Exchange rate adjustment and tightening monetary policies major issues of Q1

Adjusting exchange rate, tightly controlling dollar free market, and monetary tightening are the most significant issues in the first quarter in 2011.

Resolution 11/NQ-CP dated February 24, 2011 has clearly shown the political determination in the fight against macro instability. This resolution demonstrates drastic and powerful moves, in which growth target is entirely eliminated from the top targets in 2011. Six groups of synchronous measures are pointed out, in which the most important point is to carry out tightening monetary and fiscal policies.

After Resolution 11, many specified documents have been issued. Previously, on February 11, 2011, adjustment of exchange rate was made, which was the initial move of the measures to stabilise macro economy.

Increasing exchange rate by 9.3 percent

After a long time maintaining dollar exchange rate at 18,932 dong per dollar, which led the exchange rate difference between official and free markets to be up to 2,000 to 3,000 dong per dollar, the State Bank of Vietnam (SBV) has raised average interbank exchange rate by 9.3 percent, at the same time narrowed trading band to plus or minus 1 percent from February 11, 2011.

The exchange rate adjustment has not created a great shock to the foreign exchange market, as this move was simply to formalise and reflect the exchange rate changes which had been suppressed from 2010, when dong was under too much pressure to be devaluated due to persistent trade deficit, high inflation in the domestic, weak foreign currency reserves and the increasing expectation on dong devaluation.

By narrowing trading band to plus or minus 1 percent and changing interbank exchange rate daily, the operation of SBV on exchange rate would be more flexible.

If the exchange rate is changed daily and closely to the market, along with the regulation on the foreign currency position of commercial banks, dollar trading between SBV and commercial banks would be smoother and that may help exchange rate to unlikely to have significant changes.

Raising key interest rates

With the orientation to tighten monetary policy to stabilise macro economy, SBV increased policy interest rates. Rediscount rate was raised from six to seven percent on November 5, 2010, and to 12 percent in March 8, 2011. Refinancing rate was increased from eight to nine percent on November 5, 2011, 11 percent on February 17, 2011 and 12 percent on March 8, 2011.

Moreover, on open market operations (OMO), only trading of seven-day term is seen, with interest rate increased from 10 to 10.5 percent on January 10, 2011 and to 12 percent on February 22, 2011.

The adjustment of key interest rates from March 2011 to the same level not only reflects Resolution 11 but also is a needed and reasonable change to restrict:

1. Large-scale banks to take advantage of the rediscount activity at low interest rate to make profit on interbank market;

2. Low capital sources to only flow between government bond market and OMO. Despite being tightened, the capital resources would thus have the opportunity to be allocated more effectively and go directly into the business sector.

Reducing credit growth target and tightening lending to non-manufacturing area

With the orientation to tighten monetary policy to stabilise macro economy, credit growth target in 2011 was adjusted from 25 to 20 percent, total payment tools was adjusted from 20 to 15-16 percent.

In addition, the credit flows have been directed to manufacturing sector, while credit for non-manufacturing sector such as real estate and stock markets has been tightened.
Accordingly, credit institutions must slow down the speed and reduce the proportion of lending to non-manufacturing sector compared to 2010. This proportion must not exceed 22 percent to June 30, 2011 and 16 percent to December 31, 2011.

This is a necessary step for money flows to be truly poured into the economy, in order to increase goods supply and curb inflation, and to avoid asset bubbles that could cause great pressure on inflation. Nevertheless, non-manufacturing sector, especially real estate and stock market would face various difficulties in accessing capital sources from the formal sector.

In addition, banking sector itself would also be strongly affected, particularly small banks. In the system, outstanding credit to non-manufacturing sector is below 25 percent in only 18 banks, while it is higher in 24 banks, some banks even have outstanding credit to non-manufacturing sector of over 50 percent and their profits from lending are mainly from real estate area.

Strictly controlling free trading of foreign currencies
When making effort to avoid dollarisation and stabilise exchange rate, SBV, in cooperation with public security and market management agency, has tightly controlled the free currency exchange activities. Trading on free foreign exchange market in big cities has been stopped from March 7.

However, gold shop owners are still holding large amount of foreign currencies, to wait for further moves of the authorities. They just silently trade with familiar customers, with exchange rate difference of only 190 to 250 dong.

Banning free trading of foreign currencies at present is relatively difficult. The exchange rate policy is difficult to be effective since foreign exchange reserves remain low.
Commercial banks are still having difficulties on foreign currency resources to meet the legitimate needs of people and businesses. Meanwhile, according to the Foreign Exchange Ordinance in 2006, people still have the right to hold assets in foreign currencies.

Therefore, the free market, in one way or the other, still has reasons to exist. Banning by administrative measures without other consistent and decisive measures, may make it more difficult to control.

In fact, SBV has implemented measures to tightly control the free market for several times (June 2008 and November 2009). However, the effectiveness was low and the free market operated again after a short time.

GDP growth of the first quarter 2011 was 5.43 percent, the lowest in the first quarter of the recent years. It has reflected the impact of tightening policies. The World Bank forecasted that Vietnam’s economy would only grow by 6.3 percent in 2011.

Inflation rate of the first quarter was 6.12 percent compared to late 2010, due to food factor (in January and February) and non-food factors (in March). As forecasted, inflation in April would be about 0.9 to 1.01 percent due to the continuing impact from price increase of basic goods and foods. Inflation in the second quarter, though being lower than the first quarter, would remain high compared to the same period of last year.

Interest rates on the markets were still high in the first quarter, due to tightening policies, internal difficulties of the banking system and the expectation on dong devaluation. Interest rates might be lower in the third quarter if the expectation on inflation reduced. – NDHMoney

Tags: Vietnam economic, Vietnam economic growth, Vietnam economy, Vietnam economy 2011