Vietnam's Industrialization Strategy
in the Age of Globalization

A Proposal for the Steel Industry in Vietnam
Realistic Policy Options for an Import-Substitution Industry

Generally speaking, the steel industry is rarely an export-oriented industry in developing countries. Export orientation in steel must face the challenges of huge initial investment and volatile international markets. Under the strategy of enhancing competitiveness and export orientation of the national economy, the Vietnamese steel industry should aim at supporting export industries (through the backward linkage effect) and alleviating the balance-of-payments and foreign-exchange constraints (through import-substitution). To achieve this, the steel industry itself --even if it is not an export industry-- must improve international competitiveness. If that is not done, the steel industry may become an enormous risk and burden for the national economy. This problem is common to all domestically oriented material industries, but the size of the problem is largest in steel. For the Vietnamese steel industry, we recommend a step-by-step approach with realistic and not-too-ambitious promotion under a full grasp of Vietnam's current position in the global steel market.

1. The basic problems of the Vietnamese steel industry

The main features of the Vietnamese steel industry are as follows.

    1. Backwardness: production scale is generally small and machinery and equipment are often outdated. Production management, business strategy, marketing, etc. are not yet rational.
    2. Imbalance in product mix and production process: production is concentrated in downstream (rolling and galvanizing). Vietnam produces long products but not flat products. As a result, there is a glut in long products while imports of flat steel and billet (intermediate product) are rising.
    3. Three-tiered producers: producers are classified into foreign-invested, SOEs under the Vietnam Steel Corporation (VSC), and private enterprises not belonging to VSC. In recent years, 100% foreign-owned firms and private enterprises are expanding capacity rapidly.
    4. Undeveloped distribution system: steel distribution (including imports) is handled by VSC-affiliated trading companies, foreign trading companies and domestic merchants, but none of them plays the role of improving efficiency or stabilizing the market. State regulation on steel prices still remains.
2. The debate over the integrated steel works (ISW)
The master plan of the steel industry was approved by the Government in September 2001. With advice from JICA, it stipulates the investment plan up to 2010 by VSC including the rehabilitation of existing state-owned mills, establishment of a cold rolling mill, and additional construction of electric arc furnaces (EAFs) and rolling mills [Table]. The master plan remains subject to revision and the investment plan beyond 2005 is given only as a general direction. In the drafting process of the master plan, there was a debate inside and outside the Government over the desirability of the early construction of an integrated steel works (capacity of 4.5 million tons/year). Its construction will require a long time and a huge investment (USD 5-7 billion, or about 20 percent of GDP), far greater than other proposed steel facilities in Vietnam. The answer to this question was not given in the master plan, and the debate still continues.
Debate over the early construction of integrated steel works
(1) Steel is key to industrialization
(2) Domestic ore and coal are available
(3)Vietnam has suitable coasts and ports
(4) Steel imports are exerting balance of payments pressure
(1) ISW is not essential for industrialization
(2) The project is too capital intensive and not suitable for Vietnam
(3) Temporary protection is not available under free trade

However, it is not pragmatic for the Vietnamese Government to pay undue attention to the issue of constructing the ISW. To successfully construct an ISW, the following conditions must be met:

A huge amount of investment fund
Ability to design and build an internationally competitive ISW
Management capability for efficient operation and customer-oriented marketing
High quality infrastructure and peripheral technology to support the operation of ISW

At present, Vietnam has none of these and preparation of each of them will take a long time. If the Government and steel firms steadily make efforts, it is conceivable that Vietnam will be able to construct an ISW some time in the 2010s, but not before. On the other hand, if Vietnam fails to create these conditions, construction will never be possible. Therefore, it is not meaningful to make a final decision on the construction of the ISW now. Realistically, the early construction of the ISW is out of question.

To start the process of improving competitiveness, the Vietnamese steel industry faces two problems that are more important and urgent. First, in the long product sector, imbalance between the oversupply of final products and the shortage of inputs (billet) must be solved. Second, the construction and commencement of operation of the nation's first cold rolling mill must be successfully executed. Whether Vietnam can adequately deal with these two problems will determine the feasibility of the ISW. Anyone who cannot make profit out of a USD127 million project (cold rolling mill) certainly should not invest in an ISW which costs USD5-7 billion.

3. Selection of long product mills and expansion of billet production
Capacity imbalance in the long product sector was caused by inconsistency between the trade policy (heavy protection) and the competition policy (free entry). Since 1996, the imports of long steel products have been banned and the tariff of 30-40 percent was charged when importing them for special purposes. Meanwhile, domestic entry into this business was free until 2000. Stimulated by the high domestic price under the import ban, the domestic production capacity of long products rose quickly. The new entrants included not only joint venture companies with efficient equipment but also small factories and family businesses with low efficiency. As the AFTA deadline of 2006 approaches, Vietnam must make full use of free trade commitments and market pressure to simultaneously strengthen prospective mills and eliminate inefficient ones in the long product sector.

From 2001, the Government has limited entry into long product rolling to restore balance between demand and supply, and tried to eradicate low quality products through the enforcement of quality standards. These are efforts in the right direction, but not enough. More importantly, the Government should decide, announce and strictly adhere to the trade liberalization roadmap consistent with the objective stated above (selection and elimination), which specifies the tariff system of all steel products and the timetable for its reduction. This must be a comprehensive package covering AFTA tariffs (CEPT), non-AFTA tariffs (MFN), and non-trade barriers (NTBs, including the removal of import bans). Domestic measures (such as the special consumption tax) to offset the effect of trade liberalization should not be introduced. The announcement of gradual removal of protection with credibility will have the effect of curbing opportunistic entry as well as selection of firms willing to meet the competitive challenge in the long run.

For firms that make serious efforts, the Government should provide the carrot of stable and improved policy environment in addition to the stick of international competition. This includes, for example, further liberalization of steel pricing (to avoid undue pressure on inter-process margins by distortional price regulation), flexible adjustment of the investment plan by VSC, measures to prevent over-investment by the non-state sector, strict enforcement of quality, trademark and entry requirements, and improvement of the distribution system.

The gradual introduction of international competition will have different effects on different firms. Foreign firms with large-scale equipment and the Southern Steel Corporation (SSC), which is rearranging its capacity, have a good chance of survival if rationalization proceeds smoothly. But other state-owned factories and small-scale producers will probably face an extremely difficult situation. From this viewpoint, VSC should reconsider the second rehabilitation phase of Thai Nguyen Iron and Steel Corporation (TISCO) and the construction of additional EAFs and rolling mills, both of which raise the question of competitiveness.

4. The issues concerning the establishment of flat steel mills
The master plan approves the construction of flat steel production capacity, which does not exist in Vietnam at present. The first cold rolling mill is already under construction. Following this, a hot strip mill is planned. The flat steel market in Vietnam can be divided into three segments: high, medium and low quality. In starting a new industry, it is generally advisable for a developing country to begin with a mass production of standardized products requiring only low technology. However, this advice cannot be followed in the case of flat steel. This is because Russia and Ukraine export low quality flat steel to the rest of the world at unbelievably low prices. Vietnam should not produce low quality flat steel to avoid a fruitless war of attrition against them. Furthermore, the production scale of automobile and electronics in Vietnam still remains very small, and their demand for high-quality steel is correspondingly small. Thus the high quality market is too small to become the main target. By contrast, the medium quality flat steel market for factory and warehouse construction, household goods, motorcycles, propane gas cylinders, etc. is expanding quickly as income rises and industrialization continues.

Therefore, the new flat steel mill(s) should target the middle and high quality market, especially the former. Customers in these market segments demand not only high quality but also low deficiency ratios and prompt delivery. To ensure high operation of the proposed cold rolling mill and hot strip mill, the following are all needed: (i) thorough market research; (ii) proper choice of equipment, technology and production management; and (iii) procurement of high quality materials to match the high-quality product. The capacity and timing of factory construction must be carefully selected not to exceed the targeted demand segment.

Demand for flat steel is rising strongly in Vietnam, while it takes time to build these mills and achieve profitability. The more the initial operation is delayed, there is correspondingly less room for temporary protection. The construction of the first cold rolling mill and the feasibility study of the first hot strip mill are already behind schedule. With these in mind, flat steel production capacity must be constructed properly and without further delay.

5. Proposals for tariff structure
The design of tariff structure is extremely important for both the selection and elimination of long product producers, and the establishment of flat steel production capacity. While the ultimate tariff structure must conform to AFTA and future WTO requirements, Vietnam should be able to make use of temporary, partial and moderate protection. To design such a tariff system for the steel industry, the following points must be observed:

Trade liberalization must not be so fast as to destroy potential producers and must also not be so slow as to allow inefficient producers to survive.
Tariff rates among products and processes must always be reasonable. Firms should not be burdened unnecessarily by distorted tariff structure.
Excessive cost burden on steel users should be avoided.
For prospective firms, temporary protection should be permitted to cover initial learning and capital cost recovery.
Detailed analysis on the impact of AFTA and non-AFTA liberalization on each steel product is needed.
The deadline for AFTA is approaching. Deviation from AFTA will require arduous diplomatic negotiation.

With this list of general precautions, the following tariff policy options are evaluated for long products and flat products, respectively.

Tariffs for long products

LA is an AFTA-consistent scenario of reducing all tariff rates to 0-5 percent by 2006, and LB is a scenario of extending protection temporarily during 2006-2012. Under both scenarios, the final tariff rates will come down to zero by 2015. As to billet, the 5-percent rate applies until it is also lowered to zero by 2015. The possible policy options are: (i) apply LA to all imports; (ii) apply LB to all imports; and (iii) apply LA to imports from ASEAN and LB to imports from non-ASEAN.

Under these alternative options, possibilities of international price fluctuation, reasonable margins for long products, and increased cost at the time of startup of production are assumed. Simulations suggest the following. If international prices are depressed, policy 1 causes a massive exodus of firms and renders the construction of new mills impossible. By contrast, under policies 2 and 3, firms are given time for restructuring and the expansion of EAFs may also be possible. If international prices are high, under all options, prospects are brighter for restructuring of existing mills as well as construction of EAFs and rolling mills. In all cases, large inflows of long steel products from ASEAN neighbors are unlikely. The Government should decide the appropriate policy option based on these analyses [the new tariff schedule needs to be checked].

Tariffs for flat products

As to flat products, similar tariff scenarios for observing the AFTA commitments (FA) and allowing temporary extension of protection (FB) can be considered. From these, the following policy options are available: (i) apply FA to all imports; (ii) apply FB to all imports; and (iii) apply FA to imports from ASEAN and FB to imports from non-ASEAN. The three options are evaluated using the same simulation method.

The recent international market posed severe difficulties for hot roll producers, depriving them of adequate price margins. The low-priced exports from Russia and Ukraine, which greatly affect flat steel markets, must be watched. As to the ASEAN producers, the possibility of flat steel imports from them after trade liberalization cannot be denied entirely but seems small. According to the simulation, the first cold rolling mill will be profitable regardless of assumptions. As to the first hot strip mill, if international prices are depressed, it is not profitable at all under policy 1 but almost profitable in policy 3. The situation under policy 2 is between these two. If international prices are high, the profitability of the hot strip mill rises considerably. The MOF has not announced the medium- to long-term tariff structure for flat products. Currently, all flat products are imported with low tariffs. After the construction of flat product mills, these mills may find it difficult to start operation under such low tariffs.

Copyright © 2003 GRIPS Development Forum. All rights reserved.