BMI Vietnam Defence and Security Report Q2 2014

Q2 2014www.businessmonitor.com

VIETNAMDEFENCE & SECURITY REPORTINCLUDES 5-YEAR FORECASTS TO 2018

ISSN 1749-1762Published by:Business Monitor International

Vietnam Defence & SecurityReport Q2 2014INCLUDES 5-YEAR FORECASTS TO 2018

Part of BMIs Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: March 2014

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CONTENTS

BMI Industry View ............................................................................................................... 7Key BMI Forecasts ................................................................................................................................... 8Recent Developments ................................................................................................................................ 8

SWOT .................................................................................................................................... 9Vietnam Security SWOT .............................................................................................................................. 9Vietnam Defence SWOT ............................................................................................................................ 12Political ................................................................................................................................................. 14Economic ............................................................................................................................................... 15Business Environment .............................................................................................................................. 16

Industry Forecast .............................................................................................................. 17Defence Expenditure ............................................................................................................................... 17

Table: Vietnam's Defence Expenditure 2011-2018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17Table: Vietnam's Defence Expenditure By Changing % Of GDP, 2010-2018 (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Armed Forces ........................................................................................................................................ 19Table: Vietnam's Armed Forces, 2000-2009 ('000 personnel, unless otherwise stated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20Table: Vietnam's Manpower Available For Military Service, 2011-2018 (aged 16-49 unless otherwise stated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Defence Trade ....................................................................................................................................... 20Table: Vietnam's Defence Trade Balance, 2010-2018 (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Imports ................................................................................................................................................ 21Table: Vietnam's Defence Imports, 2010-2018 (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Exports ................................................................................................................................................ 22Table: Vietnam's Defence Exports, 2010-2018 (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Macroeconomic Forecasts ............................................................................................... 23Table: Vietnam - Economic Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Industry Risk Reward Ratings .......................................................................................... 27Asia Security Risk Ratings ......................................................................................................................... 27

Table: Asia Pacific Security Risk Ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27Table: Asia Pacific State Vulnerability To Terrorism Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Vietnam Security Risk Ratings .................................................................................................................... 28

Market Overview ............................................................................................................... 29Vietnam Defence Market Overview ............................................................................................................. 29Recent Developments .............................................................................................................................. 29Armed Forces ........................................................................................................................................ 29Domestic Industries ................................................................................................................................ 30Imports ................................................................................................................................................ 33

Vietnam Security Overview ........................................................................................................................ 37Domestic Threats ................................................................................................................................... 37

Vietnam Defence & Security Report Q2 2014

Business Monitor International Page 4

Regional Threats .................................................................................................................................... 38International Threats .............................................................................................................................. 40

Regional Overview ............................................................................................................ 41Political Risk Analysis .............................................................................................................................. 41

Global Industry Overview .................................................................................................. 54Global Political Outlook ........................................................................................................................... 54

Table: Election Timetable, 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Methodology ...................................................................................................................... 63Industry Forecast Methodology ................................................................................................................ 63Sector-Specific Methodology .................................................................................................................... 64Sources ................................................................................................................................................ 65Risk/Reward Rating Methodology ............................................................................................................. 65Sector-Specific Methodology .................................................................................................................... 66

Table: Security Risk/Reward Ratings Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66Table: Weighting Of Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67



BMI Industry View

BMI View: Given China's recent declaration of an Air Defence Identification Zone (ADIZ) in the EastChina Sea and increased territorial assertiveness in the South China Sea, Vietnam is increasingly findingitself squeezed between the US and China.

Vietnam is involved in territorial disputes with China in the South China Sea, most notably over the Spratly

and Parcel Islands. Although Beijing denies that is planning to declare an ADIZ in the South China Sea, arecent announcement by foreign minister Wang Yi that China would 'defend every inch' of its territory has

no doubt left Hanoi worried.

Beijing's increasing assertiveness n has had a pronounced effect on Vietnam's defence policy over the pastdecade. Indeed, between 2005 and 2012 Vietnam's defence spending doubled. As with most other

neighbouring countries, regional tensions have ensured that defence sales have remained buoyant despite

various economic challenges. Over the past few months, Vietnam has taken delivery of two six Kilo-class

diesel-electric submarines ordered from Russia, as well as a Ukraine-made 3D search radar ST68UM for the

S-300 missile system.

Given its increasing appetite for new defence equipment, as a result of rising tensions with China in the

South China Sea, Vietnam has become a key market for a range of countries. While Moscow has always

been Hanoi's primary defence partner, due to the latter's reliance on Soviet-era equipment, a number of

European defence companies are also expanding ties with the country. Airbus Helicopter, French naval

company DCNS and European missile-maker MBDA are all reportedly looking to win contracts in Hanoi.

Defence ties with the US have continued to strengthen since the ADIZ declaration in November 2013.

Following US Secretary of State John Kerry's visit to Vietnam in December 2013 a range of deals have

been announced between the two countries. This includes US$32.5mn in assistance for maritime lawenforcement in South East Asia, US$18mn of which is earmarked for Vietnam. In March 2014 WendySherman, the under-secretary of state for political affairs, followed Kerry's visit to Vietnam with a short

visit to Hanoi. During the under-secretary's meetings with Nguyan Chi Vinh, the Vietnamese deputy

minister of national defence, the two countries agreed to promote exchanges aimed at better coordination in

strategic consultations on defence and security, clearing bombs and mines, as well as enhancing maritime

security.



With the US' strategy of rebalancing to Asia and China antagonising traditional allies, it will be interesting

to see how the Vietnam-China-US dynamic develops. Unlike other neighbouring countries, notably Japan

and South Korea, Vietnam has maintained a cautious reaction following Beijing's announcement of anADIZ in November. However, the warm reception proffered to Kerry during his recent, may imply a

reorientation of Vietnam's web of alliances.

A notable development has been Vietnam's increased integration with its ASEAN regional partners on

matters of defence and security. Indeed, in March 2014 ASEAN members agreed to undertake jointmaritime security exercises in the Malacca Straits in 2015. The announcement comes at a sensitive time,

with five member states embroiled in territorial disputes with China, and was intended to signal solidarity in

the face of Chinese aggression and assertiveness.

Key BMI Forecasts

Defence expenditure is forecast to rise from US$5.9bn in 2013 to US$6.8n, up 15.1% year-on-year

As a percentage of GDP growth, defence expenditure is set to remain stable at roughly 3.5% of GDP.

In 2014 real GDP is set to grow 5.97% from 2013. In 2015 real GDP is forecast to grow at 6.42%.

Recent Developments

Given regional tensions, Vietnam's defence spending remains buoyant, with a number of Europeandefence manufacturers involved in negotiations over the export of supplies.

ASEAN partners announced joint naval exercises in the Malacca Straits to start in 2015.

Beijing has reportedly carried out preparations for establishing an ADIZ in the South China Sea, althoughwith no immediate plans to implement it.



SWOT

Vietnam Security SWOT

SWOT Analysis

Strengths Abundant operational experience among senior military personnel.

Large standing force.

Role of military in politics ensures its place in society.

No lack of political support for military upgrades.

Revival of diplomatic ties with US could strengthen bilateral security relations.

Longstanding relationship with Russia will ensure a steady stream of new military

equipment from Russian suppliers.

Development of new defence partnerships gives Vietnam options and flexibility.

Membership of ASEAN and common cause with other South East Asian countries

means that Vietnam has international support in its territorial disputes with China.

Weaknesses Outstanding territorial claims, specifically with China, could lead to conflict.

Chinese advances in East China Sea could be replicated in South China Sea, directly

impacting upon Vietnam's security

Low defence budget restrict operational capacity.

Antiquated, Soviet defence platforms are in need of upgrading

Economic fragility could send the country's military modernisation programme into

reverse.

The political primacy of the army versus the navy and air force means that the army

remains far too large and diverts resources away from the other services.

Systemic corruption remains a problem.



SWOT Analysis - Continued

Inefficient and uncompetitive state-run defence establishment.

Having not fought a major war for several decades, the once-feared Vietnamese

military has by now lost much of its combat experience.

Opportunities Forecast economic growth may lead to a larger military budget, although economic

fragility may counterbalance this growth.

Russia and India have offered wide-ranging assistance in Vietnam's military

modernisation programme.

Advanced new naval assets should enable Vietnam to safeguard its offshore interests.

Recent pattern of engagement with US could lead to increasing military cooperation if

the US uses Vietnam as an aid to balance the rise of China.

Access to second-hand US equipment, including P-3C Orion maritime patrol aircraft,

would give the Vietnamese a huge capability boost.

A new Code of Conduct governing activities in disputed areas of the South China Sea

being negotiated by ASEAN and China could significantly reduce the chances of a

Sino-Vietnamese maritime clash.

Defence diplomacy with a range of countries, including Australia, Israel and

Singapore, should bolster security by opening up new avenues for procurement and

also forging new strategic partnerships.

Indonesia, France, Italy, Sweden, the UK, South Korea and India are the latest

countries to have emerged as potential defence industry partners.

The refurbishment of naval facilities at Cam Ranh Bay will turn Vietnam into a regular

port of call for foreign navies, including the US Navy.

The establishment of a new Vietnam Coast Guard will enable better monitoring of

coastal waters.

Vietnam and China are co-chairing the ASEAN Defence Ministers' Meeting Plus

Expert Working Group on humanitarian assistance and disaster relief, and the co-

operation should serve to build relationships between the two countries.




The new constitution outlines plans to expand Vietnam's domestic defence industry,

which may make it more self-sufficient regarding defence and security.

Threats The Vietnamese economy is vulnerable to global shocks: a downturn could lead to

social instability, and also hinder defence modernisation.

A banking crisis is also a major threat to economic stability, which in turn could

jeopardise domestic stability.

Territorial disputes and Chinese advances in the South China Sea could lead to

conflict with China, whose naval power greatly exceeds that of Vietnam.

Piracy and smuggling continue to pose a threat off the Vietnamese littoral.

The collapse of ASEAN unity brought about by an inability to adopt a unified position

on China means that the region's security framework is now vulnerable.



Vietnam Defence SWOT

SWOT Analysis

Strengths Agreements with India and Russia could provide blueprint for industry development.

Procurement of four advanced modular corvettes from the Netherlands, two of which

will be built in Vietnam, will give industry experience of cutting-edge ship-building

tech.

The acquisition of three new Sveytlak-class patrol ships, one of which was built in

Vietnam, should similarly boost local industry know-how.

A growing defence budget provides industry with the opportunity for growth.

The recent launch of Vietnam's first domestically developed warship demonstrates

that the country's naval shipyards are making good technical progress.

Weaknesses Lack of capital to invest in research and development (R&D).

Infrastructure needed to produce larger platforms.

Government has not tapped into ready demand for small arms in Vietnamese Army.

Vietnam may struggle to afford advanced technology from Western countries.

Human rights concerns remain a barrier to arms sales in the eyes of Western

countries.

Opportunities Russia is helping Vietnam to upgrade its naval facilities at Cam Ranh Bay, boosting

defence capabilities but also local industry know-how.

A new initiative aimed at streamlining inefficient state-run enterprises by 2020 could

yield a more effective domestic defence industry.

The construction of advanced SIGMA-class corvettes, procured from the

Netherlands, should boost the knowhow of local shipbuilders.

Russian agreement to help Vietnam produce its own anti-ship missiles and UAVs will

equip Vietnamese industry with important new capabilities.




Sweden is also helping with UAV development, suggesting that Vietnamese industry

is starting to develop its own capabilities in this area.

Government orders for naval vessels are strengthening domestic industry.

India-Vietnam defence agreement could mean wider range of locally made goods as

agreement focuses on boosting domestic defence production.

Technology transfers are expected to be bargaining points.

Open to joint ventures.

Improving US ties could enable Hanoi to tap into the US's defence industry expertise

in the long term. In the short term, it could mean the lifting of the US arms embargo.

Given Vietnam's increasing appetite for defence equipment a number of European

defence manufacturers are exploring potential deals with Hanoi.

Threats Changes in commodity prices or an economic downturn resulting from a severe

downturn in Europe could reduce funds available for defence industry development.

Technology transfers likely to be preceded by asymmetric arms trade relationship.

Vietnam will most likely import defence products to gain transfers of technology.

Industry purportedly riddled with corruption at the highest levels.



Political

SWOT Analysis

Strengths The Communist Party of Vietnam remains committed to market-oriented reforms and

we do not expect major shifts in policy direction over the next five years. The one-

party system is generally conducive to short-term political stability.

Relations with the US have witnessed a marked improvement, and Washington sees

Hanoi as a potential geopolitical ally in South East Asia.

Weaknesses Corruption among government officials poses a major threat to the legitimacy of the

ruling Communist Party.

There is increasing (albeit still limited) public dissatisfaction with the leadership's tight

control over political dissent.

Opportunities The government recognises the threat corruption poses to its legitimacy, and has

acted to clamp down on graft among party officials.

Vietnam has allowed legislators to become more vocal in criticising government

policies. This is opening up opportunities for more checks and balances within the

one-party system.

Threats Macroeconomic instabilities continue to weigh on public acceptance of the one-party

system, and street demonstrations to protest economic conditions could develop into

a full-on challenge of undemocractic rule.

Although strong domestic control will ensure little change to Vietnam's political scene

in the next few years, over the longer term, the one-party-state will probably be

unsustainable.

Relations with China have deteriorated over recent years due to Beijing's more

assertive stance over disputed islands in the South China Sea and domestic criticism

of a large Chinese investment into a bauxite mining project in the central highlands,

which could potentially cause wide-scale environmental damage.



Economic

SWOT Analysis

Strengths Vietnam has been one of the fastest-growing economies in Asia in recent years, with

GDP growth averaging 7.1% annually between 2000 and 2012.

The economic boom has lifted many Vietnamese out of poverty, with the official

poverty rate in the country falling from 58% in 1993 to 20.7% in 2012.

Weaknesses Vietnam still suffers from substantial trade and fiscal deficits, leaving the economy

vulnerable to global economic uncertainties. The fiscal deficit is dominated by

substantial spending on social subsidies that could be difficult to withdraw.

The heavily-managed and weak currency reduces incentives to improve quality of

exports, and also keeps import costs high, contributing to inflationary pressures.

Opportunities WTO membership and the upcoming ASEAN AEC in 2015 should give Vietnam

greater access to both foreign markets and capital, while making Vietnamese

enterprises stronger through increased competition.

The government will in spite of the current macroeconomic woes, continue to move

forward with market reforms, including privatisation of state-owned enterprises, and

liberalising the banking sector.

Urbanisation will continue to be a long-term growth driver. The UN forecasts the

urban population rising from 29% of the population to more than 50% by the early

2040s.

Threats Inflation and deficit concerns have caused some investors to re-assess their hitherto

upbeat view of Vietnam. If the government focuses too much on stimulating growth

and fails to root out inflationary pressure, it risks prolonging macroeconomic

instability, which could lead to a potential crisis.

Prolonged macroeconomic instability could prompt the authorities to put reforms on

hold as they struggle to stabilise the economy.



Business Environment

SWOT Analysis

Strengths Vietnam has a large, skilled and low-cost workforce, which has made the country

attractive to foreign investors.

Vietnam's location - its proximity to China and South East Asia, and its good sea links

- makes it a good base for foreign companies to export to the rest of Asia, and

beyond.

Weaknesses Vietnam's infrastructure is still weak. Roads, railways and ports are inadequate to

cope with the country's economic growth and links with the outside world.

Vietnam remains one of the world's most corrupt countries. According to

Transparency International's 2012 Corruption Perceptions Index, Vietnam ranks 123

out of 176 countries.

Opportunities Vietnam is increasingly attracting investment from key Asian economies, such as

Japan, South Korea and Taiwan. This offers the possibility of the transfer of high-tech

skills and know-how.

Vietnam is pressing ahead with the privatisation of state-owned enterprises and the

liberalisation of the banking sector. This should offer foreign investors new entry

points.

Threats Ongoing trade disputes with the US, and the general threat of American

protectionism, which will remain a concern.

Labour unrest remains a lingering threat. A failure by the authorities to boost skills

levels could leave Vietnam a second-rate economy for an indefinite period.



Industry Forecast

Defence Expenditure

Vietnam is not transparent about its defence spending and its stated defence budget often varies

substantially from year to year. For example, in 2011 the government said it was increasing the budget by

70%, leading most analysts to question the numbers.

Vietnam is understood to be one of the lowest defence spenders in South East Asia, with a smaller budget

than most of its neighbours. In 2012 the country's declared that spending was U$3.36bn, around 2.4% ofGDP, although this is hard to verify. The declared 2013 spending was U$3.8bn and for 2014 this isprojected to increases to US$4.3bn. BMI forecasts defence expenditure in 2014 to reach over US$6bn,before rising to US$7.7bn in 2015.

Table: Vietnam's Defence Expenditure 2011-2018

2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

VNDmn 87,831,477 111,582,639 123,506,954 139,029,544 157,286,807 177,712,451 200,088,484 225,238,067

- % changey-o-y 10.8 27.0 10.7 12.6 13.1 13.0 12.6 12.6

- % of GDP 3.2 3.4 3.4 3.5 3.5 3.5 3.6 3.6

- VND percapita 976,839 1,228,941 1,347,157 1,502,243 1,684,254 1,886,724 2,107,044 2,353,669

US$mn 4,252.0 5,345.8 5,873.2 6,760.5 7,736.7 8,791.1 10,004.4 11,375.7

- % changey-o-y 2.5 25.7 9.9 15.1 14.4 13.6 13.8 13.7

- US$ percapita 47.3 58.9 64.1 73.0 82.8 93.3 105.4 118.9

EURmn 3,059.0 4,209.3 4,449.4 5,323.2 6,290.0 7,325.9 8,337.0 9,479.7

- % changey-o-y -2.1 37.6 5.7 19.6 18.2 16.5 13.8 13.7

- EUR percapita 34.0 46.4 48.5 57.5 67.4 77.8 87.8 99.1

US$mn,constantprices 3,506.5 3,974.3 4,126.7 4,523.2 4,950.2 5,377.3 5,856.0 6,371.7

- % changey-o-y -15.4 13.3 3.8 9.6 9.4 8.6 8.9 8.8



Vietnam's Defence Expenditure 2011-2018 - Continued

2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

- constantUS$ percapita 39.0 43.8 45.0 48.9 53.0 57.1 61.7 66.6

e/f = BMI estimate/forecast; per capita = per capita of population. Source: US Department of State's World MilitaryExpenditures and Arms Transfers report (WMEAT)

Budget restraints dictate that Vietnam must procure

much of its most advanced military equipment

through alternative means, such as via credit

agreements, or by providing oil and gas instead of

currency. For instance, in November 2013 India

extended a US$100mn line of credit for the purchaseof four offshore patrol vessels.

Our forecasts of defence spending are driven by two

variables. One is overall GDP. The other is the

percentage of GDP that is devoted to defence. In

forecasting the latter, we give consideration to the

size of defence spending as a percentage of GDP in

recent years and the likely future trends, given what

we know about the budgetary priorities of the

government.

The chart compares the rate at which defence

expenditure is increasing compared to the annual

real GDP growth rate. It shows that the rate at which defence expenditure is increasing substantially

outstrips real GDP growth. This is no doubt a response to the deteriorating security situation in the East and

South China Sea. While real GDP is set to grow by 5.97% in 2014, defence expenditure is set to increase by

12.6%.

The table displays defence expenditure as a changing percentage of GDP. The core 2014 scenario, where

defence spending equates to 3.5% of GDP, will mean that defence spending amounts to US$6.8bn.

Defence Expenditure outpacesGDP growth

Defence Expenditure % Increase Y-o-Y VersusReal GDP Growth % Y-o-Y, 2010-2018

GDP: Real GDP growth, % y-o-yEXPENDITURE: Defence expenditure, VND~ % y-o-y

2010

2011

2012

2013

2014

f

2015

f

2016

f

2017

f

2018

f0

10

20

30

f = forecast. Asian Development Bank, General Statistics

Office, US Department of State's WMEAT, BMI



Table: Vietnam's Defence Expenditure By Changing % Of GDP, 2010-2018 (US$mn)

2010 2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

Core scenario 4,146.5 4,252.0 5,345.8 5,873.2 6,760.5 7,736.7 8,791.1 10,004.4 11,375.7

Spending +0.2pp of GDP 4,372.2 4,521.1 5,656.7 6,214.1 7,150.8 8,178.9 9,289.1 10,566.1 12,008.9



Spending -0.2pp of GDP 3,920.8 3,982.8 5,034.8 5,532.3 6,370.2 7,294.5 8,293.1 9,442.8 10,742.4



e/f= BMI estimate/forecast; pp = percentage points. Source: WMEAT calculation, BMI

Armed Forces

As of 2009 the total size of Vietnam's armed in personnel was 523,000 people. The army remains far and

away the largest service, comprising 413,000 people. This owes to a tradition of defending against land

invasions and also the power and influence the army exerts within the political sphere. The Navy and Air

Force have 39,000 and 31,000 personnel, respectively. Vietnam's military also comprises a paramilitary

force amounting to roughly 40,000 people, a 40,000-strong border defence corps and 5 million reservists.

A new Vietnam Coast Guard (VCG) and a reorganised marine police will be consolidated as they comeunder the auspices of the Ministry of Defence from October. In July, the military also announced that it was

setting up a new joint Air Force-Naval brigade to perform maritime surveillance and search and rescuemissions. This unit is likely to absorb a number of the assets from the Vietnam Marine Police, due to be

folded due to the creation of the VCG.



Table: Vietnam's Armed Forces, 2000-2009 ('000 personnel, unless otherwise stated)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Army 412.00 412.00 412.00 420.00 420.00 418.00 416.00 413.00 413.00 413.00

Navy 42.00 42.00 42.00 36.30 37.40 38.00 38.50 39.20 39.20 39.20

Air force 30.00 30.00 30.00 30.00 30.00 30.30 30.60 31.00 31.00 31.00

Paramilitaryforce

40.00 40.00 40.00 40.00 40.00 40.00 40.00 40.00 40.00 40.00

Total armedforces

524.00 524.00 524.00 526.30 527.40 526.30 525.10 523.20 523.20 523.20

- % ofpopulation

0.67 0.66 0.65 0.65 0.64 0.63 0.62 0.62 0.61 0.60

Source: BMI, IISS

Table: Vietnam's Manpower Available For Military Service, 2011-2018 (aged 16-49 unless otherwise stated)

2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

Males 25,368,398 25,518,671 25,625,454 25,702,858 25,762,143 25,805,917 25,834,177 25,852,490

Females 25,047,114 25,180,068 25,278,792 25,352,205 25,407,436 25,446,511 25,469,695 25,480,216

Total 50,415,512 50,698,740 50,904,246 51,055,062 51,169,579 51,252,428 51,303,872 51,332,706

- % ofpopulation 56.1 55.8 55.5 55.2 54.8 54.4 54.0 53.6

- % changeon 10 yearspreviously 16.1 14.4 12.6 10.9 9.2 7.6 6.2 4.8

e/f = estimate/forecast. Source: BMI

Defence Trade

A former Soviet proxy, Vietnam has failed to develop its own domestic defence industry adequately. Soviet

reliance has evolved into Russian reliance, at least when it comes to advanced defence equipment.

Hindering the local industry's development has been its long history of conflict, meagre resources, lack of

domestic know-how and military doctrine of guerrilla and defensive warfare strategies. Most Vietnamese

arms were purchased from the Soviets, except for a few newly acquired platforms from North Korea, Russia

and a small number from India and Canada. Recently, Vietnam has been looking to develop defence trade

ties with new partners, such as India, Canada and France.



Table: Vietnam's Defence Trade Balance, 2010-2018 (US$mn)

2010 2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

Arms and ammunition -10.9 -10.9 -10.9 -10.9 -10.9 -10.9 -10.9 -10.9 -10.9

- % change y-o-y 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

e/f = BMI estimate/forecast. Source: BMI, UN Comtrade

Vietnam maintains a small domestic defence industry capable of supplying small arms, minor weaponry and

ammunition. For more technologically advanced production, it relies on reverse engineering and this

technique has been employed to keep its fleet of ageing Soviet aircraft in use prior to an agreement with

India. All defence production is facilitated by state enterprises, and there is little, if any, research and

development (R&D) conducted in the country aimed at creating new platforms. However, through a focusedprocurement programme, the defence industry will benefit from exposure to new technology.

Perhaps the largest inhibiting factor preventing the industry's development is capital. With Vietnam so far

behind regional leaders economically, it lacks the required industrial and scientific base necessary for any

credible defence industry. However, purchases expected to come in the next decade may include technology

transfers, allowing Vietnam to jump ahead generations and to provide the foundation for a domesticindustry.

In February 2013 Hanoi announced a new initiative whereby it plans to reorganise state-run defence

companies with a view to making them competitive by 2020. The government is planning to restructure

state-owned companies across the board, not just in defence, as it seeks to revitalise the flagging economy.The country's indebted defence firms are badly in need of an organisational overhaul if they are to enable

Hanoi to start procuring more domestic equipment, rather than rely on foreign (mainly Russian) imports.

Given Vietnam's diminutive domestic defence industry, it is no surprise that it has a substantial trade deficit

regarding arms and ammunition trade. In 2014 this deficit is expected to amount to US$10.9mn, and is setto maintain a similar level until at least the end of the current forecasting period, in 2018.

Imports

As is to be expected of a country at Vietnam's stage of development, defence imports have increased.

Between 2005 and 2012, Vietnamese defence imports actually doubled. Arms and ammunition constitutes

the main import area, with imports in 2014 expected to amount to roughly US$11.5mn.



Defence funding for new equipment remains relatively limited compared to many neighbouring countries.

Nonetheless, as the economy continues to expand, BMI expects far more significant sums of money to be

allocated towards acquiring new equipment.

Table: Vietnam's Defence Imports, 2010-2018 (US$mn)

2010 2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

Arms and ammunition 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5 11.5

Military weapon imports, excl. guns and swords 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5

Revolvers and pistols 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Bombs, grenades, mines, missiles, ammunition 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4

e/f = BMI estimate/forecast. Source: BMI, UN Comtrade

Owing to the predominance of Soviet-era defence platforms, Vietnam has traditionally acquired the bulk of

its military equipment from Russia, usually on credit. While Russia remains Vietnam's primary defence

partner, Hanoi has recently sought to establish new defence partnerships. Central to these partnerships are

technology transfers and domestic industry development. It is no surprise to see a large number of

procurement deals tied in with the development of Vietnam's defence industry.

The recent procurement of two SIGMA-class corvettes from the Netherlands is a good example of this kind

of deal. With the second of the two ships likely to be built in Vietnam, the domestic defence industry will

gain access to far more advanced technology and developed techniques than are currently available.

Exports

Vietnam's defence exports are negligible, amounting to only US$600,000 in 2013. Furthermore, exports areconfined to the area of arms and ammunitions.

Table: Vietnam's Defence Exports, 2010-2018 (US$mn)

2010 2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

Arms and ammunition 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6

e/f = BMI estimate/forecast. Source BMI, UN Comtrade



Macroeconomic Forecasts

BMI View: Vietnam's latest real GDP reading, which showed that the economy expanded by 6.0% year-on-

year (y-o-y) in Q413, has reaffirmed our conviction that the Vietnamese economy will begin 2014 on astrong note. Not only are we witnessing more evidence of a sustained pick-up in production activity andemployment in the manufacturing sector, but we also expect foreign direct investment (FDI) inflows toaccelerate as the economic recovery gathers pace over the coming quarters. We forecast real GDP growthto come in at 5.9% in 2014, versus Bloomberg consensus of 5.5%.

In line with our view that the Vietnamese economy would accelerate forcefully into the final months of the

year (see 'Economy Picking Up Pace', October 4 2013), latest data released by the General Statistics Office(GSO) showed that the economy expanded by 6.0% year-on-year (y-o-y) in Q413. This translates into full-year growth of 5.4% for 2013, just slightly above our forecast of 5.3%. The latest GDP reading, combinedwith the strong set of economic data we have seen in recent weeks (accelerating foreign direct investmentinflows, remittances, and merchandise trade exports), have reaffirmed our conviction that the Vietnameseeconomy will begin 2014 on a strong note.



Looking At A Strong Start For 2014

Vietnam - Real GDP Growth, % (LHS) & Contribution By GFCF & Private Consumption, pp (RHS)

Source: BMI, General Statistics Office. (e = estimates, f = BMI forecasts)

Signs Of Improvement

Despite the lack of progress with regards to banking sector reforms and efforts to ease lending conditions

(credit growth is estimated to have expanded by around 9% in 2013, well under the State Bank of Vietnam'sinitial target of 12%), the economy appears to be holding up well. Not only are we witnessing moreevidence of a sustained pick-up in production activity and employment in the manufacturing sector (see'Strong PMI Reading Reinforces Outlook On Growth', November 5 2013), but we also expect foreign directinvestment (FDI) inflows into the export sector to accelerate as the economic recovery gathers pace over thecoming quarters.

Private Sector Investment To Drive Recovery

According to figures published by GSO, FDI-related exports made up an estimated 67% of the country's

total exports for the first 11 months of the year. Thus, although increased FDI inflows could potentially

result in a temporary deterioration in the country's trade and current account dynamics due to a burst of



capital goods imports in the near term, we believe that this is a long-term positive for the economy.

Furthermore, we view FDI inflows as a crucial source of economic growth over the coming quarters given

that the Vietnamese government is struggling to unlock domestic lending. We forecast real gross fixed

capital formation (GFCF) growth to come in at around 10% in 2014, contributing around 2.7 percentagepoints (pp) to our real GDP growth forecast of 5.9%.

Expenditure Breakdown

Private Consumption: We expect private consumption to grow at a relatively resilient pace of 6.5% in

2014. However, we note that the risk of further bankruptcies among SMEs could potentially lead to

widespread job losses, especially in export-driven sectors. Uncertainties over the outlook for employmentcould, in turn, prompt households to cut back on spending.

Gross Fixed Capital Formation: We foresee a pickup in private sector investment growth in 2014, partly

led by increased foreign direct investment inflows. We believe lending rates will gradually ease over the

coming months as the effect of rate cuts in 2013 by the SBV begins to kick in. We are also seeing evidence

that credit conditions are improving. Accordingly, we expect gross fixed capital formation growth to

accelerate substantially from 4.1% in 2013 to 10.0% in 2014.

Public Spending: We expect total public spending to remain relatively resilient in 2014, expanding at a

respectable pace of 6.5%. However, there is limited room for the government to increase spending further

owing to concerns over the need to finance a potential bailout of ailing state-owned commercial banks.

Net Exports: Net exports remain the biggest downside risk to our outlook for the Vietnamese economy,

although we expect external demand to pick up in 2014. Vietnam's trade account has fallen back into

deficits in recent months, but we see the case for a substantial pickup in external demand on the back of a

rebound in regional growth over the coming quarters. Accordingly, we still expect exports to expand at a

moderate pace of 5.6% in 2014.



Table: Vietnam - Economic Activity

2011 2012 2013e 2014f 2015f 2016f 2017f 2018f

Nominal GDP,VNDbn 3 2,779,880.2 3,245,419.2 3,584,261.0 4,012,847.7 4,494,844.6 5,033,219.9 5,616,365.8 6,269,265.3

Nominal GDP,US$bn 3 134.6 155.6 170.6 195.1 221.1 249 280.8 316.6

Real GDPgrowth, %y-o-y 3 6.2 5.2 5.4 5.9 6.4 6.6 6.4 6.4

GDP per capita,US$ 3 1,497 1,713 1,860 2,108 2,368 2,643 2,957 3,309

Population, mn 4 89.9 90.8 91.7e 92.5 93.4 94.2 95 95.7

Industrialproduction, %y-o-y, ave 1,5 10.9 7.0 5.9 7.7 8.4 8.6 8.6 8.5

Unemployment,% of labourforce, eop 2,6 3.6 3.2 3.7e 3.5 3.5 3.6 3.5 3.5

Notes: e BMI estimates. f BMI forecasts. 1 at 1994 prices; 2 Urban Area Only. Sources: 3 Asian Development Bank,General Statistics Office; 4 World Bank/UN/BMI; 5 General Statistics Office; 6 General Statistics Office/BMI.



Industry Risk Reward Ratings

Asia Security Risk Ratings

BMI's Security Ratings service, which integrates closely with our Country Risk service, offers a

comprehensive comparative analysis of security risk in three key areas: interstate conflict, terrorism and

physical safety for expatriate workers, across major states in each region. The ratings are combined to forma composite security rating to provide an overall guide to long-term trends and risks. We integrate our short-

term political and economic ratings with the terrorism rating to indicate a state's vulnerability to a sustained

terrorist campaign or major terrorist attack. In all instances, the rated period is two years, and each countryis assigned a score out of 100, with a low score indicating a high level of risk.

Table: Asia Pacific Security Risk Ratings

Interstaterisk

Terrorismrisk

Criminalrisk

Compositedomestic

risk

Regionalrank

Compositesecurityrating

Ranking

Singapore 91 88 99 93 1 93 1

Australia 98 83 92 88 4 91 2

Japan 87 93 91 92 2= 90 3

Taiwan 71 95 79 87 5= 82 4

Malaysia 84 85 75 80 8 81 5

South Korea 65 86 88 87 5= 80 6

North Korea 46 98 87 92 2= 77 7

Thailand 86 69 73 71 9 76 8=

Vietnam 60 98 71 85 7 76 8=

China 79 85 59 72 10 74 10

Indonesia 88 68 53 61 11 70 11

Philippines 81 51 40 46 13 57 12

India 69 47 53 50 12 56 13

Pakistan 46 26 34 30 14 35 14

Scores out of 100, with 100 the highest. The 'composite security risk' is the principal rating. It comprises 'interstate' risk -the risk of becoming a primary party to an interstate conflict that threatens significant damage to homeland; 'terrorism'risk - the risk of terrorist groups (domestic or international) being able to launch a major attack/sustained campaign; and'criminal' risk the risk of (politically motivated) violence against expatriate workers. Each of the three risks is given equalweighting. The 'composite domestic risk' rating comprises 'terrorism' and 'criminal' risk, each of which is given equalweighting. Each rating (state, terrorism, criminal) is assessed subjectively by our analysts within a clearly definedmethodology, incorporating a minimum of six conceptually distinct elements. Source: BMI



Table: Asia Pacific State Vulnerability To Terrorism Index

Terrorism Short-term political Short-term economic Composite Regional rank

Singapore 88 94 90 90 1=

Taiwan 95 84 87 90 1=

South Korea 86 81 89 86 3=

Vietnam 98 79 69 86 3=

Japan 93 86 66 85 5

China 85 75 86 83 6

Malaysia 85 75 78 81 7

Australia 83 82 72 80 8

North Korea 98 66 30 73 9

Indonesia 68 66 68 68 10

Thailand 69 59 72 67 11

Philippines 51 71 74 62 12

India 47 61 62 54 13

Pakistan 26 56 48 39 14

Scores out of 100, with 100 the highest. The 'state vulnerability to terrorism index' is the principal rating. It comprises the'terrorism', 'short-term political' and 'short-term economic' ratings, which are given equal weighting. The 'statevulnerability to terrorism' rating quantifies the exposure of a state to a successful major terrorist attack/campaign,evaluating first how likely one is (terrorism) before considering the vulnerability of the political and economic environmentto a sudden shock. It incorporates subjective analysis of 15 conceptually separate analytical elements, as well as 13separate objective data points. Source: BMI

Vietnam Security Risk Ratings

Vietnam has an overall security risk rating of 76, which means that the country is regarded as being

reasonably safe and stable. This rating has improved steady over time.

The country's domestic security risk rating (85) is good and the threat of terrorism (98) is seen as beingessentially non-existent. However, Vietnam scores less highly when it comes to interstate threats (60), withthe threat of conflict with China over disputed territory in the South China Sea proving a particular concern.



Market OverviewVietnam Defence Market Overview

With Vietnam's recent economic growth and a replacement date of 2020 established for most majorplatforms, it is looking to acquire new armoured personnel carriers (APCs), battle tanks, artillery, fighters,helicopters, transports, surface assets and anti-missile systems. Given that Vietnam relies on Soviet era

defence platforms Russia remains a key defence ally, particularly when it comes to providing maintenance,

repair and training services.

However, an interesting development in 2014, which BMI expects to continue for the foreseeable future,

has been Vietnam's proactive stance towards building relationships with a number of new defence partners.

Most notable among these are perhaps India and the United States. Cooperation with these countries points

to a wider strategy to counter Chinese influence. In the second half of 2013, the Vietnamese Ministry of

Defence announced a major reorganisation of the military, with the formation of a new Vietnam CoastGuard (VCG) set to replace the Vietnam marine police.

The US is providing substantial material assistance in this reorganisation. Procurement priorities in 2014

include the acquisition of anti-submarine warfare and maritime surveillance capabilities that can deter

against potential Chinese aggression in the South China Sea.

Recent Developments

Hanoi in negotiations with a number of European defence manufacturers over the procurement of avariety of new defence platforms, including new warships and missiles systems.

Vietnam takes possession of two of six Kilo-class diesel-electric submarines ordered from Russia, Asymbol of increased defence cooperation between the countries.

Vietnam takes delivery of Ukraine-made 3D radar 36D6 for S-300 missile system.

Armed Forces

Organisation

Second only to the Communist Party of Vietnam, the Vietnam People's Army is a dominant force in

Vietnam politically, economically and socially. Many past top CPV officials have made the transformation

from the services to politics with great success.

Comprised mainly of conscripts, the military is divided into four services: the army; navy/coast guard; air

and air defence force; and the border defence corps. Hanoi also maintains the People's Self Defence Force



and the rural People's Militia. The military now serves, at least partially, as a means of employment for

many young men.

In August 2013, Hanoi announced that it forming a new VCG, which will be a reconstituted version of the

existing Vietnam Marine Police and be overseen by the Ministry of Defence. The new unit became active in

October. The United States recently provided a sum of US$18mn, a large proportion of which will gotowards acquiring five new patrol boats for the Vietnamese coast guard. China took a similar step earlier in

2013, consolidating a number of maritime agencies into one combined coast guard, and Vietnam's decision

to do likewise is a reflection of the emphasis that the South China Sea's littoral states are placing on

maritime policing and control. Vietnam is involved in long-running territorial disputes with the Chinese

over the Spratly and Parcel islands, and the government is determined to protect its sovereignty.

In a related move, the Vietnamese military announced in July that it was standing up a new joint Air Force-Naval Brigade to perform maritime surveillance and search and rescue missions. The new unit, called 954

Brigade, appears likely to inherit a number of assets from the Vietnam Marine Police, which is being folded

into the new VCG. This could include the three C212 maritime patrol aircraft recently acquired from

Airbus Military, and the six DHC-6 Twin Otter amphibious aircraft previously procured from Canada.

Vietnam is also reportedly interested in acquiring second-hand Lockheed Martin P-3C Orion maritime

surveillance aircraft.

Numbers

The army is overwhelmingly the largest arm of the services. The Center for Strategic & International

Studies estimates the total military force to stand at 455,000 personnel, with some 412,000 in the army,

13,000 in the navy and 30,000 in the air force. A tradition of defending against invasion, a large number of

former army members in politics, and lower cost platforms have made it the focal point for national

defence. Nevertheless, it must be noted that the army's operational capacity is severely limited for out-of-

country conflict and it relies on ageing Cold War platforms, which are increasingly difficult to service.

Domestic Industries

Developing domestic defence industries was made a priority in Vietnam's revised constitution, released at

the start of 2014. However, as things stand, Vietnam's domestic defence industry is limited.

In order to boost its dwindling defence industry, Vietnam is looking to collaborate with international

partners. It is hoped that such collaborations will lead to the transfer of technology and know-how necessary

for the development of a domestic defence industry.



Part of the 'Comprehensive Strategic Partnership' agreed with Russia in August 2013 is the provision to set

up a range of joint ventures that will enable Vietnam to repair and maintain its own military platforms.

Furthermore, in October 2011, the Vietnamese government announced that it was acquiring four SIGMA-

class corvettes from the Netherlands. The deal represents Vietnam's first major procurement from Europe,and the assembly of two of the ships in Vietnam will deliver important technical know-how to the local

ship-building industry. When the eight new corvettes are all in service they will greatly enhance Vietnam's

ability to patrol its territorial waters.

To complement its foreign maritime procurements, Vietnam's domestic defence industry has made some

important strides in recent years, not least in the shipbuilding sector. In January 2011, Hong Ha, a local

shipbuilder, launched the country's first ever domestically produced warship. The ship was reported to be

based on the Russian Molniya-class patrol boat design, and is expected to be the first of 12 that Vietnam

produces domestically under licence. The patrol boats are armed with artillery and anti-ship missiles, and

will boost Vietnam's ability to protect its offshore interests.

The Vietnamese government evidently has growing confidence in the local shipbuilding sector, as it

followed up these successes with further orders in October 2012 for another patrol craft and a missile

corvette. However, local industry still lacks the capability to produce larger, more sophisticated platforms,

though a lack of funds in any case currently militates against such procurements.



Weapons Of Mass Destruction

Vietnam does not have an operational nuclear reactor or known nuclear weapons. However, Hanoi hopes to

develop a civilian nuclear programme in the future, building on a 2002 Russian agreement that promised US

$100mn to upgrade a Soviet-designed research reactor in Da-lat. Hanoi hopes to have a functioning reactorfor power generation by 2015.

In Q1 2014, US President Barack Obama approved a civilian nuclear pact with Vietnam, which could leadto the sale of US reactors to Vietnam. As part of this agreement Vietnam agreed not to enrich or reprocess

uranium, key steps in the manufacture of nuclear weapons.

Although Vietnam is a signatory to the Nuclear Non-Proliferation Treaty (NPT), pursuit of a nuclearweapons programme is expected. The historic conflict with China will be used to justify research into theprogramme or other strategic short- or medium-range weapons.

If a nuclear warhead could be produced, Vietnam possesses an unknown quantity of North Korean,

modified Scud missiles bought in 1999 (likely to be Scud-C missiles), as well as an ageing cache of SS-1and Scud B ballistic missiles capable of delivering a nuclear payload. If it were looking to expand on its

current missile stocks, Vietnam would likely look again to North Korea or Russia, or possibly India. At

present, Vietnam is the only country in South East Asia to possess its own ballistic missile weapons system,

provided by the former Soviet Union.

However, this situation will change in the near future, with neighbouring states, such as Indonesia,

announcing their intention to begin their own ballistic missile weapons programmes.

To date, there is no evidence indicating that Vietnam has biological weapons, and further, the country is a

signatory to the Bacteriological Convention (1980). Although Laos and Cambodia have accused Vietnam ofusing chemical weapons, it appears unlikely that the country has any stockpiles, as it continues to lack the

industrial base to produce them domestically. However, given requisite financial resources, there is suitable

evidence to suggest that the CPV has the political will and ambition to pursue biological and chemical

weapons development.



Imports

International Relations

As a result of Chinese advances in East Asia and uncertainty surrounding its intentions in the South China

Sea, it is no surprise to see Vietnam fostering defence partnerships with countries such as the United States,

India and South Korea. Vietnam's ongoing rapprochement with the United States, most recently underlined

by John Kerry's visit to Hanoi in December 2013, has the potential to open up a range of new procurement

options for Vietnam.

For instance, the acquisition of P-3 Orion maritime patrol aircraft, from US defence company Lockheed

Martin is now a viable option. The procurement of such aircraft is deemed to be a vital part of beefing up

Vietnam's maritime security in the face of increasing Chinese aggression in the South China Sea. It is

reported that Washington is now weighing up the sale of six unarmed P-3s to Hanoi.

Vietnam is hoping to gain access to other types of American system as well, as the two countries' bilateral

relationship rapidly improves. President Truong Tan Sang met President Obama in Washington in July 2013

shortly after a several top Vietnamese military commanders also visited Washington, amid what was widely

interpreted as a concerted push by both sides to boost defence collaboration.

Ultimately, Truong's visit yielded a new 'comprehensive partnership' agreement and not any specifics on

equipment sales. However, with the US Secretary of State, John Kerry, recently visiting Hanoi these sales

look likely to occur in due course. Indeed, during his trip, Kerry announced $32.5mn in US assistance formaritime law enforcement. Approximately $18mn of this is earmarked for Vietnam, including the purchaseof five new patrol boats for the Vietnamese coast guard.

In November 2013, the Secretary General of the Vietnam Communist Party, Nguyen Phu Trong, visited

India in an attempt to bolster defence cooperation between the two countries. This can also be seen as part

of Vietnam's efforts to move away from Chinese influence in the region. Trong was successful at gaining

India's assistance in Vietnam's modernization of its armed forces. India offered a $100mn line of credit forthe purchase of four Offshore Patrol Vessels. In addition, preliminary agreements were made regarding the

sale of the BrahMos Cruise missile to Vietnam, the training of 500 Vietnamese sailors and the maintenance

of its Soviet era military platforms.

Given the predominance of Soviet era equipment in its military arsenal, Russia unsurprisingly remains a key

strategic defence ally of Vietnam. The signing of a 'Comprehensive Strategic Partnership' in 2012



underlined the significance of this relationship to Vietnam. Following a short visit to Hanoi in December

2013, it was announced that an agreement on defence cooperation had been reached. However, details were

not forthcoming. It is thought that Russia's development of the Cam Ranh Bay submarine crew training

centre will be central to the collaboration between the two countries. The Vietnamese submarine

programme reached a major milestone in late August 2012, when the Russian media reported that the firstKilo-class submarine for Vietnam had been launched at a shipyard in St Petersburg. The first two boats are

on course to be delivered in November 2013, ahead of the original schedule. All six subs are currently due

to be delivered by 2016.

Vietnam is also looking to deepen defence ties with a number of other countries. In November 2013,

Vietnam and South Korea agreed to 'expand defence dialogue' by enhancing cooperation in training,

military medicine and cyber-security.

In addition, Vietnam has endeavoured to deepen defence cooperation with European allies, such as France.

These enhanced ties are seen as an opportunity to move beyond questionable Russian/Soviet defence

platforms to what are often considered more reliable and sophisticated European equivalents In November

2013, Vietnam and France agreed to enhance defence cooperation, particularly in delegation exchanges,

training, defence industry development and maritime security.

In Q1 2014, it was reported that Hanoi was in negotiations with Airbus Helicopter, French naval companyDCNS and European missile maker MBDA. These companies view Vietnam as an exciting new market,

with plenty of potential for growth given the regional security situation, as well as Vietnam's economic

expansion.

The Vietnam Navy reportedly wants to buy Mica vertical launch surface-to-air missiles and Exocet MM40

Block III anti-ship weapons from MBDA to arm two Sigma corvettes from Dutch warship builder Damen.

Recent Imports

Major developments over the past few years include the signing of a major arms deal by then-PresidentNguyen Tan Dung in December 2009, which will see Russia supply Vietnam with six Kilo-class Project636 submarines, together with their associated weapons and equipment. The first two of these six

submarines were delivered to Vietnam in Q1 2014, ahead of the original schedule which had the deliveriesdue for 2016. In July 2011, Rosoboronexport confirmed that Vietnam had signed a contract to buy six of

the boats. Senior Vietnamese officials have since confirmed that the submarines will then be delivered over

a period of several years. The 2,300-ton boats are optimised for shallow water operations.



The Vietnamese submarine programme reached a major milestone in late August 2012, when the Russianmedia reported that the first Kilo-class submarine for Vietnam had been launched at a shipyard in St

Petersburg.

Moscow will also provide assistance with the construction of a submarine base and deliver eight Sukhoi

Su-30MK2V combat aircraft as part of the package. Russian sources estimate the total value of the 2009

agreement at US$2.6bn.

It was additionally announced in August 2013 that Vietnam is to buy a further 12 Su-30 fighters from

Russia in a deal worth up to U$600mn. The aircraft will be delivered over the next two years, and will bringthe size of the Vietnamese Su-30 fleet to 36 aircraft, or enough for three squadrons, in addition to 11

Su-27s. Introducing the new fighters will enable the air force to retire its ageing MiG-21 and Su-22 fighters,

and subsequently also the Su-27s.

In May 2012, it was reported that Vietnam was considering purchasing 18 Sukhoi Su-30K fighters, which

are currently in storage at a maintenance facility. The aircraft have a controversial history: they were

procured by India over a decade ago, but were rejected and returned to Moscow in 2003 on the grounds thatthey had faulty engines. The announcement of the purchase of 12 new Su-30s most likely means that

Vietnam also rejected these aircraft.

Separately, Moscow and Hanoi also announced in August that they were setting up a joint venture to carryout maintenance and repairs on the wide range of Russian systems that Vietnam has acquired.

In the past, Vietnam simply acquired modern military equipment, usually from Russia, and usually on

credit. While this kind of deal still occurs - and while Vietnam still sources the bulk of its military

equipment from Russia - Hanoi is beginning to adopt a more nuanced and forward-looking approach,

seeking international industry partners and demanding technology transfer as part of any procurement

package.

A notable example of this was the recent procurement of two SIGMA-class corvettes from the Netherlands.

The SIGMA, which stands for Ship Integrated Geometrical Modularity Approach, is constructed using a

unique block system. With the second of the two ships likely to be built in Vietnam, local industry has the

opportunity to absorb cutting-edge ship-building technology that it has never had access to before. The

SIGMAs may also come with advanced European weapon systems, depending on the configuration that

Hanoi has requested.



Vietnam has also encouraged tech-transfer opportunities with companies from India, Israel, Italy, the UK,

Russia and France. Most recently, Vietnam signed a defence production MoU with Bulgaria in August

2013. Singapore agreed to help Vietnam develop its defence industry in 2012 in what could prove to be a

highly significant agreement, while Vietnam laid the groundwork for the start of cooperation with Australia

in February when the two countries held their first-ever defence dialogue. Another significant intra-ASEAN

development occurred in May 2013, when Indonesia and Vietnam held talks about the sale of Indonesian

equipment - complete with technology transfer - to Hanoi.

We note that, in addition to the Netherlands corvette procurement, Vietnam ordered six Canada-built

DHC-6 Twin Otter amphibian aircraft in 2010 - its first major order for defence equipment from a Westernsource. It has also procured three C212 maritime patrol aircraft from Airbus Military, as well as operating

10 PZL M28 Skytrucks procured from Poland. These deals point to the fact that Vietnam is now an open

market for Western defence companies, with the exception of the US, which maintains its arms embargo

against Vietnam. This may be lifted in the near future, amid warming ties between Hanoi and Washington.

However, even if this happens, Vietnam is unlikely to start procuring significant amounts of US equipment,

partly because it is too expensive, and partly because it would not be interoperable with its mainly Russian

inventory.

The acquisition of second-hand platforms, notably the Lockheed Martin P-C3 Orion, which Vietnam is

reportedly keen to buy, is the obvious way to proceed, although there is competition for used US materiel

from other countries in the region, such as Indonesia and the Philippines. In November 2013 the United

States provided Vietnam with funding for five new patrol boats for the new Vietnamese coast guard.

The main barrier to growing the amount of arms imports remains funding. With few resources directed

towards the massive military and just a small percentage of the total budget allocated to new purchases,Vietnam remains temporarily handcuffed until the economy expands to such a point that significant money

is allocated to the defence budget. Vietnam's ageing platforms require replacements if the military is to have

any operational capacity within the next decade; they also need spare parts, which the US and other Western

players are unlikely to produce. Therefore, Russia will remain Vietnam's main arms trading partner for the

foreseeable future. Indeed, the two countries signed a strategic pact in 2012, and Defence Minister Phung

Qunag Thanh visited Moscow in August 2013, with President Putin returning the favour in December 2013to further defence industry collaboration.

Although no agreement has yet been reached, Vietnam has long been rumoured to be interested in acquiring

the BrahMos cruise missile from India. Of late, this procurement looks far more likely, with negotiations



between both governments about the sale of the missiles reportedly ongoing since a Vietnamese delegation

visited India in November 2013.

In Q1 2014 Vietnam took delivery of Ukrainian 3D radar 36D6-M for the S-300 missiles system. This radaris especially designed to be used with anti-aircraft missile complexes, such as the S-300 surface-to-air

defence missile system.

Vietnam Security Overview

Domestic Threats

The biggest threat to Vietnam's domestic stability stems from the economy, which appeared to be in crisis.

Though Vietnam has enjoyed a rapid rate of growth in recent years, bubbles had developed in the economyin areas such as real estate development. The government also used large stimulus packages to boost the

economy during the global financial crisis, but corruption and inefficiency led to much of that money being

wasted. The result is that a large number of bank loans are going bad, and multimillion dollar developments

are being left half-finished, the money to complete them having run out. Vietnam is also heavily dependent

on foreign investment; this has poured in over the past decade, but it has now slowed as investors are put off

by the uncertain economic outlook.

However, by August 2013 it looked like the Vietnamese economy was over the worst. Despite a wider

slowdown in South East Asia, Vietnam reported strong manufacturing data and increases in foreign direct

investment, suggesting that confidence in its economic prospects were returning. This is undoubtedly

welcome news in terms of the government's hopes of maintaining stability.

In May 2011 the Vietnamese government ordered a military crackdown on Hmong demonstrations in the

north west province of Dien Bien. Around 5,000-7,000 protesters, mainly members of the ethnic Hmong

population, took part in the demonstrations, demanding for democratic reforms and religious freedom.

Although we acknowledge public unrest remains a threat to political stability in Vietnam, we see limited

evidence to suggest a large-scale political uprising could occur in the short to medium term. Given that such

incidents do not reflect a widespread movement for political change, we believe these protests are unlikely

to attract the interest of the broader population. As such, we believe risk of contagion remains remote and

anti-establishment sentiment will remain limited to a minority group.



Regional Threats

Piracy And Maritime Security

Maritime security has become increasingly important to Vietnam in recent years. Indeed, the issue is

gaining more policy attention from neighbouring South East Asian states. Piracy in South East Asia was

still a major issue in 2011 and early 2012. The Malacca Strait, once heavily pirated, has been subjected tohuge efforts by Indonesia, Malaysia and Singapore, which have been largely successful, but the South

China Sea is still under-patrolled. The modus operandi of pirates does not appear to have changed, with

many attackers focusing on small-scale attacks on slow-moving vessels. Kidnap-for-ransom attacks appear

to be less prevalent, as are hijackings. The types of boats that were attacked in the last decade have ingeneral not changed, with bulk carriers remaining the most likely target.

In the past, the ports of Vung Tau and Haipong have reported ship attacks while in port. It should be noted

that Vietnam lacks an effective naval deterrent to piracy as the coastguard and the navy both lack funds and

equipment. The navy is now beginning to induct new, modern patrol vessels, while the government is

considering the acquisition of maritime patrol aircraft and unmanned surveillance platforms. However, a

comprehensive range of capabilities to enable Vietnam to police its littoral effectively remains some years

away.

Border Security

Along its border, Vietnam and Cambodia continue to enjoy cordial ties, and the Sino-Vietnam border islargely becoming a conduit for trade, as cheap Chinese goods flow legally and illegally into the country,

satisfying the demand of Vietnam's growing consumer base. China and Vietnam reached a permanent

settlement on border demarcation in 2009.

Elsewhere, Laos presents almost no threat to Vietnam. The only possible destabilising factor is the number

of small insurgent groups, which oppose the CPV. Their presence in a neighbouring country could create a

problem, especially if supported by a neighbouring government. However, past acts of repatriation make

this scenario unlikely.

Overall, Vietnam will continue to keep its forces squarely concentrated on domestic concerns, with a small

focus on maritime security fuelled by increased incidents of illegal fishing and piracy. International threats

appear unlikely if the security environment in the region remains stable, as predicted.



Vietnam And China

Vietnam perceives China to be its main security threat. This is partly due to historical enmity: China ruled

Vietnam many centuries ago, and the memory of Chinese imperialism still lingers in Vietnam's popular

consciousness. Indeed, Vietnam was the last sovreignstate that China attacked in 1979, resulting in a brief

border war. Since then the two countries have been engaged in the occasional maritime skirmish.

However, this perception of threat is more a result of recent developments which saw Beijing declare an AirDefence Identification Zone (ADIZ) over parts of the East China Sea in November 2013. According torecent reports Beijing has also prepared a similar defence zone in the South China Sea, although has noimmediate plans to implement it.

While the ADIZ declared in the East China Sea does not directly affect Vietnam, any ADIZ in the South

China Sea would have far greater repercussion as Hanoi is currently embroiled in territorial disputes with

Beijing over the Spratly and Paracel Islands. Any unilateral actions by China in the South China Sea couldtherefore have a serious impact on Vietnam's security.

One inevitable consequence of China's increased aggressiveness in the region is that Vietnam will

increasingly be pushed into alliance with the United States. Indeed US Secretary of State John Kerry made a

high profile visit to Vietnam in November 2013, consolidating this improvement in relations. As part of

this, the US announced that it would provide US$18mn to Vietnam to boost its maritime security. JohnKerry's visit was followed up by a visit by Wendy Sherman, under Secretary of State for Political Affairs,

Wendy Sherman inMarch 2014.

There has been friction between China and Vietnam, as there has between China and its other neighbours,

over Beijing's insistence on its indisputable sovereignty over most parts of the South China Sea, and itswillingness- as exemplified by the declaration of an ADIZ in the East China Sea- to actively assert these

claims. The Philippines, Malaysia, Brunei and Vietnam also lay claim to some islands and reefs in the oil-

rich area. Vietnam adopts a similarly inflexible approach to sovereignty issues, and claims the Paracel

Islands even though they are not particularly close to the Vietnamese coastline.

As a result it is no surprise to See Vietnam strengthening its ties with ASEAN partners in an effort to deal

with China's assertiveness. Indeed, following meetings in Q114, the military chiefs of ASEAN memberstates agreed to conduct joint Naval exercises in the Malacca Strait from 2015. This concerted action is nodoubt intended to send a strong message as Beijing ponders a new ADIZ in the South China Sea.



International Threats

United States

BMI expects further efforts by Hanoi to deepen ties with Washington over the coming years, as Vietnam

leans towards the pro-US camp that already includes some of its ASEAN peers such as Indonesia and

Thailand. China's growing influence in the region and its expanding military presence in the South China

Sea will continue to play a key role in aligning the political interests of Hanoi and Washington. Indeed,

since 2010 we have seen a marked improvement in ties between the countries. In July 2013 President

Obama announced a 'comprehensive partnership 'between the United States and Vietnam, something

reinforced by John Kerry's visit to Hanoi in December 2013.

Russia

Although a number of Western countries, including the US, are showing an increasing interest in selling

arms to Vietnam, Russia has taken steps to protect its large share of the Vietnamese defence market.

Moscow announced record arms sales in 2012, and, after India, Vietnam was one of its most important

customers. Moscow is not about to relinquish this dominant market position.

This status was underlined when Prime Minister Nguyen Tan Dung met President Vladimir Putin at the

Russian resort of Sochi in May 2013. The two sides pledged to significantly increase bilateral trade and to

deepen co-operation in a number of areas. Defence minister Phung Quang Thanh then visited Moscow inAugust, placing an order for 12 additional Sukhoi fighters, and laying the groundwork for a range of new

defence collaborations, including the establishment of a maintenance JV to help Vietnam service its large

inventory of Russian systems.



Regional Overview

Political Risk Analysis

South East Asia will face a number of challenges to its security in the 2010s, largely in the form of Islamist

militancy, piracy, weak borders and rising competition between China and the US for influence in the

region. One of the biggest individual unknowns in the region is the future of Myanmar. If the regime there

were to collapse suddenly, regional insecurity would be greatly increased.

South East Asia In A Global Context

South East Asia will remain one of the world's most important regions for the following reasons:

Population Size: It is one of the most heavily populated parts of the world, with an estimated 597mn people

in 2010, according to the UN. The population is still rising rapidly, with the UN forecasting an 11.5%

increase to 666mn in 2020, and to 723mn in 2030.

Rapidly Expanding Economies: South East Asia's economies are generally expanding rapidly and the

region is a key destination for foreign investment, business and tourism. It is also rich in commodities and

natural resources.

Islamist Militancy: Islamist militants have been active in South East Asia for some time. The region has

258mn Muslims (16% of the global total), according to a January 2011 report by the Pew Forum, providinga significant pool of potential recruits.

International Piracy: The Malacca Strait and waters around Indonesia are major zones of pirate activity.The Strait is one of the world's main maritime 'chokepoints', and there are fears that terrorists could block

the channel.

Sino-US Competition For Influence: The US dominated South East Asia during the Cold War but in

recent years Chinese influence (especially commercial) has been increasing. This raises the likelihood of aconcerted struggle for influence between Beijing and Washington.

Challenges And Threats To Stability And Security

South East Asia faces multiple challenges to its security over the coming decade and beyond. These include:



Poor Governance And Political Instability

Most South East Asian states are vulnerable to political instability and suffer from relatively poor

governance. Thailand has been wracked by multiple periods of mass protests since 2005. This instability

reflects a deep-rooted power struggle between traditional Bangkok-based royalist elites represented by the

Democrat Party, and new elites and the predominantly agricultural north eastern provinces, represented by

exiled former premier Thaksin Shinawatra and his younger sister, Yingluck, who was elected prime

minister in July 2011.

The Philippines has also been prone to political instability, with two 'People Power' popular uprisings

against corrupt presidents (in 1986 and 2001), and several repeated attempts during the 2000s. During thepast decade the Philippines has occasionally been hit by rumours of an imminent military coup, although

most of these were speculative and actual mutinies were foiled or failed to attract the support of the top

brass. Given deep inequalities in the Philippines, and high levels of political corruption, we cannot preclude

renewed instability in the years ahead.

Indonesia has achieved a high degree of stability under President Susilo Bambang Yudhoyono (2004-)following the chaos that accompanied the fall of long-time ruler Suharto in 1998. That period resulted in

three changes of president in six years (1998-2004) and the near disintegration of the state, as separatistmovements took advantage of central government weakness to break free. It remains to be seen whether the

stability achieved under Yudhoyono represents a maturing of Indonesia's political culture or is an aberration

that will end once he steps down, as mandated, in 2014.

Cambodia, Laos and Vietnam are all de jure or de facto one-party states experiencing rapid economicgrowth and social change. We do not preclude rising public unrest, especially if governments fail to

translate rapid economic growth into higher living standards. Indeed, the popular uprisings which shook the

Middle East and North Africa in 2011 show the speed at which pent-up public dissatisfaction with

authoritarian regimes can reach boiling point. Cambodia saw mass anti-government protests in 2013.

Rapid Population Growth And Urbanisation

Although birth rates have declined, populations are increasing fairly rapidly in most South East Asian

countries, with total fertility rates (TFR, the average number of children a woman is expected to have in herlifetime) above the population replacement level of 2.1. The Philippines is forecast by the UN to have the



highest TFR in the region (3.1) in 2010-2015, while Thailand will have the lowest TFR of 1.5, which isalready below replacement level, having fallen from 3.9 in 1980.

High birth rates mean governments and private sectors must create sufficient jobs to absorb the expandinglabour force. However, in many cases, job creation is prov

Documents

BMI Vietnam Defence and Security Report Q2 2014