Much like China, Vietnam is run by a nominally Communist government that has liberalized the economy while maintaining a tight grip on political power. Beijing began implementing market-oriented policies in the late 1970s, roughly a decade before Hanoi did. The post-1986 Vietnamese reforms were similar, though not identical, to the post-1978 Chinese reforms. Broadly speaking, Vietnam has followed the “China model,” and it has been enormously successful at expanding trade, luring foreign direct investment (FDI), boosting economic growth, and slashing poverty.

According to a report issued by the World Bank and the International Monetary Fund, Vietnam’s poverty rate dropped “from about 58 percent in 1993 to about 16 percent in 2006.” Shortly before leaving his post as World Bank country director for Vietnam in 2007, Klaus Rohland observed that “there’s probably no other country in the world that, over the last 15 years, has moved its development so far and so fast.” In April 2008, Goldman Sachs economist Helen Qiao released a study that said “Vietnam is a plausible candidate to write another story of sustained growth similar to that of China.” The IMF’s Shogo Ishii notes that during the past decade, Vietnam’s GDP has grown at an average annual rate of 7.5 percent (“one of the fastest rates in Asia”). It grew by 8.5 percent in 2007.

However, the past several months have offered a reality check for Vietnam, as inflation has spiked and concerns have mounted over currency depreciation and macroeconomic stability. In June, the consumer price index inflation rate jumped to 26.8 percent (year-on-year). Vietnam’s benchmark stock index, the VN Index, has declined dramatically. Meanwhile, the country’s trade deficit has ballooned, and analysts have warned that a banking crisis is possible. Vietnam clearly has hit a rough patch, and foreign investors are eager to know how the government will respond.

“The prime minister and the central bank should have intervened much earlier,” says Carl Thayer, a Vietnam expert at the Australian Defense Force Academy (and currently a visiting fellow at the Australian National University). Yet Thayer believes the present economic turbulence “will be a bump in the road.” He is confident that Vietnam’s reformers are still calling the shots.

Thuy Dam, general manager of ANZ Bank Vietnam, agrees. “It is a lesson for everybody,” she says. Rising inflation was to be expected: Vietnam’s capital inflows were exceeding the absorptive capacity of the economy. The fact that these problems emerged relatively early in the Vietnamese reform process means that the country will have an easier time recovering, Dam argues.

‘I really do think that the right people are in place to address this problem,’ says Edmund Malesky, a Vietnam expert at the University of California, San Diego.

Maybe so. But in the near term, Vietnam faces many challenges. “I think this will be regarded as a bump in the road—but it’s a big bump,” says Donald Straszheim, a former chief economist at Merrill Lynch who now serves as vice chairman of Roth Capital Partners. “I think Vietnam is an economy that’s going to have a hard landing.” It is “quite likely,” he reckons, that annual GDP growth will be below 5 percent “for the next year or two.”

Vietnam is partly a victim of its own rapid growth and partly a victim of global inflationary trends (namely, soaring food and fuel prices). But now the government must act to reassure the investment community. “I think that the benefits of this prosperity have spread wide and far enough that…the reform-minded are ultimately going to carry the day,” Straszheim says. Some of the most prominent economic reformers include Vietnamese President Nguyen Minh Triet, Prime Minister Nguyen Tan Dung, and Permanent Deputy Prime Minister Nguyen Sinh Hung. (Prime Minister Dung visited the United States in June and met with President Bush and former Federal Reserve Chairman Alan Greenspan.)

“I really do think that the right people are in place to address this problem,” says Edmund Malesky, a Vietnam expert at the University of California, San Diego. “I think the reformers are still in control.” Malesky feels that Hanoi is “making the right decisions now,” but plenty more tough decisions lie ahead.

“In some ways, this crisis is going to end up being a good thing for Vietnam,” he argues. Among other things, it will force the government to address certain structural economic problems, such as those in the banking sector and those related to the state-owned enterprises (SOEs). Malesky expects that some of the smaller Vietnamese banks that were poorly capitalized will probably dissolve, and that major conglomerates may reconsider whether to enter the banking sector.

Overall, Malesky is “pretty positive about the economy,” insisting that “the current trouble is cyclical.” (Though he says that a disturbingly large number of Vietnamese children have dropped out of school this year.) Vietnam is “highly exposed to the international economy,” and “it imported a lot of these problems.” Besides, all transition economies must experience some “growing pains.”

Regina Abrami, a Vietnam expert at Harvard Business School, makes the same point. The recent difficulties do not imply that Vietnam’s economic miracle is unraveling, she says. “These are all very normal, cyclical things you see in emerging economies.” Moreover, inflation “is not a unique Vietnamese problem,” but rather a global problem that has hit Vietnam especially hard.

‘There are encouraging signs that the authorities’ tightening polices are starting to work,’ the Asian Development Bank reports.

While Abrami deems it “a temporary setback,” she says that the government will confront hard choices, as elite politicians seek to balance the need for institutional reforms with the perceived needs of the Vietnamese Communist Party. She hopes that Hanoi will reduce wasteful spending, expand the privatization of SOEs, and establish appropriate mechanisms for bank lending.

After dithering for too long, the government has signaled that it is willing to cool the economy in order to curb inflation. “I’m very encouraged,” says Dam, noting that “credit growth has slowed down significantly.” A Morgan Stanley report issued on June 20th said that “the government has initiated the right policy measures to address the current inflation and balance-of-payments challenges head-on.” In particular, the report pointed to a tightening of monetary and fiscal policies and efforts to slow the business activity of the SOEs.

In late June, Straszheim estimated that it would take at least three to six months “to get the underlying economic and policy fundamentals strong enough so that investors will be on board and that the overall economy will be out of the woods.” In a Roth Capital Partners report, he wrote that “GDP growth of 4-5 percent seems likely in 2009. Thereafter, with progress on inflation, trade, and the budget, we believe that Vietnam will get back to its recent position as the second fastest growing economy in the world—right behind China.”

Of course, Vietnam’s short-term plight could get worse. But just last week, the Asian Development Bank (ADB) released a report that suggested Vietnam was making progress on steadying the economy. “There are encouraging signs that the authorities’ tightening polices are starting to work,” the ADB said. “Import growth has slowed while the dong [Vietnam’s currency] is stabilizing.” Meanwhile, “Strong FDI flows are continuing,” and the 2008 rice harvest “should help ease inflationary pressures.”

Indeed, despite everything, foreign investors have continued flocking to Vietnam. As the Associated Press reported this week, citing government data, “Foreign direct investment pledged for Vietnam in the first seven months of the year has hit a record $45.3 billion, up 373 percent from the same period a year ago and surpassing the record of $21.3 billion for all of 2007.”

Whatever its present woes, Vietnam remains an entrepreneurial society with a youthful, fast-growing population of around 85 million and lower manufacturing costs than China. “Its potential is remarkable,” says Abrami. The 2008 A.T. Kearney Global Retail Development Index, released in early June, ranked Vietnam as the most attractive destination for retailers, ahead of both China and India. As The Daily Telegraph recently reported, fashion giant Burberry has “pinpointed Vietnam as one of the new emerging centers of mass affluence.” Helen Qiao, the Goldman Sachs economist, emphasizes that “Vietnam’s growth was not solely built on capital accumulation or labor input increases. Rather, productivity growth has been an important source of economic growth.”

‘I think this will be regarded as a bump in the road—but it’s a big bump,’ says Donald Straszheim, a former chief economist at Merrill Lynch who now serves as vice chairman of Roth Capital Partners.

To be sure, there is evidence of sagging business confidence among Vietnamese firms. Malesky is lead researcher for the Vietnamese Provincial Competitiveness Index (PCI). In February 2008, a PCI Survey found that more than 77 percent of Vietnamese firms were “planning to increase business.” In April and May, that figure dropped below 67 percent. This reflected a steep decline among sole proprietorships: nearly 67 percent were planning to increase business in February, compared to barely 50 percent in April and May. The decline among limited liability companies over that same period was fairly minor.

So how might Vietnam’s economic turmoil influence the course of political reform? “It will have an effect,” says Abrami. “The direction of the effect remains to be seen.” As she puts it, the Vietnamese have lived through such wrenching economic and political struggles in the past that the difficulties of 2008 seem like “a cakewalk” by comparison. All the same, Abrami says that the recent government crackdown on independent journalists was aimed partly at stemming discontent.

The Vietnamese Communists are “very sensitive to public opinion,” Thayer observes. They recognize that urban Vietnamese are upset about rising prices, corruption, traffic, and pollution. There has also been an uptick in labor protests. But these are practical, everyday concerns, not deep-seated political grievances. The Vietnamese democracy movement is, alas, “small and isolated,” Thayer says. He does not believe that Vietnam’s economic downturn will significantly affect the pace or direction of political reform. The chief anti-government forces—including religious figures, ethnic minorities, and democracy activists—are a disparate lot who have never congealed into a unified, broad-based dissident movement.

As Malesky explains, there is still a “reservoir of support” for the Communist Party, thanks to Vietnam’s long-term economic progress. “Living standards have improved so much,” he says. “I think the goodwill will persist.” Malesky arrived in Hanoi a few weeks ago. When I spoke to him by phone on July 7th, he reported that he was “not seeing the type of panic that you would imagine,” adding that the big restaurants and markets were “still packed.”

That shows just how much Vietnam has changed. “It is hard for me to imagine that a few months of inflation [will] reverse 20 years of growth and poverty alleviation,” Malesky says. “I’m pretty optimistic about where Vietnam is going.” Two years from now, he predicts, the current trouble will be viewed as “just a blip on the radar screen.”