Vietnam continues to liberalise its industrial base and manufacturing sector

On the back of sound economic growth, a continuing inflow of foreign direct investment (FDI) and a healthy labour force, the industrial base in Vietnam has been steadily expanding over the past two decades, with export-orientated manufacturing playing a major role within the overall economy. The potential for manufacturing in Vietnam is much higher than it was just five years ago. A process of natural selection is now taking place, and businesses that are unable to compete – owing either to a lack of capital or technology – are disappearing from the market. As a result, while there are fewer Vietnamese enterprises now than ever before, the quality of products and players is higher. Recently signed free trade agreements (FTAs) are likely to further boost competition, as well as extend the country’s international reach, as manufacturers continue to view Vietnam as a low-cost alternative to China.

The past few years have seen significant improvements in reducing red tape and creating an encouraging business environment. Intellectual property rights are also set to receive greater protection with a newly amended criminal code to give clarity and teeth to previously abstract provisions. One big change is that organisations will now be subject to criminal punishment, whereas before these laws only applied to individual lawbreakers.

That said, the government is keen to further hone the country’s edge by upgrading education and vocational training under its Five-Year National Socio-economic Development Plan 2016-20 in order to turn out more highly skilled labour that many expanding industries will demand in coming years. Higher labour productivity and competitive capacity will be required if the government is to achieve its goal of GDP growth rate of 6.8% for 2017.

Story Of Integration

Like other emerging industrial countries, Vietnam started with low-skilled and labour-intensive industries, such as footwear and textiles, which created hundreds of thousands of jobs. But to attain higher growth, policymakers recognised that the country needed to attract significantly more high-skilled industries.

In 1999 the Law on Enterprise was passed, removing a swathe of bureaucratic hurdles that had previously blocked private companies from formally registering. With the signing of the Vietnam-US Bilateral Trade Agreement in 2000, growth in the private sector began to overtake that of the public sector, and it has continued on this trajectory in the years since. Vietnam was set on a path towards international economic integration, which would culminate in its admission to the World Trade Organisation (WTO) in January 2007.

The opening up of the Vietnamese economy came at an opportune time, as multinational corporations had begun to question their reliance on China, which was moving away from high-volume manufacturing. As the years passed, Vietnam became an attractive destination for low-cost, high-volume manufacturers. According to IMA-Asia, in 2009 Chinese manufacturing workers outearned their Vietnamese counterparts by approximately $1 per hour, and by 2015 that wage gap had widened to $2.5 per hour. With 70% of the population of working age and 58% below the age of 35, Vietnam’s relatively stable political environment, low-cost labour and demographic structure adds to its appeal.

Big Players

As a consequence, Vietnam has attracted large sums of FDI in the manufacturing segment. This includes the Japanese electronics giant Canon, which now makes more than 50% of its computer printers in a complex of plants around the city of Bac Ninh, north-east of Hanoi. Other sizeable FDI includes Samsung of South Korea, which built a $700m mobile phone plant; US chip-maker Intel, which built a $1bn factory outside Ho Chi Minh City; Hon Hai, a Taiwanese company making iPods for Apple and computers for Dell; and HP, which opened a $1bn factory near Hanoi.

Electronics

The electronics sector has indeed served as a cornerstone for the country’s industrial base and is now a key driver of the economy, making up nearly 25% of GDP in 2015, a significant increase from 5.2% in 2010. Electronics became the country’s leading export in 2013 and accounted for nearly one-third of total merchandise exports in 2016. With electronics and computer exports growing 4.9% year-on-year (y-o-y) to reach $3.73bn in the first half of 2016, the government has set a goal for total exports at approximately $40bn for 2017.

According to industry experts, however, a big challenge going forward will be increasing the output of local companies. Indeed, 90% of sales are generated by major foreign electronics firms like Samsung, Panasonic, LG, Dell and Microsoft, with local manufacturers responsible for the remainder. Foreign firms have had an upper hand due to the preferential incentives given by the government that are not made available to locals. Those large international companies investing in software manufacturing or high-tech factories, for example, pay a reduced corporate tax rate of 17%, compared to 20% for those without the investment capital or know-how.

As in other emerging markets, granting tax incentives to multinational heavyweights like Samsung and Nokia is a key strategy for attracting foreign investment and helping domestic firms evolve towards higher-value-added manufacturing. However, while there has been an influx of foreign capital and expertise, local talent and the required support industries still have some catching up to do. As the skills gap narrows and wages begin to rise, though, transnational firms may looks to move on to the next low-cost market, much as Vietnam benefited from changing labour patterns in China. This does not appear to be an immediate concern, however, as investment has continued to spread across the country. LG Display, a subsidiary of LG Electronics, plans to build a $1.5bn factory to produce high-tech digital displays. This comes on the heels of the company opening another $1.5bn manufacturing facility in 2015. Samsung, meanwhile, has invested up to $15bn in the country to date and in 2015 was the country’s biggest exporter, shipping about $33bn worth of electronics. This has all helped add muscle to the country’s growing industrial might.

Industrial Strength

The manufacturing industry has been building on the initial investments of multinational production centres, and the country is now emerging as a genuine manufacturing focal point. The manufacturing and processing industries are continuing to soak up the majority of FDI, accounting for 71% of all foreign investment in the first half of 2016, at $8.1bn, according to the Foreign Investment Agency. In 2016 the industry and construction sector expanded by 7.1%, with the manufacturing subsector growing by a more robust 11.9%. The broader sector contributed around 1.8 percentage points to overall GDP growth, according to the latest data from the General Statistics Office.

Mining and quarrying, however, was negatively affected by the decline in global energy prices, and the segment contracted by 4%, the sharpest drop since 2011. This led to a reduction of more than 1.7m tonnes of exploited crude oil output compared with 2015. Coal exploitation, meanwhile, fell by 1.3m tonnes, reaching 39.6m tonnes in total. The growth rate in mining, for its part, has also seen a continuous slide from 9% in 2012 to 4% in 2014 and 1.4% in 2015 in the wake of depressed oil prices.

Industrial production in Ho Chi Minh City grew by an estimated 7.3% in 2015, exceeding its planned target of 7%. The processing and manufacturing segment increased by 7.7%, and its four key industries – mechanical engineering, electronics, chemicals-rubber-plastics, and processed food – expanded by a combined 7.8%.

Growth in Vietnam has been aided – albeit with the exception of the mining business – by a stable currency and low inflation; however, one potential headwind going forward could be the re-emergence of inflationary pressures. A Nielson survey showed that the rate of input cost inflation accelerated in November 2016, and as a result firms raised their prices at the fastest pace in 5.5 years.

Infrastructure is also a concern for some manufacturers, as profits are often eroded by congested roads and ports. According to a press release by financial services company, IHS Markit, delivery times lagged to the greatest extent in the survey’s history, and manufacturing costs rose as a result. New tonnage rules that require suppliers to make more trips to deliver the same amount of goods have also contributed to rising prices. Many new highway weigh stations were put into operation in the middle of April 2016 to deter rampant overloading.

The added shipping cost is a real concern as it “comes at a time when exporters already incur high logistical costs”, according to Trinh Nguyen, Asia economist at HSBC. Often this adds undue burden to manufacturers that are trying to deliver goods and products around the country. “The difficulty for manufacturers is linked to infrastructure and the supply chain in Vietnam. Manufacturers are obliged to operate a plant in the northern, central and southern part of the country to be able to meet clients’ demands in the respective regions,” Nguyen Loc, member of the board of directors at Vietnam Electric Cable Corporation, told OBG.

Nevertheless, concerns are not expected to throw Vietnam’s industrial sector off track, as it continues to be an exception among regional competitors whose growth has flagged due to a slowdown in China and weak global demand. The potential gains from trade agreements are likely to keep investments flowing, in the meantime.

Opening Up

Pierre-Jean Malgouyres, general director of Archetype Group, Vietnam’s largest multidisciplinary construction consultancy, told OBG that due to the growing potential, his company has become increasingly active on the industry side, acquiring the Asia-Pacific operations of Tebodin, a company focusing on industrial projects. “Industry is interesting in light of all the FTAs being signed, and the one with Europe is moving towards the implementation phase,” he said. “This makes Vietnam unique and also a paradox; it is a communist country, but it is also one of the most liberal in South-east Asia. This drives a lot of interest from industrial players, including either existing ones looking to expand or newcomers that see Vietnam as a potential manufacturing hub in the region once all these FTAs are in motion,” he added. Recently concluded FTAs include those with the EU, South Korea, and the Eurasian Economic Union led by Russia, as well as closer integration with ASEAN through the ASEAN Economic Community.

Major Changes

However, the outcome of the November 2016 US presidential elections saw the US pull out of the Trans-Pacific Partnership (TPP) – the proposed FTA between the US, Japan, and 10 other Pacific Rim nations that together represented 40% of global GDP. Despite this setback, Vietnam has already made some major economic and legislative reforms that had been required to join the TPP.

Nghia Trong Pham, who participated in negotiations as a member of the Vietnam Labour Team, pointed out that new laws on foreign trade and promoting small and medium-sized enterprises (SMEs) have been drafted, and the Labour Code of Vietnam and other regulations on business conditions have been revised. The trade accord also served as an impetus for enterprises in key export industries, such as textiles and garments, footwear, seafood, wood furniture and agricultural products to further improve their competitiveness.

Vietnam still faces challenges; as despite its robust export figures, there has been a flood of imports as many companies are unable to produce the parts needed for the production of exported goods.

The latest data from Vietnam Customs shows that in the first half of 2016 the country spent $33bn on machinery and equipment imports, which accounted for 41% of total imports by value. In the same period, imports from China accounted for a combined $23bn, or 28.7% of total imports by value. While nearly a third of Vietnam’s imports came from China in 2015, China received just 10% of Vietnam’s exports. This imbalance is mainly due to a dependence on imported machinery and semi-finished components. Another area where Vietnam remains vulnerable to cheap Chinese exports flooding the market is steel. However, there are efforts under way to counter this by increasing local output.

Steely Determination

The vice-president and general secretary of the Vietnam Steel Association (VSA), Chu Duc Khai, told local press that steel consumption is expected to grow on the back of strong economic growth in 2016 and the undertaking of 10 steel projects in 2017. However, as he pointed out, the industry is still reliant on Chinese imports. The VSA reported that Vietnam imported more than 14m tonnes of steel in 2016, and estimated that this figure would rise to 17.5m tonnes in 2017, with Chinese steel making up 58.3% of that total.

To protect the local industry, the VSA has filed petitions to the government asking for anti-dumping measures to be imposed on several imported steel products. At the same time, local plants are ramping up production in a bid to stem the flow of imports. Vietnam’s top steel producer, Hoa Phat Group, plans to build a $2.7bn steel mill, which is slated to come on-stream in 2020 with a 4m-tonne-per-annum capacity. The second-biggest steel group, Hoa Sen, is investing $10bn on a plant that aims to quadruple its output to 16m tonnes per year by 2031.

However, for plants here to compete against Chinese steel, they will have to reduce production costs and improve overall competitiveness. Foreign players currently have an advantage over local manufacturers, which lack the capital, skills and knowledge to produce better steel at a faster rate.

On A Roll

The automotive industry has also seen a string of major foreign players move in to capitalise on the country’s potential. There are currently 13 foreign-invested businesses and 42 domestic businesses involved in automobile manufacturing and assembly, with a potential capacity of around 460,000 vehicles per year, according to the Vietnam Automobile Manufacturers’ Association (VAMA). After some tough years due to the economic downturn, sales are picking up considerably as more disposable income is available. According to the VAMA, auto sales rose by 32% in 2016 to 243,675 units. Toyota, Ford and the Truong Hai Auto – the local assembler and distributor of brands such as Mazda, Peugeot and Hyundai – all saw strong sales. While BMW has yet to undertake manufacturing in the country, its import business has seen unusually high sales since it started in 2007, growing by more than 40% in the last decade, and selling about 2000 cars and motorcycles in 2015.

It is not always easy for a new player to get a licence to manufacture, as government regulations require them to partner with an existing player. Importers, meanwhile, face challenges of their own as policies implemented to protect domestic production have resulted in higher taxes. In 2015, for example, after imports of completely built-up units saw a sharp increase, accounting for 30% of total sales, the government implemented an additional consumption tax. As part of its ASEAN free trade commitments, Vietnam will have to remove all tariffs on imports from member states in 2018, which could mean a flood of imports from Thailand and Indonesia, both of which are known for their strong cost competitiveness. This has raised concern among automakers in Vietnam and until a clear policy emerges, major expansions among manufacturers are not expected.

Pharma

The pharmaceutical industry has seen its fair share of foreign interest, but for investors the biggest challenges are being posed by sometimes unclear government regulations.

To distribute, foreign companies must form a partnership with a local entity, and while the government has drafted a bill outlining regulations for a limited liability licence so foreign companies can start distributing, however, this has yet to be passed. For manufacturing, the rules are more straightforward in that a company can come and invest in building a factory; however, they are still limited to selling only from that specific manufacturing facility.

Under Vietnam’s WTO membership, the pharma industry has been protected, and as such has not been subject to the same deregulationary pressures as other markets. However, the government has made moves to further liberalise the business by removing foreign investor caps for companies that have appropriately adjusted their business activities. This is expected to open the door for further foreign involvement and increase competition for domestic companies, which focus mainly on generic drugs and spend relatively little on research and development. This competition is expected to accelerate as FTAs take effect and tariffs are lowered. Around 60% of local consumption is made up of imports, and demand is set to increase at a compound annual growth rate of 13.8% to reach $6.6bn by 2020, according to the health care research group GlobalData.

Before a pharmaceutical company is able to introduce a new drug or vaccine to patients, it must undergo rigorous testing, including clinical trials. Nevertheless, business is expected to remain strong due to a large, ageing population, a local preference for imported, branded drugs and the government’s gradual liberalisation of the industry. The ongoing development of a universal health care system, which is still in the early stages, should also expand access to medicine and therefore the pharmaceuticals market (see Health chapter).

Outlook

Vietnam’s industry has enjoyed a steady flow of foreign investment, and big names from electronics to automobiles seem to have settled in for the long haul. But as the market continues to open under a series of free trade accords, the sector will likely face challenges. For one, the country will need to build greater industrial depth. Integrating SMEs into global value chains will also be key for the country to curb imports and bolster competition. Improving infrastructure will help drive efficiency and lower costs, while a focus on upgrading the education system and expanding vocational training opportunities should help boost productivity and address the challenges firms face in sourcing highly skilled labour.