Let the devaluations begin (or continue) with Vietnam

Vietnam's Devaluation Helps Shore Up Dong, but Problems Remain

By Alex Frangos and Patrick Barta
The Wall Street Journal
Thursday, February 11, 2010

http://online.wsj.com/article/SB1000142405274870433700457505894333300565...

Vietnam's devaluation will help shore up its currency system, but inflation and a big trade deficit mean the government has more work ahead -- and that could include further devaluations and sharply higher interest rates.

The Southeast Asian nation, which has seen an influx of Western investment capital in recent years, grew 5.5% in 2009, World Bank estimates show, despite the global financial crisis. But in the transition to a more urban, market-based economy, the country has struggled to keep a lid on inflation and trade and budget deficits, which in turn has put pressure on its currency.

Vietnamese residents have responded by hoarding dollars and gold out of fear the currency -- the dong -- will become even less valuable in the future.

The State Bank of Vietnam on Thursday lowered by 3.4% the official value of the dong, which is pegged to the U.S. dollar, bringing the currency more in line with how it trades on the street in nongovernment sanctioned venues. Now, one U.S. dollar will buy 18,544 dong, compared with 17,941 dong earlier in the week. The country also capped the interest rate on some U.S.-dollar bank accounts at 1% in order to encourage businesses and state enterprises to hold dong instead of dollars.

Vietnam's problems are unlikely to spread to neighbors such as China, Thailand and Indonesia, which enjoy strong foreign exchange reserves and trade surpluses. The rest of the region is facing pressure for their currencies to rise, rather than weaken.

Hanoi's moves this week aren't the first and will unlikely be the last, analysts say. "Unless we see moves to address the inflation and trade-balance issues, we will likely see depreciation pressure continue," said Daniel Hui, currency strategist at HSBC in Hong Kong. Inflation rose 7.62% in January compared with the year before.

Mr. Hui predicts Vietnam will have to raise its benchmark interest rates four percentage points this year to curb inflation. Higher interest rates will make it more attractive to hold dong, increasing its underlying value. But higher rates also risk snuffing out the economic rebound.

Economists at DBS forecast that the government will let the dong devalue another 5.9% this year. Vietnam announced a 5% dong devaluation in December and has had two other devaluations since June 2008.

Another move the government will likely take is to remove a cap on the rate banks can charge above the central bank's rate. That cap, currently 150% of the base rate of 8% -- makes it difficult for higher interest rates to creep into the banking system.

"We still believe that sooner or later the key will be on increasing interest-rate flexibility for deposits and loans in dong," says Martin Rama, a World Bank economist in Hanoi.

Vietnam's previous devaluation accompanied a one-percentage-point increase in interest rates to 8% as a way of boosting demand for dong. The government has also moved to prevent hoarding of gold as an alternative to the dong. It banned imports of gold for a time in 2009 and later shut down several gold exchanges.

It is unclear whether these efforts will be enough to ease the imbalances in Vietnam's economy. One risk is that each new devaluation exacerbates the dollar-hoarding problem by lowering consumer and businesses confidence.

Vietnam's macroeconomic problems stem in part from its rapid expansion between 2000 and 2007, when gross domestic product grew an average of 7.5% a year and inflation got out of control, reaching a peak of 28% in August 2008.

Although the global credit crunch helped ease inflation, it dented foreign direct investment in Vietnam and pushed exports into a slump, swelling the country's trade deficit and exposing its over-reliance on overseas markets. Vietnam estimated its trade deficit in January was $1.3 billion, with imports leaping 87% and exports rising 28%.

To finance a massive stimulus program in response to the global recession, the government has turned to international borrowings. It secured $1 billion in financing commitments from the World Bank in December 2009 and raised an additional $1 billion from Wall Street in a bond offering this month. It also arranged a $500 million loan from the Asian Development Bank and loans from the governments of Japan and France.

The devaluation and continuing inflation will make it more difficult for Vietnam to pay back those loans as the value of its currency erodes. Vietnam isn't in any danger of default, and there are enough dollar reserves and private deposits to handle a repayment crunch, according to HSBC.

Pro-growth government policies drove the widening trade gap last year. Tax cuts on car purchases pushed auto imports to record levels in 2009. Infrastructure projects required import of raw materials and construction machinery not available domestically. Korean auto maker Ssangyong Motor Co. said Thursday it signed a contract to import 15,500 partially built sports utility vehicles to Vietnam, where the autos will be fully assembled and sold.

On the plus side, the devaluation will help make Vietnam's key exports -- which include shoes, coffee, and rice -- cheaper than those of many other Asian countries, potentially improving its relative position in global trade. But that could also increase tensions with some neighbors, especially Thailand, which already is complaining that some currencies in the region, including China's yuan, may be undervalued.

Vietnam could eventually find its economy in a more balanced position. Vietnam is an oil exporter, but has to import refined products such as gasoline. New oil refineries coming online will reduce gas imports, shrink the trade deficit and bring in more foreign currency. And investments being made now in infrastructure and factories that require importation of machines and equipment will someday pay off in more export revenue.

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