HO CHI MINH CITY, Vietnam >> Hammer and sickle flags are flying here as Ho Chi Minh City, the seemingly irrepressible bastion of Vietnamese capitalism, dutifully marks the start Tuesday of the Communist Party’s National Congress, an event held every five years to chart the course of a country that has witnessed an economic miracle in recent decades.

But this time, things are different. In a region where governments are swollen with foreign currency reserves and inflation remains relatively tame, Vietnam is an island of economic instability.

The country’s economy is still growing at 7 percent a year, but double-digit price increases for food and other essentials are punishing the working class and contributed to a top credit rating agency’s recent decision to downgrade the country’s sovereign debt. Vietnam’s currency is consistently falling below the official exchange rates, creating a thriving black market for gold and dollars.

And one of the country’s largest state-owned companies is all but insolvent, brought down by debts that are the equivalent of more than 4 percent of the country’s total output.

“We are on the edge; there’s not a lot of room for mistakes,” said Le Anh Tuan, head of research at Dragon Capital, an investment company here. “The Vietnam story will depend much on how much the government understands the root of the problem and can fix it.”

The problems, say many businesspeople and economists, are rooted in Vietnam’s continued heavy reliance on state-run companies despite the country’s opening to more private enterprise, which has expanded rapidly and profitably.

For years the government considered its vast network of state-run companies as the vanguard of the economy, large conglomerates that the Communist Party could use to steer the country toward prosperity.

The reach of the state-owned companies, even after several waves of privatizations, remains impressive. It would be easy for a consumer here to spend an entire day doing business with the government: paying a cell phone bill, depositing a check at the bank, shopping at a supermarket, filling a car with gas and lunching at a fancy hotel.

But the seemingly intractable problems at Vinashin, the deeply indebted state company, have highlighted the shortcomings of relying so heavily on government-owned enterprises.

From its core mission of building ships, Vinashin expanded into about 450 businesses that it failed to make profitable and was ill suited to manage, including spas, motorcycle assembly and real estate. On the brink of bankruptcy with $4.5 billion in debts, the company is now effectively being bailed out by the government: It has been exempted from paying taxes this year and will be given interest-free loans, according to Vietnamese press reports.

Economists and businesspeople here are watching the Communist Party meeting to see whether state-run companies will be coddled or be forced to adhere to sink-or-swim discipline.

“Until now we haven’t seen many cases of the government letting them die,” said Nguyen Thi Mai Thanh, the general director of Ree Corp., a large engineering firm that specializes in air conditioning. “Sometimes you have to make an example.”

Prime Minister Nguyen Tan Dung, who is seeking support for another term at the party meeting, has been quoted in the Vietnamese press as saying that the reform of state-owned enterprises is a “key criterion for a market economy.” But analysts say attempts at reform may be complicated by the involvement of government officials and their family members in the businesses.

Investors say they are also watching to see if the government carries out long-discussed plans to reduce a paternalistic web of regulations and restrictions.

Fred Burke, the managing director of the Vietnam offices of Baker & McKenzie, an international law firm, offers this example: Driving a truck displaying an advertisement through Ho Chi Minh City requires 17 separate government approvals.

Companies that want to call a news conference or make an announcement need to get permission from the government.

Last year, in what companies see as a misguided attempt to control inflation, the government passed regulations requiring companies to submit the prices of all their ingredients in some consumer products.

Burke, who is part of a government advisory panel on cutting red tape, says there has been “backsliding on reform” in recent years and describes the management of Vietnam’s currency as “dysfunctional.” But he sees signs that the government is trying to reduce paperwork. He also sees higher-end manufacturers coming to invest in the country.

“Our business has never been better in terms of quality inbound investment,” Burke said.

Indeed, the economy has grown an average of 7 percent a year over the past five years and has grown at a similarly fast clip since the 1980s.

That growth has helped deliver unprecedented increases in material well-being: Workers earning minimum wage now have motorcycles, television sets, rice cookers and cell phones. But inflation, which is running at about 12 percent, has become a major preoccupation, especially among the poor.

“How could people be happy?” asked Pham Thi Ngoc, a fruit seller on the outskirts of Ho Chi Minh City. “Money is losing its value.”

Still, many foreign investors say they are betting that Vietnam’s legendary work ethic and a history of overcoming adversity will help it get past its latest setbacks.

“There’s no way you can understand Vietnam unless you can see the frenetic activity and the happiness that’s here,” said Peter Ryder, the chief executive of Indochina Capital, an investment company. “It’s one of the reasons the government gets away with its incompetence. After 100 years of war and starvation, people never thought life would be this good.”

© 2011 The New York Times Company