Dong devaluation barely cures Vietnam’s woes

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Vietnam risks getting stuck in a cycle of currency devaluations unless it matches its foreign exchange measures with policies to bring inflation under control and effectively limit the growing trade deficit.

Inflation is creeping higher once again and the trade deficit is expanding, undermining official efforts to draw US dollars being hoarded by Vietnamese back into circulation and so reduce a drain on foreign currency reserves.

The State Bank of Vietnam on Thursday devalued the dong by 3.25 percent and imposed a cap on dollar deposit rates. It was the third devaluation since December 2008, bringing the central bank’s daily reference rate down by a total of more than 11 percent in just over a year.

Bui Kien Thanh, a former government adviser, said neither measure addressed the underlying need for broader policy changes.

“The State Bank foreign exchange reserves will shrink further and the State Bank will be forced to take further action to defend dong parity,” he said.

“There will be no end to this vicious circle. A new approach and a new monetary policy are necessary to blow new life into the economy, instead of rearguard actions and negative regulations.”

The dong is managed in a trading band and has been under persistent pressure to depreciate for nearly two years as the economy overheated and then weakened during the global financial crisis.

Past policy steps to stop the slide have had little effect.

Many Vietnamese have traditionally saved some dollars, but officials have raised the alarm over hoarding as the global economic crisis reduced the country’s supply of the currency.

A pick up in inflation as the economy recovers and a widening trade deficit will likely give Vietnamese more reason to hoard dollars, analysts say. As long as macroeconomic worries remain, the dong will stay under pressure, economists said.

Singapore-based DBS said in a note on Thursday the devaluation was expected â€" and more would come.

“Fundamentally, the devaluation should not come as a surprise,” it said, adding “more is probably coming over the course of the year”.

Inflation, a raw nerve for Vietnamese that experienced hyper inflation in the 1980s, is on the rise once again.

After trending lower during most of 2009 to a low of 2 percent in August, it rebounded to 7.6 percent by January to stand above a 2010 government target of 7 percent.

HSBC currency strategist Daniel Hui says inflation will reach double digits in the second quarter of the year.

The trade deficit has ballooned in recent years from $5 billion (3 billion pounds) in 2006 to $18 billion in 2008. The global downturn saw it narrow to $12 billion last year but the deficit in January this year was already well over $1 billion.

The central bank said it hopes its latest measures would balance currency demand and supply and stabilise the economy.

Reaction

The devaluation pushed the weak end of the trading band to 19,100 dong per dollar, a hair’s breadth from where the currency had been trading in the unofficial market.

Unofficial rates remained outside the band on Thursday, reflecting expectations the dong will weaken further.

Indeed, DBS’s year-end target for the dong at 19,640 per dollar, predicts a 2.7 percent fall from 19,100. A senior foreign exchange trader at a Vietnamese bank said he expected the rate to hit 20,000 by the end of 2010, a drop of 4.5 percent.

Offshore one-year non-deliverable forwards were quoted at 20,194/21,194 on Thursday, implying the dong would fall more than 5 percent.

The cap on dollar deposit rates was the central bank’s latest effort to flush the US currency back into circulation. Authorities complained last year of hoarding and ordered state firms to sell dollars.

Earlier this month, the central bank reported major state-owned firms had sold $450 million to banks since December to ease the dollar shortage.

The amount was less than a quarter of the $1.9 billion in deposits seven state-owned companies named in the order were holding at the end of November, online newspaper VNExpress (www.vnexpress.net) reported, quoting central bank data.

Vietnamese have traditionally turned to dollars and gold at times of economic uncertainty and memories of hyper-inflation remain strong.

HSBC’s Hui and economist Wellian Wiranto said in a client note domestic interest rates need to rise to lower expectations of inflation and therefore the desire to hold dollars, otherwise that desire will not abate.

“In fact, the risk is that this move will only eventually exacerbate expectations of future depreciation, and fuel more dollar demand,” they said.

The central bank raised the benchmark base rate by 100 basis points in December to 8 percent and the government has said monetary policy would gradually tighten this year.

Central bank governor Nguyen Van Giau told Reuters that rates would not be raised before the Lunar New Year. But economists and bankers expect an increase in March once the seasonal dong liquidity crunch caused by the new year holiday, or Tet, subsides.

HSBC forecasts the base rate will rise as much as 4 percentage points this year to 12 percent.

The central bank’s devaluation, announced on Wednesday night, caught the market off guard.

Traders had been selling dollars in the run-up to Tet to take advantage of a rise in short-term dong rates, pushed up by increased cash demand ahead of the holiday starting this weekend.

Vietnam’s foreign reserves are a state secret, but International Monetary Fund data showed they shrank 21 percent to $18.8 billion at the end of August 2009 from the end of 2008.

Central bank rules only allow the dong to be traded against the dollar in a band 3 percent either side of the midpoint.

Vietnamese currency dong is seen at a bank in Hanoi November 25, 2009.

Source: Reuters

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