Academic journal article Journal of Southeast Asian Economies

Managing Success in Vietnam: Macroeconomic Consequences of Large Capital Inflows with Limited Instruments

Academic journal article Journal of Southeast Asian Economies

Managing Success in Vietnam: Macroeconomic Consequences of Large Capital Inflows with Limited Instruments

Article excerpt

I. Introduction

Attracting foreign direct investment (FDI) has been a key focus of market-oriented policy reforms in Vietnam. The thrust to encourage FDI is rooted in the belief that it can play a catalytic role in supporting the process of economic transition, and act as a conduit for revitalizing the private sector. Vietnam has experienced spectacular economic growth over the past decade (Table 1). This has been achieved mainly by rapid growth in capital. Capital has been drawn into countries such as Vietnam through reductions in required rates of return as a result of policies, which encourage FDI. Vietnam has policies that range from tax holidays to direct subsidies to measures designed to increase the security of foreign investment.

Although much has been written on the role and impacts of FDI in developing countries, previous studies have focused on the direct developmental impacts of FDI, and generally ignored macroeconomic consequences. There are potentially significant macroeconomic consequences of capital inflows, especially if such flows are large and rapid, that need to be considered in an overall assessment of the costs and benefits of playing host to FDI. These macroeconomic aspects can be particularly important in transitional economies like Vietnam, where at least some of the instruments of macroeconomic stabilization may be blunt or unavailable. So far, such macroeconomic consequences have been largely ignored, and this study aims to overcome this limitation.

The study is in two parts. The first will examine the trends, determinants and impacts of FDI, while the second will examine issues relating to managing the macroeconomic consequences of FDI inflows. The paper is organized in six sections. In order to provide the setting for the first part, we begin in section II with an overview of policy relating to FDI, focusing on recent reforms. Section III maps the trends and patterns of FDI inflows, including source country composition, and sectoral and geographical distribution. Evidence relating to the impacts of FDI on the host economy is summarized in section IV. Section V deals with the macroeconomic consequences of capital inflow. Large inflows of FDI can have wide-ranging consequences on transitional economies, and unless managed capably, can result in macroeconomic imbalances and even crises. In dollarized economies in particular, where the ability to conduct open-market operations or, more generally, implement an independent monetary policy, may be impaired, the result can be sharp rises in inflation. In this section, we also examine what policies are available to transitional economies like Vietnam, where the full complement of macroeconomic instruments may not be available. A final section concludes.

II. Investment Policy

The opening of the economy to FDI was part of Vietnam's "Renovation" (Doi Moi) reforms initiated in 1986. The Vietnamese National Assembly passed the first Law on FDI on 29 December 1987. The law specified three modes of foreign investor participation, namely (i) business cooperation contracts (BCC); (ii) joint-ventures; and (iii) fully foreign-owned ventures. Foreign participation in the fields of oil exploration and communications was strictly limited to BCC. In some sectors such as transportation, port construction, airport terminals, forestry plantation, tourism, cultural activities, and production of explosives, joint ventures with domestic state-owned enterprises (SOEs) was specified as the dome for foreign entry. Fully foreign-owned ventures were to be allowed only under special circumstances relating primarily to policy priorities for domestic industrial development.

The Government provided constitutional guarantees against nationalization of foreign affiliates and the revocation of ownership rights of enterprises. The incentives offered to foreign investors included exemption from corporate tax for a period of two years, commencing from the first profit-making year, followed by a preferential corporate tax rate of between 15 per cent to 25 per cent in priority sectors (as against the standard rate of 32 per cent). …

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