VIETNAM'S EXTRA-BUDGETARY FINANCING

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