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Foreign investment in Vietnam has had a rocky ride since 1996. Recent statements by Hanoi, however, indicate that the ride will be much smoother from now on. True, the economy is healthier now than a decade ago, and investments are coming in at a stronger rate than in the dismal late 1990s. But several business people with long experience in the country suggest that cautious optimism is the wise man's creed when considering investing in Vietnam. A look back at the unstable investment patterns of the past eight years will additionally help any would-be investor grasp the lay of the land.

1996-97
When Vietnam published its Foreign Direct Investment (FDI) Law in December 1987, its Soviet-style command economy began to wither, albeit slowly. The law allowed for several types of businesses: 1) business cooperation contracts, 2) 100 percent foreign-owned enterprises, and 3) joint-venture companies (JVCs or JVs). Although the government expanded the law to include build-operate-transfer projects at a later date and also allowed revenue sharing agreements for oil and gas investments, the government encouraged JVs over all else.

FDI trickled in at first, but poured in by 1995 and 1996. Licensed projects were valued at US$6.6 billion for '95 and $8.6 billion for '96. Actual inflows were lower - $2.67 billion and $2.64 billion, respectively - but inflows are typically a third lower than pledged projects. Additionally, some of these monies represented massive proposed real-estate development projects in Hanoi, Dalat and Ho Chi Minh City, some worth more than $500 million. According to Chris Freund of Mekong Capital, these projects were not done deals, but "more like options to develop the projects at a later date if the property market increased in values significantly". This phenomenon inflated licensed Vietnam FDI figures slightly, and some foreign business people assert that the government took advantage of this to skew investment statistics. However, the figures overall represented an enthusiasm on behalf of the foreign investment community to invest in Vietnam.

Foreign investment appeared so prosperous that in 1996, Hanoi declared that it wanted FDI to account for 40 percent of its investment needs from 1996-2000. That amounted to $40 billion. Major firms set up shop in Vietnam to market their products and services. All business pioneers, they included Pepsi, Coca-Cola, Grand Metropolitan Distilleries, Unilever, LG Chem, Proctor and Gamble, Nissho Iwai, IBM, J Walter Thompson advertising and SRG, a major market-research firm. Downtown Ho Chi Minh City teemed with Japanese, Taiwanese, South Korean, US, British, German and French business people. Gainfully employed Vietnamese benefited from increased purchasing power, and the quality of life in Vietnam's largest cities visibly increased.

But there were numerous developing problems. The banking sector was weak, and many lending institutions collapsed because of corruption. Government policy required many foreign investors to invest in JVs along with state-owned enterprises (SOEs), which by Western standards were inefficient. Further, excessive red tape stifled business operations and contract negotiations. Starting a business required as many as 10-20 permits, and maintaining operations required similar efforts each year. Even bureaucrats that had little to do with business asserted themselves in the system to milk foreign investors.

More, Hanoi's propensity to create restricting business laws overnight likewise created substantial barriers. For example, in 1997, Hanoi outlawed cigarette advertising and the import of various consumer goods such as shampoo, soap, toothpaste, televisions and radios. This was the government's attempt to encourage the domestic industry and increase its labor force, but foreign investors saw it as command economy politics. Lawmakers applied a similar policy to industrial sectors such as sugar, cement and steel, which reflected Hanoi's continued interest in import substitution.

But by spring 1996, a rumor circulated through Hanoi and Ho Chi Minh City that suggested the 8th Party Congress, to be held that summer, might not expand FDI policies established so far. There was a short pause in hiring as the foreign investment community held its breath, waiting for the verdict at the Congress's conclusion. In the end, the verdict was not good for FDI. The government put the brakes on further expansion of FDI policies, something the foreign business community needed in order to breach existing barricades.

Having said this, Chris Freund states that the Vietnamese government was not entirely at fault regarding the downturn of FDI. He asserts, "Many foreign investors deserve much of the blame for their failures in the mid-'90s. This is because they routinely overestimated domestic demand in Vietnam. They got excited about the 80 million people in Vietnam and the idea that [it] was going to be the next Asian Tiger but didn't consider the per capita GDP [gross domestic product] was around $320." He also says, "Much of this investment was predicated on the assumption of a rapidly ongoing reform process, but they were often being unrealistic about this."

FDI decreased accordingly. While disbursements increased to $3.25 billion, likely as a result of 1996's momentum, the worth of proposed projects fell to $4.6 billion, down $3.99 billion from the previous year. This indicated the foreign investment community's disdain for Vietnam's FDI policy turnaround, and, as Freund stated, their unrealized, overoptimistic assumptions.

To add insult to injury, the Asian economic crisis of 1997 began to rear its ugly head, severely injuring regional economies, which also penalized Vietnam. Largely immune from the crisis's direct blow because of its inconvertible currency, the dong, Vietnam instead suffered indirectly because its biggest investors - regional players such as Thailand, Japan and Taiwan - had less to invest as they propped up their own economies from the effects of currency devaluations and capital flight. Nevertheless, as investors fled in what signified the end of Vietnam's first investment wave, Michael J Scown suggested that the international community adopt a long-term investment view and summarized the country's key FDI problems as follows:
1. Lack of a coherent government FDI policy.
2. Weak domestic banks.
3. Lack of security for foreign lenders.
4. The impact of the Asian economic crisis.

1998-99
Vietnam spent 1998-99 reeling from the "one-two punch" of '96 and '97. Foreign investors hoped for a Doi Moi II - that Hanoi might reverse the policies of 1996 and once again encourage investment with more progressive investment laws. But Vietnam's investment policies remained muddled, and corruption and an excessive bureaucracy made doing business tough.

One specific policy that restricted investment in Vietnam was its currency-surrender law that seized up to 50 percent of a business's foreign money. According to a US Foreign Commercial Service and US Department of State study dated 1999, "strict controls on the holding of foreign currency [made] it difficult for investors to retain US dollars in order to pay salaries, [repay] loans and repatriate profits". As a result, investment suffered. The most significant FDI policy step forward was a 1998-99 law that stated that foreign joint-venture partners could buy out local partners. This marked a major policy turnaround from 1996, when the government allowed but discouraged 100 percent foreign-owned enterprises. Two major companies took advantage of the new law, Colgate-Palmolive and Coca-Cola. According to press accounts, each had been experiencing losses and high-profile managerial disputes with their foreign partners.

Otherwise, that was it for noteworthy investment moves. In 1998, proposed projects amounted to $3.897 billion, down $76 million from the year before. Actual disbursements fell to $1.9 billion. And for 1999, the FDI situation deteriorated still more with a major drop in proposed projects to $1.54 billion, a staggering 39 percent drop from the previous year. Disbursements fell to $1.53 billion. While Vietnam's GDP did not suffer terribly as a result, it did not expand much, either. In dollar terms, from 1998 to 1999, Vietnam grew from $25.7 billion to $26 billion. A study of press articles from the 1998-99 time period noted the following difficulties with FDI in Vietnam, with the Asian economic crisis being the lesser obstacle:
1. Corruption.
2. Excessive business "red tape".
3. A difficult-to-interpret and ever-changing investment legal system.
4. The Asian economic crisis.

2000-01
In both 2000 and 2001, Hanoi took positive steps to rectify its dismal FDI record, first by joining the foreign business community in its criticism, and second by proposing numerous FDI legal reforms. By this point, the government likely realized that its 1996 policy of FDI supplying Vietnam with 40 percent of its investment needs by 2000 - $40 billion - had not been achieved. In reality, it had provided only $13.8 billion, some $26 billion off the mark.

The National Assembly acted first. It debated investment reform in 2000 over a proposed investment law, but that law did not see fruition until the 9th Party Congress in 2001. Regardless, various assembly ministers such as Pham Chuyen and Nguyen Duc Chinh argued that while Vietnam's investment laws were adequate on many levels, many local administrative bodies hindered FDI via corruption and impending bureaucratic roadblocks. They also cited unduly high personal income taxes for foreign investors, some equal to those in Japan. Specifically, Vietnam imposed a 25 percent corporate income-tax rate, and with incentives it was acceptable to some, but the 50 percent tax rate for those in the oil-and-gas sector, major money-makers for Vietnam, were driving business away.

Perhaps reacting to the likelihood of near-future positive policy changes, FDI numbers went up. In 2000, proposed FDI projects tallied $1.9 billion, up $424 million from the year before. Disbursements rose to $1.8 billion, an increase of $264 million from the year before. These reflected a trend of smaller FDI projects away from $20 million deals such as real estate to smaller-scale manufacturing projects that sometimes required less than $5 million.

Then in January 2001, Vietnam Investment Review (VIR), one of that country's flagship business weeklies, published portions of internal government documents that discussed Hanoi's criticism of its own FDI policies. The documents focused on two key points: 1) the government's lack of agreement on the benefits of FDI, and 2) the government's misunderstanding of how to manage FDI policy.

After the publication, the government held the 9th Party Congress in spring 2001 and laid the groundwork for a new investment law that would be published in the autumn. Part of its motivation for doing so lay within preparing for the economically liberal Bilateral Trade Agreement (BTA) with the United States and taking steps to prepare the country for possible entry into the World Trade Organization (WTO) in the mid-2000s.

Nevertheless, at the meeting, the Communist Party stated in broad terms that recent economic reforms had benefited the country by reducing poverty, but further reform would help to realize the full potential of the nation's resources and human capital. It indicated that FDI was an important part of realizing that goal. Additionally, the party cited strategic drags on the economy that needed reform. The culprits included domestic business inefficiency, lack of competitiveness, slow industrial modernization, low purchasing power, a weak banking sector and "irrationalities in the investment structure" to name but a few.

The resulting Party Congress resolution, simply titled 09/2001/NQ-CP, came out in the autumn. It included improvements and transparency in FDI law; opened medical, travel and tourism sectors to foreign investment; declared its intent to change to a "common tax system"; and granted foreign businesses the ability to hire local staff on their own accord and not via local hiring agencies. Perhaps the most significant change was a lower foreign-currency surrender rate of 40 percent, down from 50 percent. (In May 2002, the government lowered this to 30 percent, and in April 2003, it disposed of this policy.)

By the end of 2001, the value of proposed FDI projects had risen to an estimated $6.3 billion, which was $4.3 billion more than 2000. Disbursements also climbed slightly to $2.3 billion, an increase of $500 million. These increases seem to have occurred in anticipation of Vietnam achieving the BTA with the US and Hanoi's reformist tack. Beginning a four-year FDI-reform movement with such criticism was a positive step in gaining investor confidence. Only time would tell.

2002-03
When time did tell in 2002, statistics did not reflect an upswing. On the contrary, the worth of both proposed projects and disbursements fell by nearly 50 percent. Proposed projects were valued at an estimated $3.6 billion, disbursements at a meager $1.3 billion, the lowest figures since before 1995. This most likely occurred because of the global economic downturn that began showing signs in the US economy in spring 2000 and had gradual ripple effects throughout the world in the years that followed.

But as the year went on, good news arrived. Based on its commitment to the BTA, a continually touted desire to join the WTO, and also the Association of Southeast Asian Nations' Free Trade Area, Moody's upgraded Vietnam's creditworthiness from "stable" to "positive" in 2002. Hanoi's slow but tangible FDI reforms probably contributed. According to a speech made by Prime Minister Pham Van Khai in early 2002, Vietnam was working on improving the FDI sector, which included creating "... a clear-cut, uniform and stable legal environment", reforming the banking sector, increasing Vietnam's foreign-currency reserves, and enhancing and speeding up investment. These were not hollow words. Several past hindrances to FDI, such as myriad permits required by investment authorities, had by this point been removed. On the other hand, there remained gripes about FDI policy:
1. Expensive telecommunications.
2. A high top income tax of 30 percent.
3. High import tariffs for various product components that cost more than the final product.
4. Forced purchase of locally produced parts for some products.

Despite its slow but significant FDI-reform measures to date, Vietnam's economy improved dramatically in 2002. GDP expanded at about 7.4 percent. Individual sectors such as agriculture grew at 5 percent, and money made off exports to the United States skyrocketed into the billions of dollars.

Depending on the source, economic figures for 2003 varied. FDI figures seemed to have improved slightly in 2003. Projects totaled $3.1 billion, a slight drop from 2002, but disbursements rose to $1.95 billion, a $6 million increase. The World Bank said GDP growth was about 7 percent, but Vietnamese figures said 7.5. Despite these numbers, Le Dang Doanh, a leading Vietnamese economist, warned early in the year for Vietnam to make rapid investment reforms or lose competition to China.

Contrary to this line of reasoning, in September 2003, Vietnam instated a 25 percent import tax on automotive parts kits for foreign manufactures with assembly plants in the country. Lawmakers wanted to force car makers such as Toyota to purchase domestically made parts, which some believe are of low quality. Politicians assert that it is designed to decrease the number of cars on Vietnam's increasingly traffic choked roadways. Regardless, some auto makers have declared their intent to raise domestic prices per unit and to scale back investment until more optimal conditions evolve.

Conclusion
FDI in Vietnam has indeed experienced dramatic fluctuations, and the journey from command economy to the present has been a bumpy ride. Hanoi admitted in 2001 that its policies and hazy laws were the root cause, but that corruption and excessive bureaucracy by local administrators also served as significant impediments. The resulting fallout has hurt the Vietnamese economy and contributed to its unnecessary sluggish growth and poorly utilized resources and workforce. All of this is unfortunate, because FDI is vital to Vietnam's modernization and poverty alleviation.

But what about the bottom line? Has FDI stabilized in Vietnam? Chris Freund says yes. "In terms of the number of projects licensed, the rate of implementation of the projects that get licensed, the number of jobs created and the tax payments of the FDI sector, it has stabilized. It is just that the nature of the projects being licensed has shifted dramatically away from capital-intensive industries and domestically oriented business like consumer products towards labor-intensive manufacturing for export, an area where Vietnam does have a competitive advantage."

Hanoi's policy turnaround has helped stabilize FDI. Freund states, "The government was very receptive to feedback on the Law for Foreign Investment in Vietnam and has made revisions several times." Further, "The legal framework as well as tax incentives for FDI in Vietnam is generally favorable." Finally, Freund comments that the numerous industrial zones around the country have made it easy to set up a factory with a small degree of red tape and bureaucratic interference. In short, the government has reformed FDI policy for the better, not by leaps and bounds, but by smaller steps. But the remaining problems are serious. Protectionist policies such as the automotive-parts tax still threaten investments.

What about the future? Will the FDI climate change for the better, and at what pace? If the seven years of reform since 1996 is any indicator, then Vietnam shows promise, but unless policymakers achieve an epiphany of capitalist prowess, then the pace will drag. In this case, investors must consider investment sectors carefully and not overestimate the country's potential, especially in the domestic market, as in 1996-97. Today, the name of the game is small manufacturing projects and export-oriented businesses, similar to what Taiwan has established. Tomorrow, Vietnam will have to compete more with China, what one Ho Chi Minh City lawyer refers to as "an overwhelming challenge", and not just for Vietnam, but for the rest of Southeast Asia as well. This will likely entail accelerating reform and developing niche sectors where FDI can both generate profits and benefit the country's labor force, foreign-currency coffers and technology intake. Similarly, government FDI policy will have to continue to change to attract FDI in an ever-increasing competitive global market. But Hanoi knows this and seems to be making a real effort to meet investor demands. For example, last April, Vietnam abandoned its foreign-currency-surrender policy for exporters a year ahead of the International Monetary Fund's suggested timeline.

Additionally, many of the BTA's statutes phase in over time, which will automatically open up the country to foreign investment and require it to follow internationally recognized standards of conduct. Hanoi's bid for entry into the WTO will have a similar effect. But while policy improvements will help better the economy, Sesto Vecchi, a longtime Ho Chi Minh City lawyer, asserts that it is time for Vietnam to look past simply improving FDI policy and work on improving the business environment.

In all likelihood, Vietnam's conservative penchant against change and protectionist proclivities will continue to butt heads with economic reform and the multitude of national changes that come with it. Because of the environment this situation creates, however, Keith Schulz, a former longtime Ho Chi Minh City business consultant, says that future FDI assessment "in general does not exist for Vietnam. It will depend on what one is investing in, and the terms one can receive. Individual opportunities for those intimate with particular conditions will continue to emerge."

As for the big picture, with the Vietnam-US BTA well under way, an increasingly economically competitive region, and possible entry into the WTO next year, the ground is set for a major leap in FDI policy at the next Party Congress in 2006. This could occur sooner if China diverts too much FDI from Vietnam. It will be up to Hanoi to seize the day.

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