Cablegate: Vietnam: State Owned Enterprise Reform

This record is a partial extract of the original cable. The full text of the original cable is not available.

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

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