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Ref: A) Hanoi 1240 and previous B) Hanoi 943 and
previous
E.O. 12958: N/A
TAGS: ECON ETRD EINV PREL PINR VM
SUBJECT: VIETNAM'S 20 YEARS OF DOI MOI: ECONOMIC REFORM
PROGRESS ACCELERATED BY THE BTA
HANOI 00001438 001.2 OF 007
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1. (SBU) Summary: This year marks the twentieth
anniversary of Vietnam's adoption of its "doi moi"
(renovation) policy aimed at transforming its command
economy to a market economy. While the momentum has
not been smooth or steady, Vietnam has made significant
progress since the policy's adoption in 1986. On a very
basic level, Vietnam can feed itself and produce enough
rice to be among the top three exporters worldwide as
well as a leading exporter of coffee and marine
products. However, the debate over the pace and extent
of reforms caused them to stall in the late 1990s.
Reviewing highlights of economic reform over these two
decades, with a focus on the last five years,
illustrates that there has been much progress, but that
the areas where reform is lagging have been the focus
of discussion in the bilateral and multilateral WTO
accession negotiations. The U.S.-Vietnam Bilateral
Trade Agreement revived economic reform efforts and,
together with the changes required on the road to WTO
accession, has maintained and accelerated it.
Nevertheless, Vietnam's leaders still need to make some
hard choices about the lagging areas of reform,
especially financial sector and state-owned enterprise
(SOE) reform. That is where the reformers need to
concentrate next. End Summary.
Why and What of Doi Moi?
------------------------
2. (SBU) Despite whatever ideological commitment
Vietnam's leadership may have had to its Marxist-
Leninist system of collectivized agriculture, heavy
industry and trade with other Council for Mutual
Economic Assistance (COMECON) countries, they failed in
their attempt to introduce a productive collective
agricultural system on the reunited south in the decade
after 1975. The effort to impose the collective system
in the South did not go far enough to make it succeed
as in many other communist countries or in North
Vietnam after 1954. Long time resident economist Adam
McCarty has attributed the reluctance to use force to
impose this change because of a desire to end bloodshed
after so many decades of war in Vietnam. At the same
time, the failed attempt to collectivize agriculture
and the resulting deterioration of the sector turned
what had been a productive market based system in the
south into a partially collectivized unproductive
system. Declining agricultural output meant food
production shrank, the GDP growth rate fell from 8.4
percent in 1984 to three percent or less in 1985-1987,
and annual inflation rose to 400 percent in 1985.
Exports slowed especially to COMECON trading partners.
In addition, a variety of external factors including
declining Soviet assistance, isolation from ASEAN
countries and others as a result of Vietnam's invasion
of Cambodia in 1978 and a short but bloody and
destructive border war with China in 1979 weakened
Vietnam's ability to cover external war debt repayment
obligations and to meet basic domestic needs.
3. (SBU) By 1986, Vietnam's weakening economic
performance and a looming famine compelled the
leadership to change course. Drawing lessons from
China's economic liberalization, but taking little
input from the few foreign assistance donors, they
crafted their own strategy. Adopted at the Sixth Party
Congress, doi moi ("renovation) acknowledged the need
for a successful private sector (especially in
agriculture), adopted a more outward oriented economic
policy, gave greater autonomy to state owned
enterprises and began to decentralize the State system.
As National Assembly Chairman Nguyen Van An recently
told visiting Speaker of the House Dennis Hastert,
"Vietnam learned that [Communist elimination of private
ownership] is an ineffective system because it deprives
people of economic incentives to work." Popular
HANOI 00001438 002.2 OF 007
confidence in Doi Moi and participation in the economy
was hesitant at first, but began to show results in the
lead up to the Seventh National Communist Party
Congress in 1991, where Doi Moi was publicly validated.
4. (SBU) Vietnam's continued economic liberalization
was also necessitated by the rapid collapse of the
Soviet Union's international subsidized economic
system, which ended friendly credit terms, subsidized
commodity sales and import quotas. A popular joke at
the time reflected Vietnam's economic desperation in
the form of a telegram exchange between economic cadres
in Hanoi and Moscow. Hanoi: ECONOMIC CONDITIONS HERE
GRAVE. ASSISTANCE URGENTLY NEEDED. Moscow: THINGS
ARE TOUGH ALL OVER. YOU MUST TIGHTEN YOUR BELTS.
Hanoi: AGREED. PLEASE SEND BELTS.
5. (SBU) By 1990, inflation was less than 70 percent,
food production was again rising and export performance
was improving. Continued improvements in agricultural
production (especially rice), the shift away from trade
with COMECON countries, expansion of exports of
petroleum as well as new products like coffee, rice and
seafood all fueled growth. The nascent private sector
began to contribute to economic activity. Foreign
investment began to flow, mainly to export oriented
sectors. In the early 1990s, Vietnam benefited from
the international rush to invest in Southeast Asia and
the beginning of trade relations with China, reopened
in 1991. In 1993, Vietnam began actively cooperating
with ASEAN, and in 1995 joined ASEAN and normalized
relations with the United States, increasing the flow
of trade and investment that began with the end of the
U.S. embargo in 1994. By that time, Vietnam was
growing well and moving towards a market economy with
inflation under control and progress in poverty
reduction. New export sectors like garments expanded
rapidly.
6. (SBU) The reform measures implemented during 1989-
1996 spanned a broad range. The Government dismantled
collective agriculture, replaced it with a system where
the family was the basic unit, guaranteed land tenure
to farmers, allowed them to sell produce on the market
and liberalized the domestic rice trade. Further
reforms included removal of most administered prices,
unifying the exchange rate and allowing it to be set by
trading on the interbank market. Two key interest rate
reforms were raising interest rates to positive levels
in real terms and switching from setting deposit rates
to controlling interest rate spreads. The size of the
civil service shrank. The Ministry of Trade eliminated
many trade barriers (including most import quotas),
allowed enterprises rather than the State to make
foreign trade decisions, and allowed more enterprises
to engage directly in trade. The Government set up the
State Bank of Vietnam as a central bank and opened the
banking system to private and cooperative banks, joint
stock banks, joint venture banks and foreign banks.
The number of State-owned enterprises (SOEs) fell from
12,000 to 6,000, though most eliminated were marginal
and quite small. Nearly all direct subsidies to state
enterprises from the budget stopped, although other
subsidies continued. The National Assembly passed laws
on the budget, foreign investment (later amended
several times in response to investor concerns),
companies and bankruptcy. The tax system changed to
include a three-tiered value added tax, a uniform tax
on enterprises rather than on profits and equal tax
rates between private and state enterprises. This
rapid progress earned Vietnam a reputation as an
emerging "tiger" and led to greater FDI inflows.
1997: Financial Crisis and Hardliner Resurgence
--------------------------------------------- --
7. (SBU) Progress stopped abruptly in 1997 for several
reasons. First, the Asian financial crisis slowed
HANOI 00001438 003.2 OF 007
growth throughout the region, causing the decline and
withdrawal of investment that had originated from other
Asian countries. In addition, many U.S. investors who
had flocked to Vietnam in the euphoria following
normalization in 1995 withdrew because of frustration
with the poor business climate and corruption.
Domestic discontent manifested itself in 1997 and early
1998 in the form of large-scale rural protests against
corruption and capricious local officials. Protests
and "instability," the rapid withdrawal of foreign
capital and the general malaise (and accompanying
political change) in the region in 1997 weakened the
hands of the reformers and led to a resurgence in the
power of so-called "hardliners," which peaked with the
replacement of the relatively reformist Communist Party
General Secretary Do Muoi by the apparatchik ideologue
Le Ka Phieu.
8. (SBU) Le Ka Phieu linked the pace of reforms to the
question of the appropriate relationship with the West
and the extent to which reforms were actually part of
"peaceful evolution" that should be resisted. This
came to a head when Central Bank Governor Cao Sy Kiem,
a key reformer, tried to move forward too fast for the
newly nervous Politburo and was discredited allegedly
for mismanaging loans. According to one long-term
observer of Vietnam, these charges were trumped up.
The bad debts were there (and still are) regardless of
who is the SBV governor. The National Assembly, acting
through its Party controlled Secretariat, refused to
approve his reappointment after the 1997 Party Plenum.
Thereafter, the National Assembly began taking a more
active role in economic management, notably by setting
the annual inflation target. Several annual
consultative group meetings of donors, as well as the
World Bank and IMF, called for Vietnam to reinvigorate
its reform process, but there was little progress.
Reformers were stifled for several years until the
recognition grew that Vietnam needed to trade with the
United States in order to integrate more fully into the
world economy. Negotiated over five years, the
Bilateral Trade Agreement (BTA) with the United States
gave the reformers a means to push forward again. The
BTA was so controversial that it took over a year for
the Party to decide to support signing the agreement;
the decision to ratify and implement the BTA came
simultaneously with the decision to eject Le Ka Phieu
and his hardliner allies from the leadership, and
represented a strong victory for reformers.
The BTA: Reform Momentum Regained
---------------------------------
9. (SBU) The BTA not only helped restore reform
momentum, but accelerated it. When it finally took
effect in December 2001, 18 months after being signed,
the BTA provided a road map with annual targets for
reform that would bring the economy and legal system
onto the path towards WTO accession. Although often
portrayed monolithically as the catalyst for a sharp
rise in bilateral trade, the BTA has also had a
profound impact on Vietnam's system of governance and
leaders. At its heart, the BTA's WTO standard reforms
foster rules-based governance, greater transparency,
protection of corporate rights and a level playing
field for all participants, which by definition reduce
the Party's power over the economy in general and over
specific economic actors in particular. The reform
framework of the BTA had the additional benefit of
eliminating ongoing case-by-case policy debate on
reform; the BTA's prescription of necessary changes
turned economic reform from a fundamental policy
question into a bureaucratic implementation issue.
BTA Spurs Lawmaking Changes
---------------------------
10. (SBU) The most profound change that the BTA set
HANOI 00001438 004.2 OF 007
into motion was establishing a process to make laws
systematically, consistently and transparently.
Requiring input from a variety of stakeholders, both
foreign and domestic, through a public comment process
contrasts starkly with the previous practice in which
the Government made all decisions in isolation.
Drafters of laws must consider not only what fits into
Vietnam's existing legal system, but also how to comply
with the BTA as well as other international
obligations, including WTO rules. The establishment of
key standards and procedures for making laws in the so-
called Law on Laws of 2002 energized the drafting
ministries, greatly improving both quality and quantity
of legislation. The BTA also requires the publication
of all laws in both English and Vietnamese in the
Official Gazette (similar to the U.S. Federal
Register). Subsequent legislation has established a
process to inform local governments of national policy
and a system to handle complaints.
The BTA Requires Trade Regime Changes
-------------------------------------
11. (SBU) The BTA provides both countries most favored
nation trade status which must be renewed annually.
Since some 60 other countries have MFN for trade in
goods with Vietnam, tariff reductions and other
privileges for trade in goods granted to the United
States under the BTA must also be extended to these
countries. It also required Vietnam to shift to
transaction valuation for customs duties which in turn
meant that the GVN had to develop and publish a tariff
schedule in late 2003. This schedule also enabled the
shift from quotas to tariffs and the reduction of
unaccounted for "customs fee charges." Tariff rates
have gone down and Vietnam has removed quantitative
restrictions on most imports. State trading
enterprises (i.e., Government and non-Government
enterprises, including marketing boards, which deal
with goods for export and/or import) must now act in
accord with WTO standard rules. Subsidies are being
phased out. Some U.S. firms have been gradually
receiving trading rights that allow them to import and
export goods directly without having to go through a
State-owned or local trading company, but they still
cannot distribute goods within Vietnam themselves. The
GVN is revising technical standards and sanitary and
phytosanitary measures based on national treatment
principles that do not create obstacles to trade.
Vietnam has removed requirements on investors such as
local content and export/import ratios in accord with
requirements of the WTO TRIMS agreement.
12. (SBU) The Government began creating a level playing
field for domestic firms by giving equal status to the
private and state sectors in 2001. The BTA requirement
to treat U.S. and domestic firms the same way (i.e.,
national treatment) expands this leveling in various
ways including the provision of services. Since the
BTA entered into force, Vietnam has eliminated
discriminatory prices (often two-tiered pricing
structures) and fees for various goods and services
such as telephone installation, telecommunications
services, water, tourist services, motor vehicle
registration, international port charges, electricity
and air passenger transport. Vietnam has also
equalized various tax rates, including those on
corporate income, special consumption tax and value
added tax as well as abolished the withholding tax on
foreign investors.
The BTA: More Market Access, But Slowly
---------------------------------------
13. (SBU) Vietnam has also taken a number of steps to
improve market access in service sectors, though far
more gradually than on goods and other commitments.
Under the BTA, U.S. firms are slowly being allowed
HANOI 00001438 005.2 OF 007
limited access often only to provide foreign firms
services in such sectors as accounting, architecture,
engineering, computer services, market research,
management consulting, construction, health, travel and
travel services. While there has been some progress in
financial services, telecommunications and
distribution, greater market access in these key areas
was on the table at the WTO bilateral discussions. The
single biggest impediment to liberalization in these
areas has been the continued dominance of State-owned
enterprises (Sues) in key sectors which still account
for 29 percent of GDP. In 2005, Vietnam raised the cap
on foreign investment in a Vietnamese non-financial
firm that is listed on the stock market from 30 percent
to 49 percent and abolished the equity limit imposed on
a single foreign investor in a Vietnamese company.
The BTA Means Greater Competition
---------------------------------
14. (SBU) The BTA called for the GVN to establish the
legal framework so that new entrants foreign and
domestic could compete on an equal footing with
established and even dominant firms. Effective in July
2006, the new Investment and Enterprise Laws aim to
create a more favorable business environment to promote
the development of the rapidly expanding private sector
and to provide more freedom to investors in doing
business while improving corporate governance at the
inefficient SOEs. Evaluating the effectiveness of
these laws must await the implementing regulations, due
out in the summer. With the establishment of the
Competition Authority under the Competition Law which
took effect in July 2005, Vietnam began laying the
basis to spur competition by protecting new entrants
against SOE monopolies in such fields as telecom and
energy. However, as in other countries, building an
effective competition authority takes time, especially
with no independent regulatory agencies in place and
few competition policy experts. Recent steps to
encourage independent power producers into the market
to boost generating capacity on a fairly urgent basis
will not only help create competition, but also put
pressure on the power monopoly, Electricity of Vietnam,
to improve its own efficiency. Other new laws such as
the revised civil code, an e-transactions law and the
intellectual property rights law are also aimed at
protecting the rights of firms. Judging the
effectiveness of these and many other new laws will
have to await the drafting and enforcement of
implementing regulations.
The BTA Changes Bureaucratic Culture
------------------------------------
15. (SBU) In changing the way that laws are created and
increasing transparency requirements, the BTA has also
spurred a profound change in the bureaucratic culture.
The GVN has moved from calling virtually all documents
"State secrets" to launching a Government information
portal, posting information on the internet and
computerizing and modernizing State administrative
management. The BTA's legal drafting requirements,
technical assistance and various cross cutting issues
have fostered interagency coordination. This
coordination began at nearly zero, but BTA
implementation and WTO negotiations and a variety of
investment missions and study tours have advanced it.
Being forced to deal with cross-cutting health issues
such as SARS, HIV/AIDS and Avian Influenza have also
fostered not only interagency cooperation and
coordination but also transparency in sensitive
subjects, some of which were previously treated as
secret. While far from perfect, especially on public
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health issues, coordination is improving and could
improve markedly with the departure of some ineffective
but influential players.
HANOI 00001438 006.2 OF 007
16. (SBU) The BTA has also spurred changes in the
culture of the judicial and legislative systems. The
GVN now recognizes the need to train judges, most of
whom were appointed for their revolutionary rather than
their legal credentials. The increased focus on
lawmaking and the return of Vietnamese attorneys
trained abroad have made lawyer organizations more
active. A meeting with U.S. Supreme Court officials
led Vietnam's Supreme People's Procuracy to decide to
publish past cases, which were previously not matters
of public record. Elected from among loyal Communist
party members, National Assembly members have begun
debating rather than just approving bills. A better
informed Assembly with a greater voice has even made
some significant changes to Government-drafted laws,
including having the State Audit report to the
legislature rather than to the Prime Minister's office.
Reform in Vietnam: What Has Not Yet Happened and Why
--------------------------------------------- -------
17. (SBU) While there has been considerable progress in
Vietnam in recent years, especially on trade reform,
there is more to be done in that area, as well as in
two other areas where reforms have lagged. Although
the GVN has long included among its goals reform of the
financial sector and of SOEs, progress in these areas
has been limited. The number of SOEs has declined from
around 12,000 in the early 1990s to below 3,200 by
September 2005, but most of those eliminated have been
quite small. Another key issue is that State-owned
commercial banks still dominate the credit market.
Since they still lend to SOEs, even to non profitable
ones, the amount of non-performing loans are considered
high, but have not yet been clearly identified. No
doubt part of this is the importance of these areas to
maintain economic growth in an economy where the State
still intervenes regularly. In addition, only in the
past year has the World Bank begun to focus at a high
level and with adequate staff on the key issue of
financial sector reform.
18. (SBU) On market access, what remains to be done is
essentially what the WTO accession process needs to
accomplish in terms of liberalizing some key services
sectors, reducing the role of the State in economy and
improving upon BTA implementation in IPR and
distribution. In evaluating this situation, one must
recall that the BTA deliberately left the most
difficult and intractable issues for WTO accession.
This explains why the difficult sectors in our WTO
bilateral accession negotiations have included
restrictions on the activities of foreign firms in the
areas of energy, telecom, finance and distribution. It
is not surprising that these areas generate a good deal
of government revenues for SOEs. Thus, the vested
interests opposing liberalization of these sectors
include not only the ministries controlling the SOEs
and the SOEs themselves (who no doubt benefit
financially from these firms), but those in the GVN
responsible for maintaining a healthy revenue stream in
the midst of tariffs declining due to cuts for the
ASEAN Free Trade Agreement and WTO, as well as an
inefficient tax collection system.
19. (SBU) On another level, one of the reasons for the
success of the BTA was Vietnam's swift recognition that
it would need technical assistance to accomplish these
reforms. The result was the USAID-funded Support for
Trade AcceleRation (STAR) program which has provided
nearly five years of independent assistance and advice
to the GVN and helped revise the legal and regulatory
framework. In fact, at the 2005 Consultative Group of
Donors which pledged USD 3.5 billion in ODA, Deputy
Prime Minister Vu Khoan singled out the USD four
million STAR project as the best of all and called on
other donors to emulate it. In areas where reform has
lagged, such as financial sector or SOE reform, there
HANOI 00001438 007.2 OF 007
is no single blueprint like the BTA. A range of
multilateral and bilateral donors engage in various
projects and spend much time coordinating to ensure
they are not duplicating efforts. But progress is
slow.
Corruption
--------------
20. (SBU) Another key area where progress has been slow
is in attacking corruption. Although there have been
more headlines about it in recent years, it continues
virtually unabated. The recent PMU-18 scandal has
focused much attention on the broader issue of
corruption in Vietnam and elicited statements from the
highest levels in Vietnam in support of ending it.
Proof of the GVN commitment, however, will have to
emerge over time in concrete actions, not only on
prosecuting the guilty in the PMU-18 scandal, but also
in legal and administrative reforms to prevent and end
corruption. The extent to which the leaders are able
to contain if not eliminate graft will be key to
maintaining not only the reform momentum, but also
their own hold on power.
21. (SBU) Comment: While the momentum has not been
smooth or steady, Vietnam has made significant progress
since it adopted doi moi in 1986. On a very basic
level, Vietnam can feed itself and produce enough rice
to be among the top three exporters worldwide as well
as a leading exporter of coffee and marine products.
On this, and the other positive impacts of doi moi, the
leadership has agreed for some time. However, the
debate continues over the pace and extent of reforms,
which is linked to the question of the appropriate
relationship with the West and the extent to which
reforms were actually "peaceful evolution." Concern
about this issue led more conservative elements to beat
back reformers bringing on the reform doldrums of the
late 1990s. Vietnam has a strong desire to climb the
technological ladder. This will be a strong incentive
to continue down the path of economic liberalization.
The BTA revived economic reform and the road toward WTO
accession has maintained it. However, for the next
phase of doi moi, Vietnam's leaders need to make some
hard choices about the lagging areas of reform, namely
financial sector and SOE reform as well as how they
handle corruption. End comment.
BOARDMAN