A cheap dong may prove costly for Vietnam

Bruce Gale

WHILE most Asian countries have struggled to keep their currencies from rising too quickly against the weak US dollar, Vietnam's problem is the reverse.

Indeed, the current weakness of the dong is evidence not so much of the success of the central bank's policies, but of the extent to which official strategies have undermined public confidence in the currency.

Vietnam announced a 5.4 per cent devaluation of the dong last week, succumbing to downward pressure on the currency as foreign reserves dwindle. Theoretically, a weaker dong should help boost exports, which declined 14 per cent in the 10 months through October. It should also slow the demand for imports, thus helping to hold down the country's widening trade deficit.

But the real problems facing the economy have more to do with the muddled approach of policymakers, especially their insistence on maintaining high growth.

Unlike most Asian countries, Vietnam has a highly dollarised economy. Many citizens, remembering the hyper-inflation of the 1980s, habitually hoard US dollars, especially in uncertain times. Gold is also seen as an important store of value, and local gold shops often double as black market currency trading centres.

Last August, Vietnamese were reminded of just how important it was to take precautions when an overheating economy resulted in inflation peaking at an annualised rate of 28.3 per cent, the highest in Asia.

The main structural reasons for the shortage of US dollars include the widening trade deficit, a fall in remittances and a sharp drop in foreign investment flows. The trade balance moved from a surplus in the first quarter to a US $8.8 billion (S $12.1 billion) deficit for the first 10 months of the year.

Mr Irvin Seah, an economist with DBS, notes that robust economic growth has produced strong domestic demand, sucking in imports. The situation has been exacerbated by Vietnam's accession to the World Trade Organisation in 2007, which obliged the country to reduce or eliminate many tariffs.

Policymakers have been reluctant to support any measures that would moderate domestic demand because this would mean accepting lower growth. The Vietnamese economy has expanded by more than 7 per cent annually over the last 10 years.

Political leaders, apparently fearing a wave of social discontent should unemployment rise, appear determined to maintain the pace. The official growth target for next year is 6.5 per cent.

In order to achieve that goal, economic planners have to maintain both an expansionary fiscal policy and a loose monetary policy. But in the current circumstances, this implies both a resurgence of inflation and a continued depreciation of the currency.

Meanwhile, the depreciating dong is producing a dramatic rise in the nation's foreign debt burden. Last month, the National Assembly's Committee for Budget and Finance put the total government debt at 44.6 per cent of the country's gross domestic product.

What should the government do? Last week's devaluation was the third in recent months. But after each move, the official exchange rate has gravitated to the low end of the trading band. The black market rate usually falls even further.

Recently, officials have made some attempt to moderate the fall in the dong, which traded at the psychologically important 19,000 level on the black market early last month.

But fearing a further erosion of foreign reserves, the central bank has thus far been unwilling to launch a full-scale defence of the currency. According to the World Bank, Vietnam's foreign exchange reserves had declined from US $23 billion at the end of last year to about US $16.5 billion by August.

Officials have instead been looking at regulatory solutions, such as forcing export companies, in particular large state-owned enterprises, to sell the US dollars they have been hoarding.

Foreign observers, however, are looking for a change of policy.

'We hope that the government will wind down the fiscal stimulus, and take a more assertive approach in monetary tightening - that means hiking interest rates', says Mr Seah.

Growing pressure on the fiscal deficit - which the World Bank expects to widen to 9.4 per cent of GDP this year - will eventually force the government to ease up on fiscal stimulus measures.

Last week's announcement that the central bank would increase its key interest rate from 7 per cent to 8 per cent from Dec 1 also suggests that monetary officials believe that it is time to change course. Without such a turnaround, foreign exchange reserves could soon decline to the point where the central bank would find it almost impossible to ensure an orderly depreciation.

But the interest rate hike is unlikely to have received anything more than grudging acceptance from the government. Recent statements by Prime Minister Nguyen Tan Dung have made it clear that the government continues to favour low interest rates (and thus a weak dong) as a means of maintaining the pace of economic growth.

Little wonder that cautious Vietnamese are continuing to exchange their dong for US dollars and gold whenever they can.

bruceg@sph.com.sg