As it emerges from COVID-19, Vietnam’s economy is set to return to growth, but not until the global economy bounces back.
This is the first of two articles where McKinsey & Company looks at the immediate impact of COVID-19 on Vietnam’s economy and identifies the long-term challenges the country can consider addressing to realize its potential as the global economy recovers.
With two months now elapsed since its last known case of community transmission Vietnam is one of the first countries to have moved past COVID-19’s initial healthcare crisis, enabling it to fully reopen its domestic economy.
While resurgence remains an ever-present threat, Vietnam’s Government is now turning its attention to repairing a damaged economy. Vietnam has fared better economically than many other countries, but it has not been spared. GDP growth in the first quarter was at its lowest level since 2010, although it was still in positive territory at 3.8%. With exports and tourism severely affected, domestic consumption has been (and is expected to continue being) critical to hold the economy together.
Staying afloat in 2020, largely thanks to spending on essentials
Buoyed by a rapidly growing middle class and rising disposable income, domestic spending has long been a key engine of growth for Vietnam, accounting for a very significant 68% of GDP. Although under pressure from falling demand – two-thirds of Vietnamese surveyed in April said their income had been disrupted by the virus and 55% said they had cut back on spending – the “engine” has largely remained in gear.
Vietnam’s lockdown on non-essential activities was limited to 22 days—significantly shorter than many other countries— and it eased some of the downward pressure on consumption. A VND27 trillion stimulus package targeted at households and small businesses that was released in March also supported demand.
It remains to be seen how long domestic consumption can keep the economy afloat in the absence of a return to growth in other key sectors of the economy, but a closer look at Vietnam’s spending characteristics gives some reason for confidence. The critical factor is the importance of spending on essential goods and services, which accounts for 42% of national GDP, compared with just 26% for discretionary spending. With the impact of spending cutbacks mostly being felt by the latter category, a significant slice of the country’s economy could be relatively well insulated.
Vietnam will still be reliant on the world economy to rediscover growth trajectory
Regardless, domestic consumption will not likely on its own return Vietnam anywhere close to its pre-COVID-19 growth trajectory. Its short-term outlook is therefore closely tied to the global economy’s ability to restart and for the rest of the world’s consumption to return. Most international agencies expect that to begin happening later this year and accelerate the next, with the Asian Development Bank, World Bank and International Monetary Fund all releasing forecasts at the end of the first quarter predicting Vietnam’s GDP growth to reach from 6.8% to 7% in 2021.
A rebound in international tourism numbers and labor-intensive manufacturing exports will be critical factors for meeting these figures. Given the unpredictable nature of COVID-19, it is difficult to analyze how the international tourism recovery will play out, but it is likely that the first arrivals will be from within the ASEAN region as borders reopen. Vietnam’s relatively virus-free status positions it well to receive an outsized share, subject to precautions to prevent resurgence.
Even a strong rebound in intra-ASEAN arrivals will not be able to prevent international tourism arrivals from sliding 50% to 70% for the full year. This represents a significant impact on a sector that has already seen the closure of thousands of operators with a worrying impact on jobs. However, aside from promotional activity, there is little that Vietnam can do until more international travel reopens. While some countries can promote domestic tourism to replace some lost earnings, with per capita GDP just three times the US$900 that a typical foreign tourist spends per trip, it will be challenging to bridge this gap if Vietnam just relies on the current local spending power.
In 2021, prospects positive for manufacturers, once demand returns
For Vietnam’s manufacturers, another key economic sector for the country’s overall return to pre-COVID growth levels, they were impacted by the virus in two ways: first through supply disruptions when China shut down and then by plummeting demand as key export markets stalled. With exports falling and the prospects of a near-term recovery looking uncertain, companies began putting planned investments on the back burner, contributing to a 21% drop in FDI disbursements in the first three months of the year.
However, there are some important bright spots to watch. The sector’s critical importance for Vietnam’s overall economy is clear and key steps have been taken to keep operations running despite the lockdown. For example, engineers for at least two major international electronics manufacturers were still allowed to enter the country earlier this year to ensure their factories continued running at full capacity. This contributed to an increase in electronics exports during the crisis. This could help bolster the attractiveness of the country with other manufacturers in a strategically important sector. The Government also worked with pharmaceutical businesses that had begun producing personal protective equipment (PPE) and facilitated access to global markets, leading to a large increase in exports from that sector.
As many manufacturers globally start to rethink their supply chain strategies to address frailties exposed by the pandemic, Vietnam has remained in a strong position. The country has long been an attractive offshoring destination – its share of labor-intensive manufacturing exports from emerging markets grew 2.2% between 2014 and 2017. It could accelerate, especially if companies increase efforts to diversify their supply chain in the wake of the pandemic. A McKinsey survey of fashion sourcing executives published last month supports this view, with 24% of respondents saying they expect to see an increase in production in Vietnam – more than any other location in Asia.
While this year may be difficult, Vietnam could expect the strong growth of recent years to return, and it will likely see its position as an offshoring location reinforced – once the global economy also begins to recover. Harnessing this to become a middle-income nation will require multiple longer-term investments—from Industry 4.0 to infrastructure development.
If Vietnam can continue to keep COVID-19 at bay and make the right structural shifts to drive growth over the next decade, it could not only recapture its pre-COVID-19 position but drive new economic growth.
By Bruce Delteil, Matthieu Francois and Nga Nguyen
The authors are from McKinsey & Company. Bruce Delteil is a Partner and Nga Nguyen is a Client Advisor. Both are based in Hanoi. Matthieu Francois is an Associate Partner in the HCMC office.