US embassy cable - 05HANOI2555

UNCLAS SECTION 01 OF 04 HANOI 002555 
 
SIPDIS 
 
STATE PASS USTR ELENA BRYAN 
 
SENSITIVE BUT UNCLASSIFIED - DO NOT POST ON THE INTERNET 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EINV, ETRD, VM, SOE, FINREF 
SUBJECT: VIETNAM'S EXTRA-BUDGETARY FINANCING 
 
  1. (U) Summary: The Development Assistance Fund (DAF) and 
  the Vietnam Postal Savings Company (VPSC) are responsible 
  for an increasingly large share of the Government of 
  Vietnam's (GVN) policy lending efforts.  The VPSC raises 
  funds from ordinary citizens through its deposit and 
  transfer services.  By law, it is required to lend this 
  money to the DAF, which then makes loans to GVN- 
  prioritized development and infrastructure projects at 
  subsidized rates.  Both organizations are difficult to 
  classify and operate outside of the normal regulatory 
  framework for financial institutions.  While neither 
  company is more than five years old, the DAF has swelled 
  to a size comparable to those of the four dominant State- 
  owned commercial banks (SOCBs), with a registered capital 
  of about USD 629 million.  In 2004, the DAF's outstanding 
  loans were roughly equivalent to 12 percent of 2004 GDP 
  (USD 45.4 billion).  There are no immediate plans to 
  equitize either the DAF or the VPSC.  End summary. 
 
  2. (U) Despite marked progress with market-based economic 
  reforms, the GVN appears committed to sustaining some of 
  its State-owned enterprises (SOEs).  SOE reforms and 
  privatization to date have focused largely on small and 
  medium enterprise (SME) SOEs, leaving the largest (and 
  often the least profitable) SOEs on the GVN payroll. 
  Balancing this SOE commitment with fiscal austerity has 
  been a challenge.  In order to keep a low budget deficit, 
  the GVN has expanded its extra-budgetary lending to SOEs 
  over the last several years.  This strategy aims to 
  finance infrastructure improvements and exports as the 
  Vietnamese economy prepares for heightened competition 
  with foreign companies and strong regional economies. 
 
  3. (U) The DAF is not only the GVN's fastest growing 
  policy lending and development assistance onlending 
  instrument, it is also the largest financial institution 
  in Vietnam in terms of registered capital (which reaches 
  almost USD 629 million).  Chartered in 1999 under Decree 
  50/1999/ND-CP (Decree 50), the DAF works closely with 
  another relatively new entrant to Vietnam's economic 
  scene: the VPSC.  This State-run service is reminiscent 
  of the postal savings systems still used by other 
  governments, most notably by Japan.  The purpose of the 
  VPSC, which was also established in 1999, is two-fold: to 
  provide deposit and lending services for remote areas 
  beyond the reach of commercial bank branches and to 
  mobilize funding for the DAF.  (Note:  The following 
  information on the DAF and the VPSC is derived from 
  conversations with GVN officials, various independent 
  assessments by the World Bank, comments to the U.S. 
  working party for Vietnam's World Trade Organization 
  accession, and our study of the DAF and VPSC's recent 
  activities.  End note.) 
 
  THE DEVELOPMENT ASSISTANCE FUND 
  ------------------------------- 
 
  4. (U) WHAT IT IS AND IS NOT:  In practice, the DAF acts 
  as a State development bank.  According to its Director 
  for Foreign Capital Management and International 
  Relations Nguyen Thu Thuy Lan, the DAF's mission is to 
  provide capital for projects and enterprises that are 
  identified by the GVN as priority borrowers for policy 
  lending (Note:  The term "policy lending" - or 
  "development policy lending" as it is also known - used 
  to be referred to as "adjustment lending" by 
  International Financial Institutions (IFIs).  It is a 
  kind of lending targeted at making structural, financial 
  sector and social reforms in order to promote sustainable 
  growth in developing countries.  End note.)  The DAF also 
  guarantees investments, supports interest rate payments, 
  provides export credit and "onlends" Official Development 
  Assistance (ODA), a term the GVN uses to describe the 
  process of taking funding received from IFIs and lending 
  the money on to private Vietnamese enterprises and 
  projects that will encourage local development and 
  growth.  Like a State-owned bank, the DAF both evaluates 
  its projects and manages its own risk. 
 
  5. (U) Despite its SOCB-like behavior, the GVN 
  technically classifies the DAF as a government-run, non- 
  bank financial institution.  This classification reflects 
  the fact that the DAF does differ from normal SOCB 
  practices in two key areas:  the composition of its 
  borrowers and the level of its lending rate. 
 
  6. (U) RESTRICTIONS ON BORROWERS:  Decrees issued by the 
  GVN designate the DAF's eligible borrowers in an annual 
  list of priority industries and sectors.  Decree 
  106/2004/NC-CP (Decree 106), which took effect last year, 
  significantly improves the internal regulatory framework 
  for monitoring the DAF originally set up by Decree 50. 
  Decree 106 makes large cuts to the number of eligible 
  borrowers, and even those who are eligible must 
  demonstrate they are capable of direct repayment, socio- 
  economic efficiency, and feasible business planning.  The 
  DAF requires borrowers to post minimum collateral of 30 
  percent of the loan's value.  The DAF does not, however, 
  maintain a fixed collateral rate; it can even be as high 
  as 100 percent, depending on the project's level of risk. 
  Acceptable collateral is normally in the form on fixed 
  assets, such as equipment or machinery, including assets 
  that the loan itself may finance. 
 
  7. (U) LENDING RATES:  In theory, The DAF's lending rate 
  is lower (normally about 80 percent of the commercial 
  rate) and its lending period longer than those of 
  commercial banks.  The prime commercial lending rate in 
  September 2005 is 7.5 percent.  The Ministry of Finance 
  (MOF) pays the difference between the DAF's subsidized 
  rate and the commercial lending rate through payments in 
  the budget approved each year by the National Assembly. 
  In practice, the MOF-set rate is usually very close to 
  the actual commercial interest rate.   Before Decree 106, 
  the DAF was able to vary its lending rate based on risk 
  or State-determined priority.  During this time (1999- 
  2003), the DAF even lent money to highly subsidized 
  projects at interest rates as low as zero percent.  Now, 
  the DAF lends at a flat rate.  DAF officials also note 
  that the DAF does not finance nor guarantee more than 70 
  percent of the total capital of an investment project. 
 
  8. (U) REGISTERED CAPITAL:  The DAF's VND 10 trillion 
  (USD 629 million) in registered capital theoretically 
  makes it the largest financial institution in Vietnam. 
  However, registered capital is a nominal distinction in 
  Vietnam, reflecting the DAF's maximum legal level of 
  capitalization rather than its actual size.  Most of the 
  DAF's capital is liquid, a contrast to the Vietnamese 
  SOCBs' practice of holding large amounts of capital value 
  in Vietnamese real estate, a market considered to be 
  significantly overvalued.  At the time it was chartered 
  in 1999, the DAF held approximately VND 3.8 trillion (USD 
  239 million) in registered capital, and by 2004, the DAF 
  had close to 5 trillion (USD 315 million).  The Prime 
  Minister decided this year to allow the DAF to expand to 
  VND 10 trillion (USD 629 million) in registered capital. 
  The DAF's capitalization is made up of about VND 3.4 
  trillion (USD 214 million) allocated from the GVN's 2001 
  budget, with VND 3.1 trillion (USD 195 million) 
  transferred from the DAF's predecessor organization, the 
  General Department for Investment and Development. 
  Another VND 200 billion (USD 12.6 million) comes from the 
  total cumulative profits of the DAF's operations over the 
  last four years.  Most observers expect that the DAF's 
  capitalization is likely to continue to increase to the 
  new limit of VND 10 trillion (USD 629 million) over the 
  next several years.  Many GVN officials believe the DAF 
  will be converted into a more conventional development 
  bank in the future.  The DAF can also mobilize additional 
  capital by floating savings bonds, borrowing from the 
  VPSC or borrowing from the Social Insurance Fund (SIF), 
  Vietnam's social security system. 
 
  9. (U) LIABILITIES:  The DAF's largest financing source 
  is ODA.  Between 2001 and 2004, the DAF onlent around VND 
  38 trillion (USD 2.4 billion) in ODA funds to a wide 
  variety of businesses and projects.  Surprisingly, the 
  DAF also reserves the legal authority to onlend ODA to 
  foreign governments, though it has yet to exercise this 
  right.  The DAF's remaining liabilities come from the 
  VPSC and the SIF.  At the end of 2004, the DAF had 
  borrowed nearly VND 5.5 trillion (USD 346 million) from 
  the VPSC.  DAF officials expect that the DAF will soon 
  float preferential bonds on the Ho Chi Minh City 
  exchange. 
 
  10. (U) ASSETS:  The DAF is still smaller than the four 
  dominant SOCBs, though its registered capital is 
  comparable in size.  While Vietcombank had VND 81.6 
  trillion (USD 5.13 billion) and Agribank VND 88.4 
  trillion (USD 5.56 billion) in assets in 2002, the DAF 
  claimed about VND 38.4 trillion (USD 2.42 billion) in 
  outstanding loans since 2004.  Since the DAF began 
  lending in 2001, it has kept about 20 percent of its 
  assets in the form of loans to privately owned domestic 
  companies and the remaining 80 percent in loans to SOEs. 
  According to DAF officials, the DAF does not use quotas 
  or other discriminatory lending practices to determine 
  its loan ratio of public and privately owned companies, 
  though an increase in private sector lending is expected 
  in the near future. 
 
  11. (U) FUTURE PLANS:  The DAF plans to reduce its 
  lending activities and increase its capitalization in the 
  near term, reducing the number of sectors and industries 
  that are eligible for loans.  The DAF's export and 
  investment credit operations will also face substantial 
  reductions as part of an effort to increase the DAF's 
  capital-asset ratio, which some DAF officials believe is 
  too low at present. 
 
  THE VIETNAM POSTAL SAVINGS COMPANY 
  ---------------------------------- 
 
  12. (U) The VPSC was chartered in 1999 as a subsidiary of 
  the Vietnam Post and Telecommunications Corporation 
  (VNPT).  The primary objective of the company is to 
  mobilize funding for the development efforts of the DAF. 
  The VPSC also provides valuable banking and financial 
  services to Vietnam's poorer, rural population who may 
  not have access to deposit and cash wiring services. 
  According to VPSC Deputy Director, Cao Thi Hoai Duc, the 
  company follows the same model as Japan's extensive 
  postal savings system does. 
 
  13. (U) Despite the fact that it is a significant 
  financial institution, the VPSC is quite distinct from an 
  SOCB.  Its deposit services are restricted to short-term 
  maturities and it lends solely to the DAF.  Duc said the 
  average deposit balance is about VND 10 million (USD 
  629).  Each year, the Ministry of Planning and Investment 
  (MPI) determines how much the VPSC will lend to the DAF. 
  The DAF then borrows the funds at one, two, three or five- 
  year maturities at the same interest rate as fixed-rate 
  government bonds (a rate set by the MOF).  Starting in 
  late 2005, the VPSC will conduct lending by purchasing 
  DAF bonds on the securities market.  The VPSC itself 
  determines interest rates for depositors, though the 
  rates are more competitive than those of commercial 
  deposit institutions.  Deputy Director Duc observed that 
  the VPSC is the nation's most secure deposit institution 
  since all of its funds are transferred to the GVN.  In 
  turn, the GVN guarantees the company, making deposit 
  insurance unnecessary. 
 
  14. (U) Over the last six years, the VPSC has loaned 
  approximately VND 30 trillion (USD 1.9 billion) to the 
  DAF.  The bank's current balance is VND 6.53 trillion 
  (USD 411 million), with almost VND 6.05 trillion (USD 381 
  million) in assets with the DAF.  Currently, the VPSC 
  keeps 10 percent of its funds in reserve.  The VPSC's 
  maximum reserve requirement is 20 percent, but the 
  company has no minimum reserve requirement. 
 
  15. (U) VPSC officials have also noted that the VPSC 
  intends to expand its retail deposit services along with 
  its customer base.  Officials are hoping that the Prime 
  Minister will approve proposals to expand payments, ATM 
  use (using "smart-card" technology), foreign remittances 
  and telephone payment services.  In the end, the VPSC 
  would like to transform itself into a development bank. 
  The company is already negotiating remittance contracts 
  to transfer money from the United States and is running a 
  pilot ATM program. 
 
  A WEAK FOUNDATION FOR GROWTH 
  ---------------------------- 
 
  16. (U) Comment:  Informed that Vietnam had a burgeoning 
  postal savings system, the newly arrived Deputy Chief of 
  Mission at the Japanese Embassy in Hanoi remarked that 
  this was a policy Vietnam should not be emulating.  While 
  Japan has been struggling for years to reform its 
  antiquated postal savings system, the VPSC in Vietnam has 
  been steadily becoming more firmly entrenched in the 
  country's financial sector.  Because the dominant players 
  in the financial sector are the SOCBs, the banks most 
  vulnerable to being crowded out by the growth of the DAF 
  and the VPSC are the joint stock banks and foreign 
  commercial banks.  Furthermore, the DAF and the VPSC 
  represent new forms of non-market elements in the 
  Vietnamese economy which are largely unregulated and 
  legally ambiguous.  The fact that the DAF reserves the 
  right to lend to foreign governments is one possible 
  abuse that is waiting to happen, and Vietnam's targeted 
  policy lending is an invitation for corruption and waste. 
  The fact that both organizations continue to expand is 
  cause for concern among foreign businesses and donor 
  communities.  Though Vietnam is on the path to reform, 
  the GVN still has not learned to trust the market.  End 
  Comment. 
MARINE