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Decade after crisis, VN has lessons to learn
(05-07-2007)
by Dr Truong Van Phuoc, Central Bank Department Director, State Bank of Viet Nam
Prevention is better than a cure. It has been ten years since the Asian financial crisis, yet the lessons are still entirely meaningful for Viet Nam in the context of integration. Viet Nam needs to implement prudent and appropriate policies and to preclude a repeat of such a crisis.
The Asian financial crisis began in Thailand in the summer of 1997. The crisis commenced with the depreciation of the Thai baht on July 2 and then spread to other East Asian countries. The pains from the crisis have never been fully eliminated. For instance, the Asian investment ratio is still lower than the levels achieved in 1996. Profits have boomed, yet investment has never fully recovered. Looking back at the crisis will bring about opportunities to evaluate and help Viet Nam avoid economic threats.
From causes to cracks
The Asian financial crisis triggered a series of events most widely-known as monetary crises which impacted countries with governments that lacked the economic and political capacity to prevent their currencies from depreciating. Causes of the crisis can be classified into three categories.
Firstly, premature liberalisation of capital accounts: High growth rates in East Asian countries were financed by huge capital inflows. These inflows created enormous pressures on overvalued currencies. Together with the fact that increasing current account deficits were only financed by capital account surpluses, the reversal of investment flows resulted in serious consequences. The only escape for these countries then was to float their foreign exchange rates.
Secondly, maturity and currency mismatches resulting from huge short term foreign borrowing from commercial banks and enterprises invested in inefficient long term projects. As the confidence of foreign investors eroded, these governments had to use their already thin foreign exchange reserves to repay debts. Eventually as the governments ran out of foreign reserves to defend their currencies, exchange rates were left floating, resulting in a banking crisis and finally a monetary crisis.
Thirdly, financial systems in Asian countries were generally fragile. The policy of offering high interest rates to attract foreign investment while stabilising the balance of payments threatened to destabilise their banking systems. To survive the bank crisis, interest rates had to be reduced. In fact, these countries did cut their rates and accepted free speculation on their currencies.
Not so lucky next time
Viet Nam was mostly unaffected by the 1997 crisis except for delays in foreign invested projects. The reason is that Viet Nam had only just launched its equity market and still did not permit foreign indirect investments. The control over Government and private foreign debts was strictly implemented and the current account deficit was not so large. At the time of the crisis, Viet Nam was applying an exchange rate policy with a thin trading band, undervaluing the nominal value of the Vietnamese dong by around 23 per cent against the US dollar from 1997 to 1998. This helped adjust the Vietnamese dong to the exchange rates of other commercial counterparts in the region.
A decade later, countries that were hit by the crisis have undergone many reforms focusing on eliminating imbalances, cleaning up financial institutions’ balance sheets, building up a financial system to better support economic growth and creating stability through legal and regulatory reform, which are prudent in liberalising the capital account, enhancing the quality of corporate governance in financial institutions, etc.
Viet Nam has been trying its best to integrate into the global economy and has undertaken reforms to catch up with world economic developments. Lessons can be drawn from the Asian crisis.
Firstly, financial liberalisation needs to be progressive and prudent steps should be taken to gradually loosen controls over capital transactions. The Vietnamese equity market has undergone amazing development during the last two years. Foreign indirect investment flows into Viet Nam are currently estimated at more than 10 per cent of GDP. For the sustainable development of our capital market and to build confidence among foreign investors, there is a need to differentiate between long and short term investors, and provide incentives to long term investors.
Secondly, Viet Nam should formulate a more flexible exchange rate policy which pegs the Vietnamese dong to a basket of currencies. This will assure the effective intervention of the State Bank of Viet Nam in preventing the Vietnamese dong from appreciation.
This not only helps promote exports but also heads off accumulation in foreign exchange rate risks.
In addition, foreign exchange derivatives such as swaps, forwards and options should be made available for commercial banks to hedge against exchange rate risks.
Foreign reserves have experienced a ten-fold increase since 1997. From 2000 to now, reserves as measured by months of imports have doubled and the pace of reserve accumulation is only lower than that of China, Russia, Brazil and Algeria among the 15 countries in a 2007 IIF Data survey.
To enhance the capacity of the State Bank of Viet Nam in precluding a crisis, it is necessary to continuously accumulate more foreign exchange reserves.
Thirdly, corporate governance over companies and financial institutions should be improved. The quality of governance is important for investment and sustainable growth. Maturity and currency mismatches need to be transparent and controlled jointly by maintaining a healthy reliance on companies and financial institutions on debt financing to head off capital structure mismatch risks. Therefore, comprehensive corporate internal controls and supervisory standards from regulators should be in place to ensure companies and financial institutions maintain healthy balance sheets and become more resilient in the face of a crisis.
Finally, an early warning system based on analysing macro economic variables should be made available since no one can tell where and when "financial tsunamis" can happen again, especially in the era of extremely high global capital mobility. — VNS
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