The State Bank of Vietnam devalued the dong by 9.3 percent on February 11 in an effort to minimize the gap between the official and black market exchange rates. Following the move, the dong slid to a record low against the dollar.
More than a week later, the gap remains wide.
On Thursday, the dong dropped to 20,895 per dollar at banks, compared with the February 10 rate of 19,490. During the same day, the currency tumbled on the black market, trading at about 21,750, compared to 21,300 on February 10.
Independent economist Bui Kien Thanh sat down with Thanh Nien Weekly to explore the bigger picture.
Thanh Nien Weekly: Why did the dong devaluation effort seemingly fail?
Bui Kien Thanh: The State Bank of Vietnam devalued the dong by a record 9.3 percent in an effort to narrow the gap between the official and black market exchange rates. But the move was a wager"”bank officials expected to revive market confidence.
Unfortunately, the market has no faith in the devaluation's effectiveness and the dong continues to slide.
Why is the gap between the official and black market exchange rates so wide?
Vietnam's foreign currency reserves are far too low at just over US$10 billion. Due to the thin foreign currency reserves, people worry that it will be hard to prevent the dong from weakening, given Vietnam's trade deficit.
Nothing on the immediate horizon indicates that the trade deficit will be narrowed. If the deficit continues to grow, the currency reserves will continue to shrink, which will further affect exchange rates.
As a result, people in Vietnam continue to convert their savings to dollars in order to protect their assets (from devaluation).
Businesses also think that if they spend dollars today, they'll only end up buying the currency at a still higher price tomorrow. So even businesses are hoarding dollars. Given the high demand and low supply, the price of dollars will continue to rise.
What can we do to stabilize the exchange rate?
To stabilize the exchange rate, we have to increase the economy's internal force.
We have to boost exports, and reduce imports. We must cut spending, especially spending of foreign currency, which will help increase our currency reserves and restore confidence (in the dong).
The most important step to take this year is macroeconomic stabilization. Vietnam needs to foster a favorable environment for business development and expansion. Banking interest rates should be lowered to facilitate stable business operations, while state spending should be cut back.
How can we go about significantly increasing exports?
We have to boost exports to earn dollars.
If we secure foreign loans and cannot pay them, our currency could continue to be devalued. We have a good supply of overseas remittances - about $8 billion each year. Thus, we have a net profit of $8 billion.
Last year, in the $100 billion economy, we saw a GDP growth of 7 percent. We invested $42 billion to turn out $7 billion worth of products. To reap a profit of $8 billion (which is equal to the overseas remittances), we have to turn out products worth $80 billion. Given our ICOR (Incremental Capital - Output Rate) of 6, we have to invest $480 billion to create products worth $80 billion.
Thus, to reap $8 billion in profits, we have to increase our annual investments eight fold. In the meantime, overseas remittances provide a stable source of foreign currency.
Prices of many goods and services have risen sharply since the devaluation. What should we do to minimize the impact of the devaluation on prices?
We have to reduce interest rates.
The State Bank of Vietnam could offer commercial loans at low interest rates to help bring down rates without increasing the credit supply. The country is not able to supply all the capital it needs so it has obtained money through foreign loans and foreign investment.
The State Bank of Vietnam could provide the money to help develop the economy, so that we won't need to borrow from foreign banks. The State Bank of Vietnam could offer commercial banks loans at 3-4 percent, and then create strict requirements that businesses use the money to boost production. If we take this step, we can control the currency, and reduce interest rates.
Commercial banks, which offer these preferential business loans, could demand contracts, and deposit them to the central bank to secure the loans. Lower interest rates will facilitate expanded production which, in turn, will help boost economic development and macroeconomic stabilization.