Administrative Measures Will Distort Market

In 2010, many economies, particularly in Asia and including Vietnam, faced high inflation. In Germany, the largest economy in Europe, inflation was the highest in two years. In China, inflation rose 5.1 percent as of November 2010 (this country started calculating from November 2009), the highest in 28 months, and 3.2 percent from January 2010, higher than the target of 3 percent set by the Government at the beginning of the year. India was projected to see 10 percent inflation in 2010.

 

In Vietnam, in last months of 2010, CPI escalated, far outstripping the target set by the National Assembly. According to a report by the World Bank (WB), Vietnam always has a higher inflation rate than neighbouring countries. Its average inflation over the past decade was about 8.8 percent, well above the 2.7 percent of Thailand and 5.1 percent of the Philippines. Particularly, in 2010, Vietnam’s inflation was the highest in the Asia - Pacific region, more than double that in China and India. Notably, although inflation in the two most populous countries in the world was considered high in Asia, it was equal to a half of their economic growth. Conversely, Vietnam's inflation was almost double its economic growth.

What caused high inflation in Vietnam in 2010? Perhaps, it was caused by a combination of cost push, demand pull and monetary policy. Other notable elements included exchange rates and interest rates interacting with public sentiment. In other words, while the prices of food and many other commodities on global markets increased and domestic currencies of many regional countries appreciated or stayed unchanged against the US dollar, the Vietnamese dong depreciated sharply against the greenback, causing a dual effect on local market prices. In addition, lending rates were too high, adding force to cost-push prices of goods and services. Furthermore, inflexible and ill-timed State management of gold import and export caused bullion prices to be higher than world rates. This also allowed a psychological effect on the devaluation of the Vietnamese dong and reduced public confidence in the currency, which significantly weighed on inflation.

 

In other words, inflation in region countries is caused by three factors: cost push, demand pull and monetary policy, but Vietnam has three more specific reasons: sentiment, public confidence, and exchange and interest rates. This explains why other countries in the region which were also affected by natural disasters and higher global prices did not have as high inflation as Vietnam.

 

Vietnam is an agricultural country. At present, agriculture is employing about 70 percent of the workforce and about 70 percent of the population is in rural areas. Higher prices of agricultural products help improve incomes for farmers who are vulnerable to many risks and low rates of return. Rising agricultural products also stimulate the restructuring of the agricultural and rural economy towards a market-based orientation.

Of course, wage earners, pensioners and poor people in urban zones are largely affected by higher food prices while wages or pensions do not increase or rise very slowly. Most of their incomes are spent on essential food demand; thus, their lives are increasingly difficult.

 

To ensure the interests of producers following WTO entry and ensuring social security, Vietnam needs macro regulatory policies, not exercising administrative measures which will distort the market.

Deposit and lending rates in both domestic currency and foreign currencies, mainly US dollars, in Vietnam have been the highest in the region since 2008. In 2010 alone, the interest rate of USD deposits averaged 4 percent to 4.5 percent per annum and the lending rate was from 6 percent to 7 percent. Interest rates of Vietnamese dong-denominated deposits and loans from the start of the year to October were lower than those in 2008 but remained very high. And, from November 2010, the base rate set by the State Bank of Vietnam (SBV) was raised from 8 percent to 9 percent per annum to curb inflation. Deposit and lending rates at commercial banks climbed roughly to the highs of 2008. In December 2010, Vietnamese dong-denominated deposit rates were kept at 14-15 percent per annum after some banks introduced a 16-17 percent rate, which existed in a short time due to the intervention of the central bank. Lending rates were popularly applied at 16-20 percent.

 

Such high lending rates are unbearable for companies and consumers, causing prices of materials, goods and services to increase. Higher selling prices will fuel pressures on consumer prices. Projects in progress will incur losses if they borrow capital because of high rates, but if they do not borrow, unused machines and equipment still depreciate and downgrade while they have to pay protection costs, interests for loans to buy these facilities, and delay principal settlement, causing layoffs and deteriorating credit quality due to overdue debt risks.

 

Thus, to curb inflation, Vietnam must take measures to stimulate production and business development in general and agricultural and food production in particular. At the same time, it should act to bring down interest rates, both deposit and lending.

 

On the monetary market, there are always large traders and small traders, and wholesalers and retailers. On the interbank market of course has small commercial joint stock banks that need to borrow and large lenders which are in favour of lending. This is because small lenders have limited operating networks and less popular trademarks and they have more difficulty mobilising capital on the primary market, or attracting deposits from companies and people, particularly large-scale companies with huge capital sources. As a result, they have to borrow on the secondary market. In contrast, State-owned commercial banks, including partially privatised lenders, often have the advantage in mobilising capital, especially long-term deposits of large companies and other organisations, with lower rates. These commercial banks often participate in the open market to borrow loans with lower interest rates; thus, they wholesale to small banks with higher rates to enjoy the margin. Thus, authorities use administrative measures and regulations on operations on this secondary market, which leads to distortion of monetary market operations and forces small lenders to be the first to raise deposit rates. According to small lenders, they would rather break the rule to borrow from other lenders in the association than borrow from big banks which offer higher rates. In such an inequitable competition, we should not brand small banks the culprit of the interest rate race, but eliminate administrative regulations distorting and limiting the role and reducing the flexibility of the monetary market. Besides, we should adopt a more flexible mechanism to facilitate small commercial banks to take part in the open market.

 

The official exchange rate was adjusted twice from late 2009. On August 18, 2010, the exchange rate of US dollar against the Vietnamese dong rose 2.1 percent from 18,544 to 18,932 on the interbank market. The increase in exchange rate was aimed to boost exports and curtail trade deficit. The rate on the free market escalated in last months of 2010, with peak of 21,500 dong per dollar in November and average of above 21,000 dong per dollar in December. Corporate borrowers had to pay surcharge to access foreign currency loans, making the real rate close to the free market. Besides, sellers of imported goods like automobiles, office equipment, furniture and equipment also use free market exchange rates to calculate selling prices in the domestic currency. The impact is clearly seen in automobile, gold, outbound travel and luxury apartment markets. Exporters also keep foreign currencies in their accounts rather than selling to banks because they want to use this money to pay for imported goods in the future or want to sell to other companies via the bank to enjoy intermediary commission.

 

These developments engender the expectation of higher prices, the depreciation of local currency and the rise in inflation. Thus, to curb inflation, it is administratively necessary to stabilise exchange rates, boost information transparency, flexibly settle unexpected situations and apply well-timed interventions.

However, reducing the current account deficit belongs to commercial policies not exchange rate and monetary policy. Hence, using monetary policy to narrow the trade gap and confining this policy to many objectives like boosting economic growth, easing inflation and reducing the trade deficit in couple with incomplete forecasts and multi-dimensional impacts of exchange rate adjustment caused the consumer price index to increase while the country’s foreign exchange reserves were not increased.