High uncertainty will require the policy mix to be adapted to changing circumstances. Firstly, a more supportive fiscal policy stance could hedge against downside risks to growth. While Vietnam has fiscal space to act, the challenge is weak implementation. Addressing institutional bottlenecks that have led to the chronic under-execution of the public investment programme would make fiscal policies more effective.

Dorsata Madani, Senior economist World Bank in Vietnam

In the short run, the focus should be on full utilisation of the recovery policy package, adopted earlier this year with a strong push on project implementation. This would help bolster the domestic demand recovery in the near term while also boosting Vietnam’s long-term potential growth.

In addition, expanding targeted social safety nets would not only help buffer the effects of the fuel price shock and rising inflation on poor and vulnerable households but cushion impacts on private consumption more effectively than the current untargeted cuts in the environmental protection tax and proposed cuts of VAT and import taxes.

Secondly, heightened inflation risks call for agile monetary policies. Since core inflation remains in check and the economy is still below potential, current accommodative monetary policies appear appropriate for the time being. However, if upside risks to inflation materialise – with core inflation accelerating and headline inflation moving above the 4 per cent target set by the government – the State Bank of Vietnam (SBV) should be ready to pivot to monetary tightening to quell inflationary pressures through interest rate hikes and tighter liquidity provision.

Accompanying these steps with clear and forward-looking communication of monetary policy decisions would help guide market participants and ensure inflation expectations remain well anchored. Over the medium term, more fundamental reforms to enhance the SBV’s monetary policy framework and move towards inflation targeting would enhance monetary policy transmission and effectiveness. This could include steps to expand the tools available to manage liquidity as well as enhanced macroprudential measures.

Thirdly, emerging financial risks also need to be managed proactively to strengthen the resilience of the financial system. The rollback of forbearance at end of June was an important step to enable the better recognition of impaired loans. Building on this, it will be important to intensify prudential supervision and ensure banks fully comply with non-performing loan reporting and provisioning requirements to enhance their loss-absorbing capacity and resilience. If capital shortfalls arise, banks should be required to develop specific and time-bound recapitalisation plans. An effective corporate insolvency regime and a functioning banking sector resolution framework are also important to deal with potential insolvencies.

Finally, deeper structural reforms are critical to supporting potential growth in the medium run and making the economy more resilient and inclusive. Fiscal reforms should focus on stabilising revenue generation through tax policy reforms and enhancing spending efficiency to expand the fiscal space for spending on Vietnam’s social, climate, and other development objectives.

Promoting more public and private investment in climate change adaptation would help make Vietnam’s economy more resilient. This could be accompanied by policies to move towards Vietnam’s carbon neutrality target, including expansion of renewable energy and carbon pricing, which could also enhance Vietnam’s competitiveness in growing markets for green products and technologies.

While efforts to enhance the business environment are crucial to enabling job creation, policymakers should also take steps to reduce skill mismatches and improve the quality of Vietnam’s labour force.