Inflationary ease and worries

High inflation is a great worry for consumers. So, taming inflation is an effective tool to revive consumer confidence which isa major boost to the economy.

Vietnam has faced the chronic problem of high inflation in recent years. The rocketing 3.32% month-on-month inflation in April boosted the rate in the first four months to 17.5% over the year-earlier period. The incremental inflation is expected to continue due to risks of merchandise price revisions and more time needed for fiscal and monetary policies to take effect. If the Government is keen on harnessing inflation and stabilizing macroeconomy, inflation may fall in the third quarter.

Reasons for inflation

The first to mention is the sharp rises of the total money supply and credit growth. In the past decade, the total credit volume of the economy has inflated by 15 times. In the past five years alone, credit rose by five times and the credit growth rate has posted a rate of 34% per annum. Vietnam is currently topping the list of developing countries in Asia registering the highest ratio of credit to gross domestic product (GDP), second only to China. In comparison with economies having equivalent per capita income, Vietnam’s ratio of credit to GDP is from two to three times higher. On average in the five year period, the real credit growth rate was some 21% and that of the real money supply as 17.5%, way above the real GDP growth rate of 7%.

The steep rise of credit growth has been spurred not only by the expansion of the private and foreign investment sectors but also from the fiscal expansion and increased investment by State-owned enterprises. Since 2006, the State sector’s credit growth has been maintained at 30-32%, according to the International Monetary Fund (IMF). Moreover, capital investment of State-funded projects has remained constantly high. Figures from the Ministry of Finance indicated that budget deficit used to be normally 5% of GDP. However, this rate in 2009 and 2010 was 6.9% and 5.8%, respectively, due to the Government’s stimulus plans to invigorate the economy. Meanwhile, IMF statistics put Vietnam’s budget deficit in 2009 at 9%.

Prolonged budget deficit has boosted public debts. By the end of last year, public debts—including government-guaranteed and local debts—soared to 57% of GDP, almost reaching the 60% cap.

Recently, inflation has been further spurred by cost-push. Rising world prices together with domestic revisions of commodity prices have exerted pressure on inflation. A short while ago, fuel prices were revised up two times with aggregate increase of 29.2%. In the mean time, power prices were 15.3% higher and coal prices soared by 20-40%. Fuel price hikes have directly made the consumer price index (CPI) climb by 1.6%, and indirect influence on the CPI is expected to be even higher because power, fuel and coal are the input materials of major services and productive sectors.

Soaring world prices coupled with the depreciation of the domestic currency has boosted inflation. In comparison with several other countries, the pressure of world prices on domestic price levels has been stronger in Vietnam because the country has greater economic openness. The ratio of export-import revenue to GDP was 150% in 2010, of which the import/GDP ratio was 82%. The balance of payment which has been deteriorating over the past three years has depreciated the dong against the U.S. dollar by 31% on the unofficial market. This is one of the reasons for the soaring inflation.

Will inflation fall as of Q3?

The Government has gone on the right track with its measures to combat inflation and stabilize macroeconomy. In Resolution 11, which was promulgated to fulfill the task, the Government requested the central bank to cut credit growth to below 20% and the total money supply to below 15%. At the same time, the Government has also asked its agencies to cut public spending, boost the reform of State-owned enterprises and take necessary measures to crack down on speculations on the gold and foreign exchange markets. Although inflation has yet to fall and the trade deficit remains high, these measures are expected to bear good fruits.

Over the time, the State Bank has increased the rediscount and refinancing rates as well as the lending rate via the open market operations. These were coupled with a reduction of money supply through the refinancing channel. As a result, the liquidity of the dong has been tightened and the overnight rate been universal at 21-22% per annum, which has significantly reduced the dong-denominated credit growth. Official statistics released by the central bank show that the entire system’s credit growth in this regard by March 16 was only 1.43% from late last year.

What’s more, the central bank has step by step stabilized the foreign exchange rate by increasing the compulsory reserves in foreign currencies and cutting U.S. dollar-denominated deposit rates. Banks have also been banned from providing lending in gold and given a two-year grace to finish off their gold mobilization.

On the unofficial market, the dong has appreciated 5.6% against the U.S. dollar over the past two months. In recent weeks, more deposits have been made in dong converted from foreign currencies.

As regards the fiscal policy, on the path to pulling down trade deficit to 5% of GDP, the Government has decided to halt the development of some projects not in the fast-track list.

Despite the high inflation and trade deficit, the success achieved by the Government’s measures is remarkable. In the foreseeable future, if the Government remains steadfast in the tightening fiscal and monetary policies, annual inflation will likely be reduced by the end of Q3 as soon as the measures committed take full effect.

Inflation woes

Until the time when inflation may fall by the end of Q3, the CPI will possibly continue to rise as soon as the Government revises up fuel and power prices. Moreover, world prices have kept increasing, the foreign exchange risk has not been completely wiped out, and as a routine, storms may be devastating in early autumn. Last but not least, these are likely to be accompanied by precipitated monetary and fiscal loosening policies. All will adversely affect inflation in the near future.

Although the dong-denominated interest rate has stood high, it seems the central bank is still haunted by a worry that commercial banks may break the 20% credit growth cap for the year. In the first three months alone, the growth was already 5%. Some skeptics have ascribed the high credit growth rate to efforts to meet estate developers’ demand of rollover loans. Although the ratio of non-productive loans by the end of 2010 was only 18.7% of the total outstanding loans, some woes have appeared as to this rate might have been higher due to technical manipulation used by some banks to shift such loans to the productive sector.

From another aspect, the public spending cut in Q1 was over 1% of the total public spending during the year. Most observers said the cut was too modest. We share the Government’s difficulties in cutting public spending in the short term because the majority of the projects are closely associated with the national agenda, making it a tough task to streamline them immediately. Meanwhile, the State-owned enterprise (SOE) reform is under way by cutting investment and preventing SOEs from straying into business fields not relevant to their core business.

In our opinion, cutting public spending and SOE reform will take full effect only in medium and long term schedules rather than after short term attempts. It is hard therefore for public spending reduction to exert strong influence on inflation in a short while.

Finally, Vietnam’s inflation is subject to prices on the world marketplace as long as the country’s economic openness is great, and her balance of payment is unstable due to low foreign reserves. The confidence in the domestic currency has returned. However, the threat of a depreciation of the dong is still out there when inflation and trade deficit remain high. – SGT

Tags: Vietnam 2011 inflation, Vietnam economic, Vietnam economy, Vietnam inflation