“Vietnam is clearly at a crucial stage of its cyclical management for inflation control and ensuring a soft landing of the economy,’’ Helen Qiao, Hong Kong-based Goldman economist said in a report.

“We believe the central bank will likely rely more on higher interest rates and credit control to reduce domestic overheating pressures, while maintaining the fixed exchange rate with a moderate downward crawl against the US dollar in 2008-2009.’’

In an effort to cool accelerating inflation, the SBV said May 17 it would increase the base rate to 12 percent from 8.75 percent effective Monday.

Consumer prices that surged 21.4 percent in April, the most since at least 1992, and rate restrictions have hurt banks’ ability to attract deposits.

Commercial banks raised the rates they offer depositors to as much as 14.8 percent Monday.

The central bank’s decision is a “positive step” toward tightening monetary policy through “market-oriented measures, which demonstrates the government’s resolution in maintaining the policy priority on inflation control over growth,’’ Goldman’s Qiao said.

But the news weighed on the stock index on the view that investors would find the higher bank rates more attractive than keeping their money in a market that has fallen 50 percent since the start of the year as inflation has jumped.

The cap on deposit rates was imposed last February to stabilize the banking system after banks started bidding aggressively for deposits when the central bank tightened monetary conditions.

In abolishing the cap, the central bank said banks can fix their own rates on dong deposits and lending at up to 150 percent of a base rate of 12 percent.

Previously, a base rate of 8.75 percent had been applied to lending.

The SBV said it would set the base rate each month but it could also adjust it when necessary.

The central bank also raised its refinancing rate on loans to commercial banks to 13 percent from 7.5 percent and its discount rate, used to buy debt from banks, to 11 percent from 6 percent.

Qiao said the move should help reduce the gap between nominal interest rates and inflation, making deposits more attractive and helping relieve tight liquidity in the wake of the central bank’s anti-inflation measures, which have included higher rates and compulsory bank reserves.

‘Hard landing’

Goldman said the risk of a “hard landing” by the Vietnamese economy isn’t big.

“On balance, we do not think the risk of a hard landing is large enough to make it our baseline scenario,” Qiao said.

“With a firm stance in holding tight monetary policy, we see a greater probability that macro stability can be maintained in Vietnam.’’

Deputy Prime Minister Nguyen Sinh Hung said last month the government would reduce the 2008 economic growth target to 7 percent from a previous forecast of as much as 9 percent.

Economic growth slowed to 7.4 percent year-on-year in the first quarter.

The economy expanded by 8.5 percent in 2007, the fastest rate since 1996.

Goldman Sachs has forecast economic growth to slow in 2008 to 7.3 percent from 8.5 percent last year.

It said the consumer price index would grow 19 percent on average in 2008 from 8.3 percent in 2007.

The fast-growing economy is a favorite foreign direct investment destination but economic risks have increased.

Bank credit grew 50 percent last year and real estate prices soared.

Standard & Poor’s Ratings Service earlier this month cut its outlook on Vietnam’s credit rating to negative from stable, citing “rising risks to macroeconomic stability from an overheating economy.’’

Source: Bloomberg