Stimulus package exacts its toll

While it has staved off the worst impacts of the global crisis, Vietnam needs to phase out government stimulus, says IMF Senior Resident Representative Benedict Bingham.

How has the stimulus package contributed to Vietnam’s economic activity this year?

The stimulus program – a combination of significant easing of monetary policy and a sizeable fiscal package – has boosted domestic demand, which in turn helped underpin the economic recovery that we have seen in the second and third quarter this year. Industrial activity is recovering, with the construction sector, in particular, rebounding strongly. Retail sales have also remained robust. As a result, we now project economic growth at 5.2 percent this year, which will be one of the highest in the region.

However, this stimulus package has come with a cost, as macroeconomic stability has again become an issue. Inflation is one concern: although the 12 month rate of inflation dropped to 3 percent in October, the monthly rate of inflation has recently been on the rise. However, the more immediate issue is the current depreciation pressure on the dong. The easing of monetary and fiscal policy under the stimulus program has boosted imports and contributed to a return to significant trade deficits. It has also prompted residents to shift their portfolio holdings toward foreign currency assets (which is equivalent to a short-term private capital outflow in the balance of payments). This combination has put pressure in the dong. As a result, the dong has traded at the weaker end of its official band for much of this year, and the spread between the official and parallel market rates is now around 4 percent. Access to foreign exchange in the official interbank market has been difficult, imposing costs on enterprises and harming investors’ perception of Vietnam’s business climate. The pressure on the dong has also resulted in a decline in official reserves this year

In a recent report, the IMF said Asian governments should continue providing fiscal stimulus until full recovery is secured. What are the implications of doing this in Vietnam?

The IMF has indeed advised those Asian governments that are in a position to do so to continue to provide support to their economy until the recovery is sufficiently robust and self sustaining. In most Asian economies, the risk of a faltering economic recovery is greater than the risk to macroeconomic stability, as they have very strong external positions. However, even in those countries, governments will need to manage a careful balancing act to ensure that their support does not ignite inflation pressures or concerns about fiscal sustainability.

Vietnam’s position is different. Its external position is weaker than most of its neighbors in the region. It runs the largest current account deficit, has low reserves, and unlike other countries in the region who are now receiving substantial capital inflows, Vietnam is still facing short-term capital outflows. Under these circumstances, the greater priority at the moment lies with preventing the reemergence of macroeconomic instability. It is also important that the government take early steps to restore a functioning, liquid, interbank foreign exchange market, as the longer the problems in the foreign exchange market persist, the more difficult it will become to persuade investors that Vietnam has a competitive investment climate, harming Vietnam’s longer-term growth prospects.

For these reasons, we have been encouraging the [Vietnamese] government to phase out the stimulus program and take steps to tackle the emerging risks to macroeconomic stability. In our view, this will require a tightening of monetary policy to rein in credit growth and reverse the short-term capital outflows. Fiscal policy will have to help as well. First, the immediate priority is to clarify the likely outturn for the fiscal plan for 2009. It is possible that the fiscal deficit for 2009 may be lower than many, including ourselves, had projected earlier, as revenues are performing stronger than expected. However, much depends on the execution of the government’s expenditure plans. Hopefully the government will clarify this during the current National Assembly session. Second, the decisions the government makes on the 2010 budget plan will be very important. Everyone accepts that the budget deficit will increase in 2009. This is understandable given the severity of the global crisis. However, it is important that the government reassure investors that fiscal policy will be restored to a more normal path in 2010; one that will help maintain macroeconomic stability as well as preserve medium-term debt sustainability. For these reasons we have recommended that the government try and limit the overall fiscal deficit [As defined by the IMF, which includes off-budget expenditure and on-lending, and treats debt repayments and “revenue carried forward” as a financing item] to 6 percent of GDP next year.

The recent signals from the State Bank of Vietnam that they intend to rein in the pace of credit growth are appropriate in our view. However, announcements of credit growth targets and other administrative measures may not be sufficient, and may also introduce undesirable distortions in the banking system. This is why we are emphasizing that the SBV needs more authority to adjust interest rates, so that it can respond to economic developments in a timely manner. Removing distortions such as the current cap on lending rates is also important as they significantly limit the SBV’s room for maneuver.

The government has announced further stimulus measures for next year. How will the move affect inflation and budget balance?

We are still waiting to hear the final details of the additional stimulus package, and how much they will cost. As I noted above, it is important that the overall fiscal deficit be constrained to more normal levels next year, and we won’t be able to tell whether that’s the case, until we see the whole fiscal plan. With regards to monetary policy, the key issue is whether the SBV will be constrained in responding to the current pressures on the dong and potential inflation risks. At first glance, the extension of the interest subsidy scheme does appear to have put additional pressure on monetary policy. However, we will have to see the final details of the extension before we can make a judgment. What is perhaps more important at the end of the day is that the State Bank of Vietnam be granted sufficient authority to adjust interest rates as needed to control inflation and respond to pressures on the dong. A clear signal on this front would do much to boost the credibility of monetary policy and confidence in the dong.

Is Vietnam facing any constraint in the foreign exchange market? What would you say about the outlook of the dong next year? Should Vietnam consider letting the dong to fall further against the dollar?

It is clear that there have been significant constraints in the foreign exchange market this year. Enterprises have been finding it very difficult to buy US dollars in the official interbank foreign exchange market and this is clearly an undesirable state of affairs. However, it is not clear that letting the dong fall further against the dollar is the appropriate response, especially as the dollar itself has been weakening in international currency markets, and there isn’t strong evidence that the dong is overvalued per se. Rather, the current pressure on the dong seems to be coming from expansionary monetary and fiscal policies. Addressing these underlying problems would be a more effective way of dealing with the constraints in the foreign exchange market than just focusing on the dong/dollar exchange rate.

Vietnam’s economy depends too much on the US dollar. What should the government do to deal with this issue?

The relatively high level of dollarization certainly complicates monetary policy and macroeconomic management more generally. At its root, this is an issue about confidence in the dong. Measures to bolster confidence in the dong, especially establishing a sustained track record of sound macroeconomic management, are central to any de-dollarization strategy. Over the past 20 years, Vietnam has been very successful in this regards, and as a result the level of dollarization in the economy has dropped significantly. The economy has been through a bumpy period over the past 2 years. However, provided the government continues to burnish its credentials for sound economic management, I am confident that the process of de-dollarization will continue in the future.

On the global scale, could you tell us how the economies worst hit by the financial crisis, e.g. Iceland, are functioning now? Is the crisis over yet?

The good news is that global economy is beginning to recover again. However, it’s too early to declare that we are out of the woods, as the recovery is still uneven and not yet self-sustaining, especially in the advanced economies. Moreover, while financial market conditions have continued to improve, they are still far from normal. Consequently, the pace of recovery is likely to be sluggish, and while the downside risks have been reducing, there is still a risk that the recovery could stall, if the policy makers in the G20 economies withdraw their policy support too early.

With regards to the countries hardest hit by the financial crisis, there are encouraging signs that Fund programs are helping stabilize their economies. While the crisis has had a profound impact on output and employment, many of the severe disruptions associated with previous crises – currency overshooting and bank runs – have so far been avoided. Signs of stabilization are emerging in these economies, although there remain significant challenges to securing a sustained recovery.

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