TAKING STOCK AUGUST 2023 MAKING PUBLIC INVESTMENT WORK FOR GROWTH TAKING STOCK AUGUST 2023 MAKING PUBLIC INVESTMENT WORK FOR GROWTH @2023 The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org This work is a product of the staff of the World Bank with external contributions. The findings, interpretations and conclusions expressed in this work do not necessarily reflect the views of the World Bank and its Board of Executive Directors. The World Bank do not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations and other information shown on any map in this work do not imply any judgement on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Nothing herein shall constitute or be considered to be a limitation upon or waiver of the privileges and immunities of the World Bank, all of which are specifically reserved. All queries on rights and licenses should be addressed to the Publishing and Knowledge Division, the World Bank, 1818 H Street NW, Washington DC, 20433, USA, Fax: 202-522-2625; email: pubrights@worldbank.org. Cover design by Le Bros, photo credit @shutterstock.com 4 MAKING PUBLIC INVESTMENT WORK FOR GROWTH CONTENTS Abbreviations 7 Acknowledgements 9 Overview 10 Recent Economic Developments, Outlook, and Risks 11 Special focus: Making Public Investment Work for Growth 15 Chapter 1. Economic Developments and Prospects 18 I. Recent Economic Developments 19 The global economy is facing strong headwinds 19 Vietnam’s economic growth decelerated sharply 19 Businesses and the labor market were negatively affected 23 The current account surplus widened, despite a contraction in exports 25 As inflation fell, SBV loosened monetary policy 28 Accelerated public investment, but implementation challenges remain 31 II. Economic Outlook, Risks, and Policy Implications 32 External headwinds expected to affect economic growth in the short term 32 As growth has slowed sharply, active fiscal policy support is warranted 34 Chapter 2. Making Public Investment work for Growth 38 I. Introduction 39 Public investment level low compared to growing needs 39 Substantive scope to increase public investment efficiency 41 II. Public Investment Performance and Challenges 41 Persistent implementation inefficiencies 41 Increasing capital spending decentralization 42 Infrastructure quality lags that of regional peers 44 Challenges are further compounded by climate change 45 III. Weaknesses in the Institutional Framework 46 Interconnected issues across the entire PIM cycle 46 Misaligned spatial planning and budgeting 48 Climate change largely absent in fiscal and investment decision 50 IV. Recommendations 51 References 53 5 TAKING STOCK AUGUST 2023 BOXES Box 1.1. Securing power supply for a high-income economy 22 Box 1.2. Reforms of Vietnam’s banking laws 36 Box 2.1. Transport infrastructure constraints 40 Box 2.2. Coordination and investment challenges in the Mekong Delta region 49 FIGURES Figure 1.1. Global GDP growth 19 Figure 1.2. Global goods trade growth 19 Figure 1.3. Real GDP growth by expenditure components 20 Figure 1.4. Contribution to GDP growth by sector 20 Figure 1.5. Industrial Production Index and exports 21 Figure 1.6. Retail sales by sector 21 Figure 1.7. Contribution of different components to growth of total nominal investment 23 Figure 1.8. Enterprise entries and exits 24 Figure 1.9. New enterprises: Use of capital and labor 24 Figure 1.10. Employment 25 Figure 1.11. Average income 25 Figure 1.12. Current account balance 26 Figure 1.13. Balance of payments 26 Figure 1.14. Exchange rate 26 Figure 1.15. Merchandise trade balance 27 Figure 1.16. Services trade balance 27 Figure 1.17. FDI commitment by sector 28 Figure 1.18. Contribution to CPI inflation 29 Figure 1.19. Price indexes of selected imports 29 Figure 1.20. Interest rates 29 Figure 1.21. Credit growth 30 Figure 1.22. NPL and provision of credit institutions 30 Figure 1.23. Budget execution 31 Figure 1.24. Government revenues 32 Figure 1.25. Government expenditure 32 Figure 2.1. Public capital stock per capita and infrastructure index 39 Figure 2.2. Public capital stock per worker at different income level 39 Figure 2.3. Capital stock accumlation as a major driver for fast-growing economies 40 Figure 2.4. Persistent execution gaps (2017–2022) 42 Figure 2.5. Increasing level of provincial spending in total public investments 43 Figure 2.6. High level of decentralization compared to development peers 43 6 MAKING PUBLIC INVESTMENT WORK FOR GROWTH TABLES Table 0.1. Selected Economic Indicators, Vietnam 2020-2025 13 Table 1.1. Selected economic indicators, Vietnam 2020–2025 34 Table 2.1. Quality of infrastructure 45 ABBREVIATIONS ASEAN Association of Southeast Asian Nations CIT Corporate Income Tax CPI Consumer Price Index EMDE Emerging Market and Developing Economies EU European Union FDI Foreign Direct Investment GDP Gross Domestic Product GER Gross Expense Ratio GNFS Goods and Non-Factor Services GFCF Gross fixed capital formation GSO General Statistics Office GW Gigawatt ICOR Iincremental capital output ratio IGF Intergovernmental fiscal IMF International Monetary Fund Km Kilometer LCI Law on Credit Institutions MoF Ministry of Finance MPI Ministry of Planning and Investment MTIP Medium-Term Investment Plan NPL Non-Performing Loans NSA Not Seasonally Adjusted NTPs National targeted programs O&M Operation and maintenance ODA Official Development Assistance OECD Organisation for Economic Co-operation and Development PAM Public asset management PDML Public Debt Management Law PFS Pre-feasibility study PIL Public Investment Law PIM Public investment management 7 TAKING STOCK AUGUST 2023 PIT Personal Income Tax PPG Public and Publicly Guaranteed Debt RCC Regional Coordination Council REER Real Effective Exchange Rate SBIMIS State Budget Investment Management Information System SBL State Budget Law SBV State Bank of Vietnam SCBA Social cost benefit analysis SME Small-to-Medium Sized Enterprise SNG Subnational government SOE State-owned enterprise TOT Terms of Trade VAMC Vietnam Asset Management Company VAT Value-Added Tax VND Vietnam Dong Y/y Year-over-year 8 MAKING PUBLIC INVESTMENT WORK FOR GROWTH ACKNOWLEDGEMENTS This report was written by Dorsati Madani (Senior Country Economist), Dung Viet Do (Senior Country Officer), Quyen Hoang Vu (Senior Governance Specialist), and Thu-Ha Thi Nguyen (Research Analyst). It benefited from inputs by Chiara Odetta Rogate (Senior Energy Specialist), Ha Thi Thanh Nguyen (Consultant), Huong Thi Lan Tran (Senior Public Sector Specialist), James Anderson (Lead Public Sector Specialist), Katia D’Hulster (Lead Financial Sector Specialist), Ketut Kusuma (Senior Financial Sector Specialist), Phuong Anh Nguyen (Senior Public Sector Management Specialist), Quang Hong Doan (Senior Economist), Serdar Yilmaz (Practice Manager), Trang Minh Ta (Consultant), Tuan Minh Le (Lead Economist), and Viet Quoc Trieu (Senior Financial Sector Specialist). We are grateful to Anh Thi Quynh Le (External Affairs Officer), and Ngan Hong Nguyen (Senior External Affairs Officer) for the communication support. Khanh Linh Thi Le (Program Assistant) provided support during the preparation of the report. The team is grateful for the overall guidance of Andrea Coppola (Lead Economist and Program Leader), Sebastian Eckardt (Practice Manager; Macroeconomics, Trade, and Investment), Alma Kanani (Practice Manager; Governance), and Carolyn Turk (Country Director for Vietnam). 9 OVERVIEW MAKING PUBLIC INVESTMENT WORK FOR GROWTH RECENT ECONOMIC DEVELOPMENTS, OUTLOOK, AND RISKS Recent Economic Developments resilient foreign direct investment (FDI) and a slight pick-up in public investment, total investment The external environment remains challenging growth also declined, driven by weak private with downside risks prevailing in the near- domestic investment which slowed substantially term. Global GDP growth is projected to decline to 2.1 to 2.4 percent (y/y) from 11.8 percent (y/y) during percent in 2023 from 3.1 percent in 2022, reflecting the same period last year. weakening demand in most advanced economies. In line with slower global growth, global trade growth The slowdown in aggregate demand is is estimated to weaken from 6 percent in 2022 to 1.7 mirrored on the production side of GDP. percent in 2023. Reflecting the contraction in export demand, the contribution of the industrial sector to growth fell After registering 8 percent real GDP growth to 0.4 percentage points during the first half of the in 2022, Vietnam’s economic growth year, compared with 2.8 percentage points during decelerated sharply in the first half of 2023, the same period last year. Exacerbating the effects reflecting a slump in external and weaker of the export demand shock, recurrent power domestic demand. Vietnam’s real GDP growth outages which affected northern Vietnam in May slowed to 3.7 percent year-on-year (y/y) during and June 2023 disrupted economic activities with the first half of 2023,1 well below growth posted losses estimated at 0.3 percent of GDP. Meanwhile, during the same period in 2022 (6.4 percent, y/y). services sector growth contributed 2.8 percentage The slowdown was led by a sharp deterioration points to overall GDP growth in the first half of the in external demand with exports contracting year, compared with 2.9 percentage points during by 12 percent (y/y) in the first half of 2023. This the same period last year, as stronger performance in turn weighed on the performance of the in the hospitality sector driven by the recovery of export sector, which is estimated to account for domestic and foreign tourism offset normalizing 50 percent of Vietnam’s GDP.2 Simultaneously, retail and wholesale trade. The contribution of the domestic demand moderated due to fading base agricultural sector to growth remained stable but effects3 from last year’s post-COVID rebound and low at 0.3 percentage points. weakening consumer confidence. Growth in final consumption expenditure4 slowed to 2.7 percent Businesses and the labor market have (y/y) in the first half of the year, compared with been negatively affected by the economic 6.1 percent (y/y) in the first half of 2022. Despite downturn. In an April 2023 survey of 10,000 firms 1 Real GDP grew by 3.3 percent (y/y) in Q1-2023, lower than other economies in East Asia except Thailand, but slightly improved to 4.1 percent (y/y) in Q2-2023. 2 The size of the export sector is measured by the domestic value-added -direct and indirect- from exports as a share of GDP. Source: Martins Guilhoto, J., C. Webb and N. Yamano (2022), “Guide to OECD TiVA Indicators, 2021 edition”, OECD Science, Technology and Industry Working Papers, No. 2022/02, OECD Publishing, Paris, https://doi.org/10.1787/58aa22b1-en. The value 50 percent is for 2019. 3 In 2022, economic growth in Vietnam benefited from low-base effects associated with the strong impact of the COVID pandemic on economic activity in 2021. 4 Final consumption expenditure refers to the sum of household final consumption expenditure (formerly private consumption) and general government final consumption expenditure (formerly general government consumption). 11 TAKING STOCK AUGUST 2023 by the Private Sector Development Committee, 60.1 first quarter of 2023, bringing the total to US$88.7 percent of firms reported a reduction in revenue of at billion, equivalent to 3.3 months of imports. least 20 percent during the first four months of 2023 and 59.2 percent reported reduction in orders. 71.2 Headline inflation declined quickly thanks percent reported a cut of at least 5 percent of their to the slowdown of fuel prices in global and labor force in the first four months of the year.5 At the domestic markets and a slowing domestic national level, growth in employment slowed from consumption, while core inflation decelerated 2.2 percent (y/y) in the first quarter of 2023 to just more slowly. The CPI fell from 4.9 percent (y/y) 1.4 percent (y/y) in the second quarter of 2023, well in January 2023 to 2 percent (y/y) in June 2023. below an average pre-covid level of about 4 percent. Meanwhile, core inflation (which excludes food, The external demand shock has especially affected fuels, and government administered prices) slowed export-oriented manufacturing firms and workers from 5.2 percent (y/y) in January to 4.3 percent with some export hubs such as the Southeast region (y/y) in June, as second-round effects of the 2022 (which includes Ho Chi Minh City and surrounding commodity price shock persisted, including provinces)6 experiencing an almost 62 percent through higher costs of construction materials and jump in the number people approved to receive subsequently of housing. unemployment benefits in the second quarter of 2023 compared to the first quarter of the year.7 Amid decreasing inflationary pressures and slowing growth, the SBV loosened monetary The current account surplus widened (1.5 policy to buttress the economy. The SBV reduced percent of GDP) in the first quarter of 2023, discount and refinancing rates by a cumulative 150- despite a contraction in exports. The positive 200 bps through a series of four policy rate cuts external position was the result of a solid inflow of between March and June 2023 to 3 percent and remittances, resilient foreign direct investment, a 4.5 percent, respectively. Despite these cuts, credit narrowing deficit in the services trade balance as growth slowed from 16.8 percent (y/y) in June 2022 foreign tourism continued to recover, and a surplus to 7.8 percent (y/y) in June 2023, reflecting weaker in the merchandise trade balance. The surplus in credit demand from businesses. Asset quality has the merchandise trade balance was caused by the been deteriorating with nonperforming loans (NPLs) fact that the contraction in imports (-15.3 percent, rising from 1.9 percent in December 2022 to 2.9 y/y, in Q1-2023) outpaced the contraction in exports percent in March 2023, compelling the SBV to re- (-11.7 percent, y/y, in Q1-2023). Despite declining introduce regulatory forbearance measures.8 commitments, foreign direct investment (FDI) disbursement remained resilient (US$10 billion) in Accelerated public investment supported the first half of the year. Consequently, the overall the slowing economy, but implementation balance of payment position improved with the State challenges remain. The 2023 mid-year fiscal Bank of Vietnam (SBV) accumulating additional balance registered a smaller estimated surplus (1.5 US$1.6 billion in foreign reserves by the end of the percent of GDP) than a year ago (5.2 percent of GDP) 5 Private Sector Development Committee, April 2023. 6 The Southeast Region includes Ho Chi Minh City and Provinces of Dong Nai, Binh Duong, Ba Ria – Vung Tau, Binh Phuoc and Tay Ninh, contributing about 32 percent of GDP. The region is home to 18.7 million people or about 19 percent of Vietnam population. 7 Ministry of Labor, Invalids and Social Affairs, June 2023 8 Circular 02/2023/TT-NHNN allows banks to restructure loans and stagger provisions over multiple financial years when owed by borrowers which are facing payment difficulties but who have been assessed to be capable to repay principal and/or interest according to the restructured repayment term. 12 MAKING PUBLIC INVESTMENT WORK FOR GROWTH as revenue collection contracted by 7 percent in the lower private investment. With the easing of the first half of 2023 compared to a year ago due liquidity conditions and SBV’s renewed guidance to the slowing economic activities. Meanwhile, on loan forbearance, the financing constraints in total expenditure rose by 12.8 percent (y/y) in the the real estate/construction sectors are expected first half of 2023, due to a 43 percent (y/y) increase to ease, supporting a moderate recovery of private in public investment disbursement related to investment from 2024 onward. implementation of the investment component (valued at 1.6 percent of GDP) of the 2022-2023 The CPI is expected to rise slightly from an Socio-Economic Recovery Plan. However, the average 3.1 percent in 2022 to an average estimated cumulative disbursement of the public 3.5 percent in 2023. The deflationary impact of investment budget remained low at 30.5 percent of slower growth and a VAT rate cut from 10 percent the annual budget at the end of June 2023. to 8 percent rolled out for the second half of 2023 is expected to be more than offset by a civil Outlook, risks, and policy implications service salary increase of 20.8 percent. The CPI will moderate to 3.0 percent in 2024 and 2025 based on Vietnam’s economy is expected to grow by the expectation of stable commodity and energy 4.7 percent in 2023, with a slow projected prices in 2024. recovery to 5.5 percent in 2024 and to 6.0 percent in 2025. While softening, domestic The fiscal balance is expected to register a demand is expected to be the main driver of small deficit of 0.7 percent of GDP in 2023. growth in 2023. Private consumption will remain Fiscal policy is expected to remain moderately resilient, - growing 6.0 (y/y) percent, albeit slowing supportive of the economy in 2023 given public below its pre-pandemic growth of 7 percent (y/y) investment implementation challenges. Starting in 2019, and contributing 3.4 percentage points to in 2024, the government will gradually move GDP growth. Overall, investment will contribute 1.8 back to consolidate its fiscal stance, in line with percentage points to growth. Private investment is the Financial Strategy for 2021-2030. Public expected to remain subdued, growing 4.3 percent and Publicly Guaranteed debt (PPG) will remain (y/y) compared to 8.2 percent (y/y) in 2019 due sustainable, stabilizing at an estimated 36 percent to uncertainties in the external environment, of GDP in 2023 before falling to an estimated 34.4 contributing 1.2 percentage points to GDP growth. percent in 2025. The current account is expected Public investment is expected to increase 9.5 to gradually improve, thanks to a modest recovery percent (y/y) contributing 0.6 percentage points to of exports, continued recovery of international GDP growth, but only partially compensating for tourism, and resilient remittances. Table 0.1. Selected Economic Indicators, Vietnam 2020-2025 Indicator 2020 2021 2022e 2023f 2024f 2025f GDP growth (%) 2.9 2.6 8.0 4.7 5.5 6.0 Consumer Price Index (average, %) 3.2 1.8 3.1 3.5 3.0 3.0 Current account balance (% of GDP) 4.3 -2.1 -0.3 0.2 0.5 1.0 Fiscal balance (*) (% of GDP) -2.9 -3.4 -0.3 -0.7 -0.3 -0.2 Public debt (% of GDP) 41.3 39.3 35.7 36.0 35.2 34.4 Source: GSO; MOF; SBV; IMF; and World Bank staff calculations. Note: e = estimate; f = forecast, *: excluding unallocated expenditures and following GFS. 13 TAKING STOCK AUGUST 2023 The outlook is subject to heightened domestic in the recent past, for example reaching only 67.3 and external risks. Slower-than-expected growth percent in 2022.9 Steps to accelerate and improve in advanced economies and China could further the efficiency of implementation would also help dampen external demand for Vietnam’s export address emerging infrastructure constraints to sector, whose size is estimated at 50 percent of growth, including critical investment needed GDP. Continued uncertainties in the global financial in the electricity transmission network and in market have the potential to rekindle stress in building resilience to climate change. These steps the global banking sector, intensify investor risk include setting investment targets and enforcing aversion, and discourage investment – including FDI accountability at different intergovernmental to Vietnam. Additional monetary policy tightening levels for achieving them; focusing on key in major advanced economies to combat persistent national investment programs such as national inflation could widen the interest rate gap between expressway, power transmission and national international and domestic markets. This could target programs; allowing flexibility in rules exert exchange rate pressures on the local currency. related to budget allocation for the projects Moreover, an escalation of geopolitical tensions and identified as part of 2022-2023 Socio-Economic climate-related disasters pose additional downside Recovery Program; and allowing some flexibility risks for the country, including through rising food on certain advance procurement activities before and fuel prices. Domestically, the financial sector budget allocation. faces heightened vulnerabilities and risks that warrant close monitoring and reforms. In addition to public investment, supporting workers and families affected by the slowdown Since the economy is constrained by weak through a more effective social protection system aggregate demand and growth has fallen could also help support aggregate demand. To significantly below potential active policy successfully do so, the authorities need to reform support is warranted: the targeting approaches and delivery mechanisms of the social protection system so it might serve z Given ample fiscal space, fiscal policy as an agile tool to support the vulnerable during should take the lead, ensuring a much economic shocks. better implementation of the investment budget for 2023. A full implementation of the z Fiscal policy support should be planned investment budget would bring public accompanied by continued monetary policy investments to 7.1 percent of GDP in 2023, up accommodation but the space for additional from 5.5 percent planned in 2022, providing a loosening is constrained. As credit demand has fiscal impulse of 0.4 percent of GDP to support remained persistently low despite interest rate aggregate demand. The government has planned cuts, further reducing interest rates may not have a 38 percent increase (y/y) in public investment the desired effect of incentivizing credit growth. for 2023 – equivalent to 1.6 percent of GDP (as Also, further interest rate cuts would increase part of 2022-2023 Socio-Economic Recovery the interest rate differential with global markets, Program). It is accelerating implementation with potentially putting pressure on the exchange rate. disbursement of the public investment budget jumping by 43.3 percent (y/y) during the first z Addressing heightened financial risks and semester of 2023. However, historical public financial sector vulnerabilities requires investment implementation rates have been low reforms to improve bank capital adequacy 9 Of planned budget approved by the National Assembly, as of December 31, 2022. 14 MAKING PUBLIC INVESTMENT WORK FOR GROWTH ratios and strengthen institutional framework in turn enhancing their contribution to sustainable for prudential supervision, early intervention, growth. Furthermore, building medium-term bank resolution, and crisis management. These resilience in exports is important to mitigate risks reforms are expected to help authorities effectively associated with external shocks. Diversifying the monitor and intervene in troubled financial product base and export destinations helps reduce institutions, preventing the escalation of crises and reliance on specific markets and products, making minimizing systemic risks. Additionally, a robust economies more resilient to global economic bank resolution framework is crucial to facilitate the fluctuations. Additionally, fully utilizing existing orderly resolution of any failed banks, protecting Free Trade Agreements (FTAs) can unlock market depositors and preserving financial stability. opportunities, boost exports, and foster economic integration with partner countries. z Launching a new round of structural reforms would help enhance the productivity z In the medium term, fiscal policy can also and sustainability of economic growth, help enhance the sustainability of Vietnam’s contributing to its ambitions to become a high- economic growth. For instance, fiscal policy income country by 2045. Continued reforms to can help build resilience to climate change by lighten the regulatory burden on businesses are incentivizing green production and consumption. necessary for productivity gains and increased Implementing carbon taxation and other fiscal competitiveness. More critically, relaunching the instruments can incentivize industries to reduce State-Owned Enterprises (SOEs) reform can act their carbon footprint and adopt more sustainable as a catalyst to attract private sector participation, practices. Simultaneously, providing time bound improve productivity, and ultimately boost overall fiscal incentives for green consumption, such as tax economic performance. Promoting an inclusive breaks or subsidies for eco-friendly products, can financial sector can empower individuals and encourage individuals to make environmentally businesses to participate fully in economic activities, conscious choices. SPECIAL FOCUS: MAKING PUBLIC INVESTMENT WORK FOR GROWTH Vietnam, in seeking to reach upper middle- infrastructure during the 2021-2030 period.10 income status by 2030 and high-income Despite growing needs, Vietnam’s public status by 2045, aspires to become a modern investments have been on a declining trend from and industrialized nation with a higher 8 percent of GDP in 2011 to 6 percent in 2022. quality of life for its citizens. To achieve this While every effort should be made to reverse this ambitious development goal, the Vietnamese trend,11 improving the efficiency of investment Government estimates that it needs to invest is also key, as it would have a major impact on an average of 7.3 percent of GDP annually into aggregate productivity growth and GDP levels. Socio-Economic Development Strategy 2021–2030 and National Development Masterplan 2021–2030, vision 2050. 10 The economy remains relatively capital scarce with a public capital stock per capita and per worker well below upper middle-income and high- 11 income countries. Meanwhile, global experience suggests that capital accumulation as the most important driver for fast-growing countries when they were at Vietnam’s level of development. 15 TAKING STOCK AUGUST 2023 The investment budget decline is compounded time-for all infrastructure at national and sub- by persistent allocative, technical, and national levels. operational inefficiencies. Between 2011 and 2019, it took more than six Vietnamese dongs in Since the 1990s, the Vietnamese Government investment to generate one Vietnamese dong in has embarked on a policy of spending additional output.12 As a result, Vietnam achieves decentralization. The share of central government much less growth per dollar of investment than investment in total public investment declined China, Malaysia, Republic of Korea, Singapore, and from 40 percent in 2017 to 20 percent in 2022. This Thailand at comparable levels of per capita income decentralization policy has channeled an average and development. Vietnam’s infrastructure quality of 80 percent of public investment (2017-2022) ranked 77th out of 141 countries worldwide,13 behind through subnational governments (SNGs), more regional peers such as China, India, Indonesia, than double the averages in unitary countries (34.5 Malaysia, and Thailand—countries that Vietnam is percent) and overall (39.5 percent). This devolution competing with for FDI. Investment budgets suffered of spending decisions to provincial authorities from chronic under-execution with only 77 percent of has created many positive outcomes, particularly allocations spent between 2017 and 2022. The large in service delivery. However, it has led to weak differences between budgeted and actual spending coordination across provinces and with central (23 percent), and the consequential high capital government and to proliferation of duplicate expenditure carried over from one year to the next, investments which are executed by both the central are significantly larger than in many peer countries, government and 63 provinces. There has been and way beyond international good practices which over-investment by provinces in low value, disjoint suggest the variation levels to be below 5 percent.14 projects and stranded assets, with potential negative Public investment management (PIM) inefficiency impact on the environment (such as low-occupancy is also manifested in significant project completion industrial parks and provincial ports). Consequently, delays and cost overruns. A recent World Bank inefficiencies have arisen from allocative duplications, review15 of selected, large-scale transport projects implementation challenges, negative externalities, found an average delay time of five years, and an and sub-optimal private sector mobilization and average cost overrun double the original cost at the financing. Vietnam has pursued several approaches to design and budget allocation stage. regional investment coordination; however, none has produced the expected results due to legal constraints In addition, public asset management remains and the lack of effective financing arrangements. inadequate. Post-construction infrastructure assets are not properly recorded nor managed after project Vietnam’s public investments and assets completion, causing inadequate maintenance of are increasingly exposed to growing climate public assets. Overall, it is estimated that the budget change related risks. These include physical only financed 40 percent of minimum needs in threats related to extreme weather events and road infrastructure maintenance.16 There are no up- climate change, and transition risks as the country to-date and integrated asset registries that capture commits to net zero emissions by 2050. Vietnam’s information—such as cost of investment, operation total incremental financing needs for the resilient and and maintenance, location, and price of asset over decarbonizing pathways could reach an estimated 12 Incremental capital output ratio (ICOR) data from Vietnam General Statistics Office (GSO). 13 World Economic Forum - The Global Competitiveness Index (2019). 14 Public Expenditure and Financial Accountability (PEFA) Framework. 15 Regional Investments in Vietnam: Challenges and Opportunities (World Bank Policy Note, 2023). In the same review, it is noted that time overrun tends to vary more widely between one to three years in the case of smaller projects. 16 Vibrant Vietnam: Forging the Foundation of a High-Income Economy” (World Bank Report, 2019). 16 MAKING PUBLIC INVESTMENT WORK FOR GROWTH US$701 billion over 2022-2040, or approximately 6.8 would be to separate land clearance and resettlement percent of GDP per year.17 Public investment—with its from the investment project particularly for large critical role as catalyst for private investment—would projects. Central ministries and provinces should account for more than one-third of the financing develop a systemic digital mechanism to identify needs, or about 2.4 percent of GDP. However, projects with a high risk of failure and streamline climate change adaptation is not fully accounted for steps for project adjustment and/or termination. Also, in the overall fiscal strategy nor in prioritization of the scope and depth of ex-post project assessments projects for budget funding in Vietnam. Subnational should be increased, at least for all large and medium governments are least prepared as they lack policies projects. Public asset management also needs to be and processes to assess and mitigate climate change’s strengthened to maximize the impact of the project physical and transition risks on large investments and after completion. Foundational steps would include assets. The lack of information on the value of assets establishing a database of all infrastructure values, and their risk exposure increases the cost of their using technology applications and data analytics insurance. Transboundary development challenges for budget allocation decisions for operations and are emerging more frequently with more severity maintenance (O&M) and new investments, and and require coordinated actions across various levels phasing in infrastructure asset accounting and of government. reporting reforms. Going forward, realizing the power of public z To rationalize intergovernmental fiscal investment in Vietnam will require sustaining institutions, it is recommended that inter its level, rationalizing its composition, and alia the government consider rebalancing addressing the shortcomings in investment the infrastructure investment budget from management and intergovernmental fiscal provincial level to central level. The budgets institutions—in ways that support Vietnam’s could be made more strategic and programmatic, move to a more resilient and greener model. instead of a list of fragmented individual projects, More specifically, the government may consider the through improving budget classification structures following measures in the short to medium-term. and operationalizing more effectively the “public investment program” modality to facilitate policy z To strengthen public investment management orientation (including regional development, green institutions, the government will need to transition, and climate resilience). In light of the improve the “quality-at-entry” of projects upcoming revision of the State Budget Law, the fiscal through providing more time and budget, and decentralization framework should be modernized— methodological guidelines to prepare project including on SNG own-source revenue assignments, pre-feasibility studies. It will be important to revenue sharing arrangements, equalization rules, regularly update unit costs and land prices close to and transfers mechanisms—to better balance market prices to ensure cost estimates are realistic. the needs of central government and SNGs and To enhance the impact of public investment on incentivize green and climate actions across levels climate resilience, the government should also of government. Legal impediments to inter-linked mandate climate change screening from the early public investment across levels of government stage of project preparation and evaluate adaptation should be unlocked. Last but not least, new co- measures in pre-feasibility studies and feasibility financing mechanisms should be institutionalized studies of projects with high risks. It is equally vital to based on a well-defined formula that integrate accelerate project implementation. A practical action external and domestic financing considerations. 17 Vietnam Country Climate Development Report (CCDR) (World Bank, 2022). 17 CHAPTER 1. ECONOMIC DEVELOPMENTS AND PROSPECTS MAKING PUBLIC INVESTMENT WORK FOR GROWTH I. RECENT ECONOMIC DEVELOPMENTS The global economy is facing strong headwinds Global economic growth is expected to decelerate substantially from 3.1 percent in 2022 to 2.1 percent in 2023 (Figure 1.1). This slowdown is due to the continued tightening of monetary policy to control high inflation and weakening demand in most advanced economies.18 Inflation is projected to decline gradually as demand weakens and commodity prices decrease but remain well above pre-pandemic levels. Global trade is expected to grow by only 1.7 percent in 2023 (2.6 percentage points lower than June 2022’s forecast, Figure 1.2). Figure 1.1. Global GDP growth Figure 1.2. Global goods trade growth Percent (y/y) Percent (y/y) 2022 2024f (Jun-23) Growth June-23 forecasts June-22 forecasts 2023f (Jun-23) 2023f (Jun-22) 25 88 66 15 44 5 22 00 -5 World Advanced China States Area EMDEs EMDEs States EuroArea World China Advanced Euro United -15 United 2018 2019 2020 2021 2022 2023f 2024f Source: Global Economic Prospects, June 2023, World Bank Vietnam’s economic growth decelerated sharply After registering 8 percent real GDP growth in 2022, economic growth decelerated sharply in the first semester of 2023, reflecting a slump in external and weaker domestic demand. Vietnam’s real GDP growth slowed to 3.7 percent (y/y) during the first semester of 2023,19 well below growth posted during the same period in 2022 (6.4 percent, y/y) (Figure 1.3). The slowdown was led by a deterioration of external demand with exports contracting by 12 percent (y/y) in the first half of 2023, in turn weighing on the performance of the export sector, which is estimated to account for 50 percent of Vietnam’s GDP directly and indirectly.20 Simultaneously, domestic demand also moderated after the last’s 18 World Bank, Global Economic Prospects, June 2023. 19 Real GDP grew by 3.3 percent (y/y) in Q1-2023, lower than other economies in East Asia except Thailand, but slightly improved to 4.1 percent (y/y) in Q2-2023. 20 The size of export sector is measured by the domestic direct and indirect value-added from exports as a share of GDP. Source: Martins Guilhoto, J., C. Webb and N. Yamano (2022), “Guide to OECD TiVA Indicators, 2021 edition”, OECD Science, Technology and Industry Working Papers, No. 2022/02, OECD Publishing, Paris, https://doi.org/10.1787/58aa22b1-en. The value 50 percent is for 2019. 19 TAKING STOCK AUGUST 2023 year strong post-COVID rebound, due to fading base effects and weakening consumer confidence. Growth in final consumption expenditure slowed to 2.7 percent (y/y) in the first half of the year, compared with 6.1 percent (y/y) in the first semester of 2022. Despite resilient foreign direct investment (FDI) and a slight pick- up in public investment, total investment growth also declined, driven by weak growth in private domestic investment which slowed substantially to 2.4 percent (y/y) in the first semester of 2023 from 11.8 percent during the same period last year. Figure 1.3. Real GDP growth by Figure 1.4. Contribution to GDP growth expenditure components by sector Percent (y/y, NSA) Percentage points (y/y, NSA) Final consumption Investment Agriculture Industry Exports Imports Services GDP Real GDP Tiêu dùng cuối cùng Đầu tư Xuất khẩu Nhập khẩu GDP Agriculture Industry Services GDP 25 25 8 8 20 7 7 15 15 6 6 10 7.43 6.46 5 5 7.12 5.76 3.72 4 5 1.74 5 4 0 0 3 3 -5 -5 2 2 -10 11 -15 -15 0 0 H1-18 H1-18 H1-19 H1-19 H1-20 H1-20 H1-21 H1-21 H1-22 H1-22 H1-23 H1-23 H1-18 H1-18 H1-19 H1-19 H1-20 H1-20 H1-21 H1-21 H1-22 H1-22 H1-23 H1-23 Source: GSO and World Bank staff calculations The slowdown on the demand side is mirrored on the production side of GDP. Reflecting the contraction in export demand, the contribution of the industrial sector to GDP growth fell to 0.4 percentage points during the first half of the year, compared with 2.8 percentage points during the same period last year. Meanwhile, services sector contributed 2.8 percentage points to overall GDP growth in the first half of the year, compared with 2.9 percentage points during the same period of 2022, as stronger performance in the hospitality sector driven by the recovery of domestic and foreign tourism offset normalizing retail and wholesale trade.21 The contribution of the agricultural sector to GDP growth remained stable but low at 0.3 percentage points (Figure 1.4). The slump in external demand and recurrent power outages dampened performance of Vietnam’s export-oriented manufacturing sector. Tracking weakness in exports, industrial production contracted by 0.4 percent (y/y) in the first quarter of 2023 and subsequently expanded marginally by 2.5 percent (y/y) in quarter 2 (Figure 1.5).22 Weaker external demand affected all key manufacturing exports in the first half of 2023, including garments and footwear (-6.8 percent, y/y), computers and other electronic products (-4.6 percent, y/y) and furniture (-7.7 percent, y/y).23 In addition, frequent rolling power outages 21 According to GSO, tourism and travel services grew by 65.9 percent y/y in the first half of 2023, while accommodation, food, and beverage services grew by 18.7 percent y/y in the same period. The number of foreign visitors increased from 0.6 M in H1-2022 to 5.6 million in H2-2023. The number of domestic visitors increased slightly from 60.8 million in H1-2022 to 64 million in H1-2023. 22 Reflecting the contraction in industrial production, imports also contracted 17.9 percent y/y, in H1-2023 23 Havers Analytics and World Bank staff calculations. 20 MAKING PUBLIC INVESTMENT WORK FOR GROWTH that affected northern Vietnam in May and June 2023 disrupted production and are estimated to have had a negative 0.3 percent impact on GDP (Box 1.1). Figure 1.5. Industrial Production Index and Exports Figure 1.6. Retail sales by sector Percent (y/y, NSA) Percent (y/y, NSA) Exports (fob) Industrial Produc�on Index Total Goods Services Exports (fob) Industrial Production Index Total Goods Services 60 60 220 220 50 50 180 180 40 40 140 140 30 30 20 100 100 20 10 60 60 10 0 20 20 0 -10 -10 -20 -20 -20 -60 -60 -30 -20 -40 -30 -100 -100 Jun-19 Dec-19 Jun-19 Dec-19Jun-20 Dec-20 Jun-20 Dec-20Jun-21 Dec-21 Jun-22 Jun-21Dec-21 Jun-22 Dec-22 Dec-22 Jun-23 Jun-23 Jun-20 Jun-20 Jun-21 Jun-21 Jun-22 Jun-22 Jun-23 Jun-23 Source: GSO and World Bank staff calculations Note: Industry includes construction Meanwhile, private consumption also slowed due to fading base effects from last year’s strong post-COVID rebound and weakness in consumer confidence. Growth of retail sales – a proxy for private consumption – slowed to 10.9 percent (y/y) in the first half of 2023 (compared with 12 percent (y/y) in the first half of 2022), with monthly retail sales growth showing a steady deceleration from 12.8 percent (y/y) in January to just 6.5 percent (y/y) in June (Figure 1.6).24 This slowdown in private consumption is partly due to fading low-base effects but also reflects fragile consumer confidence and stagnating average incomes partly related to the effects of the external demand shock on the labor market. A June 2023 consumer survey found that 43 percent of respondents saw the economic situation as worse than a year ago compared to 27 percent in January 2023.25 Data shows that average income stagnated at VND 6.3 million (real) in the first semester of 2023 after the steady improvement registered during 2022 (Figure 1.11).26 Total investment slowed substantially due to weaker private investment, which was only partially offset by a pickup in public investment. Growth in total investment slowed substantially to 4.7 percent (y/y) in the first semester of 2023, compared with 10.7 percent (y/y) in the same period of 2022, due to weaker private investment given slowing domestic and external demand (Figure 1.7). The contribution of private domestic investment to total investment eased to 1.4 percentage points in the first semester of 2023 24 Sales of goods, which contributes about 70 percent to total retail sales, slowed from 9.7 percent y/y in January 2023 to 6 percent y/y in February, well below the pre-pandemic growth rates (11.9 percent y/y), due to knock-on effects of the external demand shock and loss in consumer confidence. The substantial slowdown in sales of services is largely due to the base effect (post-pandemic normalization in sales) in tourism and hospitality services (36 percent y/y in January to 6.5 percent y/y in June). 25 Infocus, Consumer Survey June 2023. 26 GSO data, World Bank staff calculations. 21 TAKING STOCK AUGUST 2023 in contrast to 7 percent a year ago. The slowdown is related to the knock-on effect of slowing exports and expectations of continued unfavorable global economic developments, with private domestic firms cautious about making new investment (see below).27 The contribution by FDI firms to total investment also fell (0.2 percentage point) in the first semester of 2023 compared to one year earlier (1.5 percentage point). On the other hand, public investment (financed by the state budget) jumped by 43.3 percent (y/y) in in the first semester of 2023 (Figure 1.25), contributing 3 percentage points to total investment. Its share of total investment inched up from 20.9 percent in 2022 to 22.1 percent in the first semester of 2023. Box 1.1. Securing power supply for a high-income economy The power sector has been an enabler of Vietnam’s fast and inclusive economic development over the past three decades. By the end of 2021, 99.8 percent of the population had access to electricity. During the period 2000–23, the power sector was able to serve a parallel 10 percent annual electricity demand growth by installing a 16-fold larger generation capacity (5GW in 2000, 81GW in 2023). Transmission backbone lines also expanded almost four-fold over the same timeframe and overall, the sector has provided reliable electricity services for a growing population and economy. However, during May and June 2023, northern Vietnam experienced recurrent power outages that affected households and enterprises on a large scale. In May 2023, a peak demand supply deficit of 5.4GW occurred.28 The situation improved over June, and was resolved in July due to increased water availability. Power shortages during dry season already occurred in the summer of 2022 with an estimated peak demand supply deficit of 1.8GW. The preliminary estimate of economic costs for the May-June power outages is about US$1.4 billion (or 0.3 percent of GDP).29 In a small industry survey, businesses in the north reported losses of up to 10 percent of revenues.30 Based on the estimated supply deficit through June, unserved energy will also result in lost revenues for Vietnam Electricity (EVN) of approximately US$75 million.31 Supply imbalances are currently a northern issue, where demand has been growing at a higher rate (10 percent compared to 8.5 percent nationwide) and becoming more seasonal in May-July. This results from the combined effect of a supply reliance on hydro and coal-based generation32 and delays in generation and transmission investments, the latter preventing access to large surplus capacity in the south (about 20GW).33 The impacts of El Nino on water availability and electricity demand, and a greater reliance on hydropower due to increased fuel prices, highlighted regional vulnerabilities to climate change impacts (extreme temperatures and greater uncertainty in hydrological conditions) and commodity risks (global fuel price shocks).34 Prompt action is needed to mitigate future risks to energy security and economic losses. Demand side management interventions can be deployed immediately to tackle power shortages, for example load shifting of industrial loads. Critical short-term measures include: (i) avoiding any delays in the 2024 and 2025 schedules for power plant commercial operations, (ii) fast-tracking approval and implementation of transmission investments, and (iii) diversifying supply resources, from the composition of the energy mix by 2025 to increased reliance on regional imports. Energy efficiency measures can also have a relevant impact if compulsory targets and a monitoring system are immediately established as per the Law on Energy Efficiency and Conservation and through secondary regulatory instruments. 27 S&P GLOBAL, Vietnam Manufacturing PMI, July 3, 2023. “Sustained drop in new orders amid demand weakness” https://www.pmi.spglobal. com/Public/Home/PressRelease/1abc42d09ef5440c81d425f21bd38393 28 Based on reports by Electricity of Vietnam (EVN) and National Load Dispatch Center (NLDC). 22 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Figure 1.7. Contribution of different components to growth of total nominal investment Percentage points and percent (y/y, NSA) Government SOEs Private + others FDI Total 35 25 15 5 -5 H1-17 H1-18 H1-19 H1-20 H1-21 H1-22 H1-23 Source: GSO and World Bank staff calculations Businesses and the labor market were negatively affected. Data on enterprise openings and closures suggests declining private sector dynamism during the first half of 2023 as the economy cooled.35 While the number of newly registered businesses still exceeded those closing by a factor of 1.5 during the first semester (compared to 1.8 during the same period of 2022), the pace of firm exits accelerated (11 and 18.3 percent y/y in quarters 1 and 2, respectively), while new entries remained anemic (-2 and 0.8 percent y/y in quarters 1 and 2, respectively) (Figure 1.8). The average size of new enterprises also declined. According to the GSO, on average, newly registered enterprises used less equity capital (-19.8 percent) and labor (-1 percent) in the first semester of 2023 than new market entrants in the first semester of 2022 (Figure 1.9). Labor market conditions also weakened slightly during the first semester of 2023, mirroring the slowdown in economic activities. While unemployment and underemployment rates did not change during the first semester of 2023 compared to a year ago, employment growth dipped from 2.2 percent (y/y) in the first quarter of 2023 to 1.4 percent (y/y) in the second quarter (Figure 1.10), well below an average pre-pandemic level of about 4 percent, reflecting cooling economic activity. Following a gradual improvement in 2022, the labor force participation rate flattened at 68.9 percent during the first semester of 2023, still below the average level recorded for 2019 (71.1 percent). Lackluster labor market conditions were mirrored by flat average income in the first semester of 2023 (Figure 1.11). 29 Based on an estimated unserved demand of 36GWh in 2022 and about 900GWh estimated for May-June 2023 (NLDC operational reports and World Bank estimates). 30 Anonymous surveys conducted by EuroCham among its members in June 2023. 31 Applying the average sales price of 8.05 c/kWh to the 900GWh of estimated unserved energy for 2023. 32 Hydro and coal-based generation respectively accounts for about 45 percent (13GW) and 50 percent (14GW) of the energy mix. 33 NLDC reporting and World Bank estimates. 34 About 20 percent of coal consumption in 2022 was from imports, indexed (together with gas and diesel) to international fuel oil prices. 35 Data from the General Statistics Office (GSO). 23 TAKING STOCK AUGUST 2023 Figure 1.8. Enterprise entries and exits Figure 1.9. New enterprises: Use of capital and labor Percent (y/y, NSA) Percent (y/y, NSA) Entry Exit Capital of newly established enterprises Employment by newly established enterprises 100 150 80 60 100 40 50 20 0 0 -20 -40 -50 -60 -10 Q1-20 Q2-20 Q3-20 Q4-20 Q1-21 Q2-21 Q3-21 Q4-21 Q1-22 Q2-22 Q3-22 Q4-22 Q1-23 Q2-23 Jun-20 Jun-21 Jun-22 Jun-23 Source: GSO and World Bank staff calculations The slowdown in external demand especially affected manufacturing firms and workers in export hubs, such as those centered around Hanoi and Ho Chi Minh City. According to an April 2023 survey by the Private Sector Development Committee,36 71.2 percent of surveyed enterprises reported a cut of at least 5 percent in labor, while 60.1 percent revealed a reduction in revenue of at least 20 percent during the first four months of 2023. Of the enterprises surveyed, 59.2 percent reported reductions in orders. Looking ahead, more than 80 percent of enterprises anticipated worsening economic and business conditions during the remaining months of 2023. Mirroring the survey results, labor data from all 63 provinces published by the Ministry of Labor, Invalids and Social Affairs revealed an estimated 59 percent37 increase in claims for unemployment benefits between the first and second quarters of 2023. The surge was uneven across regions, with the Southeast38 experiencing a jump of more than 62 percent in the number people receiving unemployment benefits in the second quarter of 2023 compared to the previous quarter. 36 The committee is under the Government Office. The survey was conducted during April 2023 with a sample size of close to 10,000 enterprises operating in major industrial production centers in or surrounding Hanoi, Ho Chi Minh City, Danang, Haiphong, Binh Duong, Dong Nai and Ba Ria-Vung Tau. About 90 percent of respondents are domestic private enterprises, and 7 percent from the FDI sector. More than 50 percent operate in services, 42 percent in industry and construction and 7 percent in agriculture. Full report available at: https://img.vietnamfinance. vn/upload/news/hoanghung_btv/2023/5/26/BC-KS-DN-thang-5.2023_final.pdf 37 World Bank staff estimates from provincial labor data available at: https://dulieutonghop.molisa.gov.vn/so-lieu-tinh-tp-map/45 . 38 The Southeast Region includes Ho Chi Minh City and Provinces of Dong Nai, Binh Duong, Ba Ria – Vung Tau, Binh Phuoc and Tay Ninh, contributing about 32 percent of GDP. The region is home to 18.7 million people or about 19 percent of Vietnam population. 24 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Figure 1.10. Employment Figure 1.11. Average income Percent (y/y, NSA) Percent (y/y, NSA) Unemployment Underemployment Nominal Real Employment change LF participation (LHS) 72 10 7500 8 7000 70 6 6500 4 6000 68 2 5500 0 66 5000 -2 -4 4500 64 -6 4000 Q2-20 Q3-20 Q4-20 Q1-21 Q2-21 Q3-21 Q4-21 Q1-22 Q2-22 Q3-22 Q4-22 Q1-23 Q2-23 62 -8 Q1-20 Q3-20 Q1-21 Q3-21 Q1-22 Q3-22 Q1-23 Source: GSO and World Bank staff calculations Source: GSO and World Bank staff calculations Note: LHS = left-hand scale, LF = Labor force Note: Real average income is measured at 2019 constant prices The current account surplus widened, despite a contraction in exports Vietnam’s external position improved in the first quarter of 2023, underpinned by a widening current account surplus. The current account registered an estimated surplus of 1.5 percent of 2022’s GDP in the first quarter of 2023 (Figure 1.12), due to an improved merchandise trade balance (as the contraction in imports was larger than in exports), robust inflows of remittances (estimated at US$2.7 billion), and a narrowing deficit in the services trade account as inbound international arrivals continued to recover, with 5.6 million arrivals in the first semester of 2023 compared to 0.6 million arrivals in the first semester of 2022. The financial account remained in surplus as FDI disbursement and portfolio investment inflows remained steady (Figure 1.13). Vietnam recorded a significant net errors and omissions (US$7.5 billion in the first quarter of 2023),39 likely reflecting continued unrecorded outflows due to persistent devaluation expectations and interest rate differentials. Despite this elevated net errors and omissions term, surpluses in both current and financial accounts helped boost the overall balance of payments surplus, allowing the State Bank of Vietnam (SBV) to build international reserves (US$87.1 billion at end the fourth quarter of 2022 to about US$88.7 billion by the end of the first quarter of 2023, equivalent to 3.3 months of imports.40 Slowing imports and more flexible foreign exchange (FX) management introduced in 2022 by the SBV, which allowed a +5/-5 band around the central rate, contributed to a relatively stable FX market during the first semester of 2023 (Figure 1.14). 39 The high net errors and omissions in Q1-2023 are like high values in Q2-Q4 2022 (-US$8.9 billion, -US$12.4 billion and -US$7.2 billion, respectively), suggesting continued informal capital outflows even before the SBV started reducing policy interest rates in mid-March 2023. 40 In 2022, Vietnam’s international reserves lost US$22.7 billion as the SBV intervened in the FX market to defend the value of the Vietnamese dong, decreasing from a peak of US$110 billion (Q4-2021) to just above US$87 billion (Q4-2022). 25 TAKING STOCK AUGUST 2023 Figure 1.12. Current account balance Figure 1.13. Balance of payments US$ billion (NSA) US$ billion (NSA) Goods Services Primary Current account Financial account Secondary CA Balance Net Errors and Omissions Overall balance 20 40 15 30 10 20 10 5 0 0 -10 -5 -20 -10 -30 -15 -40 Q1-19 Q1-20 Q1-21 Q1-22 Q1-23 2017 2018 2019 2020 2021 2022 Q1-23 Source: SBV and World Bank staff calculations Source: SBV and World Bank staff calculations Note: CA = current account Figure 1.14. Exchange rate VND/US$ Central rate Market rate Upper band (+5%) Lower band (-5%) REER (RHS) 26000 140 25000 135 130 24000 125 23000 120 22000 115 21000 110 2 19 19 9 20 20 0 21 21 1 22 22 23 23 18 8 -2 -2 -1 -2 -1 b- n- b- n- b- b- n- n- n- b- n- ct ct ct ct ct Fe Fe Fe Fe Fe Ju Ju Ju Ju Ju Ju O O O O O Source: SBV, Haver Analytics, Global Economic Monitor Database, and World Bank staff calculations Note: A lower real effective exchange rate (REER) and a higher nominal exchange rate mean depreciation of the Vietnamese dong. RHS = right-hand scale Weaker external demand weighed heavily on Vietnamese merchandise trade during the first semester of 2023. The contraction in exports (-12 percent y/y) in the first half of 2023 (Figure 1.15), was due to a broad-based decline in exports of key manufacturing products, including electronics (-13.9 percent), machinery (-8.6 percent), textiles (-15.8 percent) and footwear (-16.9 percent), to principal markets such as the United States (-21.3 percent y/y in the first five months) and European Union (-9.6 percent y/y in the first five months).41 Total imports contracted more sharply than exports, falling by 17.9 percent (y/y) during the first half of 2023, with second quarter imports declining by 20.2 percent (y/y). Vietnam Customs, Haver Analytics, and World Bank staff calculations 41 26 MAKING PUBLIC INVESTMENT WORK FOR GROWTH As imported inputs for production of exports account for 94 percent of total imports in Vietnam, the significant contraction in imports not only reflected the current slowdown in production for exports but can also be a leading indicator of further weakening of exports production in the coming months. In contrast, trade in services continued to normalize to pre-pandemic levels, thanks to the recovery of international travel to Vietnam. Services trade balance improved substantially, registering a smaller deficit in the first semester of 2023 (-US$2.4 billion) compared to a year ago (-US$8.1 billion) (Figure 1.16). A strong recovery in international travel to Vietnam in the first semester drove this improvement (an increase of 5 million arrivals in the first semester of 2023 compared to the same period in 2022). Figure 1.15. Merchandise trade balance Figure 1.16. Services trade balance Percent (y/y, NSA) US$ billion (NSA) Cán cân TM (tỷ USD) Xuất khẩu (fob) (LHS) Balance (US$ billion) Exports (fob) (LHS) Balance Exports (fob) (LHS) Nhập Imports u (cif) (LHS) khẩ(LHS) (cif) Imports (cif) (LHS) 60 60 12 12 8 45 45 9 9 6 4 30 30 6 6 2 15 15 33 0 00 0 0 -2 -15 -15 -3 -3 -4 -30 -30 -6 -6 -6 Q2-19 Q2-19 Q2-20 Q2-20 Q2-21 Q2-21 Q2-22 Q2-22 Q2-23 Q2-23 Q2-19 Q2-20 Q2-21 Q2-22 Q2-23 Source: Vietnam Customs, GSO, Haver Analytics and World Bank staff calculations Note: fob = free on board; cif = cost, insurance, and freight; LHS = left-hand scale Despite declining commitments, foreign direct investment (FDI) disbursement remained resilient during the first semester of 2023. As global uncertainties continued to weigh on investor confidence, FDI commitments for the first half of 2023 reached US$13.4 billion, 4.5 percent lower than the same period in 2022 and equivalent to 66 percent of pre-pandemic levels (H1-2019). In contrast, FDI disbursement reached US$10 billion for the first semester of 2023, similar to the same period in 2022 and comparable to pre-pandemic levels (Figure 1.17). 27 TAKING STOCK AUGUST 2023 Figure 1.17. FDI commitment by sector US$ billion (YTD) Manufacturing Wholesales & retail Real estate Electricity, gas & water Others Disbursement (LHS) 12 20 10 15 8 10 6 5 4 2 0 H1-19 H1-20 H1-21 H1-22 H1-23 Source: GSO, Haver Analytics and World Bank staff calculations As inflation fell, SBV loosened monetary policy After peaking in January 2023, headline inflation declined rapidly thanks to the slowdown in fuel prices in global and domestic markets and slower domestic consumption, while core inflation declined at a slower pace. The CPI declined from 4.9 percent (y/y) in January 2023 to 2 percent (y/y) in June 2023, well below the 4.5 percent target policy rate for the year (Figure 1.18). Transport services were the key driver of the declining CPI, with prices falling by 12 percent (y/y) in June 2023 thanks to cooling fuel prices in global and domestic markets (Figure 1.19). Core inflation (which excludes food, fuels, and government administered prices) declined to a lesser extent during the first half of 2023 but remains above pre-pandemic levels. This indicates that the pass-through effects of the 2022 fuel price hikes persist, including through higher costs of construction materials and subsequently housing.42 In the context of declining inflation and weaker growth, the State Bank of Vietnam (SBV) has loosened monetary policy since mid-March 2023. At the end of second quarter of 2023, SBV discount and refinancing rates were set at 3 and 4.5 percent, respectively, dropping by 150-200 basis points through a series of four policy rate cuts between March and June 2023 (Figure 1.20). Caps on interest rates for deposits with maturities less than six months and lending rates for priority sectors were also reduced by the same magnitude to encourage commercial banks to provide new, cheaper loans to enterprises and individual customers. Efforts were also made to accelerate implementation of the interest rate subsidy program as well as the introduction of social housing credit program to support the economy.43 42 Increases in housing costs have been persistent since September 2022, contributing from 20 to more than 50 percent to CPI inflation during the past 10 months. 43 The interest rate subsidy program is part of the Socio - Economic Recovery Package approved by the National Assembly in early 2022. The program, with an allocated budget of US$1.7 billion, provides an interest subsidy of 2 percent for targeted businesses to recover from the pandemic. In March 2023, the government approved a US$5.1 billion credit program to promote social housing developments in Vietnam. The credit will be provided by four state-owned commercial banks with preferential interest rates for developers and home buyers. 28 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Figure 1.18. Contribution to CPI inflation Figure 1.19. Price indexes of selected imports Percentage point (y/y, NSA) Coal Jun 2019 (NSA) = 100oil Crude Petrol Food Housing Transport Food Housing Transport Coal Crude Fer�lizers oil Petrol Iron & steel Others Headline Others Headline CoreCore Fertilizers Iron & steel 88 350 350 66 300 300 250 250 44 200 200 22 150 150 100 100 00 50 50 -2 -2 00 Jun-18 Jun-19 Jun-18 Jun-20 Jun-21 Jun-22 Jun-23 Jun-19 Jun-20 Jun-21 Jun-22 Jun-23 Jun-19 Jun-19 Jun-20 Jun-20 Jun-21 Jun-21 Jun-22 Jun-22 Jun-23 Jun-23 Source: GSO, Haver Analytics, and World Bank staff calculations Source: GSO, Haver Analytics, and World Bank staff Note: Food includes grain, foodstuffs, and food consumption calculations outside the home; housing includes rent, utilities (electricity, water, fuel), and construction materials Figure 1.20. Interest rates Percent Vietnam: 10 Year Government Bond Yield (%) 2-Week VND Vietnam Interbank Offered Rate [VIBOR] (%) SBV’s discount 8 6 4 2 0 Jun-19 Aug-19 Oct-19 Dec-19 Feb-20 Aug-20 Arp-21 Jun-21 Aug-21 Oct-21 Dec-21 Arp-22 Oct-22 Dec-22 Jun-20 Oct-20 Dec-20 Feb-21 Feb-22 Jun-22 Aug-22 Feb-23 Arp-23 Jun-23 Arp-20 Source: Haver Analytics, State Bank of Vietnam The banking sector continued to face challenges during the first half of 2023. Credit growth slowed to 7.8 percent (y/y) in June 2023 (Figure 1.21), well under the SBV’s credit growth target of 14.0 percent for the year. This trend reflects weaker credit demand and investment activity amid cooling economic activity. Despite slower credit growth, the gross loan-to-deposit ratio remains above 100 percent44 and maturity mismatches in bank balance sheets are of concern. While the average capital adequacy ratio 44 Calculated by dividing total bank loans with customer deposits. This calculation is different from formal calculations of the loan-to-deposit ratio as per SBV regulations. 29 TAKING STOCK AUGUST 2023 of the banking sector (11.4 percent in 2022)45 remains above minimum prudential levels, capital buffers in some large state-owned commercial banks and smaller private banks are low, providing limited absorption capacity against shocks or rising non-performing loans (NPLs). Meanwhile, NPLs increased from 1.9 percent by December 2022 to 2.9 percent in by March 2023 (Figure 1.22).46 The corporate bond market also remained sluggish with issuances at only about a quarter of the same period in 2022 and 98 companies defaulting on corporate bond payments totaling VND128.5 trillion (US$5.4 billion), approximately 11.1 percent of the total outstanding corporate bond market. Figure 1.21. Credit growth Figure 1.22. NPL and provision of credit institutions Percent (y/y, NSA) Percent Month-on-month Year-on-year (LHS) Balance sheet NPL (LHS) Gross NPL (LHS) Provision to balance sheet NPL (RHS) 18 4 16 6% 160% 14 5% 150% 12 4% 140% 10 2 3% 130% 8 6 2% 120% 4 1% 110% 2 0% 100% 0 0 19 20 21 2 2 2 2 3 -2 -2 -2 -2 -2 Jun-19 Jun-20 Jun-21 Jun-22 Jun-23 20 20 20 Q1 Q1 Q2 Q3 Q4 Source: SBV, Haver Analytics, and World Bank staff calculations Source: FinnGroup, State Bank of Vietnam Note: LHS = left-hand scale In a bid to stimulate credit growth and address pressures on banking sector balance sheets, the authorities adopted supportive policies, including renewed regulatory forbearance. In March 2023, the government issued regulations allowing restructuring of corporate bonds and delaying additional rules for issuances as introduced in a previous regulation, providing short-term relief to borrowers and alleviating challenges in refinancing maturing bonds.47 In April, the SBV re-introduced forbearance measures48 first applied during the pandemic until June 2022. To further support social housing and industrial real estate development, SBV reduced capital charges on loan to these sectors.49 The government also relaxed the rules pertaining to buy-backs of corporate bonds by credit institutions to ease a liquidity problem in the bond market.50 45 Source: State Bank of Vietnam, FiinGroup, and World Bank staff calculation. 46 Adjusted NPLs, which include loans held at Vietnam Asset Management company and restructured loans, stood at 5.0 percent in Q1-2023. 47 Decree 08/2023/ND-CP amending and supplementing several provisions in Decree 65/2022/ND-CP. 48 Circular 02/2023/TT-NHNN allows banks to restructure loans and stagger provisions over multiple financial years when owed by borrowers facing payment difficulties, but that have been assessed as capable of repaying the principal and/or interest according to the restructured repayment term. 49 Ibid 22. 50 Decree 08/2023/ND-CP amending and supplementing several provisions in Decree 65/2022/ND-CP. 30 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Accelerated public investment, but implementation challenges remain The 2023 mid-year fiscal balance registered a smaller estimated surplus (1.5 percent of GDP) than a year ago (5.2 percent of GDP) (Figure 1.23A). The narrower budget surplus resulted from lower revenues and higher expenditures, providing a fiscal impulse equivalent to about 3.7 percent of GDP. Revenue collection fell by 7 percent (y/y) during the first semester of 2023, with falls in all major taxes, except corporate income tax51 (Figure 1.24). By the end of June 2023, revenue collection reached 54 percent of the planned budget (or 18.5 percent of GDP), compared to 67 percent recorded for end-June 2022 (or 21.3 percent of GDP) (Figure 1.23A). On the other hand, total budget expenditure increased by 12.8 percent in the first semester of 2023 compared to a year ago (Figure 1.23B). Disbursement of the public investment budget jumped by 43.3 percent (y/y) during the first semester of 2023, providing some support to the economy (Figure 1.25). The surge in disbursement of the investment budget included the roll out the investment component of the 2022–23 Socio-Economic Recovery Program approved in early 2022 (1.8 percent of GDP).52 Figure 1.23. Budget execution (A) (B) Percent of GDP Revenues (Trillion VND) Expenditure (Trillion VND) Balance Revenues Expenditure Balance (Trillion VND) Revenues growth rate (y/y) (RHS) 35 35.0 Expenditure growth rate (y/y) (RHS) 30 30.0 1000 1000 25 25 25 20 20 25.0 800 800 20 20.0 15 15 500 600 10 10 15 15.0 10 10.0 400 400 5 5 5.2 0 0 5 5.0 3.2 2.0 200 200 1.5 0 0.0 -5 -5 00 -10 -5 -5.0 -2.4 H1-19 H1-21 H1-22 H1-23 -10 6M-19 6M-20 6M-21 6M-22 6M-23 H1-20 H1-19 H1-20 H1-21 H1-22 H1-23 -200 -200 -15 -15 Source: MoF and World Bank staff calculations Source: MoF and World Bank staff calculations Note: RHS = right-hand scale While overall budget expenditure increased in the first semester of 2023, implementation challenges associated with public investment remained. By the end of June, total expenditure lagged at 39 percent of the annual plan (or 17 percent of GDP), while disbursement of public investment reached only 30 percent of the annual planned budget. These low execution rates are comparable to 2022 and previous years, partly reflective of the traditionally slow start of investments in the first half of the year and partly related to chronic administrative and regulatory issues that hamper investment budget execution. In turn, this slow implementation of budget undermines the effectiveness of intended fiscal policies. Further discussion is provided in the second chapter of this report. 51 The 16.9 percent (y/y) bump in corporate income tax in H1-2023 resulted from payments derived from 2022 tax deferrals which became due in Q1-2023. 52 The 2022-23 Socio-Economic Recovery Program includes a public investment component with a budget close to VND170 trillion (or 1.8 percent of GDP). As preparation of investment projects under this component took almost a year to complete, disbursement only commenced in early 2023. 31 TAKING STOCK AUGUST 2023 Public and publicly guaranteed (PPG) debt remains sustainable highlighting ample fiscal space to use for counter-cyclical fiscal policy. PPG debt is estimated at 35.7 percent for 2022, continuing a decline from 2016 when PPG debt was 47.5 percent, and well below the mandated threshold of 60 percent set by the National Assembly. Vietnam’s 2022 public debt is lower than its regional comparators – Indonesia (40.9 percent of GDP), the Philippines and Thailand (both 60.9 percent of GDP) and India (89.2 percent of GDP)53 – suggesting that further countercyclical fiscal policy could be undertaken without compromising debt sustainability. This is reinforced by the authorities changing the tenure of public debt to domestic long maturities bonds in the first six months of 2023. Total bond issuances reached VND180 trillion (equivalent to 45 percent of the annual plan). About 95 percent of State Treasury bond issuances had long maturities (10–15 years).54 Figure 1.24. Government revenues Figure 1.25. Government expenditure Percent (y/y, NSA) Percent (y/y, NSA) Corporate income tax Personal income tax Current Investment Total Corporate income tax Personal income tax Value added tax Current Investment Total added Value Excise tax tax Excise Trade tax Trade Total revenues Total revenues 50 50.0 40 40 40 40.0 30 30 30 30.0 20 20 20 20.0 10 10 00 10 10.0 -10 -10 0 0.0 -20 -20 -10 -10.0 -30 -30 -20 -20.0 H1-18 H1-18 H1-19 H1-19 H1-20 H1-20 H1-21 H1-21 H1-22 H1-22 H1-23 H1-23 H1-18 H1-18 H1-19 H1-19 H1-20 H1-20 H1-21 H1-21 H1-22 H1-22 H1-23 H1-23 Source: GSO, Haver Analytics, and World Bank staff calculations II. ECONOMIC OUTLOOK, RISKS, AND POLICY IMPLICATIONS External headwinds expected to affect economic growth in the short term Vietnam’s economy is expected to grow by 4.7 percent in 2023, with a slow projected recovery to 5.5 percent in 2024 and to 6.0 percent in 2025. While softening, domestic demand is expected to be the main driver of growth in 2023. Private consumption will remain resilient, growing 6.0 (y/y) percent - below its pre-pandemic growth of 7 percent (y/y) in 2019 - and contributing 3.4 percentage point to GDP growth. Overall, investment will contribute 1.8 percentage point to growth. Private investment is forecast to remain subdued, growing 4.3 percent (y/y) compared to 8.2 percent (y/y) in 2019 due to uncertainties in the external environment, and contributing 1.2 percentage point Source: https://tradingeconomics.com 53 Ministry of Finance, June 2023. 54 32 MAKING PUBLIC INVESTMENT WORK FOR GROWTH to GDP growth. Public investment is expected to increase 9.5 percent (y/y) contributing 0.6 percentage points to GDP growth, but only partially compensating for the lower private investment. With the easing of liquidity conditions and SBV’s renewed guidance on loan forbearance, the financing constraints in the real estate/construction sectors are expected to ease, supporting a moderate recovery of private investment from 2024 onward. The growth projection assumes a moderate recovery in goods exports during the second half of 2023, especially the fourth quarter, based on a gradual recovery of demand from the European Union and United States.55 Looking ahead to 2024, economic growth is projected to be driven by a moderate recovery in exports and imports, in line with the expected rebound in global growth, as well as improvements in private investment. The CPI is expected to rise slightly from an average of 3.1 percent in 2022 to 3.5 percent in 2023. The deflationary impact of slower growth and a VAT rate cut rolled out for the second semester of 2023 are more than offset by the impact of a civil service salary increase (20.8 percent).56 The 2 percent VAT tax break to support economic growth from July 2023 is expected to have a marginal and transitory impact on this year. Looking ahead, with projected declines in commodity prices in 2023 and broadly stable commodity and energy prices57 in 2024, the CPI is expected to decline to 3.0 percent in 2024 and 2025, its pre-pandemic rate. The fiscal balance is expected to register a small deficit of 0.7 percent of GDP in 2023. The wider fiscal balance is partly due to the slowdown in economic activity that affects revenue collection, with 2023 planned revenue collections by June 2023 some 7 percent lower than in June 202258. Fiscal policy is expected to remain moderately supportive of the economy in 2023, with the government intent to increase investment expenditure, albeit with partial success given persistent implementation challenges. Looking ahead to 2024 and 2025, as the economy starts to recover, the authorities are expected to revert back to fiscal consolidation in line with the Government Financial Strategy for 2021-2030.59 Public and publicly guaranteed debt will remain sustainable, stabilizing at an estimated 36 percent of GDP in 2023, before falling to a projected 34.4 percent in 2025. The current account is expected to register a small surplus in 2023, thanks to a positive trade balance, continued international tourism and resilient remittances. The global demand is expected to gradually recover from the fourth quarter of 2023 and gain momentum into late 2024, leading to increased goods trade and contributing to an improved trade balance. In addition, international tourist arrivals are projected to continue growing. Remittances are expected to reach US$14 billion in 2023 and US$14.4 billion in 2024.60 55 IMF World Economic Outlook Update, July 2023. 56 Vietnam currently has a payroll of approximately 3.5 million, including 2.5 million public service workers (including teachers, doctors, and nurses) and about one million military staff. Pensioners will also benefit from a 12.5 percent increase in their monthly pension. 57 World Bank Global Economic Prospects, Commodity Market Outlook. April 2023. “Commodity prices are expected to fall by 21 percent this year and remain mostly stable in 2024. The expected decline in prices for 2023 represents the steepest decline since the pandemic. The decline in energy prices in the first quarter of 2023 is expected to fade and be followed by stable prices over the remainder of 2023 and a slight uptick in 2024. Energy price forecasts have been downgraded sharply. The energy price index is expected to fall by 26 percent in 2023 (much of that decline has already taken place) and remain broadly unchanged (up 0.1 percent) in 2024.” (pg. 2). 58 MoF June 2023 fiscal data, World Bank staff calculations. 59 Prime Minister Decision No. 368/QD-TTg dated March 21, 2022, on Approval of Financial Strategy until 2030. 60 World Bank/KNOMAD. 2023. “Remittances remain resilient but are slowing.” Migration and Development Brief 38, World Bank, Washington, DC. 33 TAKING STOCK AUGUST 2023 Table 1.1. Selected economic indicators, Vietnam 2020–2025 Indicator 2020 2021 2022e 2023f 2024f 2025f GDP growth (%) 2.9 2.6 8.0 4.7 5.5 6.0 Growth of expenditure components Private consumption 6.0 6.0 6.5 6.0 6.0 6.5 Public consumption 4.8 4.8 4.4 4.8 4.8 4.4 Investment 5.3 5.9 6.7 5.3 5.9 6.7 Exports 2.1 3.1 4.1 2.1 3.1 4.1 Imports 3.0 3.5 4.5 3.0 3.5 4.5 Consumer Price Index (average, %) 3.2 1.8 3.1 3.5 3.0 3.0 Current account balance (% of GDP) 4.3 -2.1 -0.3 0.2 0.5 1.0 Fiscal balance (*) (% of GDP) -2.9 -3.4 -0.3 -0.7 -0.3 -0.2 Public debt (% of GDP) 41.3 39.3 35.7 36.0 35.2 34.4 Source: GSO; MOF; SBV; IMF; and World Bank staff calculations. Note: e = estimate; f = forecast, *: excluding unallocated expenditures and following Government Finance Statistics (GFS). The risks to growth have materialized and the balance of risks to Vietnam’s economic outlook remains tilted to the downside. Slower-than-expected growth in advanced economies could further dampen external demand for Vietnam’s export sector, whose size is estimated at 50 percent of GDP.61 In addition, given that China is Vietnam’s largest trade partner,62 continued weakness in China’s post-pandemic recovery heightens risks for Vietnam’s economic growth. Continued uncertainties in the global financial market have the potential to rekindle stress in the global banking sector, intensify investor risk aversion, and discourage FDI flows to Vietnam. Additional monetary policy tightening in major advanced economies to combat persistent inflation could widen the existing interest rate gap between international and domestic markets.63 This could exert exchange rate pressures on the local currency. Moreover, an escalation of geopolitical tensions and climate-related disasters pose additional downside risks for the country, including through rising food and fuel prices. As growth has slowed sharply, active fiscal policy support is warranted Given ample fiscal space, fiscal policy should take the lead, ensuring a much better implementation of the investment budget for 2023. A full implementation of the planned investment budget would bring public investments to 7.1 percent of GDP in 2023, up from 5.5 percent planned in 2022, providing 0.4 percent of GDP in fiscal impulse to support aggregate demand.64 The government has planned a 38 percent increase (y/y) in public investment for 2023 – equivalent to 1.6 percent of GDP. It is accelerating 61 The size of the export sector is measured by the domestic value-added (direct and indirect) from exports as a share of GDP. Source: Martins Guilhoto, J., C. Webb and N. Yamano (2022), “Guide to OECD TiVA Indicators, 2021 edition”, OECD Science, Technology and Industry Working Papers, No. 2022/02, OECD Publishing, Paris, https://doi.org/10.1787/58aa22b1-en. The value 50 percent is for 2019. 62 On average, 16.3 percent of Vietnam’s exports went to China during 2018-19, while 28.6 percent of its imports came from China during the same period. 63 As of July 2023, the US Federal Reserve funds rate is 2.5 percentage points higher than SBV’s re-discount rate. 64 https://www.elibrary.imf.org/display/book/9781557751928/ch005.xml. Equation (3) is used to estimate the fiscal impulse: FI=(ΔG-nG-1) - [ΔT-(ΔY/Y-1) T-1]. 34 MAKING PUBLIC INVESTMENT WORK FOR GROWTH implementation with disbursement of the public investment budget jumping by 43.3 percent (y/y) during the first semester of 2023. However, historical public investment implementation rates have been low in the recent past, for example reaching only 67.3 percent in 2022.65 Steps to accelerate and improve the efficiency of implementation would also help address emerging infrastructure constraints to growth, including critical investment needed in the electricity transmission network and in building resilience to climate change. These steps include setting investment targets and enforcing accountability at different intergovernmental levels for achieving them; focusing on key national investment programs such as national expressway, power transmission and national target programs; allowing flexibility in rules related to budget allocation for the projects identified as part of 2022-2023 Socio - Economic Recovery Program (1.8 percent of GDP); and allowing some flexibility on certain advance procurement activities before budget allocation. In addition to public investment, supporting workers and families affected by the slowdown through a more effective social protection system could also help support aggregate demand. To successfully do so, the authorities need to reform the targeting approaches and delivery mechanisms of the social protection system so it might serve as an agile tool to support the vulnerable during economic shocks. Fiscal policy support should be accompanied by continued monetary policy accommodation but the space for additional loosening is constrained. As credit demand has remained persistently low, further reducing interest rates may not have the desired effect of incentivizing credit growth. Also, further interest rate cuts would increase the interest rate differential with global markets, potentially incentivizing capital outflows and putting pressure on the exchange rate. Attempts at directing credit to priority sectors, such as the recent initiatives to support social housing or industrial real estate, should be balanced against considerations of ensuring efficiency in the allocation of credit. Financial sector fundamentals should be improved in several ways to strengthen the resilience of the banking system. While measures such as cutting interest rates, easing of liquidity constraints, forbearance and restructuring helped to address credit market difficulties in the short-run, they could also lead to a rise in NPLs and loan-to-deposit ratios, raising concern about maturity mismatches and banks’ balance sheets. In the medium term, structural reforms are critical to address emerging financial risks and position the sector to facilitate sustainable growth. Strengthening bank capital adequacy ratios ensures sufficient capital to absorb potential losses and maintain stability in the face of economic shocks. Strengthening institutional frameworks for prudential supervision, early intervention, bank resolution and crisis management helps authorities effectively monitor and intervene in troubled financial institutions, preventing the escalation of crises and minimizing systemic risks (see Box 1.2). Additionally, a robust bank resolution framework is crucial to facilitate the orderly resolution of failed banks, protecting depositors and preserving financial stability. Launching a new round of structural reforms would help enhance the productivity and sustainability of economic growth, contributing to its ambitions to become a high-income country by 2045. Continued reforms to lighten the regulatory burden on businesses are necessary for productivity gains and increased competitiveness. More critically, relaunching the State-Owned Enterprises (SOEs) reform can act as a catalyst to attract private sector participation, improve productivity, and ultimately boosting overall economic performance. Promoting an inclusive financial sector can empower individuals and businesses to participate fully in economic activities, in turn enhancing their contribution to sustainable Of planned budget approved by the National Assembly, as of December 31, 2022. 65 35 TAKING STOCK AUGUST 2023 growth. Furthermore, building medium-term resilience in exports is important to mitigate risks associated with external shocks. Diversifying the product base and export destinations helps reduce reliance on specific markets and products, making economies more resilient to global economic fluctuations. Additionally, fully utilizing existing Free Trade Agreements (FTAs) can unlock market opportunities, boost exports, and foster economic integration with partner countries. Fiscal policy can also help enhance the sustainability of Vietnam’s economic growth. For instance, investing in human capital and skills can help improve productivity and drive economic growth. Also, fiscal policy can help build resilience to climate change through prioritizing greening production and consumption. Implementing carbon taxation and other fiscal instruments can incentivize industries to reduce their carbon footprint and adopt more sustainable practices. Simultaneously, providing time-bound fiscal incentives for green consumption, such as tax breaks or subsidies for eco-friendly products, can encourage individuals to make environmentally conscious choices. Box 1.2. Reforms of Vietnam’s banking laws An opportunity to further strengthen the foundations for financial stability in Vietnam A modern financial system that aligns with international standards and good international practice is a precondition for Vietnam to achieve its aspiration to become a high-income country by 2045. Vietnam is currently reviewing the Law on Credit Institutions (LCI). The existing LCI has significant gaps that impede the SBV’s ability to adequately supervise banks and financial groups, maintain financial stability and protect depositors. Since the last limited revision of the LCI in 2017, Vietnamese banks and financial groups have become larger, more sophisticated, and complex. International standard setters and Southeast Asian peers have revised their legal frameworks to incorporate lessons from the Global Financial Crisis. The review of this law presents an opportunity to strengthen the legal powers of the State Bank of Vietnam (SBV) as the regulator and supervisor of banks, to enhance its operational independence, to improve banking supervision powers and functions, and to provide a legal framework for enabling non-viable banks to be resolved in ways that maintain financial stability and minimize public financing costs. Key considerations for fundamental changes to the current LCI include: • Aligning the law to international standards and good international practice such as the Core Principles for Effective Banking Supervision, issued by the Basel Committee on Banking Supervision and the Key Attributes of Effective Resolution Regimes for Financial Institutions, issued by the Financial Stability Board. • Enabling risk-based, consolidated, and financial group supervision to promote effective forward-looking supervision of financial institutions as well as financial groups. • Strengthening macroprudential policy, including powers, transparency, and accountability of the SBV, for formulating and implementing macroprudential policies and supervision. • Facilitating banks’ recovery planning by empowering the SBV to require credit institutions to prepare, maintain and regularly test recovery plans to enable them to respond proactively to emerging stress. • Dealing with failing banks through robust laws, policies and procedures for banks’ recovery and resolution, and associated financial safety nets (including deposit insurance and emergency liquidity assistance). Financial 36 MAKING PUBLIC INVESTMENT WORK FOR GROWTH institution failures should be managed in ways that maintain the continuity of systemically important financial systems and preserve financial stability, while also ensuring that shareholders and large creditors bear their fair share of losses. Reforms would include designating the SBV as resolution authority, specifying a clear set of triggers for entry into resolution, equipping the SBV with powers to implement a range of resolution options, and establishing a robust framework for the funding of resolutions. • Replacing special loans to financial institutions with a mechanism that empowers the SBV to extend liquidity support to a financial institution under strict soundness preconditions and does not require other credit institutions to lend to a financial institution in stress. • Promoting operational independence for the SBV, with corresponding enhanced transparency and accountability, so that regulation and supervision of financial institutions are made impartially and in a neutral manner, without undue interference. • Strengthening legal protection for SBV, its officers, staff, and agents to ensure it can meet its responsibilities in good faith and the proper performance of duties without fear of legal actions being taken against it or its officers, staff, and agents. 37 CHAPTER 2. MAKING PUBLIC INVESTMENT WORK FOR GROWTH MAKING PUBLIC INVESTMENT WORK FOR GROWTH I. INTRODUCTION Public investment level low compared to growing needs Vietnam, in seeking to reach upper middle-income status by 2030 and high-income status by 2045,67 aspires to become a modern and industrialized nation with a higher quality of life for its citizens. To achieve these ambitious development goals, the government estimates that annual gross domestic product (GDP) growth must be maintained at 7 percent during 2021–2030 and 6.5 to 7.5 percent through 2031–2050.68 The country also needs to ensure that gross capital investments from all sectors account for 32 to 35 percent of GDP on average from 2021 until 2030, including government investment at an average of 7.3 percent of GDP annually to support infrastructure development during this period.69 This is in line with global experience that fast-growing countries are characterized by high public investment, defined as 7 percent of GDP or more.70 Despite critical growing needs, Vietnam’s public investment level has declined in the past decade. From 2011 to 2022, the share of public investment in total government expenditures and GDP fell from 27 to 20 percent, and 8 to 6 percent, respectively.71 Yet the economy remains relatively capital scarce with a public capital stock per capita and per worker well below upper middle-income countries (UMICs) and high-income countries (HICs) (Figures 2.1 and 2.2). Meanwhile, global experience suggests Figure 2.1. Public capital stock per capita Figure 2.2. Public capital stock per and Infrastructure index worker at different income level Emerging and Developing Asia Public Capital Stock per Worker 2019, in thousands of constant 2017 PPP- adjusted US$ (log scale) All Other Countries Frontier 500 Infrastucture index - Hybrid indicator (Output) 140 120 Malaysia 50 Korea 100 China 80 Vietnam Indonesia 60 5 Philippines 40 Vietnam 20 0.5 5 50 0 0.5 0 10,000 20,000 30,000 40,000 Per Capita Income, 2019, thousands of constant 2017 PPP adjusted US$ (log scale) Public Capital Stock per Capita (Input) Source: IMF (2021) Source: IMF (2021), World Bank WDIs 67 Socio-Economic Development Strategy 2021–2030 (approved by Central Party Committee in 2021) and National Spatial Development Masterplan 2021–2030, vision 2050 (approved by the National Assembly in January 2023). 68 National Spatial Development Masterplan 2021–2030, vision 2050. 69 Socio-Economic Development Strategy (SEDS) 2021–2030. 70 The Growth Report: Strategies for Sustained Growth and Inclusive Development (Commission on Growth and Development, 2008). The report reviewed 3 economies that have grown at an average rate of 7 percent a year or more for 25 years or longer since 1950; and at that pace of expansion, they almost doubled in size every decade. 71 Ministry of Finance and General Statistical Office. Excludes investment by state-owned enterprises. 39 TAKING STOCK AUGUST 2023 that capital accumulation was the most important driver for fast-growing countries when they were at Vietnam’s level of development (Figure 2.3). Figure 2.3. Capital stock accumulation as a major driver for fast-growing economies Labor Human Capital Capital Total Factor Productivity 10 9 8 2.20 1.15 0.39 3.74 2.43 7 6 4.07 2.06 5 4.80 4.46 4 3 3.83 4.94 1.12 2.82 2 1.38 1 2.37 1.16 1.54 0.70 0.48 0.62 0.84 0 94 72 14 96 6 8 8 -0 -8 -1 4- 2- 4- 6- 09 76 98 n6 a0 a8 a8 m na nd in pa re si na hi la ay Ch Ko Ja et /C ai al Th Vi an M iw Ta Source: Bank staff calculations based on Total Economy Database (https://www.conference-board.org/data/economydatabase/total- economy-database-productivity). Sustaining the levels of public investment will be critical to secure productive and social infrastructure as public goods which will facilitate greater private sector investment. Vietnam has ample fiscal space—with Public and Publicly Guaranteed Debt (PPG) at 35.7 percent of GDP in 202272 compared to the 60 percent debt threshold set out by the National Assembly—and can spend more on public investment to boost sustainable growth (see Box 2.1 for illustrative example on transport infrastructure needs). Box 2.1. Transport infrastructure constraints In the past 20 years, transport spending—roughly 23 percent of general government capital spending and 3.5 percent of GDP—has focused more on rural transport infrastructure (75 percent), which is managed by provinces. Given budget constraints, this focus came at the expense of implementing nationally strategic investments. As a result, the expressway density in Vietnam is among the lowest in the East Asia and Pacific (EAP) region, and the road transport costs are highest when compared to others in the region. Many segments along the North-South expressway axis have not been constructed. Railway infrastructure has also been neglected. Multimodal connectivity is limited, particularly between roadways, seaways, in-land waterways, and railways, while connection between railways and seaports is almost non-existent. Transport connections at the gateways of major cities, as well as to economic zones, industrial parks, seaports, and border gates remains limited. Ministry of Finance. 72 40 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Substantive scope to increase public investment efficiency While higher investment is necessary, Vietnam also needs better investments and there is scope to increase the efficiency of public investment. Between 2011 and 2019, it took more than six VND in investment to generate one VND in output.73 As a result, Vietnam achieved much less growth per dollar of investment than China, Malaysia, Republic of Korea, Singapore, and Thailand74 when they were at comparable levels of per capita income and development. The IMF (2018) estimated that the output efficiency of public investment for Vietnam could be 23 percent higher if the efficiency of public investment management reached the global frontier.75 Increased public spending efficiency could have a major impact on aggregate productivity growth and GDP levels. Policy research suggests that a one percentage point rise in public investment through efficiency improvements lifts growth rates by 0.1–0.2 percentage points over the next few years.76 Efficient public investment in Vietnam is however hampered by weaknesses in both public investment management (PIM) and intergovernmental fiscal (IGF) institutions. To explore Vietnam’s potential for gains in public investment efficiency,77 this chapter reviews the overall performance and key challenges to date and provides recommendations on adjustments to the current frameworks— including legal, institutional, incentive, and enforcement arrangements. II. PUBLIC INVESTMENT PERFORMANCE AND CHALLENGES Persistent implementation inefficiencies While there have been notable efforts by the government to improve PIM in the last decade, public investment continues to suffer from persistent allocative and operational inefficiencies. Steps to boost PIM have included hardening budget constraints to eliminate expenditure arrears, introduction of independent appraisals and a centralized monitoring scheme. Despite these efforts, inefficiencies remain within the PIM cycle. Both central and provincial governments are unable to disburse their appropriated capital budgets. Between 2017 and 2022, investment budgets suffered from chronic under-execution with 73 Incremental capital output ratio (ICOR) data from Vietnam General Statistics Office (GSO): The 2011–2015 ICOR was 6.25, 2016–2019 ICOR was 6.13 and 2016–2020 ICOR was 7.04 as 2020 was an exceptional year due to the COVID-19 pandemic. 74 Various sources including World Development Indicators (2022); “Sector Assessment (Summary): Industry and Trade.” (Asian Development Bank (ADB, 2016); and “China’s Productivity Slowdown and Future Growth Potential.” (World Bank Policy Research Working Paper 9298, 2020). 75 Vietnam: Public Investment Management Assessment (PIMA) (IMF, November 2018). 76 Assessing the Effect of Public Capital on Growth (World Bank Policy Research Working Paper 8604/2018). 77 The Power of Public Investment: Transforming Resources into Assets for Growth (World Bank, 2014). Inefficiencies in PIM exist at three levels: (i) allocative efficiency—meaning channeling of resources towards programs/projects with higher social rates of return and in line with government priorities, (ii) productive/technical efficiency—meaning efficient conversion of capital spending into infrastructure, optimizing the use of resources for investment once allocated, mitigating cost overruns, delays and sub-optimal diversion from specification at design and incompleteness and (iii) operational efficiency—including using assets, new and existing, more efficiently and addressing the under- provision of complementary resources required to achieve service delivery targets for the assets created. 41 TAKING STOCK AUGUST 2023 only 77 percent of allocations spent (Figure 2.4). The differences between budgeted and actual spending (23 percent) and the resulting capital expenditure carried over from one year to the next (18 to 31 percent of total capital expenditures) are significantly larger than in many peer countries, and way above international good practices which suggest budget deviations to remain below 5 percent.78 PIM inefficiency is also manifested in significant project completion delays and cost overruns. A recent World Bank review79 of selected large- scale transport projects found an average delay of five years, and an average cost overrun of double the original cost at the design and budget allocation stage. Figure 2.4. Persistent execution gaps (2017–2022) General Government Central Government Provincial Governments Actual/Budget Ratio (%) 100 80 60 40 20 0 2017 2018 2019 2020 2021 2022 Source: MPI (mpi.gov.vn) and MoF (mof.gov.vn) websites and World Bank staff estimates. Increasing capital spending decentralization Public investment efficiency is also affected by Vietnam’s fragmented intergovernmental system and increasingly decentralized capital spending. Since the early 1990s, the Vietnamese Government has embarked on a policy of rapid spending decentralization. Within the unitary set of rules and norms applied across the country, the share of subnational governments’ (SNGs) in total government expenditures increased from 26 percent in 1992 to almost 60 percent in 2022.80 This spending is significantly higher than the international average (21.5 percent) and the lower middle-income economies’ average (18.8 percent) and Asia Pacific region (33.7 percent). As for capital expenditure, Vietnam’s central government accounted for a mere 20 percent of total government investment in 2022, compared to 40 percent seven years ago. This decentralization policy has channeled on average 80 percent (2017–2022) of public investment through SNGs (Figure 2.5), more than double the averages in unitary countries (34.5 percent) and overall (39.5 percent) (Figure 2.6). 78 Public Expenditure and Financial Accountability (PEFA) Framework, Performance Indicator 1. 79 Regional Investments in Vietnam: Challenges and Opportunities (WB Policy Note, 2023). Review sample included 14 transport projects which accounts for 13 percent of transport investment budget during 2011-20 (sourced from MOT). In the same review, it is worth noting that time overrun tends to vary more widely between one to three years in the case of smaller projects (those in group B or C). 80 Source: MoF data and staff calculations. 42 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Figure 2.5. Increasing level of provincial spending in total public investments Central Share in Total Investment Provincial Share in Total Investment 84.2% 84.8% 81.8% 81.1% 78.2% 77.9% 65.6% 66.2% 67.4% 58.0% 58.6% 58.9% 42.0% 41.4% 41.1% 34.4% 33.8% 32.6% 21.8% 22.1% 18.9% 18.2% 15.8% 15.2% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Source: MoF (mof.gov.vn) and World Bank staff estimates Figure 2.6. Vietnam high level of decentralization compared to development peers SNG investment as a share of public Share of SNG expenditure / investment in countries investment and GDP per capita SNG expenditure / investment All countries Unitary Federal countries countries 90% 8.3% SNG expenditure / % of GDP (122 countries) 6.6% 16.0% 80% Vietnam SNG expenditure / % of total public expenditure 21.5% 17.1% 41.9% (122 countries) SNG investment as a % of public investment 70% SNG investment / % of total public investment 39.5% 34.5% 59.0% (93 countries) 60% SNG investment as a share of public investment by income group 50% 60% 40% 50% 44.1% 41.5% 39.5% 40% 30% 34.8% 30% 20% 18.0% 20% 10% 10% 0% 0% 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000 All countries Low income Lower middle Upper middle High income GDP per capita (USD PPP) income income Source: Subnational Governments around the World: Structure and Finance (OECD/UCLG, 2019) and World Observatory on Subnational Government Finance and Investment (OECD/UCLG, 2022 Synthesis Report). Consequently, inefficiencies have arisen from allocative duplications, implementation challenges, negative externalities, and sub-optimal private sector mobilization and financing. This devolution of spending decisions to provincial authorities has also led to weak coordination across regions and with central government as well as a proliferation of duplicate investments-executed by both the central government and 63 provinces (some of which are very small in size).81 For example, ineffective coordination between SNGs and national governments is also evidenced by duplicate investments in 81 OECD, Multi-dimensional Review of Vietnam (2019): The average size of provinces in Vietnam is relatively small compared to those in other countries. There are on average 1.5 million inhabitants for each province and 8,500 inhabitants per municipality. These ratios are much smaller than the OECD average (three million inhabitants per region and 37,800 inhabitants per municipality) and in other more populous countries, such as China and India, but also Malaysia and Mexico. 43 TAKING STOCK AUGUST 2023 seaports, airports, and hydro-power generation. Vietnam has 47 seaports of all sizes across provinces, but 95 percent of cargo goes through three ports invested and operated by the Ministry of Transport.82 While there are 22 airports nationwide, only eight are considered international and the remainder can only accept smaller, narrow body aircrafts.83 Most airports are loss-making and unable to even cover operations and maintenance (O&M) costs. In just three Central Highlands provinces (Dak Nong, Gia Lai and Kon Tum), 256 small and medium-scale hydropower plants were approved and are being operated without fully consulting the affected stakeholders. In addition, public asset management (PAM) remains inadequate. Post-construction infrastructure assets are not properly recorded nor managed after project completion at national or sub-national levels, leading to inadequate maintenance of public assets. Overall, it is estimated that the budget only financed about 40 percent of minimum needs in road infrastructure maintenance, although some partial progress has been made in certain sectors, such as national roads and clean water and irrigation infrastructure assets.84 Infrastructure quality lags that of regional peers As a result of these challenges, Vietnam’s infrastructure quality lags that of many Asian countries and could impact its attractiveness as an FDI destination and potential growth in the long term. According to the World Economic Forum Survey, perceived infrastructure quality had improved in line with increasing capital stock, but Vietnam still trailed emerging and developing Asian countries in 2019. It ranked Vietnam 77th out of 141 countries worldwide, behind regional peers such as China, India, Indonesia, Malaysia, and Thailand—countries that Vietnam is competing with for FDI (Table 2.1). The Global Quality Infrastructure Index 2021 ranked Vietnam 51st out of 184 economies, below Indonesia (28th), Malaysia (29th), and Thailand (33rd). One example of infrastructure quality is the expressway density, which is one of the lowest in the region, while road transport costs are the highest regionally.85 The infrastructure investment gap will constrain Vietnam’s ability to attract and retain FDI, including those looking to relocate from China. 82 Haiphong city in the north and Ho Chi Minh City and Ba Ria-Vung Tau province in the south. The remaining 44 ports account for only 5 percent of cargo volume, reflecting uneconomic investments by provinces. Despite the gamut of seaports nationwide – including two special, 12 Grade I and 20 Grade II seaports – there is a dearth of modern facilities to receive ships of high dead weight tonnage. 83 According to International Civil Aviation Organization classification. There is a concentration of airports in the central coastal region, home to 14 provinces, with an average distance of around 100km between nine of the 22 airports. Only six airports have experienced passenger growth, while the remainder have hit just 40 percent of projected volumes. 84 Vibrant Vietnam: Forging the Foundation of a High-Income Economy” (WB Report, 2019). 85 In Vietnam, road transport represented about 79 percent of overall transport budget with the highest budget-to-volume ratio. Road transport remains the most important mode in terms of volumes, accounting for more than 90 percent of passengers and 70 percent of freight volumes during 2010–2020, also the costliest form of domestic freight transport. 44 MAKING PUBLIC INVESTMENT WORK FOR GROWTH Table 2.1. Quality of infrastructure Overall Roads Railroads Seaports Air transport Utility infrastructure infrastructure Score Rank Score Rank Score Rank Score Rank Score Rank Score Rank Vietnam 65.9 77 3.4 103 3.6 54 3.8 83 4.0 103 79.6 87 China 77.9 36 4.6 45 4.5 24 4.5 52 4.6 66 86.9 65 India 68.1 70 4.5 48 4.4 30 4.5 49 4.9 59 69.8 103 Indonesia 67.7 72 4.2 60 4.7 19 4.3 61 4.9 56 79.4 89 Malaysia 78.0 35 5.3 19 5.1 13 5.2 19 5.5 25 89.7 51 Thailand 67.8 71 4.4 55 2.8 75 4.1 73 5.0 48 78.9 90 Source: World Economic Forum – The Global Competitiveness Index (2019 report) Note: Overall infrastructure and Utility infrastructure Scores 1-100 Best; Sub-sector Transport infrastructure Scores 1-7 Best; Rank: out of 141 countries Challenges are further compounded by climate change Vietnam is among the 10 countries most affected by climate change and natural disasters globally.86 Each year, an average of US$852 million worth of economic activity and 316,000 jobs are at risk from riverine and coastal flooding in the agriculture, aquaculture, tourism, and industry sectors. This is particularly acute for many of the growth engines of the country and respective regions—like Ho Chi Minh City, Da Nang, and Can Tho cities—which are on the frontline of climate-related and extreme weather events. For instance, the World Bank estimates that Da Nang city would incur around VND900 billion— about 4.5 percent of its annual spending and 0.8 percent of GRDP—in asset loss annually due to extreme weather events during 2021–2030. Compounding the threats of sea level rises are risks due to salination, land subsidence, and erosion in populous regions of the country such as the Mekong Delta with more than 17 million citizens.87 Vietnam’s public investments and assets are increasingly exposed to growing climate risks and physical threats related to extreme weather events. In 2022, the cost of direct damage to energy and transport infrastructure from typhoons and floods was estimated at US$475 million. Firms had estimated expenses of US$280 million due to a lack of reliable and resilient infrastructure. Despite such risks, the average investment in disaster protection infrastructure is only an estimated 0.05 percent of GDP. The forecasted cost to improve coastal resilience will climb to US$4 billion by 2035, of which US$2 billion alone will cover the cost of constructing and heightening sea dikes.88 Vietnam’s total incremental financing needs to address the green transition and climate change- related challenges could reach an estimated US$701 billion over 2022–2040, or approximately 6.8 percent of GDP per year.89 Public investment—with its critical roles as the trailblazer and the 86 Various sources: including climateknowlegeportal.worldbank.org; climatelinks.org; and climaterisk.undp.org. 87 Vietnam Country Climate Development Report (CCDR) (World Bank, 2022). 88 Resilient Shores: Vietnam’s Coastal Development between Opportunity and Disaster Risk (World Bank, 2020). 89 Vietnam Country Climate Development Report (CCDR) (World Bank, 2022). 45 TAKING STOCK AUGUST 2023 catalyst for private investment—would account for more than one-third of the financing needs, or about 2.4 percent of GDP. The pathway to improve climate resilience alone would account for about two-thirds of this amount as substantial financing will be required to protect the country’s assets and infrastructure as well as vulnerable people. However, climate change adaptation is not fully accounted for in the overall fiscal strategy nor in prioritization of projects for budget funding in Vietnam.90 III. WEAKNESSES IN THE INSTITUTIONAL FRAMEWORK Interconnected issues across the entire PIM cycle The inefficiencies highlighted above are rooted in weaknesses in the public investment management system. Challenges persist across the entire PIM life cycle: project preparation, implementation, monitoring and evaluation, and post-construction asset management. These issues are inherently interconnected. Weaknesses during planning and appraisal—leading to low ‘quality-at-entry’— feed through to implementation and adjustment where they become apparent in cost overruns and delays. Similarly, difficulties in downstream implementation of projects amplify problems at planning and appraisal. More specially: z Project preparation/selection stage: A key impediment is the absence of unified methodological guidelines to support evidence-informed decision-making.91 Pre-feasibility studies (PFSs) are not prepared for Group B92 projects (which can be considered large for most provinces)93 and not made public, except for official development assistance (ODA) projects. The lack of rigorous project costing— due to low technical cost norms, often underestimated land acquisition and resettlement cost/ timeline—leads to subsequent adjustments and delays when inaccuracies are exposed. These chronic problems come from the lack of dedicated budget and time to prepare meaningful PFSs with credible cost estimates, since this concept proposal stage runs on a five-yearly cycle, linked to the preparation of Medium-Term Investment Plans (MTIPs). However, there is generally reluctance to revise the total investment cost at the feasibility study (FS) stage because if any change is needed, the project has to be returned to the PFS stage. In addition, life-cycle project costs, including capital and operating costs, are not estimated at the PFS stage.94 This results in the underfunding of O&M for most public investment projects. 90 This report also acknowledges the importance of greening public investment but does not discuss related issues in detail. The issues include among other things: the lack of effective green taxonomy (to scale up sustainable investment and apply eligibility criteria for green bonds/ credits), green public procurement being in its infancy (as existing legal framework needs to be operationalized and aligned better with international good practices), and green financing (particularly green bonds) not being implemented despite the availability of initial legal enablers. 91 While a feasibility study including examination of economic efficiency is required for large projects—Group A projects and nationally important projects—there are no common methodological guidelines, including for social cost benefit analysis (SCBA), to support decision- making. As in many other countries, social and political factors weigh heavily on investment decisions, with less focus placed on evidence of public value and sustainability. 92 The Public Investment Law groups projects (A, B, C) based on sectors and total investment cost. 46 MAKING PUBLIC INVESTMENT WORK FOR GROWTH z Project implementation stage: Overly complex processes impede implementation and disbursement of projects and approvals of adjustments. Despite budget appropriation at the beginning of the year, most projects take approximately three to five months to complete the detailed activity and procurement plans before implementation. The time and costs for land clearance and resettlement processes affect the roll out and implementation processes. The value-for-money advantages of open, competitive procurement – even though it is the default method as per the Public Procurement Law – are being dissipated due to frequent use of direct procurement.95 Organizational arrangements for monitoring implementation are diffuse and monitoring tends to be passive and does not lead to a fundamental review and adjustment of struggling projects. There is no systemic mechanism for central ministries and provinces to identify projects at high risk of delivery failure and take adequate remedy actions in a timely manner. The information systems on outstanding and multi-year financial commitments, essential to ensure financing of on-going projects, are poorly developed. z Project monitoring and ex-post evaluation stage: There is notable room for improvement of the project database, a critical element of a well-functioning M&E system. A State Budget Investment Management Information System (SBIMIS) developed by the MPI in 2017 now captures investment allocation and execution information of more than 41,000 projects nationwide (at national and partially at subnational levels). However, there are significant data gaps, limited compliance of investment owners on updating data, and limited data sharing across government agencies. The shares of projects monitored, inspected, and evaluated through SBIMIS in 2022 were only 47.3, 25.6 and 39.2 percent, respectively.96 The SBIMIS is not interoperable with the Treasury and Budget Management Information System (TABMIS) on necessary information—such as commitments, disbursements, and implementation progress—to inform corrective actions as needed. Some provinces invest in their own systems to monitor projects, leading to fragmented databases. Investment data is commonly not disclosed hindering M&E of public projects. While the legal basis for ex-post evaluations was established, evaluation of project completion is rarely performed, except for ODA projects, and reflecting on lessons is not a strong feature of completion reports. z Public asset management: The lack of a comprehensive legal framework for asset accounting and reporting and up-to-date and integrated asset registries has hindered effective decision-making on new infrastructure investment, O&M, and revenue policy for all infrastructure (at national and sub-national levels). While there is a clear definition of infrastructure assets in the Public Asset Management Law, there is currently only management and accounting guidance for roads and water/irrigation infrastructure assets, but even this is not consistently applied, which impedes accuracy of asset value reporting. The dual budgeting system, with the MoF overseeing the recurrent budget and MPI managing the capital budget, also accounts for the underfunding of O&M. 93 For many Groups B and C projects, to be included in the MTIPs, project owners only propose the names of projects without proper justification of their linkages to the development strategy or cost benefit analysis. 94 This is partly due to the dual budgeting system in Vietnam, where the project owner is allocated capital budget only, while O&M costs are allocated to another agency as part of the recurrent budget. 95 See Vibrant Vietnam, pp. 66-68, World Bank (2021). Also, there is historical evidence of some projects completed below cost thanks to competitive bidding, as indicated by a JICA construction assessment of about 100km of National Highway No.10 from Haiphong to Ninh Binh together with 40km of bypass roads and several bridges, with the actual project cost only 76 percent of the estimate. 96 Public investment monitoring report (MPI, 2022). 47 TAKING STOCK AUGUST 2023 Misaligned spatial planning and budgeting In the context of high levels of decentralization, the planning and budgeting systems face challenges in coordinating top-down strategic prioritization with bottom-up project identification by 63 provinces. The Spatial Planning Law (2019) aims to achieve a paradigm shift in the master planning approach towards integrated spatial development at national and regional levels. The National Spatial Development Master Plan (NSDP) to 2030, vision 2050 places an emphasis on supporting four dynamic zones and three economic corridors, with linkages within and across zones and six socio-economic regions. More recent efforts towards integrated spatial development support a coherent regional investment approach, but face implementation challenges. The plethora of planning tools—including national, regional, sectoral, and provincial 10-year masterplans—are tenuously linked to their respective five-year Medium-Term Investment Plans. Investments that span multiple provinces are critical to enhancing inter-provincial connectivity, addressing the adverse impacts of environmental pollution and climate change, and achieving synergies between public and private investments. However, there are several impediments to linkage investment, both vertically and horizontally across levels of government, including: z Legal constraints to linkage investment: The State Budget Law (SBL, 2015) does not include institutional mechanisms for vertical and horizontal coordination. On vertical coordination, the laws generally assign projects of national or inter-provincial scope to ministries. However, the nature of interprovincial investments and respective responsibilities are not clearly defined. The State Budget Law also provides a general description of responsibilities in infrastructure services without adequate consideration of resources and incentive mechanisms to ensure these services are provided. The result is underinvestment in infrastructure networks, particularly those with interprovincial characteristics. On horizontal coordination, the State Budget Law is not conducive to coordinating across spatial or sectoral jurisdictions. For example, the State Budget Law (Article 9) explicitly bans the transfer of investment funds from one province to another, even in cases where the benefits of cross-provincial projects are evident. Although the intention of the legal framework is to maintain fiscal discipline, such a strict rule creates a financing gap for regional projects. z Institutional challenges in coordination: Vietnam has pursued several approaches to regional investment coordination since the early 2000s, however, none has produced the expected results. From 2002 to 2020, several efforts were made to establish steering committees for selected regions, such as in the southwest (2002), Central Highlands (2002), northwest (2004) and most recently, the Regional Coordination Council for the Mekong Delta region (2020). However, these experiences suggest that the challenges cannot be addressed exclusively by coordination councils without addressing the real legal and financial constraints and disincentives to realize regional investment needs (see Box 2.2). z Lack of effective linkage investment and financing mechanisms: The modality of “public investment program” is included in the Public Investment Law (PIL, 2019),97 but not elaborated nor utilized effectively in practice. This modality could connect the players vertically and horizontally. For domestic resources, the only mechanism for such vertical linkages is through National Targeted Programs (NTPs). From 2011 to 2021, the government has reduced the size of targeted (or conditional) Article 4, item 8: “Public investment program refers to a combination of goals, duties and solutions designed to carry out socio-economic 97 development objectives.” 48 MAKING PUBLIC INVESTMENT WORK FOR GROWTH transfer schemes in terms of expenditure (from 9.1 to 2.8 percent of total expenditure) and in terms of their number (from 16 NTPs and 45 smaller targeted programs to three NTPs and several on-granting schemes).98 There is ongoing debate on the adequacy of size and institutional structure for NTPs to better link resourcing to targeted results. For external financing, governed by the Public Debt Management Law (PDML, 2017), the co-financing arrangement was introduced in 2017.99 Provinces have been categorized into five groups, depending on their fiscal capacity measured by the level of dependency on central budget transfers, with respective co-financing ratios. However, the programmatic mechanism that connects the central budget and multiple provincial budgets (the so-called “umbrella projects”) was removed in recent years due to concerns over its complexity.100 Box 2.2. Coordination and investment challenges in the Mekong Delta region Even in regions, such as the Mekong Delta, championed by the government and development partners, progress in promoting horizontal and vertical coordination has been slow and piecemeal. In the Mekong Delta, after significant efforts to strengthen regional coordination institutions, initial results were achieved with the establishment of the Regional Coordination Council (RCC) in 2020, a regional data center in 2022 and the Integrated Regional Master Plan in 2022. As per Prime Minister’s Decision 825 (2020), the focus of the Mekong Delta RCC, with representation from all regional provinces and key sectors, is to support development and implementation of inter-provincial investments that promote climate smart and sustainable economic transformation of the region. After two years in operation, the council has yet to receive sufficient authority and resources to intervene in planning processes. Similarly, engagement in implementation processes is dependent on the executive authority of the government, both local and central. In 2019, the Prime Minister issued Directive 23 with the promise to provide additional targeted transfers of US$2 billion to the region on top of balancing transfers for 2021–2025. As a result of ambiguity in relevant laws, it took almost another four years for the government and concerning provinces to discuss and agree in principle on priority investment projects for the package and respective expenditure assignments between central and provincial budgets. Finally, a co-financing ratio of 90:10 between central and provincial responsibilities was decided on an ad-hoc basis, different from the applicable on-lending ratio of external financing. It will expectedly take more time for the investment decisions to realize. With provincial governments holding the lion's share of public investment resources, the central government leverages co-financing from richer provinces to undertake infrastructure projects that are regional.101 The recent approval by the National Assembly of Ring Roads No.3 and 4 demonstrates the importance of such vertical coordination—albeit still on an ad-hoc basis—for nationally 98 Source: World Bank staff calculations based on MoF and MPI websites. 99 Through Decree 52 (2017), which was subsequently replaced by Decree 97 (2019) and supplemented by Decree 79 (2021) on ODA and concessional lending. 100 This mechanism was stipulated in Decree 38 (2013) then removed in Decree 56 (2020) and Decree 114 (2021) on the management and utilization of ODA and concessional financing. 101 Within this context, when regional projects need to be financed and undertaken by provinces, the case is to be made to the National Assembly, which in turn needs to issue a resolution to make a special case to adjust MTIPs. 49 TAKING STOCK AUGUST 2023 important projects.102 However, such ad-hoc decision making process raises concerns over the potential inconsistency related to co-financing ratios between central and local governments. Additionally, other inter-governmental PIM mechanisms—such as revenue mobilization, on-lending of domestic financial resources from central government to SNGs, joint procurement/contract management, and O&M responsibilities—are unclear. Climate change largely absent in fiscal and investment decision Climate change adaptation is not fully accounted for in the overall fiscal strategy nor in prioritization of projects for budget funding. The high-level policy commitment by the Prime Minister at COP26 (net zero by 2050) and the Green Growth Strategy until 2030, vision 2050 (approved by the Prime Minister in 2021) and action plans are yet to be associated with credible estimates by either the MoF or MPI of their fiscal implications. Thus, there are insufficient numbers of green and disaster/ climate-resilient infrastructure investments. On the other hand, most budget allocations include funding for complementary measures to make projects more sustainable and resilient, and a contingency for unforeseen circumstances, including climate-related events.103 Additionally, SNGs are least prepared to assess and mitigate physical and transition risks of climate change on investments and assets as they lack policies and processes. The lack of information on the value of assets and their risk exposure increases the cost of SNG’s insurance. To ease some of these challenges it would help to digitize these core public finance and asset management functions and engage in more proactive risk management. Transboundary development challenges are emerging more frequently, and with more severity, and require coordinated actions across different levels of government. These include issues such as climate change mitigation and adaptation, ground water overexploitation, surface and groundwater pollution, waste and air pollution, aging water supply infrastructure, emerging water- sharing conflicts, and increasing drought and flood events. In many cases, industrial plants, plastic waste, submersion of dredging materials in upstream provinces pollute waterways creating serious negative externalities for downstream provinces, but efforts have failed to deal with the polluters.104 For instance, in the central coast region, Danang city has sent multiple complaints to Quang Nam province and to the Prime Minister regarding problems created by changes in water flows, which exacerbate floods during heavy rains upstream and cause drought in downstream areas in dry season.105 While the estimated cost of addressing this issue in Quang Nam (upstream) is US$50 million, downstream in Danang the estimated cost of the flood risk management has ballooned to more than US$350 million.106 However, as 102 Ring Road No.3 (76km) connects four SNGs (Ho Chi Minh City and Dong Nai, Binh Duong and Long An provinces in the Southeast region) and Ring Road No.4 (113km) connects three SNGs (Hanoi city, Hung Yen and Bac Ninh provinces in the Red River Delta region). 103 While the Ministry of Natural Resources and Environment updated the national climate change and sea level risk scenarios in 2021—which alerted even more threats to low land and coastal areas—it together with sectoral ministries have not issued any guidelines for applying the scenarios in sectoral strategies and investment design for projects. Given the increasing uncertainties, a different approach—that is flexible and adaptive—is required for risk management in spatial planning, and design and management of investment projects. However, this is currently being confused with the ministry’s role in reviewing project environmental impact assessments. Therefore, an adaptation framework is not applied in practice. 104 For example, in 2017–2020, the northern provinces revealed 45 businesses as the highest polluters and requested their closure or employment of more advanced technology. However, 10 years after the establishment of the Basin Protection Committee, only 64 percent of the polluters had adopted pollution mitigation measures. 105 Small and medium scale hydropower plant development master planning in the central region (Tuoi Tre News, 2019). 106 Resilient Shores: Vietnam’s Coastal Development between Opportunity and Disaster Risk (World Bank, 2020) 50 MAKING PUBLIC INVESTMENT WORK FOR GROWTH discussed above, the current PIM and IGF systems are unable to prioritize and implement these kinds of transboundary resolutions and investments. General weaknesses in appraisal methods mean limited attention is paid to the specifics of climate change risk and adaptation. These shortcomings in the appraisal process, particularly the absence of systematic methodologies like social cost-benefit analysis, have already been identified earlier in the section discussing the PIM challenges. This weakness means there is no formal methodological basis for evaluating climate change impacts of projects and respective mitigation efforts or evaluating alternative adaptation options in response to identified climate change risks. Project appraisals for large projects require environmental impact assessments. Notionally, in relation to climate change and responses, this should consider both the impacts of and on the project. While procedures for construction projects in the Construction Law and supporting regulations recognize the need to consider climate change risks and adaptation, there is no regulatory requirement to examine climate change risks early in project preparation, such as during preparation of the feasibility study and appraisal, when it is more efficient to develop, analyze, and integrate adaptive responses. IV. RECOMMENDATIONS Going forward, Vietnam will need to sustain its level of public investment, rationalize its composition, and enhance the efficiency and effectiveness of PIM and IGF institutions. To achieve these goals, the government may consider the following: z First, it will be critical to improve project planning and appraisal, as the low ‘quality-at- entry’ has fed through to implementation and adjustment where they become apparent in cost overruns and delays. Recommended reform actions include providing more time and budget to prepare project Pre-FSs and updating Medium-Term Investment Plans on a rolling basis. Unit costs and land prices should be regularly updated closer to market prices to ensure cost estimates are realistic. In addition, providing methodological guidelines to prepare project Pre-FSs, both generic and sectoral, should be elaborated for the application of social cost benefit analyses and other complementary or supplementary tools and for the total costs for the entire project lifecycle to be estimated in project proposals. In order to enhance climate resilience of the country, climate change screening should be mandated from the early stage of investment policy and associated adaptation measures should be evaluated in both the Pre-FSs and feasibility studies of projects with high risks. z Second, it will be equally important to enhance project implementation and M&E for efficient conversion of capital spending into infrastructure once the resources are allocated. Separating land clearance and resettlement from the investment project could help accelerate implementation particularly for large projects. Effective project adjustment and termination measures should be informed by a systemic mechanism for central ministries and provinces to identify projects with a high risk of delivery failure and through streamlining steps. The use of satellite and GPS data should be explored further to analyze and make decisions. And the scope and depth of ex-post assessments of projects should be increased, at least for all large and medium projects. 51 TAKING STOCK AUGUST 2023 z Third, public asset management should be strengthened for more effective spending and revenue measures. A foundational step would be to establish a database of all infrastructure assets with their values and employ technology applications and data analytics for budget allocation decisions for O&M and new investments. Reforms on infrastructure asset accounting and reporting should be phased in methods for more accurate asset valuation and presentation of amortization and depreciation expenses. z Fourth, the budgets should be made more strategic and programmatic. This includes improving budget classification and presentation structures, and operationalizing “public investment program” modality as stipulated in the PIL more efficiently to facilitate policy orientation (including regional development, green transition, and climate resilience). z Finally, intergovernmental fiscal and investment institutions should be modernized. SNG own-source revenue assignments, revenue sharing arrangements, and equalization rules should be rationalized to better balance the needs of central government and SNGs. The SNGs include the dynamic provinces that act as growth engines and the poorer provinces. Unlock legal impediments in the State Budget Law to inter-linked public investment across levels of government will help enhance investment synergies. Mandates of Regional Coordination Councils should be extended to setting investment priorities in line with regional masterplans. New co-financing mechanisms should be institutionalized based on a well-defined formula that integrate external and domestic financing considerations into a holistic framework. Finally, fiscal mechanisms and incentives should be provided to enable green and climate actions across levels of government, such as ecological fiscal transfers and payments for ecological services. 52 MAKING PUBLIC INVESTMENT WORK FOR GROWTH REFERENCES Global Quality Infrastructure Index (GQII) Program. 2021. https://gqii.org/global-quality-infrastructure-index-2021/ Government of Vietnam. 2021. Socio-Economic Development Strategy 2021–2030. Government of Vietnam. 2023. National Development Masterplan 2021–2030, vision 2050. 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Vietnam Country Climate Development Report. Washington, D.C. https://openknowledge.worldbank.org/entities/publication/29e72556-d255-5c50-a086-245c1ccc4704 World Bank. 2023. Regional Investments in Vietnam: Challenges and Opportunities. World Bank Policy Note. Washington, D.C. World Bank. 2023. Global Economic Prospects, June 2023. Washington, D.C. doi: 10.1596/978-1-4648-1951-3. https://www.worldbank.org/en/publication/global-economic-prospects World Bank/KNOMAD. 2023. Remittances remain resilient but are slowing. Migration and Development Brief 38. Washington, DC. https://www.knomad.org/sites/default/files/publication-doc/migration_and_development_brief_38_ june_2023_0.pdf World Economic Forum. 2019. The Global Competitiveness Report 2019. https://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf 54 MAKING PUBLIC INVESTMENT WORK FOR GROWTH 55 Print 420 books, size 20.8 x 28cm. Printing house: Xuan An - 78 Tran Quy Cap, Van Mieu, Dong Da, Hanoi Confirmation of publication registration: 4126-2020/CXBIPH/7-148/TTTT Number of Publishing Decision: 417/QD-NXBTTTT, issued on November 10, 2020 Print and deposit in December 2020 ISBN: 978-604-80-5000-9 63 Ly Thai To, Ha Noi Tel: (84-24) 3934 6600 Fax: (84-24) 39350752 Email: vietnam@worldbank.org Website: www.worldbank.org.vn