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Vietnam Today

HSBC: foreign enterprises taking full advantage of Vietnam's labor force

Released at: 14:20, 03/04/2015

HSBC: foreign enterprises taking full advantage of Vietnam's labor force

Their domestic counterparts, on the other hand, face a number of challenges.

by Hung Nguyen

On the surface, the Vietnamese economy started 2015 on a strong note. Manufacturing saw an annual rise of 9.5 per cent while the service sector saw growth of 5.8 per cent. The GDP expanded 6.0 per cent, mirroring the relative firmness of the Purchasing Managers Index (PMI) over the past three months. Thanks to higher demand, private sector credit growth in the first quarter expanded by 15.5 per cent. 

However, despite the figures above, HSBC indicated that there are many issues to overcome in the immediate future.

External Pressures

Despite improving domestic demand, external conditions are worsening, putting pressure on Vietnam's two main sources of foreign exchange. Exports, though still high by regional standards, declined to 6.4 per cent for the first quarter from 12.7 per cent in the equivalent period of 2014. Shipments from domestic enterprises continued to decline last quarter, highlighting a loss of competitiveness for Vietnamese firms. 

Weakening currency competitiveness is partly to blame. On a real effect exchange rate (REER) basis, the VND has appreciated about 8 per cent since the end of 2014. Declining external demand is another. But many of the woes are domestic in nature - ranging from a worsening business environment to low productivity, which has made Vietnam dependent on cheap labor.

Vietnam's trade deficit is still small, and inflows remain sticky, as reflected in the 7 per cent year-on-year rise in disbursements from foreign direct investments (FDI) in the first quarter of 2015. But slowing reform progress may, in time, weigh on Vietnam's medium-term growth potential, which could put at risk the country's steady march towards prosperity. 

Advantage from the labor force

Undeniably, Vietnam boasts a strong demographic destiny. This has helped with the country's labor cost competitiveness and domestic demand. Sustained growth of disbursed FDI signifies the country's attractiveness as a manufacturing hub. The price to quality ratio makes Vietnamese goods competitive. Indeed, shipments of labour-intensive materials remain robust.

However, the latest PMI also raises concerns about the sustainability of manufacturing momentum. Though the headline index remains above the waterline, the pace of expansion is easing. In March, the PMI fell to 50.7, from 51.7 previously. The drag came from a decrease in new orders as well as contracting employment.

The latter is worrying, as it reflects long-standing issues. Skilled labour shortages remain a concern, as the tertiary education system fails to keep up with corporate demand. Coupled with this, management-labour relations remain a challenge, causing disruptions to production. This should not crimp output in the short-run; HSBC's preferred leading indicator of output, new orders minus inventories, continued to improve in March, pointing to future output gains, especially through foreign investment. Wage competitiveness will help Vietnam sustain FDI inflows in the months ahead.

Domestic enterprises fail to take advantage of labor

In contrast to foreign-invested firms, domestic enterprises have not been as successful in capitalizing on Vietnam's cheap labour pool. The level of quarterly exports by domestically-invested firms has stalled at around $10.6 billion. Indeed, domestic firms' exports contracted both in the first quarter of 2015 and the fourth quarter of 2014. In the first quarter, domestic firms' trade deficit widened to $3.8 billion compare to $2.4 billion at the same period last year. These firms are primarily responsible for the widening of Vietnam's overall trade deficit, to $1.8 billion in this quarter just finished. Foreign-invested firms, on the other hand, actually saw their trade surplus rise to $3.5 billion in the first quarter, up from $2 billion in the same period of 2015.

Over the past five years, Vietnam's stellar export story has been driven increasingly by foreign-invested enterprises. This is not necessarily a bad development as it gives domestic firms an opportunity to tap into global supply chains and gain efficiency.

However, the disappointing performance of domestically-invested firms suggests that this process is not happening quickly enough, and that technology spill-overs from FDI have been limited. Without a proactive strategy to help domestic firms upgrade their technological knowledge, the benefits of FDI will be limited even as the country continues to offer incentives, such as tax breaks, to attract high-tech FDI.

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