Time not right to declare victory in fighting inflation

While the central bank’s Governor is of the opinion that conditions are suitable for cutting the interest rate beginning next month to lend a helping hand to enterprises, several experts are worried that a rate cut may undermine efforts to contain high inflation. The Saigon Times Daily talks with Louis Taylor, CEO of Standard Chartered Bank, on the State Bank of Vietnam’s intended move and possible consequences on an interest rate cut. Excerpts:

The Saigon Times Daily: Now that macroeconomic stability has to some extent been achieved and inflation has shown signs of easing, do you think that it is suitable now to think about an interest rate cut?

Louis Taylor: The government and the State Bank of Vietnam (SBV) are right to focus policy on reducing inflation and achieving stability for the value of dong. High interest rates have been a significant part of enforcing those policy aims. While the pace at which inflation is growing has slowed down, it would be viewed badly by the market if “victory” was declared too early and interest rates lowered before it is clear that inflation is on a downward trend. Once it is on a downtrend, there may be scope to reduce interest rates gradually.

It is not clear that the fight against inflation is won, and until that is clear it is difficult for the authorities both to reduce interest rates and retain the markets’ confidence in its anti-inflation policy.

Recently, the central bank has lowered the rate via open market operations (OMO), which fairly reflected the good liquidity in the short end of the yield curve. However, the market was very confused as to whether the change in OMO rate marked a change in overall policy because there was little explanation given for the rate cut. When the central bank begins to reduce interest rates, it would be best if it also gives the reason behind the reduction to ensure the market understand the policy being pursued.

The Governor has lately mentioned the aim of cutting the lending rate to 17 percent-19 percent per year. Do you think current economic conditions in Vietnam support the move?

- It is possible, although the timeframe is still unclear. At some point, the SBV’s policy rates will come down, and this will also affect market rates in a similar way. At that time, it is likely that banks’ lending rates will also come down.

However, banks’ lending rates will always need to be above their deposit rates, or else there will be a loss. If banks offer depositors 14 percent they can still profitably lend at 17-19 percent. However, if banks offer depositors 19 percent then they can’t lend at 17-19 percent without incurring a loss.

In your opinions, does the deposit rate need to be higher than the inflation in a country like Vietnam to attract capital in the public? How about this in foreign countries that you had learned of?

- Deposit rates are generally lower than the inflation rate in most countries. Saving cash is a relatively low risk activity compared to investing that cash in other assets like bonds, shares, and real estate. So it is reasonable that the rate of return on a cash deposit will be lower than that expected from investing in assets that carry greater risk, and reasonable that those with cash should have to invest it in order to increase its real value relative to inflation.

How about the forex rate, how will the rate cut impact on the foreign exchange rate?

- While higher interest rates can lead to currency strength, if rates are too high for too long they can reduce economic growth to the point where confidence in the overall economy is lost. If Vietnamese interest rates are reduced gradually once inflation is clearly on a downward path, then there need not be an adverse impact on the forex rate.

If interest rate cuts are timed appropriately, the foreign exchange market will accept that it is reasonable to maintain growth in the economy, and the currency needs not automatically depreciate further.

Does Standard Chartered Bank have any forecast about Vietnam’s 2011 inflation and the forex rate at the end of this year?

- Our economists publish forecasts for Vietnam, and their latest forecast is for the average inflation rate in Vietnam for 2011 to be around 19 percent, and for the foreign exchange rate to be around VND20,600 per US dollar. These forecasts assume that the authorities stick to their stated policy objectives, and with the policy measures to achieve them.

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