CHAPTER 4: VIETNAM PUBLIC DEBT AND LESSON FROM LATIN AMERICAN PUBLIC DEBT CRISIS TO VIETNAM
4.1. Current situation of Vietnam public debt
4.1.4. The impacts of budget deficit and public debt on Vietnam macroeconomy
To clarify the impacts of budget deficit and public debt on macroeconomic variables, including GDP growth, inflation, interest rate, trade balance and exchange rates, we have carried out a qualitative analysis of possible budget deficit transmission and various solutions to financing them.
*Inflation
Government expenditure which is not funded by tax revenues or other kinds of revenue may be the culprit of excessive aggregate demand and inflation. This situation is more likely to happen if government spending is funded by surplus money supply that is pumped into the economy. If a small part of fiscal deficit is financed in that way, inflation will by no means occur. However, when the funding is enormous and continuous for several years, the economy will eventually get into a situation where the high inflation rate is seen in a long time In reality, Vietnam has experienced the same impacts in the. past years. Most of its fiscal deficit has funded by government bonds and even money issued by Central Bank in the form of advancing state budget20. However, a large number of government bonds and government-guaranteed bonds are sold to big commercial banks. They are then left in the state bank as a pledge in order for commercial banks to take out money through open market operations or rediscounting. Finally, this causes an increase in the money supply, resulting in inflation. According to statistics of the Hanoi Stock Exchange (HNX), the total amount of government bonds and government-guaranteed bonds in circulation is about 336 thousand billion dongs, equaling more than 13% of the nominal GDP and nearly 12% of money supply M2 of the year 2011. Thus, besides the private sector’s high demand for credit, public expenditure funded by government bonds has also indirectly led to sharp increasing money supply recently.
*Interest
20 According to term 23, State budget Law 2002, an advance on the state budget aims to temporarily dispose of the
Under no control of administrative limitation, interest is determined by demand and supply in the capital market, where household savings and business investment converge.
Total of government savings and private savings, also called national savings, will reflect the supply while investment represents the demand of loan market. Budget deficit results in a decline in government savings and national savings, leading to a fall in capital supply and an increase in the interest rate in the market. As a result, the increasing interest rate brings about a decline in private savings. This situation is called crowding out effect. In other words, excessive public spending is the culprit of state budget deficit. Government is put under pressure to borrow capital by issuing bonds, resulting in a lower amount of available capital in the market that the private sector is supposed to access with a low cost. In recent years, the structure of loans in Vietnam has experienced a change from external debts into domestic debts. By the end of 2011, external debts accounted for 56%
of total debts while domestic ones occupied 43% of total debts and followed an upward trend. However, this trend hardly seems to be a positive picture that Vietnam is less dependent on foreign countries. In fact, it shows a fall in foreign concessional loans.
Because of a high interest rate of foreign commercial loans, we had to switch over to domestic loans. Nevertheless, that government borrowed a large number of domestic loans crowded out private sector, leading to the lower economic growth when 1 capital unit was not used effectively by the public sector.
*Trade balance and exchange rates
Consumers in a country are able to spend more than the value of domestic products and services by importing goods from other countries. Thus, if the government expands expenditure without imposing policies on restricting private spending, there will be an increasing demand for imports and trade deficit. A decline in private investment caused by the budget deficit can be easily explained by crowding-out effect while an increase in government spending on imports is the reason for a drop in net exports. As a result of the increase in public spending and budget deficit, the gross domestic consumption is higher than the domestic output. In order to meet the demand for additional expenditure, both
domestic production and imports will go up, causing the trade deficit. Especially, the budget deficit affects adversely trade deficit in countries dependent on imported raw materials like Vietnam.
Budget deficit has other impacts on trade deficit. Importing goods and services leads to abroad asset outflow. When imports surpass exports, we have to pay an amount of foreign currency to foreigners. They, then, invest such foreign currency in stocks, corporate bonds, government bonds or real estate. As a result, when budget deficit happens, Vietnam becomes a net importer of goods and services and a net exporter of properties. Foreigners are holding more and more domestic assets. Budget deficit reduces the capital supply of private sector, causing higher interest rate. When other factors are constant, higher interest rates could attract external capital to flow to domestic market, leading to increases in the supply of foreign currency and local currency prices. However, in Vietnam, this impact is not enough to offset the pressure of the currency depreciation due to serious trade deficit. Furthermore, the inflow of capital from abroad is limited by high inflation and unpredictable exchange rates in Vietnam.
*Growth
In response to an increase in inflation and current account deficit due to long-lasting deficit, Vietnamese government as well as others usually imposes administrative interventions in controlling prices and exchange rates. However, such methods result in the shortage of aggregate demand because they distort domestic production factor markets leading to unreasonable resource allocation. It is also because the lack of imported inputs, limiting the capacity of production and exportation. Over time, long-lasting expansionary fiscal policy worsens current account balance and accelerates inflation. Deterioration in belief in domestic currency and economy will cause foreign capital outflows unless the government accepts to suffer from drawbacks of tightening money supply and raising interest rates in order to revive the belief in domestic currency. Vicious circle of budget deficit – trade deficit – budget deficit may occur when policies on price control and trade reduce revenues from taxes, especially those from imported goods. This results in more
difficulties in shrinking budget deficit, so the policy on increasing taxes or imposed new ones is the final solution to such a situation. As a result, high taxes and fees discourage production in the private sector, causing low or negative growth