New Exchange Rate Regulatory Mechanism: Flexible and Shock-avoidable

In the past five years, the SBV adjusted exchange rates 1-3 times a year, each with several percentage points. According to the new mechanism, the exchange rate will be announced on a daily basis, not in a long time as earlier.

 

The new exchange rate is considered a step forward on the path of a floating the exchange rate but the exchange rate is not fully floating. Enterprises and banks will still have to trade in the allowed band, not freely negotiable and agreeable.

 

In the context of deeper global economic integration, pegging the exchange rate in a long time makes the economy less flexible and less competitive. When pressures on exchange rate grow, the hoarding of foreign currencies to wait for the depreciation of local currency by the central bank causes scarcity and fever of foreign currencies. It is clear that the appreciation of US dollar and the depreciation of Chinese yuan have caused currencies of many Asian export-driven economies plummeted. Therefore, pegging dong/dollar exchange rate in a long time will reduce export competitiveness when export revenue corresponds to about 80 per cent of the gross domestic product (GDP). Vietnam’s efforts to stabilise the exchange rate rapidly sent its foreign reserves to below the benchmark of three months of imports. At the end of the third quarter of 2015, the ratio equalled 2.1 months of exports, equivalent to US$30.3 billion of forex reserves, compared to US$37 billion in late July.

 

The new exchange rate mechanism was officially put into effect on the first business of 2016. Accordingly, the central rate will be flexibly fixed on the daily basis in response to domestic and international developments. This flexible exchange rate system will help reduce the degree of single changes of local dong. Therefore, this move will improve forex operations as it ends the waiting attitude to dong devaluation cycles.

 

The central rate is considered a wise move by the central bank as it flexibly regulates the exchange rate but not totally float the exchange rate. The ultimate goal of foreign exchange policy is to stabilise the foreign exchange market and macro economy. Looking at the new foreign exchange regulatory mechanism and accompanying instruments of the SBV, it is quite clear that the highest objective of the new exchange rate policy is still to stabilise foreign exchange market, strengthen macroeconomic stability, support growth and empower Vietnamese dong.

 

The central bank has applied the new mechanism cautiously in the first days of mechanism operation. The exchange rate will change slowly in a narrow range, administered by the SBV, which will base on macro factors like interest rate, inflation and growth to set the exchange rate. For example, if the exchange rate is to be changed within 4-5 per cent, instead of adjusting it 3-4 times, each time with 1-2 per cent, this year, the adjustment will be effectuated every day. This very flexible operating mechanism is appreciated for more market approach by many experts. Last but not least, with the new exchange rate mechanism, derivatives will be developed more strongly and help Vietnamese forex market operate more healthily and approach international financial markets faster.

 

As long-time fixed exchange rate affects the competitiveness of exporters or importers, hardships against Vietnamese exporters are potentially attributed to no exchange rate adjustments. Vietnamese commodities became more expensive and their competitiveness weakens as a result.

 

Exporters and importers are most concerned about exchange rate issues. The new exchange rate management mechanism enables them to predict exchange rate trends more easily. For instance, if exchange rates are on the rise, they will face more difficulty in exchanging money. Nevertheless, this difficulty is not as serious as previous policy risks since companies have to anticipate how exchange rate will change at the time of payment when they sign contracts with foreigners. Unpredictable exchange rate will expose big risks to them.

 

With the central exchange rate mechanism, to better meet the demand of companies and increase market confidence, the SBV will have to work harder to apply open market operations to trading foreign currencies. Market-based exchange rate will facilitate forex business. Moreover, with the new mechanism, exchange rate fluctuations will be smaller and will not cause shocks to businesses as earlier. Of course, the new exchange rate mechanism will also require businesses to be more professional with risk management by using derivatives rather than depending solely on market movements.

 

For the unofficial market, the daily-adjusted central exchange rate will make foreign currency hoarding riskier. Hoarding will be reduced as a result.

 

There are a lot of policy objectives but forex market stability and macroeconomic stability are without doubt the most important. To achieve this goal, the SBV will take all measures as it said, including the sale of foreign currencies to intervene the market.

 

Companies borrowing and repaying foreign currencies are the most vulnerable to the previous fixed exchange rate mechanism. They now will face the risk of further dong depreciation. Foreign stock investors want a stable exchange rate as they bring foreign currencies to Vietnam and trade stocks in local dong. As a result, a flexible exchange rate adjustment will force them to manage forex risks.

 

The change in forex policy is possibly resulted from growing forex pressures that the central bank has sensed. Important factors that adversely affect portfolio investments include the interest rate hike by the United States Federal Reserve System (Fed), economic slowdown in China and stock market fluctuations in China. Exchange rate risks are of huge concerns of investors for the time being.