Managing Success in Vietnam: Macroeconomic Consequences of Large Capital Inflows with Limited Instruments

Abstract

Vietnam has experienced spectacular economic growth over the past decade, and a lot of this has been a result of massive inflows of FDI. Although much has been written on the impact of FDI in developing countries, previous studies have generally ignored macroeconomic consequences in cost-benefit assessments. These macroeconomic aspects can be particularly important in transitional economies like Vietnam, where some of the instruments of macroeconomic stabilization may be blunt or unavailable. First, growth in capital inflow needs to be accommodated by real exchange rate appreciations. In dollarized economies like Vietnam, the nominal exchange rate cannot be relied upon to deliver it, so inflation is usually the result. In dollarized economies, it is also difficult for the central bank to conduct open market operations, in order to sterilize large capital inflows, or mop up excess liquidity. Again, this could add to inflation. The combination of a young and inexperienced banking system and a investment-hungry SOE sector only exacerbates the situation, and increases the risk of imbalances that can result in a crisis.