive growth like South Korea's semi-public conglomerates.
But in 2010, Vinashin was found to be falsifying its financial reports, and it nearly collapsed under $4.4 billion worth of debt owed to both local and international creditors, a number equivalent to almost 5 percent of GDP. It eventually defaulted on a $400 million loan arranged by Credit Suisse. Prime Minister Nguyen Tan Dung -- who backed Vinashin as his pet project central to the state-run economy -- was forced to apologize before the National Assembly during a painful self-criticism session. Dung's rivals, seeking to protect their own corporate fiefdoms and political offices, had found their scapegoat: Authorities sentenced eight executives last March. But instead of speeding up its much promised and grindingly slow process of privatization initiated in the 1990s, authorities swept the debacle under the rug.
The government went into damage-control mode, refusing to back the $400 million Credit Suisse loan as the conglomerate remained uncommunicative with European creditors. Responding to the crisis, Moody's downgraded Vietnam's sovereign credit rating one notch to B1 from Ba3, signifying a "high credit risk" below investment grade.
Other Vinashin-like breakdowns were in the works, but secretive kickback networks allowed them to cover up their failing books for years, according to several state-employed newspaper editors interviewed in 2011. In May 2012, an ongoing government investigation revealed that the state-owned shipping company Vinalines had defaulted on five loans worth $1.1 billion, and accumulated debt of $2.1 billion, more than four times its equity. Since February, four executives have been arrested for mismanaging state resources; authorities, meanwhile, are on the hunt for its fugitive former chairman.
Foreign investors, facing higher costs of labor and materials, began to worry that Vietnam was losing its low-priced edge. Four foreign investors complained in interviews over the last 2 years that state-owned companies abused their position as government-connected industry gatekeepers. "They're a pain in the ass," said one American business lawyer in Ho Chi Minh City. "Nobody wants to deal with these guys."
While Vietnamese officials are now assuring investors that the worst is over, a government audit released in early July revealed that at least thirty other large SOEs carry worrisome debt burdens. The deeper problem is that in Vietnam, unlike in China, the Communist Party elite are paranoid about sharing the spoils with private, and especially foreign, businessmen. In China, the party has generally kept its markets competitive by bringing private businesspeople into the fold, improving governance, privatizing around 90,000 firms worth more than $1.4 trillion between 1998 and 2005, and more recently purging neo-Maoist gangsters like former Chongqing Party Secretary Bo Xilai. Vietnamese leaders still haven't figured out how to fix their economy without relinquishing some form of political control -- a step they're unwilling to take.
Instead of cleaning up the cobwebs between SOEs and their patron politicians, the power players have launched campaigns against a new generation of nouveau riche entrepreneurs-cum-lawmakers. In late May, the National Assembly voted 96 percent in favor of ousting deputy Dang Thi Hoang Yen, one of only a few non-Communist Party tycoons in the legislature on trumped up charges of lying on her resume.
Yen's real crime: repeatedly calling for fair treatment of private businesses, which comprise nearly half of the economy. "To clean the house is more than the system can handle," says David Brown, a former American diplomat in Hanoi.
In June, the government's tightening of credit helped bring down inflation from 23 percent last August to 6.9 percent. The problem now, complain small factory owners like Nguyen, is that the flood of easy credit has increased the chances of a banking crisis. After two devastating SOE collapses, the government is admitting that something might be fundamentally wrong with its financial system. The country's central bank head Nguyen Van Binh said in early June that about 10 percent of debt at Vietnamese banks is bad. Instead of reforming the economy, the government is suggesting more of the same: One plan is to create a national asset-management agency with $4.8 billion to deal with the debts. But that would mean setting up yet another bureaucracy caught within the patronage networks between the party elites, banks, and companies.
Investors already complain about being overburdened with red tape, and a lot of them are now thinking about moving to Indonesia, Bangladesh, and Myanmar, said Denny Cowger, a corporate lawyer at Duane Morris, an American law firm with offices in Hanoi and Ho Chi Minh City. In the World Economic Forum's Global Competitive Report for 2011 and 2012, Vietnam fell six places to number 65, due to  burdensome regulations, inflation, budget deficits, and strained infrastructure )it commended the country for a fairly efficient labor market and "innovation potential").
The state sector, meanwhile, continues to gobble up as much as 40 percent of GDP. "The bottom line is that Vietnam must undertake some fundamental domestic economic reforms to remain competitive," said Carl Thayer, an emeritus professor at the University of New South Wales. "It is more likely that Vietnam's leaders will use the global financial crisis as an excuse for more of the same."