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Key driver

Released at: 08:11, 24/03/2014

Key driver

FIEs contribute a great deal to the local economy through job creation and export earnings but could do better in other respects.

by Hai Bang

When addressing the contributions made by foreign-invested enterprises (FIEs) to Vietnam’s economy, senior officials often say that neither the country nor its local enterprises would be what they are today without foreign investment. This statement is especially true given the fact that foreign direct investment (FDI) and the presence of FIEs have helped catapult Vietnam’s economy to a new level over the last 25 years.

Vietnam is today host to 14,500 FIEs, which accounted for 60 per cent, or $80.91 billion, of the country’s export turnover and about 18 per cent of GDP in 2013. “From my industry’s perspective, I think that FIEs have made a significant contribution to Vietnam’s economy, in particular to export turnover,” said Mr Nguyen Son Hai, First Deputy General Director of the VINATA construction company. While a large number of local enterprises have ceased operations due to the economic difficulties, FIEs continued to expand their operations and investment in 2013. “FIEs are not only strong in management and financial capacity but also at coping with difficulties,” said Mr Hai. “Local enterprises should use this as motivation to stand up and compete with FIEs.”

Over the last 25 years FIEs have been persistent in their efforts to come to Vietnam, viewing the country and its 90 million people as being important to their ambitions. Foreign business leaders have been impressed, if the latest investment figures are anything to go by. In 2013 total new FDI commitments to Vietnam reached $21.6 billion, an increase of 54.5 per cent year-on-year and proof that Vietnam is still among the most attractive destinations for multinationals.

Export engine

It’s no surprise that the role played by FIEs in Vietnam’s export performance is considerable. “The presence of FIEs affects export performance directly by increasing the volume of manufacturing exports and the number of exporting enterprises,” said Mr Phan Huu Thang, former Director of the Foreign Investment Agency under the Ministry of Planning and Investment. “It also ties the local economy more fully into global trade activities.” Prior to 2001 the FIE sector accounted for only 45.2 per cent of the country’s total export turnover, but in 2003 the export performance of FIEs began to surpass local enterprises. Moreover, FIEs have also played a key role in shifting the export structure towards higher value-added products and relatively high tech-intensive goods.

For example, Vietnam exported some $21.5 billion worth of mobile phones and spare parts last year, with the largest contributor being Samsung Electronics Vietnam, which accounted for around 10 per cent. “Many FIEs, especially those in hi-tech industries like mobile phones, computers and cameras, have far exceeded their local counterparts and play an increasingly important role in the country’s export sector,” said Mr Thang.

Based on the figures, analysts point out that Vietnam has become progressively more dependent on FIEs in its foreign trade activities. Yet Samsung and other FIEs are often asked about how much value they actually bring to Vietnam. The answer is that while they may contribute more to Vietnam’s export revenues than their local counterparts, they do not benefit the country to a huge extent because value-addition is low.

In fact, the production stages that bring the highest value-addition to a product, such as design or component making, are generally done overseas. FIEs in Vietnam only assemble or make packaging for products and this is why their added value is low. In the case of Samsung, the ratio of locally-made materials used by the South Korean giant is estimated at just 20 per cent. Vietnam therefore needs to strengthen the research and development of products so that more local enterprises can participate in Samsung’s production chain.

Job machine

FIEs are a critical component of and major contributor to the strength of local economies as they present a range of employment opportunities. While not immune from the recession, FIEs and private enterprises have nonetheless been key drivers of job creation. They now employ more than 2 million people directly and 3-4 million indirectly, across all sectors of the economy.

Training is important for any business and FIEs generally train their staff more than local enterprises. FIEs complain at times about the lack of basic work readiness among new recruits but many have responded positively to the problem by providing in-house training both before an employee starts working and while they are on the job. Worth mentioning here is that FIEs also target to raise the skills of their home grown talent, who one day can replace foreign staff.

FIEs remain objects of fear among many local companies, who view them as direct competitors, but they aren’t simply about helping local employees to earn a living. FIEs in Vietnam have a significant and largely positive impact not on only the lives of individuals but on society as a whole. When an FIE opens a factory or buys a business they attract a lot of satellite companies to come and invest. These then stimulate the local economy and create demand for more homes, shops and entertainment. This ripple effect explains why provincial leaders are so eager to attract foreign investors.

For example, LG Electronics in September last year poured $1.5 billion into the Trang Due Industrial Park in Hai Phong to produce household electrical appliances, hi-tech electronic products, and smart phones. “The company aims to build not only a simple plant on an area of more than 402,000 square metres but also a production complex,” Mr Kim Jong Sik, Co-President of LG Display, was quoted as saying. “This will create more than 20,000 jobs and lure many LG satellite enterprises to Hai Phong as well.”

Other side of the coin

To encourage foreign investors to come to Vietnam, central, city and provincial administrations have long offered them generous tax incentives. But as Vietnam struggles to find the resources required to bridge its budget deficit an argument has emerged that the government has placed too much emphasis on providing these incentives to FIEs at a time when more resources are needed to finance socio-economic programmes.

In some provinces FIEs have been granted a tax holiday the first ten years of operations and then pay just half for the following ten years. Local authorities often give land priority to foreign investors, setting aside lots in prime sites. Despite receiving incentives that local enterprises could only dream of, FIEs’ tax bills are surprisingly small given the income generated and Vietnam is now finding that the FIEs it worked hard to attract are paying much less in taxes than expected. Even so, the country plans to lower the corporate tax rate to 22 per cent this year, from the current 25 per cent.

Many FIEs are actually exploiting tax rules and using transfer pricing to evade tax. Despite reporting losses over many years, many FIEs continue to expand. For example, the Hualon Corporation Vietnam, an FIE specialising in fibre production and fabric weaving with investment capital from Malaysia, Taiwan and the British Virgin Islands, was reported to have dodged $3.7 million in income tax payments last year. Established in 1993, it has reported losses for nearly 20 years, stating cumulative losses of more than $47.7 million as at the end of 2010 - a result that saw escape any income tax obligations. Yet tax inspectors conducted an investigation and determined that Hualon had indeed made significant profits and decided to therefore impose $3.7 million in penalty taxes.

Concerns regarding transfer pricing have been raised many times in Vietnam over the last few years, after it emerged that during the period of economic growth in 2007-2012, some 122 FIEs used transfer pricing and related tactics to avoid paying tax. It should be noted that the government clearly understands the problem and is closely monitoring FIEs’ interest and fee payments to their parent companies, to make it difficult for them to use transfer pricing. Tax authorities have also gone ahead and imposed $9.5 million in tax penalties on the 122 FIEs.

There can be no doubt that Vietnam needs FIEs, but as independent economist Ms Pham Chi Lan said, the country, too some extent, only sees their sparkling contribution to GDP growth and exports but not their actual value to the economy, as the country has become over-reliant on the FIE sector. “If Vietnam can no longer provide incentives to FIEs they would leave immediately,” she said, adding that authorities need to reconsider the incentives given to FIEs and create a fairer playground for local enterprises.

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