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Vietnam’s recent economic slowdown highlights the underlying strains on its economy and government institutions, and raises questions about the country’s long-term development goals. Vietnam’s economy grew by only 4.14% in the second quarter of 2023, the country’s lowest Q2 growth since 2011. While an improvement from the first quarter’s 3.3% growth, the data indicates the economy is falling well short of the government’s official 6.5% growth target. The government further anticipates that June exports will have declined by 11.4% from 2022, due in large part to decreased textile manufacturing in the south and electronics manufacturing in the north. In recent weeks, Vietnam has implemented measures to spur growth, including cutting interest rates four times since March (most recently on June 23). The government will also reduce the value-added tax rate from 10% to 8% from July 2023 through January 2024. But these stimulus efforts will struggle to compensate for strong global and domestic headwinds.

The Ministry of Planning and Investment calculated that Vietnam must grow 7.5% quarter-on-quarter in Q3 and Q4 to offset the recent suboptimal performance.

According to workers’ testimony, electronics manufacturers in the country such as Samsung are slashing workers’ hours, furloughing employees and renewing fewer contracts. Worker dormitories built to house tens of thousands are now ”half empty.” In total, 45,000 workers in the electronics manufacturing sector lost their jobs in the first five months of 2023.

Multiple financial institutions, including Standard Chartered, Oxford Economics, the International Monetary Fund (IMF) and the World Bank, have reduced Vietnam’s economic growth outlook in recent months. For example, the IMF reduced its 2023 projection from 5.8% to 4.7% in June.

The primary driver of Vietnam’s economic slump is a dearth of post-COVID-19 export demand in foreign markets. On the back of major investments in the electronics sector, Vietnam was the second most prolific smartphone exporter in 2021, with its exports totaling $60.5 billion. Among the chief drivers of this performance was the U.S.-China trade war instituted under former U.S. President Donald Trump and continued under President Joe Biden. The U.S. tariffs on Chinese manufacturing led to a mini exodus of foreign electronics manufacturers from China, with Vietnam among the most popular relocation destinations due to its relatively young population, low labor costs and proximity to China. This transfer of investment from China to Vietnam continued apace throughout 2022. However, part of the boom in demand for smartphones and other electronics was a result of pandemic conditions requiring billions of people around the globe to stay indoors, which produced a lag effect in terms of supply and demand. When pandemic restrictions decreased and inflation escalated, Vietnam’s smartphone export values dropped to a combined $53 billion in 2022 and are still sinking.

Prior to the COVID-19 pandemic, Vietnam had consistent 6-7% annual growth since 2000, higher than any Asian economy other than China’s.

Exports to North America, the European Union and China comprised 93.3% of Vietnam’s GDP in 2021.

A growing energy crisis is compounding Vietnam’s economic woes, which will discourage foreign investment in the short term. The region is experiencing a historic heat wave, which — combined with Vietnam’s limited energy production capacity — has resulted in rolling blackouts. Authorities have subsequently demanded that factories reduce power usage, thus negatively affecting output and the trade-dependent broader economy. Additionally, Vietnam’s largest refinery and gasoline producer, Nghi Son, will go offline for two months starting in August, which could spark a gas shortage across the country. The state-run company that operates that refinery, Nghi Son Refinery and Petrochemical, is so cash-strapped that it could default as early as November, which would at least temporarily shut down the refinery and exacerbate energy shortages. These limitations are preventing Vietnam from reliably providing energy to the many new factories and fabrication plants the country hosts, which is discouraging additional short-term investment.

The European Chamber of Commerce wrote a letter to the Vietnamese government in June urging it to find an immediate solution to what was an unexpected energy crisis. The head of the Korean Chamber of Business in Vietnam predicted that the ”power cut issue will be very serious for not only firms who have already invested in Vietnam, but also for us trying to call for investors to come to Vietnam.” The chairman of the French Chamber of Commerce and Industry balked at government demands to reduce power usage in factories, saying to comply would mean ”slowly dying.”

While Vietnam’s economic growth is expected to accelerate in 2024, the country’s lack of policies to promote domestic innovation could prevent it from achieving its longer-term economic goals. Global financial institutions expect Vietnam to rebound when consumer demand in export markets recovers in 2024. However, Vietnam’s longer-term goals of becoming an upper-middle income economy by 2035 and high-income by 2045 rely on more than just imitation, assembly and testing; they require indigenous innovation to thrive in the current information economy. By most measures, Vietnam has not implemented a mission-oriented, substantially-funded technology policy (akin to ”Made in China 2025,” for example) to further this goal. To shift its trajectory, Vietnam will need to use expertise from foreign tech companies like Samsung, as well as knowledge gained from abroad or from the Vietnamese diaspora by CEOs of tiny startups, to upskill and reskill its population. If Vietnam is unable to innovate new technology on its own terms, the country’s attractiveness as an investment destination would decrease amid tight competition from other markets, which could pull Vietnam into the middle-income trap.

Institutional and political shortcomings may also negatively impact Vietnam’s prospects for long-term growth. In recent months, the Vietnamese government has broadly disposed of economically pragmatic leaders in favor of cadres with more national security and Party discipline priorities, and leadership will likely remain entrenched until the end of the current National Assembly term in 2026. This turnover is creating new business risks for those who might otherwise have braved Vietnam’s opaque institutions, byzantine legal system and weak intellectual property protections. Additionally, Vietnam’s workforce is no longer as young and cheap as it was when investors first relocated their operations from China, which weakens the country’s pull factors, and a weak rule of law may further dissuade investment. If that were not enough, many of the drivers currently propelling foreign investors out of China — such as tightly controlled currency, the prominence of state-owned enterprises and questionable anti-corruption campaigns — likewise exist in Vietnam. Without systemic reforms to the country’s political and financial systems, the combination of these factors risk making Vietnam an increasingly unappealing investment destination, which would limit economic growth. Politically, if Vietnam’s economy does not grow fast enough to satisfy its expectant populace, the Communist Party’s political legitimacy could be called into question, risking unrest and challenges to the Party’s authority, which has long lacked an ideological raison d’etre in Vietnam’s market economy.

Source: Stratfor July 19, 2023