Financial Services in Vietnam and ASEAN

Hanoi—Li Minh Hung, the State Bank of Vietnam’s Governor, gave an interesting series of interviews here about upcoming changes for the financial services industry in Vietnam.  He was speaking in the context of an Asian Banker Summit conference aimed largely at the financial services industry in Vietnam and in the region.

A few points were worth highlighting for a wider audience. 

Vietnam, of course, is in a somewhat unique position within the region.  It is a member of the ASEAN Economic Community (AEC).  It has also signed the Trans-Pacific Partnership (TPP).  It also has a series of new bilateral free trade agreements and many of these deals come with new commitments in financial services. 

The gaps between Vietnam’s existing regulatory and competitive environment for the banking sector and what might come in the future could be substantial.  Not all ASEAN member states can boast (or have to worry about) such a constellation of changes on the horizon. 

Nevertheless, it is striking how enthusiastically the government is embracing the challenge.  The Prime Minister came to open the conference here before an audience so large they had to open another overflowing ballroom just to try to accommodate all the interested listeners.  

Governor Le tried to argue that both the AEC and the TPP will lead to a more efficient and sustainable banking sector.

This is not really the case.  The AEC promised “free movement of goods, services, investment, skilled labor, and freer movement of capital.”  The somewhat odd term “freer” came about because the original 2020 deadline for implementation of the AEC was not changed for financial services in ASEAN.  In other words, while the rest of the AEC goals were to have been met on January 1, banking sector changes are not due for another five years.

It is certainly possible that the AEC, by 2020, will include new provisions on financial services.  Or, as hopeful vendors outside the ballroom at the Hanoi Marriott suggest, new technology may create greater market access and opportunities for millions of companies and customers across Southeast Asian markets long before the AEC deadlines kick in.

At the moment, most of the ASEAN-level commitments for banking, insurance and all other financial services sectors are far from creating an open market.  Services and investment commitments, in general, are also poor. 

A trade agreement is not the only way to open markets.  Companies can invest now in some markets that are—on paper at least—not open.  Conversely, some sectors that appear to be “open” are rife with licensing requirements or manpower restrictions or various non-tariff barriers that make apparently open markets impossible to penetrate.

But a trade agreement does make it easier for companies to operate.  Regional agreements are definitely simpler for firms to use and reduce risk and uncertainty.  They can remove much of the burden for staff.

Historically, financial services and telecommunications have been viewed as essential “backbone” services.  These have always been treated differently than other service sectors with slower liberalization and significantly greater caution in rule making.

The TPP is no different.  The agreement has a specific chapter on financial services.  The interlocking nature of the deal means that some of the benefits for the banking industry can also be found elsewhere including in the investment and services chapters. 

When Governor Le talks about the importance of a trade agreement to restructure credit institutions, he really means using the TPP to help Vietnam’s domestic industry level up. 

As of May 2016, he pointed out that Vietnam was host to 50 foreign bank branches, 6 wholly owned foreign-invested banks, 52 representative offices, and 2 joint venture banks.  In the future, these numbers are clearly expected to grow.

Financial service players, however, ought not just be thinking about the potential to set up new branches.  Instead, as the TPP gets set to shift up supply chains in Vietnam, companies should be considering how to play a role across a wide range of financial services that will be needed in the near future.

Such services include finding new local partners, offering up new trade financing for companies in Vietnam (and elsewhere) who currently have no access to such financing or have had poor terms, creating markets for insurance products of all types, and financing products that have likely never been offered in the market before, including products for small and medium sized firms that make up the bulk of the companies in Vietnam. 

Banks should also be ready to finance infrastructure and to support the inbound investment of many different kinds of companies looking to Vietnam and other TPP member countries.

Firms will need to carefully read the TPP commitments, as the financial services chapter contains many country-specific rules and exceptions.  How TPP rules are implemented at the domestic level will also be important.  In Vietnam, the government is now working on a comprehensive reform of the credit institutional system. 

Another promising area of focus for financial service firms that we have been working on is cross border mobile payments as part of the e-commerce negotiations for RCEP.  These talks will bring together 16 countries in Asia, including Vietnam with the rest of ASEAN, China, Korea, Japan, India, Australia and New Zealand.

It is not possible to get smaller firms to participate in e-commerce if they cannot be paid for their goods and services.  Mobile payments provisions were not well developed in the TPP, as the agreement closed some time ago (substantive work on most chapters finished as long ago as two years).  In the world of fintech, two years ago is a lifetime.  Hence, there is ample scope for RCEP countries to consider new provisions to let smaller firms buy and sell goods and services across borders using mobile devices.

We are working on a position paper on the subject now for the next round of RCEP negotiations in New Zealand in mid-June.  If you would like to participate in our efforts, please let us know.  We would very much like to hear from a wider array of companies.

Financial services are a vital part of trade, as Vietnam’s top leadership has recognized.  Building and sustaining a competitive industry is a laudable goal.  Hopefully, other governments across the region will also embrace this challenge in the future.

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***

Lipstick, Bicycle Chains and Durians: All Free Trade Agreements Are Not The Same

Free trade agreements (FTAs) have been mislabeled—they ought to have been called preferential trade agreements (PTAs) instead.  The agreements are not so much about “free” trade as they are about giving preferences or benefits to member state firms that non-member firms do not receive.  The net effect might be more “freeing” but this is not the same thing as giving the same set of benefits for everyone. 

We can argue about whether or not granting different access to various partners is helpful or harmful.  Rather than engage in a philosophical discussion about the merits of global vs. regional vs. bilateral trade deals, this post highlights differences in one important element of existing trade agreements:  various tariff preferences granted for specific products into just one country.  Showing how existing trade agreements signed by Vietnam handle the same limited set of products like lipstick, bicycle chains and durians helps illustrate variations across FTAs.

The primary outcome of existing FTAs has been to grant member firms lower tariffs than non-members receive.  FTAs may do lots of other economic things, including opening up markets for services or investment or creating new commitments or rules for intellectual property rights or competition policy.  But most of the focus and use of existing FTAs has been to receive lower tariffs (that can be thought of as a tax on imports) than firms could receive before an FTA came into existence.

Whenever we assess “quality” of an FTA, a key element is the extent to which the agreement provides new market access for firms by lowering tariffs on goods.  Countries can agree to make no new commitments at all—the existing tariff on imported goods in a category remains unchanged (at the MFN level that applies to all WTO members).  Or countries can agree to lower tariffs in certain product categories.  They can do so all at once at the very beginning of the deal or they can do so gradually over time (in even stages or in “lumpy” reductions where a tariff might drop a little bit up front and steeply at some distant time). 

More ambitious deals generally offer 1) deeper tariff cuts on 2) more products in 3) a shorter time frame.  Because FTAs are the result of negotiations, the content of any individual FTA varies—all parties have to agree on the final commitments.

As newer agreements get signed, the old agreements are not retired.  Instead, companies can opt to use whatever deals provide the most useful benefits for their products.  For many products, FTAs provide no difference in tariffs as the MFN rate is already 0.

But for other items, FTAs do provide benefits that can vary by agreement.  To see how this works in practice, consider specific products that firms may want to export to Vietnam.  Vietnam has multiple agreements in force, mostly centered on ASEAN.  The country has enthusiastically been signing new deals, including the TPP and a bilateral agreement with the EU and another with South Korea, but these have not yet taken effect.

A company that wants to ship lipstick into Vietnam from a country with no existing FTA has to pay the MFN rate of 20%.  But firms in ASEAN can ship lipstick into Vietnam with no tariff at all using ATIGA.  The ASEAN-China agreement (ACFTA) also allows Chinese companies to ship lipstick duty free to Vietnam. 

As with any FTA, firms do have to meet rules of origin (ROO) criteria to be eligible to receive lower tariffs.

Korean companies currently have no benefits for lipstick in their ASEAN-Korean FTA (AKFTA).  This means that, while many Korean products receive lower tariff rates on products using this agreement, lipstick exporters are out of luck and must pay the MFN rate of 20%. 

Japanese exporters are granted a slight duty reduction at 20% in the ASEAN deal (AJCEP) but a bilateral agreement between Vietnam and Japan gives Japanese companies an improved deal at 14.5% (VJEPA). 

Australian and New Zealand (AANZFTA) companies get access to the lipstick market of Vietnam with a 10% duty and India receives (AIFTA) a reduction to 20%. 

Under the TPP, the 11 parties in the agreement can look forward to 0 duties, but only after the current rate drops in four equal installments across 4 years.  Hence, in relatively short order, Japanese, Australian and New Zealand companies can expect to receive the same 0 duty preferences that their ASEAN competitors already receive.  Since the TPP will grant better benefits than existing deals, firms should start using the TPP.  For American or Mexican or other TPP lipstick companies that only had MFN rates before, the post-TPP preferences are especially important.

Vietnamese customers might be asking whether all these trade deals mean that they can expect to pay less for lipstick in the future.  The answer is that they might—if firms decide to pass the tariff savings through into lower prices.  Firms could also opt to keep the savings in the form of higher profits or greater shareholder returns. 

It’s also possible that lipstick manufacturers will not take advantage of FTAs, as the market in Vietnam is not attractive enough—for whatever reason—to ship lipstick no matter how high or how low the tariffs might be on the product.

The same uneven set of benefits can be seen for other firms shipping goods to Vietnam.  Bicycle chains are surprisingly complicated, with multiple categories of chain.  For a roller chain of expanded metal (HS73151111), the MFN rate is 40%.  ASEAN firms pay a 5% duty.  Chinese firms pay 20%.  Korean firms have no specific benefits under AKFTA and pay 40%.  Japanese firms (under both the ASEAN agreement and the bilateral deal), Australian and New Zealand firms all pay 35%.  Indian firms are charged 36%.  TPP members will pay 0 duty in four years.

Durians and many other fruits are subject to an MFN rate of 30%.  But ASEAN, Chinese, and Korean farmers can ship durians duty free now.  Japanese firms get better benefits under the ASEAN agreement than the bilateral (20% vs. 22.5%).  Australia and New Zealand are currently subject to 10% tariffs on durians and Indian companies pay 20%.  Post-TPP entry into force, however, members will pay 0 duties immediately for durian shipments to Vietnam.

The examples show the differences across trade agreements.  For most products where the existing MFN rate is higher than 0, ASEAN already grants duty free access to Vietnam.  Some of the existing trade agreements match these 0 tariff rates or at least provide lower tariff levels than non-FTA members receive.  Since the TPP is both broader and deeper than existing agreements for Vietnam, firms should expect better benefits (or tariff cuts that match ASEAN) for nearly all products either on entry into force of the agreement, or in the near term. 

***Talking Trade is a blog post written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***

Unleashing Vietnam’s Textiles

In Hoi An in Central Vietnam.  This charming town could be viewed as ground-zero for tailoring.  Over the past few years, the number of tailor shops has zoomed past 500.  Most are located in the old, UNESCO-heritage listed central core that is only a kilometer or two across.

Tourists are here from everywhere, with a strong presence of Europeans and Australians at this time of year.  The number of hotels in the area has also increased markedly in the past five years to service the increasing demand from overseas visitors to this region.  Few people leave Hoi An without at least a few items of clothing stashed into their suitcases or newly purchased bags or backpacks.

Despite the roaring success of the tailor shops in Hoi An and the textile sector as a whole in Vietnam, the industry is set for a significant change in the coming five years. 

Vietnamese officials have been extremely active in signing free trade agreements.  They are in the last stages of work on a deal with the European Union.  They just signed an agreement with Russia, Belarus, and Kazakhstan.  But the biggest prize will be the completion of the Trans-Pacific Partnership (TPP). 

Vietnamese apparel exporters face competitive challenges getting their products into the United States, including relatively high and complicated tariffs.  Exporters are also at a disadvantage compared to manufacturers in countries like Mexico with existing FTAs with the Americans, since Mexican textiles have significantly reduced tariff rates.   Despite these problems, Vietnam’s clothing exports have continued to rise.

Under the TPP, many of the current tariffs are set to fall significantly.  To take advantage of these benefits, however, the agreement also calls for textile and apparel producers to use complex rules of origin (ROO). ROOs are necessary in FTA agreements to ensure that only products produced in member countries can take advantages of the benefits provided by the agreement.  If an FTA were finished without ROOs, any country (whether they are actually a member of the deal or not) could simply ship items and enjoy the benefits of reduced tariffs:  it would be no different than receiving the payoff from unilateral tariff cuts. 

The United States requires an especially complicated ROO for apparel—the so-called “yarn forward” rule.  Under yarn forward, items in a product must be made with the original yarn in the fabric sourced from the United States to qualify for FTA benefits.

Right now, Vietnam’s textile manufacturers generally use imported cloth.  Most comes from China.   Under a different set of textile rules, the “cut and sew” method of determining origin, Vietnam could continue to manufacture products as they currently do but would have the added benefit of lower tariffs in the American market.  The U.S. market is of prime importance to the clothing industry of Vietnam.

Note that cut and sew ROOs would not allow third-parties or non-members to sneak into TPP markets.  Members like Vietnam would still be required to demonstrate that a portion, like 40% of the final value of the product, came from Vietnam or other TPP member countries to obtain lower tariff benefits.

But the cut and sew rules are largely not allowed in the TPP either.  Instead, under strong pressure from American textile manufacturers, U.S. officials have stuck with yarn-forward ROOs for most products.

This presents a challenge and an opportunity for Vietnamese textile and apparel manufacturers.  While Vietnamese firms have done quite well under the current system and could continue to use the same sourcing methods for yarn and fabric, they cannot send the finished products to the United States under the new, lower tariffs.  If firms want to benefit from lower tariffs (perhaps 10-40% lower depending on the product), they will have to change sourcing patterns to get U.S. or TPP-made yarn and fabrics.

Hence the potential exists for radical changes in the textile industry in Vietnam.  In the past, Vietnam has not been able to wean itself off reliance on the Chinese market for raw materials.  Chinese-made fabrics have come to dominate the trade, even here in Hoi An. 

But since it became clear that the TPP is likely to materialize, firms are beginning to plan for the future.  Vietnam has started getting more and more companies (particularly from South Korea and China), relocating production of weaving, spinning and dyeing to here.  These are quite capital-intensive industries, so it has always been a challenge for local firms to decide to open such plants themselves.  The TPP, however, is such an important opportunity that these facilities are now necessary.

Another post will track some of the new inward investments.  For now, it is enough to note that the tailors of Hoi An are likely to offer new products in the future.  This includes a different range of fabrics for creating the dress, suit or shirt of a tourist’s dream.  Perhaps a new set of shops will be offering denim in five years, for example.  Certainly, the number and types of locally manufactured fabrics is likely to be dramatically larger than what is on offer now.