China's ever-increasing trade surplus with the world's major trading nations has led to aggravating international sentiments and thereby lays grounds for further concerns of protectionist measures against China exports. Considering this risk, it makes sense for Hong Kong companies to think about diversifications.

Compared to China, Vietnam's external sector in general has better market access to some of the world's major trading nations (particularly the US). Also blessed with a fairly skilled but inexpensive labour force, Vietnam is viewed by many as a competitive production base outside China, especially the province of Guangdong.

In general, Guangdong and Vietnamese workers are viewed as being hardworking, peace-loving and obedient to authority. Textiles and electronics are both considered their leading strengths. While salary levels for both Guangdong and Vietnam are showing some upward pressure due to an increasing shortage of labour, Vietnam appears to provide cheaper labour costs - the average annual salary for a worker in Guangdong is US$2,778¹ whereas a Vietnamese worker earns about US$1,200. In Dongguan, the minimum wage levels are at US$87 whereas the minimum wage in Ho Chi Minh City is US$55.

Concerning supply chain management, the complementary potential of Guangdong and Vietnam is evident. Take footwear (accounting for about 9% of Vietnam's exports in 2005) as an example, in 2005, Vietnam imported US$42.5 million worth of footwear from China (over 95% were insoles or other intermediates) and subsequently processed them for exporting to the US, EU and the member countries of the Association of South East Asian Nations Free Trade Area (ASEAN).

Established in 2005, the China-ASEAN Free Trade Agreement (CAFTA) created the world's third-largest free trade area (after NAFTA and EU) with 1.7 billion population and US$130.5 billion bilateral trade. Due to its geographical position and extensive coast line, Vietnam becomes a natural gateway for Chinese companies, including Hong Kong manufacturers in Guangdong, in reaching out to the rest of CAFTA.

In addition to being a gateway, Vietnam also emerges as a promising market for Chinese exports - electronics (US$414.8 million in 2005, up 57.9% from 2004), jewellery (US$315 thousand in 2005, up 32.2% from 2004), textiles (US$785.2 million in 2005, up 50.1% from 2004), timepieces (US$1.1 million in 2005, up 96.9% from 2004), and toys (US$4.8 million in 2005, up 27.5% from 2004).

While Vietnam may not come first in Hong Kong companies' priority list (Hong Kong's 26th largest trading partner in 2005), its trade with Hong Kong is growing with momentum (total volume of trade between the two amounted to US$1.8 billion in 2005, up 6.6% from 2004). Across local retail markets in Vietnam, Hong Kong brands are not uncommonly seen - e.g. Bossini and Giordano have both established local retail outlets in Vietnam while VTech's electronic toys are sold locally in some of the modern retail outlets (e.g. Diamond Plaza in Ho Chi Minh City).

According to both AT Kearney² and PriceWaterhouseCoopers³, Vietnam is among the world's most promising retail markets (ranked the 3rd most promising emerging retail market in the world). Brand is reported⁴ to be the No. 1 factor affecting the higher-income consumers' purchasing decisions, leading other factors such as after-sales service, and product quality and design, etc., but national spending on advertising stays as low as US$4 per capita (less than one-eighth of China's and 1.5% of the US'). This explains why the Vietnamese retail market is considered by many as a green field for brand equity investment.

On the regulatory front, alongside its announcement that foreign retailers would be allowed to set up jointly- and wholly-owned local outlets within the next three years, the Vietnamese government has introduced sweeping policy reforms and legislative amendments in order to meet the various prerequisites for its WTO accession - e.g. Vietnam has just introduced the new Law on Investment and Law on Enterprises (effective from July 1, 2006): the former is aimed at unifying the landscape for both domestic and foreign investments whereas the latter is targeted to put all enterprises in Vietnam, regardless of their ties with the state or foreigners, under the same rule.

Externally, after years of closed-door policy, Vietnam is now determined to strengthen ties with its trading partners and to raise its profile in international scenes - it joined ASEAN in 1995; signed the US-Vietnam Bilateral Trade in 2001; reached WTO-related bilateral agreements with the EU and the US in late 2005 and early 2006; now just months away from joining the WTO (expected in late 2006 or early 2007); Ho Chi Minh City will host a trade ministers' meeting of the Asia-Pacific Economic Co-operation (APEC) forum; and Hanoi will host APEC's 2006 ministerial summit.

The combination of a reformed regulatory framework and improving international relations have attracted good attention from foreign investors. In 2005, Vietnam's FDI inflow reached US$6.3 billion, up 50% from 2004. For the first six months of 2006, FDI inflow from Hong Kong ranked No. 1 across all foreign investors in Vietnam, with registered capital amounting to US$615.2 million. Light-industry manufacturing and real estate (i.e. hotels, and commercial and residential buildings) seem to be Hong Kong investors' favourites, jointly accounting for over 75% of FDI inflow from Hong Kong between 1998 and 2005. Among the various urban centres across Vietnam, Ho Chi Minh City (US$1,773.9 million or 48.1%), Dong Nai (US$438.7 million or 11.9%) and Hanoi (US$369.3 million or 10%) ranked the top three in attracting investment from Hong Kong.

Sitting on this massive FDI inflow, Vietnam has the vision to become a world-class tourism centre and has targeted to attract six million foreign visitors per year by 2010. Currently, Vietnam has about 5,900 hotel businesses providing a total of 124,000 rooms but about 80% of the hotels are considered small-scale (less than 20 rooms).

In addition to hotels, the supply of quality office and residential buildings across Vietnam's top urban centres is also very limited in comparison to the surging demand. In the commercial segment of Hanoi, it is reported⁵ that among the very few buildings that are above four to six floors and are fit for commercial use, 5% must be destroyed as soon as possible and 62% are in need of upgrades - and still, office occupancy rates are staying above 95% in Hanoi and Ho Chi Minh City. Further, it is expected that the surging speed of Vietnam's urbanisation will further expedite population growth in Vietnamese cities (e.g. the population of Hanoi and Ho Chi Minh City is expected to double in the next 10 to 15 years) - strong demand for quality residential space driven by new higher-income households will continue to outpace planned supply.

On the heels of surging real estate investment, Vietnam is investing heavily in its logistics infrastructure - due to be completed in 2008, three mega corridors (East-West, North-South, and Southern) will link different parts of Vietnam to Laos, Cambodia, Thailand and Myanmar. In particular, the 1,500 km-long East-West corridor, which cuts across mainland Southeast Asia, will shorten the one-week sea trip between Vietnam's central seaport of Danang and the Andaman Sea in Myanmar to a 48-hour drive.

In connecting to China, Vietnam is planning to build a 264km Hanoi-Lao Cai Expressway. Regarded as the important traffic artery of the Kunming-Haiphong road corridor, the expressway is purported to strengthen the border trade between Vietnam and China, and, thereby, to further boost the socioeconomic development in the Mekong sub-region.

Standing as a choice for investment in light-industry manufacturing and real estate, and a prospering retail market with the vision to become a logistics and tourist centre for the Southeast Asian mainland (also known as "Indo-China"), Vietnam's "3-in-1 package" looks very appealing to Hong Kong companies.

Behind this "3-in-1" glamour, Vietnam is far from a challenge-free market. Widespread low household incomes, a dominant but unmodernised segment in the retail sector, and the concentration of economic power in the hands of the state-owned/-related enterprises have made Vietnam a very complex market. For Hong Kong companies interested in Vietnam, "be cautious" pays.

This new report is available at TDC's Retail Outlets. It can also be purchased through the TDC Bookshop section in the TDC's trade portal: info.hktdc.com.