US embassy cable - 04HANOI898

UNCLAS SECTION 01 OF 04 HANOI 000898 
 
SIPDIS 
 
STATE PASS USTR FOR EBRYAN 
STATE ALSO PASS USAID EFERRARA 
TREASURY FOR OASIA 
USDOC FOR 4431/MAC/IFP/OKSA/HPPHO 
BANGKOK FOR USAID 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EAID, VM, SOE 
SUBJECT: VIETNAM:  STATE OWNED ENTERPRISE REFORM 
 
REF A: 03 HANOI 2795  REF B: HANOI 221 
 
SENSITIVE BUT UNCLASSIFIED - PLEASE HANDLE ACCORDINGLY. 
 
1. (SBU) SUMMARY:  Reform of the state-owned enterprise 
(SOE) sector is one of the primary pillars of Vietnam's 
reform efforts and ongoing transition to a market economy. 
Relying on a four-pronged strategy that includes increasing 
competition, hardening budget constraints, divesting "non- 
strategic" enterprises, and strengthening autonomy of 
remaining SOEs, Vietnam has decided to retain a leading, but 
diminished, position for SOEs.  The GVN examined approaches 
to transformation of the state sector taken in Eastern 
Europe, the former Soviet Union, and China and clearly 
decided that it will reform slowly.  Unfortunately, though, 
it is falling behind its own schedule.  Resistance by vested 
interests threatens to delay not only SOE reform but also 
impede reform in other areas, including in trade 
liberalization and the banking sector.  END SUMMARY. 
 
REFORM STRATEGY 
--------------- 
 
2.  (U) In 1986, Vietnam's economy was composed only of 
state-owned enterprises (SOEs).  Facing high unemployment 
rates, a growing supply of labor, and widespread poverty, 
Vietnam undertook a policy of reform called "doi moi." 
Among other aspects, Vietnam committed in this program to 
make the transition to a "socialist-oriented, market 
economy."  Now, after 18 years, the state sector contributes 
around 40 percent of GDP, 38.7 percent of industrial output, 
and 39 percent of employment.  The GVN's present approach to 
SOE reform maintains an important role for the state sector 
while at the same time deploying four strategies for 
reforming the operation of SOEs:  1) increasing competition 
in markets through trade liberalization and a more level 
playing field with the private sector; 2) hardening the 
budget constraint by limiting government subsidies and by 
introducing a ceiling on the growth of credit to SOEs; 3) 
divesting non-strategic enterprises; 4) strengthening 
autonomous decision-making and accountability in those SOEs 
remaining under state ownership. 
 
3.  (U) INCREASED COMPETITION:  Increased competition, which 
should force SOEs to act more like commercial entities, is 
the first and most visible prong of the SOE reform program. 
Vietnam has committed to integrate into the global economy 
through agreements, such as the U.S.-Vietnam Bilateral Trade 
Agreement (BTA)(see ref A) and the ASEAN Free Trade 
Agreement (AFTA), programs with the World Bank and 
International Monetary Fund (IMF), and eventually membership 
in the World Trade Organization (WTO). (Note: The IMF 
program is currently stalled due to a disagreement over the 
IMF's requirement of an audit of the State Bank of Vietnam. 
End note).  As part of its efforts toward international 
integration, Vietnam has pledged to liberalize trade and 
investment rules, lower tariffs, abolish most quantitative 
restrictions, and create a transparent rules-based regime. 
Implementing these key obligations is expected to increase 
dramatically competitive pressures on Vietnamese 
enterprises. 
 
4.  (U) The GVN has started to create a more level playing 
field not only between foreign and state-owned enterprises 
through the above agreements, but also with domestic private 
ones.  Although SOEs are subject to a different corporate 
law from private domestic and foreign invested enterprises, 
a SOE law, which passed in November 2003 and will become 
effective in July 2004, will regulate only relations between 
the state and enterprises.  Currently, operational matters 
are left to the Enterprise Law, which also covers domestic 
private firms.  The GVN is, furthermore, discussing 
harmonizing all enterprise and investment laws (see ref B) 
and is drafting a competition law that would include the 
state sector.  (Note: Key clauses in the current draft of 
the competition law allow the exemption of state-owned 
monopolies deemed to be in the public interest and may 
diminish the impact the competition law has on key SOEs. End 
note).  In this new, more equal environment, SOEs will have 
to become more commercially viable or vanish. 
 
5.  (U) SOE BUDGETS CONSTRAINTS:  GVN attempts to harden the 
SOEs' budget constraints and eliminate directed lending (see 
septel) should make them more profitable or force them to 
declare bankruptcy.  In reality, though, GVN fears about the 
potential effect on an enterprise's workers and vested 
interests have made it easier for SOEs to avoid declaring 
bankruptcy.  Although many SOEs lose money, only 46 have 
actually been declared bankrupt while 124 have filed for 
bankruptcy since 1995. (Note: The Ministry of Finance 
estimates that around approximately 35 percent of SOEs are 
loss-making, 15 percent break even, and 50 percent make a 
profit even though it is unclear how profits and losses are 
calculated. End note).  Still, the GVN has stated that it 
will dissolve insolvent, loss-making enterprises that are 
not "strategic".  At the same time, it has committed to 
restructuring the debt and assets of those for which it 
"must" maintain ownership.  Real proof, beyond GVN 
statements, regarding this prong of the SOE reform program 
remains elusive given the lack of transparency of SOE 
financial accounts. 
 
6.  (U) DIVESTITURE:  Unlike in many former socialist 
economies where privatization of SOEs played a central role 
in transforming the state sector, Vietnam has taken a "go 
slow", decentralized approach to this aspect of its 
strategy, declaring its intention to retain a significant 
portion of its state sector.  In April 2002, the GVN issued 
a decision laying out principles governing "divestiture", 
declaring that the state will "reorganize toward merger or 
dissolution," those SOEs not meeting criteria related to 
industry, size, profitability and modernity.  At the same 
time, the Decision stated the GVN will retain full ownership 
in a wide range of areas deemed "strategic."  (Note: Vietnam 
does not call this process privatization, instead referring 
to it as equitization, divestiture, or transformation. End 
note).  A January 2003 Directive from the Prime Minister 
further explained that the GVN will retain at least 51 
percent of shares on initial public offering of profitable 
state enterprises that have state capital of 5 billion VND 
(approximately 320,000 USD) or more. 
 
7.  (SBU) Under the present approach, each Ministry, 
Province, and General Corporation formulates its own 
timetable for the transformation of its SOEs, with plans 
compiled into a published roadmap containing names and 
timeframes.  In 2003, the GVN began this undertaking by 
compiling the 104 divestiture plans drawn up by line 
ministries, provinces, and General Corporations (GCs) into a 
list of 2800 "transformations" for the 2003-2005 timeframe. 
Assembling these divestiture plans was designed to increase 
the "ownership" over the process from the point of view of 
the state agencies that "own" concerned SOEs, but it has 
made the process appear optional, rather than mandatory.  It 
gives the impression that the determination not to transform 
a SOE could go uncontested, which seems to ensure that SOEs 
with entrenched interests, regardless of whether or not they 
are "strategic" or profitable, will never be equitized. 
 
8.  (SBU) Within the international community, concern not 
only exists about the pace of SOE reform, but also its 
scope.  With the majority of SOEs, including the large 
General Corporations, slated for "restructuring" rather than 
divestiture, it appears that some key officials in the 
political leadership and GVN continue to entertain 
unrealistic expectations that SOEs can be successfully 
restructured and re-emerge as highly-competitive 
conglomerates in an integrated economy.  Although some may 
succeed, most will probably fail due to entrenched 
weaknesses.  Such an outcome will damage the financial 
sector (where state-owned banks have provided extensive 
loans to SOEs) and the economy as a whole, as well as 
possibly impede trade liberalization efforts if the GVN 
believes that it must protect these weaker SOEs at the 
expense of moving forward with its international 
obligations. 
 
9.  (U) ACCOUNTABILITY AND AUTONOMY:  The GVN recently 
addressed the issue of SOE accountability through a Prime 
Ministerial Decision.  Outlining various criteria related to 
financial, business, and social factors, the Decision states 
that the GVN will use this information to evaluate the 
operational efficiency of each SOE and its "owner."  The 
results of these assessments are to serve as a basis for 
making decisions on the future of SOEs and their management. 
At the same time, the GVN is attempting to increase SOE 
autonomy by separating state management from business 
monitoring.  It is thus planning to create the State 
Financial Investment Corporation, which will be fully 
responsible for investing state capital in order to make a 
profit.  In addition, this body is supposed to manage GVN 
investments in SOEs, leaving state agencies to be engaged 
only in state management issues.  Although such efforts 
should encourage SOEs to act more like commercially oriented 
entities, it is too soon to evaluate their effectiveness. 
 
OTHER ISSUES 
------------ 
 
10.  (U) FOREIGN PARTICIPATION:  Under a March 2003 Prime 
Ministerial Decision, anyone, including foreign 
organizations and individuals, can buy shares of equitized 
enterprises.  However, foreigners can only buy up to thirty 
percent of the charter capital.  In addition, the Ministry 
of Finance established priorities regarding to whom shares 
should be sold, giving preference to outside investors with 
technology, market access, and managerial skills. 
Interested foreigners can buy unsold shares through an 
auction.  Supporters of the stock market were disappointed 
that the GVN did not allocate this role exclusively to the 
stock market; rather the GVN only allowed that it was one of 
the possible vehicles for auctioning shares. 
 
11.  (U) VALUATION:  Enterprise valuation determines share 
structure.  2002 guidelines on this issue require the 
appraisals to be based on the enterprises' financial 
accounts at the time of equitization, the quantity and 
quality of assets, the assets' specification and market 
price, value of the land use rights, and value of the 
business goodwill.  If a company supplies services, it is to 
be valued using discounted cash flow methods. 
 
12.  (U) REDUNDANT WORKERS:  In Vietnam, significant concern 
has centered on the future of workers that are likely to be 
made redundant by SOE reform.  Therefore, the government 
established a social safety net fund for this group in April 
2002.  The account provides compensation in addition to the 
amount prescribed by the Labor Code for those redundant 
workers who began their employment before April 1998 or are 
on contracts from 1 to 3 years.  After much debate between 
the GVN and international donors, it was determined that 
each redundant worker can receive six months of salary, six 
months of training, and a lump sum.    Redundancy payments 
are said to average about 1,000 USD. (Note:  This is about 
2.5 times average GDP per capita.  End note).  The fund 
additionally covers any shortfall in enterprise obligations. 
Because SOE directors are considered public servants, rather 
than enterprise employees, they are not entitled to such 
compensation. 
 
AFTER EQUITIZATION 
------------------ 
 
13.  (U) In 2002, the World Bank and the Vietnamese Central 
Institute for Economic Management undertook a study of 422 
enterprises equitized prior to 2001.  This review reveals 
the relative success of these enterprises, with sales 
growing at almost 20 percent per year, employment, at 4 
percent, wages, at 12 percent, and assets, at 21 percent. 
Furthermore, over 70 percent of respondents indicated that 
they considered the enterprise to be performing better after 
equitization.  Such positive results are partially 
attributable to the self-selecting approach taken to 
equitization, because those who anticipated commercial 
success chose to equitize first.  Still, equitized 
enterprises did experience problems.  Many are similar to 
those that other private sector counterparts encounter, 
including difficulties accessing credit from banks and 
obtaining government licenses and permits. 
 
THE NUMBERS 
----------- 
 
14.  (U) Vietnam began addressing the issue of the state 
sector in 1990 when around 12,000 SOEs existed.  Since 1998, 
the GVN further reduced this number from over 6000 to 
approximately 4900 SOEs through liquidation, transformation, 
and mergers.  Unfortunately, this decline has slowed down 
over recent years.  Whereas in 1999, 370 SOEs were 
"transformed", the first ten months of 2003 only saw 213. 
(Note: These numbers include "equitizations", transfers, 
sales, liquidations, and bankruptcies. End note).  It is 
clear that the GVN did not approach the roadmap's ambitious 
target of 1459 transformations in 2003. 
 
15.  (U) In mid-2001, the process of creating new SOEs 
almost came to a halt when the GVN instituted a requirement 
that the Prime Minister approve the creation of every new 
SOE.  This change was ratified in 2002, creating strict 
controls over the creation of additional SOEs.  The 
expectation by the World Bank and IMF was that the new 
policy would freeze all new SOEs; it did not.  In fact, 
eight new SOEs came into existence in the first nine months 
of 2002. (Note: According to the World Bank, only 30 to 40 
percent of SOEs created in 1998-2001 represented new state 
activities. End note). 
 
16.  (U) Most transformed enterprises are small, with the 
average number of employees about 250, and almost 85 percent 
having chartered capital of less than VND 10 billion 
(approximately 640,000 USD).  Furthermore, they generally 
had carried an average of about 370,000 USD in debt prior to 
transformation.  The reduction in the number of smaller SOEs 
and the development of the larger, more successful ones 
means that the absolute size of the state sector has 
actually increased.  This fact explains why the state 
sector's share of total GDP has remained consistent at 
around forty percent for the last five years.  Meanwhile, 
the SOE share of industrial output has declined considerably 
due to the private sector's simultaneous rapid growth. 
 
17.  (U) Debt levels in SOEs continue to cause serious 
concern.  The outstanding bank debt of SOEs amounts to 
approximately 6 billion USD, representing approximately 
forty percent of total domestic credit.  Although the share 
of credit going to SOEs is gradually declining, credit to 
SOEs as a fraction of total outstanding loans remains at 
between 40 and 60 percent. (Note: Because of the dubious 
quality of the banks' audited accounts, there is probably no 
definitive accounting. End note) Although non-state-owned 
commercial banks nearly halved their credit exposure to 
SOEs, state-owned commercial banks (SOCBs) exposure only 
moderately decreased and remains four times as high as that 
of other banks (see septel for more on the banking sector). 
 
18.  (SBU) COMMENT: After examining approaches to 
transforming the state sector taken in Eastern Europe, the 
former Soviet Union, and China, Vietnam made a conscious 
decision to undertake reform slowly, especially with respect 
to SOEs.  However, it is presently not even meeting its own 
targets.  Initially, the GVN could blame the lagging reform 
on technical issues, given the enormity of the scope and 
complexity of the job.  Now that the GVN has laid a 
significant portion of the legislative foundation, 
recalcitrant vested interests in the SOEs themselves and 
their home Ministries are emerging as a strong impediment to 
reform.  (Note: It has revised or issued 14 legal documents 
related to SOE reform since 2001. End note). 
 
19.  (SBU) COMMENT CONTINUED: The GVN started equitization 
with the easiest cases, leaving the difficult (and more 
politically sensitive) cases for later.  It has repeatedly 
stated that uncompetitive SOEs will simply disappear through 
increased competition.  However, the GVN appears to lack 
clear priorities regarding "strategic" sectors.  Our concern 
is that delays in SOE reform could negatively impact the 
GVN's trade liberalization agenda as the government attempts 
to protect all sectors due to entrenched interests and fears 
over unemployment.  The World Bank has argued that the GVN 
needs to take a conservative approach since a major 
"restructuring" fiasco early on would only serve to delay 
the program further.  Now it is up to the GVN to address the 
hard cases and show its commitment to a complete SOE reform 
program. 
PORTER