It has been exactly 20 years since Vietnam drafted a foreign investment law and first began seeking FDI to support its economic transition and development programme. Without a domestic private sector of its own at that time, the initial aim was to import one, albeit primarily in the form of joint ventures with state-owned firms in select sectors. Over the past two decades, restrictions on FDI have been relaxed considerably to permit activity in most sectors and the enactment of wholly owned foreign projects. The initial response from the international business community was tentative, however, because Vietnam was a complete unknown to investors operating outside the socialist bloc and the country remained the subject of various trade and investment embargoes.

The first wave

European energy companies led the first wave of foreign investors in the late 1980s, keen to explore the country’s offshore territory for oil and gas reserves, while their US peers were shut out by Washington’s embargo. Investor sentiment towards Vietnam rose to lofty heights in the mid-1990s, as Western firms that were late to plug into the so-called ‘Asian miracle’ clamoured to hitch a ride on the region’s late developer.

It was not until 2000, though, and a clear resumption of pro-business regulatory reform, after some fits and starts, that Vietnam really began to feature on many multinationals’ radar screens. The key signal was the first Enterprise Law of 1999, which revolutionised the regulatory environment for domestic firms and triggered a radical and sustained increase in the number of local firms.

Since 2000, FDI inflows have grown steadily, and 2006 proved to be a red-letter year. Initial estimates suggest that Vietnam attracted $10bn in new investment pledges last year, across some 750 individual projects. This brings the total stock of registered FDI to about $60bn, across about 7000 licensed projects, with the largest number coming from east Asian neighbours.

There were also relatively substantial inflows of portfolio investment funds to Vietnam last year, which helped to make the fledgling stock market’s index the best performing in Asia, and perhaps in the world.

The highest-profile FDI project last year was Intel’s decision to build a $1bn chip assembly and testing plant, close to Ho Chi Minh City. The project is beginning to be seen as something of a milestone for Vietnam, in terms of the country’s ability to attract ever larger and more technologically sophisticated FDI projects to its shores. However, the country has yet to develop a robust community of domestic firms that can serve as major component suppliers to foreign-invested manufacturers and assemblers.

The paucity of local firms with the right skills, and lack of consistency in production, remains an Achilles’ heel in Vietnam’s bid to attract more FDI. “The key challenge over the next decade is for Vietnamese firms to move up the technology ladder and compete along more of the supply chain,” says Claas Schaberg, chief representative of global communication consultancy APCO in Vietnam. “A central component of this is government support in the form of a national technology policy, and work is still needed in this area.”

The big time

A number of positive factors combined in 2006 to bring Vietnam into the big time. Gaining entry into the World Trade Organization (WTO) was clearly an important development for Vietnam, as was gaining permanent normal trading relations (PNTR) status with the US. This brings closure on the various outdated international business restrictions and barriers that Hanoi has successfully been able to chip away at in the past two decades. For foreign investors attracted to Vietnam as a host country platform for export-oriented manufacturing, this has been critical.

Hosting the Asia-Pacific Economic Co-operation (APEC) summit late last year put Hanoi in the international limelight and, coinciding with WTO accession approval, the summit proved to be something of a coming out party for Vietnam. Providing the most consistent macroeconomic growth figures in south-east Asia in the past decade or more, with a stable socio-political environment, it is easy to understand the allure of Vietnam. Offering many of the attractions of neighbouring China, but serving as an alternative host country option for multinationals not wishing to be overly exposed to China, the case for Vietnam has become a persuasive one.

Put into effect last July, an Enterprise Law and an Investment Law now serve as the primary pillars of a new legislative framework spanning business activity in Vietnam. They also herald the end of the two-track Foreign Investment Law and Domestic Investment Promotion Law, which had previously treated local and foreign-owned enterprises differently. From now on, the actions of local and foreign investors are to be governed by the same laws, under a more (if still not wholly) equitable legislative framework. Some anticipate that this regulatory change will prove to be as epochal to foreign investors as the 1999 Enterprise Law was to domestic companies.

Faster inflows

A slight delay in issuing the handful of implementing decrees to support the two new business laws may have cost Vietnam some new FDI pledges in 2006, as investors waited to peruse the regulatory small print. With this uncertainty now removed (all that remains to see the light of day is a decree pertaining to build-operate-transfer projects), FDI inflows will almost certainly accelerate in 2007. The US ambassador to Hanoi was recently quoted in the local media as expecting a doubling in US FDI inflow pledges in the coming months.

Another factor has been a clear acceleration in the state enterprise sector divestment process (known as equitisation). In the past few years, there has been a marked increase in the flow of state firms being partially divested, in terms of both numbers and the size of firms selling shares. For the first time, corporate entities familiar to most Vietnamese are starting to sell minority stakes at auctions, with some also listing on the fledgling, but burgeoning, stock market. (The index has grown from just two firms at the time of its launch in mid-2000 to more than 150.)

And, according to Chris Freund, founder of private equity firm Mekong Capital: “We’re starting to see a generational shift in the management of former state-owned enterprises. Senior management of some of these firms is being transferred to younger and more internationally exposed individuals, which is creating new investment opportunities.”

Crucially, the government has also signalled that strategic investors will be able to participate directly in the equitisation process, which was previously confined to retail investors and a handful of investment funds. Although the precise definition of a ‘strategic investor’ is a little unclear, it is widely thought to include foreign multinationals that are active in relevant sectors and industries. This shift in divestment strategy almost certainly marks the beginning of a new wave in FDI inflows to Vietnam, as multinational firms seek to buy into large-scale Vietnamese corporates and their established customer bases and client networks.

Consumer market

As 20 years of sustained economic growth begins to translate into increasing urban affluence, Vietnam’s domestic market is becoming markedly larger and more attractive. No longer is the country considered primarily in terms of a low-cost platform for export-oriented production in labour-intensive manufacturing fields, such as garments and footwear. As more of its 85 million citizens leave poverty behind them, and a sizable urban middle class takes shape, the country is becoming a substantial consumer market in its own right.

“When we set up our first investment fund in 2002 and looked around at which companies were making money in Vietnam, it was mainly exported-oriented manufacturing companies,” says Mr Freund. “Now when we look around at who is making money and growing the fastest, it is typically domestically oriented consumer product and retail companies. The growth in Vietnamese spending power has been notable in recent years.”

Taking a stake

For foreign firms that wish to take advantage of the liberalised domestic market that WTO accession brings, taking a strategic stake in a large local entity – as opposed to trying to build something organically, which could take a considerable time – is likely to be an enticing proposition. This dynamic is particularly apparent in large parts of the trade and services sector where foreign investment has been markedly constrained by regulations, until now.

Needless to say, investing in Vietnam is not without its risks and frustrations. Among other things, foreign investment into local firms is still capped at 30% of equity in most cases, and it will take time for the new business laws and their implementing decrees to bed down.

As APCO’s Mr Schaberg warns: “2006 was often described as a critical year for Vietnam,” notably in terms of various regulatory reforms. “However, 2007 will be the year in which these developments are submitted to the litmus test [of implementation].”

But there is a sense that Vietnam’s economy has graduated to a new level, and is attracting a wider spectrum of foreign investors into a more diverse range of business sectors and through a greater range of permitted market entry formats. Once considered a rather esoteric emerging market, Vietnam is in the process of entering the FDI mainstream.