10. Avoiding crises: macroeconomic management

1. 10. Avoiding crises: macroeconomic management

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

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

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

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

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

7. Do good times make for bad policies?

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

9. Foreign Investment

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

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

12. Role of state-owned enterprises • Favored for “leading role” in economic development • Domestic monopolies, cheap land, cheap and easy credit, government contracts, … • Little direct supervision over their activities • Do SOEs promote development? • Receive about ½ of all enterprise capital increases • Many projects of dubious value to long-term growth • Account for only ¼ of GDP growth • Almost zero employment growth • 2005-08 growth rate of jobs: Private sector 18%; foreign-invested sector 18%; state sector 0.6%

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

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

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

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