Vietnam Outlook: Inflation Prompts Policy Tightening Page 1 of 5

Access Other Products

Home > Commentary

Vietnam Outlook: Inflation Prompts Policy Tightening

By Marshall Carter in West Chester
May 17, 2011

Containing inflation is Vietnam’s biggest near-term hurdle.

Monetary and fiscal tightening will keep GDP growth at around
6% in 2011.
The dong will be under pressure until macroeconomic
fundamentals improve.
Exports will grow as the global recovery firms, but bringing down
the trade deficit will be a challenge.

Vietnam’s GDP growth will moderate this year as the government tightens
monetary and fiscal policy to fight inflation. Credit expansion averaging about
35% annually over the past three years, combined with robust capital inflows
have fueled investment and private consumption growth and created upward
pressure on prices.

Inflation rose to 17.5% year on year in April, prompting the State Bank of
Vietnam to assume a tighter monetary stance. The bank raised interest rates,
lowered its credit expansion targets and placed lending restrictions on
commercial banks.

Growth slows in first quarter

First quarter GDP in 2011 slowed to 5.4% on a year ago basis compared to
6.8% in the fourth quarter. The deceleration touched most industries:
manufacturing, agriculture, construction, mining and even services.

Yet trade flows remained robust. Exports over the first four months of the
year rose 36% on a year-ago basis. The value of textile and footwear
shipments, together comprising a fifth of total exports, each rose about 30%.
Coffee exports, about 5% of the total, surged 111% as the commodity’s price
rose. On the downside, imports grew 29% and monthly trade deficits widened
over the year to $1.4 billion in April.

Inflation accelerates

http://www.economy.com/dismal/pro/article.asp?sid=00333DC9-1FA1-46BB-9599-86E47... 5/18/2011
Vietnam Outlook: Inflation Prompts Policy Tightening Page 2 of 5

Inflation has been in double-digit territory for the last six months, reaching a
two-year high of 17.5% year on year in April, owing to rapid credit growth and
recent government measures.

The 9.3% dong devaluation in February made imports of capital and

intermediate goods more costly in domestic currency terms. Additionally, the
sharp jump in world oil prices persuaded the government to reduce domestic
fuel and electricity subsidies. As a result, petrol and diesel fuel prices were
increased 17% and 24% respectively in February, while the price of electricity
rose 20% the following month. This lifted the cost of manufacturing and
transporting domestic goods. Food prices jumped 24% in April, while housing
and construction material prices climbed 19%.

The rapid price rise has prompted policymakers to shift focus from output
growth to inflation reduction. The central bank increased its refinancing
rate—the rate it charges commercial banks—by 600 basis points over a 6-
month period to 14% in May. The discount rate—the rate earned by
commercial banks on their reserves at the central bank—rose 700 basis
points to 13% over the same period. The government has also reduced its
GDP growth target to 6.5% this year, roughly in line with last year’s growth
and down from an initial target of 7% to 7.5%.

The central bank is expected to raise rates further this year, but walks a fine
line between combating inflation and ensuring that higher financing costs do
not cut too much into growth.

Currency pressure

Maintaining exchange rate stability will remain a challenge. Rising inflation

has weakened confidence in the Vietnamese currency, the dong; households
and businesses have sought to reduce their holdings in favor of foreign
currency and gold. The resulting downward pressure has obliged
policymakers to devalue the dong four times since November 2009, for a

http://www.economy.com/dismal/pro/article.asp?sid=00333DC9-1FA1-46BB-9599-86E47... 5/18/2011
Vietnam Outlook: Inflation Prompts Policy Tightening Page 3 of 5

cumulative drop of about 20%. February’s adjustment of the trading band

from VND18,932/USD to VND20,693/USD represented the largest downward
adjustment in about 20 years.

To make dong-denominated deposits more attractive, the central bank

capped foreign-currency deposit rates at 3 percent for individuals and at 1
percent for non-credit institutions last month. It also raised the amount of
dollar deposits lenders must set aside as cash by 2 percentage points, to a
range from 3 percent to 6 percent. Dong deposits fetch a 14% return.

Dwindling foreign reserves

Crumbling demand for the dong is linked to Vietnam’s dwindling foreign

exchange reserves. According to the IMF, foreign exchange reserves stood
at $13.6 billion in October, down from $26.4 billion in March 2008. The
reduced level of reserves does not give the central bank enough ammunition
to support the dong in the foreign exchange market.

Declining reserves have put Vietnam’s chronic trade deficits in the spotlight,
raising questions about the country’s ability to finance its imports. Vietnam’s
trade deficits widened in recent years; the current account deficit ballooned
from 0.3% of GDP in 2006, to 12% in 2008, narrowing to a still high 6% in
2009. Not surprisingly, international investors are concerned about currency
risk and a possible balance-of-payments crisis. The dong is likely to remain
under pressure until inflation subsides and the trade deficit narrows.

Reducing the trade deficit

Vietnam’s export niche is in products that use low-cost labor and also raw
materials such as crude oil and coal. Exports jumped as a share of GDP from
55% in 2000 to about 70% in 2009. The country is a major exporter of textiles
and food products, such as rice and seafood, and raw materials such as coal
and crude oil. Its largest export markets are the U.S., Japan, and China.

http://www.economy.com/dismal/pro/article.asp?sid=00333DC9-1FA1-46BB-9599-86E47... 5/18/2011
Vietnam Outlook: Inflation Prompts Policy Tightening Page 4 of 5

Value-added is low due to the high import content of Vietnam's exports. In

addition, Vietnam’s reliance on imported capital goods makes it difficult to
lower chronic trade deficits through currency devaluation. As a result, robust
export growth will be offset by robust import growth.

The long-term solution is to shift the structure of exports toward higher value-
added products. There has been recent significant growth in exports of
higher value-added items such as computer components and electronic
equipment, although their share of the total remains modest. These new
sectors are being supported by foreign- directed investment inflows and
could become the next driver for exports. As an example, Intel Corp. opened
a $1 billion assembly and testing plant, the company’s largest in the world, in
Ho Chi Minh City last year.

Continued modest growth

GDP growth is expected to exceed 6% in 2011 and 2012, but will fall short of
the 8%-plus rates seen in the three years to 2007. Monetary and fiscal
tightening will slow the pace of consumption and investment, creating a drag
on growth, as policymakers attempt to slow the pace of inflation and narrow
the trade deficit.

The global economic recovery bodes well for Vietnam’s exports, and the
recent dong devaluation has made the country’s products cheaper for foreign
consumers. However, the government will need to improve macroeconomic
fundamentals to allay foreign investors’ concerns regarding the country’s
balance of payments position.

Longer term, Vietnam must shift its export mix toward higher-value added
products, which will support wealth creation and lower the country’s reliance
on imports. Additional reform of state-owned enterprises is important to
improve these institutions’ international competitiveness and support an
innovative export sector. The default on a $60 million loan payment by state-
owned shipbuilder, Vinashin, late last year highlights these institutions’
inefficient use of capital and adds to the country’s debt burden.

PRINT | BOOKMARK | PERMALINK | HOME

© 2011, Moody's Analytics, Inc. and/or its licensors and affiliates (together, "Moody's").
All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY
COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR
OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED,
TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR
SUBSEQUENT USE FOR ANY PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR
MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT
MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by

http://www.economy.com/dismal/pro/article.asp?sid=00333DC9-1FA1-46BB-9599-86E47... 5/18/2011
Vietnam Outlook: Inflation Prompts Policy Tightening Page 5 of 5

Moody's from sources believed by it to be accurate and reliable. Because of the

possibility of human and mechanical error as well as other factors, however, all
information contained herein is provided "AS IS" without warranty of any kind. Under no
circumstances shall Moody's have any liability to any person or entity for (a) any loss or
damage in whole or in part caused by, resulting from, or relating to, any error (negligent
or otherwise) or other circumstance or contingency within or outside the control of
Moody's or any of its directors, officers, employees or agents in connection with the
procurement, collection, compilation, analysis, interpretation, communication, publication
or delivery of any such information, or (b) any direct, indirect, special, consequential,
compensatory or incidental damages whatsoever (including without limitation, lost
profits), even if Moody's is advised in advance of the possibility of such damages,
resulting from the use of or inability to use, any such information. The financial reporting,
analysis, projections, observations, and other information contained herein are, and must
be construed solely as, statements of opinion and not statements of fact or
recommendations to purchase, sell, or hold any securities. NO WARRANTY, EXPRESS
OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS,
MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH
OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR
MANNER WHATSOEVER. Each opinion must be weighed solely as one factor in any
investment decision made by or on behalf of any user of the information contained
herein, and each such user must accordingly make its own study and evaluation prior to
investing.

Proprietary Rights Privacy Policy Terms of Use

Copyright © 2011 Moody's Analytics, Inc., and/or its licensors and affiliates. All rights reserved.

http://www.economy.com/dismal/pro/article.asp?sid=00333DC9-1FA1-46BB-9599-86E47... 5/18/2011