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Monday, May 10, 2021

Demand stimulus: where to begin?

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Private sector consumption is a major growth driver of the Vietnamese economy. It is all the more important as the Covid-19 pandemic has sent global demand plummeting and countries worldwide imposing travel restrictions. In an economy with a large population, low income, and a high rate of savings like Vietnam, which policy shall be adopted to stimulate demand in a sensible way?

To cope with Covid-19, many governments around the world have had to accept economic sacrifices, with a rise in the public debt-to-GDP ratio and budget deficits. The budgets of quite a few governments have fallen into a situation of more spending and less revenue: spending on the health system, cash and credit supports for workers and the business community, plus reductions and deferment of payments of various taxes. In some states with a decent social security system like in Europe, the ratio of public debt to GDP is up to 80-110%, while budget deficits reach 8-9% of GDP.

Regarding economic aid packages, in terms of their proportion to GDP, Vietnam is quite modest compared to other countries. Such packages put together by the EU are estimated at 5% of GDP, while the percentages in the two nations quite close to Vietnam in ASEAN, Malaysia and Thailand, are 2.5% and 1.23% respectively. Meanwhile, the VND62 trillion support package (not yet fully disbursed so far) is equivalent to only 0.7% of Vietnam’s GDP.

In the context that many countries boldly adjust their budgets, perhaps Vietnam still has plenty of room to stimulate domestic consumption demand. That said, consumption depends on income and price, so where to begin?

The average monthly income of the poor, near-poor and middle-income groups in 2018 were VND931,000, VND1.8 million and VND2.77 million respectively. This means nearly 15 million households, or about 60 million people, have no access to a lot of basic goods and services due to the gap between income and price. It is worth noting that the sum these households spend on food, drink, and smoking makes up a sizable part of their income – 48% in the 2016 survey, the most recent figure. Their other needs such as housing, electricity, water, sanitation, household appliances, healthcare, travel, education, culture, sports, and entertainment, of course, face more limitations.

Therefore, in the short term, consumption demand stimulus will be effective with interventions in the price of goods and services. A subsidy policy will be able to do so directly or indirectly, but its focus of attention should be placed on food and foodstuff, since the need for safe, quality food is considerable among the three income groups mentioned above. Another thing to do is to boost the accessibility of commodity groups related to housing and home appliances. For example, help may come in the form of value added tax adjustments, or direct support for businesses. In case it is necessary to offset the VAT revenue deficit, the personal income tax rate bracket can be modified, reducing the number of taxable groups and putting up the tax rate for high-income earners.

Long-term for resilience and sustainability

As it is impossible for the relief policy to go on forever, stimulus policies should focus on improving people’s income, through employment generation. To do so, it is necessary to encourage domestic enterprises to make greater investment in manufacturing, industry and service sectors.

As per data for the first nine months of 2020, capital goods account for 93.5% of all imports, whereas consumer goods only make up 6.5% with an estimated value of US$12.16 billion. In addition to those items which must be imported as input for export, the proportion and value of consumer goods, equipment and tools suggest there is a huge potential of replacing imports to serve the local market.

Vietnamese manufacturers of electrical appliances, electronics, household appliances and furniture remain limited in terms of capacity and number. Many of them are simply outsourcing, so the added value is insignificant. For this reason, there need to be policies that encourage private enterprises to invest in these fields, to gradually increase the localization rate and eventually command the entire technological line, including part or all of the input.

The growing number of domestic enterprises will take in a large workforce, and create jobs that generate income. This is a driving force for sustainable consumption. In addition, stable employment is also a guarantee for the future cash flow, via which the capacity to spend on credit may be amplified.

The Covid-19 pandemic came as a great shock to most economies, including Vietnam. Still, Vietnam’s resilience proves this is also an opportunity for the country to give the private sector and the domestic market more attention. The public debt-to-GDP ratio is expected to be 46.1% in 2021, on the basis of GDP revaluation, so it is quite possible to improve this ratio, especially in the context of real interest rates around 0% in developed economies, plus a high savings rate at home. However, policies such as increasing public debt and curbing inflation need to be carefully studied with data of Vietnam concerning the following two issues.

The first is the difference of the interest rate “r” and the rate of growth “g”. Quite a few studies suggest that if the “r” minus the “g” is smaller than zero, the public debt ratio shall reach a stable threshold. In case the starting point of the debt-to-GDP ratio is not too high, it will be feasible to step up borrowings thanks to low interest expenses and the offset by growth.

The second is the correlation between real interest rates and growth. The results of the research on this correlation so far remain ambiguous, due to the differences between countries when it comes to the research model: in some cases, they are proportional, but in others, there is no apparent relationship at all. If Vietnam falls into the first category, adjusting real interest rates will be more important than just looking at inflation.

In short, demand stimulus in the current state of the Vietnamese economy in the short term should come with a pro-consumption policy which encourages people to spend more on goods and services. In the long term, it is necessary to create more jobs from local enterprises, focusing on manufacturing and service sectors. Long-term policies need to be based on reliable research results.

By Dr. Vo Dinh Tri (*)

(*) University of Economics Ho Chi Minh City, IPAG Business School Paris, and AVSE Global

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