VIETNAM: Opportunities and pitfalls ahead of E.U. free-trade agreement

By the end of 2017 Vietnam is set to be the first developing country to conclude a free-trade agreement (FTA) with the European Union (E.U.). This report will investigate the policy details and identify the key benefits and challenges to foreign investors doing business in the country.

Overview

Bilateral negotiations for the E.U.-Vietnam FTA (EVFTA) which started in October 2012, will reach the final ratification stage by the end of 2017. Both parties have indicated their hope that the agreement will come into force by early 2018, which would make Vietnam the second South-East Asian country, and the third Asian country after Singapore and South Korea, to conclude an FTA with the E.U.

Broadly, the EVFTA will gradually eliminate up to 99 per cent of tariff and non-tariff barriers between both parties over a 10-year period. The E.U. Commissioner for Agriculture and Rural Development estimates this would amount to up to EUR170 billion-worth of tariffs eliminated on the Vietnamese side. The FTA would also deepen bilateral trade relations, given that the E.U. is already Vietnam’s second-largest trading partner after China, and is also a key export market for Vietnamese products alongside the U.S. In 2015, close to EUR30 billion-worth of Vietnamese goods reached Europe, a 30 per cent increase from the previous year.

The affected economic sectors are wide-ranging and include both parties’ main exports. According to the European statistics agency, the top three Vietnamese exports to the E.U. are electrical and mechanical machinery (50 per cent), garments, textiles and footwear (22 per cent) and coffee and tea (5 per cent). The top E.U. products to Vietnam are electrical and mechanical machinery (28 per cent), aircraft (14 per cent) and pharmaceutical products (8 per cent).

In addition to goods, the EVFTA also removes barriers in the services sector. European companies will gain improved access into the healthcare and packaging industries, while Vietnam has pledged to align its regulations to conform to international best practices and E.U. standards. At the same time, customs duties are also exempted on electronic transmissions, alongside intensified bilateral co-operation over cross-border electronic commerce (e-commerce) issues.

Another key feature is the adoption of non-discriminatory policies between Vietnam’s state-owned enterprises (SOEs) and E.U. firms when engaging in commercial transactions. At present, there are some 2,000 SOEs in Vietnam, accounting for about 40 per cent of the economy. The authorities have typically given SOEs preferential access to land, capital, and other resources. However, under EVFTA, E.U. companies will be able to bid for contracts in infrastructure, power generation, railway projects and healthcare on an equal footing with the SOEs.

Provisions are also in place to protect data and intellectual property rights (IPR), particularly in the pharmaceutical sector. This has typically been a weakly enforced regulatory area in Vietnam, in common with many other developing countries. Under EVFTA, Vietnam would be required to adopt international standards and regulations governing IPR-related products set by bodies including the World Health Organization and the Organisation for Economic Co-operation and Development.

Benefits to Vietnam

The immediate benefit to Vietnam would be an increase in investment inflows, particularly in manufacturing. The country has demonstrated its ability to utilise foreign investment to push its manufacturing sector up the value chain. A decade ago, local manufacturing was restricted to handling raw materials and simple processing. Today, Vietnam is starting to produce goods of higher value, such as smartphones and similar devices.

In 2016, the country received USD15.8 billion of foreign direct investment (FDI), a 9 per cent increase from a year ago. A 2016 investment report by Asean also pointed out that Vietnam had attracted the largest amount of investment among countries in the Cambodia, Laos, Myanmar, and Vietnam (CLMV) region.

China’s slipstream

The key industries that would gain most from the FTA are textiles, garments and footwear (TGF), electronics and machinery. These sectors will benefit from the fact that macroeconomic conditions in China have become challenging in the past five years, and are set to become more complex due to global and domestic economic and political trends. China’s early economic advantages as the world’s dominant industrial exporter are being eroded by high inflation, rising wages, an ageing workforce, labour unrest and the potential for protectionist policies in its major markets.

Vietnam is among several neighbouring countries, including Indonesia, the Philippines and Thailand, which have benefited from companies shifting production out of China. It has managed to gain the most from this shift, largely because of low labour costs. The average monthly wage in Vietnam was USD197 in 2014-15, according to the U.N.’s International Labour Organization, with only workers in Cambodia, Timor-Leste and Indonesia in South-East Asia receiving lower pay than the Vietnamese. The elimination of tariffs under the EVFTA will be an additional incentive for European firms with an existing presence in East Asia to shift their labour-intensive and lower-technology processes to Vietnam.

Further, the country’s geographical centrality in South-East Asia and its land border with China make it easier to integrate into global supply chains. The E.U. Commission notes that small- and medium-sized entrants can take advantage of Vietnam’s location as a gateway or as a regional distribution centre for European products and services into regional markets.

Given the sensitivity of the TCF sector, the E.U. has agreed to the gradual elimination of customs duties for Vietnam-made goods over a five- to seven-year period. Additionally, there are strict rule-of-origin conditions imposed, requiring imported garments only to use locally made fabrics in order to prevent de facto Chinese products entering the E.U. market via Vietnam. The only exception will be for fabrics made in South Korea, which is another E.U. FTA partner.

Nevertheless, the growth potential for Vietnam is immense under the EVFTA as the E.U. imports only about 8 per cent of TCF products from Vietnam, compared to 50 per cent from China. Moreover, government policies are also supportive of TCF exporters, allowing duty-free imports of raw materials if they are exported as clothing products. The expectation of the above-mentioned benefits due to the EVFTA will likely see strong investment inflows into the TCF sector in the three- to five-year outlook.

Similarly, global electronics manufacturers have also been moving into Vietnam. The biggest investor is South Korean conglomerate Samsung Electronics, which produces about half of its mobile phones in Vietnam. Over the past 30 years the company has invested about USD14.5 billion in the country, or approximately 10 per cent of Vietnam’s total foreign investment over that period. However, Vietnam is still far behind Malaysia, South-East Asia’s electronics manufacturing hub, as it is still engaged in low-value assemblage work. Nevertheless, it is moving towards creating more productive jobs, including an I.T., finance and accounting outsourcing sector. According to the Vietnam Software and IT Services Association, this sector has been growing annually between 10 and 15 per cent since 2011, with more than 400,000 jobs to be created over the next few years.

Challenges

Despite being in the final stages of negotiations, there are plenty of challenges for Vietnam and businesses seeking to capitalise on the benefits derived from the potential FTA.

Corruption risk will be a major issue for European companies, who already face increased regulatory scrutiny at home. According to Transparency International’s 2015 corruption perception index, Vietnam ranked 112 out of 168 countries. Corruption is endemic in the large state sector, from tendering and procurement processes to customs and other areas of the country’s often-inefficient bureaucracy. Companies surveyed by the Vietnam Chamber of Commerce said they believe government regulations, which are usually poorly defined, are often used to extract ‘informal charges’ – a common euphemism for bribes.

This will be a key challenge for foreign firms operating in the country or working with suppliers and contractors in Vietnam. In 2014 U.S.-based life-science company Bio-Rad Laboratories paid a USD55 million fine under the U.S. Foreign Corrupt Practices Act for making improper payments to Vietnamese and Russian officials over a period of five years in exchange for business deals.

The immediate benefit to Vietnam would be an increase in investment inflows, particularly in manufacturing. The country has demonstrated its ability to utilise foreign investment to push its manufacturing sector up the value chain

Despite Vietnam’s anti-corruption laws, enforcement remains poor. Local media have reported on numerous high-profile corruption cases over the past few years involving billions of U.S. dollars in state and private capital. However, few of those deemed responsible have been brought to trial and the authorities have to date only recovered VND92 billion (USD4 million) of fines and losses.

Business with operations in the U.S. and U.K should be fully aware that they are subject to stringent transnational anti-corruption and bribery laws; companies are liable under these laws even if they have limited exposure to the country in question. Proper oversight and controls should be in place to prevent and mitigate the risk.

A general lack of transparency in Vietnam’s political and economic systems is also reflected in the legal sector. Under the EVFTA, commercial disputes will be settled through a new permanent investment court, referred to in the treaty as a ‘Tribunal’. The Tribunal will consist of nine members, with the E.U. and Vietnam each appointing three nationals, and the last three drawn from third-party countries. The Tribunal will be set up as an independent organisation designed to bypass the national judicial system, which is controlled by the ruling communist party and lacks both independence and transparency.

While this could be an effective system for resolving disputes involving private entities, it might have less utility in conflict between E.U. interests and Vietnamese SOEs, particularly those that are entirely owned by the government. State-owned enterprises have long enjoyed preferential access to resources, and investors seeking to enter into public-private partnerships with these entities should be aware that they might face complex legal challenges when resolving disputes.

Furthermore, it could also generate a backlash from Vietnamese SOE and public sector employees as their status, political and economic interests will be threatened as SOEs lose their privileged position under the FTA. This raises the risk of business disruption to foreign companies that could come in the form of orchestrated labour unrest to prevent business continuity as well as other forms of non-co-operation at the local level by workers, such as sabotaging of plants, equipment and infrastructure.

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