Vietnam’s acute dilemma over inflation or growth

Which do you deal with first, inflation or economic growth? That question faces policymakers all over Asia these days. Soaring food costs continue to push up consumer prices at a time when governments are increasingly looking for ways to stimulate growth in response to another global recession.
In Vietnam, however, the dilemma is particularly acute. Year-on-year inflation last month was 22.4 per cent – the highest in Asia. The case for continued tight monetary policy therefore remains strong. But the policy translates into higher borrowing costs for companies.

Vietnam’s economic growth slowed in the first three quarters of this year after the government pushed up borrowing costs in a bid to bring down inflation. Official figures show that the economy expanded by 5.76 per cent in the first nine months of this year, down from 6.54 per cent in the first three quarters of last year.

In late August, however, State Bank of Vietnam (SBV) governor Nguyen Van Binh began pressuring commercial institutions to lower their lending rates. He also said the bank would reduce policy rates if inflation slows.

But is now the right time to switch from fighting inflation to promoting growth? The impact of current policies on the private sector can certainly be exaggerated. ‘A lot of companies are complaining about lack of access to capital, but I don’t see any of them going out of business,’ notes Adam McCarty, chief economist at consulting firm Mekong Economics in Hanoi.

The latest SBV move is not popular with international lending institutions. Last month, the International Monetary Fund warned the Vietnamese government not to reduce interest rates too soon because it could raise questions about the government’s commitment to fighting inflation. High inflationary expectations have become a headache for policymakers in recent months.

And while inflation remains below the peak of 28.3 per cent seen in August 2008, the battle is far from won. Recently announced minimum wage rises for workers in nonstate companies take effect this month.

Lower interest rates could also trigger further selling of an already weak local currency.

Current policies already work to discourage middle-class Vietnamese from holding dong. Local banks are officially allowed to offer interest rates of no more than 14 per cent on dong deposits. The Asian Development Bank, however, predicts that inflation will average around 18.7 per cent this year.

Vietnam’s chronic trade deficit also needs to be considered. Exports rose faster than imports in the first nine months of this year. But with the global economy weakening yet again, prospects for closing the trade gap are fading fast. Such deficits put pressure on the dong and undermine efforts to boost foreign reserves. Another devaluation – the bane of foreign investors – is therefore possible. It would be the fifth since November
2009.

Successive devaluations increase the foreign debt burden. Foreign debt accounted for 42.2 per cent of Vietnam’s gross domestic product last year, up from 39 per cent in 2009. This figure remains manageable, but it also needs to be watched. Selling government bonds on the domestic market is not an option because the local capital market is too thin.

Such a move would merely drive up local interest rates. All three of the world’s major credit rating agencies – Fitch, Moody’s and Standard & Poor’s – cut Vietnam’s rating last year, underlining the increased economic risks facing the country.

Since beckoning outsiders with great fanfare in the 1990s, Vietnam has given many foreign investors a rough ride. Inflation and foreign exchange weakness in the wake of the global economic downturn eroded much of the early optimism. In 2009, Indochina

Capital Advisers decided to liquidate a London-listed Vietnam equity fund that had lost half of its value. And in November of that year, San Francisco-based hedge fund Passport Capital demanded the return of uninvested cash from a fund that bought Vietnamese and Cambodian property.

According to the Asian Development Bank, the value of foreign direct investment flowing to Vietnam has been declining in recent months. For those who know the country well, of course, there are still opportunities. Late last month, for example, South Korean retail giant Lotte Mart said it was preparing to boost its presence in the country. But recent developments can hardly have encouraged fresh investors.

Straight Times

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