This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 05 HANOI 003385 
 
SIPDIS 
 
STATE PASS USTR ELENA BRYAN 
STATE PASS USAID FOR ANE/AA KUNDER/KENNEDY/WARD 
USDOC FOR 4431/MAC/AP/OPB/VLC/HPPHO 
TREASURY FOR OASIA 
 
SENSITIVE - DO NOT POST ON THE INTERNET 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV ETRD VM FINREF SOE
SUBJECT: VIETNAM'S FISCAL POLICY: STILL MUCH ROOM FOR 
IMPROVEMENT 
 
¶1. (U) Summary: After two years of implementation, it id 
clear that the 2002 "Law on State Budget," which came into 
effect on January 1, 2005, has significantly improved 
Vietnam's budgetary fiscal transparency.  Other new laws and 
regulations have helped modernize Vietnam's revenue 
collection and expenditure policies, especially with regard 
to corporate taxation, trade tariffs and fiscal 
decentralization.  At the same time, the Government of 
Vietnam's (GVN) USD 406 million subsidy of gasoline and 
petroleum products in the first six months of this year has 
had a detrimental effect on the budget balances.  At 
present, the GVN is focusing its spending on infrastructure 
improvements, social services, science and technology 
development, and poverty reduction.  Vietnam has only a 
slight budget deficit, but extra-budgetary financing for GVN- 
sponsored development projects and State-owned enterprises 
(SOEs) is a growing cause for concern among foreign 
investors and the donor community.  End Summary. 
 
BUDGETARY FISCAL TRANSPARENCY 
----------------------------- 
 
¶2. (U) Recent steps towards improved fiscal transparency 
have led to more thorough public disclosure of Vietnam's 
national budget.  The new "Law on the State Budget," which 
took effect on January 1, 2004, requires budget settlements 
to be published within 18 months and budget estimates within 
60 days of approval.  The Law also requires, for the first 
time, a public release of total expenditures by the 
Ministries of National Defense and of Public Security.  The 
GVN has previously published State Budget Final Accounts 
(for the fiscal year two years prior to the year of 
publication) and the annual State Budget Plan since 2002. 
The GVN's fiscal year is the same as the calendar year. 
 
REVENUES 
-------- 
 
¶3. (U) Revenue totals constituted about 21-22 percent of 
Vietnam's gross domestic product (GDP) in 2004 (total 
revenue was VND 196,787 billion or USD 12.4 billion), a 
relatively small amount for a nation of 83 million people. 
Compared to per capita income in Cambodia (USD 320 in 2004), 
Thailand (USD 2600 in 2004), and the Philippines (USD 1000 
in 2004), Vietnam's USD 550 per capita (USD 550 is the World 
Bank's 2004 number for Vietnam; the GVN estimates per capita 
will rise to USD 640 when year-end numbers are calculated 
for 2005) is rather low.  Around 95 percent of the GVN's 
revenue comes from taxes (including import/export duties). 
In recent years, the most significant change to budget 
policy-making has been the new "uniform tax policy," which 
Ministry of Finance (MOF) officials say has created a "level 
playing field" for all categories of industrial and 
commercial entities, regardless of their ownership models. 
 
¶4. (U) The GVN professes to have made a serious commitment 
to reducing the public tax burden, and they have made some 
progress in this area.  Since the 2002-2003 fiscal year, the 
GVN has nearly eliminated its taxes on agricultural land and 
reduced and simplified the corporate income tax (CIT).  The 
GVN now levies a flat 28 percent tax on all corporate 
income.  The previous tax system involved several different 
levels that usually resulted in a tax rate of around 32 
percent, depending on a company's subsidies and preferences. 
In addition to introducing the flat tax, the GVN also 
recently eliminated the 20 percent value-added tax (VAT), 
leaving the VAT at only five to ten percent. 
 
¶5. (U) This expansionary fiscal policy has already proven 
its worth.  The new tax policies have encouraged investment, 
so that even though tax rates have decreased, revenues have 
been remained relatively stable.  During the 2001-2005 
period, budget revenues increased by 16 percent annually, a 
higher rate than the seven percent average annual increase 
in GDP. 
 
¶6. (U) The GVN has also reduced import and export tariffs as 
part of its commitment to international economic 
integration, particularly to meet the Common Effective 
Preferential Tariffs (CEPT) for the ASEAN Free Trade Area 
(AFTA) agreement.  Further reductions will probably be 
necessary once Vietnam accedes to the World Trade 
Organization (WTO), although the Vietnamese are trying hard 
to maintain high tariffs in certain industries - 
automobiles, for instance - which they want to protect.  The 
tariff reductions are certain to reduce budget revenues in 
the short-term.  Tariffs constituted 17 percent of Vietnam's 
budget revenues and 23 percent of its tax revenues from 2001- 
¶2003. 
 
¶7. (U) According to sources at the MOF, the GVN has spent 
nearly VND 6.454 trillion (about USD 406 million) 
subsidizing gasoline and petroleum products in the first six 
months of the this year.  (NOTE: Year-end statistics are not 
yet available.  End Note.)  The MOF eliminated import 
tariffs on petroleum products on March 17 in an attempt to 
curb price increases in Vietnam.  This subsidy, coupled with 
the tariff cuts, has resulted in a significant loss in GVN 
budget revenue.  To reduce pressure on the GVN budget in a 
period of high world oil prices, the GVN has raised the 
price of gasoline and petroleum products periodically 
throughout the year. 
 
EXPENDITURES 
------------ 
 
¶8. (U) The GVN has tightened its budget expenditure 
objectives over the last several years and is now 
concentrating on a narrower set of priorities.  MOF 
officials list those priorities as infrastructure (with 
particular emphasis on transport and irrigation); social 
services, education and culture; science and technology; and 
poverty reduction.  Investment and development spending 
makes up approximately one-third of total budget 
expenditures.  The GVN has boosted education spending twice 
over the last seven years, so that in 2005 more than 19 
percent of total spending will go to education.  By 2008, 
the GVN expects spending on education to reach 20 percent. 
Although science and technology expenditures have doubled 
during the last five years, MOF officials say that this 
increase was not part of the National Assembly's "Five-Year 
Plan," but was one element of a long-term development 
strategy.  Despite spending constraints, the GVN has made 
significant progress in poverty reduction.  In 1993, some 58 
percent of Vietnamese households subsisted on incomes below 
the poverty line, but by 2003, the GVN reported that number 
to be 26 percent.  (Note: According to a government- 
controlled newspaper, impoverished households earn less than 
USD 7.50 per month in rural and mountainous regions and USD 
10 per month in cities.  Policy makers are considering 
whether to raise the poverty line.  End note).  With regard 
to poverty reduction, the GVN budget targets specific 
preferential policy and geographical regions, allowing some 
room for discrimination against the minority peoples who are 
often the poorest but also the lowest priority for GVN 
poverty alleviation efforts. 
 
FISCAL DECENTRALIZATION 
----------------------- 
 
¶9. (U) A notable element in the GVN's efforts to alleviate 
poverty and improve fiscal management is the growing shift 
towards budget decentralization.  The 1996 "Law on the State 
Budget" provided the first impetus for decentralization, and 
an amended "Law on the State Budget" passed in 2002 advanced 
the process even further.  The 2002 law makes few 
fundamental changes to the expenditure decentralization 
effort, but allows far more autonomy for provincial 
governments to manage fiscal policy on the district and 
commune levels.  According to the World Bank, Vietnam's 
expenditure structure is among some of the world's most 
decentralized fiscal models.  Whereas sub-national 
governments (provinces, districts and communes) spent 26 
percent of total revenues in 1992, that figure rose to 43 
percent in 1998 and 48 percent in 2002. 
 
¶10. (U) Vietnam faces several expenditure decentralization 
policy problems.  Chief among them is a lack of legal 
clarity that has caused imbalances between the central 
government's expenditure assignments and the capacity of 
local budgets to handle those assignments.  Some local 
governments have been handed disproportionately large 
spending assignments, but allocated inadequate funding to 
carry them out. 
 
¶11. (U) In addition to these vertical budget imbalances, 
subnational governments are legally incapable of borrowing 
adequate capital.  The World Bank estimates subnational debt 
to be 0.43 percent of 2003 GDP and considers this percentage 
rather low by international standards.  Given that many 
provincial governments are responsible for building and 
maintaining costly infrastructure projects, it is even more 
impressive.  Current regulations keep outstanding provincial 
debt below 30 percent of each locality's capital budget. 
The World Bank recommends that restraints on provincial 
borrowing be loosened, perhaps by instituting caps on debt 
service spending or by regulating total debt as a percentage 
of subnational revenues. 
 
¶12. (U) The 2002 "Law on State Budget" also gives 
considerable discretion to provincial governments to 
determine revenue assignments to district and commune 
governments.  The central government claims revenues from: 
export and import taxes, VAT and excise taxes on imports; 
taxes and other revenues from the petroleum industry; and 
corporate income taxes on enterprises with uniform 
accounting.  Tax revenues assigned to the subnational level 
include land and housing taxes, natural resource taxes 
excluding those on petroleum activities, license tax, taxes 
on transfer of land use rights, fees on land use, land rent, 
revenues from the leasing and sale of publicly owned 
dwellings, registration fees and most other fees and 
charges.  The central and subnational governments also share 
taxes based on formulas unique to each province.  The GVN 
believes that budget revenues allocated to subnational 
governments accounted for about 30 percent of all tax 
revenues at the end of 2004. 
 
¶13. (U) Allocating revenue to local governments while 
avoiding internal trade barriers is a policy challenge for 
the GVN.  The World Bank recommends granting more tax 
autonomy to provincial governments by allowing subnational 
governments to select tax rates for at least one significant 
source of revenue at a rate somewhere between the minimum 
and maximum rates stated by the National Assembly.  (Note: 
The Vietnamese constitution stipulates that the National 
Assembly is charged with approving the national and 
consolidated subnational budgets.  End note.)  In addition, 
the World Bank recommends greater specificity for tax 
sharing regimes, especially with regard to the corporate 
income tax (CIT) and the VAT.  The current tax regime tends 
to benefit larger cities, where CITs are actually collected 
and debited.  The World Bank believes an equitable 
apportionment regime between provinces would allow more 
appropriate revenue distribution, such as a VAT system based 
on final consumption in each jurisdiction.  In the case of 
the CIT, a regime based on the geography of the company's 
payroll would distribute revenue more equitably. 
 
BUDGET NEARLY IN BALANCE 
------------------------ 
 
¶14. (U) The MOF has recently been maintaining a budget 
deficit of less than three percent of GDP. (Note: By law, 
the budget deficit cannot exceed five percent of GDP.  End 
note.)  The GVN restricts on-budget borrowing to investment 
expenditures.  For the most part, foreign commercial 
borrowing and domestic bonds covered the deficit.  Greater 
dependence on domestic borrowing over the last two years has 
caused interest rates to rise relative to foreign borrowing, 
which is comprised almost entirely of concessional loans. 
 
¶15. (U) To look only at on budget borrowing, however, 
distorts the reality of Vietnam's public debt situation. 
Some bonds issued to finance infrastructure and education 
have been kept off budget, along with expenditure arrears 
from past transport sector infrastructure improvements.  In 
the former case, the GVN's 2004 expenditure report says VND 
5 trillion (about USD 316 million) in bonds were issued to 
finance infrastructure improvements (namely, the Ho Chi Minh 
Highway, rural road improvements and irrigation projects in 
the central provinces) and VND 2.5 trillion (about USD 158 
million) were issued for education.  While the published 
budget does not reflect the principal payments on these 
loans, interest payments will be shown on budget in the 
future.  State-owned commercial banks (SOCBs) and insurance 
firms were the primary purchasers of these bonds, reflecting 
the continued dependence on policy lending by GVN 
institutions and banks.  Transport sector arrears represent 
a growing disparity between the Ministry of Transport (MOT) 
and MOF's expenditure records.  Specifically, MOF records 
show that transport spending reached 3.5 percent of GDP in 
2002, whereas MOT records showed spending of about 5 
percent.  The problem stems from past MOT expenditure 
commitments that were not shown on budget. The subsequent 
accumulation of about VND 6.5 trillion (about USD 411 
million) in arrears should be paid on budget in the future. 
 
¶16. (U) Financed through Official Development Assistance 
(ODA) and loans from the Vietnam Postal and Savings Company 
(VPSC), the Development Assistance Fund (DAF) is yet another 
substantial extra-budgetary policy lending vehicle.  The DAF 
floated VND 7-8 trillion (USD 441 - 504 million) in bonds in 
¶2004.  According to the GVN's expenditure report, the DAF's 
domestic capital sources amount to roughly 9 percent of 
annual GDP in 2004, "making it the biggest financial 
institution in the country."  About 80 percent of the DAF's 
lending went to State-owned enterprises (SOEs), though the 
DAF also reserves the right to lend to private and joint 
venture firms and even to lend ODA to foreign governments. 
Despite its bank-like functions, the DAF is not subject to 
standard banking regulations and its accounting practices, 
risk management and reporting standards are still very 
rudimentary.  The DAF has to seek annual budget approval 
from the National Assembly.  The recently issued decree 
106/2004/ND-CP is a step towards regulating the DAF while 
maintaining the GVN's ability to continue its policy lending 
to GVN institutions.  The decree narrows the list of 
eligible borrowers while establishing a more market-oriented 
basis for the DAF's on-lending activities by imposing new 
requirements on borrowers for direct repayment, collateral 
assets and feasible business plans.  Both the World Bank and 
the International Monetary Fund (IMF) have expressed serious 
concerns about the DAF and the fact that it increases the 
number of poor quality loans. 
 
SOE AND DEFENSE BUDGET ITEMS 
---------------------------- 
 
¶17. (U) MOF officials confirmed that SOE revenues are 
reported on budget, but only as corporate tax revenue.  Only 
crude oil exports from cooperative contracts with foreign 
firms are reported on budget.  Using this accounting regime, 
oil-producing SOEs contributed 34 percent of CIT revenues in 
2003 (which accounted for 31 percent of total tax revenues 
that year), according to the World Bank. 
 
¶18. (U) Defense expenditures are also now shown on budget in 
accordance with the new Law on State Budget. However, no 
defense items appear on any of the published budget reports, 
possibly because budget projects are published 18 months 
after the end of a given fiscal year (the revised law only 
came into effect in 2004). 
 
¶19. (SBU) It is also worth noting that the GVN is loosening 
its control on price setting for commodities.  The GVN will 
continue to set prices for certain public services like city 
buses. 
 
¶20. (SBU) Comment: While the GVN's fiscal policy appears 
healthy on paper, its persistent dependence on directed 
lending and extra-budgetary financing has resulted in 
several contingent liabilities.  Greater budget transparency 
and SOCB restructuring will be necessary to improve the 
GVN's fiscal stance.  Both are required as part of WTO/BTA 
commitments, but progress has been slow to date.  Short of 
immediately dissolving or "equitizing" on lending and policy 
lending financial institutions like the DAF, such 
institutions should at least face the same regulatory 
scrutiny as chartered banks and firms.  Regarding tax 
revenues from trade, it is difficult to predict when lowered 
tariffs will bolster foreign trade to the extent that they 
compensate for lost budget revenues.  It is more likely that 
as the domestic economy improves due to global economic 
integration, the importance of trade tariffs on the budget 
sheet will decline.  Vietnam's fiscal priorities and poverty 
reduction achievements are commendable.  The GVN should 
avoid letting budget decentralization impede the central 
government's short and medium-term plans for fighting 
poverty and instituting market reforms.  It should also seek 
similar rather than different tax regimes in each province, 
which could hinder domestic trade and investment.  End 
comment. 
 
MARINE