Hot spots: Vietnam.(INTERNATIONAL SECTION)

It is now 30 years since the fall of Saigon, and the takeover of Vietnam's South by the Communists. Much has changed in the interim to turn one-time combatants into economic partners. The U.S. has become Vietnam's largest export market, and Prime Minister Phan Van Khai's trip to the U.S. in June took him not only to the White House, but also to Seattle (to visit with Microsoft's Bill Gates and Nike and Boeing executives), New York (where he got to ring the bell of the NY Stock Exchange), and Boston (to tour Harvard University and the Massachusetts Institute of Technology).

Vietnam's economy will continue to improve, with strong growth and easily manageable external deficits. The expansion of real gross domestic product has been averaging an impressive 7% per annum, accelerating from 7.7% last year to 7.3% in 2003. Indications are that it will come to at least 7.5% in 2005, with exports remaining buoyant, terms of trade continuing to improve, and Vietnamese companies increasing their penetration of new markets abroad. The elimination of regulations discriminating against the private sector and measures to support small and medium-sized enterprises have gone a long way in promoting the development of private business.

A surge in credit growth remains a cause for concern. It has been due largely to the initiation of a number of big investment projects by state-owned enterprises (SOEs), which are being financed mainly by state-owned commercial banks (SOCBs). This has contributed a great deal to accelerated inflation--virtually nonexistent in 2001. Monetary erosion came to 4.0% and 2.9% in 2002 and 2003, respectively, and then jumped to 9.5% in 2004. In recent reports, it slowed to 8.5% in April, but this was mainly the result of delays in the pass-through of leaps in world market prices of oil and other goods. There is little doubt that inflation will reaccelerate in the second half of 2005. The Central Bank has sought to fight it by tightening monetary reins, but this failed to raise deposit and loan interest rates materially and did not stem the flow of new bank loans. One reason was that the CB announced it would not allow the local currency, the dong, to depreciate by more than 1% against the dollar during the course of 2004, and this made the cost of foreign currency borrowing highly attractive. While total bank credit grew by 42% in 2004, commercial banks' foreign currency lending shot up 58%. This generates risks in the event the dong is subjected to a steeper downgrading.

The State Bank of Vietnam has indicated that in 2005, as in 2004, it wants to limit the dong's decline versus the USD to 1%, but the IMF has been urging Hanoi to let the unit respond more freely to supply and demand in the marketplace. For now, the Vietnamese policy makers are hesitant to do this, but a more flexible exchange rate would help make the country less vulnerable to external shocks. This is not to say that Vietnam's external accounts pose major risks at this time. While the current-account BoP deficit may well increase this year, after contracting in 2004 to around 4.4% of GDP from 4.7% in 2003, strong tourist receipts and brisk homebound remittances by ...