Public debt of Vietnam: Risk and challenges

Journal of Economics and Development Vol.13, No.3, December 2011, pp. 5 - 23 ISSN 1859 0020 Public Debt of Vietnam: Risk and Challenges Pham The Anh National Economics University, Vietnam Email: pham.theanh@neu.edu.vn Abstract The paper aims to analyse risks and challenges of Vietnam’s public debt. The analysis is a combination of statistical description and numerical simulation. It basically shows that the public debt sustainability and liquidity are still below the conventional safety thresholds but the macroeconomic conditions are quickly dete- riorating as a result of the recent highly-rising public debt. Given the Vietnamese government’s targets, the benchmark scenario implies that Vietnam’s public debt to GDP ratio will consistently increase to around 65% in 2015 and then 82% in 2020. Facing increasing risks of high public debt and limited potential revenue sources, the only way for the government to avoid an explosive path of public debt is to reduce public spending seriously and persistently. Keywords: Public debt, macroeconomic volatility, Vietnam JEL Classification: E60, E62 and E66 Journal of Economics and Development 5 Vol. 13, No.3, December 2011 1. Introduction also be divided into domestic and external The Vietnamese economy has probably debt. (External debt is the amount of debts in been experiencing the hardest time since its foreign currencies through bilateral or multi- renovation (Doi Moi) started in the early lateral arrangements, or through international 1990s. The recent global economic crisis has financial markets.) The fiscal situation and the revealed many shortcomings of the economy performance of the economy are closely relat- which had been enjoying high growth regard- ed through a number of vital macroeconomic less of its long term stability. Economic variables. A prolonged budget deficit will growth slowed down while prices increased finally result in a high level of internal public dramatically. Furthermore, macroeconomic debt. Meanwhile, external public debt is main- imbalances such as the trade deficit and public ly caused by the deficiency in national savings. debt continued to increase, threatening the A rapid growth of public debt may limit the country’s sustainable growth and stability. effects of monetary, fiscal, and exchange rate Vietnam, like many other developing coun- policies. tries, has a high demand for loans in order to Government budget deficit is defined as the implement various socio-economic projects. gap between total expenditure and total rev- There are many reasons for policy makers to enue in a given period. Meanwhile, public debt be tempted by the prospect of vast borrowing is computed by accumulating these deficits programs. The loans may be used to finance over many years. Statistics on Vietnam’s pub- public infrastructure to improve the economy’s lic debt are very inconsistent. Different capacity, to invest in health and education to sources report different data. In recent years, raise human capital and long run growth, or to data from the Ministry of Finance (MoF) of temporarily loosen fiscal policies in response Vietnam showed a surprising similarity to a cyclical recession. However, the conse- between actual and projected figures. In partic- quences of the public debt crises that happened ular, both the actual and projected state budget in emerging markets during 1990s and in deficit always fluctuated slightly around 5% of Europe recently are good lessons for the coun- GDP except for 2009 when Vietnam imple- try to be careful with its budgetary decisions. mented its stimulus package to escape from the In this paper, we first attempt to evaluate the economic recession. However, the above fig- current situation of Vietnam’s public debt and ures reported by the MoF were very different consequently point out its potential risks. We from those by international agencies such as then discuss the relationship between public the Asian Development Bank (ADB) or the debt and other important macroeconomic indi- International Monetary Fund (IMF). For cators such as growth and inflation. Finally, we example, in 2009 the budget deficit reported give some predictions of Vietnam’s public debt by the MoF was 6.9%, which was far below in the next ten years. 7.7% and 8.9% reported by the ADB and the IMF respectively. Together with the differ- 2. Data inconsistency ences in budget deficit figures were the differ- According to the law on public debt man- ences in public debt statistics. Despite the agement that came into effect on 1st January inconsistency, both the MoF and the IMF cur- 2010, Vietnam’s public debt is defined as gov- rently reported an increasing trend of ernment debt, government guaranteed debt, Vietnam’s public debt to go over 55% of GDP. and municipal debt. The total public debt can The data inconsistencies mainly came from Journal of Economics and Development 6 Vol. 13, No.3, December 2011 Vietnam’s strange accounting norms which are external debt and external public debt were very different from international standards. around 30% and 25% of GDP respectively. Firstly, they counted principal payments as They have correspondingly jumped to over part of total expenditure and hence contributed 40% and 30% of GDP by the end of 2010, to the budget deficit. In contrast, some of the delivering a warning signal on public debt expenditure funded by government bond management of Vietnam. issuance, on projects in education, health, 3. Public debt evaluation water resources, etc., was not included in the budget deficit. Furthermore, spending on big Following the debt crisis in the 1980s and and prolonged projects was recorded into the 1990s, there was intensive research on deter- state budget based on its disbursement, not on minants of a sovereign debt crisis and various the amount of bonds issued. The inconsistent attempts to build early warning models. For data caused some noise for market partici- example, Reinhart (2002) found that about pants. It also created hurdles for international 84% of the countries in his sample had been in comparison, monitoring, and managing the a debt crisis following a monetary crisis. nation’s public debt. Therefore, economic indicators used for pre- There is a similarity between Vietnam’s sta- dicting monetary crises were also suitable for tistics on total external and external public debt crisis forecasts. In addition, Catão and debt. Although there is a gap between figures Sutton (2002) argued that the volatility of from different sources, all show a rapidly monetary policy, fiscal policy, and exchange increasing trend. At the end of 2008, total rates also played an important role for trigger- Table 1: Budget Deficit and Public Debt in Vietnam Unit: %GDP Source: MoF, IMF, and ADB Journal of Economics and Development 7 Vol. 13, No.3, December 2011 Table 2: External Debt in Vietnam Unit: %GDP Source: MoF, IMF, and ADB Table 3: External Public Debt in Vietnam Unit: %GDP Source: MoF and IMF ing crisis risks. Based on Manasse and Roubini warning signals before a sovereign debt crisis. (2005), in this section, we carry out evaluation Their work showed that most crises occurred on Vietnam’s public debt via some measures: due to: (i) insolvency (because of high levels (i) solvency, e.g. public debt and external pub- of debt and hyperinflation); (ii) illiquidity and; lic debt as a fraction of GDP; (ii) liquidity, e.g. (iii) economic recession and currency overval- short term public debt and debt service as a uation. Their model successfully identified fraction of foreign reserves and; (iii) volatility warning signals that arose before a crisis. In of economic growth, inflation, current account other words, the probability of failure to pre- dict a crisis before it actually happened, the balance, and exchange rates. type I errors, was very small. However, the Some key indicators of Vietnam’s public probability of false alarms, the type II errors, debt and macroeconomic conditions are pre- was higher than desirable. Although there were sented in Table 4. Thresholds are taken from certain limits, the paper was relatively compre- Manasse and Roubini (2005). In their paper, hensive and successful in providing warning Manasse and Roubini (2005) employed a new signals before sovereign debt crises. statistical method to systematically examine Therefore, thresholds given by Manasse and Journal of Economics and Development 8 Vol. 13, No.3, December 2011 Roubini (2005) will be used to make a compar- equals or exceeds net present value of its debt. ison with corresponding indicators of Vietnam. Similarly, a nation is solvent in external debt if This helps obtain a more precise overview of the discounted value of its future trade bal- the current public debt situation and macro- ances is greater than the net present value of economic prospects of the country. foreign debt. Hence examining budget and 3.1. Solvency trade balances is very important to evaluating Solvency reflects debt sustainability of a solvency of a country’s public debt. Persistent country. It depends on the stock of debt, com- budget and trade deficits will accumulate to pared with the ability to pay, measured by the current stock of debt. Currency overvalua- GDP, exports, or government revenue. A coun- tion might result in trade imbalance and exter- try is solvent in public debt if the discounted nal debt. In contrast, a high GDP growth rate value of its future primary budget balances will raise the ability to pay debt. Table 4. Some Selected Indicators on Public Debt, 2005 – 2010 (%) Source: The author’s calculation from the MoF’s public debt data and the ADB’s economic data Journal of Economics and Development 9 Vol. 13, No.3, December 2011 An investigation on Vietnam’s public debt In addition, Vietnam’s public debt to total solvency implies that, by the end of 2010, the budget revenue ratio is also rising rapidly. In public debt-to-GDP, external debt to GDP, and particular, by the end of 2010, total public debt external public debt to GDP ratios were over was about double of the total budget revenue, 55%, 40%, and 30% respectively. It is hard to up from 1.6 times in 2008. Meanwhile, state say whether they went over safety levels, since budget remains in deep deficit in the last few different research produced different warnings years and there are no signs of improvement for different countries. For example, Li et al in the near future. State budget projections (2010) pointed out that Eastern European and imply that the government will continue to Central Asian countries were normally in carry out expansionary fiscal policies with crises with their external debt to GDP ratio annual budget deficit of approximately 5% of surging to highs between 42% and 88%. GDP. As a consequence, the public debt to Meanwhile, low and lower middle income GDP ratio will certainly not halt at the current countries fell into crises with a much lower level of around 57%. ratio. External and external public debt in 3.2. Liquidity these economies before crises occurred accounted for less than 40% of GDP. However, Liquidity measures a country’s capacity to it is noticeable that Vietnam’s solvency situa- pay debt in the short term. It is normally calcu- tion has been deteriorating rapidly in recent lated as the ratio of short term external debt years. According to the MoF statistics, within and/or external debt service over reserves or two years, from 2008 to 2010, its public debt exports. Since over 80% of the external public to GDP ratio rose by over 20 percentage debt is long term with preferential interest points, from 36.2% to 57.3%, while the exter- rates, Vietnam faces almost no liquidity risk. Its nal public debt to GDP ratio also went up over short term external public debt to reserves ratio 6 percentage points, from 25.1% to above is approximately 20% while the external public 31.1%. The increasing trend clearly threatens debt service to reserves ratio is just below 10%. Vietnam’s financial safety and the country The figures were well under the safety thresh- needs to respond in a timely fashion. old warned by international agencies. Figure 1: Debt Service in 2011 – 2023 Source: The author’s calculation from the MoF and Bloomberg data Journal of Economics and Development 10 Vol. 13, No.3, December 2011 Domestic public debt service is computed economy was probably its relatively rapid based on the amount of existing government growth despite the context of the global crisis. and government guaranteed bonds. In addition, solvency and liquidity measures Meanwhile, external public debt was taken were still below safety thresholds. However, from the External Debt Report No. 7 by the after years of pursuing high growth, mainly MoF. It can be seen that, from 2011 to 2013, through demand expansion, the country’s eco- most of the government’s debt service will be nomic prospects deteriorated faster than paid to domestic creditors. The total amount in expected. Within the last three years, the the next three years will be around 215 trillion growth rate slowed down remarkably and is VND (over USD10 billion). The figure is unlikely to get back to the level before even equivalent to more than 40% of the total state when the global crisis ends. budget revenue in 2010 and roughly equals In recent years, Vietnam’s current account Vietnam’s present foreign reserves. Currently, deficit has rocketed to roughly 10% of GDP, the large amount of domestic public debt plus causing persistent depreciation of the home large annual budget deficit will put more pres- currency. From the beginning of 2010 to the sure on monetary policy and inflation in the first quarter of 2011, the Dong depreciated coming times. around 20% against the U.S. dollar. At the External public debt service is relatively sta- same time, prolonged budget imbalance and ble over time. In the next three years, on aver- high money growth rates have made inflation age, Vietnam will pay about VND 32 trillion spiral out of control. Specifically, since the (USD 1.5 billion) in forms of interests and beginning of 2008, Vietnam’s consumer price principal each year. The number is just above index has gone up by nearly 75%. Currently, 10% of the country’s current reserves. the government bond rate has been over 12% - Nevertheless, prolonged trade deficit is threat- a phenomenon that often appears before a debt ening to deplete its reserves and weakening crisis. liquidity in the long run. Vietnam has been consistently downgraded 3.3. Macroeconomic volatility by international agencies due to its macro The most positive signal from Vietnam’s instability. The credit default swap (CDS) Figure 2: Credit Default Swap on G-Bonds by Selected Countries, 2006 – 2010 Source: Bloomberg Journal of Economics and Development 11 Vol. 13, No.3, December 2011 rates, measuring the government bond risk in Vietnamese bore a tax over income rate from international markets, has surged and stayed 1.4 to 3 times higher than other Asian coun- high during the last few years. On the contrary, tries due to severe trade protectionism and tax other regional countries’ CDS index has been overlaps. Raising taxes and fees to narrow the falling since the early 2009. Vietnam’s eco- country’s budget deficit is clearly limited. nomic prospects have become less appealing Further analysis of the state revenue compo- to international investors. Perhaps, it is right nents in the past five years shows that about time for Vietnam to put aside its desire for short term high growth to settle economic two thirds of total state revenue come from instability. three main types of taxes, namely value added tax (VAT, 23%), corporate income tax (CIT, 4. Revenue analysis 30%), and tariff (13%). The rising trend in tar- Total government revenue is one of the indi- iff revenue, from 9% in 2006 to 17% in 2009 cators used to assess the solvency of public and 14% in 2010 shows, on the one hand, a debt. Due to its importance and unique charac- rapid development of international trade; on teristics, we conduct a deep examination on the other hand, high trade protection. The the risk of revenue sources. To maintain an annual balanced budget, thereby reducing the heavy dependence on this revenue source may public debt to GDP ratio, a government has cause a more serious budget deficit since two choices: either cutting spending or Vietnam has to follow its tariff cut route as increasing revenue. Public spending, to a cer- committed to the WTO in the coming years. tain extent, can be controlled immediately just Moreover, as in a typical low-income coun- by tightening which is very likely to be sup- try, Vietnam’s individual income tax (IIT) ported by the public. By contrast, raising rev- accounts for only a small proportion (3-4%) of enue is probably much more difficult due to the total revenue and, in contrast to CIT, it limited revenue sources, and of course tends to increase in recent years. In addition, receives no support from businesses as well as special consumption tax on domestically pro- other tax payers in the economy. duced goods (SCT) accounts for 6% of the According to the ADB statistics, on average, total revenue and is also on an increasing Vietnam’s annual government revenue exclud- trend. More noticeably, revenue from land use- ing grants in the previous decade reached right assignment and state-owned house sales 25.3% of GDP. Out of it, revenue from taxes is declining in both absolute size and propor- and fees accounted for 21.5% of GDP, much tion of the total budget revenue as these assets higher than any other regional countries. In have been gradually depleted. Many econo- particular, the ratio stood at 15% in Thailand, mists believe that to truly reflect the govern- 15.5% in both China and Malaysia, 13.3% in ment budget situation, the receipts from selling Philippines, 11.8% in Indonesia and only 7.3% in India. Except for 2009 when the govern- assets should not be counted in the annual ment implemented a series of tax cuts and budget balance. These returns are included by exemptions to stimulate aggregate demand, the government since they reduce the severity Vietnam’s taxes and fees to GDP ratio has no of the budget deficit implied by the numbers tendency to fall. The preliminary estimate in reported. In fact, this situation is similar to a 2010 and projection in 2011 showed that this person selling his or her property to finance ratio remains high, at around 23% GDP. This spending. The debt may decrease but his or her implied that, in addition to paying a high infla- stock of assets also falls proportionally. In tion tax of over 10% each year, overall other words, the person becomes less wealthy. Journal of Economics and Development 12 Vol. 13, No.3, December 2011 Figure 3: Total Tax Revenue/GDP: An International Comparison Source: ADB Figure 4: Revenue Decomposition Source: Annual State Budget Statements and Projections (MoF) Journal of Economics and Development 13 Vol. 13, No.3, December 2011 Box 1: Inflation Tax Government often opts for different management tools were most severely methods to finance its budget deficit, rang- affected. ing from increasing taxes, borrowing, to In Vietnam, food and food–related prices printing new money. In the case of increas- always go up faster than others. Meanwhile, ing money supply, it will consequently lead spending on these items accounts for a large to rising prices of goods and services in the proportion in the budget of those with a economy. lower income. Accordingly, inflation tax, The price increase, in this situation, is although reducing government’s debt bur- deemed to be a hidden tax. Suppose that den, relatively transfers income from the prices increase by 10%, diminishing the poor to the rich, broadening the gap purchasing power of money. The effect of between them. this action is as if government imposes a 10% tax on its citizens’ income. Given that the current public debt exceeds Accordingly, inflation caused by printing USD 50 billion and is rising as the govern- new money to finance spending is called ment continues to run a budget deficit, infla- inflation tax. tion tax is still considered one of the major tools to reduce public debt burden. Although both inflation and income tax Advancing next year’s budget revenue for reduce people’s real income, the former is the current year’s spending and buying back less noticed and less opposed by the citizens than the latter. Therefore, many govern- government bnds by the State Bank of ments are tempted to go with inflation tax, Vietnam are the two channels causing money especially when central banks are not inde- supply and inflation to increase rapidly. pendent. The burden of inflation tax falls Inflation tax can be avoided by commit- mostly on money holders or on those who ting to a balanced annual budget, and this have fixed income. Normally, people with can only be achieved by adopting a strict and low and lower middle income lacking risk long-term oriented spending cut program. Figure B2. Money Supply, Domestic Borrowing and Inflation, 2000 – 2010 Source: ADB and] GSO Journal of Economics and Development 14 Vol. 13, No.3, December 2011 Decomposing total revenue by different sec- become very high compared to its neighbors; tors in the last five years shows that, on aver- chances to raise revenue seem very small age, state owned enterprises (SOEs), although while many revenue sources are unsustainable large, contributed only 17% of total revenue and may slump or disappear in the coming and the figure only improved slightly over the years. Efforts to restrain and gradually elimi- years. Revenue from foreign invested enter- nate deficits hence depend strongly on tighten- prises, excluding crude oil, and that from non- ing public spending, a task which probably state enterprises made up around 10% of the requires a comprehensive budgetary reform total. Meanwhile, crude oil and others occu- and economic restructuring. pied respectively 20% and 42% of the total 5. Interest rate and exchange rate risks budget revenue in the last five years. Notably, From 2000 to 2007, Vietnam arose as one of revenue from crude oil decreased from 29% in the fastest growing and most stable economies 2006 to only about 13% in 2010. However, in the region. According to the ADB statistics, returns from crude oil are similar to income Vietnam’s economic growth averaged at 7.6% from selling national assets. On the one hand, per annum while inflation and budget deficit to it helps relieve current budget deficit. On the GDP ratio stayed low at around 4.6% and other hand, it reduces state owned assets. 1.6% respectively over this period. Being a Moreover, the earnings are unsustainable since low-income country coupled with its econom- resources are limited and depletable. ic achievements, Vietnam subsequently bene- In addition, we also believe that to evaluate fited from preferential loans with low interest precisely the country’s budgetary status, future rates from international organizations. Both obligations must be considered. One of the onshore and offshore investors had no doubt in most important obligations in annual budget the country’s debt repayment capacity. During expenditure is pension and social subsidies. this time, local government bond rates stood at Part of employees’ income is currently being far below 10%. Meanwhile, the External Debt extracted in the form of social insurance. In Report No. 7 by the MoF showed that, by 31st essence, this resembles government’s borrow- December 2010, up to 80% of Vietnam gov- ing from workers, and government’s duty to ernment’s foreign loans had preferential fixed pay future pension is no different from paying interest rates under 3%. Since the report did its debt. During the last five years, pension and not specify the interest rate for each loan, the social subsidies in Vietnam increased by more effective interest rate could not accurately be than three times, from about VND 22 trillion determined. Alternatively, this rate would be (8.25% of total budget expenditure) in 2006 to approximated based on the bands of interest nearly VND 71 trillion (12.2% of total budget rates reported. A simple calculation indicates expenditure) in 2010. The burden of these pay- that the effective interest rate of Vietnam’s for- ments is forecasted to increase sharply because eign debt is approximately 1.54-3.75%, around of the fast growing number of retirees in the one-third of that of domestic debt of 9.45%. coming years, especially when the Vietnam’s This reflects that the burden on external debt currently golden aged population ages. service is quite small. The report, however, According to a recent forecast of the Institute also showed that the size of commercial loans of Labor Science and Social Affairs (ILSSA), with increasing interest rates had tended to go the number of pensioners in Vietnam in 2020 up. By the end of 2010, nearly 6.8% of the will rise by over 2.5 times as compared with total external public debt had interest rates 2010. from 6% to 10% and more than 7.0% of the The revenue analysis above shows that total external public debt had floating interest Vietnam’s revenue to GDP ratio has already rates. Journal of Economics and Development 15 Vol. 13, No.3, December 2011 After many years, Vietnam’s economy that fluctuations. A depreciation of the Dong would leaned much on quantity instead of quality has create a higher external debt burden in terms of revealed its weakness as economic growth local currency. The External Debt Report No. started to slow down while the Dong continued 7 also showed a rigid structure of external debt to depreciate. In the aftermath of the global by currencies over time. By the end of 2010, economic crisis, the risk of a sovereign default Vietnam’s external public debt comprised by some European governments worries the mainly of hard currencies including Japanese international community. Investors are con- yen - JPY (38.8%), Special Drawing Rights - cerned over the debt repayment ability of those SDR (27.1%), USD (22.2%), and EUR countries with high public debt and persistent (9.2%). Debt in other currencies only made up budget deficits. During the last three years, less than 3% of the total. Classifying by credi- Fitch Ratings, an international credit rating tors, Japan was the biggest lender (34.3%), fol- agency, downgraded Vietnam twice, to BB- in lowed by the International Development May 2008 and to B in July 2010. It also Association - IDA (24.9%) and the ADB warned the country of its economic and finan- (15.0%). The U.S and EU countries accounted cial instabilities. High growth of M2 and cred- for only 0.3% and 6.9% of Vietnam’s total it in many consecutive years results in a high external public debt respectively, but the pro- proportion of non-performing loans. portion of debt in the currencies of these coun- According to the ADB and the IMF, on aver- tries was very large. This demonstrates that age from 2000 to 2010, Vietnam’s M2 and lenders tend to use hard currencies. credit growth hit a record highs of approxi- Consequently Vietnam was exposed more to mately 30% and 33% respectively. Therefore, exchange rate risks as these currencies normal- in addition to becoming a lower middle- ly appreciated against the Dong over time. income country, Vietnam is expected to find it In more detail, from the beginning of 2010 to hard to access preferential external loans in the the end of second quarter of 2011, some main future. currencies including EUR, USD, and JPY have In spite of the low cost, Vietnam’s external appreciated by around 12%, 13%, and 26% public debt conveys high risk of exchange rate against the Dong respectively. This implies that Figure 5: External Public Debt by Interest Rates Source: The External Debt Report No.7 (MoF) Journal of Economics and Development 16 Vol. 13, No.3, December 2011 foreign public debt in terms of local currency public debt. The result shows that the Dong has greatly risen and puts more pressure on fis- effectively depreciated by 41% from 2002 to cal deficit and monetary policies. To have a bet- 2010. However, the real value of the debt ter overview of exchange rate risks on external dropped as Vietnam’s inflation rocketed by public debt, we calculated the nominal effective 110% in the same period, implying the burden exchange rate (NEER) of the Dong against a of the debt has been shared to the public through basket of other currencies in Vietnam’s external inflation tax. Figure 6: Effective Interest Rates on External Public Debt Source: The External Debt Report No.7 (MoF) Figure 7: External Public Debt by Currencies by 12/2010 Source: External Debt Report No.7 (MoF) Journal of Economics and Development 17 Vol. 13, No.3, December 2011 Box 2. Nominal Effective Exchange Rate The nominal effective exchange rate wi is the weight of the foreign currency i (NEER) is used to determine an increase or and n is the number of foreign currencies in decrease in relative value of a country’s cur- the debt basket. rency to a basket of others. Here the NEER is measured by computing the weighted An increase in the NEER indicates the average value of the home currency against Dong is appreciating while a decrease foreign currencies in the external debt bas- means the Dong is depreciating against ket of Vietnam. More specifically, it is cal- other 18 foreign currencies in Vietnam’s culated as follows. external public debt basket. A fall in the NEER also implies a rising burden of in which, e is the nominal exchange rate Vietnam’s foreign debt. The NEER in the period of 2002-2010 is calculated and pre- of VND against USD; ei is the exchange rate of the currency i against the US dollar; sented in Figure B3. Figure B3: Nominal Effective Exchange Rate (NEER) and CPI (2002 = 100) Source: The author’s calculation from MoF and GSO data Journal of Economics and Development 18 Vol. 13, No.3, December 2011 6. Public debt prospects 2011-2020 to minimize the risk of a financial crisis. In Budget deficit and public debt sometimes order to do so, public spending cuts must be are necessary for a country, especially for made thoroughly to ensure that public debt those developing countries with high demand grows at a lower rate than the economy. This for infrastructure investment or in need of a means that the debt should not grow faster than stimulus package to counter a cyclical down- turn caused by external shocks. However, per- its income. sistent budget deficit and rapidly increased To predict the future of public debt, we gen- public debt not only lead to sovereign default erate various scenarios of the public debt to risks but also affect negatively macro-econom- GDP ratio under different assumptions on ic stability or prosperity of a country in the budget deficit, bond rate, exchange rates, and long term. inflation in Vietnam from now to 2020. By With an average domestic savings rate of definition, public debt is the accumulation of about 28% of GDP while national investment accounting for approximately 36% of GDP, deficits in the past and present. Assuming that Vietnam public debt increased quickly in the there is no money printing, government must last 10 years. Borrowing may temporarily help borrow to finance budget deficit, resulting in increase total investment but eventually princi- new debts. Thus, a change in current public pals and interests must be repaid in the future. debt is calculated as follows. Put simply, the larger the debt today, the more will be paid tomorrow. (1) Prolonged budget deficit and borrowing in which, D is total public debt, G is total also creates more pressure on inflation, espe- government spending, T is total revenue, rD is cially when the central bank has no independ- interest payments. Dividing both sides of ence. In principle, to finance budget deficit, equation (1) by nominal gross domestic prod- the government can choose to raise taxes uct, Y, yields: and/or to borrow. The ability to increase Vietnam’s government revenue seems to be (2) limited because the mobilization rate is already among the highest levels in the region Finally, noticing that ∆D/Y = and many revenue sources are unsustainable. ∆(D/Y)+(∆Y/Y)(D/Y), we obtain the expres- Borrowing via issuing bonds, on the one hand, sion reflecting the change in public debt to would push up the interest rate and hence GDP ratio over time as follows. crowd out private investment. On the other hand, it would loosen money supply if issued (3) bonds are repurchased via the discount win- dow and open market operations. in which, g = ∆Y/Y is nominal GDP growth Statistics also show a high correlation rate. All variables in Equation (3) are between budget deficit and inflation in devel- expressed in nominal terms. The equation can oping countries. High inflation is considered the root of the distrust in the local currency, be interpreted as follows. Public debt to GDP causing dollarization and volatility of foreign ratio will increase if either government runs a exchange rates. primary budget deficit, (G - T), and/or the Vietnam should be prudent and more interest rate is higher than nominal GDP responsible with its budget spending decisions growth. Journal of Economics and Development 19 Vol. 13, No.3, December 2011 Box 3. Vinashin story and lessons for state owned conglomerates Vietnam Shipbuilding Industry Suisse. Within five years, Vinashin also Corporation (VSIC) was established on received a significant amount of land to 31st Jan 1996 by consolidating all ship- develop their projects and then used them as building enterprises throughout the country. collateral to borrow from domestic banks. The company’s main objective is to develop However, instead of focusing on its core the shipbuilding industry with advanced business, Vinashin quickly spread invest- and modern technology, and to become a ment into other areas in which they had lit- leading industry of the nation. tle experience, ranging from financial On 15th May 2006, the Prime Minister investment, mining, construction, etc. to issued Decision No. 103 and 104/QĐ-TTg automobile shop, resorts, and even pig on setting up an experimental Vinashin farms. Adventurous projects made Group based on reorganizing VSIC for Vinashin’s debts grow rapidly and the group diversified businesses. In particular, ship suffered losses. Lax supervision from high- building & repairing and maritime transport er levels and poor management of the are its core business, closely linked to sci- group’s leaders resulted in a series of ineffi- ence and technology, research & develop- cient and incorrect capital uses such as bor- ment. rowing to repay old debt, using short-term With the government’s support, Vinashin loans to support long-term debt, and even rapidly developed and was expected to using working capital to invest. become one of the largest ship building and The global crisis in 2008-2009 did cause maritime transport corporations in the a severe hit on unhealthy financial condi- region and over the world. During the peri- tions at Vinashin. Demand for shipbuilding od of 1996-2006, by utilizing skilled work- and shipping in the world plunged and ers and engineers in the field, Vinashin con- Vinashin was not insulated from this. In stantly achieved a growth rate of return 2008 alone, customers canceled contracts from 35% to 40% per year. By 2010, worth USD 8 billion with Vinashin. Vinashin had a network of hundreds of cor- However, the group kept hiding its losses porations, subsidiaries, joint ventures and and reported profits in 2009 and in the first associates. The total number of employees quarter of 2010. By June 2010, although at Vinashin was once about 70,000 and Vinashin’s total assets were estimated to be accounted for more than 1.5% of Vietnam’s VND 104 trillion (USD 5.4 billion), its debt workforce. went up to VND 86 trillion (USD 4.5 bil- Among state owned conglomerates, lion). Vinashin received more financial favors In December 2010, Vinashin officially from government. In 2005, the group was defaulted on the first installment, worth given USD 750 million funded by govern- USD 60 million of the USD600 million ment bonds issued in international markets debt issued in 2007 to international credi- with a yield rate of 7.125% per annum. In tors. Credit rating agencies such as Moody 2007, the group was also permitted to issue immediately downgraded the rating of USD 600 million of bonds in international Vietnam and its state owned corporations. markets under the arrangement of the Credit Consequently, Vietnam Electricity, Journal of Economics and Development 20 Vol. 13, No.3, December 2011 PetroVietnam and Vinacomin were forced profits after taxes to invest in what they to postpone or cancel their plans to issue want. Many enterprises, especially those bonds in international markets after the operating in natural resources mining with event. high return such as PetroVietnam and In August 2010, the Vietnamese govern- Vinacomin are also making investments out ment established a committee to begin of their core business without being con- restructuring the failing Vinashin. trolled. Subsidiaries that were not in shipbuilding Debt and losses of Vinashin as well as were transferred to other state owned enter- other state owned groups and corporations prises. A “new” Vinashin will focus on the are raising alarm about the effectiveness core businesses of shipbuilding, repairing and lax supervision in this sector. and supporting industry. However, whether Recent statistics show that total public or not the group will be able to repay its investment, apart from being funded debt in the coming years remains question- through state budget allocation and borrow- able. ing, was also largely financed by state- Behind the consequences and lessons owned enterprises’ retained profits and from Vinashin are concerns about the effec- state-owned assets. On average, it account- tiveness and financial health of other state ed for 24-30% of the total investment. owned corporations. The current financial Cutting public investment probably has to mechanism allows these entities to retain start from these figures. To forecast public debt, according to rized as follows. Equation (3), we have to predict primary budg- Economic growth will help increase nation- et deficit and nominal GDP growth rate over al income, therefore reducing the D/Y ratio. In the years. Firstly, the component (G - T) is return, economic growth in any given year equal to overall deficit minus interest pay- depends partly on budget deficit. If govern- ments. Primary budget deficit is determined ment increases spending or lowers taxes to based on its own historical data and fiscal pol- stimulate growth, D/Y may fall if Y increases icy orientations in the future. Interest pay- or may increase if budget deficit is higher. In ments on external public debt are provided in the benchmark scenario, the economic growth the External Debt Report No.7 by the MoF is assumed to be at 6% per annum during the while interest payments on domestic public period 2011-2020. debt are estimated based on outstanding gov- Inflation is a hidden tax. It can help reduce ernment bonds in the domestic market. D/Y ratio as it enhances nominal GDP. Secondly, estimates of nominal GDP growth However, it should be noticed that inflation rate are based on different scenarios of real erodes the burden of debt in domestic curren- GDP growth and inflation in the economy in cy only. For external debt, the burden might the period 2011-2020. increase as inflation will triggers depreciation We simulate D/Y using different assump- of the Dong. Besides, inflation is greatly driv- tions about macroeconomic environment. The en by money supply growth, which is in turn impacts and assumptions of some key vari- strongly related to budget deficit. In the bench- ables in the benchmark scenario are summa- mark scenario, except for 2011 when inflation Journal of Economics and Development 21 Vol. 13, No.3, December 2011 is expected to be about 18%, we assume that all budget deficit reported by the ADB Vietnam’s inflation will stand at 6% per year accounted for 7.71% of GDP and interest pay- from 2012 to 2020. ments estimated from the state budget state- Exchange rates are closely related to D/Y ment was around 1.42% of GDP. Therefore, because they affect the burden of external pub- primary deficit in that year equaled 6.29% lic debt. A devaluation of domestic currency GDP. The corresponding estimated number in has an important impact on D/Y ratio as exter- 2010 stood at around 4.5% GDP. Primary nal public debt accounted for two thirds of budget deficit will be accumulated to current Vietnam’s total public debt. In the benchmark public debt. In the benchmark scenario, we scenario, in the period 2011-2020, the Dong is assume that Vietnam will manage to maintain assumed to depreciate by 5% per year against its primary budget deficit to GDP ratio at 2.5% the U.S. dollar. per year during 2011-2020. To achieve this Interest is the cost of borrowing. The greater rate, austerity must of course be followed with the interest rate is, the larger the budget deficit a long-term commitment. remains and so does the public debt. Interest Lastly, external public debt to domestic on domestic debt can be calculated based on public debt ratio is assumed to remain at the detailed information about the amount and present level of around 2:1. Interest rates of coupon rate of outstanding government bonds public debt in domestic and foreign currencies and government guaranteed bonds. Annual will stand at 10% and 5%, respectively. interest payments on foreign public debt are Forecasts for overall budget deficit and pub- extracted from the External Debt Report No.7. lic debt in the benchmark scenario are present- Primary budget deficit is calculated by sub- ed in Figure 8. This scenario implies that pub- tracting interest payments from overall budget lic spending should be drastically constrained deficit. For example, in 2009, Vietnam’s over- to bring down overall budget deficit from Figure 8: Forecasts on Budget Deficit and Public Debt in 2011-2020 Source: ADB and the author’s calculation Journal of Economics and Development 22 Vol. 13, No.3, December 2011 7.7% in 2009 to 4.3% in 2011, 3.2% in 2015, More noticeably, if primary budget deficit to and 2.9% of GDP in 2020. Accordingly, public GDP ratio increases by one percentage point debt will temporarily halt in 2011 due to from the benchmark scenario, it will cause hyperinflation (about 18%). However, in the overall budget deficit to GDP ratio to rise by following years, public debt to GDP ratio will 1.0 percentage points per year, and public debt rise steadily to 65.5% in 2015 and then 81.7% will reach 91.5% of GDP in 2020. Even if the in 2020. government succeeds to maintain its annual We also simulate budget deficit and public primary budget balanced, an overall budget debt in different scenarios. The results show deficit may still occur because of interest pay- that, ceteris paribus, every percentage point ments and domestic currency depreciation. In increase/decrease in inflation or GDP growth this scenario, public debt will remain at from the benchmark scenario would approximately 55% of GDP in 2020, a circum- decrease/increase overall budget deficit to stance that will never happen given the current GDP ratio by approximately 0.65 percentage levels of government revenue and expenditure. points per year. As a result, public debt to GDP ratio would decrease/increase by about 6.5 The prospects of Vietnam’s public debt con- percentage points by 2020. Similarly, for every vey a clear message. In order to maintain a sta- percentage point increase in the home curren- ble public debt to GDP ratio, besides triggering cy depreciation from the benchmark situation, high inflation, the government must be able to overall budget deficit to GDP ratio would control a balanced primary budget. Given the increase by 0.4 percentage points each year country’s current high level of revenue to GDP and consequently, public debt to GDP ratio ratio, the job can only be done through public will go up to 85.6% in 2020. spending contraction. References ADB (2010), Key Indicators for Asia and The Pacific, Asian Development Bank. Catão L. and Sutton B. (2002), ‘Sovereign Defaults the Role of Volatility’, IMF Working Paper No. 02/149. IMF Country Report: Vietnam Statistical Appendix, 2003, 2007, and 2010. International Monetary Fund (2010), World Economic Outlook Database. Li Y., Olivares-Caminal R., and Panizza U., (2010), ‘Avoiding Avoidable Debt Crises: Lessons from Recent Defaults’, in the book Sovereign Debt and the Financial Crisis: Will This Time Be Different? by Carlos A. Primo Braga and Gallina A. Vincelette (2010), World Bank. Manasse P. and Roubini N. (2005), ‘Rules of Thumb for Sovereign Debt Crises’, IMF working paper No. 05/42. Ministry of Finance (2010), External Debt Report No. 7. Reinhart, C. M. (2002), ‘Default, Currency Crises and Sovereign Credit Ratings’, NBER Working Paper 8738; Ministry of Finance, State Budget Statements and Projections (2003 – 2011), Publishing House of Finance, Hanoi. Vũ Tuấn Anh (2010), ‘A summary on Vietnam’s public investment in the last ten years’, Vietnam Institute of Economics. Journal of Economics and Development 23 Vol. 13, No.3, December 2011