1. 10. Avoiding crises: macroeconomic management 0

2. Contents Debt, institutions and vulnerability Stabilization or growth? 1

3. Debt, institutions and vulnerability: lessons from Thailand (Siamwalla article) Rapid economic growth over a decade or more creates pr(over)confidence about future growth rates Vulnerability to a crisis: international borrowing in short- terms markets to make long-term loans in domestic markets (especially nontradables like property dev’t) Problem of excess supply and falling property prices Problem of inflation due to rises in nontradables’ prices Current account deficit due to Big inflows of borrowed foreign capital Shift in investment and labor from tradables to nontradables 2

4. Debt, institutions and vulnerability Overconfidence extends to regulators such as Central Bank – reluctance to “prick the bubble” (bring down growth rate to stabilize economy) Reluctance to acknowledge crisis, even when banks and other borrowers on int’l mkt are seen to be in deep trouble Bailouts using Gov’t money to prevent/disguise bankruptcy Institutional weaknesses made worse by diminished institutional performance (“technocracy”) Central Bank (should act to stabilize, e.g. by raising interest rates or restricting lending) not fully independent of political demands 3

5. Debt, institutions and vulnerability Central government unable/unwilling to act in national interest (i.e. stabilize economy) largely due to political dependence on support from provinces and large public corporations  need to keep money tap flowing to them Provinces/corporations pursue own interests, not concerned with national goals Corruption: political leaders benefit from preferential treatment given to provinces/public corporations Summing up: neither private actors, not State regulators, nor civil government are willing/able to act effectively for stabilization as the economy overheats  Vulnerability; with a trigger, we have macro crisis 4

6. Why macro instability matters for develop’t Inflation creates uncertainty (exchange rate, future growth) which discourages investment Perceptions of loss of regulatory/political control undermine investor confidence – int’l borrowing rates rise Liquidity falls; projects cannot be funded Lower capital inflows make current account deficit worse Inflation erodes the real incomes of the poor Lower investment  fewer jobs created Real incomes eroded by higher cost of living Credit tightening may exclude marginal (poor) borrowers 5

7. Do good times make for bad policies? 6

8. Vietnam Main development policy task: create > 1m jobs/year WTO accession January 2007  flood of FDI inflows, increased domestic borrowing in world markets Important borrowers: SOEs, provincial governments Projects: not all contribute to long-term productivity gain E.g.: Vinashin Borrowing to finance wide range of investments; total debt $4.4bn Dec. 2010: default on interest due on $600m foreign loan Spillovers to entire economy (credit rating downgrade)

9. Foreign Investment

10. Increasing growth, greater vulnerability Much of VN’s growth has been funded by loans – initially ODA (very cheap), but now at commercial rates Domestic credit growing at 30%/year Much (most?) into large dev projects and land development Land sales support provincial revenues SOEs like land development: showcase projects funded with cheap capital Private developers get quick returns on land deals But credit growth >> GDP growth fuels domestic inflation 9

11. GDP by ownership, 1995-2009 Labor force grew by >1m workers/year in 2005-09 State sector employs only 10% of total labor force.

12. Role of state-owned enterprises Favored for “leading role” in economic development Domestic monopolies, cheap land, cheap and easy credit, government contracts, … Little direct supervision over their activities Do SOEs promote development? Receive about ½ of all enterprise capital increases Many projects of dubious value to long-term growth Account for only ¼ of GDP growth Almost zero employment growth 2 005-08 growth rate of jobs: Private sector 18%; foreign- invested sector 18%; state sector 0.6% 11

14. Instability: causes and symptoms Excessive credit growth & chronic government deficit  high inflation (World food and fuel prices also contribute to inflation, but this affects all countries equally) Inflation means that savings in banks earn negative real rate of interest Inflation reduces tradable sector profits and competitiveness  current account deficit  VND is expected to depreciate  Preference for gold and US Dollars over VND  More pressure on currency (“free market rate” > official exchange rate) Defense of VND:USD exchange rate target depletes foreign reserves Currency reserves are critically low ($13bn; were $23 bn in 2008)

15. Stabilization vs. growth Much of Vietnam’s current growth is based on speculative investment Susceptibility to uncontrolled capital inflows, sparking monetary growth and demand-pull inflation Gov’t exhibits strong preference for growth over macro stability Recent stabilizations have been brief and indecisive Provinces and SOEs have too much autonomy “One of our top priorities now is to stabilize the macroeconomy in order to maintain the pace of growth” Contradiction! See: Thailand, 1996 14

16. Summing up Vietnam’s growth has been very strong… until now Continued long-run growth of GDP and jobs depends on vitality of non-State sectors Challenges they face: Crowding-out of investment by competition with SOEs Rising production costs due to land prices, inflation, congestion in cities Reduced new investment due to exchange rate instability High cost of debt due to VN’s bad credit rating Fixing these problems is necessary is growth is to continue 15

17. Could “bad times make for good policies”? In 2010-11, attempts to restrict credit growth (high bank interest rates) have been unsuccessful Biggest borrowers (SOEs) are largely outside banking system High commercial interest rates merely penalize private investors, including producers of globally competitive tradables (which also generate many jobs) Stabilization requires a sacrifice of some short-run growth Not doing so risks crisis – maybe wipe out the economic (and employment) gains of several years of growth What’s needed? Is there political will to reform the economy? Ask for an IMF loan with “structural adjustment” conditions? 16