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Thursday, October 21, 2021

How much Vietnam can increase fiscal spending to cope with Covid-19(*)

By Dr. Dinh Truong Hinh(**)

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Vietnam is grappling with an unprecedented crisis facing its economy, society and health care. Besides the necessity of tackling the most pressing issues of Covid-19, this article focuses on the economic aspects and answers the question of how much Vietnam can increase its spending in response to the pandemic without igniting macroeconomic problems. This article shows that cash transfer to households can rise to 15 times the current level (from 0.2% of GDP to 3% of GDP) without hampering macroeconomic stability.

The analysis is based on a basic model on the sustainability of public debt and a more complex model on payments and financial sustainability.

By mid-2021, Vietnam had spent little on activities pertaining to Covid-19, at least in comparison with other developing countries. It is unclear whether this is intentional or arises from a lack of coordination in the Government’s response to an unprecedented health threat. Given the gravity and scale of the pandemic at present, it is crucial to ponder if government spending can soar without impeding macroeconomic stability.

This article adopts a simple but consistent economic framework to assess the impacts of government spending to combat Covid-19 on Vietnam’s internal and external balances.
First, it will provide an overview of what has been spent since Covid-19 started sweeping through Vietnam. The macroeconomic legal framework proposed to analyzed financial spending will be discussed briefly. Since the theoretical and empirical foundation for this type of analysis is widely available and rather technical, it is included in appendices 1 and 2 of the English research report but not presented in this article, which focuses on policy implications for Vietnam.

How much has Vietnam spent?

As of mid-July 2021, according to data from the International Monetary Fund (IMF), Vietnam had spent very little on the battle against Covid-19, at least in comparison with countries at a similar or lower stage of development. Chart 1 shows that Vietnam’s spending is among the lowest in the world. Table 1 shows that Vietnam spent about 1.4% of GDP adopting measures that have an impact on the budget, lower than the 4% of GDP observed in emerging economies and the 1.6% rate in low-income countries.

An analysis shows that 84% flows into enterprises via value-added tax or rental support (Table 1). As of March 2021, households received about VND12.7 trillion of cash (equivalent to US$564 million, or 0.2% of GDP), or about US$5.6 per person. Even then, this modest amount only reaches a few poor people. Data updated as of June 2021 did not differ much.
Not only do households receive less than enterprises but there is also a shortfall in implementation. Only 31% of the money set aside to help poor households is disbursed, compared with 42% for enterprises. This is worrying since those in the informal sector is hit the hardest by Covid-19, especially when jobs evaporate, savings are reduced and access to funds is restricted.

Consistent macroeconomic framework

The macroeconomic framework used for this analysis is a standard and classical model on internal and external balances. It uses financial policies for internal balance and monetary policies for external balance. As Prof. James Branson (1992) pointed out, policy changes based on this classical approach are similar to those in sustainable debt analysis used by Bretton Woods Institutions.

This framework can be used to evaluate the importance of government spending—in particular, that pertaining to Covid-19, with respect to Vietnam’s internal and external balances and based on fundamental assumptions about growth, inflation and interest rates.

“Green zone” (safe zone) where no Covid-19 infections are detected is protected

Base scenario

In the base scenario, outlined in Table 2, the article focuses on other assumptions by IMF and two main factors that influence public debt—budget deficit (excluding interest rates) and automatic debt dynamics. The first factor is directly affected by spending for combating Covid-19 while the second factor depends on interest rates and GDP growth. Figures for 2019 and 2020 are actual data and those for 2021 are estimated.

This scenario reflects the sustainability of public finances, when public debt as a share of GDP is still below 65%. After peaking at 48% in 2021, it sinks; the figure for 2025 is less than that of 2020.

Consider the case in which financial support doubles (direct cash transfer, at 0.2% of GDP at present, becomes 15 times as much).

How will this affect debt sustainability?

Financial spending with an impact on Covid-19 in 2020 was 1.4% of GDP (Table 1), so if it rises to 3% of GDP in 2021 and 2022, the budget deficit will rise from 3.4% and 3.1% in the base case (Table 2) to 6.4% and 6.1% (Table 3). How will debt dynamics change and what are the implications for debt sustainability? Table 3 shows the outcomes.

This scenario once again suggests financial sustainability, with public debt as a share of GDP rising from 46.6% in 2020 to 53.2% in 2022 (still below 65% of GDP) and gradually decreasing to below 50% in 2025. Of course, the assumption is that other policies are still on the right track as IMF applies in the base case. For example, if debt such as the loss incurred by State-owned enterprises rises, financial policies must look for alternative sources of revenue such as privatization of public assets.

Among the measures that the Vietnamese Government adopts in Table 1, direct cash transfer remains the most urgent and important policy to help the poor, especially in the informal sector. However, most poor people do not have bank accounts, so it is hard to manage who has received the cash. At present, some African countries use mobile money to carry out direct cash transfer.

The analysis above shows that direct cash transfer can become 15 times as much as it is at present without spelling trouble for macroeconomic stability.

How to finance the additional spending

Should the Government borrow from domestic or foreign creditors for this additional expenditure? There is not much difference and the decision hinges on the development of the domestic financial market. Borrowing from domestic institutions makes more sense if a country has a thriving financial market. However, if the domestic financial market is still in the nascent stage, there may be little choice but to borrow from foreign institutions. Seigniorage is another option. The above scenario on economic growth, inflation and money demand growth shows that the revenue of 1.4% of GDP in 2021 can be used.

Vietnam can also consider Special Drawing Rights (SDR) worth 456 billion SDR, or US$650 billion, that IMF has created to support the post-pandemic global recovery. Although it remains too early to know with certainty how this will be allocated, Vietnam may receive an amount corresponding to its quota (almost US$2 billion). The country can also borrow from international organizations to ease its long-term debt burden.

Conditions for escalating budget

Important variables that influence debt payment capabilities and sustainability are GDP growth and interest rates. This section will explore specific conditions under which debt as a share of GDP will rise.

A GDP growth rate decrease alone (two percentage points in 2021 – 2023) will not cause many problems. In this scenario, debt as a share of GDP will surpass 55% in 2023 but slide below 50% of GDP in 2025.

However, slower GDP growth coupled with higher interest rates, probably because of anti-inflationary monetary tightening in developed countries, may be a cause for concern. For example, if GDP growth slows and interest rates rise by two percentage points in 2021-2023, debt as a share of GDP will reach 57% in 2023 and remain above 53% throughout the period although there is still a downward trend.

Conclusion

This article shows that direct cash transfer to households can rise from 0.2% of GDP to 3% of GDP in 2021 and 2022 (15 times, or about VND260 trillion a year) without threatening macroeconomic stability. In this case, budget deficit will rise from 3% of GDP to about 6% of GDP each year. Financial sustainability will remain since public debt as a share of GDP is below 50% in 2025, far below the threshold of 65%.

Should the Government borrow from domestic or foreign sources to finance this additional spending? In the current context, since its financial market remains in the infant stage, Vietnam should embrace multiple approaches, including SDR allocation by IMF and foreign loans.

The microeconomic aspect of direct cash transfer – how to ensure it reaches the poor with efficacy and transparency – is the greatest challenge. The aim is to minimize the impact of the pandemic on workers and long-term productivity while sustaining and protecting the people’s well-being.

(*)This article summarizes the author’s research entitled “How Much Vietnam Can Increase Fiscal Spending To Cope With Covid-19 Without Jeopardizing Macroeconomic Stability”, part of a book written for the PCNS research institute on the effects of Covid-19 on developing countries.

(**)Chairperson of Economic Growth and Transformation, LLC, Great Falls, VA, USA; Senior Fellow, Policy Center for the New South (PCNS), Rabat, Morocco; and Senior Research Fellow, Indiana University, Bloomington, IN, USA. The author would like to express utmost gratitude to Professor Gregory N.T. Hung, Dr. P. D. Chi, and Dr. T.V. Can for their feedback and V.T. Hang for helping with the presentation.

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