VINACHEM

Do, 71, has been a barometer of Vietnam’s fortunes sincethe French left in 1954. As the country divided, her family fledto the south, surviving the war, Communist victory and a decadeof hardship that followed by growing vegetables. As the economyopened in 1986, she switched to coffee and prospered as the rateof economic growth tripled in five years.

Then, the boom that benefitted Do and millions of othersstarted to slow. Prices of fuel, raw materials and labor soaredas the currency fell. Banks, tied to funding state monopolies,became reluctant to lend to small businesses. Bad debts rose.Growth fell below 7 percent in 2008 for the first time in sevenyears and could drop to 5.2 percent this year, the governmentestimates, the slowest since 1999.

“This year has been very difficult for everyone,” said Do,who had to raise pay 20 percent for harvest pickers, to 120,000dong ($5.75) a day. “We need funds for cultivation, but we havelimited access to bank lending. You can get a loan if you havegood connections. Otherwise, it’ll be little or no money.”

After two decades of development, Vietnam risks fallinginto the so-called middle-income trap, where rising earnings andcosts outpace productivity. Government pledges to restructurebanks, curb corruption and reorganize the public sector may takeyears, prompting investors to turn to faster-growing rivals inSoutheast Asia such as the Philippines and Indonesia.

’Hard Part’

“Moving through the middle-income bracket is risky andrequires time, political will, perseverance and luck,” saidJonathan Pincus, an economist in Ho Chi Minh City with theHarvard Kennedy School’s Vietnam program. “The government needsto do more to reform the economy and get back to a sustainablehigher rate of growth. You have to do the hard part of buildinginstitutions, building a legal system, enforcing the rulesgoverning financial institutions.”

Government efforts to curb rising prices and stabilize thedong slowed growth to 4.7 percent in the first nine months of2012. Inflation eased to a year-on-year pace of 6.48 percent inSeptember from more than 23 percent in August 2011. The currencyhas risen about 0.9 percent this year against the dollar, afterfalling more than 7 percent in 2011.

Stocks Drop

The slowdown has hurt stocks, with the benchmark VN Index,Asia’s worst performer in 2011, down 18 percent since its peakthis year on May 8. Yields on five-year government bonds havefallen 220 basis points since the start of 2012, to 10.35percent, as inflation decelerated and lenders sought therelative safety of state-backed debt.

Communist Party General Secretary Nguyen Phu Trongapologized two days ago in a televised address to the nation for“big mistakes” made by the ruling party, including corruptionand lax oversight of state-owned conglomerates.

“We are trying to speed up the restructuring process ofstate companies, aiming to improve their operations andefficiency,” Deputy Finance Minister Vu Thi Mai, said in an Oct.11 interview. She said that as of the end of last month, 53state enterprises had submitted restructuring plans to reducecosts and accelerate “the privatization process.”

The country faces a challenge that others have struggled toovercome. Of 101 middle-income economies in 1960, 13 attainedthe World Bank's high-income bracket by 2008, including Japan,Hong Kong, Singapore, South Korea and Taiwan, according to a report this year from the Washington-based development lender.

Income Group

Vietnam joined the World Bank’s lower-middle income bracketin 2009, with gross national income per capita rising to $1,260last year, from $110 two decades earlier, according to thebank’s website. The World Bank classifies lower-middle-income economies as those with GNI per capita of $1,026 to $4,035 andupper-middle income from $4,036 to $12,475.

Once Southeast Asia’s fastest-rising destination forforeign investment, Vietnam risks losing out as other nations inthe region become more attractive to investors.

Pledged foreign direct investment to Vietnam fell 28percent in the first nine months of 2012 from a year earlier,the government says. FDI inflows rose more than 31 percent inMalaysia and Indonesia in 2011 and an estimated 89 percent inneighboring Myanmar, compared with a 7 percent drop in Vietnam,according to the United Nations Conference on Trade andDevelopment.

Myanmar Appetite

“The appetite that a lot of global investors have forMyanmar in particular now, but also countries like Indonesia andthe Philippines, is based in part on disillusionment aboutVietnam’s performance relative to its promise,” said MarkGillin, a director of AIM Capital Management Ltd. in Ho Chi MinhCity. “Given the work ethic and the dynamism of the people here,Vietnam should be doing far better.”

Moody’s Investors Service on Sept. 28 cut the rating onVietnam’s debt for the first time since 2010 to B2, leaving iton a par with Cambodia and five levels below Indonesia.Vietnam’s banks have the highest level of bad debt in SoutheastAsia, according to Moody’s.

Vietnam dropped 10 places to 75 on the World Economic Forum' Global Competitive Index this year, swapping places withthe Philippines, which rose 10 slots to 65.

Even so, the country has come a long way since 1986, whenthe government swapped Soviet-style central planning for “DoiMoi,” or economic renovation -- allowing private business andgranting packages of land to farmers to grow their own crops.

Changed Life

Do and others who began growing coffee were some of thefirst to gain. “Coffee changed my life and the lives of manypeople here,” said Do in the highland region of Dak Lak.

Production of coffee, introduced in French colonial days,more than quadrupled in the five years following the start ofDoi Moi, reaching 118,800 metric tons in 1991, according to theU.S. Department of Agriculture’s Foreign Agricultural Service.

Vietnam is now the world’s largest coffee exporter afterBrazil, shipping 1.6 million tons in the last crop year,according to the government. The 10 tons a year that Do harvestsfrom her 2.5-hectare (6-acre) plot earned her enough to build a160 million dong home, school her nine children and send two ofthem on to college.

Change spread as entrepreneurs started businesses in otherindustries, and the opening attracted overseas manufacturerssuch as Samsung Electronics Co. and Canon Inc.

‘Exciting’ Times

“It was exciting,” said Le Quoc Vinh, 44, chief executiveof publisher Le Media Joint-Stock Co. in Hanoi, who was studyingEnglish at Hanoi University as Doi Moi began. “It was the firsttime we really felt we had to compete to improve our lives.”

Vinh publishes five consumer titles, including Vietnam’sbest-selling fashion magazine, Dep, or Beauty, and features 14top Vietnamese models on its latest cover and advertises LouisVuitton bags and Shiseido cosmetics. Like Do, he prosperedduring the boom and now drives a Mercedes, and his eldest son isstudying in Australia. He said many clients have cash-flowchallenges and advertisers are struggling to sell their products.

“If you’re not inside the system, you don’t really have achance,” said Vinh. “If you’re not friends with that bank,it’s almost impossible to borrow. If you’re not friends withthat state-owned company, it’s difficult to win a contract.”

Even with the restraints on business, the commercial hub ofHo Chi Minh City, formerly called Saigon, shows the changes ofthe boom years. In the new terminal at Tan Son Nhat airport, thescene of intense fighting in the last days of the Vietnam War,travelers eat at Burger King and Domino’s Pizza. Downtown, theyellow, Roman-columned building that once housed South Vietnam’sparliament is now the Ho Chi Minh City Stock Exchange.

No Honking

Foot passengers who five years ago paid 500 dong to takethe antiquated ferry across the Saigon River to District Two,now walk over Thu Thiem bridge, while cars speed through aJapanese-financed tunnel, where the frenetic lane-changing andhorn-honking of the city’s streets are banned.

The carved images of gods of the 18th-century, incense-filled Giac Vien pagoda rub shoulders with the water slides ofDam Sen water and amusement park, where the increasingly chubbychildren of the new middle class view the changing city from aFerris wheel.

“I grew up in a difficult time, where everybody around mehad to work very hard, and the money we could make was not verymuch,” said Vinh, the publisher, who as a four-year-old hidwith his parents in a small room in their house as U.S. bombsrained down. “Now, some families have become rich while otherfamilies are not so rich. There is a gap between neighbors.”

Bank Ties

To sustain Vietnam’s growth trajectory and narrow that gap,the government has pledged to address the inefficiency that hasgrown through ties between banks and the state companies thatreceive much of their lending.

State enterprises’ non-core investments, such as propertyand stocks, account for as much as 12 percent of theirregistered capital, Deputy State Auditor Le Minh Khai said inJuly. Vietnam Electricity, known as EVN, and Vietnam NationalShipping Lines, or Vinalines, have “large” investments in non-core businesses, Khai said. Government-controlled companiesaccount for about a third of the total market value of the VN Index (VNINDEX), according to data compiled by Bloomberg.

EVN’s Chairman Dao Van Hung was fired in February after thepower company lost 11.5 trillion dong over two years, accordingto the government’s website. The utility has been building a93,351 square meter twin-tower headquarters since 2007 that thecompany said may be completed next year. Behind a solitary guardunder a parasol, the empty structure with a rubble-strewnentrance looms above the city’s old quarter.

Making Arrest

Police arrested Duong Chi Dung on Sept. 4 after a three-month manhunt for the former chairman of Vinalines, part of aninvestigation into contracts that the government says raised thecost of a floating dock by 72 percent in 2007.

The restructuring of state monopolies is inextricablylinked with a clean-up of the banks that funded them.

The government promised to complete the restructuring ofweak banks by the end of next year. Prime Minister Nguyen Tan Dung approved a plan in March that would allow the finance ministry to buy collateralized non-performing assets fromcommercial banks to strengthen their balance sheets.

The central bank chief, Nguyen Van Binh, said in April thelevel of bad debt at some lenders may be “much higher” thanreported. The bank estimated non-performing loans were 8.6percent at the end of March.

Political Pressure

Government-run banks are often subject to politicalpressure to lend to favored state-owned enterprises, accordingto a January policy paper from the Harvard Kennedy School.

Binh has vowed to crack down on violations by groups withvested interests who are working against the banking reforms. Ina televised interview posted on the government’s website on Oct.7, he said some lenders are controlled by only one or twoindividuals or a small group of shareholders, and 70 percent to90 percent of outstanding loans at some banks are made to“serve those shareholders.”

“They may manipulate operations at one bank and affect thewhole system,” Binh said. “Group interests are the biggestobstacle in the entire Vietnam banking system restructuringprocess.”

Police arrested Asia Commercial Bank (ACB) founder Nguyen Duc Kien, one of the country’s wealthiest men, on Aug. 20 foralleged economic mismanagement, sparking a run on the bank.

Capital Needed

The financial system needs an injection of 250 trilliondong to 300 trillion dong, according to a 298-page reportpublished in September by the National Assembly’s EconomicCommittee and compiled by an advisory group.

Vietnam is still attractive to some external investors,especially as China is getting more expensive, said Pincus atthe Harvard Kennedy School. Intel Corp. opened a $1 billionassembly and testing plant in 2010 in Saigon Hi-Tech Park thatRick Howarth, general manager of Intel Products Vietnam, saidlast month was “ramping up smoothly.”

In Jabil Circuit Inc. (JBL)’s factory nearby, a young Vietnamesetechnician carefully solders parts for an electronic point-of-sale terminal, checking her work against a computer screen aboveher station. As many as 20 percent of Jabil’s 1,350 localworkers had no previous computer experience, said KesavanSwaminathan, general director of the Vietnam unit of St. Petersburg, Florida-based Jabil.

“We teach them here,” said Swaminathan at the plant,which operates 24 hours a day, seven days a week. “Some of theminitially freaked out, but as they are being guided and coached,they realize it’s an additional skill they are learning.”

Bus 611

The technology park has a new, four-lane avenue flyoverabove the clogged main road of Le Van Viet Street, along which bus 611 carries riders for 4,000 dong -- without air-conditioning, and in a haze of motorbike fumes and tropical heat-- across a bridge that’s only wide enough for a single truck.

Symbols of Vietnam’s boom years in the capital Hanoi arejuxtaposed with reminders of how far the country still has to goto even out the benefits of economic gain.

Between the Bentleys and Range Rovers in the square byHanoi’s yellow-and-cream opera house, street vendors carry foodand wares on bamboo poles on their shoulders. Across the square,burnished in gilt, a Gucci outlet sells handbags for twice theaverage annual wage, while a cleaner in a French maid’s pinaforemops the marble floor.

“Business has been very difficult this year,” said NguyenThi Nhung, 38, who sells lingerie and hair accessories from amobile metal cart. “People do not want to spend on frivolousitems like pretty bras.”

Pushing Cart

In a conical hat and face mask to shield her from thetraffic fumes, she pushes her cart for miles each day till after10 p.m. to pay for her children’s schooling.

“My dream is that my kids will one day work in an officelike that,” she said, pointing to a 10-story glass office block,that houses foreign firms and a private gym on the top floor.“I want them to have an easier life than I do.”

Vietnam isn’t the only country in the region facing aslowdown as Europe’s debt crisis erodes trade. Growth indeveloping East Asia, which excludes Japan and India, willprobably ease to an 11-year low of 7.2 percent, from 8.3 percentlast year, the Washington-based World Bank said in an Oct. 8report.

Still, Vietnam is only at the bottom rung of the middle-income ladder, and must first catch more-advanced neighbors,such as Thailand, where GNI per capita last year was $4,420.

Bite Bullet

“Will Vietnam grow from $1,500 to $5,000 per capita incomeuninterrupted or will it have to go through the boom and bustcycles?” said Deepak Mishra, World Bank lead economist forVietnam in Hanoi. “If it wants a smooth transition to an upper-middle-income status, it will have to bite the bullet andcredibly restructure its economy.”

In her yellow house in Dak Lak, Do retains the optimismthat characterizes many Vietnamese who’ve seen their livesimprove since 1986.

“The situation will gradually get better in the next fewyears when the global economies recover and the government sortsout problems like the bank lending,” she said. “I’ve seen somany things here improve in the past few decades.”