Business Banter
(13-06-2008)
How rate hikes are stabilising the economy
By Ha Phuong
The State Bank of Viet Nam’s whopping two per centage point interest-rate hike and the weakening of the local currency by almost another two per cent are welcome steps to reduce inflation and to narrow the burgeoning trade deficit.
However, more requires to be done to reach national targets.
Given that some organisations predicted Viet Nam might need an IMF-style assistance prog-ramme, the Prime Minister has confirmed Viet Nam does not need help at this stage.
On Tuesday, the central bank lifted the prime rate from 12 to 14 per cent, the refinance rate from 13 to 15 per cent, and the discount rate from 11 to 13 per cent – the second time it has raised the benchmark in within four weeks.
At the same time, to control the overheated economy, it adjusted down the Vietnamese dong against the US dollar by 1.96 per cent to VND16,461 from the previous VND16,139.
The two decisions came two weeks after the release of a 25.2 per cent annualised inflation rate in May – the highest since 1992 – and a trade deficit of US$14.4 billion caused by surging imports.
Foreign investors at a business forum in Ha Noi earlier this month warned local commercial banks they were facing a severe liquidity situation and might have to merge to survive. A Goldman Sachs report on Tuesday stated that by adjusting the price of money, interest-rate hikes would be more efficient than administrative measures, such as credit controls and raising compulsory reserve requirements.
It added that this would create less distortion and have more long-lasting impact on slowing the economy.
The International Monetary Fund (IMF) last week also suggested Viet Nam tighten monetary and fiscal policy to fix its overheating economy.
IMF’s chief representative in Viet Nam, Benedict Bingham, said the central bank should raise interest rates to provide adequate returns to those savings – and to bring credit growth and inflation under control.
On the other hand, some economists now believe the central bank should increase interest rates even more.
Vo Tri Thanh, senior economist with the Central Institute for Economic Management said that a further one to two per cent rise in the prime rate would be acceptable "if the inflation shows no sign of braking."
Normal adjustment
The resetting of the inter-bank exchange rate at VND16,461 was a dramatic rise from VND16,139 the previous day – and some were concerned that this meant a real devaluation of the dong by the central bank.
However, late last week, Prime Minister Nguyen Tan Dung said Viet Nam would not devalue the dong.
Responding to the concerns, the SBV’s governor, Nguyen Van Giau, explained that the change was a normal adjustment to make the exchange rate closer to market forces.
"It’s not a currency devaluation at all. Any adjusting is aimed at gradually stabilising the market. When the market becomes more stable, we will stop our adjustments. I have thoroughly discussed the situation with the Prime Minister," said Giau.
In other words, when people look at the nominal and real exchange rates, they will realise the latest moves will benefit exporters.
So far this year, the exchange rate has remained stable at about VND16,000 to the US dollar. If it had not been for marker interventions by the central bank, the dong would have appreciated early this year when capital inflows were still considerable, said an economic update titled "Taking Stock" by the World Bank.
However, the report added that the Vietnamese currency depreciated slightly when portfolio inflows slowed down and the surging growth of imports used up a large amount of US.
The apparent stability of the nominal exchange rate hides a sizeable real appreciation of the dong in recent months.
"This was the result of the two opposite forces. By implicitly pegging the dong to the dollar, the monetary authorities allowed a depreciation of the dong because the dollar depreciated against the other major currencies Viet Nam uses to import or export goods," the World Bank report said.
It added that if Viet Nam had pegged the local currency to a basket of currencies, including the euro and the Japanese yen, with the weights reflecting the pattern of Viet Nam’s foreign trade, the price of the dollar to the dong would have fallen by roughly 5 per cent.
However, during this period, inflation in Viet Nam was much higher than that of its main trading partners. This gap amounted to a loss of competitiveness for the domestic economy.
The World Bank said that if the central bank tried to maintain competitiveness with Viet Nam’s main trading partners, the price of a dollar to the dong should have increased by about 12 per cent.
The report claimed that the appreciation of the dong was not a welcome development when the economy was facing a large trade deficit.
So, according to the Goldman Sachs report, it was "laudable that the Vietnamese monetary authority has reacted pre-emptively against the Vietnamese dong overvaluation in real terms and undertook a policy change before the currency crisis risks escalated to a less-manageable level."
Many now understand that the weakening of the dong is modest based on the calculations of the World Bank. In fact, the dong could have easily fallen to 18,075 to the dollar.
However, there are those who believe the depreciation is still not big enough to cut losses for Vietnamese exporters – and therefore encourages the importation of goods.
The IMF believes greater exchange-rate flexibility would simplify monetary management and help the central bank manage shifts in capital flows more effectively. — VNS
