How would you evaluate the current level of Vietnam’s public debt?

Mr. Do Thien Anh Tuan,
Lecturer at the Fulbright Economics Teaching Program

Over the last ten years Vietnam’s public debt has increased nearly 18 per cent annually, much higher than its rate of economic growth and resulting in a noticeable escalation in the debt-to-GDP ratio. Public debt-to-GDP announced officially by the government in 2012 was only 55.7 per cent but reflected the potential risk of the public debt burden. The current public debt-to-GDP ratio is estimated to have surpassed the level specified by the government and is about to hit the 65 per cent of GDP threshold for 2020 that was set out in the government’s financial strategy in mid-2012.

Although Vietnam defines public debt quite similarly to IMF standards, which include government debt, provincial government debt, and government debt guarantees, this definition has ignored the debts of State-owned enterprises (SOEs) - a component that plays an important role in the transformation of Vietnam’s national economy. 
In fact, if an SOE was to go bankrupt, regardless of whether its debt was secured by a government guarantee or not it would definitely require intervention by the government in one way or another. If SOE debt was counted in Vietnam’s total public debt then the actual ratio would be around 100 per cent, which still excludes outstanding loans, which account for at least 1.5 per cent of current GDP.

So what should the safety threshold be for the public debt-to-GDP ratio?

The figure of 65 per cent mentioned above, I must say, should not really be considered a safe level for Vietnam’s public debt. In fact, there is no accurate definition of a “safe level”, as it depends on various factors, one of which is institutional quality in particular. A country with good institutional quality may have a higher threshold than those with poor institutions. Moreover, the safety threshold for each country is dynamic, not static. Countries in the Eurozone have much better institutional quality than Vietnam but the threshold for their public debt is 60 per cent of individual GDP. It is unclear what basis was used for Vietnam putting the figure at 65 per cent.

Evaluation of public debt, in general, should not only look at the ratio of public debt-to-GDP for conclusions. It is important to look at the risks that the debt burden might bring. The risks are sometimes more critical than the amount of the debt themselves. Lessons from many other countries have shown that even private debt can be a heavy burden on the government budget in some specific cases.

So how do view the risk Vietnam’s current public debt may pose?

For Vietnam, public debt has potential risk in both the short term and the long term. First of all, there is currently no sign of a decline in the amount of public debt. After nearly 30 years of reform there has not been a single year that Vietnam experienced a budget surplus to subsidize its public debt repayments. What Vietnam does is pay old debt by acquiring new loans.
According to the loan and repayment plan approved by the government, Vietnam has dedicated VND70 trillion ($3.27 billion), or nearly 20 per cent of its total new loans of VND367 trillion ($17.17 billion), to rollovers. Repaying debt in this way is never sustainable.

Vietnam’s economic growth, moreover, has been quite sluggish in recent years. Many enterprises have declared bankruptcy in the last few years and that has had a direct impact on State budget revenue. Meanwhile, the need to expand fiscal policy to foster demand in the national economy will definitely put more pressure on the country’s budget deficit and public debt.
Public investment, however, is not very efficient and corruption is still an issue. It is normal for governments to borrow for the purpose of public investment but the loans should be used efficiently. Furthermore, public investment in Vietnam should not overly impact on business opportunities and on the resources of the private sector.

In addition to public investment, it is also critical to look at the debts of SOEs. Many SOEs are operating inefficiently despite being given many privileges and protection from competition in some cases. The debts of SOEs that are partially guaranteed by the government have already been counted in the public debt figure, but those that have not been guaranteed currently have a significant chance of turning into public debt.

In the structure of public debt, overall foreign debt accounted for approximately 41 per cent of GDP, posing a variety of challenges in operating exchange rates. Devaluation of the Vietnam dong may be beneficial for exports and improve the trade balance but will increase the burden of foreign debt measured in domestic currency. This really is a dilemma in operating exchange rates.

Most of Vietnam’s foreign debt is preferential, such as ODA loans, but commercial loans have also increased greatly over the last few years as Vietnam has been considered a lower-middle-income economy and the costs of debt will increase as a result.

The increase in public debt will also certainly degrade Vietnam’s credit rating, which means that the government will have to pay debts at higher interest rates. A consequence of this is that it will be much more difficult for the private sector to seek low-cost credit. The private sector is therefore bearing part the public debt costs for the government.

Each Vietnamese individual currently carries approximately $900 in public debt. In terms of demographics, Vietnam is considered to be in a so-called “golden age”, but this advantage has not been used and exploited well for industrialization policies. Vietnam’s low labor productivity will not feasibly pull the country out of the middle income trap. The pressure from public debt will be extremely challenging over the next 20 or 30 years, when the “golden age” comes to an end.

What impact does the increasing public debt have on socio-economic growth?

Public debt, after all, is the debt of the people. As debt increases people might think that the government will raise tax rates in the future, but that will reduce their real incomes. People will therefore tighten their belts and that will reduce total consumption, affecting economic growth and undermining people’s confidence in the government.
More critically, public debt will not only affect the lives of the current generation but also subsequent generations. The pressure from inflation and other macro-economic instabilities will affect the distribution of social income. Salaried workers will suffer the most as their nominal wages are usually stable at low levels. The rich-poor gap will become much greater, putting pressure on the implementation of socio-economic development policies.

What, then, are the solutions?

As mentioned above, Vietnam’s economic growth is still very low and there are grounds for concern when looking at the current economic outlook, the scope of the economy, etc. The budget deficit for 2014 is expected to be 5.3 per cent of GDP and with the amount of public debt estimated there is the possibility that the current threshold for public debt, of 65 per cent of GDP, will be exceeded in 2015 rather than 2020.

To solve this problem, social policy reform by itself will not be enough. It is important to ensure that resources and opportunities are shared more equitably between people. Fiscal discipline should to be tightened, the size of the State-owned sector should be cut, privileges to SOEs should be eliminated, and institutional reform should be implemented faster. If these can be done, Vietnam will not only resolve the issue of increasing public debt but will also escape the middle income trap.