Vietnam: Trade regulations

According to Economist Intelligence Unit figures based on preliminary government data, Vietnam’s exports rose by 21.5% year-on-year in 2005, to US$32.2bn. Imports rose by 17.1%, to US$36.8bn. The four largest exports remained the same as in 2004: crude oil (22.9% of exports), textiles and garments (14.9%), footwear (9.3%) and fisheries (8.5%). According to the Ministry of Trade (MoT), the most dynamic exports in the first ten months of 2005 in terms of rates of increase were steel (19.8%), paper (19.4%), textile and garments (17%) and cotton (12%). Imports of capital goods in the form of equipment and machinery grew by 48.1% year-on-year and remained by far the largest import in the first ten months of the year. Equipment and machinery accounted for 14.2% of all imports for all of 2005, followed by refined petroleum (13.5%) and steel (8.1%).According to a January 2006 report by the General Statistical Office, the trade deficit dropped to US$4.65bn in 2005, compared with US$5.45bn in 2004, equalling 14.4% of export revenue in 2005 compared with 20.6% in 2004. With the economy growing quickly, Vietnam’s thirst for energy, capital goods and manufacturing inputs remains high.

Breakdowns of export destinations and import markets by country were not yet available for 2005 in April 2006. Vietnam’s main export markets in 2004, according to preliminary data from the Ministry of Planning and Investment, were the United States (which accounted for 18.8% of exports), Japan (13.2%), China (10.3%) and Australia (6.9%). China was the top source for Vietnamese imports in 2004 (13.9% of imports), followed by Taiwan (11.6%), Singapore (11.3%) and Japan (11.1%).

The MoT has continued to simplify its labyrinthine system of quotas, bans and licence requirements for imports and exports in preparation for the country’s widely anticipated entry into the World Trade Organisation (WTO) by 2007, even as selective trade barriers persist in certain sensitive sectors. Liberalisation has not yet made much of a dent in the smuggling trade, however, though the precise focus of smuggling varies from year to year depending on supply and demand and price trends in given product markets (sugar, petrol, pork product and poultry smuggling grew considerably in 2005). The General Customs Department (GCD) detects only a fraction of smuggled goods and in any case has serious corruption problems itself. Border officials often operate in collusion with import-export companies that deal in contraband, such as motorbike parts, refrigerators, television sets, alcohol and cigarettes. However, ongoing efforts to modernise customs-clearance procedures and other practices in line with international norms–for example, periodic high-profile crackdowns and the handing out of harsh punishments–ahead of WTO accession hold the promise of at least making a dent in these longstanding practices. In March 2006, the government executed a former senior customs official who had taken and distributed bribes and played a major role in a smuggling cartel. The cartel brought some US$83m worth in goods, mostly in cars and electronics, into the country over 1994-97.

Red tape and a confusing import-export tax system detract from Vietnam’s value as a base for exporting to the region. However, the country’s system of export-processing zones has greatly facilitated exports, particularly to nearby countries and the United States.

The government continues to take significant steps to streamline customs procedures and cut the red tape that entangles exporters, as part of a long-term effort to meet international standards. The National Assembly passed a Customs Law in 2001, which came into force on January 1st 2002. Circular 1494 of December 26th 2001 and Decree 101 of December 31st 2001 established the fundamentals of the new customs regime, including a new framework for random customs checks and a shorter customs procedure for duty-exempt goods. The National Assembly passed Law 42 amending and supplementing the Customs Law on June 14th 2005, which entered into force on August 4th 2005. Law 42 establishes, among other provisions, electronic-transactions and electronic-customs-clearance procedures (building on a successful two-year pilot programme); implementation of the WTO Agreements on Customs Pre-Shipment Inspection, Rules of Origin, Trade-Related Aspects of International Trade and other international agreements by the time of the country’s WTO accession (now expected by 2007); transition to a system of minimised custom inspection; extensions of time limits for making customs declarations and of their validity for customs clearance; and strict prohibitions on commercial fraud, smuggling and bribery.

The move to implement international norms on customs valuation defined by the General Agreement on Tariffs and Trade (GATT) means that the primary basis for customs valuation will move comprehensively towards “transaction value”, from the previous system based on value of goods in the country of origin (which generally yielded a higher tax). By December 2003 Vietnam had moved towards the transaction-value system for imports from the US and Association of South-East Asian Nations (ASEAN) countries as well as for foreign-invested enterprise exports. The government previously imposed strict regulations on minimum dutiable prices for customs duty purposes for goods from all countries when the declared value for import tax was 80% or less of the minimum price. Under Official Letters 5326 and 5312, both dated May 19th 2004, transaction pricing has applied to imports from Australia from May 1st 2004 and to a list of 31 countries from May 6th 2004: Cyprus, Hong Kong, New Zealand, Taiwan and the member countries of the enlarged European Union.

But the move towards greater and soon to be across-the-board use of transaction valuation has not been without its complications for both government and firms. The GCD reported that the difficulties in detecting under-invoiced goods, particularly under a system of post-clearance inspection, led to US$31.5m in customs tax evasion in 2005. A February 2004 study based on interviews with 500 US firms in Vietnam released by the US-Vietnam Trade Council (USVTC) complained that a system based on “ad hoc valuations and reference pricing” makes it impossible for firms to estimate actual values to be determined by customs officials, and makes it likely that prices will vary considerably across entry ports and across transactions involving the same good. The report characterises the review process by which firms can challenge a customs determination as “time consuming, costly, burdensome and ineffective”, and many firms are said to be reluctant to pay the higher price pending the outcome as a “deposit” since it is very difficult to recover such sums later. The USVTC had not yet released new studies of the matter by March 2006.

Decree 79 of June 16th 2005 updates conditions for operation and registration of customs agents and agencies.

Import and export duties change constantly in Vietnam, though investment risk will decline somewhat once Vietnam becomes locked in to World Trade Organisation rules and norms. Vietnam’s tariff policy uniformly discourages the import of finished consumer goods and encourages the import of intermediate and investment goods. At the same time, it provides significant protection for certain locally made products and industries.

Tariffs are based on the declared invoice price of the imported goods, and fines are imposed for false declarations. The most recent restatement of the rules came in Ministry of Finance Circular 8 of January 2002, though for goods from the United States and Association of South-East Asian Nations (ASEAN) countries and, more recently, an expanded list of 31 countries, including all European Union members, these rules are revised in accordance with the General Agreement on Tariffs and Trade (GATT)/WTO “transaction value” method. From the moment of Vietnam’s accession to the WTO (anticipated in 2007), these rules will apply to trade with all WTO members.

The values of all imports under the outgoing valuation system (applicable essentially to all countries other than the US, ASEAN and EU) is based on cif prices–that is, the actual (or contractual) purchase price at the destination port, plus insurance and freight costs. If there is no invoice available, the item is assumed to be worth the minimum value as it appears on the government’s own goods pricing list. According to Circular 8, if the contractual price of the goods is less than 80% of the price listed for that good on the government’s schedule, then the government-listed price is used for tax purposes.

In June 2002 the government issued Decree 60, which entered into force on July 1st 2002, regulating the determination of the dutiable price for imported goods subject to import tax and strengthening the integration of Vietnamese customs into the world trading system. Imported goods subject to Decree 60 are those officially imported under a commercial contract from countries or organisations where Vietnam is committed to implement the GATT. The determination of the dutiable price of goods other than those mentioned is based on the current law on export/import tax.

There are six methods for determining the dutiable price of imported goods: (1) transaction-value method (which has become the norm for many trading partners and will be used across the board when Law 42 of August 2005 becomes fully implemented); (2) transaction-value-of-identical-goods method; (3) transaction-value-of-equivalent-goods method; (4) selling-price-less-profit-margin method; (5) cost-calculation method; and (6) assumption method. In December 2002 the Ministry of Finance released Decision 149 promulgating a list of minimum dutiable prices applicable to goods whose prices are not controlled by the government. The minimum dutiable price applies when goods do not satisfy the requirements for the application of contract price. The decision came into force on January 1st 2003 and replaced all previous regulations of the General Customs Department on this matter. For used goods, the minimum dutiable price is equal to 70% of the value of new goods of the same category.

The customs system includes a wide range of tariffs–18 rates in all (though this has been reduced for trade with ASEAN countries). Very few items draw an import duty of more than 50%, though certain products can be as high as 60% (like alcohol, cigarettes and cars).

There are many tariff categories (now about 35), and multiple possible purposes mean that the same good can draw a different rate depending on how it will be used. Vietnam applies the Harmonised Commodity Description and Coding System nomenclature for merchandise trade, as developed by the World Customs Organisation. Exemptions from duties are generally granted on equipment and machinery used in production, which is an important incentive for foreign investors. Exemptions may also apply to some construction materials. Imports of cement, certain types of steel and, from time to time, cars have been banned in order to boost those industries in Vietnam. Moreover, steep tariffs are occasionally and temporarily applied to these sectors, usually as an anti-dumping tool (now regulated by the Anti-Dumping Ordinance) and often aimed at China or Thailand. Certain imported raw materials are also exempt from customs duties, such as cotton used in local factories to make goods for export and machinery needed to make spare parts. Enterprises do not have to pay import duties on raw materials if the finished items are destined for export.

A duty-free holiday of up to five years may apply to raw materials for certain enterprises the government wants to encourage. The Ministry of Planning and Investment produces this list of enterprises each year; the ministry is the main authority for licensing foreign businesses. There is also a one-off exemption on machinery and specialised vehicles that form part of the fixed assets of hotels, offices, apartments, business centres, supermarkets, golf clubs, and finance and consulting offices. Under Circular 13, which entered into force on March 2001, companies that manufacture goods for export may defer import-tax payments for up to nine months on imports of raw materials used in production. A company that exports more than 80% of its products can get a five-year import-duty exemption from the date it begins exporting.

The latest round of scheduled tariff cuts to which Vietnam was committed under the 2001 bilateral free-trade agreement with the United States were implemented on December 10th 2004: duties on perfumes and scents were reduced from 50% to 30%; on cosmetics, from 50% to 20-30%; on cameras, from 30% to 20%; and on refrigerators, from 30-50% to 20-40%.

On January 1st 2006 Vietnam joined the ASEAN Free-Trade Area (AFTA) and began to implement comprehensive tariff reductions to 0-5% which, by 2013, will cover 10,000 goods. Most will see at least partial tariff reduction towards these levels by end-2006; the country is committed to having at least 65% of customs classifications at the 0-5% level in order to become a full party to AFTA. Protection of “sensitive” items, including unprocessed produce, will gradually be phased out over 2006-13.

By end-2005 and since joining ASEAN, Vietnam had lowered tariffs to 0-5% for 6,312 goods, in accordance with the Common Effective Preferential Tariff (CEPT) programme. When the government made its previous major round of AFTA tariff cuts, in September 2003, it also issued an adjusted tariff list with 10,721 separate items set at 15 different tax rates at 0-100%. Five rates (those of 12%, 18%, 35%, 45% and 120%) were eliminated altogether. The average CEPT for AFTA countries rate fell to 9.3% in 2003, and it will fall to 3% by end-2006. Several smaller rounds of AFTA tariff reductions were enacted in 2004 and early 2005. The complex regime of import duty rates for cement, polymers and carboxylic acids was reduced by varying amounts beginning January 1st 2005, under Decree 151 dated August 27th 2004. Import duties for 37 items (mostly consumer products and a few agricultural commodities) were reduced to zero and duties on 53 other products were lowered to 5-10% in 2005, under Decree 81 of October 15th 2004.

Under a December 2004 decree that applied retroactively to goods entering the country since January 1st 2004, duties on 19 imports (including tyres, engines and other car, motorcycle and bicycle parts, were cut to 20% (from January 1st 2004) and to 10-15% (from January 1st 2005) and will fall to 0-5% (from January 1st 2006).

Vietnam will continue to protect 58 categories of items while implementing its AFTA obligations by 2010. From January 1st 2004 firms operating in Vietnam’s export processing zones (EPZs), which had been able to sell up to 20% of their exports to the domestic market since 1999 but whose goods are treated as imports, also become subject to the lower CEPT tariffs. The EPZ-based firms must provide certificates of origin (Form D) to prove that 40% of the content of their goods originated in ASEAN member countries. These regulations allow EPZ firms to sell goods without limits into the local market (previously, this was limited to 20% of all sales).

Under a decree issued on February 25th 2004, the prime minister approved a list of 484 Chinese products to be subject to a series of phased tariff cuts under an ASEAN-China comprehensive economic co-operation framework agreement. The cuts begin in 2006 and will be completed by end-2007; duties will reach 0% by 2008.

In June 2005 the EU agreed to extend the ad hoc market-economy status that it had first granted to its trade with Vietnam in 2000. This means that in the event of a bilateral trade dispute, the EU will judge on a case-by-case basis whether the Vietnamese companies involved operate according to market-economy standards. If so, the data these companies give about prices and production costs will be accepted; otherwise, the firms would have to provide additional data from third-country sources. Vietnam continues to seek full market-economy status vis-a-vis not only the EU but also the US and other major trading partners.

On October 9th 2004 the EU and Vietnam announced an agreement to reduce tariffs on agricultural, fisheries and industrial products to 24%, 22% and 16%, respectively, from January 1st 2005, as part of a bilateral accord on Vietnam’s accession terms to the World Trade Organisation. In addition, a bilateral EU-Vietnam agreement on December 3rd 2004 mandated full removal of garment and textile quotas for Vietnam from January 1st 2005, the same date for multilateral quota abandonment pursuant to the phase-out of the Multi-fibre Accord. Canada followed the EU’s lead on December 22nd 2004, ending its quotas for Vietnam, also to take force on January 1st 2005. The December 2004 EU decision superseded the textile and apparel terms of a three-year trade agreement with the EU signed in February 2003 that gave Vietnamese exporters extra quotas.

However, other terms of the 2003 agreement remain in effect. Vietnam and the EU pledged in that agreement not to apply non-tariff barriers in the textiles and clothing sector, or for wines and spirits or ceramic tiles. The 2003 agreement introduced a tariff quota for the import of motorbikes and scooters of EU origin; tariffs for scooters were lowered on January 1st 2005 (by 10%) to 70% for a quota of up to 3,500 annually. The 2003 accord also reduced import tariffs on wines and spirits of EU origin to 80% and mandated a reduction from January 1st 2005 to 70%. (On May 19th 2004 Vietnam had responded to complaints from the US and Australia by extending the same provisions to these two countries’ wine exports, beginning May 1st 2004.) However, the December 2004 bilateral market access agreement further reduced the tariff on EU wine to 65%, beginning January 1st 2005.

In February 2006 the EU announced it would begin in April 2006 to phase in over several months duties on Vietnamese footwear that will reach 16.8%, in response to a finding that Vietnam (as well as China) was dumping shoes on the European market.

In 2001 the Vietnamese government approved a list of 6,130 items scheduled for across-the-board (rather than trading-partner-specific) tariff reductions and exemptions during 2001-06 for all countries with which Vietnam has most-favoured-nation (MFN) relationships. A total of 510 items had their tariffs cut to 0-5% in 2002, and 710 more followed in 2003; the remainder of the reductions are scheduled to be completed by the end of 2006. By end-2004 the measures had brought simple average tariffs to 29.4% for agricultural goods and 17% for non-agricultural goods. There were no further reductions in 2005; reductions will resume in 2006. Pursuant to the US-Vietnam bilateral agreement, further tariff reductions on several goods went into effect in December 2004 that applied to all of Vietnam’s MFN trading partners.

Vietnam’s value-added tax (VAT) of 10% applies to imported goods, though it is refunded once the goods are sold. VAT revenue should help offset lost revenue from lower tariffs as Vietnam seeks to comply with ASEAN’s CEPT programme; nevertheless, importers have continued to complain vociferously about the application of VAT to imports. If a product is subject to the special consumption tax, imports of that good also attract the tax.

On May 25th 2002 the National Assembly issued an ordinance on safeguards intended to protect the domestic market from surges in cheap foreign imports. Implementing Decree 150 of December 2003, which entered into force on December 26th 2003, provided the following six measures to cope with cheap imports that negatively affect domestic production, sales of local goods, job generation, wages and investment attraction: import tariffs, quantitative restrictions, customs quotas, tariff barriers, import licences and surcharges. The measures may be taken for up to four years, with possible extension for another four years. Decree 150 makes the Ministry of Trade (MoT) responsible for determining whether to take safeguard measures, publicising the results of inspections, and consulting with the relevant ministries and agencies before any measures are announced. Either the MoT or producers representing 25% of the domestic market for the good may initiate investigations. Pending a decision, the MoT may require import permits for up to 200 days but only to monitor (not limit) imports of the goods.

After the safeguard ordinance, the second of three new ordinances to regulate imports adopted in anticipation of the opening of Vietnam’s market upon the country’s accession to the WTO was the anti-dumping ordinance passed in April 2004 (Ordinance 20) and implemented on October 1st 2004. The ordinance aims to limit the adverse effect on Vietnam’s manufacturing industries caused by dumping of imported goods. It established an Anti-Dumping Investigative Body (ADIB) and an oversight Anti-Dumping Council under the MoT to conduct investigations and, where appropriate, authorise interim anti-dumping measures (either anti-dumping duties or requirements that the party undertake with the ADIB (or domestic manufacturers if the ADIB so determines) measures to cease the dumping actions. Implementing Decree 90 of July 11th 2005, with effect from August 4th 2005, regulates the bases for determining dumping, the composition of the investigative body, and other aspects of the enforcement and implementation of the anti-dumping body and council (which will come under the administrative umbrella of the Vietnam Competition Administration Department (VCAD); see Competition and price policies overview).

On August 20th 2004, the National Assembly approved Ordinance 22, the “anti-subsidy ordinance”, effective January 1st 2005. The ordinance allows the government to investigate and impose measures against imports to Vietnam that pose a threat to domestic production and whose prices are found to be subsidised. The government has begun to establish a governmental anti-price subsidy committee for carrying out inspections before applying retaliatory measures when domestic production is threatened. After receiving a temporary judgement, the trade minister will decide whether an imported product is subsidised or supported by a government, whether its import will be a disadvantage to domestic production and whether or not to impose anti-sudsidy duties on a particular product. Implementing Decree 89 of July 11th 2005, effective August 4th 2005, details the enforcement of the ordinance. For example, it provides specifics on determining when investigations are warranted and when domestic harm exists; the composition of the anti-subsidy investigation committee; the composition of the council that deals with anti-subsidy cases (distinct from the investigation agency); and the contents of anti-subsidy complaint files. Like the anti-dumping bodies, the anti-subsidy committee will also operate under the VCAD.

[Table]

Fundamental indicators: foreign trade
Foreign trade (% growth)	2004 actual	2005 estimate	2006 forecast
Exports of goods and services	25.7	8.9	10.2
Imports of goods and services	21.9	7.7	11.6
Foreign trade (% of GDP)
Exports of goods and services	65.9	70.4	72.6
Imports of goods and services	73.5	72.9	74.9
Trade figures (US$ bn)
Current-account balance	-0.9*	-0.2	-0.6
as a percent of GDP	-2.1*	-0.3	-1.0
Goods: exports fob	26.5*	32.2	37.3
Goods: imports fob	-28.8*	-33.5	-38.7
Trade balance	-2.3*	-1.3	-1.3
Services: credit	3.9*	4.5	5.1
Services: debit	-4.7*	-5.5	-6.2
Services balance	-0.9*	-1.0	-1.2
* Economist Intelligence Unit estimates.
Source: Economist Intelligence Unit, Country Forecast Vietnam, March 2006.

Besides applying tariffs, the government tries to control trade by licensing companies for import-export trade in particular items. Until recently, foreign companies had to trade with Vietnam through licensed local trading companies, most of which are state owned. Decree 44 of 2001 relaxed these rules, and since many private enterprises are now authorised to engage in direct trade, foreign-invested companies are turning to these more often to act as their import agents. Foreign companies should check with the Vietnam Chamber of Commerce and Industry to make sure a particular trader is licensed to deal in a specific commodity or item. The Ministry of Trade (MoT) indicated in April 2001 that it wished to allow foreign enterprises to import goods not listed on their investment licence, but Decree 24 made no change to the rules as they appear in Decree 57 of 1998.

Vietnam’s import trade continued its gradual path towards liberalisation with Decree 12 of January 23rd 2006, which entered into force on May 1st 2006. The decree implements the new Commercial Law, which came into force on January 1st 2006, and which regulates the international purchase of goods, including import, export, temporary import for re-export and transshipment. It also regulates activities of principals and authorised dealers in importing and exporting and also commercial agents for sale/purchase, processing and transit of goods involving foreign business entities. Trading rights are generally liberalised along the lines of World Trade Organisation (WTO) principles. Under Decree 12, Vietnamese entities with no foreign capital will now enjoy full trading rights, with no limitations; the only exception is goods on the list of prohibited and restricted imports or exports.

The new Commercial Law also provides for expanded trading rights for foreign-invested firms (which have been tightly restricted), but crucial implementing regulations were still pending as of April 2006. The latest draft of the implementing decrees would allow the establishment of joint-venture and fully foreign-owned sole-purpose commercial enterprises (independent of any associated manufacturing activity). However, such enterprises will be permitted only in accordance with the terms (regarding timing and sectors) established in international treaties with specific trading partners (except in certain unspecified exceptions that can be granted by the MoT). Trading and distribution rights are currently addressed only in agreements with the US, EU, and Japan. For other WTO members, these rights would apply in principle from the time of Vietnam’s accession to that body. Foreign-invested commercial enterprises (FICEs) would be licensed by the MoT, according to the draft decree, and would subsequently be able to apply for an investment licence to engage in manufacturing. FICEs would be allowed to establish representative offices and branches in Vietnam and overseas. Only one retail sales outlet in Vietnam would be permitted initially, and the creation of any additional outlets would be subject to the terms of international agreements.

Vietnam’s import trade remains highly regulated in terms of conditions applying to particular goods. A few goods are banned altogether, but it is primarily via high import duties and other import controls that Vietnam regulates the inflow of goods. For example, import permits apply to goods such as sport weaponry, and a specialised regime applies to medicines. Other restrictive measures include excise taxes, import licences, quotas and reference prices. Many goods are still subject to import prohibition (as confirmed by Decree 12 of January 2006): weapons, munitions, military equipment, addictive drugs, toxic chemicals, pornography, second-hand bicycles, subversive cultural products, firecrackers (except those used for maritime traffic safety), harmful toys, cigarettes (except permitted quantities in personal baggage), second-hand consumer goods (electronics, shoes, textiles, clothing, household appliances, cars with right-hand steering wheels (except for special-purpose vehicles such as cranes and roadwork vehicles), certain kinds of second-hand goods such as combustion engines, motorcycles and motor tricycles, ambulances, cars, buses, amphibole-derived products (like asbestos), materials containing amianthus amiant, and coding machines and cipher software programs used to protect state secrets. Only the prime minister can grant exemptions. Beginning May 1st 2006 second-hand cars with less than five years of use will be eligible for import for the first time, under a decision adopted in February 2006.

The government issued a decree on June 11th 2003 allowing local firms and individuals trading and processing gold to import and export material gold (including bullion, leaf gold and crushed gold) if they have a licence from the State Bank of Vietnam (the central bank). Gold-jewellery processors in the country must now ask for quotas from the bank before importing the material.

Simplification of procedures for issuing import licences for those goods subject to import licensing is one of the conditions for WTO entry. Beginning September 1st 2005 any regulations on import licensing must be published in the Official Gazette 21 days prior to their promulgation, and they must be posted on the MoT website and at import-licensing bodies. Licence applications may be filed at only one body at a time and may be submitted to a total of three (consecutive) licensing bodies. Refusals are not to be made based on small errors or discrepancies in information in the application, and reasons for refusal of applications must be given in writing.

Prime Ministerial Decision 46 of April 2001 reduced the number of goods categories requiring an import licence to 14 from 25. The list still includes black and white Portland cement; coloured and transparent glass equal to or thicker than 1.5-2 mm (excluding ribbed, multi-layered, safety or reinforced glass); several kinds of construction steel; refined liquid vegetable oil; refined and unrefined sugar; completed motorcycles and motor tricycles; and cars with fewer than ten seats. The MoT has also said that it intends to reduce the range of goods for which “import co-ordinators” (who act as agents to facilitate and expedite import orders and customs clearance) are required to include only radio-transmission facilities, pharmaceuticals, dynamite, fertiliser, books and films. (This issue has not been covered by the initial implementing decrees under the new Commercial Law, but more implementing regulations are expected.) The ministry abolished surcharges on several kinds of imported steel in March 2003.

With pharmaceutical prices increasing sharply (by around 30% year-on-year in 2003 and by nearly 10% in 2004) in tandem with imports, the government has moved to tighten controls over drug imports. In August 2004 the government outlined new regulations requiring pharmaceutical producers to register and list the imported, wholesale and retail prices of their products. The government also drew up a list of restricted drug imports containing any of 62 named ingredients.

Formal import quotas were implemented on January 1st 2005 for seven commodities: tobacco, salt, cotton, condensed and uncondensed milk, maize and eggs. However, in March 2005 the Ministry of Finance removed maize, cotton and milk, pursuant to earlier pledges. Nonetheless, these goods remain subject to quantitative restrictions on the volume of imports eligible for lower tariff rates. Quotas and licences remain in force for sugar; however, with prices surging in March 2006, the MoT and the Ministry of Agriculture and Rural Development sent a proposal to the government to remove them.

The import quota for oil and petroleum products is provided to licensed importers during the fourth quarter of the preceding year, and its fulfilment is treated as not just a ceiling but an obligation. The technical criteria controlling imports (based on quality, hygiene, food security and environmental concerns) have remained unchanged since 1999. Scrap metal may be imported, but only certain kinds, and under conditions spelled out in Ministry of Science and Technology Decision 65 of December 2001.

An important new procedural reform moving towards international standards is Decision 41 of March 2nd 2005, implemented September 1st 2005, which aims to increase the transparency of regulations on important licences and issuance of the licences themselves. Any such regulations and licences will now have to be published in the Official Gazette at least 21 days before implementation, posted on the MoT’s website and disseminated through import licensing entities. Licence denials must be accompanied by written explanations. Decision 41 creates two forms of licensing: self-regulating, with a seven-day decision period on receipt of applications, and non-self-regulating, with a 30-day decision period. Foreign-exchange controls will be administered equally whether or not a good is under an import-licensing regime. Finally, Decision 41 requires the MoT to provide information on import-licensing to the WTO’s Import Licensing Committee and to WTO members once Vietnam is admitted to that body (expected in 2007).

Imports of used equipment for foreign-invested projects are subject to restrictions in Ministry of Science and Technology Circular 2 of February 2001. The goods must still be in good condition and must satisfy local safety and hygiene standards, and the ministry may decide to evaluate the goods itself. There is a long list of used equipment that may not be imported, such as the following: equipment in the petroleum-processing industry, the power industry, cement production lines, the ore processing and metallurgy industries; equipment in the industries producing basic chemicals, fertiliser and insecticide; equipment in industries with high-precision requirements (such as measuring facilities, equipment for experiments and for testing); equipment used on post and telecommunications networks; equipment with high safety requirements (such as boilers, lifts, nuclear-reaction controls); equipment for inspecting and controlling security systems; equipment affecting large areas (such as waste-treatment equipment); sluice gates; and production-line equipment used in work stages where accidents might easily occur causing serious environmental pollution.

Personal property belonging to diplomats or other workers in international organisations is exempt from import restrictions. From May 2001 certain classes of expatriates living in Vietnam (diplomats, aid workers, ethnic Vietnamese with foreign nationality and investors holding an investment-incentive certificate) have been able to import non-tradeable goods without an import licence.

Trade Ministry Circular 4 of 2001reaffirmed strict regulations on labelling goods manufactured in Vietnam for domestic use or for export and for goods manufactured overseas and imported into Vietnam. The name of the goods and their origin, the name and address of the business responsible for the goods, quantity, composition, main quality standards, manufacturing date, use-by date, preservation and guidance for use must be displayed. The rules also require the primary language on the label to be Vietnamese, unless the goods are explicitly made for export. If a foreign foodstuff is imported, the supplier must supply a label with the contents listed in Vietnamese or add a supplementary label in Vietnamese. Most foreign suppliers leave this task to the Vietnamese importer.

Decree 19 of February 20th 2006, implementing the new Commercial Law that went into force on January 1st 2006, regulates how to determine the origin of imported goods and exported goods and also the process of certification of origin of goods.

Export rates are specified in the Export and Import Tariff for Commercial Goods (issued in 1994 and amended several times). Export duties are levied on relatively few items (compared with import duties), mostly on natural resources and commodities such as coffee, fish, metals, nuts, seeds and wood products. The maximum rate is 45% of the fob price (the price of goods as they leave port excluding the cost of insurance and shipping), but the rate can be as low as 1%. An export tax of 6% was levied in April 2001 on rubber exports to fund an export support and development scheme for the industry. Most export taxes will be eliminated or reduced as Vietnam enters the Association of South-East Asian Nations Free-Trade Area and the World Trade Organisation.

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The government first organised industrial zones (IZs) and export-processing zones (EPZs) in 1991 to be legal bases for investors seeking to avoid Vietnam’s bureaucracy, restrictive investment rules and protective tariffs. EPZs allow for duty-free imports of inputs as long as finished goods are exported. The administration of an IZ takes care of applications for investment licences; this is a significant advantage in a country where bureaucratic delays from miscommunication and misunderstandings during the licensing stage can delay a project for months. In many IZs, it is now possible to obtain a licence in as few as seven days, or even within 24 hours. Some of the tax incentives temporarily lost by new projects entering southern IZs and EPZs were restored by new implementing regulations issued in 2004. A complex structure of investment incentives that encompasses geographical criteria favouring remote and underdeveloped regions, types of investment and level of priority by sector is now in place (see Incentives). All tenants in IZs automatically receive 50-year investment licences, the maximum permitted by the foreign-investment law.

Sales to EPZ tenants are effectively treated as exports, creating significant, though evolving, value-added-tax (VAT) advantages. On October 10th 2002 the Ministry of Finance released Circular 90 stipulating the tax treatment of goods sold to foreign businesses but delivered to other companies in Vietnam (called “in-country” exported goods). Most such in-country exported goods are entitled to a zero-rate VAT if the following conditions are satisfied: the signing of a sales/purchase contract with the foreign purchaser; bank settlement of payment by foreign purchasers to exporting enterprises; completion of customs-clearance procedures; and consistency of exported goods with the exporting enterprise’s investment licence. The exporting firm is entitled to an import-duty refund for materials used for in-country exported goods. In addition, the enterprise receiving the goods will be treated as an importer and must complete the same customs-clearance requirements as normal imports.

Exporters from EPZs can recoup VAT charges or have their goods grouped within the zero-rate VAT tax bracket, though they must now demonstrate that goods or commodities brought in from abroad or outside the zone are “export-related” for VAT exemption.

Special VAT rules apply for companies in EPZs. Such firms do not pay VAT on imports; there is no withholding tax on services from foreign companies; and sales of goods from local companies (“in country” exported goods) are zero-rated. Decree 148 of July 23rd 2004, which entered into force on August 16th, and implementing Circular 84 of August 18th 2004 restored a zero-rate VAT to a wide range of services rendered to export-processing enterprises (EPEs), after a firestorm of protest from foreign investors (see Turnover, sales and excise taxes). Firms in EPZs were made exempt, beginning on January 1st 2004, from taxes on imports of services and commodities from abroad that are demonstrably “export-related”, though some firms experienced troubles in 2004 with effective enforcement of this principle. Goods or services bought by EPEs for use in the domestic market (such as petrol, food, leasing meeting rooms or residential housing) or for their employees’ personal use (like food, electricity or housing) have long been subject to VAT.

The list of goods subject to export prohibition or restriction changes frequently; most recently, it was confirmed in Decree 12 of January 13th 2006, to take force on May 1st 2006. Restrictions ban exports of weapons and explosives, military equipment, antiques, addictive drugs, toxic chemicals, most types of timber sourced from domestic natural forests, wild animals, rare fauna and flora, and any coding or cipher equipment used in the protection of state secrets.

Export restrictions apply to precious stones, which until recently, were smuggled out of the country at a hectic pace. Vietnam has at last issued its new mining law and accompanying implementing regulations; it is hoping to get this problem under control by bringing in international mining companies, although there has been little movement so far.

Several export categories are subject to hands-on regulation and/or quotas. Exports of coal and coffee are still subject to close control. The rice export-quota system, which had been cancelled in May 2001, was re-introduced briefly in 2005. That May, following several floods and typhoons, the government ordered exports to be limited to 3.8m tonnes for 2005, but it lifted the limits in August as normal harvests ensued. The Ministry of Trade (MoT) said in January 2006 that it would not impose export quotas for this year, since a bumper crop is expected.

Timber exports were previously restrained by a quota system, but Decision 46 placed a total ban on exports of round and sawn timber, firewood and charcoal from domestic natural forests.

The government has had to adjust and refine its garment industry export-quota system repeatedly as the US market was opened and then restricted and as EU markets have expanded. Greater export opportunities–and a relative tightening on January 1st 2005 (except for the EU and Canada) as other countries benefit from the end of the Multi-Fibre Agreement worldwide quota system that Vietnam is still outside of because of its non-World Trade Organisation member status–have led to a continuous struggle by firms to grab quotas. On December 5th 2003 the MoT issued new guidelines for fulfilment of quotas for the EU market, with effect from January 1st 2004 (Decision 5583): automatic export licences will be granted for five categories of goods (working uniforms, brassieres, fibres, all kinds of nets and children’s wear). Beginning December 10th 2004 automatic licensing for exports of trousers and men’s coats were added to the list for exports to the EU. Previous automatic licensing procedures applicable to the EU and to quota markets like Canada and Turkey still appear to apply. Exports to these markets are automatically licensed unless 50% of the annual quota is filled in the year’s first quarter, or 70% in the first half. If automatic licensing is halted for this reason, allocation (sometimes through a tender process) is overseen by the municipal authorities of Hanoi, Ho Chi Minh City, Danang and Haiphong.

On March 22nd 2004 Vietnam adopted the US electronic visa information system (ELVIS) for exports of textiles and garments to the US in order to streamline exports sent under the new quotas and to help prevent fraud. Under the new system, foreign governments transmit electronically to the US details of shipments of quota-controlled textile goods they have made to the US. Previously, export visas, certificates of origin, export licences and other documents needed to take advantage of the quotas were frequently faked by exporters, and US customs received information from Vietnam too late to detect such abuses. Under ELVIS, data on shipments are transmitted from the Ministry of Trade to US customs officials every few days.

Foreign-invested firms and parties to business co-operation contracts (BCCs) may export any category of good, not just their own products. But there is a list of goods (contained in Decision 46) that may be exported only subject to certain conditions, and foreign-invested firms may export goods on this list only if their investment licence permits it. Implementing regulations for the new Commercial Law may address this issue.

Decree 44 frees companies from the requirement of using intermediaries in exporting. It allows Vietnamese firms to recruit foreign business entities to act as overseas sales agents in foreign countries, and states that any goods exported to these agents may be re-imported into Vietnam without attracting import duty, and with export duties refundable. Decree 12, with effect from May 1st 2006, implementing the new Commercial Law, allows domestic businesses to engage foreign business entities as their sales agents in foreign countries. All revenue from the agency contract must be remitted to Vietnam in accordance with foreign-exchange regulations.

Foreign-invested firms are restricted from buying certain domestically produced goods for export. These include weapons, explosives, military equipment, antiques, addictive drugs, various wood products, rice, animals, forest plants used as stock strains, precious stones, precious metals and natural pearls. Trade Ministry Circular 26 of December 2001 removed coffee, minerals, certain wood products and garments covered by quotas from the restricted list.

Foreign-invested firms in certain industries are required to export 80% of their output. This list was formerly quite extensive, but Ministry of Planning and Investment Decision 718 of December 2001 removed from the list garments, footwear, household plastic products, electric fans, detergent and paints. The requirement is still in force for 14 items: two-wheeled vehicles; tourist buses and lorries of less than 10 tonnes; small-scale water pumps; low- and medium-voltage electricity cable; normal communication cable; smaller-sized shipping vessels and boats; video and audio products; shaped aluminium products; commonly used construction steel; NPK fertiliser; PVC; bicycles and accessories; distribution transformers of less than 35 kv; and diesel engines of less than 15 cv. Such export-performance requirements will likely have to be phased out or eliminated once Vietnam enters the World Trade Organisation.

All Vietnamese-made export goods must carry the words “Made in Vietnam” on their label; this has riled several Japanese and South Korean electronics firms that do not wish to advertise the country of origin, since Vietnam does not yet have a reputation for quality manufacturing.

Bao Viet, the dominant state-operated insurance company, offers export insurance. In January 2006 PV Insurance became the first insurer in Vietnam to provide international-standard insurance services to foreign oil and gas projects. PV is the country’s biggest foreign-currency earner from export-insurance services, with total revenues of D2.68trn in 2005.

Export credits exist through recently established agreements with Australia, EU members and Japan. In March 2004 Vietnam and the European Union agreed to establish a US$15m fund to help Vietnamese small and medium-sized enterprises (SMEs) export goods to the EU. Funding goes to commercial banks, which then provide the SMEs with easy access to loans.

Companies from the United States can obtain export finance from the US Export-Import Bank (Exim Bank), which opened a full operation in Vietnam in 1999. Exim Bank offers loans, loan guarantees, working-capital guarantees and export-credit insurance. Another option for US firms is the Overseas Private Investment Corporation (OPIC), which offers project finance and political-risk insurance.

Many foreign banks in Vietnam provide export financing, though only cautiously. HSBC (UK) provides two-way trade financing, in part through co-operative agreements with state-owned Bank for Investment and Development of Vietnam. A government export-support scheme set up by Decision 133 of September 2001 still provides short- and long-term low-interest loans and credit guarantees, which includes joint ventures as potential recipients.

The government’s on-again, off-again plans to create an official export-import bank took a new twist in March 2006, when the government announced that the state-run Development Assistance Fund (DAF) would be transformed into a large independent investment bank. DAF now provides concessional loans and export-credit guarantees for exporters and is the state’s biggest lender to development investment projects. The newly spun-off DAF would act as a profit-making entity rather than draw on state budget allocations, and it would be active in every part of the economy that has operations relating to productive investment and export-import activities. Under the plan, DAF would become the largest bank in Vietnam; its present chartered capital of D5trn is already 3-4 times larger than that of the leading state-owned banks.

Domestic investors in manufacturing in designated high-technology zones (HTZs) are eligible under the DAF for preferential credit in the form of concessional interest rates, loans and interest repayment. Any investor in an HTZ that engages directly in exports is eligible for export-credit assistance.

Deferred letters of credit have also become a more viable tool for importers and exporters based in Vietnam, following the introduction of new rules in 2001.

EIU ViewsWire. New York: Apr 28, 2006.

Vietnam: Licensing and intellectual property

A foreign manufacturer has different options for selling products in Vietnam: direct importing; licensing a Vietnamese firm to manufacture the products using proprietary trademarks, methods or industrial designs; or setting up a venture under the Law on Foreign Investment (which the Law on Investment is scheduled to replace on July 1st 2006).Licensing a local manufacturer is generally the quickest option for foreign companies, and it offers the licenser some advantages: skirting import restrictions, which can be highly restrictive; avoiding all or part of the cost of market research and marketing; using the local company’s distribution network and expertise, to the extent that the local importer has the latter; and not needing to commit a substantial investment during the risky initial phase of market penetration. The last is a particularly big advantage since many of Vietnam’s markets, though promising, are too small to justify large-scale investment in production.

But licensing has its downsides: stringent regulations, long approval times, restrictions on payments and limited contract duration, and potential intellectual-property rights violations. Perhaps the greatest challenge is finding a partner with adequate capacity to manufacture and market the goods. Moreover, there are substantial bureaucratic obstacles to establishing a proper licensing operation. The Ministry of Science and Technology (MoST) must approve licensing arrangements that involve state-operated companies; in addition, licensing deals with private companies must be registered with MoST’s National Office of Industrial Property (NOIP).

Some foreign investors take a staged approach, beginning with a licensing agreement and later moving to direct investment, as the project develops. The foreign manufacturer then finds a local partner and licenses the products under the foreign company’s trademark. But given the lack of local partners with adequate skills and capacity, foreign investors more often enter into a joint-venture contract with a local company to set up a factory for large-scale production, with licensing and technology-transfer contracts as an integral part of the deal.

Pending completion of a factory, the foreign manufacturer may export the same products into Vietnam via a local partner under an import licence. Such an import scheme often lasts as long as necessary to complete local production facilities. There have been a number of examples of this licensee-to-joint-venture evolution, for a variety of consumer goods, including 555, Marlboro and Dunhill cigarettes; Coca-Cola, Pepsi-Cola and Schweppes soft drinks; and Heineken, Tiger, Carlsberg and San Miguel beers.

Care should be taken when choosing a local partner. Domestic enterprises regularly “disappear” from official purview: after obtaining operational licences, they simply close their registered addresses and relocate without informing the authorities, probably because of excessive business regulations. The original Enterprise Law (expanded into the Law on Enterprise, which will take effect on July 1st 2006) established a more comprehensive system to keep track of companies.

Under pressure from foreign investors, who demanded comprehensive rules before they would import advanced technologies into Vietnam, the Vietnamese government has made substantial efforts over the past decade and a half to strengthen its legal framework for licensing and protecting industrial property and technology transfers. But intellectual-property violations remain a considerable problem, and counterfeit goods are rife in almost every field of production.

There are restrictions on the rights of foreign licensers to sublicense technology; for example, tie-in arrangements are restricted. The restrictions are generally worded in such a way that the foreign licenser may not “unreasonably” restrict the licensee–though the determination of what is reasonable is unclear. The length of permitted licensing contracts is 7-10 years, unless the licensing is part of a foreign-invested joint venture; the term of the arrangement would then be subject to negotiation.

A new licensing alternative may emerge over the next few years: franchising. The practice of franchising first emerged in Vietnam in 1990, but the concept is only now beginning to become more widely understood, particularly following the success in recent years of Trung Nguyen Coffee, a retail (and now manufacturing) chain that has 2,000 franchise coffee shops in Vietnam and has established eight franchised outlets overseas in Singapore (two), Thailand, Cambodia, Germany, Japan, the United States, and–in February 2006–China. Vietnam now has two other franchise retail trademarks: Kinh Do and Pho 24. At least nine foreign franchises operate in aspects of retail: Bourbon Group (France), Metro Cash & Carry (Germany), Lotteria (Japan), Parkson (Malaysia), Medicare (US), KFC (US), Jollibee (Philippines), and Dilmah and Qualitea (both of Sri Lanka). Analysts expect franchising activities to grow in the coming years in the food, beverage, fashion and supermarket sectors.

The new Commercial Law of June 14th 2005 that came into effect on January 1st 2006 lays the groundwork for a much-needed regulatory framework for franchising in Vietnam, though in April 2006 the key implementing regulations had not yet been issued. Franchising is now defined more widely than under Decree 11 of March 2nd 2005 on technology transfer, which was the first to regulate the practice in the country and had defined it as a form of technology transfer. Franchising is now treated as a commercial activity whereby a franchiser authorises and obligates a franchisee to conduct on its own behalf the purchase and sale of goods or services in accordance with two conditions: (1) the franchiser specifies the method of business organisation for the purchase and sale of goods or services by the franchisee, and the franchisee’s activities must be associated with the brand name, trade name, business know-how, business mission statements, business logo and advertising of the franchiser; and (2) the franchiser has the right to control and offer assistance to the franchisee in the conduct of the business.

The latest draft implementing decree for the new Commercial Law, which the Ministry of Trade was reviewing in April 2006, would regulate three distinct types of contracts: inbound franchising (from a foreign country into Vietnam), domestic franchising (within the territory of Vietnam) and outbound franchising (from Vietnam to foreign countries). All franchising would be implemented on the basis of a written franchise contract. A franchise description document (rather than the contract per se) would have to be submitted to the ministry together with the application for franchise registration (by the franchiser); the document would have to contain detailed information about the franchiser’s activities, fees payable, obligations of the parties and the franchiser’s franchising system. The franchiser would have to register only once rather than separately for each franchising arrangement. The franchiser would be required to give the franchise description document to prospective franchisees at least 15 days before the franchise goes into effect. If the franchiser fails to do so, or the registration is denied, then any signed contract may be considered invalid. All franchising activities would be subject to registration by the franchiser within 15 days of signing the franchise contract. The registration bodies are the Ministry of Trade for inbound and outbound franchising, and the provincial or municipal Department of Trade in jurisdictions under central authority in which the franchisee is located for domestic franchising. The relevant registration body would be required to grant or deny registration within five days. Under the draft decree, the duration of a franchise contract would be open to negotiation by the parties, but no less than five years.

The delay in the implementing decree, originally expected by end-2005, creates something of a temporary legal and regulatory vacuum for new franchising agreements. In recent years and in the absence of clear regulations, lawyers have recommended that a franchiser split a franchising agreement into two separate contracts: a standard trademark licensing and technology-transfer agreement (which is more apt to receive regulatory approval), and one containing the remainder of the franchising agreement and ensuring that the franchisee was bound to the entire contract. The second contract might not be enforceable in the courts, however, and it remains to be seen in practice if the new Commercial Law and its pending implementing decree will do so.

The 1996 Law on Foreign Investment (amended in 2000) did not contain specific provisions on the naming of enterprises, but the new Law on Enterprise does, and they are the same as the provisions of the 1999 Law on Enterprises that pertained only to private domestic enterprises. Beginning on July 1st 2006 the names of all companies, including foreign-invested firms, must not be the same as or cause confusion with the name of an already registered company; they must not contravene established national customs, ethics and traditions; they must be written in Vietnamese (renderings in foreign languages may be added underneath in smaller font size); and they must indicate the form of the company (such as limited liability or shareholding).

Ever since Vietnam opened its economy to foreign investment and trade in 1986, respect for intellectual-property rights (IPR) in the country has been a concern. With the introduction of the Civil Code (which took effect in July 1996) and accompanying implementing regulations, most intellectual- and industrial-property rights first became legally recognised and protected in Vietnam. However, the IPR regulatory framework has continued to evolve through a wide and sometimes confusing variety of legal documents. With the promulgation of a revised Civil Code in June 2005 (which took force on January 1st 2006) and the adoption on November 29th 2005 of a Law on Intellectual Property (which will take force on July 1st 2006), the country’s framework is advancing somewhat but primarily by consolidating and unifying previously scattered regulations into a comprehensive guiding law.

The 2005 Civil Code sets out general provisions for all types of contracts. In its previous version, the Civil Code was the foundation of the whole system of IPR protection, it now retains only the civil principles relevant to the issue, including provisions on entities, objects, content, establishment grounds and transfer of IPR in respect of each category of such rights. The Law on Intellectual Property (LIP) sets regulations on copyright and related rights, industrial-property rights, rights over plant varieties, and the policies, procedures and measures protecting these rights.

Among the more significant changes in trademark regulation under the LIP are the following:

the principle that “identical” applications for trademarks filed at the same time by different applicants are denied by authorities if the applicants cannot reach an agreement on registration rights will now be extended to automatic denial of “applications of confusing similarity”;

more elaborate criteria are specified for identifying and protecting a well-known trademark (thus weakening the firm “first to register” principle that is now used);

for the first time, the principle of joint application for and co-ownership of trademarks will be recognised, consistent with international trademark norms;

the time limit for authorities to examine applications for trademarks will be shortened, from three months to one month for the “formal examination” process and from nine months to six for the “substantive examination” phase (a total of seven months, compared with average total processing times of 12 months at end-2005);

competent state authorities may compel the licensing of inventions and plant varieties for purposes of national defence and security, public health, prevention of monopolies and “other urgent needs of society”, and under strict conditions and procedures;

opportunities for carrying out professional services for property-rights holders (such as management, consultancy or legal representation) are expanded; and

more-detailed provisions are established on special kinds of trademarks (namely collective marks, certification marks, marks under joint ownership and well-known marks) and how to determine their authenticity.

The new law recognises and refines three basic types of IPR enforcement: civil, criminal, and administrative (the last includes border-control measures). Greater emphasis is placed on civil procedures and remedies than in previous regulations. For the first time, there will be separate and specific civil procedures and remedies expressly for IPR protection, apart from those contained in the Civil Code for other types of disputes (which will remain available as well). In response to legal actions taken by IPR holders, courts will be able to compel parties found to be infringing IPRs to desist; to engage in public rectification and apology; to fulfil civil obligations; to pay damages; and/or to destroy or distribute for non-commercial use goods, materials and implements used for creating goods that infringe IPRs. Where courts order compensation for damages (whether “moral” or material, and which must be documented by the plaintiff), awards are capped at D500m for material damages and at D50m for moral damages (that is, to the plantiff’s business reputation).

Criminal procedures and penalties are also part of the new enforcement regime created by the LIP. Counterfeiting intellectual-property goods is defined as infringing trademark or geographical indication, copyright piracy, and doing business with counterfeit goods. Such counterfeiting will now be considered crimes of production of and trading in counterfeit goods under the Criminal Code, in addition to crimes of IPR infringement.

During the interim period until the LIP takes effect on July 1st 2006, the confusing and sometimes overlapping array of previous regulations will remain in force. In any event, the LIP will largely preserve the basic outlines of these regulations. The (now defunct 1995) Civil Code’s provisions on the licensing of patents, utility solutions and industrial-design trademarks are explained in detail in Decree 63 of October 24th 1996. Ministry of Science and Technology Circular 825 of May 3rd 2000 clarifies when companies may take action against imitation trademarks (see below). Two decrees (Decree 54 of October 2000 and Decree 06 of February 2001) updated the rules and toughened the penalties for infringements. Decree 54 offers some protections to industrial-property rights and trade secrets (see below); Decree 06 empowers the National Office of Industrial Property (NOIP), set up under the Ministry of Science and Technology (MoST), to award the rights to use well-known and widely recognised trademarks and affiliated trademarks, and to set more-stringent penalties for violating the rules.

The industrial-property regulations set up a first-to-file (as opposed to first-to-use) trademark-registration system, following registration with the NOIP. To be granted the rights of industrial-property ownership, a party must register industrial-property rights with the NOIP. This gives the party sole right to use the property, transfer it, petition the government to stop acts of infringement and sue for damages in court. Multinational companies should waste no time in registering their trademarks.

The NOIP remains the principal authority for administering the country’s laws and regulations on industrial-property rights, though in practice it shares its enforcement responsibilities with a diverse and sometimes confusing array of other agencies (see below). It is responsible for registering property rights, disseminating the registrations to concerned or interested parties, settling disputes over the rights, and filing licensing contracts and technology-transfer contracts approved by the MoST.

As at November 2005, 115,000 brand names had been registered for protection on the domestic market, and 1,000 brand names for trademark protection abroad. The number of trademarks registered increased by 20% in 2005 compared with 2004.

The (former) Civil Code also addresses copyright, with details in Decree 63 of July 1996 and Circular 3055 of November 1996. These elaborate on the meaning of certain terms used in the Civil Code, such as “author” and “owner of a work”, and they contain guidance on issues such as inheritance of copyright and protection periods. The copyright decree reaffirmed the principle that copyright arises the moment a work is created, irrespective of whether it is made public at that time. Making a work public connotes its presentation in the form of publication, performance, broadcast or other forms. Neither the 1995 Civil Code nor the copyright decree ties ownership to registration. The decree outlines procedures for registration, though these apply solely to domestic authors and owners.

Circular 27 of May 10th 2001 listed all works protected by Vietnamese copyright law, extending explicit protection to the work of foreigners. The Supreme People’s Court, the Supreme People’s Procuracy, and the Ministry of Culture and Information (MoCI) jointly issued Circular 01 on December 5th 2001. It establishes procedures for taking legal action to enforce copyright and resolve copyright-related disputes.

Implementing regulations should clarify aspects of the new law and determine if any of the inherited provisions described above will be modified in practice. Though a more elaborate and comprehensive regime of IPR protection will now come into place with the mid-2006 implementation date of the Law on Intellectual Property, investors are advised to proceed with caution and seek expert guidance in navigating the transitional period of the new law’s introduction.

The United States-Vietnam bilateral trade agreement (BTA) which came into effect in December 2001 committed Vietnam to meeting World Trade Organisation standards on protecting intellectual property (Trade-Related Aspects of Intellectual Property Rights–TRIPs) within 18 months. (In addition, the US-Vietnam copyright agreement of 1998 allows US companies to take copyright infringers to court.) Most observers agree that changes in recent years have brought statutory laws roughly into line with the TRIPs agreement, and the new law seems to consolidate and extend those advances; however, serious problems of enforcement remain, and this will be the ultimate test of the effectiveness of the new law that takes force in mid-2006. A February 2004 report by the US-Vietnam Trade Council based on a survey of 80 American firms active in Vietnam–the latest study issued on the subject by the organisation–cited “improvement in the recognition of well-known marks” but “ongoing apprehension and unease [by US firms] that their patents, trademarks and copyrights remain unprotected and highly susceptible to anti-competitive conditions, thereby negating market access opportunities…available to them through the BTA”. The report also complained of overly broad and ambiguous laws that are difficult to enforce; low fines for copyright infringement; and the first-to-register–as opposed to first-to-use–trademark registration system; the report claims that this has resulted in a “large number of registered copycat trademarks”. The NOIP announced in April 2005 that most of the more than 400 cases of alleged violations brought to it during 2004 concerned products of foreign-invested enterprises. (No figures for 2005 had yet been released in April 2006.) Of such violations, 65% involved trademarks, 25% industrial design and 10% other IPR.

Vietnam signed the Bern Convention for Protection of Literary and Artistic Works on June 7th 2004, with effect from October 1st 2004. This is Vietnam’s first multilateral agreement on copyright. The Bern Convention requires the country to protect the copyright of works from 155 other member countries, and it will enjoy reciprocal protection for Vietnamese works in those countries. Nevertheless, the capacity of the Ministry of Culture and Information to ensure such protection remains to be seen. In March 2006, for instance, the vice-chair of Time Warner Asia-Pacific, part of a US company of the same name, declared that prevalent violations of intellectual property might be obstacles for the company’s ambition to set up state-of-the-art digital cinemas and present new feature films in Vietnam.

One persistent enforcement problem has been that many different agencies share the enforcement responsibility: the NOIP, the courts, the economic police, border and customs agents, MoST inspectors, the Ministry of Culture and Information, the national Market Monitoring Bureau, and provincial and municipal market control boards. But none of these has overall authority. Nevertheless, there have been increasing efforts to improve co-ordination in enforcement. In January 2006, for example, six ministries–those of Culture and Information, Science and Technology, Police, Finance, Agriculture, and Rural Development–signed the Joint Co-operation Programme for Anti-Software Copyright Violation for 2006-10. A study in July 2005 by the Business Software Alliance, a private industry group, found that 92% of all software used in Vietnam in 2004 was pirated, the highest incidence in all of the Asia-Pacific and one of the four highest in the world. The Ministry of Culture and Information announced in March 2006 that Vietnam aimed to reduce the rate of software piracy to 84% by the end of 2006. Accordingly, state authorities are accelerating inspections of information-technology businesses, especially computer production and trading companies, and software sales shops nationwide. In the same month, inspectors from the Ministry of Culture, along with officials from the Ministry of Police, raided a major computer company in Hanoi, Vietnam Japan Equipment Trading Company (commonly known as BEN Computers), confiscating illegal software valued at over D500m. The government is considering more-severe punishments for violations of software property rights. Violators are now subject to fines of up to D500m.

To enforce an industrial-property right against imitations in the market, firms have had several less-than-optimal choices. The holder of a registered trademark can ask the NOIP for an official evaluation, either directly or though an industrial-property agent. The request must be in writing and provide proof of the legal trademark, an evaluation certificate and a sample of the imitation goods. Once the company has received an official evaluation, it may then ask the MoST to enforce the trademark. This process can be lengthy and bureaucratic since judges tend to be poorly trained in intellectual-property law and must thus consult with other agencies before making rulings. Consequently, foreign-invested companies tend not to wait for regulatory support.

Another option has been to take the matter directly to court. This has traditionally been a lengthy and complicated endeavour, though the new LIP will in principle strengthen somewhat the civil procedures and remedies. To illustrate the problem with legal recourse to date, by April 2006, the Supreme Court had not taken action on an appeals case by Nippon Paint Vietnam, a subsidiary of Nippon Paint of Japan, which since 2003 has sought to revoke the NOIP’s decision refusing aspects of a trademark application it filed for “Nippon Paint Super Maxilitex with stylised N and shape”. In August 2004 a Hanoi Court rejected the firm’s motion, and Nippon Paint Vietnam then took the appeal to the higher court. The NOIP had ruled in December 2003 that the company’s proposed logo did not sufficiently distinguish itself from the existing trademark for “Maxilite” paint held by ICI, a British chemicals firm. (The dispute did not deter Nippon Paint Vietnam from opening in December 2005 the first automotive paint plant in Vietnam, with an investment of US$10bn.)

Other companies have been taking matters into their own hands, and some begin by approaching the infringers directly. Coca-Cola (US) has joined forces with local authorities, consumer associations and the police to help nab offenders. Many firms negotiate informally with enforcement bodies like the economic police and Market Monitoring Bureau in order to get them to put pressure on violators. But this approach might open avenues to corruption. La Vie took another approach. La Vie is a bottled-water joint venture between Perrier Vittel Group of France and Long An Trading Company of Vietnam, and it moved in March 2001 to an expensively redesigned bottle with a new logo in an effort to distinguish itself from copycats that had cut into sales.

The Steering Committee for Control of Smuggling, Counterfeit Goods and Trade Fraud and SICPA, an international supplier of security products based in Switzerland, signed a co-operation agreement in February 2005 to develop a modern technology system to detect smuggling and increase tax revenues, particularly in the problem areas of tobacco, medicines, foods and spirits. The VIETRACE system, scheduled to be operational in 2007, is intended to assist state agencies and producers in the fight against counterfeit products and smuggling, and to help functional agencies and consumers distinguish between legal and contraband goods.

Business associations have also formed to take action on IPR-protection issues. The Vietnam Anti-Counterfeiting and Industrial Property Protection Association (an association of foreign-invested enterprises, recognised by the Ministry of Interior in January 2005) aims to fight counterfeiting and to promote industrial- and intellectual-property rights. It also serves as a liaison with market-management bodies, the economic police, customs, state intellectual-property bodies and the courts on enforcement issues. A similar group to help domestic companies fight counterfeiting and copyright violations is the Vietnam Association for Anti-Counterfeit and Trademark Protection, which was licensed in May 2004.

The Customs Law of 2001 and its implementing regulations state that owners of registered intellectual- or industrial-property rights can ask customs officials to postpone customs clearance of goods where infringement of those rights is suspected. Interministerial Circular 58, which took force on November 2003, allows copyright owners to register for long-term copyright protection or case-by-case protection. However, companies have not taken advantage of this legislation, apparently deterred by the bond of 20% of the value of the questionable goods that they must post during the investigation and by the fact that they cannot view the goods themselves. The new LIP (see above) spells out border-control measures in detail, but it remains unclear if the 20% bond will still be required when the law goes takes force.

MoST Decree 54 of October 2000 represented a major step forward for protecting industrial property, offering trade-secrets protection whether or not they had been registered with the NOIP. This is in principle a “first-to-use” system, which the new LIP somewhat modifies in terms of greater latitude for establishing “well-known trademarks”. Rights of ownership over these kinds of property can be established automatically under Decree 54 if certain conditions are satisfied. Another section of the decree clarifies when companies may take action against unfair competition concerning industrial property.

MoST Circular 825 of May 2000 spells out the three criteria for establishing a trademark violation in court: (1) the same symbol on the same kind of good, (2) a similar symbol on the same kind of good or (3) the same symbol on a similar kind of good. Although the range of administrative fines has been D2m-100m, law-enforcement agencies have tended to assess fines of D10m-20m. When criminal penalties have applied–which is rare–they have been D20m-200m; it is not clear if the implementing regulations of the new LIP will increase this amount, or if the scope for criminal actions will increase under its purview. Studies released separately in early 2004 by the United States-Vietnam Trade Council and by the Vietnam Chamber of Commerce and Industry had criticised the existing fine levels as inadequate as a deterrent.

Technology transfer is regulated separately. It is understood legally as taking four forms: (1) from overseas into Vietnam, (2) forming capital contributions to foreign-invested projects, (3) from Vietnam overseas, or (4) as domestic transfers. Decree 11, which was issued on February 2nd 2005 and took force on March 2nd 2005, abolished all limits on the amount of technology-transfer fees for private companies. Decree 11 also removed prescribed fees for transfers involving state-related entities; however, fees involving private firms must be approved by the relevant investment decision-making body. Corporate income tax exemption and reduction policies continue to apply to all transfers. The maximum length of contracts under technology-transfer agreements remains seven years, which many firms consider to be an overly short period. Technology-transfer contracts with a value exceeding D1bn must be registered with the MoST, and those valued at less than D1bn with the local Department of Science and Technology. The authority must respond to applications within 15 days; if it does not, they are considered automatically registered.

Trademark licences may continue to be included in a technology transfer contract in a separate section, as under the previous decree, but they remain subject to separate registration. Although Decree 11 changes the language from “approval” to that of “registration” regarding government consideration of technology-transfer contracts, the process in fact remains burdensome because of the considerable documentation that is still required (such as evidence of parties’ legal status, supporting documents on the technology to be transferred and minutes of the board meetings where approved, in certain circumstances).

Decree 16 of May 2000 spells out penalties for violating technology-transfer regulations. Decree 59 of June 2002 updated and simplified them, and Circular 11 of November 2002 abolished a number of licences. Decree 59 removed the requirement that a technology-transfer contract to Vietnam needed the approval of the MoST. Instead, the contract must be forwarded to the ministry and, if the MoST does not request that the contract be amended within 15 days, the contract is deemed approved (and registered) and takes force. This relaxation of requirements applies to contracts for domestic technology transfer; contracts for technology transfer from abroad to Vietnam for investment projects not funded by state-owned capital; and contracts for technology transfer from abroad to Vietnam for investment projects funded by state-owned capital–the value of which is less than the equivalent of US$30,000. The previous 20% cap on capital contributions by foreign investors in the form of technical transfer was scrapped under Decree 27, dated March 19th 2003, guiding the implementation of the Law on Foreign Investment. The value of technology transfer as capital contribution to a foreign-investment project is now subject only to agreement among the parties.

Conventions

Paris Convention for the Protection of Industrial Property (1949), Madrid Agreement Concerning the International Registration of Marks (1949), Stockholm Convention (for the establishment of WIPO, 1976), Patent Co-operation Treaty (1993), Bern Convention for Protection of Literary and Artistic Works (2004).

Basic laws

Law on Intellectual Property (approved November 29th 2005, with effect from July 1st 2006); Civil Code of the Socialist Republic of Vietnam (July 1st 1996, revised with effect from January 1st 2006); Government Decree 63 Providing Detailed Regulations and Guidelines for Implementing the Civil Code Provisions on Industrial Property (October 24th 1996); Government Decree 76 Providing Guidelines for Implementing the Civil Code Provisions on Copyright (November 29th 1996); Circular 3055 Guiding the Implementation of Procedure of Establishing Industrial Property Right and other Procedures Stipulated in Decree 63 (December 31st 1996); Circular 28 Guiding the Transfer of Technology into Vietnam (January 22nd 1994); Circular 61 Providing Guidelines on a Number of Provisions in Government Decree 48 on the Organisation and Activities of the Film Industry (October 1st 1996); Regulations on the Registration of Drugs under the Decision 1203 (July 11th 1996); Government Decree 12 on Administrative Findings in the Intellectual Property Field (March 6th, 1999); Circular 825 (May 3rd 2000) implementing Decree 12; Government Decree 54 (October 3rd 2000) on industrial-property rights and trade secrets; Government Decree 06 (February 1st 2001) on industrial property and well-known trademarks; Decree 56 Amending Civil Code Provisions (February 11, 2001); Circular 27 of May 10th 2001 on the copyright of works by foreigners; Circular 01 (December 5th 2001) on procedures for taking legal action to enforce copyright; Circular 30 (November 5th 2003) superseding Circular 3066 of 1996; Government Decree 28 on Registration of Trademarks (February 14th 2004).

Patents

Types and duration. The patent system in Vietnam is broadly similar to that of other countries, with some important differences. Vietnam also has a very broad compulsory-licensing provision. Computer software is regulated by copyright law, and from July 1st 2006 by the new Law on Intellectual Property (LIP). The use of protected property is defined by the implementing regulations on industrial property (and carried forward by the new law) as follows.

For an invention or utility solution:

to manufacture the protected products;

to introduce the protected process;

to exploit the protected products;

to put into circulation, advertise, offer for sale and store for sale the protected products or products manufactured by the protected process; or

to import protected products or products manufactured by the protected process.

For an industrial design:

to manufacture;

to put into circulation; advertise, offer and store for sale; or

to import the product with outer appearance protected as an appellation of origin of goods.

For a trademark and appellation of origin of goods:

to fix the protected trademark or appellation of origin of goods in commodities, package of commodities, means of service or documents used for transactions in business activities;

to put into circulation, advertise, offer and store for sale the commodities bearing the protected trademark or appellation of origin of goods; or

to import commodities bearing the protected trademark or appellation of origin of goods.

The author, or his or her inheritor in title, of an invention, utility solution or industrial design may file an application for the protection of these rights. If an enterprise employed the author when he or she created the invention, utility solution or industrial design, the enterprise has the right to file for protection, though the author continues to enjoy certain “moral” rights. The same principle applies for an invention, utility solution or industrial design created under a scientific or technological research-and-development contract, unless otherwise agreed in the contract. A Vietnamese national or legal entity may file a patent application directly with the National Office of Industrial Property (NOIP), as may foreign individuals “permanently residing in Vietnam” or foreign companies with offices in Vietnam. All others must file through a licensed representative service organisation in industrial property.

The NOIP examines patent applications and maintains the patent register. It also has an extensive patent information centre, which provides search materials for patent examinations.

The three types of patents are described in the new Civil Code and LIP, as follows:

(1) An invention is a technical solution that is distinguished by having worldwide novelty in terms of the present state of technology, is non-obvious and is applicable to various social and economic fields (Civil Code, Article 782). A patent for an invention is valid for 20 years from the date the application is submitted.

(2) A utility solution is a technical concept that is distinguished by having a worldwide novelty in terms of the present state of technological development in the world, and is applicable to various economic and social fields (Civil Code, Article 783). Prior legislation required only novelty compared with Vietnam’s technical level; the change was made because the government felt this might discourage creativity. A patent for a utility solution is valid for ten years from the date the application is submitted.

(3) An industrial design is the shape of a product that is formed by lines, three-dimensional forms and colours, or a combination thereof, that has worldwide novelty and is used as an ornamental pattern for industrial or handicraft (Civil Code, Article 784). A patent for an industrial design is valid for five years from the date the application is submitted and may be extended for two successive five-year terms.

Unpatentable. The following may not be protected as inventions or utility solutions: scientific intentions, principles and inventions; methods and systems of education, teaching and training (including training of domestic animals); language systems, information systems, classification and arrangement of data; designs and layouts of construction projects, planning and classification of territorial characteristics; agreed signs, schedules, symbols, rules and laws; computer software, computer-chip designs, mathematical models and diagrams used for reference and similar forms; breeds of animals and seeds of plants; methods of disease prevention, diagnostic methods and treatments.

The following may not be protected as an industrial design: outer appearance of products that are easily created by a person of average professional knowledge in the relevant technical field; outer appearance of civil or industrial construction works; appearance of a product that has only aesthetic value.

Compulsory licensing. There are three conditions under which Vietnam may order owners of an industrial right to transfer the right to use inventions, utility solutions or industrial designs; these will be maintained and strengthened under the incoming LIP. The owner must receive “reasonable” compensation, though what constitutes reasonable is not clear. The Ministry of Science and Technology (MoST) is the enforcing agent in such cases; MoST may also ask the parties concerned to negotiate to resolve discrepancies in opinions in order to enter into a “voluntary” licensing.

Fees. The official fees for filing various patents range from US$60 to register a licence contract to US$100 for filing a patent application. Patents are also subject to an annual annuity payment of US$30-280. Additional charges for claiming convention priority, appeals and other processing also might apply. Charges are subject to revision by the NOIP. Agents’ charges are US$100-250 for services related to registration.

Trademarks

Types and duration. The new LIP defines trademarks as the symbols used to distinguish goods or services of the same kind made by different producers. It adds that a trademark can be expressed by words, images or a combination thereof in one or several colours.

The right to file an application to protect a trademark belongs to:

a person or legal entity engaged in production activities and/or service activities for the product on which the trademark will be used;

a person or legal entity engaged in commercial activities for the product on which the mark will be used, as long as the producer does not oppose title application; or

a person or legal entity representing a collective group using collective trademarks.

A trademark is protected for ten years from the date of application, and it may be extended indefinitely by additional ten-year terms. A well-known trademark is protected indefinitely from the outset. A registered trademark can be cancelled if the mark has been registered for at least five years but has not used in Vietnam during the five years prior to the filing of a cancellation action.

A trademark can also be cancelled if it is ruled that the registered mark was identical or confusingly similar to a mark registered before it, to a well-known mark in accordance with the Paris Convention, or to a widely used and recognised mark. Holders of widely recognised marks can claim rights over those marks.

Non-registrable. The following signs may not be registered under Vietnam’s intellectual-property law:

signs that do not possess distinctive characteristics, such as shapes and simple geometrical shapes, numerical figures, alphabetical letters or letters that cannot be pronounced as an expression; foreign languages that are not widely used, except in exceptional cases where the signs have been widely used and recognised for a long time;

signs, conventional symbols or common figures and denominations of goods in any language that are widely used and a matter of public knowledge;

signs expressing time, place, manufacturing process, type, quantity, quality, nature, composition, purpose or values that are of a descriptive character in relation to the product, service or appellation of origin of goods or services;

signs that are liable to mislead, confuse or swindle the customer over the origin, nature or purpose of the product; quality or value of goods or services;

signs that are identical or similar to official initials indicating control, quality or warranty of Vietnam, foreign countries or international organisations; or

signs, names (including photographs, names, pseudonyms or pen-names), shapes or symbols that are identical or similar at a level that may cause confusion with the national flag, national emblem, portraits of national leaders or heroes, geographical designations or Vietnamese or foreign organisations, except where permission has been obtained.

Fees. The registration fee for filing a trademark is typically US$500 per class. Agency service fees vary; however, there are a number of licensed intellectual-property agents in Vietnam whose services and charges are competitive. The agent’s service fee for registering a trademark in one class starts as low as US$120, but some agents are known to charge up to US$500.

Copyrights

Types and duration. Articles 745 through 779 of the Civil Code address the issue of copyrights. Authors are defined as those who personally create all or part of a literary, artistic or scientific work; persons who translate, modify or transform an existing work; persons who compile works or comment on and collect the works of others and form new and creative works.

Copyright arises at the time a work is created in a definite form, regardless of whether it had been made public at the time. Intellectual-property law in Vietnam distinguishes between “moral rights”, “personal rights” and “economic rights” conveyed in a copyright. Moral rights are protected indefinitely; other personal and economic rights are protected either for the author’s lifetime plus 50 years or for 50 years from the date the work is first publicised.

Works that are covered by copyright protection are as follows:

works written in characters or in signs such as novels, stories, short stories, notes, travelogues, essays, memoirs, poems, epics, dramas, pieces of music, cultural, literary and artistic studies and other forms of writing;

lectures and speeches prepared in writing or orally presented but recorded and circulated as written documents;

theatrical works and other forms of artistic performances presented on stage, such as plays, songs, dances, circus and puppetry;

cinematographic and video works with or without sound;

radio and television works created for transmission by radio waves to the public;

press works, including printed, spoken and visual press in Vietnamese, languages of ethnic minorities in Vietnam or in foreign languages;

musical works, including vocal and instrumental music;

architectural works, including designs with creative ideas involving houses, construction or space planning already or not yet materialised;

plastic art works and applied fine art works;

photographic works that record images of objects on photosensitive materials;

scientific works, textbooks, teaching materials in the fields of research, teaching and training;

graphics, drawings, diagrams and maps for topography, architecture or scientific projects;

translated, re-created, adapted, transformed works and compiled, annotated, selected and anthological works; and

computer software, including computer programs, documents describing programs, supportive documents, and databases.

The implementing regulations on copyrights, as well as the new regulations to come into effect under the LIP, do not extend protections to foreign works, however, unless they are created in Vietnam or their first place of publication is Vietnam. The principle of “national treatment”, by which foreign copyrights holders get the same treatment as Vietnamese holders, will presumably be implemented from the time of the country’s accession to the World Trade Organisation, subject to particular provisions Vietnam agrees to in its bilateral market-access negotiations which are part of the accession process. Vietnam and the United States signed an agreement for protection of copyright in June 1997, which came into effect on December 24th 1998. The accord gives “national treatment” to protect against the illegal copying and distribution of literary, musical and dramatic works, audio-visual works and technology. The agreement makes specific reference to protection against unauthorised copying and sale of films and computer software.

The agreement states that “the contracting parties shall ensure the holder in a work shall have the exclusive right to authorise and prohibit the reproduction of a work, preparation of derivative works based upon the work, and the distribution of copies of works:

“In the case of literary, musical, dramatic and choreographic works, pantomimes, and motion pictures and other audio-visual works, the public performance of work; and

“In the case of literary, musical, dramatic and choreographic works, pantomimes, and pictorial, graphic, or sculptural works, including the individual images of a motion picture or other audio-visual work, the public display of work”.

Fees. The fees for registering copyright are US$40-50. If an agent is needed for the process, agent fees start at US$100.

For legal property protection by the Vietnamese government, the owner should apply for a patent certificate, also known as a Trademark Protection Certificate. Under the new Law on Intellectual Property (LIP), which takes force on July 1st 2006, Vietnam will continue to recognise five types of industrial-property rights. Growing fear of trademark theft among domestic businesses has resulted in increases in trademark registration applications since 2002. The National Office of Intellectual Property (NOIP) received a record number of about 20,000 patent and trademark applications for overseas markets during fiscal year 2005, up from the previous record of 17,000 in fiscal year 2004. Improved staffing, the opening of new branch offices and successive phases of computerisation have enabled NOIP to keep pace with the steady surge in applications and even to reduce the wait time to 12 months (from 13) by end-2005.

The NOIP is empowered to consider applications for protection of industrial property, issue registration certificates and publicise protected objects under official procedures. If a foreign company has an authorised presence in Vietnam (that is, a representative office or a registered investment), it may apply directly at the NOIP for registration; otherwise, registration must be via a licensed industrial-property agency, which forwards applications to the NOIP. Such agencies do not advise on the strategic and legal considerations involved.

The right of protection depends on the priority date, which is the date when the certificate of registration is issued by the NOIP or the date dictated by an international treaty to which Vietnam is a party. But the term of validity runs only from the date the application is filed. Applicants claiming a right of priority under an international treaty have the burden of proof to establish that right.

Applications for registration of industrial property should be filed with the NOIP on forms published by that office. The following documents and information must be submitted in Vietnamese: name of the company; address; nationality; name of the product and/or trademark; and description of the product and/or trademark if it is a utility solution. If the applicant does not have a representative office or licensed investment in Vietnam, a letter from a licensed industrial-property agency also must be submitted.

Other required documents include a notarised power of attorney from the applicant (if any); a licence or sub-licence of right to file an application (if any); and, if claiming convention priority, the date, place and number of the first filing, to be followed within three months of filing by a certified copy of the original applications. Additional requirements might apply, depending on the type of property being registered. The applicant must often include 15 samples of the trademark, a range of other supplementary information and duplicate copies of various documents. Any accompanying foreign-language submissions must include a Vietnamese translation.

The NOIP is supposed to examine an application using the basic form within 15 days of receipt, but it is allowed up to three months to do so; the LIP will reduce this time to one month, as from July 1st 2006. A more detailed examination follows, for which up to nine months is now allowed (six months under the LIP). Applications for patents of invention should then take 18 months from the date of application to the issuance of a certificate, according to the NOIP. Utility-solution and industrial-design patents should take nine months; the appellation of origin of goods should take six months; trademarks applications should take one year. (It is not clear if these examination periods will be shortened under any LIP-implementing regulations). The term for trademark protection is ten years; it is renewable every ten years, though trademarks not used for five consecutive years will be forfeited. The period of protection for well-known trademarks is indefinite.

It is possible to transfer industrial-property rights, except appellations of origin; however, they must be executed by a written contract filed with the NOIP. This now takes place under the rules on licensing and transfer of technology in Decree 11, which took force on March 2nd 2005. Decree 11 abolished all limits on the amount of technology-transfer fees for private companies, and it removed prescribed fees for transfers involving state-related entities; however, fees involving private firms must be approved by the relevant investment-decision-making body. Corporate income tax exemption and reduction policies continue to apply to all transfers.

Circular 132 abolished the dual-pricing structure for industrial-property registration, whereby foreign firms paid higher fees than local firms, with effect from January 31st 2005. There is now a single pricing structure for all firms.

Mitsubishi Heavy Industries (MHI) of Japan signed an agreement in November 2005 for an undisclosed sum under which it will license its low-speed diesel-engine technology to Vietnam’s state-owned shipbuilding company, Vietnam Shipbuilding Industry. (Vinashin). Under the agreement, Vinashin will enjoy the rights to manufacturing Mitsibushi’s large-sized diesel engines through 2014. The agreement also encompasses marketing and servicing of these engines in Vietnam. MHI aims to promote further penetration of its engines into the Vietnamese market.

GlaxoSmithKline (GSK) signed a deal in the same month with Vietnam OPV Pharmaceutical, a subsidiary of OPV of the US, to manufacture the British firm’s patented drugs for sale in Vietnam under the GSK brand and to receive technology transfer. Starting in April 2006, OPV began to produce Actifed (a cold medication) and Zental (an anti-infection drug) at a US$20m plant in Bien Hoa in southern Dong Nai province. Vietnamese authorities approved the deal because consumer prices for the drugs will be much lower than for imports of these and comparable medications.

Potential local partners may be found through a business directory. The most reliable one is published by and available through the Vietnam Chamber of Commerce and Industry or in local bookshops.

Narrowing a list of prospects to a few candidates is especially difficult in Vietnam, given the lack of public information about the finances of companies. Nevertheless, the wrong choice can be very expensive, so it is advisable to spend the extra time and, if necessary, money on the selection. A professional and knowledgeable local consultant might be very helpful in short-listing candidates and conducting a comprehensive comparative study on the remaining ones. When choosing such a consultant, it is important to make sure the person does not have a personal stake or interest of any sort in the decision.

Since many potential partners have limited knowledge about the value of transferred know-how, they are often very reluctant to pay the price required by the licenser. As a result, the foreign partner must sometimes be deeply involved in the business of the local partner to guarantee the most effective use of the licence.

Information on licensing agreements may be obtained from the National Office of Industrial Property or industrial property agents.

From March 2nd-December 31st 2005, under Decree 11 on technology transfer, franchising contracts were briefly negotiated as a form of technology transfer; before that franchising contracts were negotiated on the basis of the 14-year-old law on economic contracts, geared towards sale and purchase agreements. The new Commercial Law has governed franchising contracts since January 1st 2006, but the crucial implementing decree was still pending in April 2006. Until the continuing uncertainties about franchising regulation can be sorted out, particular care should be taken to specify the jurisdiction where the contract is enforceable, the clauses of the contract law that apply and the mechanisms for dispute resolution, remedies, assignment and termination.

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Before it can become effective, a licensing contract between a Vietnamese concern and a foreign company must be approved by the Ministry of Science and Technology (MoST) and filed with the National Office of Industrial Property (NOIP). Decree 11, which took force on March 2nd 2005, issued implementing regulations on technology transfer. They eliminate caps on fees for transfers involving private companies, loosen them for transfers involving state-owned-entities and retain the existing time limits on such contracts.

Decree 63 (October 1996), Circular 3055 (December 1996) and Decree 06 (February 2001) regulate the licensing of patents, utility solutions and industrial-design trademarks, superseding previous documents (Decree 11 superseded their regulations on technology transfers); the new Law on Intellectual Property (LIP) will supersede all except Decree 11 on July 1st 2006, although the same basic regulations will remain intact. Circular 3055 states that a licence contract may not “unreasonably” limit the rights of the licence transferee by:

limiting the export of products produced under licence to places where the foreign investor does not already have industrial-property rights for the product;

obliging the licence transferee to buy raw materials, parts and equipment from a person chosen by the foreign investor;

banning the licence transferee from improving the product;

requiring the licence transferee to transfer free of charge such improvements to the foreign investor;

banning the licence transferee from making a claim against the validity of the industrial-property right; and

banning the licence transferee from awarding an exclusive subordinate licence.

There are no longer any restrictions on which kinds of Vietnamese organisations may sign licensing contracts with foreign companies. As noted above, the MoST’s approval is required only for licensing agreements involving state companies; agreements involving private firms may go directly to the NOIP. The terms of licences may be 7-10 years, starting from the date of approval.

A compulsory licensing provision in Decree 06 permits the government to order or force an owner to transfer the right to use an invention, utility solution or industrial design for “reasonable compensation”. The new LIP updates these provisions (adding plant varieties), which were previously specified under the now defunct 1995 Civil Code: purposes of national defence and security; public health; prevention of monopolies; and “other urgent needs of society”. Strict conditions and procedures continue to govern such a practice. Previously, the conditions were failure to use such industrial property or having used industrial property in a manner not in accordance with the needs of the economic or social development of the country without reasonable motive; refusal by the owner to conclude a contract with persons needing to use such inventions or designs despite good-faith efforts by the latter to negotiate in different ways and offer a reasonable price; or when necessary to meet the needs of national defence, national security, health or other needs of society. By April 2006 there had been no instances of compulsory licensing in Vietnam, though clearly this is a potentially broad right.

Another potentially worrisome restriction is that inventions, utility solutions, industrial designs, trademarks and appellations of origin may be used without permission or compensation to the owner when the industrial property is not used for commercial purposes or when the industrial property is used in connection with products that have been marketed by the owner, prior users or the licensee of the industrial-property right.

Disputes arising in the course of a contract must first be addressed through procedures specified in the contract. If a contract fails to specify how to resolve a particular dispute and the two sides fail to negotiate a solution, the case may be referred to arbitration or the economic courts. Ordinance 13 on the Execution of Civil Judgments (amended), in force since July 1st 2004, provides for enforcement of decisions on bankruptcy and domestic arbitration awards as civil judgments. The time limit for issuing a decision on enforcement of a judgment by the relevant enforcement body was reduced to five days (from seven days where the enforcement body was also the decision-making body and ten days where it was not). The limitation period on the enforcement of judgments is now three years.

EIU ViewsWire. New York: Apr 28, 2006.

Vietnam: Forex regulations

Vietnam: Forex regulations

COUNTRY BRIEFING

FROM THE ECONOMIST INTELLIGENCE UNIT

The government recently took two major steps towards eliminating exchange controls adopted in the wake of the Asian financial crisis of 1997-98. First was Decision 07 of the State Bank of Vietnam (the central bank) of January 26th 2006, with effect from June 1st 2006. Decision 07 abolishs Decision 319 of September 29th 1998 which requires daily reports by financial institutions on receipts and payment in foreign currencies equivalent to US$50,000 or more (including interbank transfers by a customer). This change will remove the last reporting requirements, save those introduced by the new anti-money-laundering regime introduced in 2005 (see below).

Second, the National Assembly adopted a long-awaited new ordinance on foreign exchange, Ordinance 28 of December 13th 2005, with effect from June 1st 2006. (Ordinance 28 will repeal in full the stop-gap Decree 63 dated August 17th 2005, which began to address some of the same issues.) The new ordinance will enshrine in law Vietnam’s obligations to the International Monetary Fund (under Article VII) on freedom of current-account transactions. It will lift the requirement of a permit for (resident and non-resident) individuals to purchase, remit, and transfer foreign currency through banks; in its place, simple verification of valid documents will be required. Procedures for issuing permits for a variety of specific current transactions will be simplified.

Ordinance 28 defines indirect foreign investment as a type of capital transfer for the first time, but does not alter the conditions. An indirect investment is when a non-resident person purchases or sells securities and other valuable papers and/or contributes capital or purchases shares in the forms stipulated by Vietnamese law, but does not participate in the management of the enterprise (the same definition contained in the new Law on Investment). As before, foreign-currency capital for such transactions must be exchanged into dong and any profits in dong must be exchanged into foreign currency for remittance abroad. Ordinance 28 will also allow individuals to take out foreign loans, and permit credit organisations freely to provide loans to overseas subjects (and other economic organisations to do so with government permission); individuals will remain prohibited from providing such loans. As before, foreign-currency transactions within the territory of Vietnam remain highly restricted; they may take place only through authorised credit institutions (see below). Under Ordinance 28, non-banking credit institutions will be able to register with the central bank to participate in the foreign-exchange market for the first time, separate approval for engaging in foreign-exchange transactions by banking institutions will no longer be required, and other institutions will be able to seek a license to engage in foreign-exchange operations (see Capital sources).

The cap on foreign-currency remittances by individuals was relaxed by SBV Decision 921 of June 29th 2005, with effect from July 15th 2006, on Carrying Cash by Individuals Entering Into or Exiting Vietnam. The cap was raised from US$3,000 to US$7,000 if in dollars (or equivalent in other foreign currency), and from D5m to D15m if in local currency.

Legitimate foreign-currency trading has been allowed on the foreign-currency interbank market since 1994. The market is intended to allow banks to trade in foreign currency with one another, to regulate the amount of foreign currency in the market and to adjust the value of the dong in line with government monetary policy. The government sets the official foreign-exchange rate by averaging rates from the previous day’s interbank transactions. This crawling-peg system set up a trading band allowing dong/dollar exchange deals to be executed within a tight band of 0.1% above or below the official rate. The band was expanded to 0.25% in 2002.

Until May 15th 2002 Vietnam required the immediate conversion of 40% of foreign-currency receipts earned through current trading into dong. Decision 61 reduced this amount to 30%. This applies to Vietnamese economic organisations, foreign-invested enterprises, parties to business co-operation contracts, foreign branches and foreign contractors. Previous indications had been that this requirement might be scrapped altogether, and this may yet happen over the longer term.

The State Bank of Vietnam (SBV) reintroduced a swap mechanism in the interbank market in July 2001 (Decision 893 of July 17th), after a three-year period in which it had been outlawed. The mechanism allows the SBV to buy the commercial banks’ dollars at spot rates and resell them to the banks after a given time period. The mechanism ran into problems initially, with the banks saying that the spot rates were too high and that a swap deal took too long to execute. The SBV released a set of fixed rates for swap deals in August 2002, and then in October it guaranteed to carry out all swaps in a single day.

Foreign banks tended to have much more trouble carrying out swap deals, but in a move designed to facilitate them, the SBV began allowing interest rate swaps on November 1st 2003. With an eye towards enlarging banks’ services and providing businesses (particularly local ones) with more interest-rate options to hedge against interest-rate risk, the SBV now permits parties to exchange fixed interest rates for floating rates and vice versa. The regulation applies only to credit institutions with chartered capital exceeding D200bn (US$12.7m) that have already established a process for swaps, and to loans denominated in either dong or foreign currencies. Credit institutions must earn a profit from their swap contracts; if they make a loss, the total losses must not exceed 5% of the institution’s chartered capital. Where providing swap services for loans in foreign currencies, lenders must have already obtained a licence from the central bank allowing them to operate in the foreign-exchange field. Clients may include other local and foreign credit institutions, as well as businesses having credit relations with any credit institutions. The central bank also stipulated that the maximum time for an interest-rate swap contract is five years, and that total lending under swap contracts may not exceed 30% of the lender bank’s chartered capital.

Decision 648 of May 28th 2004 loosened the permissible terms of forward and swap transactions from a minimum of seven days and maximum of 180 days to a minimum of three days and maximum of 365 days. The decision also allowed banks to come to free agreements with their customers on the forward swap rate between dong and US dollars, as long as they do not exceed a rate based on the following required formula: the spot rate on the date of signing the transaction; the difference between the current published annual dong interest rate and the Federal Funds target rate of the United States Federal Reserve Bank; and the contract terms. Decision 1452 of November 10th 2004 regulates spot, forward, and swap transactions, and creates for the first time “options to conduct a foreign-exchange transaction” between two foreign currencies (not involving the dong). Decision 1452 also simplified and eased the foreign-exchange controls on banks–prescribed conditions and specific licences to conduct spot, forward and swap foreign-exchange transactions are no longer required. (Citibank had been the first foreign bank authorised to offer these services, and from March 2005 it was authorised to conduct interest-rate swaps between the US dollar and dong for corporate and commercial-bank clients.) The applicable term for swap and forward transactions was set at 3-365 days.

Decision 61 of April 2001 broadened the range of transactions for which foreign-invested enterprises (FIEs) may buy foreign currency to include some capital-account transactions as well as current-account transactions. But the right of FIEs to buy foreign currency depends on the bank’s ability to supply that currency at that particular time–unless the FIE belongs to the priority list of special (mostly infrastructure) projects whose right to acquire foreign currency is guaranteed by the government.

Since January 2001 foreign investors have been allowed to purchase foreign currencies at prescribed banks in Vietnam without an SBV permit. Ordinary foreign-currency accounts may be used to service current-account transactions, and no regulatory approval is needed. But a special, separate foreign-currency bank account is still required to conduct certain capital transactions, including offshore transfers of legal capital, profits and revenue; offshore medium- and long-term loan repayments; and foreign-currency withdrawals and deposits. Another special account, known as a foreign-currency deposit account, may be opened to receive foreign loan capital, repay foreign loans or simply at the request of a foreign lender. An offshore bank account can be used for this purpose, but SBV permission is required.

FIEs based in Vietnam with offshore branches or offices may also open an offshore bank account, as may build-operate transfer projects with special requirements. Permission may be granted in other circumstances on a case-by-case basis.

Under SBV Official Letter 606 of June 2001, virtually none of the restrictions on foreign-currency earnings, payments and exchange transactions apply to companies operating in export-processing zones.

Decision 1550 of December 6th 2004 governs remittances of funds into Vietnam to purchase listed securities, conversion of foreign currency into dong and dong into foreign currency for such purchases, opening and use of dong bank accounts for such purposes, and remittances abroad related to such purchases. The decision keeps intact the provision that foreign funds must be converted into dong for the purchase of listed securities, and these funds must still be held in a specialised, on-call securities-trading account (in either dong or foreign currency) at a securities-trading firm held at an authorised bank (though this can now include local banks in addition to a foreign depository bank). Major reforms under Decision 1550 include the repeal of the one-year restriction on remittance abroad of investment funds transferred into such securities-trading accounts, and a significant reduction in documentation required to transfer funds into and out of such accounts. It appears that Decision 1550 will continue in force under the new foreign-exchange ordinance, which takes force on June 1st 2006, though the status of the requirement of using securities-trading accounts remains murky and could be addressed by implementing regulations before the new ordinance takes effect.

The government set up the Vietnam Securities Deposit Centre (VSDC) in July 2005 to register, act as a depository for and provide services related to securities trading. By April 2006 the State Securities Commission had granted approval to 14 securities companies and six banks (including two foreign banks–Deutsche Bank and Citibank) to provide custodian services through the VSDC.

In June 2005 the government moved to create an anti-money-laundering regime for the first time, under Decree 74, with force from August 1st 2006. Decree 74 defines money-laundering as conduct of an individual or organisation seeking a way to legalise assets obtained through a crime, via one of the following methods:

participating (directly or indirectly) in a transaction involving assets obtained from the crime;

receiving, appropriating, transferring, converting, assigning, transporting, using or carrying across a border money or assets obtained as a result of a crime

investing in a project or construction works, contributing capital to an enterprise, or seeking other ways to conceal or hinder verification of the true source and nature or of the sites and process of the movement of, or ownership of, money or assets obtained from a crime.

The decree applies to foreign and Vietnamese individuals and organisations and also to stateless persons who reside or operate in Vietnam who conduct transactions with or provide services to customers which involve monetary or other asset transactions in Vietnam. It also applies to foreign individuals and organisations not residing or operating in Vietnam but who conduct transactions with or provide services to customers in Vietnam involving money or asset transactions taking place in the country.

“Transacting entities” that are required to combat and prevent money-laundering fall into four categories: financial institutions; casinos; real-property companies; and lawyers, legal consultants and law firms when conducting monetary or other asset transactions on behalf of clients (such as through trust accounts). All such entities and individuals are required to report to the SBV one or more cash transactions on a single day totalling D200m or D500m in respect of savings-account transactions, as well as other suspicious transactions (defined as exhibiting any one of 13 specific features detailed in the decree). The SBV is charged with issuing periodic supplements to the criteria characterising suspicious transactions and with setting up an Anti-Money-Laundering Centre. Transacting entities have the right to reject transactions where they suspect money or assets are criminally related or where the individuals or organisations are on a warning list compiled by the police. Authorities have the right to freeze accounts, seal or seize assets and take other temporary measures when covertly investigating suspicious transactions and parties reported by a transacting entity.

There are no restrictions on receiving inward remittances. However, all inward remittances of foreign currency must either be converted to Vietnamese dong or be deposited into a foreign-currency bank account; in any event, 30% of all foreign-currency earnings must be converted into dong.

Although any enterprise or individual may open a foreign-currency account, outward remittances from such accounts may be made only to pay for imported goods and services.

Circular 124, which was issued on December 24th 2004 and took force on January 1st 2005, allows foreign investors to repatriate profits derived from the following activities:

business operations licensed under the Foreign Investment Law;

capital assignments, after fulfilling corporate income tax obligations;

reinvestments of profits;

corporate income tax refunds or overpayments

Circular 124 permits remittances annually at the termination of the financial year, provisionally every quarter or semester after paying corporate income tax (unless exempt from such tax), or on termination of business activities in Vietnam.

In any event, all remittances must be made through a foreign-currency bank account registered with a provincial or municipal branch of the central bank. Extensive documentary support is typically required to buy foreign currency for remitting purposes. This includes sales contracts and import licences for foreign currency needed to buy imports; service contracts to buy offshore services; a loan contract to repay loans; or minutes of a board meeting and tax authority approval to remit profits.

If an enterprise is terminated or dissolved, foreign investors have the right to transfer abroad the capital invested and reinvested in the enterprise, as long as all tax and other liabilities have been met. If this amount exceeds the original amount of capital and invested capital, the excess may be repatriated only with the approval of the body that issued the original investment licence.

Remittance of profits is permitted, but compliance with local tax obligations remains an essential pre-condition. Profits are defined as the difference between total revenue and expenditure, and the Foreign Investment Law (supplanted by the Law on Investment from July 1st 2006) clearly lists the components of each. Export-directed enterprises have preference in remitting profits.

Profits earned from foreign securities investment do not require central-bank approval to be remitted abroad, but documentation must be submitted to the appropriate bank for transactions into and out of the securities trading account (though this was relaxed under a December 2004 decision; see Exchanging and remitting funds overview).

Circular 26 of March 26th 2004 repealed the profits remittance tax (of 3-7%) on income earned on or after January 1st 2004. Tax on remittance of profits earned before end-2003 was abolished retroactively, but in all cases of remittances, investors are required to fill out a designated form and file it with the appropriate local tax office in order to claim the exemption. Circular 24 also clarifies that, from January 1st 2004, foreign investors using profits and other income from investments in Vietnam in order to undertake new or expanded investments are not entitled to corporate income tax exemption on those reinvested profits.

Circular 08 of January 18th 2001 abolished profit withholding tax for foreign-company branches.

Under Decree 38 of April 15th 2003, making possible the transformation of foreign-invested enterprises into shareholding (joint-stock) companies, profits from share transfers from a foreign founding-shareholder to a Vietnamese individual or company may be remitted overseas only with government approval.

In theory, foreign-invested enterprises should have no difficulty remitting both principal and interest on loans sourced abroad, as long as the State Bank of Vietnam (SBV), the central bank, approved the loan at the outset. Yet SBV restrictions on dong convertibility make the practice difficult, though conditions have improved in recent years. Enterprises cannot make overseas payments if they cannot obtain foreign currency, and there is no guarantee that banks will always have sufficient foreign exchange to cover such transactions. Financing projects from commercial bank loans in Vietnam remains difficult.

SBV Decision 1432 of November 2001 states that foreign loans must be registered with the SBV within 30 days. The decision scraps the requirement that foreign investors must seek SBV approval to amend the terms of a registered foreign loan. Decentralisation provisions allow SBV branches to certify the registration of foreign loans up to US$10m. Decision 980 of August 2001 gives borrowers complete discretion over the interest rates and terms of their foreign loans.

Decision 233, dated December 20th 1999, promulgates regulations on government guarantees for foreign loans by state-owned enterprises and state-owned credit institutions. It applies to such loans for investment and development projects, capital contribution to joint ventures with foreign parties, lending and other projects subject to the prime minister’s approval. The conditions in the statute must be met to obtain a government guarantee. The Ministry of Finance is the competent guarantor for enterprises; the SBV is the guarantor for credit institutions. The decision also specifies procedures for obtaining a government guarantee for a foreign loan, the contents of a letter of guarantee, obligations of the Ministry of Finance, the SBV, the Ministry of Justice, and obligations of guaranteed enterprises and credit institutions. Circular 9 of December 2004, which took force on January 19th 2005, makes some minor changes, requiring the registration of short-term loans when they are extensions of previous loans and total loan term (original plus extended) exceeds one year in length (rather than only when the extended term exceeds one year). Any changes to foreign loans must now also be made in writing, and new forms are provided for this purpose.

Foreign investors in Vietnam may remit royalties received for providing service and transfer of technology, but the amount is strictly regulated. Any royalties that a branch based in Vietnam pays to the offshore parent company or to an affiliated branch of the company are no longer tax deductible.

Since May 2002 foreign-invested firms must convert 30% of their foreign-currency earnings from exports into Vietnamese dong. This requirement exposes the investor to all the risks of local currency devaluation and might complicate repatriation of profits at times of restricted hard-currency access. The rules do not apply to enterprises operating out of export-processing zones.

Until 2001 banks tended to use sight letters of credit (L/Cs) and L/Cs of no more than 180 days. But SBV Decision 711 of May 2001 and Decision 1233 of September 2001 re-introduced deferred L/Cs as a viable tool for importers and exporters based in Vietnam. Together, the decisions revoke the requirement that a deferred L/C could be issued only by those banks that had no overdue deferred L/Cs outstanding. Banks that open deferred L/Cs no longer have to set up a guarantee risk fund.

Banks may open short-term deferred L/Cs (that is, those of less than 12 months duration) for enterprises with a sound credit track record. The payer must provide the bank with a payment schedule and some form of security. The value of the security or deposit is at the bank’s discretion, above a certain statutory minimum. The security may be a deposit, mortgage or guarantee but not a bank loan or bank guarantee. The bank must make payments to the payee according to the schedule, regardless of whether the payer has fulfilled his payment obligations. If the payer has not fulfilled those obligations, the bank will make the payer a debtor.

Banks must obtain approval from the central bank to open medium- and long-term deferred L/Cs (that is, with a term longer than 365 days). The maximum opening fees for a deferred L/C is 2% per year of the L/C’s value. The payment acceptance fee is 2% of the accepted payment.

Traders are generally advised to use banks based in Hanoi and Ho Chi Minh City when dealing with L/Cs, since non-metropolitan banks lack the capacity to handle these transactions. Traders should also ensure that the L/C is clearly classified as either revocable (where the bank may cancel it at any time) or irrevocable.

Foreign banks reserve credit for some Vietnamese commercial banks–mainly five state commercial and some joint-stock banks–to provide L/C confirmation and re-guarantee services, and they also provide technical assistance to Vietnamese partners on L/C issues as well as, increasingly, information to investors regarding L/C transactions with Vietnamese banks.

EIU ViewsWire. New York: Apr 28, 2006.

Vietnam: Tax regulations

Vietnam: Tax regulations

COUNTRY BRIEFING

FROM THE ECONOMIST INTELLIGENCE UNIT

After several years in flux, Vietnam’s corporate tax system experienced relatively little change in 2005. Several important modifications to corporate income tax regulations had occurred in 2003, with further clarifications in 2004.

The level of taxes is comparable to that in other countries in the region, but the structure is very complicated, and foreigners are often accused of trying to avoid payment. Investors claim that even if an honest attempt is made to pay, the system makes it difficult to figure out which taxes apply. Inconsistent regulations and poor-quality tax officials make complying even harder, and many companies bridle at the burdensome regime of tax inspections.

Vietnamese firms have historically regarded taxes as an obstacle to be creatively avoided, and the dominance of the cash economy makes this a relatively easy task. A 2003 study (most recent data) by the International Finance Corp, an arm of the World Bank, estimated that for every dollar of Vietnam’s gross domestic product, 50 cents worth of unrecorded transactions take place. Nevertheless, increased collection has been spurred by the government’s determination to make up for the habitual shortfalls in tax revenues. An increasingly sophisticated and computerised tax-inspection system has left fewer options for investors to make an “arrangement” with local tax officials.

Vietnam’s budget revenue (predominantly tax collection) from domestic sources was D170.5trn in 2005, 19% above the year’s target and 19.1% more than was collected in 2004, according to the Ministry of Finance. All provinces and cities met their state budget revenue-related targets in 2005, for the first time ever.

The contribution of taxes collected from businesses increased from 66.4% of total budget revenue in 2000 to 71.4% in 2005. However, the General Department of Taxation (GDT) has continued to express concerns about tax evasion, particularly of value-added tax. The GDT inspected 93 private companies and collected D12.5bn in underreported taxes in 2004, it reported in October 2005. Despite increasing tax revenues, the Ministry of Finance reported that by end-2005 outstanding tax debts had reached D4trn. Tax agencies lack the legal power to enforce tax payments or punish tax violators, complained the GDT, explaining that they are not authorised to acquire information, conduct investigations or make decisions on tax violation cases. Although Decree 100 of 2004 in principle gave tax agencies the power to punish tax violators with fines of up to D100m, municipal authorities are reluctant to charge maximum fines. Although tax fraud and evasion fines can be set at 1-5 times higher than the normal tax value, tax officers tend to assess only minimal fines.

Since January 2004 Vietnam has been conducting a pilot programme in self-declaration and self-payment of taxes, targeting state-owned and local private enterprises and trying to promote a more modern and efficient tax-collection system with greater taxpayer responsibility. Nine GDT agencies in Quang Ninh, Binh Thuan, Ba Ria-Vung Tau, Dong Nai, Thua Thien-Hue, Khanh Hoa, An Giang, Ho Chi Minh City, and Hanoi successfully applied the self-declaration and -payment method on a trail-run basis in the 2005 tax year, and the authorities reported higher tax revenues as a result. The government announced plans in March 2006 to extend the programme nationwide for enterprises and family-run businesses beginning in 2007.

Vietnam introduced a value-added tax (VAT) in 1999 and a supplementary income tax, to catch highly profitable firms, in 2001. Since 2003 exporters have received VAT refunds only if they can prove they were paid for their exports though the banking system, which makes it harder for them fraudulently to overstate their export values.

Other taxes that can affect certain investors include special sales tax, production royalties, property rates and export duties.

The tax system is regularly used as a way to offer incentives to foreign investors that establish themselves in not just particular industries but also particular locations. For example, foreign-invested software and information-technology firms enjoy tax holidays and a much-reduced rate. Infrastructure and construction projects are also highly favoured.

The government ruled in March 2004 that the representative offices of multinational companies would be treated as permanent establishments if they sell items into Vietnam, which resulted in new tax exposure for the parent companies. The GDT now requires local tax agencies to inspect representative offices for income tax compliance.

The GDT continues to crack down on transfer pricing (also known locally as “price changing” or “price transference”–the practice of manipulating expenses between an offshore parent and local subsidiary to create artificial losses) at both foreign-invested and joint-venture firms. GDT Official Letter 3138 of 2001 first announced the crackdown on transfer pricing. The ongoing investigation encompasses enterprises conducting transactions with affiliated companies in the following areas: import-export, contract processing, technology transfer, technical assistance, management services, debt finance or capital-equipment purchases. Official scrutiny focuses on companies with “extraordinary business results”; these include many years of losses, unusually large profits in tax-holiday years or significant fluctuations in profitability. Companies with affiliates in countries where tax rates vary widely from Vietnam’s also will be closely investigated. This crackdown followed earlier attempts to tighten rules on the deductibility of management fees between parent companies and their Vietnamese subsidiaries.

The tax department in Ho Chi Minh City found that among the 1,450 foreign-invested enterprises (FIEs) operating in the city in tax year 2004, only about 190, or just 13%, reported a profit; the rest reported losses or claimed that they were in the initiation phase of their investments, where they could carry losses forward. The department investigated more than 50 FIEs in the first half of 2005 and found that many had misreported their accounts by understating taxable profit. The tax agency said the most common evasion method employed by FIEs was a price transfer from parent companies to increase input costs to reduce taxable profit derived locally. The tax agency managed to collect extra taxes of nearly D60bn from the investigated FIEs.

The government has continued to try to bring its accounting system (the Vietnamese Accounting System–VAS) into line with international standards. (FIEs usually choose between foreign or Vietnamese standards when determining tax liability, but when using VAS, they still typically use international financial reporting standards in reporting to home offices.) In 2001 the Ministry of Finance issued the first few Vietnamese accounting standards based on international accounting standards (IAS) in the areas of inventories, intangible fixed assets, tangible fixed assets, and revenue and other income, which took force for accounting periods starting on January 1st 2002. The Ministry of Finance released the second batch of Vietnamese accounting standards based on IAS on December 31st 2002. These took force on January 1st 2003 and cover the general standard on accounting, lease of property, effects of changes in foreign-exchange rates, construction contracts, financing costs, and cashflow statements. By April 2006 a total of 16 accounting standards had been promulgated, including those for corporate income tax. The Ministry of Finance had originally aimed to issue 35 standards by end-2005.

These measures are part of a project begun in 1996 to develop a legal accounting framework for Vietnam. In June 2002 the government clarified the application of VAS to FIEs subject to the Foreign Investment Law (FIL) and to foreign legal firms, petroleum contractors and other foreign contractors not subject to the FIL. (The Law on Enterprise of November 2005 will replace the FIL on July 1st 2006.) In what PricewaterhouseCoopers characterised as “a number of very positive changes”, the government made amendments in such areas as reporting foreign-exchange gains, costs incurred prior to initiating operations of a new investment and loan-loss provisions. The National Assembly approved the Law on Accounting in May 2003; it promulgates provisions on accounting-mechanism systems and on accountants. All business enterprises must organise their own accounting-mechanism system or assign personnel or hire certified persons or organisations to be accountants and chief accountants. The accountants must meet certain specified standards on professional morals, professional skills and qualifications that are set out in detail in the new law. Decision 59 of the Ministry of Finance, dated July 9th 2004, updates requirements for certifying auditors and accountants, specifying educational and experience requirements, a standardised examination, and requirements for those auditors and accountants certified abroad. It applies to both foreigners and Vietnamese, and replaces Decision 53 of April 2002.

The Law on Accounting applies to all entities including state agencies, professional units, business enterprises of all economic sectors, branches and representative offices of foreign companies, co-operatives and non-incorporated home-based enterprises. Financial reports must be issued in dong, the local currency. A company may report economic and financial transactions denominated in the foreign currency on its balance sheets, but for final accounting purposes, the amount must be converted into dong at a specified exchange rate for this purpose–common to all enterprises–that is announced periodically by the central bank.

Decree 129 of May 29th 2004, which took force on June 30th 2004, further tightened the training requirements for a chief accountant, which is now required for all businesses–except representative offices, co-operatives, individual family businesses and firms hiring a certified external accountant. (According to the Accounting and Auditing Regime Department of the Ministry of Finance, in 2005 Vietnam had 780 accountants, only 106 of whom held international certification.) The decree also stipulates that accounting firms can only take the form of limited-liability companies, partnerships or foreign-invested firms; consequently, state-owned and other forms of accounting enterprises must convert to these new forms. The decree also regulates accountancy examinations and certifications, establishes guidelines for annual accounting submission by FIEs and foreign branch offices, and regulates the use of electronic accounting vouchers.

Decree 105 of March 30th 2004, which took force on April 21st 2004, and implementing Circular 64 of June 29th 2004, which took force on July 30th 2004, regulate independent professional auditing firms, which continue to grow in importance. Foreign auditing firms without a presence in Vietnam may operate in the country in three circumstances: (1) if an auditing firm in Vietnam has been admitted as a member of that foreign firm (in which cases, both firms sign off on the audit); (2) for a one-off audit in co-operation with a firm in Vietnam (in which case, the firm established locally signs off); or (3) for an independent audit for circulation in Vietnam, provided that the Ministry of Finance gives approval. Auditing firms established in Vietnam must have at least three locally licensed auditors, with at least one of its managers also a licensed auditor.

Decree 105 established partnerships, private enterprises or FIEs as the forms that auditing companies could take; Decree 133 of October 31st 2005, which took force on November 22nd 2005, added limited-liability companies as a permissible form. In addition, Decree 133 added a requirement that auditing enterprises publicly announce their firm when trading or operating. The establishment of new state-owned or shareholding auditing companies remain prohibited as before; any such firms established prior to the passage of Decree 105 must convert to one of the allowable forms by April 21st 2007. Decree 133 charged the Ministry of Finance with the responsibility to set guidelines and procedures for establishing limited-liability and partnership auditing firms.

Corporate tax rates and regulations were revised substantially from January 1st 2004 in an effort to unify the tax system for both Vietnamese and foreign-invested enterprises (FIEs). This began with the passage of the new law on Corporate Income Tax in May 2003 and implementing Decree 164 of December 22nd 2003. FIEs licensed since January 1st 2004 are subject to the new tax regime. FIEs licensed prior to this date remain subject to the tax rates stipulated in their licences.

Corporate income tax (CIT) rates under Decree 164 apply to all business establishments, including joint venture companies, business-co-operation contracts and wholly-foreign-owned enterprises; foreign companies and organisations operating in Vietnam outside the Foreign Investment Law (FIL; from July 1st 2006, the new Law on Investment); foreign individuals conducting business and having income generated in Vietnam; and foreign companies operating in Vietnam via their resident establishments.

The 2003 law and Decree 164 abolished the tax rates provided for by the 1997 Law (32% for domestic firms and FIEs not under the FIL; 25% for FIEs under the FIL), and replaced them with one uniform tax rate of 28%. In principle, this means a CIT rate increase for most foreign corporations operating in Vietnam, though preferential rates of 20%, 15%, and 10% continue to apply under revised foreign-investment incentives (see Incentives). The 28% rate applies to all businesses except for oil and gas exploration and exploitation projects (on which a tax rate from 28-50% is imposed).

Another significant change was that CIT is now assessed on income gained from the transfer or sale of Land Use Rights (LURs). Decree 164 also provides for cases of transfer or sale of LURs in which CIT is not imposed, such as when LURs are used by a business to contribute to a joint-venture company with local and foreign organisations and individuals, or when LURs are transferred upon a split, division, merger or bankruptcy of a business. (Income generated from the transfer of LURs by households and individuals, will be assessed personal income tax instead of CIT.)

The new tax regime of 2003-04 abolished earlier provisions about the CIT refund for enterprises that have paid CIT on reinvestment income (an important tax advantage previously enjoyed by FIEs over domestic enterprises) and the “excess profits tax” that applied in certain circumstances. Earlier regulations on tax incentives applicable to FIEs were substantially revised in 2003-04, becoming even more differentiated based on geography and type of investment. The net effect is complex, lowering some tax liabilities for FIEs and decreasing some tax benefits; effects are apt to vary considerably based on a firm’s particular circumstances.

The 2003 law also eliminated withholding taxes on overseas profit remittances by FIEs. After a period of uncertainty, this change was confirmed by a March 2004 decree that was retroactive to profits generated from January 1st 2004.

Under Decree 164, earnings from scientific research and technology-development contracts and the sale of products made in the trial process are exempt from CIT for six months. No CIT is levied on technical service contracts in the agricultural sector, and investors who use patents, technical know-how and technology transfer, among others, for capital contribution. In certain circumstances, tax holidays and tax reductions may be available for newly established businesses and businesses that move their locations under the revised investment incentives.

Since January 1st 2003 the business registration tax (also known as the commercial licence tax) was increased from D850,000 annually to D1m-3m annually, depending on the type of business. Since FIEs continue to receive investment licences (as ratified by the incoming Law on Investment, as from July 1st 2006), only domestic firms pay the registration fee. Ministry of Finance Circular 96 of October 2002 and Circular 113 of December 2002 provide guidelines on the tax rates applicable to the various types of business entity. The tax now applies to all firms adopting an independent accounting system (including state-owned enterprises, shareholding companies, limited-liability companies and private enterprises), irrespective of revenue.

Circular 42 of May 7th 2003 clarified that the following business establishments are liable for business registration tax: branches or shops (under a company or branch); businesses that adopt a dependent cost accounting system or have a “current account”; businesses that have been issued a certificate of business registration; and businesses that have registered for tax payment and have been granted a 13-number tax code.

Businesses or individuals who carry out business activities in Vietnam outside existing regimes such as the Foreign Investment Law (from mid-2006 the new Law on Investment) or banking laws are generally referred to as “foreign contractors”. New guidelines on taxation of foreign contractors were issued under Circular 5, which was dated January 11th 2005 and took force on February 16th 2005. They replace Circular 169 of December 1998 and expand the scope of the concept of foreign contractors.

Circular 5 determines the tax payable by the following foreign organisations or individuals:

those that practise independently or do business in Vietnam on the basis of a contract, agreement or commitment with a Vietnamese organisation or individual, or with another foreign organisation or individual doing business in Vietnam;

those that supply goods in Vietnam or supply goods accompanied by services provided in Vietnam; or

those that do business and have income (such as from royalties or technology transfer) in Vietnam but without a presence in Vietnam.

In a decision taken in 2002, the extension of loan contracts signed before January 1st 1999 is no longer subject to foreign-contractor withholding tax (FCWT). This extended the original terms of Circular 169 as long as no changes are made to the terms of the original signed contract and the extension duration is not more than 12 months for short-term loans, or half of the original loan duration for medium- and long-term loans. Circular 5 simplified procedures for tax declaration and payment. Foreign contractors now pay value-added tax (VAT) and corporate income tax (CIT) by way of withholding by the payer; the payer withholds in its payments to the contractor the amount owed to the tax authorities, and forwards this amount directly to the latter. Foreign-contractor taxes under Circular 5 include VAT, CIT, special sales tax, import and export duties, and personal income tax. However, Circular 5 provides detailed guidelines only on VAT and CIT. VAT rates are set by business line: 10% of value added for trading, distribution and supply activities; 50% for services; 30% for construction and installation without supply of materials or equipment; 50% for construction and installation with materials and/or equipment; and 50% for other production and business and transport services. Where a double-tax agreement applies, a foreign individual subject to the tax may apply for an exemption from business income tax under provisions of Circular 95 and Circular 37 of the Ministry of Finance.

[Table]

Corporate tax, 2005
Below is a simplified example of the approximate tax burden facing a hypothetical 50-50 joint-venture hotel company operating in Vietnam in 2005. Taxable income is assumed to be US$1m. It is assumed that no tax treaty applies. The example uses a uniform corporate tax of 28%, according to the revised Law on Corporate Income Tax of December 2003. This calculation does not include value-added tax of about 10%.
Foreign capital invested	US$5,500,000
Revenue for the year	2,500,000
Expenses	1,500,000
Profit	1,000,000
Standard corporate tax of 28%	280,000
Net profit	720,000
50% remitted overseas	360,000
Total tax paid	280,000
Tax paid as a percent of gross profit	28.0%
Source: Economist Intelligence Unit calculations, based on Ministry of Finance figures.

The Foreign Investment law (the new Law on Investment from July 1st 2006) defines taxable profits as the difference between total revenue and total expenditure plus other additional profits of the enterprise in the tax year, minus any losses that may be carried forward to the following year. Foreign-invested operations may carry forward losses for five years, either spreading the loss evenly or fully offsetting it against profit in a particular year.

Revenue includes the sales of products, the provision of services and all other revenues. Profit also covers any affiliates and branches. Income subject to taxation also includes that from the leasing or sale of assets, the transfer of shares, joint-venture operations with other economic entities and financial operations–such as the difference between interest on deposits in banks and interest on loans from banks. Foreign investors with a range of business co-operation contracts must account for each separately.

According to General Department of Taxation Official Letter 56/4 of December 2001, certain types of interest income earned by foreign investors are taxable. The letter asks banks to withhold corporate income tax from their interest payments to foreign investors. Letter 56/4 is supposed to be consistent with a previous ruling on the taxation of interest income, namely Ministry of Finance Circular 169 of 1998, but the two documents do not agree on exactly which types of interest income are subject to withholding tax; consequently, banks and investors are unsure which rule to apply.

Deductible expenditures remain the same under Decree 164. They are defined as follows:

costs of raw materials and fuel to manufacture principal products and by-products or to provide services;

salaries, allowances and social insurance paid for employees (including compulsory home-country social-security contributions for expatriates, with proper documentation);

employment termination (up to one month of salary for each employee per year of service);

utility costs;

travel allowances;

depreciation of fixed assets under regulations provided by the Ministry of Finance;

acquisition costs or fees paid for the right to use technical documents, patents, technology and technical services;

enterprise-management expenses;

scientific and technical research expenses;

taxes, fees and assessments on the nature of taxation paid;

interest payments on loans at rates below certain ceilings;

costs of insuring assets of the enterprise (as long as the insurer is licensed to operate in Vietnam);

payments relating to education, training and healthcare activities, including subsidies to other local organisations/individuals; and

other expenses not exceeding 5% of total expenditures.

Decree 164 made advertising expenses deductible up to a maximum of 10% of all deductible expenses (raised from 7%).

Expenses that are not deductible include the following: any not related to earning taxable income; depreciation exceeding normal rates; loss from theft, natural disasters or unidentified causes; bad debts; fines or compensation for breaches of laws and contracts; and losses from disruption to production, regardless of the cause.

There is no general provision on tax deductibility of a company’s expenses. Any application for a tax deduction for expenses must be supported by invoices for all items worth more than D50,000.

Circular 8 of January 2001, which took force on February 2nd 2001, capped deductions on business-management fees charged by the parent company for foreign branches. Moreover, branches may not deduct royalties, fees or payments related to the intellectual property of parent companies, a condition that has irked local law firms. Also not deductible are interest payments on loans from the parent and loans from foreign banks used to help make up the branch’s legal or registered capital. However, Official Letter 2033 dated June 6th 2003 confirmed that expenses incurred overseas may be deducted when determining income subject to CIT. The expenses must be evidenced by complete invoices, payment vouchers, contracts and other relevant source documents and be demonstrated to have been used for the purposes of business activities of the corporate taxpayer in Vietnam.

Tax losses may be carried forward to the following year, to any year over the following five years or spread across that five-year period. These decisions must be made in advance, and careful planning is required to ensure that losses are used effectively along with any tax-holiday entitlements. Tax losses may not be carried back.

All branch-parent transactions must be at market prices. Branches are required to pay tax provisionally, but more implementing regulations are expected on this.

Unless a company obtains the approval of the Ministry of Finance, depreciation rates must be in accordance with Circular 31, dated July 18th 1992.

The circular allows for depreciation of all fixed assets contributed by foreign-invested enterprises or foreign partners, including non-physical fixed assets, which would include fees of compensation and the right to use land, patents and know-how.

Ministry of Finance Official Letter 3352 of December l995 says that foreign-invested enterprises must use the straight-line accounting method of depreciating assets for tax purposes (but see below).

Normal depreciation rates for assets such as buildings, plants, equipment and vehicles depend on the estimated useful life of the asset. Typical life expectancies are 20 years for a hotel, exchange centre or trade centre; 7-15 years for a plant or mill; 5 years for equipment; and 5-7 years for vehicles. Annual depreciation rates are 5-15% for buildings, plants and architectural constructions; 10-25% for machinery and equipment; 15% for measuring and laboratory devices; 10-18% for a means of conveyance; 20-25% for office machinery and equipment; 30% for establishment costs, compensation for relocation, expenditures before production and non-physical fixed assets, such as know-how and patents; and 10-15% for other fixed assets.

The Ministry of Finance may award accelerated depreciation or investment allowances on a case-by-case basis if convinced that the asset in question has technological characteristics that require special treatment. Assets may be revalued if there is any reason to believe that the residual value is lower or higher than the market price (that is, for inflation or when the asset’s utility value has declined comparatively in the market). For inflation, depreciation can be figured from the new asset value, and no tax will apply to the amount of revaluation. The government issued a decision on January 21st 1995 to reinforce this flexible depreciation policy to encourage foreign investors to introduce more-advanced machinery and equipment. However, this decision provides that, unless there is a special arrangement, no company may have a depreciation allowance more than 20 percentage points higher than the government-prescribed level.

Depreciation of fixed assets in accordance with finance ministry regulations can be used as a deductible expense.

The Vietnamese tax year is the same as the calendar year. Corporate income tax must be paid each quarter on a provisional basis, based on the previous quarter’s declaration. It is then adjusted at the end of the year based on the final numbers. A foreign-invested enterprise is expected to file its quarterly declaration within five days of the end of the quarter; payment must occur by the end of the quarter. An annual tax return must be submitted within the first 60 days of the following year. If the actual tax liability is greater than the provisional tax already paid, the difference must be remitted within ten days of the final date for filing the tax return.

Tax losses and a carry-forward projection must be reported immediately after the loss-making year in order to gain entitlement to carry forward those losses. Without a projection plan, the tax authorities will automatically offset the loss against the profits earned in the five years subsequent to the loss on a first-in-first-out basis (as clarified in Official Letter 4825 dated December 20th 2002 from the General Department of Taxation). Audited annual accounts are to be filed within three months of the end of the financial year.

Foreign investors working under business co-operation contracts that have been in force for less than one year must pay corporate tax in two instalments: the first payment takes place on the last day of the mid-term of the contract, and the second on expiry. The timing of the payment of the special sales tax depends on the volume of sales.

Circular 13 of March 2001 imposed stiff penalties for tax evasion or late payment. The fine for tax evasion is five times the amount due, and late payment attracts a daily 0.1% charge. However, as noted above, tax inspectors are often reluctant to assess maximum fines in some circumstances.

Personal income tax on regular income is finalised annually, but it must be deducted and paid provisionally on actual monthly income. Employers must file monthly returns and pay tax on employees’ income by the 15th of the following month. Payments are reconciled at year-end, when any outstanding amounts are settled. Any rebates are credited against future tax liabilities. All returns must be filed by February 28th, or within 30 days of terminating a contract. If a foreigner leaves Vietnam permanently, tax calculations are finalised one month before departure.

Circular 13 requires all foreign firms to pay tax in Vietnamese dong, even if their income is largely in foreign currency. This codifies what is already a very common practice, but one that might inconvenience some firms.

In November 2001 the government released a draft of a proposed asset tax for organisations and individuals, and the General Department of Taxation mentioned it again in June 2003. Nevertheless, there had been no further mention of the issue by April 2006.

Gains by foreign companies on the transfer of interests in a foreign-invested or Vietnamese enterprise (“capital assignment”) are subject to a flat tax of 25%. The taxable gain is determined as the excess of the sales proceeds less cost, less transfer expenses. The application of this tax is limited to changes of direct ownership of foreign-invested enterprises. Transfers of capital to state-owned enterprises are exempt, and transfers to Vietnamese enterprises are taxed at 12.5% (but under Decree 164 of December 2003, a 50% tax reduction is available for income generated from the transfer by a foreign investor of his/her equity to a Vietnamese enterprise).

The rules covering tax on capital transfers and capital gains for foreign-invested enterprises and joint ventures were clarified in Ministry of Finance Circular 13 of March 2001 and in General Department of Taxation Official Letter 448 of February 2001. Official Letter 11684 of September 16th 2005 removed inconsistencies related to the treatment of assignment of capital or shares held in domestic enterprises. The initial value of assigned capital is subtracted from income earned from the assignment in determining taxable income, and the corporate income tax rate applicable to the assignment is the same as that applicable to the principal business activity of the domestic enterprise whose capital or shares are assigned. If the domestic enterprise in question engages in several different business activities subject to different corporate income tax rates, it remains unclear which rate will apply.

Profits earned by foreign investors in Vietnam and transferred abroad or retained outside Vietnam (remittances) have not been subject to withholding tax since January 1st 2004.

Dividends earned by individual foreign investors remain exempt from personal income tax under Official Letter 4708 dated May 23rd 2001.

Under Circular 169, a 10% withholding tax on interest payments on offshore loans took force from January 1st 1999. This applies only to loans taken out after January 1st. Nevertheless, interest payments can be exempt where bilateral treaties apply.

A foreign company transferring industrial-property rights as part of a licensing agreement must pay a 10% tax on royalties. But if the transfer of patents, technical know-how, technology processes or technical services is used as part of the capital contribution of a foreign-invested enterprise, there is no tax related to the technology transfer. (This was reconfirmed under Decree 164 of December 2003, and it is not affected by Decree 11 on technology transfers, which took force on March 2nd 2005; see Licensing.)

Branches may not deduct royalties, fees or payments related to the intellectual property of parent companies, which has particularly irked local law firms. This rule has only limited effect, however, since only banks, law firms and tobacco companies now use branch structures.

Circular 8 of January 2001, which came into force on February 2nd 2001, allows a Vietnamese branch to claim business-management fees paid to its parent company as a tax-deductible expense.

Vietnam has concluded double-taxation agreements with 41 countries (see the table below). An agreement has been signed but not ratified with Mauritius. Vietnam is also negotiating tax treaties with several other countries, including Morocco, New Zealand and Slovakia. A draft multilateral treaty that would harmonise double-tax arrangements across the ten-member Association of South-East Asian Nations (ASEAN) was prepared in 2002 but, by April 2006, had not yet achieved sufficient ratifications by member countries to take force. Negotiations with the United States on a double-tax agreement were continuing in April 2006 in the broader context of ongoing bilateral negotiations on the terms of Vietnam’s World Trade Organisation accession.

Circular 133 of December 31st 2004, which took force on February 1st 2005, updated guidelines for implementing double-tax agreements that were first issued in December 2004 for direct taxes levied on income and revenues of foreign individuals and business enterprises generated in Vietnam. However, foreign investors may be disappointed if they were hoping that the new guidelines would make the process for seeking relief from double taxation less onerous and time-consuming. Considerable documentary evidence is still required: a copy of the foreign income tax declaration; original proof of overseas tax payment; and confirmation from foreign tax authorities of taxes paid. Moreover, tax officials still have the right to request additional documentation at their discretion. In addition, there is no change to the requirement that a firm applying for relief must pay its local obligations upfront and then request and wait for a refund.

A difficulty in applying double-tax agreements is determining the taxpayer’s residency. The length of stay, the main focus of business interest and the country of citizenship continue to determine the residence of the taxpayer. For a corporation, where the business actually operates is important. Double taxation applies where an individual is considered to be living or operating in two countries. A foreign company that has a permanent office in Vietnam should pay tax on the income it earns in Vietnam. Companies earning income from sea transport or aviation services pay taxes only in the home country. Revenues from the transfer of assets are subject to double taxation. However, certain revenues remain subject to tax payment in the country where the transaction actually takes place.

Ministry of Finance Circular 37 of 2000, still in effect in April 2006, stipulated that foreign enterprises are subject to Vietnamese tax law if their income is derived through its resident office or through business activities conducted on the basis of a contract signed between the foreign enterprise and a Vietnamese organisation or individual.

[Table]

Withholding-tax rates under tax treaties(a (%))
Country	Dividends(b)	Interest	Royalties
Australia	10	10	10
Belarus	15	10	15
Belgium	5/10/15	10	5/10/15
Bulgaria	15	10	10
Canada	5/10/15	10	10
China	10	0/10	10
Czech Republic	10	0/10	10
Denmark	5/10/15	0/10	5/15
Finland	5/10/15	10	10
France	7/10/15	–(c)	10
Germany	5/10/15	0/10	10
Hungary	10	10	10
Iceland	10/15	10	10
India	10	0/10	10
Indonesia	15	15	15
Italy	5/10/15	10	10
Japan	10	0/10	10
Laos	10	10	10
Luxembourg	15	10	10
Malaysia	10	0/10	10
Mongolia	10	0/10	10(d)
Netherlands	5/7/15	0/74	5/10/15(d)
Norway	5/10/15	0/10	10
Philippines	15	15	15
Poland	10/15	10	10/15
Russia	10/15	10	15
Romania	15	10(d)	15
Singapore	5/7/12.5	0/10(d)	5/15
South Korea	10	0/10	5/15
Sweden	5/10/15	0/10	5/15
Switzerland	7//10/15	0/10	10
Taiwan	15	10	15
Thailand	15	0/10/15	15(d)
Ukraine	10	10	10
United Kingdom	7/10/15	0/10	10(d)
Uzbekistan	15	0/10	15
(a) Rate information was not available for Bangladesh, Egypt, North Korea, Pakistan or Spain. (b) Where more than one rate appears, the actual tax is determined by the category of the company receiving the payment–except for Australian dividends, where 10% applies to companies receiving dividends in Australia and 15% to firms in Vietnam. (c) Withholding tax rate under French law applies. (d) Most-favoured-nation provisions require a re-negotiation of withholding rates in specified circumstances.
Sources: International Bureau of Fiscal Documentation; Economist Intelligence Unit research.

Management fees to a parent company should be included under licence payments.

Circular 8 of January 2000 allows a Vietnamese branch to claim business-management fees paid to its parent company as a tax-deductible expense. The deduction is capped according to a formula: the ratio of the foreign branch’s income to the parent company’s total income, expressed as a fraction, is multiplied by the total business management fees charged by the parent company worldwide. This sets the maximum amount of fees that can be deductible; it aims to prevent the Vietnamese branch from claiming that it pays fees that are disproportionate to the parent’s practice worldwide.

The rules in Circular 8 continue to run counter to those of Circular 13 of 2001, which ruled that the management costs incurred by foreign parent companies are not deductible expenses of the local enterprise. Circular 13 is lent support by Official Letter 389 of 2002 from the Ministry of Finance to Diethelm Vietnam, a foreign-invested tourism-services company. The letter ruled that the management fees of a parent company will not be brought to account as deductible expenses for calculating business income tax unless Diethelm Vietnam and its parent company had entered into a management contract to provide consultancy and management services to Diethelm Vietnam. Circular 13 had imposed remittance tax in certain circumstances, but the remittance tax was abolished as from January 1st 2004.

On July 9th 2002 the General Department of Taxation issued Official Letter 2559, reiterating that the financial support provided by a parent company to a subsidiary in Vietnam is not subject to value-added or business income taxation. However, the expenses covered by this financial support are not tax deductible. Thus, if the Vietnamese company has already claimed a deduction for these expenses, the support received would be taxable.

Income from all auxiliary companies under the head office is included in the latter’s total income for tax purposes.

A value-added tax (VAT) replaced Vietnam’s turnover tax, with its 11 separate tax rates, on January 1st 1999. The government subsequently tinkered with the VAT system in a steady flow of circulars, official letters and amendments. Beginning on January 1st 2004, the highest rate of VAT (20%) was eliminated, and VAT is now levied at only three levels: a standard rate of 10%, and reduced rates of 0% and 5%. All items previously covered by the 20% rate are now covered by the 10% rate. The amendment of the VAT Law of October 2000, which the National Assembly approved in May 2003, also stipulates that 28 commodities previously subject only to special consumption tax (see below) are also now subject to VAT.

Beginning on October 1st 2002 under Decree 76, the deemed input-VAT deduction was reduced to a flat 1% rate (from 2-3%) for all qualifying items, including: (1) unprocessed agricultural, forestry and fishery products purchased directly from manufacturers without invoices and soil, sand, rock, gravel and scraps of all kinds; (2) goods and services purchased from taxpayers who are VAT-direct-method taxpayers; (3) unprocessed agricultural, forestry and fishery products purchased from producers who issue VAT invoices but whose goods are VAT exempt; (4) goods subject to special sales tax purchased by traders from manufacturers; and (5) insurance indemnity paid by insurance companies. Under the same decree, payment must now be settled via banks as a mandatory condition for VAT reimbursement on zero-rated exported goods and certain services.

Under Official Letter 3437 of September 12th 2002, services provided by a Vietnamese enterprise for a foreign client that are used overseas remain VAT exempt, but only if payment of the service fee is settled through a bank.

The VAT is broadly applied, although there are now roughly 30 categories of exemption. Four new categories of exemption were added on January 1st 2004: tramcars, lotteries, commodity exports and the export of services, including banking, finance and insurance. Other VAT-exempt categories include stock-exchange activities, certain kinds of imports (see below), technology transfer, local sales of software products and services, services provided to consumers and firms outside Vietnam, and a range of exemptions relating to firms in export-processing zones (EPZs; see below), and (beginning August 18th 2004) registration and insurance services for international means of transport.

The three rates of VAT are as follows:

the 0% rate applies to export goods subject to special sales tax (see below), exports of software, services to firms operating in EPZs (with fewer restrictions since August 2004; see below), goods processed by sub-contractors and goods sold by a foreign-invested enterprise to a foreign customer but delivered in Vietnam; and construction and installation activities for construction projects abroad;

the 5% rate applies to around 41 groups of goods and services, including coal, machinery, metallurgy products, moulds, chemicals, computers and accessories, dynamite, tyres and inner tubes, welding sticks, construction and installation service, equipment and transport repair services, registration services for means of transport and communication, and industrial concrete products. Since January 1st 2004 several goods previously assessed at 10% are now 5%. These include turpentine, sugar, sugarcane, drinking water, fertiliser, pesticides, medical equipment, pharmaceutical products, toys, unprocessed farm produce and forestry products, computers and disks;

the 10% rate applies to 16 specific categories of goods and services, and a 17th catch-all group defined as any good or service not subject to the other two rates. Since January 1st 2004 trade in gold, silver and gems, shipping agents, brokerage services, four-seat vehicles, petroleum, gas, electronics, home electric appliances, fabric, garments, construction, installation, postal, telecommunications, consultancy, accounting, tourism and shipping services are also assessed at 10% (these categories were previously assessed at the now abolished 20% rate).

Imports for the purposes of relief, non-refundable aid and technology transfer are not subject to VAT. A 50% reduction in VAT remains available for computers, construction and installation activities, basic chemical products, transport and stevedoring services, and certain mechanical products and metallurgical products.

VAT may sometimes be levied on official development assistance (ODA), but most projects affected can get a 100% VAT deduction. However, a July 2002 decision restricted the application of exemption from VAT (and import duty) to goods imported only by owners of “non-refundable” ODA. Hence, organisations providing ODA in the form of credits and loans are no longer free of VAT and duty.

VAT is payable on imports at the cif price plus import duty, and importers are responsible for declaration and payment. General Department of Customs Official Letter 1266 of April 3rd 2001 exempts VAT on the following imports: capital equipment import items for use in the oil and gas industry that are not produced locally; films, books, newspapers and pictures; weapons for national defence and security purposes; humanitarian donations and gifts; goods sold in duty-free shops; goods in transit; and raw materials imported for processing goods for export.

Foreign investors should note that importers must pay the 10% VAT immediately, although it is refunded once the goods are sold. Nevertheless, this ties up importers’ capital for a period of time. In addition, the amendments to VAT law that entered into force on January 1st 2004 also tightened regulations for procedures to obtain VAT refunds–for example, requiring businesses to carry out transactions through the banking system–to prevent fraud in reimbursements.

Special VAT rules apply for companies in export-processing zones (EPZs). Such firms, also known as export-processing enterprises (EPEs), do not pay VAT on imports; there is no withholding tax on services from foreign companies; and sales of goods from local companies (so-called “in country” exported goods) are zero-rated. After a firestorm of protest by foreign investors, Decree 148 of July 23rd 2004, which took force on August 16th, and implementing Circular 84 of August 18th 2004, restored a zero-rate VAT to services rendered to EPEs. The following goods and services sold to EPEs and to EPZs are now subject to zero-rate VAT: accounting; auditing; banking; consulting; insurance; leasing of offices, houses and warehouses; posts; telecommunications; transport and warehousing; consumer goods and services for employees; and petroleum sold to means of transport. VAT was previously assessed at 5% or 10%. Since January 1st 2004 firms in EPZs have been exempt from taxes on imports of services and commodities from abroad that are demonstrably “export-related”, though some firms experienced troubles in 2004 with effective enforcement of this principle.

Contractors who construct or install equipment for companies in EPZs are still considered exporters and do not need to charge VAT. Goods or services bought by EPEs for use in the domestic market (such as food, petrol, leasing meeting rooms or residential housing) or for their employees’ personal use (like food, electricity, consumer goods or housing) are still subject to VAT.

Another special case is financial leasing, a practice whose regulation is still evolving. VAT is payable on all financial leases and applies to lease contracts signed on or after January 1st 1999–though lease payments, commitment fees and the sale of assets at the end of the lease term are not subject to VAT. However, under a July 11th 2002 decision, leasing by a foreign leasing firm to a foreign-invested enterprise is no longer subject to VAT (though it is subject to 10% business income tax on net profits). In addition, if the leased equipment is on the list of equipment exempt from import tax, no import tax will be imposed.

Since a financial-leasing company has no revenue subject to VAT, it may not claim any input credits on costs incurred. Importantly, this includes the VAT paid on the import, or local purchase, of the leased asset. The lessee must repay the VAT paid on import or purchase to the leasing company in six monthly instalments over the term of the lease. The leasing company invoices for this notional VAT; moreover, if the lessee is a taxable business, it can claim an input credit for the VAT repaid. The effect of this is to increase the cost of leasing compared with outright purchase. (Under financial leases, the recovery of the input credit for the leased asset must effectively be spread over the life of the lease, whereas in an outright purchase, the buyer may claim the full input credit upfront.) For lessees that cannot claim full input credits, leasing will be disadvantageous if they might otherwise have claimed the VAT exemption on the import of the asset.

If foreign contractors use the Vietnamese Accounting System, they may use the VAT-deduction method. If not, they will be subject to the regular business income tax and VAT at specified rates on their taxable turnover. Various rates are specified, depending on the nature of the service. In Official Letter 465 dated December 6th 2002, the General Department of Taxation (GDT) determined that foreign contractors who do not register for Vietnamese accounting standards are subject to business income tax at a 2% rate, though this applies only to manufacturing, transport and construction activities (including survey, design and supervision in connection with construction activities).

A special consumption tax (SCT), also known as the special sales tax (SST), is levied on goods such as cigarettes, alcohol, spirits and beer, vehicles with fewer than 24 seats, petrol, playing cards, joss paper and some air conditioners. There is also an excise tax on some services, including dancing, massage, karaoke, casino, jackpot machine games, certain betting activities and golf. The tax also applies to imports of these goods and services, at rates of 15-100%, based on the cif price (the actual purchase price at destination, plus insurance and freight costs). The SST rates applicable to vehicles were lowered on January 1st 2006; the exact rate depends on the size of the vehicle. Rates were equalised for locally-made and imported vehicles on March 31st 2005, ending previous discrimination against imports, and the time limit for submissions of SST declaration was extended to 60 days from the end of the calendar year (previously 45 days).

Stated intentions to simplify, reduce or phase out the SST over the next few years seem to have disappeared as changes to SST provisions have instead continued and not gone uniformly in one direction or the other. All SST goods and services (with a few exceptions) have also been subject to standard 10% VAT since January 1st 2004; the taxable price is the selling price plus the SST. Beginning January 1st 2006 plant and animal products, aquaculture and unprocessed/untreated sea products are no longer subject to VAT, and pre-treated cotton is subject to a reduced VAT rate of 5%.

There are taxes on imports and exports of a range of goods. Foreign airlines operating from Vietnam are taxed under Circular 169 of 1998. The oil industry has also operated under a specialised tax regime since July 2001. The 28% corporate income tax rate does not apply to exploration and exploitation of oil and gas; these projects are subject to rates of 28-50%, depending on the particular project.

Employers must contribute 15% of their employees’ total salary to the Social Insurance Fund.

Interest-rate swaps and foreign-exchange options are still new instruments in Vietnam, so taxation policies are still in flux. The General Department of Taxation has proposed that interest-rate swaps and foreign-exchange options be exempt from VAT, while suggesting that corporate income tax consist of a specified fixed amount deducted from the contracts that banks sign with customers. This would provide incentives for the new practice, but no action had yet been taken in April 2006. The Ministry of Finance clarified in October 2004 that there were currently no taxes assessed on either type of financial instrument.

EIU ViewsWire. New York: Apr 28, 2006.

Vietnam: Investment regulations

Vietnam: Investment regulations

Despite more than two decades of market reforms, Vietnam remains a difficult business environment. Relative political and economic stability must be weighed against poor physical infrastructure, government red tape and corruption, unevenness of skills and other obstacles to foreign investment.

The regulatory framework for foreign investment remains highly restrictive in Vietnam; it places major limits on the industries in which foreign investors may operate, the structure of their investment vehicles, their ability to finance their operations and their capacity to respond to changes in economic circumstances. Continued signs of progress in liberalising this regime materialised in 2005. On September 29th, for example, the prime minister issued Decision 238, increasing the cap on total foreign shareholdings in traded Vietnamese enterprises from 30% to 49%, with effect from October 10th. The Ministry of Finance’s implementing Circular 90 of October 17th 2005 clarified the terms of Decision 238. The looser cap of 49% applies to companies listed at the Ho Chi Minh City Securities Trading Centre and those registered for trading at the Hanoi Securities Trading Centre. The circular stipulates that the new 49% cap applies to the total investment-fund certificates that have been listed or registered for trading by a securities investment fund. Decision 238 also specifies that, with respect to foreign-invested shareholding companies (FISCs), the 49% cap applies only to other foreign firms’ purchase of the publicly-listed portion of such firms’ shares.

Decision 238 and Circular 90 continue to allow foreign investors to purchase an unlimited percentage of the bonds issued by any firm; the previous cap of 40% was lifted in mid-2003. Foreign securities-trading organisations are still allowed to purchase up to 49% of the charter capital of a joint-venture securities company or securities investment fund-management agency, as first specified in mid-2003.

In November 2005 the National Assembly adopted the new Laws on Enterprise and Investment required for Vietnam’s accession to the World Trade Organisation, which is expected by end-2006. The two new laws, which will take force on July 1st 2006, consolidate basic regulations for foreign, domestic private, and state-owned enterprises, replacing the separate laws that regulated each (the 1996 Law on Foreign Investment, the 2000 revised Law on Foreign Investment and the 1998 Law for Promoting Domestic Investment).

The Law on Investment ensures that foreign investors continue to enjoy the privileges written into their investment licences if and when laws or policies are changed; they are guaranteed that any special incentives for which they are eligible will be written into these investment licences. Firms may be compensated by the government for losses incurred because of such changes through one of four means: tax deductibility of incurred losses (available previously); continuation of the incentives for a designated period; change of the operational objective of the project; or payment of compensation. The requirement that each of a firm’s investment projects in different sectors be registered separately (now governed by the Law on Enterprise) and approved separately (now governed by the Law on Investment) remains, and poses burdens on foreign investors. Implementing regulations are expected to clarify certain aspects of the two laws before they enter into force on July 1st.

In principle, Law 20 of June 15th 2004 has allowed 100%-foreign-owned banks since October 1st 2004 (six years earlier than the date by which it was committed to do so under the United States-Vietnam Free-Trade Agreement). Foreign credit institutions were previously permitted to set up only joint-venture (JV) banks, branches or representative offices, and JV or 100%-foreign-owned non-banking institutions. However, Decree 22 of February 2006 set out somewhat more specific terms for creating 100%-foreign-owned banks and liberalising operations by JV banks and foreign bank branches (see Capital sources overview).

Law 20 also allowed foreign credit institutions to contribute capital to and purchase shares in joint-stock commercial banks (JSCBs). But no definitive implementing regulations had been released by April 2006; a September 2005 draft, still under discussion in April, would increase the cap of the stake of any foreign organisation or individual in a JSCB from 10% to 30% and maintain the existing cap on total foreign shareholdings at 30% of charter capital. Interim regulations for the JSCB provisions of Law 20 were provided by State Bank of Vietnam (SBV) Decision 787 of June 2004. The decision stipulates that SBV approval must be obtained in order for a JSCB to apply to the State Securities Commission for permission to list shares and conduct a public offering. Under this provisional, case-by-case regime, the SBV has granted approval to only one foreign bank to buy shares in a Vietnamese bank (ANZ Bank’s purchase of a 10%, US$27m, stake in Sacombank in March 2005). Several other applications have remained pending for more than a year.

Government Decision 260 of May 2002 simplified procedures for investing in a wide variety of local joint-stock companies. The measure allows foreign ownership in non-state enterprises in 35 designated industries, including agriculture, forestry and fisheries, science and technology, education and medicine. It also instituted a simple local registration procedure to replace the burdensome requirement of approval from the prime minister.

Decree 27 of March 2003 amended Decree 26 of 2000 on Implementation of the Law on Foreign Investment. Among other things, Decree 27 scrapped the 20% cap on capital contribution in the form of technical transfers and eased preferential licensing conditions for firms that export more than 80% of their products (previously 100%) or manufacturing firms with capital of up to US$40m. These provisions will continue to apply under the new Investment Law that takes force on July 1st 2006, unless rescinded or modified by any future implementing regulations (none had yet been issued for the law in April 2006).

Since October 2003 domestic and foreign investors have been allowed to build electricity plants in Vietnam with capacities of less than 100 mw, and sell energy directly to local customers. The state-owned Electricity of Vietnam retains its monopoly only over power transmission and construction of plants of more than 100 mw. US telecommunications firms have gained further access to the Vietnamese market through joint ventures with Vietnamese partners with up to 49% foreign ownership in the following sectors: value-added telecom services such as e-mail, voice mail, Internet data searching and online information processing (from December 2003); Internet services (December 2004); basic telecom services such as mobile communications (December 2005); and operation of fixed telecom services (2007). These liberalisation measures were mandated under the US-Vietnam free-trade agreement. Majority- or wholly-owned foreign-invested enterprises (FIEs) remain illegal in the telecoms sector. Non-US FIEs in telecoms are still limited to business co-operation contracts (BCCs), in which foreign firms develop the telecom infrastructure and local partners provide telecom services.

Foreigners bought more than 6m shares and sold more than 2m shares on the Vietnamese stockmarket in 2005. On September 29th the prime minister issued Decision 238, increasing the cap on total foreign shareholdings in traded Vietnamese enterprises from 30% to 49%, with effect from October 10th. The Ministry of Planning and Investment (MPI) signed Decision 260, with effect from May 25th 2002, listing sectors in which foreigners may buy shares in non-state-owned companies without approval from the prime minister. The sectors are organised into five groups: (1) agriculture, forestry and fisheries; (2) processing industries; (3) tourism, hotels and restaurants; (4) transport and telecommunications; and (5) science, technology, healthcare and education. Circular 121 of December 12th 2003 also allowed foreign investors to buy unlimited volumes of bonds issued by a listed firm (although the cap for convertible bonds is 30% when they are converted into shares). Circular 121 also permits foreign investors to hold a 49% stake in a securities joint venture or a fund-management joint venture.

The government created a Foreign Investment Agency (FIA) in July 2003, which comes under the purview of the Ministry of Planning and Investment. In March 2006 it was still operating only two investment-promotion centres, in Ho Chi Minh City (for southern Vietnam) and Da Nang (for the northern provinces).

Foreign direct investment (FDI) is measured in terms of both registered capital (a minimum value of newly committed capital nominated by foreign firms that receive a licence) and disbursed capital (the amount of capital that foreign-invested firms spend in implementing and expanding already approved projects). Vietnam attracted US$5.8bn in FDI in 2005, of which almost US$4bn came from 771 newly licensed FDI projects. This was the largest expansion of FDI since the mid-1990s, 25% higher than in 2004 and 29% above the annual goal of $4.5bn. FDI created about 14.3% of Vietnam’s total GDP for 1998-2004, according to the most recent available data from the MPI. The government aims to attract up to US$9bn per year in FDI in 2006-10.

By end-2005, there were 6,030 operational FDI projects with a registered capital US$51.07bn in Vietnam, according to the MPI. Industry and construction accounted for 67.2% of total FDI projects, 60.8% of registered capital and 69.5% of total disbursed FDI capital. Services accounted for 19.7% of projects, 31.8% of approved capital and 24% of disbursed capital. Agriculture accounted for 13.1% of projects, 7.4% of approved capital and 6.5% of disbursed capital.

Industrial zones (IZs), including export-processing zones (EPZs), accounted for almost half of all new foreign investment commitments in Vietnam in 2005, attracting 305 new foreign-invested projects worth US$1.82bn, according to the MPI. Ongoing projects within IZs received additional foreign capital of US$1.03bn, representing 60% of total FDI disbursements in the country. In 2005 the government approved the establishment or expansion of 20 IZs. In total, there were 130 approved IZs in April 2006, though only 75 were in operation at that time. IZs accounted for almost 30 % of the country’s industrial production in 2005, a jump of over 25% compared with 2004.

Official figures have given the impression that US investors have been slow to invest in Vietnam compared with those from other nations. However, a report prepared in late 2005 by the MPI’s Foreign Investment Agency (FIA), in co-operation with the US Agency for International Development (USAID)-funded STAR-Vietnam Project, found that US investment has been vastly understated because much of it takes place through overseas subsidiaries of corporations based in the US, particularly those in Hong Kong, Singapore, and Japan (and investment from these latter countries consequently overstated). The report, which provides data through end-2004, found that accumulated “US-related” FDI (sourced from both home offices and overseas subsidiaries of US corporations) was US$2.6bn, more than three times the official figures (which are based only on the proximate source of FDI). By this measure, US accumulated FDI would have ranked first in Vietnam by end-2004 rather than 11th, constituting nearly 20% of the total. In addition, the report found that US-related direct investment grew at a healthy rate of 27% per year in 2002-04, following the 2001 entry into force of the bilateral trade agreement. The February 2006 granting of a licence for a US$600m investment by Intel, a chipmaker, and the prospect of Vietnamese accession to the WTO may give an additional stimulus to US investment. According to the US Department of Commerce, US investment in Vietnam had a profitability rate of 11.2% in 2004, a significant increase from 7.8% in 2003.

EIU ViewsWire. New York: Apr 28, 2006.

The World’s Most Innovative Companies

It was a fitting way to wrap up the first day of IBM’s (IBM ) innovation-themed leadership forum, held in Rome in early April. Guests were treated to small group tours of the Vatican Museum, including Michelangelo’s frescoes in the Sistine Chapel. They sipped cocktails on a patio in the back of St. Peter’s, the vast dome of the basilica outlined by the light of the moon. They dined in a marble-statue-filled hall inside the Vatican. What better place than Italy to hold a global confab on innovation, the topic di giorno among corporate leaders? It was, after all, the birthplace of the Renaissance, another period of great innovation and change.

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The next day, at the Auditorium Parco della Musica, 500-odd corporate executives, government leaders, and academics listened as a diverse group of innovative leaders took the stage. Sunil B. Mittal, chief executive officer of Indian telecom company Bharti Tele-Ventures Ltd., described his radical business model, which outsources everything but marketing and customer management, charges 2 cents a minute for calls, and is adding a million customers a month. Yang Mingsheng, CEO of Agricultural Bank of China, the country’s second-biggest commercial bank, spoke of building a banking powerhouse from a modest business making micro loans to peasant farmers.

Their stories echoed a comment IBM CEO Samuel J. Palmisano had made the day before: “The way you will thrive in this environment is by innovating — innovating in technologies, innovating in strategies, innovating in business models.”

Palmisano, to be sure, was making a subtle pitch for IBM and its ability to help the assembled leaders do well in an increasingly challenging business environment. But he also summed up the broad focus of innovation in the 21st century.

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Today, innovation is about much more than new products. It is about reinventing business processes and building entirely new markets that meet untapped customer needs. Most important, as the Internet and globalization widen the pool of new ideas, it’s about selecting and executing the right ideas and bringing them to market in record time.

In the 1990s, innovation was about technology and control of quality and cost. Today, it’s about taking corporate organizations built for efficiency and rewiring them for creativity and growth. “There are a lot of different things that fall under the rubric of innovation,” says Vijay Govindarajan, a professor at Dartmouth College’s Tuck School of Business and author of Ten Rules for Strategic Innovators: From Idea to Execution. “Innovation does not have to have anything to do with technology.”

THE QUICK AND THE BLOCKED
To discover which companies innovate best — and why — BusinessWeek joined with The Boston Consulting Group to produce our second annual ranking of the 25 most innovative companies. More than 1,000 senior managers responded to the global survey, making it our deepest management survey to date on this critical issue.

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The new ranking has companies evoking all types of innovation. There are technology innovators, such as BlackBerry maker and newcomer Research In Motion Ltd. (RIMM ), which makes its debut on our list at No. 24. There are business model innovators, such as No. 11 Virgin Group Ltd., which applies its hip lifestyle brand to ho-hum operations such as airlines, financial services, and even health insurance. Process innovators are there, too: Rounding out the ranking is Southwest Airlines Co. (LUV ) at No. 25, a whiz at wielding operational improvements to outfly its competitors.

At the top of the list are the masters of many genres of innovation. Take Apple Computer Inc. (AAPL ), once again the creative king. To launch the iPod, says innovation consultant Larry Keeley of Doblin Inc., Apple used no fewer than seven types of innovation. They included networking (a novel agreement among music companies to sell their songs online), business model (songs sold for a buck each online), and branding (how cool are those white ear buds and wires?). Consumers love the ease and feel of the iPod, but it is the simplicity of the iTunes software platform that turned a great MP3 player into a revenue-gushing phenomenon.

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Toyota Motor Corp., which leapt 10 spots this year to No. 4, is becoming a master of many as well. The Japanese auto giant is best known for an obsessive focus on innovating its manufacturing processes. But thanks to the hot-selling Prius, Toyota is earning even more respect as a product innovator. It is also collaborating more closely with suppliers to generate innovation. Last year, Toyota launched its Value Innovation strategy. Rather than work with suppliers just to cut costs of individual parts, it is delving further back in the design process to find savings spanning entire vehicle systems.

The BusinessWeek-BCG survey is more than just a Who’s Who list of innovators. It also focuses on the major obstacles to innovation that executives face today. While 72% of the senior executives in the survey named innovation as one of their top three priorities, almost half said they were dissatisfied with the returns on their investments in that area.

The No. 1 obstacle, according to our survey takers, is slow development times. Fast-changing consumer demands, global outsourcing, and open-source software make speed to market paramount today. Yet companies often can’t organize themselves to move faster, says George Stalk Jr., a senior vice-president with BCG who has studied time-based competition for 25 years. Fast cycle times require taking bets even when huge payoffs aren’t a certainty. “Some organizations are nearly immobilized by the notion that [they] can’t do anything unless it moves the needle,” says Stalk. In addition, he says, speed requires coordination from the hub: “Fast innovators organize the corporate center to drive growth. They don’t wait for [it] to come up through the business units.”

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Indeed, a lack of coordination is the second-biggest barrier to innovation, according to the survey’s findings. But collaboration requires much more than paying lip service to breaking down silos. The best innovators reroute reporting lines and create physical spaces for collaboration. They team up people from across the org chart and link rewards to innovation. Innovative companies build innovation cultures. “You have to be willing to get down into the plumbing of the organization and align the nervous system of the company,” says James P. Andrew, who heads the innovation practice at BCG.

Procter & Gamble Co. (PG ) (No. 7) has done just that in transforming its traditional in-house research and development process into an open-source innovation strategy it calls “connect and develop.” The new method? Embrace the collective brains of the world. Make it a goal that 50% of the company’s new products come from outside P&G’s labs. Tap networks of inventors, scientists, and suppliers for new products that can be developed in-house.

The radically different approach couldn’t be shoehorned into managers’ existing responsibilities. Rather, P&G had to tear apart and restitch much of its research organization. It created new job classifications, such as 70 worldwide “technology entrepreneurs,” or TEs, who act as scouts, looking for the latest breakthroughs from places such as university labs. TEs also develop “technology game boards” that map out where technology opportunities lie and help P&Gers get inside the minds of its competitors.

To spearhead the connect-and-develop efforts, Larry Huston took on the newly created role of vice-president for innovation and knowledge. Each business unit, from household care to family health, added a manager responsible for driving cultural change around the new model. The managers communicate directly with Huston, who also oversees the technology entrepreneurs and managers running the external innovation networks. “You want to have a coherent strategy across the organization,” says Huston. “The ideas tend to be bigger when you have someone sitting at the center looking at the company’s growth goals.”

ASKING THE RIGHT QUESTIONS
Coordinating innovation from the center is taken literally at BMW Group (BMW ), No. 16 on the list. Each time BMW begins developing a car, the project team’s members — some 200 to 300 staffers from engineering, design, production, marketing, purchasing, and finance — are relocated from their scattered locations to the auto maker’s Research and Innovation Center, called FIZ, for up to three years. Such proximity helps speed up communications (and therefore car development) and encourages face-to-face meetings that prevent late-stage conflicts between, say, marketing and engineering. In 2004 these teams began meeting in the center’s new Project House, a unique structure that lets them work a short walk from the company’s 8,000 researchers and developers and alongside life-size clay prototypes of the car in development.

For many companies, cross-functional collaborations last weeks or months, not years. Southwest recently gathered people from its in-flight, ground, maintenance, and dispatch operations. For six months they met for 10 hours a week, brainstorming ideas to address a broad issue: What are the highest-impact changes we can make to our aircraft operations?

The group presented 109 ideas to senior management, three of which involve sweeping operational changes. One solution about to be introduced will reduce the number of aircraft “swaps” — disruptive events that occur when one aircraft has to be substituted for another during mechanical problems. Chief Information Officer Tom Nealon says the diversity of the people on the team was crucial, mentioning one director from the airline’s schedule planning division in particular. “He had almost a naive perspective,” says Nealon. “His questions were so fundamental they challenged the premises the maintenance and dispatch guys had worked on for the last 30 years.”

Managers are scrambling to come up with ways to measure and raise the productivity of their innovation efforts. Yet the BusinessWeek-BCG survey shows widespread differences over which metrics — such as the ratio of products that succeed, or the ROI of innovation projects — should be used and how best to use them. Some two-thirds of the managers in the survey say metrics have the most impact in the selection of the right ideas to fund and develop. About half say they use metrics best in assessing the health of their company’s innovation portfolio. But as many as 47% said measurements on the impact of innovation after products or services have been launched are used only sporadically.

Actually, most managers in the survey aren’t monitoring many innovation metrics at all; 63% follow five gauges or fewer. “Two or three metrics just don’t give you the visibility to get down to root causes,” says BCG’s Andrew. Then there are companies that track far too many. Andrew says one of the top innovators on our list — he’s mum as to which one — collects 85 different innovation metrics in one of its businesses. “That means they manage none of them,” he says. “They default to a couple, but they spend an immense amount of time and effort collecting those 85.”

The sweet spot is somewhere between 8 and 12 metrics, says Andrew. That’s about the number that Samsung Electronics Co. uses, says Chu Woosik, a senior vice-president at the South Korean company. Chu says the most important metrics are price premiums and how quickly they can bring to market phones that delight customers. Samsung also watches the allocation of investments across projects and its new-product success ratio. That, Chu says, has nearly doubled in the last five years. “You want to see it from every angle,” he says. “A lot of companies fall into the trap that they thought things were really improving, but in the end, it didn’t work out that way. We don’t want to make that mistake.”

AWARDS AND ETHNOGRAPHY
One of the biggest mistakes companies may make is tying managers’ incentives too directly to specific innovation metrics. Tuck’s Govindarajan warns that linking pay too closely to hard innovation measures may tempt managers to game the system. A metric such as the percentage of revenue from new products, for instance, can lead to incremental brand extensions rather than true breakthroughs. In addition, innovation is such a murky process that targets are likely to change. “There’s a dialogue that needs to happen,” says Govindarajan. “Operating plans may need to be reviewed, or you may need to change plans because a new competitor came into your space.”

Susan Schuman, CEO of Stone Yamashita Partners, which works with CEOs on innovation and change, says that besides numbers-driven metrics, some clients are adding subjective assessments related to innovation, such as a manager’s risk tolerance, to performance evaluations. “It’s not just about results,” she says. “It’s how did you lead people to get to those results.”

That’s one reason the bastion of Six Sigma-dom, General Electric Co. (GE ), has begun evaluating its top 5,000 managers on “growth traits” that include innovation-oriented themes such as “external focus” and “imagination and courage.” GE has also added more flexibility into its traditionally rigid performance rankings. GE will now have to square its traditional Six Sigma metrics, which are all about control, with its new emphasis on innovation, which is more about managing risk. That’s a major change in culture.

How do you build an innovation culture? Try carrots. Several companies on our list have formal rewards for top innovators. Nokia Corp. (NOK ) inducts engineers with at least 10 patents into its “Club 10,” recognizing them each year in a formal awards ceremony hosted by CEO Jorma Ollila.

3M (MMM ) has long awarded “Genesis Grants” to scientists who want to work on outside projects. Each year more than 60 researchers submit formal applications to a panel of 20 senior scientists who review the requests, just as a foundation would review academics’ proposals. Twelve to 20 grants, ranging from $50,000 and $100,000 apiece, are awarded each year. The researchers can use the money to hire supplemental staff or acquire necessary equipment.

Of course, rewards won’t help if the inventions aren’t focused on customer needs. Getting good consumer insight is the fourth most cited obstacle to innovation in our survey. Blogs and online communities now make it easier to know what customers are thinking. Hiring designers and ethnographers who observe customers using products at work or at home helps, too. But finding that Holy Grail of marketing, the “unmet need” of a consumer, remains elusive. “You need time, just thinking time, to step out of the day to day to see what’s going on in the world and what’s going on with your customers,” says Stone Yamashita’s Schuman.

THE WORLD IS YOUR LAB
Try learning journeys. That’s what Starbucks Corp. (SBUX ), up 10 spots from 2005 to No. 9, does. While the coffee company began doing ethnography back in 2002 and relies on its army of baristas to share customer insights, it recently started taking product development and other cross-company teams on “inspiration” field trips to view customers and trends. Two months ago, Michelle Gass, Starbucks’ senior vice-president for category management, took her team to Paris, Düsseldorf, and London to visit local Starbucks and other restaurants to get a better sense of local cultures, behaviors, and fashions. “You come back just full of different ideas and different ways to think about things than you would had you read about it in a magazine or e-mail,” says Gass.

A close watch of customer insights can also bring innovation to even the most iconic and established products. Back in 2003, 3M began noticing and monitoring two consumer trends. One was troubling: Customers were using laptops, cell phones, and BlackBerrys to send quick memos or jot down bits of information. Every thumb-tapped message or stylus-penned note on a personal digital assistant meant one less Post-it note.

The other trend, however, was encouraging: the rise of digital photography. While observing consumers, 3M researchers asked to see their photos. What followed was always a clunky process: Consumers would scroll through screen upon screen of photos or have to dig through a drawer for the few shots they printed. Nine months later a team of one marketer and two lab scientists hit upon the idea of Post-it Picture Paper, or photo paper coated with adhesive that lets people stick their photos to a wall for display. “We listened carefully to what consumers didn’t say and observed what they did,” says Jack Truong, vice-president of 3M’s office supply division.

To get a sense of the value of customer research, imagine you’re a Finnish engineer trying to design a phone for an illiterate customer on the Indian subcontinent. That’s the problem Nokia faced when it began making low-cost phones for emerging markets. A combination of basic ethnographic and long-term user research in China, India, and Nepal helped Nokia understand how illiterate people live in a world full of numbers and letters. The result? A new “iconic” menu that lets illiterate customers navigate contact lists made up of images.

Other innovative ideas followed. By listening to customers in poorer countries, Nokia learned that phones had to be more durable, since they’re often the most expensive item these customers will buy. To function in a tropical climate, it made the phones more moisture-resistant. It even used special screens that are more legible in bright sunlight.

Consumers increasingly are doing the innovation themselves. Consider Google Inc. (GOOG ), our No. 2 innovator, and its mapping technology, which it opened to the public. This produced a myriad of “mash-ups” in which programmers combine Google’s maps with anything from real estate listings to local poker game sites.

Google’s mash-ups are just one example of the escalating phenomenon of open innovation. These days the world is your R&D lab. Customers are co-opting technology and morphing products into their own inventions. Many companies are scouting for outside ideas they can develop in-house, embracing the open-source movement, and joining up with suppliers or even competitors on big projects that will make them more efficient and more powerful. “When you work with outside parties, they bear some of the costs and some of the risks, and can accelerate the time to market,” says Henry W. Chesbrough, the University of California at Berkeley Haas School of Business professor who helped establish the concept with his 2003 book, Open Innovation.

India and China are growing sources of innovation for companies, too. The BusinessWeek-BCG survey shows that they are nearly as popular as Europe among innovation-focused executives. When asked where their company planned to increase R&D spending, 44% answered India, 44% said China, and 48% said Western Europe. Managers tended to look to the U.S. and Canada for idea generation, while a lower percentage looked to Europe for the same tasks. India and China, though, are still seen as centers for product development.

Few companies have embraced the open innovation model as widely as IBM, No. 10 on our list. While the company’s proprietary technology is still a force to behold — Big Blue remains the world’s largest patent holder, with more than 40,000 — the company is opening up its technology to developers, partners, and clients. Last year it made 500 of its patents, mainly for software code, freely available to outside programmers. And in November it helped fund the Open Invention Network, a company formed to acquire patents and offer them royalty-free to help promote the open-source software movement.

Why the generosity? IBM believes that by helping to create technology ecosystems, it will benefit in the long run. “We want to do things that encourage markets to grow,” says Dr. John E. Kelly III, senior vice-president for technology and intellectual property at IBM. By helping nurture those markets, says Kelly, “we know we’ll get at least our fair share.”

GOING OUTSIDE FOR IDEAS
P&G has helped establish several outside networks of innovators it turns to for ideas the company can develop in-house. These networks include NineSigma, which links up companies with scientists at university, government, and private labs; YourEncore Inc., which connects retired scientists and engineers with businesses; and yet2.com Inc., an online marketplace for intellectual property.

Only a CEO can change a business culture at top speed, and in Alan G. Lafley, P&G has its own innovator-in-chief. Lafley sits in on all “upstream” R&D review meetings, 15 a year, that showcase new products. He also spends three full days a year with the company’s Design Board, a group of outside designers who offer their perspective on upcoming P&G products. “He’s sort of the chief innovation officer,” says P&G’s Huston. “He’s very, very involved.”

That sort of support from the CEO is essential, says Jon R. Katzenbach, co-founder of New York-based management consultancy Katzenbach Partners LLC. “The CEO determines the culture,” he says. “If the CEO is determined to [improve] the surfacing of ideas and determined to make critical choices, then the chances of an [organization's] figuring that out are much, much greater.”

Infosys Technologies Ltd. (INFY ), the Bangalore-based information technology services company that popped up at No. 10 on our Asia-Pacific list, takes a direct approach to making sure management stays involved in the innovation process. Chairman and “chief mentor” N.R. Narayana Murthy introduced the company’s “voice of youth” program seven years ago.

Each year the company selects nine top-performing young guns — each under 30 — to participate in its eight yearly senior management council meetings, presenting and discussing their ideas with the top leadership team. “We believe these young ideas need the senior-most attention for them to be identified and fostered,” says Sanjay Purohit, associate vice-president and head of corporate planning. Infosys CEO Nandan M. Nilekani concurs: “If an organization becomes too hierarchical, ideas that bubble up from younger people [aren't going to be heard].”

Mike Lazaridis, president and co-CEO of Research In Motion, hosts an innovation-themed, invitation-only “Vision Series” session in the Waterloo (Ont.)-based company’s 100-seat auditorium each Thursday. The standing-room-only meetings focus on new research and future goals for the company that gave us the BlackBerry.

Lazaridis is likely the only chief executive of a publicly traded company who has an Academy Award for technical achievement. (He won it in 1999 for an innovative bar-code reader that he helped invent that expedites film editing and production.) He has donated $100 million of his own money to fund a theoretical physics institute and an additional $50 million to a university quantum computing and nanotechnology engineering center in Waterloo. He has even appeared in an American Express (AXP ) commercial, scratching complex equations across a blackboard while proclaiming his commitment to the creative process. “I think we have a culture of innovation here, and [engineers] have absolute access to me,” says Lazaridis. “I live a life that tries to promote innovation.” As the BusinessWeek-BCG survey demonstrates, it is a life every manager around the world must embrace.

By Jena McGregor, with Michael Arndt and Robert Berner in Chicago, Ian Rowley and Kenji Hall in Tokyo, Gail Edmondson in Frankfurt, Steve Hamm in Rome, Moon Ihlwan in Seoul, and Andy Reinhardt in Paris

http://www.businessweek.com/magazine/content/06_17/b3981401.htm

Offshoring: The Next Industrial Revolution?

A CONTROVERSY RECONSIDERED

In February 2004, when N. Gregory Mankiw, a Harvard professor then serving as chairman of the White House Council of Economic Advisers, caused a national uproar with a “textbook” statement about trade, economists rushed to his defense. Mankiw was commenting on the phenomenon that has been clumsily dubbed “offshoring” (or “offshore outsourcing”) — the migration of jobs, but not the people who perform them, from rich countries to poor ones. Offshoring, Mankiw said, is only “the latest manifestation of the gains from trade that economists have talked about at least since Adam Smith. … More things are tradable than were tradable in the past, and that’s a good thing.” Although Democratic and Republican politicians alike excoriated Mankiw for his callous attitude toward American jobs, economists lined up to support his claim that offshoring is simply international business as usual.

Their economics were basically sound: the well-known principle of comparative advantage implies that trade in new kinds of products will bring overall improvements in productivity and well-being. But Mankiw and his defenders underestimated both the importance of offshoring and its disruptive effect on wealthy countries. Sometimes a quantitative change is so large that it brings about qualitative changes, as offshoring likely will. We have so far barely seen the tip of the offshoring iceberg, the eventual dimensions of which may be staggering.

To be sure, the furor over Mankiw’s remark was grotesquely out of proportion to the current importance of offshoring, which is still largely a prospective phenomenon. Although there are no reliable national data, fragmentary studies indicate that well under a million service-sector jobs in the United States have been lost to offshoring to date. (A million seems impressive, but in the gigantic and rapidly churning U.S. labor market, a million jobs is less than two weeks’ worth of normal gross job losses.) However, constant improvements in technology and global communications virtually guarantee that the future will bring much more offshoring of “impersonal services” — that is, services that can be delivered electronically over long distances with little or no degradation in quality.

That said, we should not view the coming wave of offshoring as an impending catastrophe. Nor should we try to stop it. The normal gains from trade mean that the world as a whole cannot lose from increases in productivity, and the United States and other industrial countries have not only weathered but also benefited from comparable changes in the past. But in order to do so again, the governments and societies of the developed world must face up to the massive, complex, and multifaceted challenges that offshoring will bring. National data systems, trade policies, educational systems, social welfare programs, and politics all must adapt to new realities. Unfortunately, none of this is happening now.

MODERNIZING COMPARATIVE ADVANTAGE

Countries trade with one another for the same reasons that individuals, businesses, and regions do: to exploit their comparative advantages. Some advantages are “natural”: Texas and Saudi Arabia sit atop massive deposits of oil that are entirely lacking in New York and Japan, and nature has conspired to make Hawaii a more attractive tourist destination than Greenland. There is not much anyone can do about such natural advantages.

But in modern economies, nature’s whimsy is far less important than it was in the past. Today, much comparative advantage derives from human effort rather than natural conditions. The concentration of computer companies around Silicon Valley, for example, has nothing to do with bountiful natural deposits of silicon; it has to do with Xerox’s fabled Palo Alto Research Center, the proximity of Stanford University, and the arrival of two young men named Hewlett and Packard. Silicon Valley could have sprouted up elsewhere.

One important aspect of this modern reality is that patterns of man-made comparative advantage can and do change over time. The economist Jagdish Bhagwati has labeled this phenomenon “kaleidoscopic comparative advantage,” and it is critical to understanding offshoring. Once upon a time, the United Kingdom had a comparative advantage in textile manufacturing. Then that advantage shifted to New England, and so jobs were moved from the United Kingdom to the United States. Then the comparative advantage shifted once again — this time to the Carolinas — and jobs migrated south within the United States. Now the comparative advantage in textile manufacturing resides in China and other low-wage countries, and what many are wont to call “American jobs” have been moved there as a result.

Of course, not everything can be traded across long distances. At any point in time, the available technology — especially in transportation and communications — largely determines what can be traded internationally and what cannot. Economic theorists accordingly divide the world’s goods and services into two bins: tradable and nontradable. Traditionally, any item that could be put in a box and shipped (roughly, manufactured goods) was considered tradable, and anything that could not be put in a box (such as services) or was too heavy to ship (such as houses) was thought of as nontradable. But because technology is always improving and transportation is becoming cheaper and easier, the boundary between what is tradable and what is not is constantly shifting. And unlike comparative advantage, this change is not kaleidoscopic; it moves in only one direction, with more and more items becoming tradable.

The old assumption that if you cannot put it in a box, you cannot trade it is thus hopelessly obsolete. Because packets of digitized information play the role that boxes used to play, many more services are now tradable and many more will surely become so. In the future, and to a great extent already, the key distinction will no longer be between things that can be put in a box and things that cannot. Rather, it will be between services that can be delivered electronically and those that cannot.

THE THREE INDUSTRIAL REVOLUTIONS

Adam Smith wrote The Wealth of Nations in 1776, at the beginning of the first Industrial Revolution. Although Smith’s vision was extraordinary, even he did not imagine what was to come. As workers in the industrializing countries migrated from farm to factory, societies were transformed beyond recognition. The shift was massive. It has been estimated that in 1810, 84 percent of the U.S. work force was engaged in agriculture, compared to a paltry 3 percent in manufacturing. By 1960, manufacturing’s share had risen to almost 25 percent and agriculture’s had dwindled to just 8 percent. (Today, agriculture’s share is under 2 percent.) How and where people lived, how they educated their children, the organization of businesses, the forms and practices of government — all changed dramatically in order to accommodate this new reality.

Then came the second Industrial Revolution, and jobs shifted once again — this time away from manufacturing and toward services. The shift to services is still viewed with alarm in the United States and many other rich countries, where people bemoan rather than welcome the resulting loss of manufacturing jobs. But in reality, new service-sector jobs have been created far more rapidly than old manufacturing jobs have disappeared. In 1960, about 35 percent of nonagricultural workers in the United States produced goods and 65 percent produced services. By 2004, only about one-sixth of the United States’ nonagricultural jobs were in goods-producing industries, while five-sixths produced services. This trend is worldwide and continuing. Between 1967 and 2003, according to the Organization for Economic Cooperation and Development, the service sector’s share of total jobs increased by about 19 percentage points in the United States, 21 points in Japan, and roughly 25 points in France, Italy, and the United Kingdom.

We are now in the early stages of a third Industrial Revolution — the information age. The cheap and easy flow of information around the globe has vastly expanded the scope of tradable services, and there is much more to come. Industrial revolutions are big deals. And just like the previous two, the third Industrial Revolution will require vast and unsettling adjustments in the way Americans and residents of other developed countries work, live, and educate their children.

But a bit of historical perspective should help temper fears of offshoring. The first Industrial Revolution did not spell the end of agriculture, or even the end of food production, in the United States. It just meant that a much smaller percentage of Americans had to work on farms to feed the population. (By charming historical coincidence, the actual number of Americans working on farms today — around 2 million — is about what it was in 1810.) The main reason for this shift was not foreign trade, but soaring farm productivity. And most important, the massive movement of labor off the farms did not result in mass unemployment. Rather, it led to a large-scale reallocation of labor to factories.

Similarly, the second Industrial Revolution has not meant the end of manufacturing, even in the United States, which is running ahead of the rest of the world in the shift toward services. The share of the U.S. work force engaged in manufacturing has fallen dramatically since 1960, but the number of manufacturing workers has declined only modestly. Three main forces have driven this change. First, rising productivity in the manufacturing sector has enabled the production of more and more goods with less and less labor. Second, as people around the world have gotten richer, consumer tastes have changed, with consumers choosing to spend a greater share of their incomes on services (such as restaurant meals and vacations) and a smaller share on goods (such as clothing and refrigerators). Third, the United States now imports a much larger share of the manufactured goods it consumes than it did 50 years ago. All told, the share of manufacturing in U.S. GDP declined from a peak near 30 percent in 1953 to under 13 percent in 2004. That may be the simplest quantitative indicator of the massive extent of the second Industrial Revolution to date. But as with the first Industrial Revolution, the shift has not caused widespread unemployment.

The third Industrial Revolution will play out similarly over the next several decades. The kinds of jobs that can be moved offshore will not disappear entirely from the United States or other rich countries, but their shares of the work force will shrink dramatically. And this reduction will transform societies in many ways, most of them hard to foresee, as workers in rich countries find other things to do. But just as with the first two industrial revolutions, massive offshoring will not lead to massive unemployment. In fact, the world gained enormously from the first two industrial revolutions, and it is likely to do so from the third — so long as it makes the necessary economic and social adjustments.

THIS TIME IT’S PERSONAL

What sorts of jobs are at risk of being offshored? In the old days, when tradable goods were things that could be put in a box, the key distinction was between manufacturing and nonmanufacturing jobs. Consistent with that, manufacturing workers in the rich countries have grown accustomed to the idea that they compete with foreign labor. But as the domain of tradable services expands, many service workers will also have to accept the new, and not very pleasant, reality that they too must compete with workers in other countries. And there are many more service than manufacturing workers.

Many people blithely assume that the critical labor-market distinction is, and will remain, between highly educated (or highly skilled) people and less-educated (or less-skilled) people — doctors versus call-center operators, for example. The supposed remedy for the rich countries, accordingly, is more education and a general “upskilling” of the work force. But this view may be mistaken. Other things being equal, education and skills are, of course, good things; education yields higher returns in advanced societies, and more schooling probably makes workers more flexible and more adaptable to change. But the problem with relying on education as the remedy for potential job losses is that “other things” are not remotely close to equal. The critical divide in the future may instead be between those types of work that are easily deliverable through a wire (or via wireless connections) with little or no diminution in quality and those that are not. And this unconventional divide does not correspond well to traditional distinctions between jobs that require high levels of education and jobs that do not.

A few disparate examples will illustrate just how complex — or, rather, how untraditional — the new divide is. It is unlikely that the services of either taxi drivers or airline pilots will ever be delivered electronically over long distances. The first is a “bad job” with negligible educational requirements; the second is quite the reverse. On the other hand, typing services (a low-skill job) and security analysis (a high-skill job) are already being delivered electronically from India — albeit on a small scale so far. Most physicians need not fear that their jobs will be moved offshore, but radiologists are beginning to see this happening already. Police officers will not be replaced by electronic monitoring, but some security guards will be. Janitors and crane operators are probably immune to foreign competition; accountants and computer programmers are not. In short, the dividing line between the jobs that produce services that are suitable for electronic delivery (and are thus threatened by offshoring) and those that do not does not correspond to traditional distinctions between high-end and low-end work.

The fraction of service jobs in the United States and other rich countries that can potentially be moved offshore is certain to rise as technology improves and as countries such as China and India continue to modernize, prosper, and educate their work forces. Eventually, the number of service-sector jobs that will be vulnerable to competition from abroad will likely exceed the total number of manufacturing jobs. Thus, coping with foreign competition, currently a concern for only a minority of workers in rich countries, will become a major concern for many more.

There is currently not even a vocabulary, much less any systematic data, to help society come to grips with the coming labor-market reality. So here is some suggested nomenclature. Services that cannot be delivered electronically, or that are notably inferior when so delivered, have one essential characteristic: personal, face-to-face contact is either imperative or highly desirable. Think of the waiter who serves you dinner, the doctor who gives you your annual physical, or the cop on the beat. Now think of any of those tasks being performed by robots controlled from India — not quite the same. But such face-to-face human contact is not necessary in the relationship you have with the telephone operator who arranges your conference call or the clerk who takes your airline reservation over the phone. He or she may be in India already.

The first group of tasks can be called personally delivered services, or simply personal services, and the second group impersonally delivered services, or impersonal services. In the brave new world of globalized electronic commerce, impersonal services have more in common with manufactured goods that can be put in boxes than they do with personal services. Thus, many impersonal services are destined to become tradable and therefore vulnerable to offshoring. By contrast, most personal services have attributes that cannot be transmitted through a wire. Some require face-to-face contact (child care), some are inherently “high-touch” (nursing), some involve high levels of personal trust (psychotherapy), and some depend on location-specific attributes (lobbying).

However, the dividing line between personal and impersonal services will move over time. As information technology improves, more and more personal services will become impersonal services. No one knows how far this process will go. Forrester Research caused a media stir a few years ago by estimating that 3.3 million U.S. service-sector jobs will move offshore by 2015, a rate of about 300,000 jobs per year. That figure sounds like a lot until you realize that average gross job losses in the U.S. labor market are more than 500,000 in the average week. In fact, given the ample possibilities for technological change in the next decade, 3.3 million seems low. So do the results of a 2003 Berkeley study and a recent McKinsey study, both of which estimated that 11 percent of U.S. jobs are at risk of being offshored. The Berkeley estimate came from tallying up workers in “occupations where at least some [offshoring] has already taken place or is being planned,” which means the researchers considered only the currently visible tip of the offshoring iceberg. The future will reveal much more.

To obtain a ballpark figure of the number of U.S. jobs threatened by offshoring, consider the composition of the U.S. labor market at the end of 2004. There were 14.3 million manufacturing jobs. The vast majority of those workers produced items that could be put in a box, and so virtually all of their jobs were potentially movable offshore. About 7.6 million Americans worked in construction and mining. Even though these people produced goods, not services, their jobs were not in danger of moving offshore. (You can’t hammer a nail over the Internet.) Next, there were 22 million local, state, and federal government jobs. Even though many of these jobs provide impersonal services that need not be delivered face to face, hardly any are candidates for offshoring — for obvious political reasons. Retail trade employed 15.6 million Americans. Most of these jobs require physical presence, although online retailing is increasing its share of the market, making a growing share of retail jobs vulnerable to offshoring as well.

Those are the easy cases. But the classification so far leaves out the majority of private-service jobs — some 73.6 million at the end of 2004. This extremely heterogeneous group breaks down into educational and health services (17.3 million), professional and business services (16.7 million), leisure and hospitality services (12.3 million), financial services (8.1 million), wholesale trade (5.7 million), transportation (4.3 million), information services (3.2 million), utilities (0.6 million), and “other services” (5.4 million). It is hard to divide such broad job categories into personal and impersonal services, and it is even more difficult to know what possibilities for long-distance electronic delivery the future will bring. Still, it is possible to get a rough sense of which of these jobs may be vulnerable to offshoring.

The health sector is currently about five times as large as the educational sector, and the vast majority of services in the health sector seem destined to be delivered in person for a very long time (if not forever). But there are exceptions, such as radiology. More generally, laboratory tests are already outsourced by most physicians. Why not out of the country rather than just out of town? And with a little imagination, one can envision other medical procedures being performed by doctors who are thousands of miles away. Indeed, some surgery has already been performed by robots controlled by doctors via fiber-optic links.

Educational services are also best delivered face to face, but they are becoming increasingly expensive. Electronic delivery will probably never replace personal contact in K-12 education, which is where the vast majority of the educational jobs are. But college teaching is more vulnerable. As college tuition grows ever more expensive, cheap electronic delivery will start looking more and more sensible, if not imperative.

The range of professional- and business-service jobs includes everything from CEOs and architects to typists and janitors — a heterogeneous lot. That said, in scanning the list of detailed subcategories, it appears that many of these jobs are at least potentially offshorable. For example, future technological developments may dictate how much accounting stays onshore and how much comes to be delivered electronically from countries with much lower wages.

The leisure and hospitality industries seem much safer. If you vacation in Florida, you do not want the beachboy or the maid to be in China. Reservation clerks can be (and are) located anywhere. But on balance, only a few of these jobs can be moved offshore.

Financial services, a sector that includes many highly paid jobs, is another area where the future may look very different from the present. Today, the United States “onshores” more financial jobs (by selling financial services to foreigners) than it offshores. Perhaps that will remain true for years. But improvements in telecommunications and rising educational levels in countries such as China and, especially, India (where many people speak English) may change the status quo dramatically.

Wholesale trade is much like retail trade, but with a bit less personal contact and thus somewhat greater potential for offshoring. The same holds true for transportation and utilities. Information-service jobs, however, are the quintessential types of jobs that can be delivered electronically with ease. The majority of these jobs are at risk. Finally, the phrase “other services” is not very informative, but detailed scrutiny of the list (repair and laundry workers appear, for example) reveals that most of these services require personal delivery.

The overall picture defies generalization, but a rough estimate, based on the preceding numbers, is that the total number of current U.S. service-sector jobs that will be susceptible to offshoring in the electronic future is two to three times the total number of current manufacturing jobs (which is about 14 million). That said, large swaths of the U.S. labor market look to be immune. But, of course, no one knows exactly what technological changes the future will bring.

A DISEASE WITHOUT A CURE

One additional piece of economic analysis will complete the story, and in a somewhat worrisome way. Economists refer to the “cost disease” of the personal services as Baumol’s disease, after the economist who discovered it, William Baumol. The problem stems from the fact that in many personal services, productivity improvements are either impossible or highly undesirable. In the “impossible” category, think of how many musician hours it took to play one of Mozart’s string quartets in 1790 versus in 1990, or how many bus drivers it takes to get children to school today versus a generation ago. In the “undesirable” category, think of school teachers. Their productivity can be increased rather easily: by raising class size, which squeezes more student output from the same teacher input. But most people view such “productivity improvements” as deteriorations in educational quality, a view that is well supported by research findings. With little room for genuine productivity improvements, and with the general level of real wages rising all the time, personal services are condemned to grow ever more expensive (relative to other items) over time. That is the essence of Baumol’s disease.

No such problem besets manufacturing. Over the years, automakers, to take one example, have drastically reduced the number of labor hours it takes to build a car — a gain in productivity that has not come at the expense of quality. Here once again, impersonal services are more like manufactured goods than personal services. Thanks to stunning advances in telecommunications technology, for example, your telephone company now handles vastly more calls with many fewer human operators than it needed a generation ago. And the quality of telephony has improved, not declined, as its relative price has plummeted.

The prediction of Baumol’s disease — that the prices of personal services (such as education and entertainment) will rise relative to the prices of manufactured goods and impersonal services (such as cars and telephone calls) — is borne out by history. For example, the theory goes a long way toward explaining why the prices of health care and college tuition have risen faster than the consumer price index for decades.

Constantly rising relative prices have predictable consequences. Demand curves slope downward — meaning that the demand for an item declines as its relative price rises. Applied in this context, this should mean decreasing relative demand for many personal services and increasing relative demand for many goods and impersonal services over time. The main exceptions are personal services that are strong “luxury goods” (as people get richer, they want relatively more of them) and those few goods and impersonal services that economists call “inferior” (as people get richer, they want fewer of them).

Baumol’s disease connects to the offshoring problem in a rather disconcerting way. Changing trade patterns will keep most personal-service jobs at home while many jobs producing goods and impersonal services migrate to the developing world. When you add to that the likelihood that the demand for many of the increasingly costly personal services is destined to shrink relative to the demand for ever-cheaper impersonal services and manufactured goods, rich countries are likely to have some major readjustments to make. One of the adjustments will involve reallocating labor from one industry to another. But another will show up in real wages. As more and more rich-country workers seek employment in personal services, real wages for those jobs are likely to decline, unless the offset from rising demand is strong enough. Thus, the wage prognosis is brighter for luxury personal-service jobs (such as plastic surgery and chauffeuring) than for ordinary personal-service jobs (such as cutting hair and teaching elementary school).

IS FOREWARNED FOREARMED?

What is to be done about all of this? It is easier to describe the broad contours of a solution than to prescribe specific remedies. Indeed, this essay is intended to get as many smart people as possible thinking creatively about the problem.Most obvious is what to avoid: protectionist barriers against offshoring. Building walls against conventional trade in physical goods is hard enough. Humankind’s natural propensity to truck and barter, plus the power of comparative advantage, tends to undermine such efforts — which not only end in failure but also cause wide-ranging collateral damage. But it is vastly harder (read “impossible”) to stop electronic trade. There are just too many “ports” to monitor. The Coast Guard cannot interdict “shipments” of electronic services delivered via the Internet. Governments could probably do a great deal of harm by trying to block such trade, but in the end they would not succeed in repealing the laws of economics, nor in holding back the forces of history. What, then, are some more constructive — and promising — approaches to limiting the disruption?

In the first place, rich countries such as the United States will have to reorganize the nature of work to exploit their big advantage in nontradable services: that they are close to where the money is. That will mean, in part, specializing more in the delivery of services where personal presence is either imperative or highly beneficial. Thus, the U.S. work force of the future will likely have more divorce lawyers and fewer attorneys who write routine contracts, more internists and fewer radiologists, more salespeople and fewer typists. The market system is very good at making adjustments like these, even massive ones. It has done so before and will do so again. But it takes time and can move in unpredictable ways. Furthermore, massive transformations in the nature of work tend to bring wrenching social changes in their wake.

In the second place, the United States and other rich nations will have to transform their educational systems so as to prepare workers for the jobs that will actually exist in their societies. Basically, that requires training more workers for personal services and fewer for many impersonal services and manufacturing. But what does that mean, concretely, for how children should be educated? Simply providing more education is probably a good thing on balance, especially if a more educated labor force is a more flexible labor force, one that can cope more readily with nonroutine tasks and occupational change. However, education is far from a panacea, and the examples given earlier show that the rich countries will retain many jobs that require little education. In the future, how children are educated may prove to be more important than how much. But educational specialists have not even begun to think about this problem. They should start right now.

Contrary to what many have come to believe in recent years, people skills may become more valuable than computer skills. The geeks may not inherit the earth after all — at least not the highly paid geeks in the rich countries. Creativity will be prized. Thomas Friedman has rightly emphasized that it is necessary to steer youth away from tasks that are routine or prone to routinization into work that requires real imagination. Unfortunately, creativity and imagination are notoriously difficult to teach in schools — although, in this respect, the United States does seem to have a leg up on countries such as Germany and Japan. Moreover, it is hard to imagine that truly creative positions will ever constitute anything close to the majority of jobs. What will everyone else do?

One other important step for rich countries is to rethink the currently inadequate programs for trade adjustment assistance. Up to now, the performance of trade adjustment assistance has been disappointing. As more and more Americans — and Britons, and Germans, and Japanese — are faced with the necessity of adjusting to the dislocations caused by offshoring, these programs must become both bigger and better.

Thinking about adjustment assistance more broadly, the United States may have to repair and thicken the tattered safety net that supports workers who fall off the labor-market trapeze — improving programs ranging from unemployment insurance to job retraining, health insurance, pensions, and right down to public assistance. At present, the United States has one of the thinnest social safety nets in the industrialized world, and there seems to be little if any political force seeking to improve it. But this may change if a larger fraction of the population starts falling into the safety net more often. The corresponding problem for western Europe is different. By U.S. standards, the social safety nets there are broad and deep. The question is, are they affordable, even now? And if so, will they remain affordable if they come to be utilized more heavily?

To repeat, none of this is to suggest that there will be massive unemployment; rather, there will be a massive transition. An effective safety net would ease the pain and, by so doing, speed up the adjustment.

IMPERFECT VISION

Despite all the political sound and fury, little service-sector offshoring has happened to date. But it may eventually amount to a third Industrial Revolution, and industrial revolutions have a way of transforming societies.

That said, the “threat” from offshoring should not be exaggerated. Just as the first Industrial Revolution did not banish agriculture from the rich countries, and the second Industrial Revolution has not banished manufacturing, so the third Industrial Revolution will not drive all impersonal services offshore. Nor will it lead to mass unemployment. But the necessary adjustments will put strains on the societies of the rich countries, which seem completely unprepared for the coming industrial transformation.

Perhaps the most acute need, given the long lead-times, is to figure out how to educate children now for the jobs that will actually be available to them 10 and 20 years from now. Unfortunately, since the distinction between personal services (likely to remain in rich countries) and impersonal services (likely to go) does not correspond to the traditional distinction between high-skilled and low-skilled work, simply providing more education cannot be the whole answer.

As the transition unfolds, the number of people in the rich countries who will feel threatened by foreign job competition will grow enormously. It is predictable that they will become a potent political force in each of their countries. In the United States, job-market stress up to now has been particularly acute for the uneducated and the unskilled, who are less inclined to exercise their political voice and less adept at doing so. But the new cadres of displaced workers, especially those who are drawn from the upper educational reaches, will be neither as passive nor as quiet. They will also be numerous. Open trade may therefore be under great strain.

Large-scale offshoring of impersonal-service jobs from rich countries to poor countries may also bear on the relative economic positions of the United States and Europe. The more flexible, fluid American labor market will probably adapt more quickly and more successfully to dramatic workplace and educational changes than the more rigid European labor markets will.

Contrary to current thinking, Americans, and residents of other English-speaking countries, should be less concerned about the challenge from China, which comes largely in manufacturing, and more concerned about the challenge from India, which comes in services. India is learning to exploit its already strong comparative advantage in English, and that process will continue. The economists Jagdish Bhagwati, Arvind Panagariya, and T. N. Srinivasan meant to reassure Americans when they wrote, “Adding 300 million to the pool of skilled workers in India and China will take some decades.” They were probably right. But decades is precisely the time frame that people should be thinking about — and 300 million people is roughly twice the size of the U.S. work force.

Many other effects of the coming industrial transformation are difficult to predict, or even to imagine. Take one possibility: for decades, it has seemed that modern economic life is characterized by the ever more dehumanized workplace parodied by Charlie Chaplin in Modern Times. The shift to personal services could well reverse that trend for rich countries — bringing less alienation and greater overall job satisfaction. Alas, the future retains its mystery. But in any case, offshoring will likely prove to be much more than just business as usual.

Alan S. Blinder. Foreign Affairs. New York: Mar/Apr 2006.Vol.85, Iss. 2;  pg. 113

Ensuring Energy Security

OLD QUESTIONS, NEW ANSWERS

On the eve of World War I, First Lord of the Admiralty Winston Churchill made a historic decision: to shift the power source of the British navy’s ships from coal to oil. He intended to make the fleet faster than its German counterpart. But the switch also meant that the Royal Navy would rely not on coal from Wales but on insecure oil supplies from what was then Persia. Energy security thus became a question of national strategy. Churchill’s answer? “Safety and certainty in oil,” he said, “lie in variety and variety alone.”

Since Churchill’s decision, energy security has repeatedly emerged as an issue of great importance, and it is so once again today. But the subject now needs to be rethought, for what has been the paradigm of energy security for the past three decades is too limited and must be expanded to include many new factors. Moreover, it must be recognized that energy security does not stand by itself but is lodged in the larger relations among nations and how they interact with one another.

Energy security will be the number one topic on the agenda when the group of eight highly industrialized countries (G-8) meets in St. Petersburg in July. The renewed focus on energy security is driven in part by an exceedingly tight oil market and by high oil prices, which have doubled over the past three years. But it is also fueled by the threat of terrorism, instability in some exporting nations, a nationalist backlash, fears of a scramble for supplies, geopolitical rivalries, and countries’ fundamental need for energy to power their economic growth. In the background — but not too far back — is renewed anxiety over whether there will be sufficient resources to meet the world’s energy requirements in the decades ahead.

Concerns over energy security are not limited to oil. Power blackouts on both the East and West Coasts of the United States, in Europe, and in Russia, as well as chronic shortages of electric power in China, India, and other developing countries, have raised worries about the reliability of electricity supply systems. When it comes to natural gas, rising demand and constrained supplies mean that North America can no longer be self-reliant, and so the United States is joining the new global market in natural gas that will link countries, continents, and prices together in an unprecedented way.

At the same time, a new range of vulnerabilities has become more evident. Al Qaeda has threatened to attack what Osama bin Laden calls the “hinges” of the world’s economy, that is, its critical infrastructure — of which energy is among the most crucial elements. The world will increasingly depend on new sources of supply from places where security systems are still being developed, such as the oil and natural gas fields offshore of West Africa and in the Caspian Sea. And the vulnerabilities are not limited to threats of terrorism, political turmoil, armed conflict, and piracy. In August and September 2005, Hurricanes Katrina and Rita delivered the world’s first integrated energy shock, simultaneously disrupting flows of oil, natural gas, and electric power.

Events since the beginning of this year have underlined the significance of the issue. The Russian-Ukrainian natural gas dispute temporarily cut supplies to Europe. Rising tensions over Tehran’s nuclear program brought threats from Iran, the second-largest OPEC producer, to “unleash an oil crisis.” And scattered attacks on some oil facilities reduced exports from Nigeria, which is a major supplier to the United States.

Since Churchill’s day, the key to energy security has been diversification. This remains true, but a wider approach is now required that takes into account the rapid evolution of the global energy trade, supply-chain vulnerabilities, terrorism, and the integration of major new economies into the world market.

Although in the developed world the usual definition of energy security is simply the availability of sufficient supplies at affordable prices, different countries interpret what the concept means for them differently. Energy-exporting countries focus on maintaining the “security of demand” for their exports, which after all generate the overwhelming share of their government revenues. For Russia, the aim is to reassert state control over “strategic resources” and gain primacy over the main pipelines and market channels through which it ships its hydrocarbons to international markets. The concern for developing countries is how changes in energy prices affect their balance of payments. For China and India, energy security now lies in their ability to rapidly adjust to their new dependence on global markets, which represents a major shift away from their former commitments to self-sufficiency. For Japan, it means offsetting its stark scarcity of domestic resources through diversification, trade, and investment. In Europe, the major debate centers on how to manage dependence on imported natural gas — and in most countries, aside from France and Finland, whether to build new nuclear power plants and perhaps to return to (clean) coal. And the United States must face the uncomfortable fact that its goal of “energy independence” — a phrase that has become a mantra since it was first articulated by Richard Nixon four weeks after the 1973 embargo was put in place — is increasingly at odds with reality.

SHOCKS TO SUPPLY AND DEMAND

After the Persian Gulf War, concerns over energy security seemed to recede. Saddam Hussein’s bid to dominate the Persian Gulf had been foiled, and it appeared that the world oil market would remain a market (rather than becoming Saddam’s instrument of political manipulation) and that supplies would be abundant at prices that would not impede the global economy. But 15 years later, prices are high, and fears of shortages dominate energy markets. What happened? The answer is to be found in both markets and politics.

The last decade has witnessed a substantial increase in the world’s demand for oil, primarily because of the dramatic economic growth in developing countries, in particular China and India. As late as 1993, China was self-sufficient in oil. Since then, its GDP has almost tripled and its demand for oil has more than doubled. Today, China imports 3 million barrels of oil per day, which accounts for almost half of its total consumption. China’s share of the world oil market is about 8 percent, but its share of total growth in demand since 2000 has been 30 percent. World oil demand has grown by 7 million barrels per day since 2000; of this growth, 2 million barrels each day have gone to China. India’s oil consumption is currently less than 40 percent of China’s, but because India has now embarked on what the economist Vijay Kelkar calls the “growth turnpike,” its demand for oil will accelerate. (Ironically, India’s current high growth rates were partly triggered by the spike in oil prices during the 1990-91 Persian Gulf crisis. The resulting balance-of-payments shock left India with almost no foreign currency reserves, opening the door to the reforms initiated by then Finance Minister Manmohan Singh, now India’s prime minister.)

The impact of growth in China, India, and elsewhere on the global demand for energy has been far-reaching. In the 1970s, North America consumed twice as much oil as Asia. Last year, for the first time ever, Asia’s oil consumption exceeded North America’s. The trend will continue: half of the total growth in oil consumption in the next 15 years will come from Asia, according to projections by Cambridge Energy Research Associates (CERA). However, Asia’s growing impact became widely apparent only in 2004, when the best global economic performance in a generation translated into a “demand shock” — that is, unexpected worldwide growth in petroleum consumption that represented a rate of growth that was more than double the annual average growth rates of the preceding decade. China’s demand in 2004 rose by an extraordinary 16 percent compared to 2003, driven partly by electricity bottlenecks that led to a surge in oil use for improvised electric generation. U.S. consumption also grew strongly in 2004, as did that of other countries. The result was the tightest oil market in three decades (except for the first couple of months after Saddam’s invasion of Kuwait in 1990). Hardly any wells were available to produce additional oil. That remains the case today, and there is a further catch. What additional oil might be produced cannot be easily sold because it would not be of sufficiently good quality to be used in the world’s available oil refineries.

Refining capacity is a major constraint on supply, because there is a significant mismatch between the product requirements of the world’s consumers and refineries’ capabilities. Although often presented solely as a U.S. problem, inadequate refining capacity is in fact a global phenomenon. The biggest growth in demand worldwide has been for what are called “middle distillates”: diesel, jet fuel, and heating oil. Diesel is a favorite fuel of European motorists, half of whom now buy diesel cars, and it is increasingly used to power economic growth in Asia, where it is utilized not just for transportation but also to generate electricity. But the global refining system does not have enough so-called deep conversion capacity to turn heavier crudes into middle distillates. This shortfall in capacity has created additional demand for the lighter grades of crude, such as the benchmark WTI (West Texas Intermediate), further boosting prices.

Other factors, including problems in several major energy-exporting countries, have also contributed to high prices. Indeed, the current era of high oil prices really began in late 2002 and early 2003, just before the start of the Iraq war, when President Hugo Chvez’s drive to consolidate his control over Venezuela’s political system, state-owned oil company, and oil revenues sparked strikes and protests. This shut down oil production in Venezuela, which had been among the most reliable of oil exporters since World War II. The loss of oil to the world market from the strikes was significant, greater than the impact of the war in Iraq on supplies. Venezuela’s output has never fully recovered, and it is currently running about 500,000 barrels per day below the prestrike level.

Saddam’s failing regime in Iraq did not torch oil facilities during the 2003 war, as many had feared, but the large postwar surge in Iraqi output that some had expected has certainly not occurred. The tens of billions of dollars required to bring the industry’s output back up to its 1978 peak of 3.5 million barrels per day have not been invested both because of the continuing attacks on the country’s infrastructure and work force and because of uncertainty about Iraq’s political and legal structures and the contractual framework for investment. As a result, Iraqi oil exports are 30 to 40 percent below prewar levels.

Over the past five years, by contrast, Russia’s oil fields have been central to the growth of worldwide supply, providing almost 40 percent of the world’s total production increase since 2000. But the growth of Russia’s output slowed substantially last year because of political risks, insufficient investment, uncertainties over government policy, regulatory obstacles, and, in some regions, geological challenges. Meanwhile, despite such problems in some major supplier countries, other sources that get less attention, such as Brazil’s and Angola’s offshore fields, were increasing their output — until Hurricanes Katrina and Rita shut down 27 percent of U.S. oil production (as well as 21 percent of U.S. refining capacity). As late as January 2006, U.S. facilities that before the hurricanes had produced 400,000 barrels of oil a day were still out of operation. Altogether, the experience of the last couple of years confirms the maxim that a tight market is a market vulnerable to events.

All of these problems have provoked a new round of fears that the world is running out of oil. Such bouts of anxiety have recurred since as far back as the 1880s. But global output has actually increased by 60 percent since the 1970s, the last time the world was supposedly running out of oil. (The demand shock of 2004 attracted more notice than the cooling off of the growth in demand that occurred in 2005, when Chinese consumption did not grow at all and world demand returned to the average growth rates of 1994-2003.) Although talk about an imminent peak in oil output followed by a rapid decline has become common in some circles, CERA’s field-by-field analysis of projects and development plans indicates that net productive capacity could increase by as much as 20 to 25 percent over the next decade. Despite the current pessimism, higher oil prices will do what higher prices usually do: fuel growth in new supplies by significantly increasing investment and by turning marginal opportunities into commercial prospects (as well as, of course, moderating demand and stimulating the development of alternatives).

A good part of this capacity growth is already in the works. A substantial part of it will come from the exploitation of nontraditional supplies, ranging from Canadian oil sands (also known as tar sands) to deposits in ultradeep water to a very high-quality diesel-like fuel derived from natural gas — all made possible by continuing advances in technology. But conventional supplies will grow as well: Saudi Arabia is on track to increase its capacity by about 15 percent, to over 12 million barrels per day, by 2009, and other projects are under way elsewhere, such as in the Caspian Sea and even in the United States’ offshore fields. Although energy companies will be prospecting in more difficult environments, the major obstacle to the development of new supplies is not geology but what happens above ground: namely, international affairs, politics, decision-making by governments, and energy investment and new technological development. It should be noted, however, that current projections do show that after 2010 the major growth in supplies will come from fewer countries than it comes from today, which could accentuate security concerns.

A NEW FRAMEWORK

The current energy security system was created in response to the 1973 Arab oil embargo to ensure coordination among the industrialized countries in the event of a disruption in supply, encourage collaboration on energy policies, avoid bruising scrambles for supplies, and deter any future use of an “oil weapon” by exporters. Its key elements are the Paris-based International Energy Agency (IEA), whose members are the industrialized countries; strategic stockpiles of oil, including the U.S. Strategic Petroleum Reserve; continued monitoring and analysis of energy markets and policies; and energy conservation and coordinated emergency sharing of supplies in the event of a disruption. The emergency system was set up to offset major disruptions that threatened the global economy and stability, not to manage prices and the commodity cycle. Since the system’s inception in the 1970s, a coordinated emergency drawdown of strategic stockpiles has occurred only twice: on the eve of the Gulf War in 1991 and in the autumn of 2005 after Hurricane Katrina. (The system was also readied in anticipation of possible use before January 1, 2000, because of concerns over the potential problems arising from the Y2K computer bug, during the shutdown of production in Venezuela in 2002-3, and in the spring of 2003, before the invasion of Iraq.)

Experience has shown that to maintain energy security countries must abide by several principles. The first and most familiar is what Churchill urged more than 90 years ago: diversification of supply. Multiplying one’s supply sources reduces the impact of a disruption in supply from one source by providing alternatives, serving the interests of both consumers and producers, for whom stable markets are a prime concern. But diversification is not enough. A second principle is resilience, a “security margin” in the energy supply system that provides a buffer against shocks and facilitates recovery after disruptions. Resilience can come from many factors, including sufficient spare production capacity, strategic reserves, backup supplies of equipment, adequate storage capacity along the supply chain, and the stockpiling of critical parts for electric power production and distribution, as well as carefully conceived plans for responding to disruptions that may affect large regions. Hence the third principle: recognizing the reality of integration. There is only one oil market, a complex and worldwide system that moves and consumes about 86 million barrels of oil every day. For all consumers, security resides in the stability of this market. Secession is not an option.

A fourth principle is the importance of information. High-quality information underpins well-functioning markets. On an international level, the IEA has led the way in improving the flow of information about world markets and energy prospects. That work is being complemented by the new International Energy Forum, which will seek to integrate information from producers and consumers. Information is no less crucial in a crisis, when consumer panics can be instigated by a mixture of actual disruptions, rumors, and fear. Reality can be obscured by accusations, acrimony, outrage, and a fevered hunt for conspiracies, transforming a difficult situation into something much worse. In such situations, governments and the private sector should collaborate to counter panics with high-quality, timely information. The U.S. government can promote flexibility and market adjustments by expediting its communication with companies and permitting the exchange of information among them, with appropriate antitrust safeguards, when necessary.

As important as these principles are, the past several years have highlighted the need to expand the concept of energy security in two critical dimensions: the recognition of the globalization of the energy security system, which can be achieved especially by engaging China and India, and the acknowledgment of the fact that the entire energy supply chain needs to be protected.

China’s thirst for energy has become a decisive plot element in suspense novels and films. Even in the real world there is no shortage of suspicion: some in the United States see a Chinese grand strategy to preempt the United States and the West when it comes to new oil and gas supplies, and some strategists in Beijing fear that the United States may someday try to interdict China’s foreign energy supplies. But the actual situation is less dramatic. Despite all the attention being paid to China’s efforts to secure international petroleum reserves, for example, the entire amount that China currently produces per day outside of its own borders is equivalent to just 10 percent of the daily production of one of the supermajor oil companies. If there were a serious controversy between the United States and China involving oil or gas, it would likely arise not because of a competition for the resources themselves, but rather because they had become part of larger foreign policy issues (such as a clash over a specific regime or over how to respond to Iran’s nuclear program). Indeed, from the viewpoint of consumers in North America, Europe, and Japan, Chinese and Indian investment in the development of new energy supplies around the world is not a threat but something to be desired, because it means there will be more energy available for everyone in the years ahead as India’s and China’s demand grows.

It would be wiser — and indeed it is urgent — to engage these two giants in the global network of trade and investment rather than see them tilt toward a mercantilist, state-to-state approach. Engaging India and China will require understanding what energy security means for them. Both countries are rapidly moving from self-sufficiency to integration into the world economy, which means they will grow increasingly dependent on global markets even as they are under tremendous pressure to deliver economic growth for their huge populations, which cope with energy shortages and blackouts on a daily basis. Thus, the primary concern for both China and India is to ensure that they have sufficient energy to support economic growth and prevent debilitating energy shortfalls that could trigger social and political turbulence. For India, where the balance-of-payments crisis of 1990 is still on policymakers’ minds, international production is also a way to hedge against high oil prices. And so India and China, and other key countries such as Brazil, should be brought into coordination with the existing IEA energy security system to assure them that their interests will be protected in the event of turbulence and to ensure that the system works more effectively.

SECURITY AND FLEXIBILITY

The current model of energy security, which was born of the 1973 crisis, focuses primarily on how to handle any disruption of oil supplies from producing countries. Today, the concept of energy security needs to be expanded to include the protection of the entire energy supply chain and infrastructure — an awesome task. In the United States alone, there are more than 150 refineries, 4,000 offshore platforms, 160,000 miles of oil pipelines, facilities to handle 15 million barrels of oil a day of imports and exports, 10,400 power plants, 160,000 miles of high-voltage electric power transmission lines and millions of miles of electric power distribution wires, 410 underground gas storage fields, and 1.4 million miles of natural gas pipelines. None of the world’s complex, integrated supply chains were built with security, defined in this broad way, in mind. Hurricanes Katrina and Rita brought a new perspective to the security question by demonstrating how fundamental the electric grid is to everything else. After the storms, the Gulf Coast refineries and the big U.S. pipelines were unable to operate — not because they were damaged, but because they could not get power.

Energy interdependence and the growing scale of energy trade require continuing collaboration among both producers and consumers to ensure the security of the entire supply chain. Long-distance, cross-border pipelines are becoming an ever-larger fixture in the global energy trade. There are also many chokepoints along the transportation routes of seaborne oil and, in many cases, liquefied natural gas (LNG) that create particular vulnerabilities: the Strait of Hormuz, which lies at the entrance to the Persian Gulf; the Suez Canal, which connects the Red Sea and the Mediterranean; the Bab el Mandeb strait, which provides entrance to the Red Sea; the Bosporus strait, which is a major export channel for Russian and Caspian oil; and the Strait of Malacca, through which passes 80 percent of Japan’s and South Korea’s oil and about half of China’s. Ships commandeered and scuttled in these strategic waterways could disrupt supply lines for extended periods. Securing pipelines and chokepoints will require augmented monitoring as well as the development of multilateral rapid-response capabilities.

The challenge of energy security will grow more urgent in the years ahead, because the scale of the global trade in energy will grow substantially as world markets become more integrated. Currently, every day some 40 million barrels of oil cross oceans on tankers; by 2020, that number could jump to 67 million. By then, the United States could be importing 70 percent of its oil (compared to 58 percent today and 33 percent in 1973), and so could China. The amount of natural gas crossing oceans as LNG will triple to 460 million tons by 2020. The United States will be an important part of that market: although LNG meets only about 3 percent of U.S. demand today, its share could reach more than 25 percent by 2020. Assuring the security of global energy markets will require coordination on both an international and a national basis among companies and governments, including energy, environmental, military, law enforcement, and intelligence agencies.

But in the United States, as in other countries, the lines of responsibility — and the sources of funding — for protecting critical infrastructures, such as energy, are far from clear. The private sector, the federal government, and state and local agencies need to take steps to better coordinate their activities. Maintaining the commitment to do so during periods of low or moderate prices will require discipline as well as vigilance. As Stephen Flynn, a homeland security expert at the Council on Foreign Relations, observes, “Security is not free.” Both the public and private sectors need to invest in building a higher degree of security into the energy system — meaning that energy security will be part of both the price of energy and the cost of homeland security.

Markets need to be recognized as a source of security in themselves. The energy security system was created when energy prices were regulated in the United States, energy trading was only just beginning, and futures markets were several years away. Today, large, flexible, and well-functioning energy markets provide security by absorbing shocks and allowing supply and demand to respond more quickly and with greater ingenuity than a controlled system could. Such markets will guarantee security for the growing LNG market and thereby boost the confidence of the countries that import it. Thus, governments must resist the temptation to bow to political pressure and micromanage markets. Intervention and controls, however well meaning, can backfire, slowing and even preventing the movement of supplies to respond to disruptions. At least in the United States, any price spike or disruption evokes the memory of the infamous gas lines of the 1970s — even for those who were only toddlers then (and perhaps even for those not yet born at the time). Yet those lines were to a considerable degree self-inflicted — the consequence of price controls and a heavy-handed allocation system that sent gasoline where it was not needed and denied its being sent where it was.

Contrast that to what happened immediately after Hurricane Katrina. A major disruption to the U.S. oil supply was compounded by reports of price gouging and of stations running out of gasoline, which together could have created new gas lines along the East Coast. Yet the markets were back in balance sooner and prices came down more quickly than almost anyone had expected. Emergency supplies from the U.S. Strategic Petroleum Reserve and other IEA reserves were released, sending a “do not panic” message to the market. At the same time, two critical regulatory restrictions were eased. One was the Jones Act (which bars non-U.S.-flagged ships from carrying cargo between U.S. ports), which was waived to allow non-U.S. tankers to ship supplies bottlenecked on the Gulf Coast around Florida to the East Coast, where they were needed. The other was the set of “boutique gasoline” regulations that require different qualities of gasoline for different cities, which were temporarily lifted to permit supplies from other parts of the country to move into the Southeast. The experience highlights the need to incorporate regulatory and environmental flexibility — and a clear understanding of the impediments to adjustment — into the energy security machinery in order to cope as effectively as possible with disruptions and emergencies.

The U.S. government and the private sector should also make a renewed commitment to energy efficiency and conservation. Although often underrated, the impact of conservation on the economy has been enormous over the past several decades. Over the past 30 years, U.S. GDP has grown by 150 percent, while U.S. energy consumption has grown by only 25 percent. In the 1970s and 1980s, many considered that kind of decoupling impossible, or at least certain to be economically ruinous. True, many of the gains in energy efficiency have come because the U.S. economy is “lighter,” as former Federal Reserve Chair Alan Greenspan has put it, than it was three decades ago — that is, GDP today is composed of less manufacturing and more services (especially information technology) than could have been imagined in the 1970s. But the basic point remains: conservation has worked. Current and future advances in technology could permit very large additional gains, which would be highly beneficial not only for advanced economies such as that of the United States, but also for the economies of countries such as India and China (in fact, China has recently made conservation a priority).

Finally, the investment climate itself must become a key concern in energy security. There needs to be a continual flow of investment and technology in order for new resources to be developed. The IEA recently estimated that as much as $17 trillion will be required for new energy development over the next 25 years. These capital flows will not materialize without reasonable and stable investment frameworks, timely decision-making by governments, and open markets. How to facilitate energy investment will be one of the critical questions on the G-8’s energy security agenda in 2006.

FUTURE SHOCKS

Inevitably, there will be shocks to energy markets in the future. Some of the possible causes may be roughly foreseeable, such as coordinated attacks by terrorists, disruptions in the Middle East and Africa, or turmoil in Latin America that affects output in Venezuela, the third-largest OPEC producer. Other possible causes, however, may come as a surprise. The offshore oil industry has long built facilities to withstand a “hundred-year storm” — but nobody anticipated that two such devastating storms would strike the energy complex in the Gulf of Mexico within a matter of weeks. And the creators of the IEA emergency sharing system in the 1970s never for a moment considered that it might have to be activated to blunt the effects of a disruption in the United States.

Diversification will remain the fundamental starting principle of energy security for both oil and gas. Today, however, it will likely also require developing a new generation of nuclear power and “clean coal” technologies and encouraging a growing role for a variety of renewable energy sources as they become more competitive. It will also require investing in new technologies, ranging from near-term ones, such as the conversion of natural gas into a liquid fuel, to ones that are still in the lab, such as the biological engineering of energy supplies. Investment in technology all along the energy spectrum is surging today, and this will have a positive effect not only on the future energy picture but also on the environment.

Yet energy security also exists in a larger context. In a world of increasing interdependence, energy security will depend much on how countries manage their relations with one another, whether bilaterally or within multilateral frameworks. That is why energy security will be one of the main challenges for U.S. foreign policy in the years ahead. Part of that challenge will be anticipating and assessing the “what ifs.” And that requires looking not only around the corner, but also beyond the ups and downs of cycles to both the reality of an ever more complex and integrated global energy system and the relations among the countries that participate in it.

Daniel Yergin. Foreign Affairs. New York: Mar/Apr 2006.Vol.85, Iss. 2;  pg. 69

Vietnam: Competition and price regulations

Vietnam is only slowly emerging from a centrally planned, socialist economy dominated by state-owned monopolies. In key industries like electricity, aviation and telecommunications, the state-owned company occupies a monopoly position, with market share of at least 80%. Other heavily regulated industries tend to have some foreign and private-sector participation but are dominated by a state-owned oligopoly–several large firms with a market share of 10-40% each. These include cement, sugar refining and sales, minerals, banking and petroleum, where prices tend to be high and most firms are neither efficient nor competitive.The Vietnamese government sees the merits of market competition, in particular that it makes domestic firms more efficient. But the authorities are still preoccupied with the potential job losses and corporate insolvencies that might follow from giving free rein to market forces. Moreover, there is concern about the fate of consumers; indeed, public subsidies are the only thing keeping prices stable in some industries, and introducing competition might cause price rises over time in those industries.

A new Competition Law was passed on December 3rd 2004 and went into effect on July 1st 2005. The law applies to business enterprises and professional and trade associations in Vietnam; foreign-invested enterprises (100% owned and joint venture); overseas enterprises and associations with activities in Vietnam; public utilities and state monopoly enterprises; and (in so far as certain anti-competitive measures are proscribed for them) state administrative bodies. “Overseas enterprises” include foreign companies with a commercial presence (such as branch or sales offices) and foreign contractors having an office or otherwise doing business directly in Vietnam such as foreign construction contractors (but not offshore contractors conducting crossborder activities). Whether the law covers offshore foreign entities investing in onshore foreign-invested enterprises (FIEs) or commercial presences remains unclear.

The new competition law prohibits four broad types of anti-competitive activity: (1) agreements that restrain competition; (2) abuse of monopoly or dominant market position; (3) unlawful “economic concentrations”; and (4) acts of unhealthy competition. The last three are considered to be subsets of the first category.

Agreements that restrain competition among parties who represent a combined 30% or more market share may take the form of price fixing, market or supply sharing, limiting production, fixing unrelated trading conditions, impeding market entry, restricting market entry and colluding to award a tender to a specific party.

Abuse of monopoly or dominant market position applies to single firms holding at least a 30% market share, or groups of 2-4 firms that are “capable of substantially restricting competition” under specified formulae (for instance, where four firms collectively hold more than a 75% market share). Dominant-market or monopolistic firms are prohibited from the following activities: selling goods below costs to restrict a competitor; fixing an unreasonable selling or purchase price or minimum purchase price; restricting production, distribution, markets, or technical development in ways that harm consumers; applying different commercial conditions to the same transactions; fixing unrelated trading conditions; and preventing market entry. Dominant-market firms are also prohibited from imposing disadvantageous conditions and unilaterally amending terminating contracts without reason. Whether these provisions will apply in practice to state-owned enterprises in monopoly sectors such as public utilities remains unclear.

Unlawful economic concentrations are defined as any conduct by a firm that aims to govern the activities of other enterprises, including but not limited to mergers, acquisitions and joint ventures that have this aim. Concentrations are allowable if they result in the formation of a small or medium-sized enterprise, or combined possession of less than 30% market share. Where concentrations exceed 30% but are less than 50%, they must be reported to the Vietnam Competition Administration Department (VCAD), an enforcement body provided for under the new law that was created by Decree 06 of January 9th 2006. Within 45 days, VCAD must determine whether the concentration is prohibited. All concentrations holding more than 50% market share are prohibited.

Firms guilty of one of these anti-competitive behaviours may sometimes be exempted from the new law. Firms wishing for such exemption must apply to the VCAD, which must notify the applicant of the completeness of its application file within seven days. VCAD then submits its opinion to the Ministry of Trade, under whose jurisdiction it will be. The ministry will have 60 days from receipt of the application to issue a decision if it determines that the decision is within its legal authority. If the ministry determines that the decision is within the legal authority of the prime minister, it will refer the commission’s opinion to that office. The prime minister will then issue an exemption decision within 90 days of application.

The commission or the prime minister may grant exemptions where they consider that an anti-competitive practice’s harm to the economy and competitors is outweighed by one or more of the following considerations: corporate restructuring; promotion of technical progress and improved quality of goods and services; promotion of uniform product variety or quality standards; unification of conditions of trade, delivery or payment without affecting prices; increases in the competitiveness of small and medium-sized enterprises; or increases in the competitiveness of Vietnamese firms in international markets.

The new law also provides detailed rules and procedures governing complaints and investigations of alleged abuses and penalties of the law. Either an affected party or the VCAD itself can initiate complaints, and where the commission determines that it has jurisdiction over an external complaint (within seven days from receipt of complaint), it must appoint an internal investigator. A preliminary investigation determines whether a formal investigation is warranted. If criminal laws have been broken, a formal investigation can lead to referral for criminal prosecution. In less serious cases, the investigation can simply lead directly to minor administrative prevention measures.

Cases of restraining competition may be referred to the other enforcement body, the Vietnam Competition Council (VCC), which was set up by Decree 05 of January 9th 2006. The VCC will then establish a specific case panel to hold a hearing. If it finds that there has been a violation, the panel can take one of three courses of actions (by majority vote): issue administrative prevention measures; impose a warning or fine; or impose other administrative sanctions (such as divestiture, revocation of permits or certificates, or confiscation of means used to carry out the breach). In instances of alleged unhealthy competitive practices, the VCC can impose a warning or fine or other administrative sanctions.

Decree 120 of September 30th 2005 implemented the following fines for non-compliance:

Band one offences (misleading instructions, infringing business secrets, coercion in business, disrupting competitor’s business or defamation) are fined D5m-10m;

Band two offences (advertisement or promotion aimed at unfair competition or discrimination by an association) are fined D15m-25m; and

Band three offences (illegal multi-level, or pyramid, selling) are fined D50m-70m.

In some economic sectors, the government has begun to allow limited deregulation or competition. For example, telecommunications was opened to domestic competition in 2000. The state has licensed other state-owned enterprises to compete with Vietnam Post and Telecommunications (VNPT), the state-owned telecoms company, in several areas while VNPT allows these companies to use its infrastructure. In fixed-line services, VNPT now competes with the army’s Viettel and ETC nationally and with Saigon Postel and Hanoi Telecom in those cities. In data communications and Internet services, VNPT’s subsidiary Vietnam Data Communications (VDC) maintains a monopoly on Internet gateways and accounts for around 50% of the Internet service provider (ISP) market, competing with 15 licensed ISPs (of which seven were actually operational in April 2006). In mobile telephony, VNPT operates two GSM mobile operators, MobiPhone and VinaPhone, which compete for subscribers. Saigon Postel now runs a rival national CDMA network called S-Fone, and Viettel runs a GSM mobile service in three cities. The government plans to end VNPT’s monopoly by 2010 and open 50% of the market to new businesses.

The Ministry of Posts and Telematics began in March 2003 a process of restructuring, rationalising, and modernising the structure of the telecoms sector to promote competitiveness. Prime Ministerial Decision 58 of March 28th 2005 established the Vietnam Post and Telecommunications Group (VTPG), a process formally completed in March 2006. VNPT and its member companies have been restructured to operate under a parent-subsidiary model. The equitisation of the state-owned post and telecoms businesses will continue in order to turn the companies into subsidiary and associate companies of VPTG. Companies with 50% of their total statutory capital owned by VPTG, including Vietnam Mobile Services, Vietnam Telecom Services and other joint-stock and limited liability firms, also are under the equitisation scheme. VNPT will act as the parent company overseeing the finances and development strategies of subsidiaries, which otherwise will operate independently.

Under guidelines issued in January 2004, all telecoms-service providers with a market share in any given service of less than 30%–that is, all except VNPT–can set their own prices rather than have prices controlled by the Ministry of Posts and Telematics (MPT) In February 2004 the MPT turned down a proposal from the VNPT to calculate mobile-phone charges for its Vinaphone and MobiFone networks in 30-second increments rather than 60-second increments. The MPT noted at the time that its policy is to support new market entrants.

The government also made some concessions to foreign investment in the telecommunications sector under the United States-Vietnam bilateral trade agreement.

The new Commercial Law that took effect on January 1st 2006 sets very general prohibitions on unfair competition but does not regulate competition per se, except for prohibiting anti-competitive advertising and promotions. The new Competition Law now provides the main body of law on the regulation of competition and investigation and punishment of its abuses, replacing the very vague and little enforced prohibitions on certain practices (such as bribery, threats to competitors, and infringing trademarks and copyrights) in the old Commercial Law of 1997.

In the new competition law that took force on July 1st 2005, monopolies and “market-dominant” firms (oligopolies) are defined through numerical market share (see Competition and price policies overview for details). Generally speaking, prohibitions apply to abuses of market power by firms, not the actual existence of a monopolistic or market-dominant entity. Newly created “economic concentrations” (particularly through mergers, acquisitions and joint ventures) involving a 30% or greater market share will have to pass regulatory muster, and those involving a 50% or greater share are prohibited in principle and are allowed to proceed only if they apply for and are granted an explicit exemption. For new economic concentrations, there appears to be considerable room for discretion by the soon-to-be-created Competition Commission and Competition Council, though much will depend on how the new bodies are structured and how they interpret the laws in practice.

The government’s plan to join the Association of South-East Asian Nations (ASEAN) Free-Trade Area and the World Trade Organisation may force Vietnam gradually to dismantle some of the regulatory mechanisms that protect its state monopolies.

The new competition law’s antitrust provisions, which took force on July 1st 2005, affect merger-and-acquisition (M&A) activity in complex ways that were difficult to predict in April 2006. The new competition bodies were newly established, and much will depend on their precise interpretations and perhaps further implementing decrees. At the very least, M&As will be treated as instances of “economic concentrations” that must pass regulatory examination by the new competition bodies if they exceed the 30% market threshold, and they will be allowed to proceed only with explicit exemption if they exceed the 50% threshold.

Decree 24 of July 31st 2000 has facilitated M&As between wholly-foreign-owned firms and joint ventures already established in Vietnam. The decree, and the government’s Circular 12 of September 15th 2000, established the legal, economic and tax consequences when a foreign-investment vehicle changes its structure, merges with another such vehicle or buys out its local partner. The result has been a marked increase in buy-out activity, although it is often a highly complex procedure.

Circular 12 recognises that foreign-invested enterprises and parties to a business-co-operation-contract (BCC) that divide, separate, merge or consolidate are simply changing their legal status. They were previously seen as having liquidated one form of investment and established another, creating a rat’s nest of legal complications.

The rules remain somewhat vague; hence, the way a merger is carried out may have unexpected and unintended consequences. In a consolidation, the consolidating companies disappear, whereas in a merger, there is a surviving company; it is unclear, however, how the disappearing company’s legal rights are transferred to the new or surviving company. The lack of clarity means it may be possible to alter the rights, obligations, assets and liabilities of the disappearing company during the merger.

Up to now, merger proposals have had to be submitted to the authorities that originally granted investment licences to the foreign firms involved. It is not clear if, in cases of 30% or more market share, mergers should now be reported only to the Vietnam Competition Administration Department or also to the relevant investment-licensing authority. Until the matter is clarified, firms are advised do both.

Mergers can have complex tax implications. Where a company has several operations across Vietnam, each branch reports to its own provincial tax office. After Coca-Cola Vietnam merged three of its branches into one corporate entity in late 2001, the Finance Ministry sent the company Official Letter 287 dated January 17th 2002, which ruled that value-added tax and personal income tax payments (for employees) must still be handled at the provincial level and that branch losses must be reported separately, although depreciation of assets can be handled by the merged company. Thus, it appears the General Department of Taxation continues to require keeping branch-tax payments decentralised even after a merger.

There are no formal restrictions on producers’ ability to sell their products to distributors and dealers of their own choosing. Foreign manufacturers have not to date been allowed to participate in the distribution system, unless distributing goods manufactured at their own factories in Vietnam (tariff issues would then arise if they are in export-processing zones). In principle, this situation will change under the new Commercial Law that took effect on January 1st 2006, which allows for the establishment of foreign-invested commercial enterprises specialising in the purchase and sale of goods and services directly related to the purchase and sale of goods in Vietnam. Implementing regulations that would implement the right were still pending in April 2006, but in the latest draft decree under consideration, both wholly- foreign-owned and joint-venture commercial enterprises would be permitted to engage solely in commercial activities (import, export, distribution), independently of any associated manufacturing activities. The right would be extended, under the draft decree, consistent with Vietnam’s international commitments to specific countries, regarding sectors and timing. (At present, the country has trade agreements covering distribution rights only with the United States, Japan and the European Union.)

In recent years, foreign investors have begun to gain some access to direct participation in the domestic retail market through supermarkets and trading centres. Foreign-invested food retailers operating in Vietnam include the Bourbon Group of France and Metro Cash & Carry of Germany (technically a wholesale outlet).

Distribution must therefore take place through an agent, where the risk of non-payment lies with the foreign investor, or through an official distributor, which sets up more-explicit mechanisms of legal protection and recourse. It would appear that the new Commercial Law would remove at least some of these restrictions, but by April 2006 such key issues had not been dealt with under the initially issued implementing decree.

There is extensive regulation of a company’s promotional and advertising activities. The new Commercial Law (much like the old Commercial Law of 1997) covers sales promotions, prizes and give-aways; the Ordinance on Advertising, which took force in May 2002, covers advertising more generally. Only Vietnamese business entities, foreign-invested enterprises and foreign business entities with a branch in Vietnam may–directly or through an advertising company–advertise their products, business activities and commercial services. Foreign businesses that do not have a local representative must employ a Vietnamese advertising company. The content of advertisements is subject to close regulation.

The following kinds of advertisements are forbidden under the March 2003 implementing decree: coercive messages; ads that depict state or Party leaders; spots that discriminate against Vietnamese or racial, ethnic or religious minorities; ads that promote violence or use vulgar or shocking language; ads that disrupt traffic or worksites or violate noise laws; ads that compare or promote confusion of the promoted product with that of another manufacturer or use individuals’ names without permission; and messages that promote prescription drug or prohibited medical services, equipment or instruments.

Foreign representative offices may not engage in promotional and marketing activities, although they may advertise. Foreign individuals or organisations without operations in Vietnam may advertise, but only through Vietnamese advertising agencies or distributors.

The National Assembly passed a legal amendment on May 27th 2003 that raised the tax-deductibility cap on advertising spending, as a percent of total corporate expenditures, from 7% to 10%. The amendment was made retroactive to January 1st 2003.

Sales promotion of certain types of goods is expressly banned, including beer, spirits and cigarettes to children younger than aged 16. Promotions may not be staged outside schools, hospitals and other designated places.

A producer may sue unauthorised dealers through the court system or ask an enforcement agency such as the Market Management Bureau to take action. In general, smuggled and counterfeit goods are more of a problem than unauthorised dealing in a company’s own product.

No regulations exist on minimum resale prices or similar controls, other than government price controls that apply to state-operated enterprises. Prices are fairly fluid for many consumer goods at the retail level, and bargaining is still the norm (except in large supermarkets).

The government continues to set rates for electricity, petrol, telecommunications, water, and fares for train and air travel. An uptick in inflation beginning in early 2005 led the government to instruct key industries such as coal, electricity and cement to hold the line on prices even if their costs rose, and it asked relevant agencies to be vigilant in enforcing existing price controls in key sectors. In December 2005 the prime minister asserted that if domestic prices increase considerably because of high import costs of input materials (such as steel and cement), the Ministry of Finance would issue measures to reduce input costs and curb escalating output prices.

In March 2006 Electricity of Vietnam (EVN) was forced to backtrack on an announced 14.1% increase in electricity rates; an inter-ministerial task-force reduced the increase to 8.8% despite protests from EVN authorities that the amount was insufficient to cover rising costs. Possible rolling blackouts have been predicted for some areas of the country later in 2006.

In most utility services and the travel sector, rates were traditionally higher for foreigners, although harmonisation has eliminated some of these disparities. The price gap for foreigners and locals for domestic air travel was eliminated on January 1st 2004. Television advertising rates charged to foreign firms dropped to local rates during 2003, and single uniform electricity rates have applied to both foreign-invested and domestic enterprises since January 1st 2005.

Decision 137 of 1992 empowered the Government Pricing Committee (GPC) to set prices. The government is considering reducing the list of industries in which the state directly fixes prices, though decisions have thus far been made on a case-by-case basis and in response to specific sectoral circumstances. In general, inflation concerns in the past year have undercut any longer-term moves towards price liberalisation. Under the Ordinance on Prices (which took force on July 1st 2002) and implementing Decree 170 (which took force on January 1st 2004), the state is empowered to take certain measures to stabilise prices for essential goods, such as petrol, oil, liquefied gas, cement, iron, steel, rice, coffee, cotton, sugarcane, salt and some medications. Official Letter 11026, dated September 29th 2004, requires tax departments to inspect regularly the sales prices reported by foreign and domestic firms for petrol production and trading, steel, iron and cement and to report the results on a monthly and quarterly basis to the Ministry of Finance. In addition, Decree 29 of September 26th 2004 updated fines for violations of price-stabilisation guidelines, increasing them (for both foreign and domestic firms and individuals) to D5m-10m.

The alleged dumping of goods on the local market at cut-throat prices has continued to be a concern, but the issue can now be dealt with in principle under an anti-dumping ordinance that took effect in May 2004 (see Tariffs and import taxes for details). However, some remaining price controls will come under considerable pressure once Vietnam joins the World Trade Organisation, which is expected by late 2006 or 2007.

The GPC has stepped up efforts to establish standards and principles for property valuation (an issue also addressed in the new land law; see Acquisition of real estate), as an initial step in developing the legal framework for the country’s price-valuation industry, in preparation for regional integration. The land law creates an elaborate administration structure to oversee land pricing.

The government has had to concede that price controls in some industries are ineffective. Ceiling prices for natural gas were removed in 2001 to promote greater competition among those firms importing gas and those procuring it domestically. Here, as in other sectors like aviation, the government has been willing to countenance steep increases in rates for consumers.

On two occasions over the past year, competitors of Vietnam Post and Telecommunications (VNPT) have submitted complaints of price gouging to the Ministry of Post and Telecommunications (MPT) when the firm has announced price cuts. In July 2005 FPT made such a complaint against VNPT’s cuts in broadband Internet charges, but by September–with the MPT’s investigation of charges still underway–FPT had slashed its own rates to 30% lower than VNPTs’ already reduced charges. Similarly, when VNPT announced plans in mid-2005 to lower both call and line-rental charges on mobile services, competitors Saigon Postel and Viettel protested to the authorities, and as a result the MPT only allowed VNPT to lower line rental charges. Under government guidelines that took force on January 6th 2003, telecoms-service providers that have market shares of less than 30% are allowed to set their own charges, whereas VNPT and its subsidiaries (the only firms that exceed that threshold) essentially remain subject to administrative review of their pricing decisions.

Among its measures to restructure the pharmaceutical sector and set up new distribution system, the government has moved to set up a medicine reserve bank with around D800bn in total investment. Law 34 of June 15th 2005 (the Pharmacy Law), which took force on October 1st 2005, comprehensively regulates all aspects of state policy and business administration and licensing regarding pharmaceuticals, including pricing. Although it removes the former statutory discrimination between private and state pharmaceutical activities and enshrines the right of drug companies to set their own prices, it also grants the state the right to intervene to stabilise prices when public health is threatened. Earlier, in March 2005, the Ministry of Health announced it would fine and possibly revoke or suspend the licences of drugs producers and traders who raise the prices of medicines without its permission.

EIU ViewsWire. New York: Apr 28, 2006.

Asian FTA would simplify rules: Japan needs wider agriculture trade

Apr. 11–Thai business leaders have welcomed a Japanese proposal to create an East Asian Free Trade zone to integrate economies in the region, but they were sceptical about whether Japan would liberalise its sensitive agricultural sector.

If Japan’s idea comes true, they said, it would help countries in the region overcome the “spaghetti bowl” effect of proliferating bilateral free trade agreements with different trade rules.

Last week, Japan proposed the formation of a vast Asian economic free trade zone that would cover about half the global population and rival the European Union and North American Free Trade Agreement (NAFTA) markets.

The 16-nation zone would include China and India, the world’s two fastest growing major economies, along with the 10-member Association of Southeast Nations (ASEAN) and Australia, Japan, New Zealand and South Korea.

Japan proposed starting negotiations in 2008 and concluding the pact in 2010.

But Pornsilp Patcharintanakul, the deputy secretary-general of the Board of Trade, questioned whether Japan is ready to liberalise agricultural products, a politically sensitive topic in Japan.

“Is Japan already to give, in particular, its farm sector,” he asked, noting that many Asian countries are large agricultural exporters.

Mr Pornsilp, who follows the country’s free trade agreement policies closely, referred to the negotiations for a closer Thai- Japan economic partnership, which excluded major Thai farm products such as rice, sugar and tapioca.

The agreement was suspended when the Thaksin government dissolved parliament in late February.

Mr Pornsilp added that it was unlikely that two years would be long enough for negotiations about the East Asian free-trade zone because the economic developments of member parties were different.

But he anticipated common regulations under a new zone would make trading easier for the 16 nations. East Asian countries, Australia and New Zealand have formed over a dozen free trade pacts.

But senior officials at the Commerce Ministry were unsure how Japan’s East Asian Economic Zone differed from an original proposal from Malaysia a few years ago, which comprised of 10 South East Asian nations and three far East Asian countries: China, Japan and South Korea.

“Since the first East Asean Summit [late last year], we started talking about other countries joining the community such as India, Australia and New Zealand. So what’s Japan proposing and why,” the senior official asked.

An earlier report said the push stemmed from Japan’s tense relations with its biggest trading partner China and its worries that it is slipping behind in securing bilateral free-trade pacts with countries in Asia.

Meanwhile, the 25-country European Union has been supporting negotiations for a single South Eastern Europe free trade pact to replace the existing plethora of bilateral free trade agreements.

The negotiations will enlarge and modernise the existing Central European Free Trade Agreement between Bulgaria, Romania, Croatia and the former Yugoslav Republic of Macedonia in the future, to cover other countries of the Western Balkans and Moldova and conclude by 2006.

Credit: Bangkok Post, Thailand

Woranuj Maneerungsee. Knight Ridder Tribune Business News. Washington: Apr 11, 2006. pg. 1