Inflation threat looms after dong devaluation

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The government has weakened the dong to increase liquidity in the foreign exchange market and narrow the trade deficit, but experts worry that the move may worsen inflation with rising costs of input materials for production and public fear that the dong may be devalued again.

The State Bank of Vietnam devalued the dong by 9.3 percent on February 11, bringing the official exchange rate to 20,693 from 18,932 per US dollar, and narrowed the currency's trading band to 1 percent on either side of the rate from the previous 3 percent.

Nguyen Duc Thanh, director of the Center of Economic Policy Research under the Economic University of Hanoi National University, said it was the correct decision and that it would help minimize the gap between the official and black market exchange rates, and facilitate economic development.

The dong slumped to 20,890 per dollar at banks on February 17, compared with 19,490 on February 10.

Tran Hoang Ngan, a member of the National Monetary and Financial Policy Advisory Council, said the devaluation was one of the biggest in Vietnam's monetary history, but inevitable. It was a way to regularize the foreign exchange rate market's development, he said.

Ngan said the devaluation would encourage exports and exert a downward pressure on imports, helping reduce the country's trade deficit. This would, in turn, foster macroeconomic stability, at which time the dong could even increase against the dollar, he added.

Inflation specter

The devaluation, however, has also raised worries about inflation because of higher production costs. A lot of Vietnamese products, including those slated for exports, depend on imported materials. Many of Vietnam's key exports, such as garments and footwear, have up to 90-percent of their materials imported.

Ngan said the devaluation of the dong will cause inflation to rise as the prices of many goods will increase. "The degree of openness of Vietnam's economy (measured as exports plus imports divided by GDP) is large, about 150 percent. Thus, fluctuation in the foreign exchange rate market will strongly affect prices of goods."

He warned that producers and retailers may use the devaluation as an excuse to hike their prices, as has happened earlier.

Early this week, car producers in Vietnam raised their prices. Toyota Vietnam increased prices of each car by between VND34 million and over VND100 million.

Nguyen Ngoc Tu, director of the Hoang Tuan car dealership, said the higher exchange rate has kept people from buying cars. "Car sales now are very slow. Prices have risen about 5 percent on average."

Nguyen Thi Anh, owner of an electronics store on Hanoi's Hai Ba Trung Street, said: "The increase in prices of electronic products, in the context of the higher exchange rate, cannot be avoided. Some distributors have already announced 5-10 percent increases, while others are probably recalculating."

Tran Duc Sinh, chairman of the Members' Council of the Vietnam Forest Corporation, said 80 percent of his firm's wood materials are imported, so the higher exchange rate has pushed up production costs. While his firm would increase its selling prices, the increase would not match the rise

in input costs, causing many difficulties, he said.

The increase in prices following the devaluation is likely to put more pressure on inflation control measures.

Inflation hit 11.8 percent last year, exceeding the government's target of 8 percent.

This year, the country has aimed to keep inflation at below 7 percent. But the experts doubt this can be achieved after prices rose 1.74 percent month-on-month in January, and were expected to increase another 2 percent or so in February.

Cao Sy Kiem, former governor of the State Bank of Vietnam, said: "If no drastic measures are taken to restore people's confidence in the dong, reduce the budget deficit and increase investment effectiveness, it will be very difficult to fulfill the inflation control target."

Ngan from the National Monetary and Financial Policy Advisory Council said: "We cannot control inflation and stabilize the macroeconomy within a day or a month. The important thing is that we have to eliminate worries that the dong may be devalued again in the coming time."

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